The thing about useful stuff is: The mob is baying for Private Equity blood

The mob is baying for Private Equity blood Thursday, March 08, 2007

As "testament" to its' listening credentials especially when it's from their core financial supporters, not to mention sniffing a tax raising opportunity, Ed Balls, the Economic Secretary to the UK Treasury, has announced a review into the tax treatment applied to private equity funds, a move which could add billions to Government coffers, at a time when corporate tax revenues are falling.

It is to investigate the growing use of so-called "shareholder loans" in highly leveraged structures normally put in place by private equity funds. In essence, Private Equity Funds usually invest only a small amount as direct equity in a company (5% or so of the total finance), with the vast majority provided as debt. The financing cost of the debt incurred by the company is tax deductible, unlike dividend payments.

Whilst the structures are complex, in essence a Private Equity fund will direct 95% of the total investment as equity in offshore Special Purpose Vehicle ("SPV") and this will then recycled back as debt to the company. The interest payments made will be reduce the companies profits and hence their corporate tax bill in the UK, but the interest income earned by the SPV will not be taxed in the UK - a tax efficiency which is a key reason for the fall in corporation tax revenues.

The political play here is simple. By announcing this review, Balls throws the Trade Unions something they can claim as a victory in their crusade against "evil" Private Equity.

For the Private Equity industry it may kick the whole issue into the "long grass" for many months by which time the Trade Unions may have found a new victim for their rants. However, this is more likely to be a deferral of the matter rather than an end, since the tax take opportunity will be too juicy for the Government to ignore, particularly as it will be perceived as a victimless tax i.e. no votes lost.

However, if these loans are taxed differently, then private equity returns will fall and the attraction of moving offshore increased. Moreover, the beneficiaries of private equity investments such as pension funds will once again be clobbered, having already seen the Labour Government plunder £100bn from pension funds on changing the treatment of dividend tax credits in 1997 - an ironic situation given that the Trade Unions also bemoan the perilous state of pension funds and the impact on their members.

Balls has apparently confirmed that there are no plans to change the principle of the tax-deductibility of interest, as this is something open to all investors, not simply private equity.

Labels: private equity, tax, VC