Private equity’s sweetheart deal with tax authorities was always a ‘charade’

For more than 35 years, managers of private equity funds have been taxed as if they were making investments.

But most private equity funds aren’t vehicles for managers to invest in startups. Instead they allow managers to borrow money, buy companies, strip out their assets and then resell.

The managers of these “buyout” funds aren’t investing – they are trading – but they still pay tax at a sweetheart rate of 28% rather than the 47% they should pay.

All of this dates back to a shady deal that the private equity industry cut with the Inland Revenue – now HMRC – back in 1987, a story we can now tell, thanks to a cache of documents released when Good Law Project helped Dale Vince to challenge this outrageous practice.

The industry had been preparing the ground with Norman Lamont, a former investment banker serving as Financial Secretary, since July 1986. When they met with the Revenue in September, they outlined their demand: that private equity income “must be taxed as capital”.

The civil servants were wary, with one official calling the arrangements a “charade”, but under pressure from Lamont and the Chancellor Nigel Lawson they eventually understood that the Government was “anxious to help” the industry and caved in.

The deal has continued for 36 years, at a cost to the Exchequer, in the last year for which we have data, of around £420m a year – enough to pay the salary of 16,000 nurses.

HMRC has now conceded the key argument raised by Vince and Good Law Project, accepting that the money managers receive from buyout funds – known in the trade as their “carried interest” – where appropriate “would be taxable as trading income in the hands of UK tax resident individuals. HMRC would expect such individuals to file their self-assessment returns accordingly.”

This admission means the policy can now be reversed – collecting back taxes – without the need for any legislation. But with a Government in hock to wealthy bankers there’s little prospect of any immediate change.

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