ALL the ingredients were there for the perfect storm.
Hours before the private-equity industry faced its severest political
examination, the American buyout group Blackstone revealed that its
co-founders, Stephen Schwarzman and Peter Peterson, stood to reap as much as
£1.3 billion between them when the business floats later this year.
As if that wasn’t enough, MPs on the powerful cross-party Treasury select
committee were already fired up by suggestions that private-equity
executives pay tax at a lower rate in Britain than their cleaners.
So when the industry’s trade body, the British Venture Capital Association,
faced the parliamentarians last Tuesday, it was inevitable that the
lobbyists were going to have a hard time.
They faced ferocious questioning about the lack of transparency and beneficial
tax status of the private-equity industry. In response, executives from the
BVCA mumbled, prevaricated and squirmed as they tried to dodge difficult
questions.
They failed to explain why private-equity executives should benefit from
special tax treatment – a break that enables them to pay tax of only 10% on
their stakes in buyout funds.
The association’s vice-chairman even implied that many top buyout executives
based in the UK did not pay tax in Britain at all.
“I genuinely don’t have a problem with private equity,” said Angela Eagle, a
Labour committee member after the hearing. “But they gave a series of
disingenuous answers. We have not just fallen off a Christmas tree. They
could have done with treating us with a bit more respect.”
And within hours of the mauling by the select committee, the industry turned
on its own.
Big buyout funds privately attacked the BVCA for its inability to deal with
the political storm and accused the organisation of being riddled with
in-fighting. By Tuesday afternoon, the BVCA announced that it would conduct
a strategic review; by Thursday lunchtime its chief executive, Peter
Linthwaite, had quit.
It had clearly been the worst week for the industry in its 20-year history.
And it was braced for more to come: this Wednesday, top executives from five
of the biggest buyout firms – KKR, Blackstone, Carlyle, 3i and Permira –
face a similar grilling by the committee.
The debate over private equity has captured the imagination of left and right
by igniting a discussion about our attitude to entre-preneurship and wealth
creation, to taxation, fairness and justice in society.
As The Sunday Times reported last week, Gordon Brown, the chancellor, is ready
to clamp down on buyout executives’ tax breaks. But the debate is moving on
to a broader examination of the British financial-services industry. Few in
the City doubt that hedge funds will be next to come under scrutiny. And
with the IMF having recently branded Britain as the biggest tax haven in the
world, there will inevitably be a wider discussion about transparency and
accountability and how that can be achieved without damaging the
competitiveness and success of the UK economy.
Sir Ronald Cohen, founder of Apax Partners and one of Brown’s closest
associates in the business world, last week backed plans to force
private-equity partners to pay more tax, while arguing that small
private-equity funds of £500m or less should be excluded.
Cohen’s comments turned the spotlight on his own personal tax affairs and
those of the industry’s most prominent executives. He refused to say whether
he had paid tax on the sale of his stake in Apax and whether he is
“nondomicile” for tax purposes because he was born in Egypt. Such as status
could help him negotiate a lower tax bill.
The Liberal Democrats this weekend called for Cohen to come clean about his
own tax affairs. Matthew Oakeshott, Lib-Dem Treasury spokesman, said: “Sir
Ronald Cohen is the acceptable and socially responsible face of private
equity. But if he won’t come clean, he pours petrol on the flames of
criticism that private equity is secretive and pays too little tax.”
If Cohen were shown to be nondomiciled, it would be embarrassing for Brown,
who appointed him chairman of the Social Investment taskforce. Cohen also
works closely with the Treasury through his position as chairman of the
Commission on Unclaimed Assets. Bridges Community Ventures, a
venture-capital fund chaired by Cohen and investing in deprived areas, has
received £20m of public funding.
Friends of Cohen this weekend would say only that he pays millions of pounds
in tax in Britain each year.
Several of the top buyout executives in Britain avoid British tax. Mike Smith,
a high-profile executive at CVC Capital Partners, has moved offshore to
Monaco to cut his personal tax bill.
And the private-equity funds themselves are almost all domiciled offshore.
According to the latest Guernsey Fund Encyclopaedia, the largest promoters
of funds domiciled in that tax haven in 2006 were Apax Partners with $12.8
billion (£6.5 billion) under management and Permira with $11.5 billion. Many
other funds have tentacles in other tax havens, including Luxembourg and the
Cayman Islands.
Structuring the funds in this way benefits the so-called limited partners –
investors, including pension funds – rather than buyout executives
themselves. But the statistics show how enmeshed private-equity funds are in
the opaque world of offshore finance.
Richard Murphy, adviser to the Tax Justice Network and research fellow at
Nottingham Business School, insists that the private-equity sector is
serviced “on the basis of secrecy, not paying tax and being unaccountable”.
“This is not the way to do business and brings no credit on them or the UK,
which allows these activities to happen,” he said.
Murphy, who was appointed by the Trades Union Congress to brief MPs ahead of
this week’s select committee hearing, hopes to explode the principal
argument used by the BVCA that the private-equity industry receives no
special tax breaks.
Private-equity executives were the unintended beneficiaries of tax breaks set
up by Brown in 1998 to benefit small companies and entrepreneurs who build
up businesses or stake their own money in them. What the BVCA failed to
point out at last week’s hearing was that it lobbied for and secured special
treatment for the private-equity industry in 2003, when these benefits came
under threat in the Finance Bill.
Section 421 of the Income Tax (Earnings and Pensions) Act was designed to
clamp down on abuse of employee share-option schemes. This would in effect
have killed off the private-equity reward model of granting stakes or
so-called carried interests in buyout funds to top buyout executives in
return for beating certain minimum-return hurdles.
The clampdown meant carried interests were in danger of being caught by the
new measures. Pri-vate-equity partners’ carried interests would be
classified as income rather than one-off capital gains: as a result, they
would attract a much higher tax rate.
Ferocious lobbying from the BVCA – a body co-founded by Cohen – won the battle
with Brown, securing an exemption for the industry. In July 2003 a special
“memorandum of understanding” was created between the BVCA and the taxman on
the income-tax treatment of venture capital and private-equity partnerships
and carried interests.
Murphy points out that the memorandum of understanding does not have a
statutory basis and that it has never been to parliament. “In other words,
the BVCA memorandum of understanding is a nonstatutory concession given by
HMRC [HM Revenue & Customs] to this one industry which favours it above
all other sectors of the economy,” Murphy told the TUC last week.
The memorandum of understanding is freely available on the government’s own
websites. But the document cannot be accessed by the public on the BVCA’s
website – it has set upa special pass code to restrict access to its
members. Its spokesman last week preferred to describe the memorandum as a
“clarification” rather than an exemption from tax legislation.
Now private-equity executives at the biggest buyout firms are showing signs
that they are prepared to bow to the inevitable.
In their words, there needs to be an “intelligent debate” about taxation. Some
were privately conceding last week that the tax rates they pay should
perhaps be more closely aligned with other European countries. Permira is
expected to state this week that tax rates should be higher.
It can reasonably be argued that the private-equity industry has made ailing
companies more efficient. In the process its executives have got very
wealthy with the help of generous tax breaks. The returns from private
equity are already becoming slimmer as buyout groups turn their attention
from start-up businesses and ailing companies to big brand names such as
Boots and J Sainsbury. Getting personal tax breaks to buy Boots was never
likely to last long.
It is hard to avoid the conclusion that the industry has now lost the argument
on taxation, and the benefits its super-rich executives enjoy. Last Tuesday
may come to be remembered as the day their luck ran out.
