Carried interest reform sweeps across Europe

Commenting on the furore surrounding Mitt Romney's personal taxes in the US, Joe Dear, chief investment officer of CalPERS (which currently has around $50bn invested in private equity funds), said the tax breaks enjoyed on carried interest were "indefensible".

Perhaps more surprising was when Henry Kravis - arguably the biggest name in global private equity - said that carried interest should be looked at as part of wider reforms: "We have to look at the whole tax system, so that means you have to look at everything across all segments there. Carried interest could be part of that clearly, but there are lots of other things that need to be looked at," he said in an interview in April.

While much of the focus has been on private equity in the US, some parts of Europe are far closer to implementing legislation to increase the amount of tax paid on carried interest. Sweden has, perhaps, moved the furthest in this direction, with the country's finance ministry proposing taxing carried interest as income up to a ceiling, at which point it would revert to the 30% capital gains taxation rate. Sweden's tax authority has also been clamping down on tax avoidance measures and applying retrospective tax demands in some cases.

Germany is also currently looking at proposals to lift the rate of tax paid by those in the private equity industry, with four regional governments hoping to remove a clause that prevents them taxing more than 60% of a fund manager's profits. However, the law would need to be changed on a federal basis, and the state of Bavaria, a popular base for the country's financial sector, says it will stand against any change (see page 45).

The result of France's recent presidential race could also spell higher taxes on carry. French managers currently pay 38%, a relatively high rate of CGT compared to other parts of Europe. However, François Hollande, the Socialist who recently ousted Nicolas Sarkozy in France's presidential election, seems likely to further increase taxes on fund managers, as outlined in his election manifesto.

UK change unlikely
While the UK government has not made any further moves to further tax carried interest, former government minister Lord Myners has called for moves to crackdown further, saying: "Private equity fund managers are getting equity-like returns without taking equity-like risks. This appears to be an anomaly."

However, Caspar Noble, a tax partner specialising in private equity at Ernst & Young, does not believe there will be any further changes before the next general election. "I doubt this government will attempt to increase tax paid on carry," he said. "But it is possible the next could, particularly if we end up with major tax changes in the US emerging out of the Romney vs Obama presidential race."

If a future UK government sought to increase taxation on fund managers, they may find it difficult to achieve without a major rewriting of the country's tax laws. As carried interest is simply a share of the underlying gains in the fund, there is no mechanism with which to tax fund managers' carry other than existing CGT rules. However, many would argue against a further increase in this tax's rate, as this would have far wider implications than simply reducing carry for fund managers, as CGT is intended to encourage investment, and hence is taxed at a lower level than normal income.

Furthermore, additional taxation could simply drive fund managers away from the UK: "If we compare private equity funds to hedge funds, while GPs are paying currently around 28%, a lot of hedge fund managers have migrated offshore to pay very little or no UK tax.

"If you clamp down on carry and charge full income tax there's more incentive for GPs to pursue this kind of action," explains Noble.

In fact, maintaining the existing tax situation in the UK could, alongside moves to increase taxation in Europe, mean the UK is in a relatively strong position to attract fund managers, despite a 10% hike in CGT.

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Industry
• United Kingdom
• France
• Germany
• Sweden
• Ernst & Young
• KKR
• CalPERS