Liz Elsewhere

The American , September 14th, 2007
“Over Here, Over There”
by Liz Mair Link to original source


Private equity taxation is a hot topic in Great Britain, too.

The British government recently held a series of hearings on the buyout industry, and next month, Chancellor Alistair Darling is expected to propose changes to the tax system that will impact private equity. According to The Independent, these changes are likely to include increasing the effective capital gains tax rate from 10 percent to 20 percent for investments classed as business assets (e.g., shares in unlisted companies). In addition, Forbes reported last month that the British might also extend the "taper relief" period - the amount of time for which shares must be owned in order to qualify for taxation "discounts" - from two years to five years.

But there is public pressure for other tax changes, too.

Great Britain currently allows "non-domiciled" UK residents to avoid paying taxes on investment and other non-UK income, except when it is remitted to the UK. With up to 80 percent of British investment gurus claiming this status (according to the BBC), and with many of them receiving investment income overseas which they never bring into the country (but which relates to their work there), there is renewed public outcry about their failure to pay a "fair share" of the domestic tax burden.

Following an analysis released last month by Britain's National Audit Office stating that almost a third of the UK's 700 biggest businesses paid no corporate tax in the 2005-06 financial year, attention is also shifting onto the ability of companies to deduct interest costs under current tax law. In particular, that rule benefits highly-geared companies, such as private equity investees - and it's a rule that Brendan Barber, the leader of the British Trades Union Congress (TUC), specifically wants the Labour government to nix.

As in the United States, the debate over an overhaul of the tax system that would target private equity is primarily being fueled by concerns about the divide between rich and poor.

According to The Independent, the richest 1 percent of the British population controls 21 percent of the country’s wealth, and the gap between rich and poor has reached its highest point in over 40 years. The Guardian recently reported that total bonuses in London’s financial services-dominated City (the equivalent of Wall Street) over the last year amounted to £14 billion. In addition, The Observer has pointed to a 74 percent increase in those claiming non-domiciled status on their tax returns between 2002 and the tax year ending in April 2005.

With data like those, it’s not surprising that efforts at rejigging the tax system in order to redistribute wealth are gaining a foothold. (All three of Britain’s major parties seem to be focusing on government action to reduce the wealth gap.) Still, that does not mean that what Chancellor Darling is likely to propose will be a good idea.

Setting aside generic arguments about tax increases harming the economy, Richard Lambert, director-general of the Confederation of British Industry (roughly equivalent to the National Chamber of Commerce), noted in a column in Britain’s Daily Telegraph earlier this month that increasing taxes on “high fliers” could have the effect of cutting Britain “out of the global talent market.”

A brain drain in the financial sector, generally, would be of particular concern, given the prominent role it plays in the British economy. According to The Guardian, finance shapes the UK’s economy more than it does any other member of the G8, bringing in (together with the business services sector that supports it) just over a third of Britain’s national income, compared to about a fifth in the United States. In London, finance dominates: Calculations done for The Guardian by consultants at Experian indicate that finance delivers over two-thirds of the city’s income, while central London itself contributes more to the UK economy than any other G8 capital, apart from Tokyo.

Were higher taxes on investment gurus pursued via changing the rules on taxation of investment income and capital gains accruing to non-domiciled UK residents, Britain would likely experience more than just a brain drain. The country’s tax code, as well as the lifestyle offered by its capital city, acts as a magnet for everyone from Greek shipping tycoons to wealthy Russians who buy up soccer teams. Turning away their money has been contemplated before—and always rejected, because the potential for capital flight is too severe.

Last week John Moulton, managing partner of the private equity giant Alchemy, observed that, “If you jack tax up, people will leave. The industry can move overseas in minutes.” There are also concerns that hiking capital gains taxes could lead to a sell-off of shares on London’s Alternative Investment Market (AIM). Director of Finance Online, an online resource for financial decision makers, reported last month that AIM investors could receive a tax bill of up to £1.4 billion if the qualifying period for business asset taper relief jumps from two years to five years. It is feared that the mere prospect of such a large tax bill might be enough to trigger a sell-off, which in turn could cause market chaos and big losses for investors.

While serving as chancellor, Prime Minister Gordon Brown enjoyed cozier-than-expected relations with London’s finance-driven City. But now, with trade unions and activists clamoring for a shakeup of the tax system, that relationship could sour. As the debate continues, all eyes remain on Chancellor Darling, Brown’s successor at No. 11 Downing Street. When October rolls around, watch for him to make or break New Labour’s reputation as business-friendly.

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