London private equity professionals foresee a way of avoiding Labour's tax plans

Working in private equity is notoriously lucrative, but as governments globally look for ways of raising additional tax, it stands to become less so in the future.

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At issue is the way that carried interest is taxed. Historically, it's been taxed as capital gains. In the future, it may be taxed as income. Britain's new Labour government is leading the charge: it thinks it can raise an additional £188k ($240k) per highly paid private equity professional by tweaking the tax system in this way. It's currently asking for submissions from the private equity industry and is suggesting that a change will be implemented in the budget on 30 October.

Private equity professionals in the City seem relatively unconcerned. Junior and mid-level private equity professionals whose net earnings stand to be most affected over their careers, but who mostly don't receive carried interest yet anyway, say that they're ok to pay more tax while predicting that firms will also find a way to avoid it.

"Most young people in private equity aren't strictly opposed to paying more tax, and we can see the rationale of this change," says one experienced associate in London. "We just wish that public finances were used more effectively." A principal at one large fund in London, says he's more interested in stable UK politics and sound public finances than minimizing personal taxation. Stability and soundness will lead to, "greater foreign direct investment, stable currency, greater private markets (therefore PE investments), greater UK listings, all good for UK businesses and economy," he observes.

A hypothetical openness to higher tax may, however, remain just that. As the government comes for carried interest, some in private equity predict that funds will simply pivot in the way they pay people.

As we reported last week, equity in the general partnership is already the name of the game for the most senior staff in PE, but general partners could equally form multiple mini-limited companies as owners of each individual fund and make employees invest as shareholders in each. Many do this already: KKR, for example, has 10s of companies listed on the UK's companies house. 

In Germany, where only 60% of carried interest is taxed, but where that tax rate is then 45%, one private equity professional says this approach is standard. "We pay €500 as an investment and then we are taxed at 25%," he says. "Firms will always find a way of classifying something as a capital gain."

Gail McManus, CEO of private equity recruitment firm PER says funds are preparing for the tax change. "There is plenty of scenario planning going on to identify whether other structures may be better suited to recognising the capital creation role that the funds are playing in their portfolio.” 

Other industry sources say the likelihood is that co-investing will simply become more prevalent: "That way you would own a share of a specific company so there would be a definite capital value." The expectation is that there will be coinvestment schemes where individuals will be given shares in the individual companies the fund is investing in, and therefore will incur only a capital gain when those shares are sold.

The other alternative is to move to Milan, where carried interest is taxed at a straight 26% and there are no proposals to change this. KKR is opening an office there. Some London PE professionals are apparently entertaining moves now that they can do meetings via Zoom. Milan isn't entirely popular, though. "People tend to move between London and Paris," says one European private equity professional. "Milan is for the Italians. I don't see many Britons, French or Germans going to Italy." 

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