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Private equity industry dismayed by planned UK tax changes

Representative of the UK's private equity industry and advisory firms have expressed their disappointment with the decision by Chancellor of the Exchequer Alastair Darling to abolish business taper relief on capital gains and to impose a flat capital gains tax rate of 18 per cent from next April.

Although this represent a reduction from the previous top rate of 25 per cent, the move abolished the previous 10 per cent reduced rate for investments held more than two years. The chancellor's initiative was prompted by a political storm on both sides of the Atlantic over the ability of private equity firm partners to have carried interest profits from their funds taxed at favourable rates of capital gains tax rather than as income, at a rate of up to 40 per cent.

Darling announced to Parliament in his Pre-Budget Report: 'I can tell the house the changes I propose to capital gains tax, taken together with the tax loopholes that I am closing, will ensure that those working in private equity pay a fairer share.'

Simon Walker, chief executive designate of the BVCA, the British Private Equity & Venture Capital Association, says: 'The BVCA notes that the chancellor has placed emphasis on innovation, enterprise and the need to maintain the UK's competitive position.

'However, we are concerned that the elimination of taper relief means all capital gains, including carried interest, will now be taxed at a single rate, no matter how long they have been held.

'This move will hit not just private equity but thousands of venture capitalists, family businesses and small and medium-sized companies. A rate of 18 per cent means capital gains tax is higher in Britain than France (16 per cent), Italy (12.5 per cent) or the US (15 per cent), let alone countries like Switzerland which have no CGT.

'The British private equity industry - which accounts for 60 per cent of the European market - is core to maintaining London as the world's financial capital. We regret the rise in the effective rate our investors will pay, but hope the industry will now be recognised for the contribution it makes to pension funds and the wider economy. Above all, private equity and venture capital need certainty and stability.'

Paul Davies, UK head of tax for Ernst & Young, says: 'The changes to taper relief are clearly motivated by the heightened focus on private equity. We are extremely disappointed with these proposals, as they threaten to undermine the entrepreneur culture that has blossomed over the last decade.

'Complete abolition of the taper removes a large incentive for entrepreneurs and challenges the 'Dragon's Den' success of the UK. The taper applies to many more areas than private equity, and this will increase the tax paid by many employees of companies that offer other share incentives.'

Anneli Collins, head of private equity tax for KPMG in the UK, says: 'PE bosses will indeed now pay the same tax rate as their cleaners. But entrepreneurs who have built up businesses over their lifetimes and were perhaps looking forward to selling up to fund retirement will find that unless they can do it before next April, they will pay eight per cent more tax than they were expecting to.

'True, the changes mean a single rate will be in force, but the playing field has not been levelled at all. UK private equity will be taxed at 18 per cent, while non-UK domiciled private equity will be subject to a flat tax of £30,000 per year - and then only after seven years.'

Grant Thornton believes there will be a rush of business sales before April 6 next year, as business owners seek to avoid the increase in the tax due when disposing of their businesses, and that the move will also intensify pressure on a private equity sector already suffering from the credit crunch.

According to corporate tax partner Stephen Quest, the increase in capital gains tax represents in effect an 80 per cent rise from what is currently paid. It may act as a major disincentive for private equity executives to take the risks they were currently taking, and is likely to impact negatively the industry's recruitment and retention rates.

The next 12 months are already set to be extremely difficult for buy-out firms, who reported their most negative forward-looking expectations ever in a survey carried out by Grant Thornton Corporate Finance last week, with 63 per cent of private equity executives predicting a downturn in deal values.

Quest argues that private equity firms may now be reassessing their present models, and even the competitiveness of remaining in the UK. 'This has certainly shifted the goal posts for private equity at a time when it has been predicted by the industry that the value of deals is set to fall considerably,' he says.

'Following this massive increase, we can only hope private equity firms remain open to taking the risks on underperforming businesses that they have done in the past, given the likelihood of more UK corporates experiencing financial pressure over the coming year as the credit shortage filters through the economy.

'This is the most negative forecast we have ever seen from the private equity sector and a huge drop in confidence from just three months ago. With the capital gains tax increase announced today, it seems the light at the end of the tunnel is an oncoming train.'

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