Carry in the crosshairs ahead of UK election

Fresh debate on carried interest taxation is erupting ahead of an upcoming UK general election thanks to recent research published by campaign group 38 Degrees. The report claims that the UK government is helping private equity executives to avoid up to £700 million ($1.08 billion; €950 million) in tax per year by taxing carry at the favourable capital gains rate, a practice 38 Degrees calls the “Mayfair tax loophole.”

Currently, carried interest is taxed at the UK’s capital gains rate of 28 percent. 38 Degrees calculates that if those profits were taxed as income, the UK would be making potential tax revenues of between £280 million and £700 million every year. The report notes that fund managers can also qualify for entrepreneur’s relief when they form new management teams at portfolio companies and potentially lower their tax rate to 10 percent on the first £10 million of their carry.

38 Degrees describes the Memorandum of Understanding between HM Revenue and Customs and the British Venture Capital Association (BVCA) that establishes the tax rate as “government-sponsored tax avoidance on a breathtaking scale.” The nonprofit considers the “sweetheart tax deal” a result of the close relationship between big political donors in the private equity industry and members of both the Conservative and Labour parties.

Major UK news outlets including The Guardian, The Independent and The Daily Mail have all covered the report, which included findings that paint private equity executives as large financial supporters of the right-leaning Tory party. The UK general election will be held on 7 May 2015. 

BVCA has fired back at the report, calling the argument made by 38 Degrees “mistaken in almost every dimension” and noting that taxing carry at the capital gains rate is not a unique “loophole” in the UK, but rather a standard practice for most countries in the Organization for Economic Cooperation and Development.

38 Degrees commissioned external tax expertise to draft a legislative amendment that could be inserted into the bill, calling for carried interest to be re-characterised as ordinary income and taxed at the highest income tax rate: 45 percent.

“This is manifestly ludicrous. Who would make this sort of investment if the worst case scenario was that you lost all of your money and the best case outcome was that you were taxed at exactly the same rate as you would have been if you had chosen the far less risky option of salaried employment instead?” said BVCA director general Tim Hames in an email to pfm. “It is precisely for this reason that both Conservative-led and Labor-led Governments in the UK have decided that the status quo is the revenue-maximizing position.”