PE Panorama: Is the UK Budget 2016 really PE-friendly?

Private equity (PE) populism looks to be in the news again – though in a context that’s unlikely to win too many votes for the instigators. This time it’s the UK, and Chancellor George Osborne’s latest budget. The UK Budget 2016 (the Budget) includes a significant reduction in the UK capital gains tax rate to 20% – which however, will not apply to the carried interest earned by PE general partners (GPs) on investments. This will still be taxed at the old rate of 28%. Even worse, carried interest will be taxed as income, potentially attracting up to 45% in tax – rather than capital gains – if the investing GP exits the investment within three years (supposedly an inducement for PE groups to actually engage in longer-term business-building).

“These new rules ensure that carried interest will be taxed as a capital gain only when the fund undertakes long-term investment activity with investment horizons longer than three years”, states the Budget document. And other provisions reduce tax offsets on debt repayments, potentially raising the price of leverage in the UK. The UK Treasury is reportedly claiming that only a maximum of around 10% of PE fund managers will be affected. Hedge funds, which do not usually book carried interest, will not be affected.

All this might make PE groups shun the UK – if they were likely to get a warmer reception anywhere else. However, the global initiative against base erosion and profit shifting (BEPS), targeted by the Organisation for Economic Co-operation and Development (OECD) in its OECD/G20 BEPS Project, is dragging friendlier venues into line. Thoughtful tax policies might be welcome where it arises, and there are some signs of the UK government trying to incentivise economically-useful behaviour by PE funds in this Budget.

However, the broader BEPS moves are regarded by many commentators as playing out with an eye to the gallery – focussing as much on the public perception that multinationals, PE fat cats, etc., pay too little tax, as on the actual realities of cross-border taxation. Regulators and governments everywhere are wary of post-financial crisis populism and public disenchantment, which are likely to be the themes driving many policy initiatives in years to come. Better that than more Trumping, after all.

Signs are that the policies under and paralleling the BEPS Project will become part of the financial markets landscape in years ahead. If this does happen, GPs can look forward to a stricter and less attractive global taxation regime with less opportunity for regulatory and tax arbitrage across borders. Given PE’s reputation for rewarding its practitioners though, I doubt too many tears will be shed.