Industry calls foul on UK tax crackdown

UK Treasury Secretary Danny Alexander's call to investigate GPs that lend to their own firms is being challenged by the private equity community.

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The British Private Equity and Venture Capital Association (BVCA), the UK trade body, has hit back at claims the industry is indulging in tax avoidance.

Speaking at the Liberal Democrat conference in Glasgow on Tuesday, UK Treasury Secretary Danny Alexander said he will close “unfair” tax loopholes that have enabled private equity professionals to shelter £100 million from state coffers. 

The tax practice under attack from Alexander is known as compensating adjustment. It involves a private equity professional lending fund profits due their way to a company that is ultimately owned by the persons in the partnership. Under the arrangement, private equity professionals can reinvest profits in the partnership at the 23 percent corporate tax rate instead of individually claiming their due share of fund profits at an income tax rate as high as 45 percent. 

But Treasury says the interest rates agreed under these loans are not being made at an arm's length. For example, a fund manager may charge the “incorporated partner” a 15 percent interest rate when the going rate on a standard loan is 5 percent.  

In order to satisfy UK transfer pricing rules, private equity professionals will pre-agree a market rate of interest, say five percent, under the compensating adjustment structure. In the end, the fund manager only needs to pay 5 percent on interest payments paid to him by the lending company. That's because HMRC will not double tax any profits (the company pays 10 percent of the 15 percent loan, and could use the five percent agreed loan rate as tax-deductible interest payments).

“When the vast majority of people in an industry are finding ways to exploit that difference, and that industry is the preserve of the very wealthy, I have no hesitation in acting,” said Alexander.

But BVCA director general, Tim Hames, told PE Manager that it is not a structure designed to enable individuals to avoid tax but rather a clear set of rules that make commercial sense for private equity firms. 

“The fact that private equity firms must submit these practices to the HMRC – which has plenty of opportunities to say it doesn't like a particular structure – is telling,” said Hames, adding the tax authority has not raised red flags on compensating adjustment before now. 

The BVCA, via its tax committee, has been in dialogue with the Treasury and HMRC on the issue and will continue to do so through the consultation period, the trade body said in a statement. 

Hames insisted that the government would find that this is not a “black and white question” – but a far more complicated matter, with implications that extend well beyond the private equity industry. 

“We will have to persuade the Treasury institutionally – and the HMRC will be on our side for this one – that if you want to change this you’ll have to replace it with something else with sufficient flexibility and subtlety,” said Hames.