“Never have so many crustaceans died in vain,” mocked a top Tory on Labour’s wooing of business ahead of 1992 elections won by his party. Such pushes are nicknamed “Prawn Cocktail Offensives” after a cheap hors d’oeuvre. The latest may sacrifice fewer shrimps needlessly. Shadow chancellor Rachel Reeves is impressing business leaders and Labour is ahead in opinion polls.
Higher taxation of buyout bosses is therefore on the cards. Reeves previously accused private equity groups of asset stripping. She now courts them as key UK investors. She is also adamant that if Labour won the general election expected next year she would withdraw a lucrative tax break used by buyout executives. Would she be right to do so?
The perennial bone of contention is carried interest. This is a bonus paid to buyout executives when gains on a private equity fund exceed a set level. Traditionally, the masters of the universe receive 20 per cent of returns over a threshold of 8 per cent.
The figure would be less controversial if carried interest was taxed as personal income, typically at 45 per cent for the highest earners. Instead, it attracts capital gains tax at 28 per cent. Carried interest was worth £4.3bn in 2020-21 alone, according to tax analyst Dan Neidle. The tax lost from the lenient treatment of the payments has been estimated separately at £600mn annually.
There are three strands in arguments for raising taxation on carried interest to the higher level. The first is nakedly ideological. It asserts that private equity executives become millionaires by firing workers and stripping assets. They should therefore be penalised with higher tax rates.
It is understandable that the excesses of private equity attract opprobrium. Some businesses appear to have been conspicuously badly run and some employees poorly treated by buyout firms. But private equity is a broad church. Some businesses thrive following buyouts. It would be wrong to punish buyout bosses via tax for failings many cannot be accused of.
The second argument frames the tax treatment of carried interest as a category error. This is the view of Neidle, whose acute analysis of Nadhim Zahawi’s affairs resulted in the MP being sacked as chairman of the Tory party.
Carried interest has been treated as capital gains since 1987 partly because buyout funds are classified as investors rather than trading businesses. But Neidle believes private equity has key characteristics of the latter. These include buying business assets using debt, modifying those assets and then trading in them.
Scrutiny of HMRC definitions during any judicial review might just reclassify buyout funds as trading businesses. That would put them in the same camp as securities trading operations, including high-frequency hedge funds. But this would be incongruous. Buyout funds are closer to investment companies. Their typical holding period is 3 to 5 years, for example.
The third strand of argument is the most convincing. This elegantly elides financial and societal equity, which should appeal to a Labour chancellor. Buyout executives typically contribute just 1 to 2 per cent of the value of each fund. This helps produce a disproportionate payback, equivalent to over one quarter of returns, if carried interest is triggered.
The latter resembles a success fee charged to external fund investors far more than a return on a personal investment. A success fee usually counts as income, subject to the appropriate tax, as investment bankers might point out.
Buyout bosses are also highly paid professionals, like chief executives and surgeons. They should surely be taxed in the same way.
If Reeves went ahead with the reform, she should expect only token resistance from business. This is not the hill a revived CBI would choose to die on. The British Private Equity & Venture Capital Association might hint darkly that investment and talent would flee abroad.
I know no buyout bosses who yearn to relocate to Dubai. Scorching weather aside, it would divorce them from vital contact networks. The buyout magic of cost cuts plus leverage works best when you can keep a close eye on portfolio companies.
It would be a shame if Labour sold the reform as a form of retribution against private equity. The world has changed since unions were all mortal enemies of private equity, back then a secretive fraternity. If Reeves frames the tax hike as the price of admission to a big and influential tent few buyout bosses would seriously object.