Labour’s plan to close a tax “loophole” for private equity gains has drawn mixed reactions from the tech and investment community.
Some have argued that removing tax benefits for private equity investments disincentives capital being directed to UK businesses. Others have claimed it will generate much-needed government revenue and increase equality in taxation.
Announced in Labour’s general election manifesto, the policy would change the way tax is collected on carried interest – the revenue made by private equity managers after an exit.
It would mean profits made by a private equity fund would be taxed as income instead of the lower capital gains rate.
Roughly 2,000 people receive carried interest each year, amounting to £2bn a year and an average gain of £1m, according to the Resolution Foundation think tank.
Labour argued that private equity is the “only industry where performance-related pay is treated at capital gains”.
Disincentivising growth
Mark Woolhouse, CEO of investment tech startup Treble Peak, said the policy was “counterintuitive” given the UK’s goal to “differentiate itself from its European neighbours”.
Woolhouse warned that changing the tax treatment of carried interest could “drive private markets managers out of the UK” and in the long term “diminish innovation and growth”.
The policy was described by Thomas Adcock, a tax partner at the tech-focused accountancy firm Gravita, as a “huge blow for UK-based talent”. Adcock said the UK’s current system was “roughly aligned” with other countries such as the US, suggesting that the UK could lose its competitive edge if private investments lose these tax incentives.
Research in 2019 from the Institute for Fiscal Studies suggested, however, that low capital gains tax rates do not lead to increased investment.
The study found that while businesses are able to hold on to more cash due to capital gains being taxed at a lower rate than income, those retained profits are generally retained and not deployed into more investments.
The IFS noted that these incentives provide “large benefits that disproportionately accrue to the rich” without necessarily encouraging additional investments.
Generating revenue
It’s no secret that public spending will be tight regardless of the party able to form a government in July.
The tax burden on everyday people reached its highest level since the end of World War Two under the Conservatives, forcing both major parties to rule out increases to income tax in the short term.
Therefore, closing a “tax loophole” in one of the world’s most valuable industries is seen by some as a necessary way of providing the government with some financial headroom.
Julie Cunningham, founder and CEO of compliance startup Portend, said the policy could “generate significant revenue”, as long as it was balanced with “investment incentives”.
The argument over whether the policy will or will not disincentivise private investments into UK firms remains open. However, research has suggested the private equity industry has a track record of avoiding paying its fair share.
A study from the University of Oxford found that the world’s largest private equity firms have avoided paying income tax on over $1tn of incentive fees since 2000.
The aim of the study from Prof Ludovic Phalippou was to demonstrate the immense wealth controlled by fund managers that has been kept from the state.
Speaking to the Financial Times, Phalippou said: “It shows you the upper bound of what you could collect if all of the countries in the world coordinated to tax that pot.
“Once you understand how much money we are talking about, you can understand why private equity is the largest donor to politicians and universities.”
Daniel Jacob, managing partner at the law firm Marriott Harrison, said the tax crackdown “will see that Labour redistributes this regained £545m across various sectors including the NHS”. However, Jacob questioned whether this revenue is “worth the trade-off of hugely disrupting a substantial part of the UK economy”.
“If options abroad look more fruitful than at home, [private equity firms] will inevitably move. We are looking to grow the UK economy and make the UK a tech and science superpower – and this change isn’t going to help move the needle.”
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