UK entrepreneur and Labour party donor Dale Vince is planning to challenge the country’s tax authority over the way it taxes private equity profits.
The planned legal action is the latest twist in a long-running debate over the tax treatment of so-called carried interest, the share of profit buyout fund managers typically receive from asset sales. Such payments are currently taxed as capital gains, rather than at the higher rate of ordinary income.
The payments dealmakers can individually earn from successful deals can run into the tens of millions. In the tax year 2020-21, a group of just 255 of the UK’s top private equity executives earned £2.7bn in carried interest.
Lawyers acting for Vince, the founder of UK renewable energy company Ecotricity, have sent a “pre-action protocol” letter to HM Revenue & Customs saying they intend to seek a judicial review of the tax authority’s approach to the private equity sector, according to a copy of the letter seen by the Financial Times.
The letter argues the UK’s stance on taxing carried interest is “potentially unlawful”. It claims HMRC has failed to apply the letter of the law and incorrectly based their approach on a lobbying agreement between the treasury and industry dating back to the 1980s.
Vince told the FT: “It’s a very big sum of money being gifted to some very wealthy people in our country through a tax loophole that’s being handed out by HMRC . . . it just seems wrong.”
The letter from lawyers at the Good Law Project, which is backing Vince, argued HMRC has taken a “blanket approach” to assessing private equity funds since a 1987 statement agreed between the industry and the tax authority — that is now reflected in HMRC’s internal manuals.
This statement said fund profits would not normally be taxed as income from trade but instead as profits from investment. The capital gains tax rate is 28 per cent, while the marginal income tax rate is 45 per cent.
The buyout industry argues its payments are not bonuses but investment returns as investors are required to invest their own money in deals to be entitled to them. This makes them eligible for the lower rate of CGT.
But Vince’s legal challenge contends the everyday reality of most private equity firms, particularly buyout firms, means they should be considered trading, not investment, businesses.
“As far as we are aware, HMRC opened no trading inquiries into the tax returns of buyout fund managers, challenging their treatment of carried interest as capital,” the letter said. “If it is correct that HMRC does not, in practice, conduct a proper factual assessment of the operations of each fund before concluding whether or not it is trading, we consider that they may be acting unlawfully.”
The letter gives HMRC until June 9 to respond before launching the judicial review. HMRC declined to comment.
Tax campaigner and former Clifford Chance lawyer Dan Neidle, whose research the legal claim drew on, has estimated the treasury was missing out on about £600mn a year by taxing carry as a capital gain.
Neidle said the 1987 agreement was well known in City circles and a source of jealousy from other sectors, notably banking and hedge funds, who did not enjoy the same certainty the agreement gave private equity.
“Private equity is not being taxed on the basis of the letter of the law but on the basis of a sweetheart deal in 1987 and that is not a proper way for tax to work.”
