Labour Risks Surprising Private Equity With Tough Tax Message

Katherine Griffiths, Ben Stupples and Alex Wickham
·6-min read

(Bloomberg) -- Attendees at private equity’s glitzy conference in Berlin last week said they were hopeful that Labour’s plans to raise their UK taxes would be modest. But, as the party’s manifesto is about to be released, the industry is at risk of being in for a nasty surprise.

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Anyone hoping Labour won’t target private equity will be disappointed. On Thursday, Labour is expected to reiterate its promise to target carried interest in its election policy pledges. The party plans to close the loophole that allows private equity fund managers to pay a capital-gains tax on their investment returns, a person with knowledge of Labour’s plans said.

The payments would instead be taxed at a higher rate as income, with the additional amount raised being used for public services, the person said, asking not to be identified discussing information that isn’t public. The party may not elaborate on its plans for now.

Rachel Reeves, Labour’s shadow chancellor, first said in 2021 she would target tax loopholes benefiting the private equity industry. At the time, she said she could raise about £440 million ($560 million) by changing the treatment of carried interest — a slice of profits from an investment shared by select employees in a private equity fund — to make it like income, not a capital gain.

In times of rising valuations the carry has led to eye-popping bonuses for staff who can buy into the fund, and created a new class of multimillionaires. Those huge payouts rarely make it into the public domain.

In just over three weeks, the UK’s main opposition party, which is hovering about 20 percentage points ahead in opinion polls, may form the next government. For the private equity industry, after years of facing vague threats, the big question is how tough Reeves is going to be. At one extreme, she may push carried interest into the world of income tax, raising the rate to 45% for many.

Alternatively, she could make a more modest change, taking it somewhat higher than the 28% people now pay under the current capital-gains tax regime — such as to France’s 34% level.

At stake is a valuable source of potential tax revenue for Labour that has ruled out raising several mainstream taxes at a time when the next government will urgently need funds for public services. But also on the line is Labour’s relationship with the country’s wealthiest people for years to come.

Hazem Ben-Gacem, the London-based co-chief executive officer of private equity firm Investcorp, said he expects the tax rate to rise in the UK, but not to a level higher than in France, and that Britain’s thriving ecosystem would remain.

“The UK has all that, and many young Europeans in finance still want to come here,” Ben-Gacem told Bloomberg News at the SuperReturn International conference in Berlin last week.

Others at the conference also said they thought Labour was headed for moderation and was keen to avoid spurring flight to other European financial centers. The party has stressed the importance of encouraging economic growth and is working to set up a wealth fund that it wants private equity to invest in, they said.

Reeves may have sent friendly signals to the business and finance community, but there have been mixed messages, as she also wants to pursue ambitious plans to change the tax system to make it fairer, according to several people with knowledge of her thinking. Labour is also planning a crackdown on people who aren’t domiciled in the UK for tax reasons, and is looking at other breaks for the wealthy that could be reversed, the people said.

A spokesperson for the Labour Party declined to comment.

The uncertain mood has already prompted some to rethink their location. Claire Madden, a managing director at London-based private equity firm Connection Capital, said she is directly aware of individuals in her sector currently making plans to leave Britain for elsewhere, including Italy, Switzerland and the UK crown dependencies of Jersey and Guernsey.

“There are a lot of people who have got substantial backlogs of carried interest that’s built up who are not waiting around to see what happens,” she said. “That should start ringing alarm bells.”

Wealthy Wait

Most, however, are waiting for more clarity on Labour’s plans, including a proposal to scrap UK inheritance-tax exemptions on non-doms’ overseas assets. There is a large overlap among non-doms, those who earn carried interest and people wanting to keep wealth offshore for their descendants, said a lawyer involved in the area.

Labour is expected to look at detailed information from the Treasury and HM Revenue & Customs before finalizing its plans, which will then be assessed by the Office for Budget Responsibility for how much cash they will actually bring in.

The party could make changes to carried interest in several ways, including through legislation or by undoing an agreement the private equity sector reached with the Conservative government in the 1980s for carried interest to be treated differently from income — a deal that the tax authority wasn’t happy with at the time, according to Jolyon Maugham, executive director of the Good Law Project, a group that campaigns on legal and social issues.

“There are three ways Labour could make the change,” he said. “One would be to equalize capital gains and income tax rates. Another would be through specific legislation to treat carried interest as income. The third would be just to invite HMRC to treat carried interest as income, which is what it thought the answer was in 1986, before it was bullied into conceding a different treatment by Tory ministers a year later.”

With Labour’s direction unclear, there has been talk among some private equity executives about whether there could be a legal challenge to HMRC, according to two people with knowledge of the matter. That possibility is seen as remote, partly because of the optics for the industry, one of them said.

Detail Decisions

Details to be decided by Labour include whether to exclude venture capital and infrastructure investment from any tax change to encourage startups and support industries such as green energy.

There could also be a distinction offered between people putting their own money into a fund, and those borrowing that money. Co-investment puts someone’s own capital at risk, and thus is more likely to be taxed as a capital gain, while any windfall from borrowed money looks more like a bonus, with a case for being taxed as income more easily made, people with knowledge of the matter said.

With Labour expected to settle its policy quite quickly so it can start raising revenue, the lobbying is intensive, with companies spending large sums on firms plugged in with Reeves’ team, the people said. The British Private Equity & Venture Capital Association, led by former Liberal Democrat cabinet minister Michael Moore, is emphasizing jobs and investment, and engaging with all political parties.

“Labour have set out their taxation position, and we have shown the party how much the industry contributes to the UK, backing 2.2 million jobs across the economy, in addition to the 140,000 in the industry itself,” Moore said. Last year alone, the private capital industry invested more than £20 billion in UK businesses, he said. “Whoever wins the election, we will look forward to discussing how private capital will continue to be partners for growth in the UK.”

--With assistance from Loukia Gyftopoulou, Swetha Gopinath and Jan-Henrik Förster.

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