Editor’s Note – March issue 2006

UK Chancellor of the Exchequer, Gordon Brown, will make his ninth Budget speech on March 22, amid hopes from the UK private equity industry that it can influence the UK Treasury to maintain an environment in which the UK continues to be one of the most competitive for UK private equity firms, in relation to its continental European counterparts.

Measures to cut red tape for small- to medium-sized business, ironing out transfer pricing anomalies for private equity-backed companies and simplification of capital gains tax taper relief rules will be among some of the issues the private equity industry is hoping will be addressed.

There are also fervent hopes among the UK Venture Capital Trust fund manager community that the Budget will contain a further year of 40% income tax relief for all investors in the tax year 2006/07. The introduction of this relief (highly successful VCT fund raisings were previously predicated on a capital gains tax relief of 40%) dramatically reinvigorated fund raising for VCTs in the tax year 2006/06. This tax year, which is now drawing to a close, was again able to raise in the region of £500m for investment in VCT funds, up massively on the £50m raised in the prior tax year.

To this end, the British Venture Capital Association put together its pre-Budget statement submission in October, in time to be reviewed for the pre-Budget statement in early December last year. That statement, when it came, offered little comfort for the private equity industry, although acknowledged that since 1997 almost one million jobs have been created by small businesses, the very entities suffering under the current government’s increasing legal and regulatory burden. Although the statement did highlight attempts to negotiate a more flexible VAT payment option for small businesses. But in the main the statement was noted for its billion pound raid on oil company profits.

But much of the concerns over red tape, capital gains tax taper relief etc paled somewhat when it came to light late February. In a letter from the British Venture Capital Association to its members, the contents of which broadly made their way into The Sunday Times newspaper, it was revealed that the HM Customs & Excise is reviewing the two memoranda of understanding secured by the British Venture Capital Association back in 2003 that many regard as protecting the competitive position of the UK private equity industry in relation to its European counterparts.

The memoranda of understanding, published in July 2003, were always understood to be the subject of a future review, and fearful that this signals the end of what effectively amounts to a 10% capital gains tax taper relief treatment on the carried interest of private equity investment professionals and the equity-incentivised management teams in the companies they back, there has been some relief that in fact no further announcement is expected in the forthcoming 2006 Budget. Rather, the current state of play is that the UK Treasury is to go out to consultation on the matter, a process that will necessarily take a matter of months rather than weeks.

The British Venture Capital Association which acts as the collective voice for the UK industry in its representations with both the domestic and wider European government will be heavily engaged in this process. Much of the groundwork has already been done in that the association produces an annual survey detailing the jobs growth, revenue generation and impact on export growth of private equity-backed companies in the UK.

But while all of this paints a picture of the importance of maintaining the vibrancy of the UK private equity market, what the UK Treasury must consider is whether any action they take as a result of the consultation on these two memorandum could make the UK less competitive than its continental European neighbours. Given the increasing pan European nature of middle market (and larger) private equity, locating the investment professionals and their investee companies that are in any event often trading across a variety of borders in a more benevolent tax environment, is a real and present danger. Belgium, for example, has no capital gains tax so private equity buyers will normally set up a Belgian vehicle to which a company is sold, resulting in no payable tax by the vendor.

Worse case scenario, the UK Treasury might end up collecting less revenue than it currently does if professionals and firms feel it is in their best interests to move outside its grasp. Given the current pressure on Gordon Brown from the EU, among others, desirous to see the UK budget deficit reduced to 3% of GDP, to maximise collection of tax receipts is clearly a priority. The challenge will be not to throw the baby out with the bathwater.