The public outcry over tax breaks for billionaires in the private equity industry has presented Gordon Brown with a serious dilemma.

For ten years, the Chancellor has gone out of his way to suck up to the City, recognising its importance for the growth and strength of the UK economy. While it has allowed regulations to creep over small and medium-sized businesses, Labour has learnt to leave the UK's financial services sector well alone.

That strategy has paid off. By all accounts, London has surpassed New York as the world's most powerful financial services centre. The sector is now growing faster than any other in the UK and accounts for 9 per cent of GDP. Private equity alone generates billions in fee income for British banks, lawyers, accountants.

To help stimulate that growth, the taxman struck a deal with the British Venture Capital Association, the private equity lobby group, in 2003 to allow the income from “carried interest” on investments to be treated for tax purposes as a capital gain, which was subject to taper relief if you held on to the investment for more than two years.

The idea was to give entrepreneurs with small businesses a chance to grow without being clobbered by excessive taxes along the way.

But for private equity, which generates the bulk of its profits from “carried interest”, it means firms such as Permira, Apax, CVC and Blackstone, have got away with paying 10 per cent tax or less.

The secretive financiers have enjoyed these tax breaks for years, making many of them billionaires several times over.

But now, as private equity has mushroomed in size and its deals, to acquire household names such as Boots, have become so high profile, Mr Brown is facing severe criticism from all fronts that he is giving away billions in tax breaks to some of the UK’s wealthiest people.

The Prime Minister-in-waiting has already announced a review of the 2003 agreement, but as the days pass it becomes clearer that he will have to act and risk alienating the very community he has worked so hard to nurture and get on side.

That was the background against which the Treasury Select Committee grilled a line-up of private equity bosses today.

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