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šŖ Labour's issue with private equity
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If you take just one thing from this emailā¦
Labour wants to close a tax āloopholeā that currently allows private equity managers to pay less tax on their bonuses. This change could raise nearly Ā£600 million in taxes ā but could also result in private equity firms moving to countries with more relaxed tax laws.
EDITORāS RAMBLE š£
Hoping to switch to a 4-day work week?
Well, Greece has something else in mind.
The countryās legally introduced a 6-day working week.
The (controversial) decisionās been taken to boost Greeceās productivity ā population is shrinking and most high-skilled workers are leaving.
I thought it was interesting to see how social factors (like a shrinking population) can result in changes in law in order to protect the economy.
(just donāt let law firm managing partners find out this is an option)
Idin
FEATURED REPORT š°
šŖ Labour's issue with private equity
Credit: Giphy
What's going on here?
The newly-elected Labour government is planning to close a āloopholeā that private equity managers use to pay less tax. Labour claims this will raise Ā£600 million in taxes.
Whatās private equity?
Private equity is when investors pool their money into a fund. A fund manager then decides which private companies to buy, and aims to increase their value before selling them for a profit.
If youāre interested, we covered how private equity funds structure their deals to maximise their returns.
Okay, so whatās the āloopholeā?
If a private equity fund becomes really profitable (which can takes years) it pays out lump sums of cash to its investors.
Most of this will go to the fundās clients, but a percentage will go to the private equity manager as a bonus, which is called ācarried interestā.
The managers receive this bonus as well as their normal salary.
The issue is that carried interest is taxed as capital gains (at 28%) rather than income (taxed at 45%).
How big of an impact can this make?
Well, letās work through an example.
Jeff is a private equity fund manager.
He successfully raises Ā£100 million from investors to create a new private equity fund.
The investors agree that Jeff will only start earning carried interest (his bonus) if the fund returns more than an 8% annual hurdle rate. This means the fund must grow beyond Ā£108 million (the initial Ā£100 million plus 8% return) before Jeff can earn additional profit.
After this point, Jeff can take 20% of any additional profit ā thatās his carried interest.
Jeff and his team invest the Ā£100 million in some promising companies, which grow in value. After several years, Jeff and his team sell the investments, making Ā£150 million.
The fundās total profit is Ā£50 million (Ā£150 million ā the original Ā£100 million).
As agreed, the first Ā£8 million goes to the investors (8% of Ā£100 million).
This leaves Ā£42 million.
Jeffās entitled to carried interest earned at 20% of Ā£42 million ā which is Ā£8.4 million.
How should this money be taxed?
Well, if itās taxed as capital gains, Jeff pays around Ā£2.3 million in tax (28% of Ā£8.4 million = Ā£2.352 million)
If itās taxed as income, Jeff pays around Ā£3.8 million in tax (45% of Ā£8.4 million = Ā£3.78 million)
So, if carried interest is considered income, Jeff would pay Ā£1.5 million more in tax.Ā§
Why does Labour want to change this?
They think the way carried interest is taxed unfairly helps wealthy people.
If they make the change, they believe itāll raise Ā£600 million more in taxes which could be used for something different (for example, the NHS).
Whatās the private equity industry saying?
Theyāre not happy.
They argue the money can be tied up in a risky asset for 10+ years before the managers receive any payout ā so itās not like income. Itās more similar to capital gains youād make on owning a house.
If the changes go through, a lot of firms are thinking of moving elsewhere in Europe. Countries like France, Germany, Italy and Spain all have friendlier tax conditions for private equity managers (they tax between 25 and 30%).
If this happens, the UK government would lose tax revenue and the countryās private equity industry would see a drain on talent.
Why should law firms care?
Well, law firms wonāt want the change to take place if it means private equity funds leave.
Less private equity activity in the UK means less work for corporate law firms (private equity is super lucrative for them).
But if funds actually end up moving abroad, the UKās loss could be Europeās gain. The number of deals in more tax-efficient jurisdictions like Spain, Italy and France would increase.
Credit: Antonella Gemmoni
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