Jun 20 2007
Tax “breaks” and venture capital
As soon as something is successful in the UK people pop up to condemn it and demand that it be taxed more.
Most countries would?? be delighted to have the concentration of talent and business skill that the UK has assembled in the private equity area. If we do tax it too much then the industry will move somewhere else more welcoming, but still be able to bid for UK companies from an overseas base.
??The Trade Union and Labour MP enemies of private equity have highlighted two "tax breaks" which they think are "unfair". The first is??taper relief??on capital gains tax on investments in companies held for a sufficiently long time. The second is the deduction of interest from profits before charging corporation tax.
??The first thing to understand is that there are no special tax deals or arrangements for private equity. Private equity investors and managers have to pay tax in exactly the same way as everyone else. If you????increase taxes on them you increase them on??everyone else.??
The second thing to understand is that private equity has not found a way to pay 10% income tax instead of 41% Income tax and National Insurance on higher earnings. As they pay themselves salaries??they have to pay 41% on the money.
If they issue free shares to managers and staff, the people concerned have to pay income tax on the value of those shares granted to them, usually at the higher rate of 40%.
The Trade Unions seem to be most concerned about cases where venture capitalists only pay 10% capital gains when their investments are successful. This case arises where a) they have put up money to buy the shares in the first place out of taxed income, b) where they have held the investment for a long time and c) it is successful. Like everyone else they can use taper relief to pay 10% instead of the 40% standard rate of CGT.
This idea of taper relief was introduced to encourage people to put up money to create new or better businesses. Why stop it when it is successful? It would mean ending it for everyone,including individuals and familes who work hard over the years to build up a family business. The government does not pay the losses if the investments go wrong.
??The industry does borrow to enable it to invest in substantial companies. Every business is allowed to deduct the interest it pays on its borrowings before paying tax on profits. That is the only way to do it, as interest is a cost of doing business just like paying the wages or the suppliers. If you decided to make venture capitalists pay corporation tax on the interest they pay the banks you would kill the industry in the UK, and would bankrupt quite a lot of other companies that borrow money to do business and would not have spare cash to pay tax on their interest payments.
The other thing the critics forget is that many people are beneficiaries of private equity success in improving the performance of companies. Anyone who is part of??a pension scheme may find their pension plan is invested in private equity funds as well as directly in company shares. Some of private equity’s critics may well beneficiaries themselves, who clearly are not telling their pension fund trusteees to avoid such investments.
The media concentrate on telling us the industry has been no good at putting its case. That’s because they are getting on with investing and growing UK businesses. If the government buys the idea that business has to pay more tax in the UK they simply have lost the plot. We should not be discussing removing some tax "breaks" that allow people to be enterprising here, but discussing how we can lower tax rates on enterprise and saving more generally, so we can grow the economy more quickly, creating more jobs and higher incomes.
John Redwood has been the Member of Parliament for Wokingham since 1987. First attending Kent College, Canterbury, he graduated from Magdalen College...
Agree 100% with your comments. Part of the problem is the myths surrounding even the words “private equity”. Ask the average person what is a PE business and you will get many varied and incorrect answers. The recent publicity on the risks to both jobs and pensions from PE deals is in grave danger of turning people against such business’s for totally the wrong reasons. If PE is in some way prevented from access to major business purchases or has its real cost of capital increased by tax changes then as you say the free market will simply see predators from such friendly places as Russia, China, the Middle East step in and then the UK’s free market will require new legislation to prevent them doing whatever it is we then decide we dont like!! Free markets are meant to be that and PE should be left to get on with it without further government involvment in new tax laws etc.
I think the main issue, as I understand it, is that Private Equity companies have been putting income aside for two years as “carried interest” and then claiming it as a capital gain as their fund grows. That income comes from a 2% (or so) charge on assets invested by their clients and 20% (or so) of the profits they make for their clients. They are not investing their own money and taking risks with it.
I fully agree that you can’t change the rules for private equity alone because they are rich but you can look at whether the rules are doing what they were supposed to do. Taper relief was provided so that people investing in a business would be incentivised to do so. Originally it was ten years and now it is two years before the relief was available.
Two years is too short.
It allows private equity to use the taper relief for their short-term investments that make money instead of for the long term investments that really do build businesses. Raise the taper to relief threshold to five years and we’ll see it being used for the purposes it was created.
Personally I blame Richard Gere’s portrayal of the PE boss in ‘Pretty Woman’.
John,
You are misreading my comment.
1. The contentious tax issue is NOT about money invested by PE companies. It is about how their 20% slice of profits is taxed. Is it taxed like an investment or as income. Currently it is taxed as though they have made the investment themselves rather than as a charge made by the company. You are being disingenuous suggesting otherwise. I agree that to change the tax regime to avoid this would be difficult and possibly unfair.
2. I have not suggested closing any “loophole” or treating PE differently. I am saying that the taper relief kicking in at 2 years is too short because it rewards short term money-making as opposed to long term investment that builds businesses. It incentivises people, like venture capitalists, to sell companies too quickly. It is my understanding that taper relief on Capital Gains Tax was introduced to incentivise investment in building businesses.
3. Please don’t be so patronising as to suggest I am motivated by jealousy.
4. I don’t propose a special footballers tax, but I would rather that they did pay tax on their earnings in this country. Do you prefer them to be paid abroad so they avoid tax in the UK simply because they can afford the best accountants?
Finally, thank you for replying to my comment and also on a different note, thank you for speaking out so strongly on the Freedom of Information (amendment) Bill debacle.
Reply: Yes you could lengthen the period for taper relief, but I would