The UK government in December proposed to simplify tax rules for multinationals and exempt foreign dividends received by UK groups from tax, as part of an effort to stem the tide of companies leaving the country due to recent reforms. Asset management firm Henderson, which is setting up a new parent company in Ireland to keep its tax rate to 20 percent, joined a number of companies including pharmaceutical maker Shire, publisher United Business Media, Shell and insurer Omega that are looking elsewhere for tax relief.
In the past the UK's “non-domiciled” tax laws made it a haven for foreigners who benefitted from paying no UK tax on their earnings or capital gains outside the country. But in its biggest reform last year the government demanded that foreigners who have been residing in the country for more than seven years will have to pay a £30,000 (€32,000, $62,000) annual charge or else pay UK tax on their worldwide earnings.
The proposal led to warnings from private equity managers about the impact this could have on the UK's competitiveness. “This was obviously very unpopular, and I think the concern in the private equity industry was that this was going to frighten managers away from the UK and they were going to set up shop elsewhere,” said Elizabeth Conway, a partner at Link laters.
In addition, the government also abolished the concept of “taper relief” on carried interest that allowed private equity executives to pay a 10 percent tax on capital gains. Instead the government introduced a flat rate of capital gains tax of 18 percent. While this is still a far cry from the previous 40 percent standard rate of capital gains tax, “obviously the people who were previously paying 10 percent weren't too happy about that”, Conway says.
Conway, however, believes the government struck a good balance between the interests of private equity and the demands of unions and politicians who wanted to see more oversight for the industry. Chancellor of the Exchecquer Alistair Darling moved to alleviate the concerns of foreigners by promising that those who pay the £30,000 fee will not have to make additional disclosures about their income and gains earned abroad, while removing the threat of new retroactive taxes.
While the recent changes may not have been as drastic as feared, the amount of uncertainty caused by various proposals has already had an effect on making some foreigners feel less welcome. “Previously we would see people coming to the UK from overseas, often from the States, and the big selling point for the UK was stability and certainty,” said Anthony Stewart, a partner at Clifford Chance. “There's been a lot of tax change and this is disruptive. We certainly find clients asking about the new rules before they decide to set up in the UK.”
Stewart adds that while tax is just one of the factors that determine where people locate, and the £30,000 a year charge and the other changes are unlikely to lead to an exodus from the UK, if there were to be additional tax changes “there comes a point when the arguments [against remaining in the UK] become compelling. I'm convinced people don't want to go, but as many hedge fund and private equity professionals are international in outlook, speak several languages and would be as comfortable elsewhere in Europe or the US as they are in the UK, it wouldn't be as difficult for them to relocate as some may think”.
Nick Mace, another Clifford Chance partner, echoes these concerns at the corporate level. “Uncertainty in the tax treatment of UK target companies makes deal pricing difficult. Add to this a perception that the UK tax compliance burden is increasing, and the UK risks becoming less attractive a jurisdiction in which to invest.”
This has opened the door for competing tax havens such as Luxembourg, Qatar, Dubai, Shanghai and especially Ireland to woo foreign companies. However, so far no other private equity firms have followed Henderson's lead. Conway believes that non-domiciles, especially in the private equity arena, will likely not have to contend with any new tax changes for at least 2009, while the UK's image as an attractive destination for private equity funds is secure for now.
“In terms of the whole fund industry, generally outside of just private equity the government in the last six months or so has put forward a number of proposals for reforms which will make the UK more competitive for setting up those funds here and for being an investment or asset manager,” she says.