It has been almost two decades since Nicholas Ferguson, a grand figure in the private equity business, caused a storm by talking out loud about his industry’s dirty little secret. It could not be right, he said, that highly remunerated private equity executives could pay less tax than a cleaner or other low-paid workers.
Things have moved on a bit since 2007. So-called “carried interest”, or carry – the portion of an investment profit that the private equity managers retain as a bonus for success – is now taxed at 28% under the capital gains regime; in the old days, rates in effect as low as 10% could be secured thanks to various exceptions.
But the underlying point remains. Why on earth should a performance-related bonus be treated as a capital gain rather than as income, where it would normally be taxed at the higher rate of 45%? Bonuses in banking and other parts of the financial sector don’t get the same special treatment.
The Labour party’s line in its election manifesto was admirably clear. “Private equity is the only industry where performance-related pay is treated as capital gains. Labour will close this loophole,” it said. The document even spelled out the projected extra receipts for the Treasury – £565m a year – and said where the money would be spent, notably on recruiting 8,500 mental health staff.
But Rachel Reeves flunked it on Wednesday. Capital gains tax rates on carried interest will be merely increased to 32% from April 2025. From April 2026, carry will be taxed within the income tax framework but, critically, with “bespoke rules to reflect its unique characteristics”. The Office for Budget Responsibility (OBR) suggested that will work out at about 34%. You can see the effect in the projections: forget £565m on extra receipts, the peak year yields £140m.
As reported elsewhere in the Guardian, this is a lobbying triumph for the buyout barons’ trade body, the British Venture Capital Association, which was warning darkly that funds would skip off to the EU if the manifesto pledge was implemented. The chancellor has instead settled for a rate that, on the OBR’s numbers, is similar to that in France and the Netherlands.
The threat of a mass exodus may indeed have been real, rather than standard posturing, it should be said. It’s not too much harder to run a private equity fund from Paris rather than London. As the OBR notes, even its modelling on the new rates “is highly uncertain as it is driven by the behaviour of a small number of high-net-worth taxpayers”.
But the irritation factor with Reeves’s fudge is still high for a number of reasons. First, that manifesto pledge was not given lightly. It was made after a three-year period in which Labour had argued consistently that it had heard the counter-arguments but still judged that private equity should not have a separate treatment.
Second, carried interest is income on any logical interpretation because the amount of personal capital risked by partners tends to be tiny. There really aren’t inherently “unique characteristics” that couldn’t be claimed by other professionals, from software engineers to plumbers. It’s just that private equity has always had special treatment going back to 1987.
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Third, even if the chancellor felt compelled by that history to compromise, she should have at least gone for a rate in the high, rather than the low, 30s. As it is, private equity practitioners cannot believe their luck.