Mixed response for UK Treasury tax review

Leading buyout figures in the UK are divided on the implications a Treasury review of the tax treatment of shareholder loans may have. Some are dismissing it as political show-boating while others see a real threat to returns.

Plans for a UK Treasury review of the tax treatment of shareholder loans in buyouts have met with a mixed response, ranging from bafflement to dismay, after Ed Balls, the UK economic secretary, said today the government wanted to look again at rules introduced in 2005.

Moulton: no impact

Jon Moulton, managing partner of Alchemy Partners, dismissed the review as a political sop: “I thought his comments were rather off-target. Shareholder loans are already largely not tax-deductible. All grandfathered loans ceased to be tax-deductible on 1 February this year. They are announcing something they introduced two years ago.”

Moulton said: “This will not have any impact on us.”

However, Ian Armitage, managing partner of HgCapital, said: “It is a worry and we take it seriously. If the rules are tightened it could mean there is less cashflow to pay down debt. This could in the short-term hit returns and ultimately affect the prices firms are willing to pay.”

Balls said in a speech today at the London Business School the review was to ensure that existing rules are working as intended. Currently shareholder loans, which can account for as much as 90 percent of the equity in a deal, are subject to “transfer pricing” rules. These restrict interest deductibility to the maximum debt a third-party lender would be willing to provide.

The UK economic secretary had previously supported the industry which in recent weeks has weathered a barrage of attacks from trade unions, in particular the GMB, and contenders for the Deputy Leadership of the Labour party.

The BVCA, the UK private equity trade association, had responded by launching a working party to look at ways to make the industry’s activity more transparent, which Balls welcomed.

Peter Linthwaite, chief executive of the BVCA said: “We welcome the acknowledgement by Ed Balls of the role the UK private equity industry plays in keeping the UK and wider European economy successful and dynamic.

He said in anticipation of a review of this type the BVCA had set up a working party specifically to consider the tax issues arising from private equity funding, and in particular the provisions surrounding transfer pricing, six months ago.

However, a partner at a UK firm was scathing of the latest developments: “It is another example of the industry sleepwalking into disaster. Balls is playing to the political gallery. But what was the BVCA, which prides itself on its lobbying, doing? This has crept up from nowhere.”

Brooks Newmark, a Conservative MP and a member of the Treasury Select Committee, which said it will investigate private equity in the UK, said: “I am curious to see specifically what Balls is going after. The devil is in the detail. The Treasury wants to be seen doing something by the unions and some Labour MPs, while also supporting the industry which is a huge benefit to UK Plc.”

Newmark is also a senior adviser to US buyout firm Apollo Management.

Balls has conceded there is nothing specific to private equity in the tax-deductibility of interest. He said any kind of company can claim it, and most quoted companies do.

He said “It is also the international norm that interest is in general treated as a business expense and deductible from taxable profits for companies in any form of ownership. We have no plans to review this principle.”

Shiv Mahalingham, head of transfer pricing at tax advisers Chiltern, said the Treasury review could look at three possible scenarios. It could abolish interest deductions for shareholder debt completely.

Or it could introduce statutory safe harbour ratios, as applied in many other jurisdictions. This would involve HM Revenue and Customs setting acceptable ratios for debt to profits and income to profits and then disallowing interest deductions where the ratios are breached.

Alternatively, it could increase the number and intensity of transfer pricing challenges. He said this may require an increase in resource at HMRC.