Guy Hands, chief executive of UK buyout firm Terra Firma, has become one of the first industry heavyweights to speak out in defence of the current tax treatment of carried interest.
In a letter to the Financial Times, Hands argued that there were huge differences between carry and other elements of a typical remuneration package, like the bonuses and options received by public company directors. As a result, he said, it was right to treat it differently for tax purposes.
Carried interest, the portion of a fund’s profits that accrues to the investment team, is treated as capital gains rather than income. This means buyout executives – like entrepreneurs and private company shareholders – qualify for the taper relief rules that reduce the rate of tax to ten percent, as long as they hold the asset for two years.
Hands argued that carry is completely different from other remuneration elements, for three key reasons. First, it is by no means guaranteed to be paid out – the team will only receive carry once investors have received all their money back, plus an additional capital gain of 8 percent, compounded annually. In addition, it vests over a long time period – sometimes as much as ten years.
However, some firms like Kohlberg Kravis Roberts, whose Dominic Murphy is facing the Treasury Select Committee this week, do not have a hurdle, and pay carry on a deal-by-deal basis.
Finally, Hands said, private equity’s model requires buyout executives to put their own capital at risk by investing alongside external investors; in Terra Firma’s case, about 5 percent of its latest fund came from its investment team.
Under these rules, “80 percent of private equity funds would never pay out any carry,” according to Hands.
The Terra Firma head compared this to the chief executive of a FTSE-100 company, where a fall in the company’s share price during the year “simply means the executive gets more options”. He added: “I do wonder how many FTSE-100 executives would be prepared to take the risk of abolishing their bonuses and option schemes in return for capital gains-based carry, which would only start to be paid if they delivered real shareholder value in excess of 8 percent compound over a seven year period!”
Hands also made a thinly-veiled attack on unnamed “eminent figureheads” – likely to refer to SVG Capital chairman Nick Ferguson and Apax Partners founder Sir Ronald Cohen – who have “benefited from the current tax regime themselves” yet are now advocating changes to the existing arrangements. “These grandees and private equity’s critics might all do well to think through the long-term consequences of any proposals they make, rather than playing to the gallery,” he said.
However, he acknowledged this view was becoming increasingly unpopular, prefacing his argument with the admission that he was “running the risk of seemingly being the only person in Britain prepared to defend the current UK tax regime as it applies to private equity practitioners.”