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Hole in metal mesh fence | accountingweb | The end of carried interest?

Is this the end of the carried-interest loophole?


The Good Law Project is claiming to have banished the carried-interest loophole that hands tax savings to private equity executives, but HMRC lacks the resources to respond to the challenge.

17th Oct 2023
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The Good Law Project (GLP) instigated a legal challenge earlier this year, imploring HMRC to close the “carried-interest loophole” that hands hefty tax savings to private equity (PE) executives. This has now concluded with the GLP claiming victory while HMRC insists it has shot the GLP’s fox as the proposed challenge “lacks any legal merit”.

What is carried interest?

PE executives, the fund managers, usually buy into the funds that they manage in the form of “carry points”. If the fund performs above a set level (“the hurdle”), “carried interest” is (typically) 20% of investment returns above that hurdle. It is allocated to the fund managers according to the number of carry points that each holds.

When considering how carried interest should be taxed, the principle of substance over form comes to mind – surely it is performance-related and should be taxed as income. The GLP and Ecotricity founder Dale Vince argues that it should. In Vince’s words, “private equity funds can be subject to the same tax rules as nurses and teachers”.

The "sweetheart deal" 

Thanks to what the GLP refers to as a "sweetheart deal" between the then Inland Revenue and the British Venture Capital Association (BVCA) in 1987 (although the BVCA assert that this was a mere statement of the existing law), carried interest is treated as capital, attracting the 28% capital gains tax (CGT) rate – much lower than the 47% full marginal rate (including national insurance) that an equivalent banker would pay on similar performance-related income. This, says the GLP, has cost the government “hundreds of millions of pounds a year – enough to pay the salaries of more than 10,000 nurses”. Put in those emotive terms, it’s easy to see why the Labour Party has pricked up its ears and vowed to “close the carried-interest loophole”.

PE never part of the deal

The 1987 statement was designed to deter venture capital (VC) funds from taking their activities offshore to enjoy more favourable tax treatment. VC funds typically buy a minority interest in start-up businesses, so tax breaks in this sphere play a part in encouraging UK entrepreneurship. PE tends to swoop in at the other end of an investee company’s life, with PE buyout funds purchasing mature businesses, flipping them and selling them for a profit.

The spirit of the "deal" has somewhat lost its way due to HMRC’s seeming to apply a “blanket policy” to carried interest across VC and PE, although the 1987 deal does not explicitly mention PE. Paragraph 1.4 reads: “Where a venture capital fund is run through the medium of a limited partnership and it purchases shares and securities with the intention of holding them as investments, any profits or losses on disposal of those shares and securities will not… be treated as income of a trade.”

HMRC highlighted this in its response to the GLP. Paragraph 7 states: “(a) Paragraph 1.4 of the 1987 BVCA Statement concerns venture capital funds, not private equity buyout funds.

“(b) HMRC’s Investment Funds Manual does not proceed on the unexamined assumption that capital gains and not income tax treatment applies to carried interest. No such assumption is made in relation to private equity buyout funds.”

This, claims HMRC, renders the legal challenge redundant and the carried-interest loophole a figment of the imagination. The real issue at stake is whether private equity buyout funds are being adequately assessed to determine whether they are “trading”. If so, all parties agree that the carried interest should be taxed as income.

Repeatedly denying the existence of any blanket policy, HMRC’s letter continues: “While HMRC does not consider at present that this is a ‘high risk’ area that merits a greater allocation of its limited resources, HMRC would naturally give appropriate consideration to evidence concerning a particular fund or fund type with activities that might weigh more in favour of trading.”

HMRC says “whatevs”

HMRC has consistently rebuffed the suggestion that it applies a blanket policy to all PE buyout funds, but in doing so it acknowledges that the facts should be considered on a fund-by-fund basis. The logical conclusion would be greater scrutiny in the process and the tax treatment corrected accordingly.

But with HMRC barely staying afloat, the likelihood of resources being conjured out of thin air and diverted to compliance investigations in this area is remote. The HMRC letter concludes “responding to [the proposed challenge] is using up substantial amounts of scarce resources, which could otherwise be deployed in service of HMRC’s statutory function of collecting tax”.  As one commenter beneath Dan Neidle’s article put it, “This is a ‘whatevs’ from HMRC.” 

But “whatevs” doesn’t quite cut it with an estimated £600m per year at stake. The clarification of the legal position means fund managers and HMRC can no longer, as Neidle says, “pretend that private equity funds aren’t trading”. Fund managers can’t fall back on the 1987 agreement and advisers will need to be absolutely clear on whether each fund is trading before determining the tax treatment.

