BOSSES of firms backed by private equity may have to pay hundreds of millions of pounds in extra tax after a shock Treasury review.

The changes, which are being examined by both the Treasury and Revenue & Customs, threaten to severely dent an industry that has created scores of millionaires over the past two decades.

In one option under consideration, the tax rate on capital gains would rise from about 10% to 40%. Private-equity industry insiders regard this as a worst-case scenario, and hope they will be able to achieve a less punitive compromise.

The enormous financial rewards of private equity have attracted many senior executives who would previously have worked for large public companies. Private-equity firms are estimated to own companies that employ about 20% of the UK’s private-sector workforce — those companies include Debenhams, Focus Wickes and the AA.

The Treasury is thought to be concerned at the substantial wealth being created in an area that is lightly taxed and attracts little public scrutiny.

The tax review was revealed in a letter sent last Thursday to members of the British Venture Capital Association (BVCA), the private-equity industry’s trade body. In the letter, which has been seen by The Sunday Times, BVCA chief executive Peter Linthwaite writes: “It is clear that the Treasury is under a great deal of pressure ... about perceived anomalies.”

The Revenue is targeting two particular areas. It is examining whether management teams should pay more tax on any gains they make on the stakes they acquire when they lead buyouts. And it is looking at whether it can charge more tax on private-equity fund managers’ share of the profits from any given investment — known as the “carried interest”. Typically, this amounts to 20% of the profit on a deal.

With private-equity professionals collecting an estimated £2 billion a year from carried interest, that could potentially provide several hundred million for the Treasury.

The most successful executives in the sector include Cinven’s Robin Hall, Gordon Bonnyman of Charterhouse and Sir Ronald Cohen, founder of Apax Partners.

Raising the level of tax would also make it much harder for private-equity bosses to attract management to run the companies they buy. One of the key attractions of running a firm backed by private equity is the chance to own a much larger stake in the business than would be considered acceptable at a publicly quoted company.

Among the best-known names to have made millions running companies backed by private equity is John Lovering, who led the buyout of Homebase, while several bosses of public companies, such as Roberto Quarta, of engineering group BBA, have quit to become private-equity executives.

Private-equity bosses argue that any move by the Treasury to raise taxes on their carried interest could encourage firms to move offshore. One executive said: “Private equity makes a substantial contribution to the UK economy. They would be blowing up another success story if they do this. It would be a disaster.”

Another said: “There would be an exodus. The Treasury would be cutting off its nose to spite its face.”

The Revenue said it was looking at the rules. “We wish to engage in a dialogue to explore the issues and the impact on commercial arrangements,” it said.

The BVCA said: “We are continually in discussions with the Treasury on a range of issues, This is part of that ongoing process to help protect and promote the UK private equity and venture-capital industry’s best interests.”

But the letter sent to members last week revealed that Linthwaite has reacted by forming a working party, which he will lead, and which will also include the BVCA chairman, the chairman of the taxation committee and a small team of tax experts. This group will lead the discussions with the Treasury.

The current tax regime for management equity and carried interest hinges on two “memoranda of understanding”, drawn up by the Revenue several years ago. But the industry was put on alert about the possible tax rises at a conference this month when a representative from the Revenue said the memoranda would need to be reviewed.