Carried interest: London’s dealmakers bask in rare lobbying win
Rachel Reeves went into the 2024 general election promising to close the “carried interest loophole” long-enjoyed by “asset stripping” private equity executives. So far, though, the sector has escaped the worst of Labour’s promised crackdown, writes Ali Lyon.
For someone who once argued private equity was full of asset strippers driving beloved British businesses to the ground, Rachel Reeves has taken an unorthodox approach to reigning in the sector’s excesses.
In the Autumn of 2021, the then shadow Chancellor accused the UK’s dealmakers of being behind nearly 60 per cent of all UK retailers that had collapsed the previous decade, all while raking in tens of millions of pounds in undeserved pay packets.
How on earth could it be fair, she lamented to The Guardian, that just as Boris Johnson was hiking national insurance to fund Britain’s creaking social care sector, Britain’s buyout bosses were enjoying a “tax break… as they asset strip some of our most valued businesses”?
To rectify the perceived inequity, Reeves then promised voters that, if elected, Labour would immediately close the “loophole” enjoyed by the sector, known as ‘carried interest’, and collect £500m for the public purse in so doing.
But four years, a sweeping election victory and two fiscal events later, and the now Chancellor’s bark has – as far as the City’s private equity sector is concerned – proved bigger than her bite.
The carried interest quandary
Also known as ‘carry’, carried interest is a bonus-like scheme enjoyed by private fund managers that enables them to collect a share of profits from a deal they have worked on. Ever since 2015, it has been treated by the Exchequer as an earning derived from investment, meaning it was taxed at a generous 28 per cent, marginally higher than the then 20 per cent rate of capital gains tax.
In that 2021 interview, the Chancellor promised to treat all carried interest as income, taxing it at 45 per cent, like bankers’ bonuses. But while she followed through with the first element of her promise – moving carry into the orbit of income tax – at her maiden Budget, Reeves only upped the levy to 32 per cent subject to a consultation; a striking last-minute change of heart after a protracted industry-wide lobbying campaign.
The big pushback from industry during the consultation period was around the technicalities
Relief swept through the City’s skyscrapers and Mayfair’s townhouses. But more good news was still to come: the extent of the sector’s lobbying efforts was also evident in the Treasury’s post-consultation proposals, published earlier this month, which contained two more concessions for the very industry against which the Chancellor once railed so passionately.
“People’s general reactions are – given where we were – that there’s been a good amount of thought put into it [by the Treasury], and how we can get to a pragmatic outcome,” says Michael Moore, former Lib Dem MP and chief executive of British Private Equity and Venture Capital Association (BVCA), private investors’ main lobby group.
Two more concessions
The first major shift between the policy announced Autumn and now surrounds rules on co-investing, a condition which the Chancellor had once fervently backed. Last year, she lamented that a tax that was “essentially a bonus” was lower than employment income even when buyout bosses weren’t putting [their] own capital at risk.”
In the post-Budget incarnation of the reforms, the Treasury demanded bosses put their own money into funds they manage if they wanted to qualify for the favourable 32 per cent treatment. However, that condition was nowhere to be seen in most recent proposals, with officials citing “practical challenges” for their omission.
The second change relaxed rules around the minimum waiting period the government mandated between the carried interest being awarded and paid out. As a means of encouraging long-term investing, dealmakers had been required to wait 40 months before being allowed to collect their carry. As with co-investment, though, that caveat was dropped in the reforms’ post-consultation incarnation.
Those in the Treasury, and some in the private equity industry, argue the two climbdowns represent minor tweaks to ensure the policy’s efficacy rather than any ideological U-turn. Indeed, last week, the department held a call between officials and respondents to the consultation which was described variously to City AM as “unexciting” and “highly technical”.
“The big pushback from industry during the consultation period was not that the changes were unfair or were an onus,” says Rhys Owen, managing director of the tax practice at City consultant Alvarez and Marsal (A&M). “It was more around the technicalities. Those conditions – basically – didn’t really work, and they weren’t really really going to achieve anything that’s not already achieved by the existing rules.”
But to others they were further evidence of concession-making to private equity bosses. The telegraphed nature of the changes gave the dealmaking industry time to mount an aggressive and protracted rearguard action.
‘Very heavy’ industry lobbying
Spearheaded by the BVCA, buttressed behind the scenes by industry juggernauts like Blackstone and CVC Capital Partners, the sector made a deluge of warnings and representations to the Treasury. Taxing carry too harshly, their main argument went, would spark an exodus of the very fund managers on which the Chancellor will rely to back her major investment and infrastructure push.
“I’m sure it was the warnings of private equity executives being ready to leave that scared the Treasury into not following through,” says Arun Advani, a director of the Centre for the Analysis of taxation (CenTax) that had called for raising carry in the run up to Reeves’ Autumn fiscal statement. “There was a lot of reporting on very heavy industry lobbying before the Budget, and I guess they would have all said the industry is going to leave if you do this.”
For now, the changes appear to have staved off that exodus, and have been hailed across the industry as a welcome example of pragmatism over ideology. Unlike the flurry of non-doms leaving the country since October, evidence of entire funds relocating their footprint to Milan or Paris – as was forewarned by several industry veterans – has been scarce.
But some worries around the more technical elements of the latest arrangement persist. Charlotte Grieves, a director at investment consultants HHG Financial Services, has found confusion to be the overriding response from her clients as they scrambled to get their head around how best to reorganise their funds.
And both the BVCA’s Moore and A&M’s Owen raised fears around double taxation. “Private equity partners are often mobile, as they can conduct business in multiple countries,” Moore tells City AM.
“In many cases paying tax in the one country would cancel out the need to pay it in a second. However, there is currently a risk that – by the UK seeking to tax carried interest received by people who have left the UK or who divide their time between here and abroad – other jurisdictions demand the right to tax their own residents, on top of any tax charged in the UK.”
Some industry figures believe little can be done to square this circle before the policy comes before Parliament this summer. That could leave dealmakers in the sub-optimal predicament of finding out the extent of the problem through practical trial and error rather than any concrete agreements with other jurisdictions.
One industry lobbyist, though, played down those fears, saying the scenario could “theoretically happen” with the heavily stressed caveat that “painting it as a major sticking point wouldn’t be entirely merited”.
Asked to comment, a Treasury spokesman said: “The new regime for carried interest will put its tax treatment on a fairer and more stable footing for the long-term while preserving the UK’s competitive position as a global asset management hub.
He added that the post-consultation updates would provide “additional clarity” for the industry.
Owen says it is precisely this “pragmatic” kind of policymaking that will keep the industry’s biggest players in the UK.
“Will a decision on hiring or office expansion by a big US inbound house be driven solely by tax? No,” he says. “Will the tax rate and carried interest, and the reward framework for carried interest be a factor in those decisions, almost certainly. Losing them, would be the real, existential threat to the industry.”
If recent comments made by two of America’s largest private markets investors are anything to go by, the Treasury can, for now at least, rest easy. Last month, Blackrock boss Larry Fink heaped praise on the government’s efforts to “tackle some of the [country’s] hardest issues”. And shortly after, the president of rival investor Blackstone said Rachel Reeves had got off to an “encouraging start”, and that her embrace of business deserved “a lot of credit”.
The kind of one-year report cards you’d welcome from anyone; not least the industry you accused of running beloved businesses into administration just four years ago.