£4 billion tax gap for private equity managers under threat

Private equity executives have benefited from a tax break worth up to £4 billion under carried interest rules, which Labor wants to abolish if it wins the general election.

The figures, drawn from data obtained by The Times, highlight that favorable tax treatment of private equity managers' profits has enabled some of Britain's wealthiest individuals to significantly reduce their tax liabilities.

Dan Neidle, a leading tax expert and founder of the think tank Tax Policy Associates, has labeled these rules a “loophole.” Under the current system, private equity managers invest together with other investors and receive “carried interest” on profits, which are taxed at the capital gains rate of 28%, instead of the combined income tax and national insurance rate of 47% . . This is an important part of their reward.

The private equity sector has warned that changing the tax treatment of carried interest could lead to a mass departure of financial services professionals from Britain and dampen investment. Some industry voices argue that such a change could be as damaging to the status of the City of London's financial center as Brexit.

Figures from HM Revenue & Customs, obtained through a Freedom of Information request, show that private equity managers paid £1.4 billion in capital gains tax on declared carried interest in the 2021-2022 tax year, up from £ 921 million the previous year.

If carried interest were taxed as income, private equity managers would owe a further £2.3 billion in taxes. Including carried interest from non-domiciled managers, the total could be £4 billion, Neidle estimates.

Labour's proposal to align carried interest with income tax and national insurance contributions could generate significant revenue for the Treasury, especially at a time when public finances are under pressure.

Despite substantial lobbying from industry, Rachel Reeves, the shadow chancellor, confirmed on the BBC with Laura Kuenssberg on Sunday that this policy remains part of the Labor platform.

Adjustment of the carried interest regime is advocated for reasons of fairness. According to the tax authorities' FoI response, more than 80% of those who declared carried interest also paid the top income tax rate of 45% on their regular income.

In March last year, Neidle published an article in the British Tax Review calling for a change in the tax treatment of carried interest. He questioned the extent to which the tax benefit would be collected if the law were to change, acknowledging that some executives could leave the UK while others, particularly non-domiciled individuals, may already be considering leaving due to other government changes.

“It is very difficult to justify that one sector gets a tax break that no one else gets. High-earning programmers, doctors, lawyers, bankers and hedge fund managers all pay taxes of 47%. Why should private equity be any different?” Neidle argued.

The British Private Equity and Venture Capital Association responded by stating that it was “committed to maintaining the internationally competitive arrangements that attract capital and investment professionals to Britain. Whoever wins the election, we look forward to discussing how private capital will continue to be partners for growth in Britain.”

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