Tax Britannia

“We have an interesting few months – or years – ahead of us,” says one GP as he mulls over the new, seemingly stable, British government.

The UK election on 6 May yielded no overall majority winner and after protracted negotiations between The Conservatives and the Liberal Democrats, the country has a coalition government for the first time since 1945. The two parties have pronounced the dawn of a “new politics”.

One of the few Lib Dem policies to make it unscathed through the coalition negotiation process was a proposed increase in capital gains tax. While the finer details of the change will only be revealed in the new government’s first budget in June, it looks likely that CGT will be taxed at the same rate as income. For high earners, this could effectively mean a 50 percent rate rather than the current rate of 18 percent.

But while an increase in CGT will smart, there is a sense among private equity practitioners that tax increases are inevitable. There is such a big job to do in terms of reducing the budget deficit, we have to be realistic about what is around the corner. One senior London-based private equity lawyer recently suggested that private equity professionals had been getting “a free ride” in terms of tax on capital gains.

But CGT has to be a secondary consideration for private equity practitioners. It is stability that dealmakers – particularly those in private equity – crave. And very early signs suggest that is what is being delivered.

“Once we know what’s happening – no matter how good or bad the news – we can then plan accordingly and take some longer term decisions,” says Steve Tudge, managing director of ECI Partners, one of the UK’s longest-running private equity firms.

With a certain level of clarity over the future – and £6 billion public spending cuts due this year – opportunity now knocks for private equity firms.

Firstly, the need to find efficiencies across the public sector opens the door for any portfolio companies that offer products and services that can help with this task.

Secondly – and more pertinently – is the buying opportunity. As part of a Herculean revenue raising exercise it faces, many expect the government to size up some of its trading entities and ask which can realistically be sold off. Assets such as the Tote, a sports gambling group currently owned by the government, and Northern Rock, the banking group which was nationalised in 2007, would certainly be on the block.

This would not be a new development: last year CVC Capital Partners held talks with the government over a possible £2 billion privatisation of the Royal Mail postal service. And a sale of the Tote has been explored on numerous occasions throughout the last decade.

At a recent lunch meeting to discuss 3i Group’s latest annual results, chief executive Michael Queen emphasised the good opportunities to buy from and partner with governments. “Every European government has deficit issues, and will have to act,” he said.

Governments have not historically been the most successful sellers. The Carlyle Group’s investment in UK government-owned defence company Qinetiq serves as an example of the reputational risks involved. The UK’s National Audit Office conducted an inquiry following public outrage that surrounded the 112 percent IRR Carlyle made when it took Qinetiq public in 2006, and found the competitive process, which also included Permira, Candover and Goldman Sachs, could have secured “more for the taxpayer”.

Notwithstanding the public outrage, Qinetiq generated nearly £1 billion in returns for the UK taxpayer, as Graham Love, the former Qinetiq chief executive, pointed out in a letter to the Financial Times in May.

Queen went on over lunch to outline the collaborative way in which private equity firms can partner with governments and thus avoid accusations of profiting at the expense of the taxpayer. The government sells a minority stake of 30 percent to the private equity firm, which then puts the business through its operational paces. Both government and financial sponsor are then positioned to benefit from a full exit.

“A new relationship is needed between the financial sector and society at large,” said Queen. If executed well, these type of partnership-based privatisations could boost the reputational stock of the private equity industry and help forge this new relationship. In the austere times coming, however, those on both sides of these deals need to be careful to ensure that the proceeds are shared.