On 9 October, the UK government launched an attack on entrepreneurialism in Britain. Chancellor of the Exchequer Alistair Darling's decision to do away with a declining tax rate over time from the sale of business assets (popularly known as taper relief) and instead apply a flat rate on all types of capital gain is a blow to anyone involved in building companies in the UK. Not only do takers of entrepreneurial risk now face the prospect of paying 18 pence in the pound instead of 10 pence but, to add insult to injury, people betting on stocks, shares, wine and fine art, who are currently taxed 40 percent on any gains, will be paying the same amount.
Unsurprisingly given the crudeness of the measure, most of those affected, as well as the media, have been scathing in their criticism of Darling's ideas.
When the change was announced, it came out of the blue, even though everyone knew that the government was keen to tax the carried interest earned by private equity executives – which under the existing regime qualifies for taper relief – more aggressively. Many thought the Treasury would ultimately decide against changing the rules for private equity on capital gains tax (CGT) because doing so would threaten an important incentive for equity owners in Britain, especially the founders and owners of small and medium-sized businesses. “They won't meddle with CGT; they'll increase the tax on management fees instead,” one of the most senior UK private equity professionals suggested to me in September.
Just days before Darling's already infamous pre-budget report came out, accountants Grant Thornton said in a note: “While there may be some minor technical changes announced, which will have limited application, there should not be a substantive change to the general capital gains tax rules. It is expected that the 10 percent CGT rate will remain […] to gains made on monies invested to ensure the UK retains a competitive tax environment for entrepreneurs and financial investors alike.”
Wrong. In removing an incentive that his own party had introduced in 1997 to stimulate company building, enterprise and innovation in Britain, Darling doesn't seem to have worried about throwing the baby out with the bathwater. When studying the complexities surrounding capital gains, he appears to have decided he was looking at a modern-day version of the Gordian Knot and pulled out his sword.
Britain's business lobbyists and interest groups stand united in their contempt for the government's strike. Among them is the British Venture Capital Association, most of whose members invest in SMEs and the mid-market. The BVCA has expressed its “concern” over the u-turn, citing the impact on not just buyout funds and venture groups but “family businesses and small and medium-sized companies” as well. It is the owner-drivers of these businesses, whose interests are almost invariably aligned with those of their private equity backers by way of equity incentive packages, who will be hit hardest by the new regime.
It is noteworthy too that Britain's Conservative opposition have quickly seized upon the frustration in the entrepreneurial community to present their party as the party of business. Given the incumbent government's increasing sensitivity over the next election, which was called off just days before the pre-budget, it may be the opinion polls that will yet drive the Treasury boss back to the drawing board.
If instead he sticks to his guns, those critical of buyout funds will take Darling's intervention as further evidence that private equity rarely loses. Their argument will be as follows: up until now, a small number of private equity professionals were benefiting disproportionally from a tax break that was never designed for them; now, as a result of a move born of political expediency, there will be a large number of business people disadvantaged by the removal of a tax break that was designed for them. Was this the best the chancellor could come up with?
You don't have to be a private equity sceptic to be disappointed with Darling's effort. At 18 percent, the UK now faces a higher rate of CGT than, for example, Italy and the US. Entrepreneurs will continue to operate from, and flourish in, Britain. But no thanks to the government: as it stands, its fiscal reform does nothing to support them in their efforts.