BVCA welcomes clarification on ratcheted returns guidelines

The revision of guidelines for taxation of ratcheted and geared returns received by employees of private-equity backed companies has been welcomed by the British Venture Capital Association.

The UK’s HM Revenue & Customs has revised its guidelines on the taxation of ratcheted and geared returns for private equity-backed management shareholdings.
The move follows discussions between HM Revenue & Customs and the British Venture Capital Association (BVCA) regarding interpretation of the Finance Act 2003’s Schedule 22, including provisions for taxation of employee shareholdings as benefits.
HM Revenue & Customs’ concern had been that management could receive a disproportianate reward through their equity holding compared to how much they had paid and their lack of contribution to any debt funding for a buyout.
Following legal counsel, HM Revenue & Customers released guidelines earlier this week confirming that taxation of geared and ratcheted returns on employee shareholdings “was not sustainable where the benefit to the holder of the shares from these ratchets reflected rights already present in that class of share at the time of acquisition by the employee”.
Peter Linthwaite, chief executive of the BVCA, welcomed the move but said that it was simply a clarification of existing guidelines rather than any changes to the act: “The Revenue now accepts our interpretation of the law. It clarifies the position in a way that is positive for the industry and positive for management, but they haven’t changed the law, just the interpretation.”
As a result of the previous lack of clarification, Linthwaite said that there had been complaints following submission of income tax returns.
Linthwaite added: “There was a difference of opinion between companies and their advisors and the Revenue as to interpretation. The question related to management ratchets if performance targets were met where mangers could increase their percentage in a business and whether that was seen as getting something for nothing and should be taxable as income.”
The BVCA is also in discussions with the Treasury regarding reclassification of taxation of profits from carry and management stakes as normal income than capital gains. Linthwaite said the discussions were ongoing and no decisions had yet been taken.