£4bn Tax Loophole for Private Equity Executives Under Threat

The government’s flagship City reform initiatives, including the rollout of the British ISA and the Pisces private market, face uncertainty following Prime Minister Rishi Sunak’s decision to hold an early election in July.

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

The figures, in data obtained by The Times, highlight that a favourable tax treatment of private equity executives’ profits has enabled some of the wealthiest individuals in Britain to reduce their tax liabilities significantly.

Dan Neidle, a prominent tax expert and founder of the Tax Policy Associates think tank, has labelled these rules as a “loophole.” Under the current system, private equity executives invest alongside other investors and receive “carry” or “carried interest” on profits, which is taxed at the capital gains rate of 28%, rather than the combined income tax and national insurance rate of 47%. This constitutes a major part of their remuneration.

The private equity sector has cautioned that altering the tax treatment of carried interest could lead to a mass departure of financial services professionals from the UK and may dampen investment. Some industry voices argue that such a change could be as detrimental to the City of London’s financial hub status as Brexit.

Figures from HM Revenue & Customs, obtained through a Freedom of Information request, reveal that private equity executives paid £1.4 billion in capital gains tax on declared carried interest in the 2021-22 tax year, an increase from £921 million the previous year.

If carried interest were taxed as income, private equity executives would owe an additional £2.3 billion in taxes. Including non-domiciled executives’ carried interest, the total could reach £4 billion, Neidle estimated.

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

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

Adjusting the carried interest regime is being advocated on grounds of fairness. More than 80% of those declaring carried interest also paid the top income tax rate of 45% on their regular earnings, as per the FoI response from the tax authority.

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

“It’s very hard to justify giving one sector a tax break that nobody else gets. High-earning coders, doctors, lawyers, bankers, and hedge fund managers all pay tax at 47%. Why should private equity be different?” Neidle argued.

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

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£4bn Tax Loophole for Private Equity Executives Under Threat