Taxing times

Tax hikes are creeping up on private equity in the UK at just the wrong time, writes Toby Mitchenall

Defending high earners in the financial services sector against tax hikes is never an easy ask. At times like these, when governments are looking to fill widening holes in their budgets – brought about in the main by a financial services sector crisis – it becomes harder still. The latest tax changes in the UK, however, could have lasting implications for the country’s status as a private equity hub.

Last month Alistair Darling, the UK Chancellor of the Exchequer, announced increased income tax for those earning more than £150,000 (€169,000; $226,000) per year from 40 to 50 percent from April 2010. The move was criticised by some as more to do with political posturing, designed to tap into the rising popular discontent with the wealthy, rather than constructive fiscal policy.

Toby Mitchenall

The tax hike comes at an inopportune time for private equity. Professionals based in the UK – typically reliant on cash generated by capital gains – will face increased tax on their income. This might not have been a problem two years ago, when holding periods for assets were short and returns generated from capital gains were big, but now that funds are looking at sitting on investments for longer, salaries paid from the management fee income will become increasingly important.

The tax change has wider implications for private equity in the UK. It comes a little over a year after the government hit the UK’s 116,000 non-domiciled residents – foreigners living and working in the country – with a £30,000 annual levy. This affected all those internationally mobile private equity professionals based in London.

Neither the non-dom tax and the income tax rise were the subject of meaningful consultations. The former received at most some “tweaking” around the edges during a short consultation period, while the latter was larger and sooner than trailed in the chancellor’s pre-budget report.

“Neither the non-dom changes or 50 percent tax rate would likely be fatal by themselves if the economic circumstances were fine, but together with some of the other developments they have broken the predictability and trust of the tax system in people's minds,” said Daniel Lewin, a tax partner at law firm Kaye Scholer.

International private equity practitioners did not choose London as the place to establish a team because they like inclement weather. They chose it for the tax regime and the financial infrastructure. Neither of the two tax changes discussed would be considered a deal-breaker on its own, but they will most likely leave the private equity jet-set wondering “What will be next?”

But discontent among high earners is one thing, and a fully fledged tax migration is another. Sources tell me that a number of managers are currently looking at setting up small outposts in Switzerland, but as yet the centre of gravity has stayed put. If it does shift, smaller players and new entrants to the market will shift with it or risk being at a competitive disadvantage. The UK’s loss could be Switzerland’s gain.