The impact of covid-19 and the UK’s departure from the EU has the Chancellor in a tight spot. While coming up with a way to raise money due to all the pandemic-related spending, Rishi Sunak also has to make sure the UK stays attractive for asset managers and retains its competitive edge.
Therefore, a careful balance needs to be established. A potential rise in taxes that may hit private equity firms and other asset managers, combined with the impact of regulatory issues caused by Brexit, could push people over the edge, leading to a flight of capital we have not seen before.
We have already observed a number of fund manager executives in recent years moving to other countries, such as Italy and Portugal, where there are attractive tax regimes for new residents.
Expectations of tax rises
A potential rise in capital gains tax is on the cards. For private equity fund managers, this could be significant, as while any fees generated by funds are taxed as income, carried interest and co-investment returns have historically been treated as capital gains.
The highest income tax rate in the UK is 45 percent, compared with 28 percent on carried interest and 20 percent on most other gains. Therefore, if these rates are aligned, it could mean a significant increase for taxpayers in the asset management sector. The changes would also impact investors generally.
Many will hope that given the sweeping changes to the taxation of fund managers in 2015 and 2016 that the sector would be immune from further changes, but there is no guarantee.
Historically, CGT has not been a massive contributor to government coffers. For example, in 2018 only £8.3 billion ($11.5 billion; €9.6 billion) of CGT was collected compared with income tax of £180 billion according to HMRC. Therefore changes to CGT could work more as a social equaliser to show that the government is not favouring the wealthy.
While the Chancellor considers changes to CGT, fund managers are also busy dealing with Brexit regulatory issues and there has been a large increase in the number of funds being established in Luxembourg over the last five years.
That being said, for funds that do not need a marketing gateway to Europe perhaps due to investor jurisdiction or reverse solicitation, the UK and Crown dependencies continue to prove popular locations for fund establishment locations due to the higher costs and staff migration required to maintain a Luxembourg fund.
While there hasn’t been a flight of capital from the UK in the past due to tax policy, a major change in the CGT landscape combined with existing Brexit issues could cause that now.
Inheritance tax and corporation tax
Another potential change could be seen around inheritance tax. Until now, it has arguably been relatively easy to pass on wealth because of the ability to make gifts free of tax. Of course, changes to the inheritance tax system, such as the mooted introduction of a gift tax, do not just impact fund managers.
But the government needs to consider who is affected because it could be a deeply unpopular measure. And for those who have the means, any increase in their tax bill will play a part in deciding where they will be based, particularly in a sector like asset management where teams are small in numbers and internationally mobile.
In terms of actual revenue raisers, there have also been discussions on increasing corporation tax rates. A rise by a few percentage points should still mean the UK is an attractive place to do business, particularly given that recent corporate interest deduction and loss relief changes, which are arguably more impactful, did not seem to materially change the landscape. However, substantial rate increases could have a negative impact on the attractiveness of the UK as an investment location or as a location for an asset manager set up as a company.
Not the right time
Despite a need to generate revenue as a response to the pandemic-related spending, this may not be the right time to introduce significant increases to taxes. We are still in the thick of the crisis and it is better to take time and take stock and determine the correct approach.
The UK has to remain open and attractive to the financial services industry. One way to balance that might be through introducing exemptions to higher tax rates for particular types of investment into the UK and the establishment of management platforms within the UK. However, the difficulty with targeted reliefs is that they can easily be changed overnight, as evidenced by the material changes to Entrepreneurs’ Relief in this Parliament, and may not give long term confidence.
What is clear is that the sensible thing to do would be to let the post-Brexit and post-covid-19 economy play out a little before making any changes.
Daniel Parry is a managing director with Alvarez & Marsal Taxand in London. He has more than 20 years of tax experience and specialises in the structuring of and advisory work for investment funds.