PE pros face higher taxes

Senior private equity professionals in the UK are in danger of losing a larger proportion of their pay to taxation.

Tax advisors say Her Majesty's Revenue and Customs (HMRC) is in the process of scrutinising the earnings private equity professionals derive from equity in companies they invest in.

At present, these earnings are subject to capital gains tax, which tapers down to an effective rate of 10%. Under new proposals, they could be subject to 40% income tax as well as national insurance.

"The Government and Revenue have been getting very antsy about the fact that private equity companies appear to be getting a hidden upside," says Mary Carter, a tax specialist at KPMG. "There have been dark mumblings about imposing a special benefits charge, which would see profit made on equities effectively treated as income."

Carter says funds are a victim of their own success. As the proportion of debt used to finance private equity deals has risen, the potential to earn upside on the equity of companies invested in has also increased, and the taxman has his eye on the rewards.

"Companies are now so thinly capitalised that the Revenue thinks private equity funds are earning hidden benefits," she says. "If you have a company worth 100m that has 100m of debt and 10m of share capital, that share capital will be worth very little until the debt has been paid down. But once the debt has been paid, every share owner will be in possession of 10% of a company worth 100m."

HMRC is understood to be taking advice from senior tax specialists on the viability of increasing the tax paid on equity gains by the management at investor companies. Carter says this could have implications for private equity professionals, too.

Early indications are that the HMRC's plans may prove unworkable under existing regulations. But Carter warns any respite may prove only temporary: "It begs the question whether there will be any change in the law to try and catch these situations. I wouldn't be surprised if there were something in the November tax statement about this."