Carried interest regime update

The latest YouGov election poll is predicting that we are likely to have a Labour government on 4 July and this brings uncertainty for the Private Equity (PE) industry, specifically around the carried interest regime.

Historically, it seemed to be a forgone conclusion that the carried interest ‘loophole’ would be closed should Labour take control of parliament. As mentioned in our article last year - The saga that “carries on…” we questioned whether this approach was tenable given similar (albeit more conditional) regimes in Europe and the US and the resultant possibility of a potential exodus of PE funds should the tax advantage be removed in its entirety.

However, it seems as though Rachel Reeves, Shadow Chancellor of the Exchequer, may be moving the dial slightly on this and considering a compromise position. From her commentary this week, she has suggested that those fund managers who invest their own capital alongside their investors can be seen to be taking a risk and, as such, it follows that their carried interest should be treated as capital gains. For those fund managers who do not take such a risk, she views their carried interest akin to an income taxable bonus. This has eased the grumbling in the city somewhat and the shadow chancellor seems to have recognised that a carte blanche removal of the advantageous tax treatment could be detrimental to the PE industry and the attractiveness of the UK for investment.

What remains to be seen is what the compromise will look like. Would the fund managers having invested 1% of the value of the fund be sufficient to qualify as a co-investment under this potential regime (similar to the thresholds in France and Italy) or can we conclude that her suggestion that the current levels of co-investment are “small” (when we understand 1% is the level adopted by some UK fund managers) may mean that we set the bar higher than other European jurisdictions?  If Rachel Reeves does adopt a threshold higher than 1%, there remains a possibility that our new regime could be too aggressive to mitigate the departure of funds from the UK. It is unclear whether other conditions will be entertained by Labour e.g. a minimum holding period for 5 years, as is the case in Spain.

It is unclear exactly what parameters Labour has used to estimate a c£565m fund raise from their proposed change. How has this has been calculated and what value of fund departures are anticipated and how large is the compromise being made for the benefit of the fund managers that gets us to this figure? We understand Labour intends to consult with the industry before finalising any changes should they be successful on 4 July, but the scope and consequence of that consultation will be watched with interest and PE funds should be cautious in getting too excited just yet.