On 9 October, UK Chancellor of the Exchequer Alistair Darling announced plans to change Britain's rules on capital gains tax (CGT). Ever since, those affected by the proposal, especially UK-domiciled entrepreneurs, have had a hard time trying to calm down. I wrote about the issue on this page a month ago, but the furore surrounding it is still so intense that a follow-up is in order.
The bone of contention, you will recall, is Darling's idea to scrap “taper relief” on business assets sold after a two-year holding period in favour of a flat rate of tax payable on any kind of capital gain. Under the plan, vendors who expected a tapered 10 percent levy on capital gains will have to pay 18 percent instead.
In and of itself, 18 percent may not seem horrendously high. But given how strongly most people feel about taxation and the shifting of goalposts around it, it is no surprise that those confronted with an 80 percent increase in CGT have taken the news very badly.
Neither did the government impress anyone by attempting to dress up the move as the “closing of a loophole”. Under the existing rules, far from exploiting a “loophole”, people are taking advantage of a benefit that was deliberately introduced in 1997 to stimulate entrepreneurial activity in Britain. To throw out taper relief is suddenly to take a dim view of an economic policy that for the past ten years has been promoted as vital for the country's future prosperity.
Because Darling's stance is widely seen as a – failed – effort to target private equity taxation generally and carried interest in particular, entrepreneurs were quick to identify the culprits. According to one London-based buyout executive I spoke to recently, his phone rang just minutes after Darling's announcement with a businessperson his firm had backed calling to say “thanks very much – this is all your fault”. Other private equity professionals are also conscious of fingers pointing in their direction.
However, some in the industry were slow to realise that they would get the blame: when news of the attack on taper relief first broke, a number of buyout executives rather cheerfully went on the record to welcome the proposals on the grounds that they weren't as bad for private equity as they might have been. Not a smart move: with vitriol already flying (and public opinion of private equity at a historic low anyway), it served as a reminder that some in the industry are still not very good at managing their PR. Better to keep your heads down on this one.
In the meantime, the dust has far from settled. In November, the beating of Darling over the issue intensified, with the likes of Sir Ronald Cohen and Sir Richard Branson calling on the government to backtrack. Cohen, retired co-founder of Apax Partners and a confidant of British Prime Minister Gordon Brown, has described the increase in CGT as an “unfortunate signal to would-be entrepreneurs”; Branson wants to see taper relief reinstated, with the qualifying period bumped up from two to five years, expressly so as to make it more difficult for private equity professionals to minimise the tax they pay on carried interest.
It is unclear what if anything the government will do next. Its apparent desire to respond to political pressure by taxing buyout investors more aggressively is at odds with its implicit recognition that a strong private equity industry is ultimately a good thing for Britain. Moreover, in strictly practical terms, one thing the Chancellor will have learned in recent weeks is that changing the playing field for private equity without making enemies elsewhere is no small challenge. Of course, this may not stop him from trying again.
While the government is working out its next move (did anyone mention “deductibility of interest on leveraged loans”?), private equity professionals based in Britain are left to ponder an uncertain future. This will hardly be crippling: German practitioners for instance have demonstrated for years that it is possible to operate under huge uncertainty over the fiscal rules applying to themselves and their investors. They have coped, and so will their British colleagues. But private equity people already preoccupied with things like the credit crunch, the possibility of a global recession and the potential impact of both on their investment could be forgiven for thinking that here's another headache they could do without.
For more on tax in Europe, see this month's supplement: The 2007 European Private Equity Tax Roundtable.