Labour party donor and entrepreneur, Dale Vince, has put the spotlight back on the controversy surrounding the tax treatment of carried interest received by private equity fund managers, by instructing The Good Law Project to serve a “pre-action protocol” letter on HMRC seeking judicial review of its practice of taxing such carried interest as capital gains as opposed to income. Such treatment results in carried interest holders being taxed 28% as opposed to income tax of up to 45%

Central to the case, is the argument that this favourable tax treatment is based on a Memorandum of Understanding from 1987 which The Good Law Project has referred to as a “sweetheart deal” and, thus, have labelled it as “unlawful”.  Furthermore, it is argued that a “blanket approach” has been applied to carried interest and there has been a failure to assess in each case whether a fund is “trading” or legitimately “investing” to determine which tax regime should apply.

It is reported that closing what has been described in numerous reports as the “loop-hole”, would result in £600m a year of additional tax being payable to HMRC. This argument has rumbled on for decades.  In 2007, for example, it was headline news that private equity bosses paid less tax than their cleaners. It is this argument that has formed the basis of the UK Labour Party’s plan to reform this tax treatment which was first announced by Labour in September 2021.   

Indeed, similar challenges and soundings have been launched against the similar regime in the US and there have been numerous attempts by Obama, Trump, Bush and more recently, Biden, to scrap the carried interest tax break in the US- so far, unsuccessfully. 

In the EU, various regimes regarding carried interest have been put in place in recent times to provide some element of favourable tax treatment, for example the Arthuis regime in France and, more recently the “Start Up Law” which came into force in Spain at the beginning of the year. However, these regimes are subject to multiple conditions that need to be satisfied, with the consequence that insurance products are becoming available in the market to mitigate the risk of tax authorities challenging the applicability of these regimes to recipients of carried interest. Interestingly, one of Vince’s arguments is that applying the rules on a case-by-case basis is something that HMRC are not doing, but perhaps availability of insurance products due to the perceived risk of challenge in other jurisdictions suggests that this is something other countries are doing?

The PE industry has long argued that carried interest is rightfully treated as investment return, on the basis that investors are required to invest money to achieve such gain, as opposed to being treated as trading profit. 

Aside from the more technical arguments, we will, no doubt, continue to see arguments suggesting that a change of regime will make the UK less attractive as an investment opportunity, particularly considering the similar regimes in the US and Europe mentioned above (whilst ever they continue to be unsuccessfully challenged), which may be even weightier in light of the existing challenging economic conditions facing the country and in light of the fact that the PE industry has recently been heralded for helping businesses in the UK weather the storm of challenging market conditions (e.g. Covid-19).