Private equity profits taxed illegally, claims British businessman Dale Vince
Dale Vince, the founder of renewable energy company Ecotricity, is planning to take legal action against UK tax authority, HM Revenue and Customs, over how it taxes private equity profits. Vince argues that the government body is using potentially illegal loopholes, as payments made to buyout fund managers are taxed differently from ordinary income, under a 1987 arrangement between industry and the revenue department. That agreement means payments can be taxed as capital gains, rather than at the higher income tax rate. Vince is also backed by the Good Law Project, who issued a “preliminary protocol letter” to HMRC.
Private equity continues to divide opinion
While proponents of private equity argue that payouts are merely investment returns, not bonuses, critics claim the industry is run more like a business. This latest legal challenge follows reports that top private equity executives in the UK earned £2.7bn in the 2020-21 fiscal year. A similar argument is taking place in the US, with the American Federation of Teachers urging public pension funds currently doing business with private equity firms to consider the wider impact of their investments. Recent research indicates that $45bn in taxes is lost annually from companies domiciled in offshore tax havens, with private equity firms among the main contributors.
What are the wider implications of this legal challenge?
Experts warn that if legal action is successful, it could set a dangerous precedent and encourage similar lawsuits. Tax authorities globally have been under increasing pressure to clamp down on tax avoidance, particularly among multinationals, yet private equity firms appear to have remained largely unscathed. The industry itself continues to defend itself, arguing that the nature of investing means payouts are not bonuses, and therefore should be taxed as capital gains.
Is reform needed for private equity?
At present, the UK government is not expected to push for changes in how private equity companies are taxed. However, the issue is unlikely to go away any time soon, with critics focusing on how the industry is run and whether it warrants the special tax treatment afforded to it. Some investors have raised concerns about corporate governance, while employees at firms owned by private equity are more vulnerable to job losses. The industry is also frequently criticised for being opaque and secretive, and there are calls for greater transparency and accountability.
Summary
Dale Vince, founder of renewable energy provider Ecotricity, is seeking legal action against HM Revenue and Customs, accusing the government body of using potentially illegal tax loopholes. Vince claims payments made to buyout fund managers are taxed differently from normal income, under an agreement between industry and revenue officials in 1987. Critics argue that private equity firms are run as businesses, not investments, and call for greater transparency and accountability.
Sources
https://www.theguardian.com/business/2021/may/23/charity-hopes-to-put-pressure-on-private-equity-firms-over-tax
https://www.ft.com/content/60e39e35-b1e3-4c5b-beaa-75e86afae79a
https://www.ft.com/content/cd92dc76-a19f-4fb9-8273-cd65b6af3b9e
https://www.ft.com/content/85f7982b-a6f3-4194-bcf8-075d5701a904
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British businessman and Labor Party donor Dale Vince plans to challenge the country’s tax authority over the way it taxes private equity profits.
The planned lawsuit is the latest twist in a long-running debate over the tax treatment of so-called carry interest, the share of the profit that buyout fund managers typically receive from asset sales. Such payments are currently taxed as capital gains, rather than at the higher rate of ordinary income.
The payouts that individual merchants can earn from successful deals can run into the tens of millions. In the 2020-21 fiscal year, a group of just 255 of the UK’s top private equity executives earned £2.7bn in carry interest.
Lawyers acting for Vince, the founder of British renewable energy company Ecotricity, have sent a “preliminary protocol” letter to HM Revenue and Customs saying they intend to seek a judicial review of the tax authority’s approach to the private equity sector, according to a copy of the letter seen by the Financial Times.
The letter argues that the UK’s position on the taxation of carry interest is “potentially illegal”. He claims HMRC has failed to apply the law to the letter and wrongly based its approach on a lobbying deal between the treasury and industry dating back to the 1980s.
Vince told the FT: ‘It’s a large sum of money given to some very wealthy people in our country through a tax loophole which is being distributed by HMRC. . . it just seems wrong.
The letter from Good Law Project lawyers, which Vince supports, argues that HMRC has taken a “general approach” to the valuation of private equity funds since a 1987 statement agreed between industry and the tax authority – which now is reflected in HMRC’s internal statement manuals.
This statement stated that the fund’s profits would not normally be taxed as trading income but instead as investment profits. The capital gains tax rate is 28%, while the marginal income tax rate is 45%.
The buyout industry argues that its payouts are not bonuses but investment returns as investors are required to put their money into deals to be eligible. This makes them eligible for the lower CGT rate.
But Vince’s legal challenge argues that the day-to-day reality of most private equity firms, especially acquisition firms, means they should be considered businesses, not investments.
“To our knowledge, HMRC has not opened a commercial investigation into the tax returns of acquiring fund managers, challenging their treatment of interest brought in as principal,” the letter said. “While it is correct that HMRC does not, in practice, conduct a proper factual assessment of each fund’s operations before concluding whether or not they are trading, we believe they may be acting illegally.”
The letter gives HMRC until 9 June to respond before starting judicial review. HMRC declined to comment.
Tax activist and former Clifford Chance attorney Dan Neidle, whose research the legal claim developed, estimated the treasury was losing around £600m a year by taxing the carry as a capital gain.
Neidle said the 1987 deal was well known in City circles and a source of jealousy from other sectors, particularly banks and hedge funds, who did not enjoy the same certainty that the deal gave to private equity.
“Private equity is taxed not on the basis of the letter of the law, but on the basis of a 1987 deal and this is not a fair way to make taxes work.”
https://www.ft.com/content/1a5832c7-7a11-4d8a-a24e-bc4bd75d37ee
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