UK private equity industry faces uncertainty over taxation of carried interest

The Labour party’s manifesto made it clear that changes to the taxation of carried interest would be made if they came to office.

“However, it is hoped that the new chancellor takes the opportunity to consult on proposals for change before rushing to change the tax treatment. An area of particular uncertainty will be the effect of any changes to existing unreleased holdings of carried interest, retrospective changes would be particularly unwelcome,” said Peter Morley, corporate tax expert at Pinsent Masons.

Carried interest payments are due when a fund reaches a certain level of profitability and an agreed-upon amount of profit has been distributed to investors.

There has been a great deal of speculation as to the form the expected changes would take. Labour’s proposals aim to ensure that carried interest is taxed at a rate more aligned with income tax. However, industry experts have said that treating carried interest as a return on investment does not accurately reflect the situation.

The ‘sledgehammer’ approach would be to treat all receipts as income, even as employment income with national insurance contributions applying. There are also other options such as applying a different rate of capital gains tax to carried interest payments.

The UK is not alone in offering more favourable tax treatment for carried interest. Beneficial regimes exist in the US, France, Germany and Spain. These countries typically tax individuals at rates similar to or lower than the current UK regime.

Morley said: “It may be that the new government will look to mirror the rules in other jurisdictions, which will require fund managers to have more skin in the game in order for carried interest to be taxed as capital. The range of responsibilities and implications of each strengthens the case for there to be considered approach to change which involves the industry.”

The Labour party has said that allowing managers to share in the fund’s overall profits aligns their interests with those of investors, in turn promoting long-term growth. The government’s projections suggest that tax changes could raise between £400 million and £500 million for the exchequer.

Full details of amendment are to be set out in the chancellor’s next budget, expected at the end of September or beginning of October.