There is a view within the PE industry that this is a political football, unlikely to lead to any tangible change. Tax structuring is a key element of the fundraising process and in the face of heightened scrutiny from HMRC, this will be enhanced to ensure buyout funds do not fall into the realms of trading.

What’s next?

A spotlight is now beaming down on a tax treatment that favours the fat cats and the government will be hard pushed to ignore it. The risk of course is that removing the tax break will push the industry overseas, with serious knock-on effects for the UK economy and entrepreneurship. Charities and pension funds also risk losing valuable exemptions if their PE investments are treated as trading, not investing. 

But as Neidle asserts: “We can’t have a tax system where one sector gets special favours thanks to a politically driven technically suspect backroom deal 36 years ago. We should be taxed by law, not by lobbying or litigation.”

Legislative change seems likely, with one popular suggestion being to equalise the rates of capital gains and income tax. How that might work, particularly with the potential abolition of inheritance tax, is a topic for another article.

Replies (15)

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By AndyC555
17th Oct 2023 16:28

The Good Law Project does in deed claim victory, stating on its website:

"HMRC has now conceded the key argument raised by Vince and Good Law Project, accepting that the money managers receive from buyout funds – known in the trade as their “carried interest” – where appropriate “would be taxable as trading income in the hands of UK tax resident individuals. HMRC would expect such individuals to file their self-assessment returns accordingly.”"

But if you read HMRC's letter it is obvious that they did not concede the point as the quote from HMRC's letter has been trimmed by the GLP and what HMRC said in full was:

“In circumstances where carried interest is generated from an underlying fund which is carrying on a trade, that carried interest would be taxable as trading income in the hands of UK tax resident individuals. HMRC would expect such individuals to file their self-assessment returns accordingly.”

By leaving out the "in circumstances where carried interest is generated from an underlying fund which is carrying on a trade" the GLP changes the meaning of what HMRC said. HMRC's position is that they have always held that view and nothing has changed.

Thanks (4)
Replying to AndyC555:
By Justin Bryant
18th Oct 2023 09:37

Yes indeed and I note DN also predictably makes a huge, overblown, lefty lawyer, biased, attention-seeking, song & dance about all this too. I don't know why this website indulges these overtly biased people so much without any scrutiny as to accuracy (RM is another one). That job's left to people like you & me it seems.

Also, DN's website blatantly ripped off one of my old OPs here on a dodgy tax scheme and had the gall to claim it was their "original analysis", yet Aweb failed to point that out when indulging DN re all that (it was pointed out by others here).

Thanks (3)
Replying to Justin Bryant:
Ray McCann
By Ray McCann
18th Oct 2023 11:07

You really don't like DN, do you Justin? I assume RM is Richard Murphy and that you don't like him either?

Have you seen much carried interest transactions in action? It has been a blatant giveaway from day one and those defending it lose sight of the fact that for years, many of those benefiting from it were non-dom so not only were we not getting income tax, in many cases we were not getting tax at all.

And they also miss the point that the BVCA agreement was intended to prevent needless examinations of position that on balance were likely to be investment and not trading. In the end however it provided a safe harbour for everyone.

If the UK is dependant upon tax handouts then we really are done for, no?

Thanks (6)
Replying to RayM55:
By Justin Bryant
18th Oct 2023 11:21

Actually you're wrong yet again, as I have commended some of DN's stuff here (I don't think anyone but an idiot would commend RM - even JC had the measure of him). Check your facts and all that. In any event, this is all peanuts compared to the £52bn stealth taxes reported this week, which is more newsworthy but of course less sexy to the likes of DN et al (as far as I can tell, no-one has tried to quantify this alleged carried interest loophole and possibly that's telling and also you need to factor in how much upside there is to PE types staying in the UK due to this, like non-doms currently do and that DN analyses very badly with much bias).

Thanks (0)
Replying to Justin Bryant:
Ray McCann
By Ray McCann
18th Oct 2023 16:57

Ah Justin, wrong again eh? I agree you do on occasion make a positive comment but it does seem that on most such occasions you quickly accuse him of nicking an idea from you, indeed you do that here. He has one clear attribute you lack, a willingness to put his neck on the line. When was the last time you spoke out publicly against abuse of the tax system or any particular individual?

And I agree that what is not paid on carried interest is nowhere near the additional tax from stealth but is that relevant, the tax lost on evasion is less, should we give up on that?

I also agree that in some places his analysis is perhaps not spot on but is that not just inevitable when you are describing a jigsaw and you don’t have all the pieces and no clear way to get them all?

So a little bit less arrogance and a bit more actual analysis from you would perhaps make your posts a bit more readable, just a thought.

Thanks (2)
Replying to Justin Bryant:
By stepurhan
19th Oct 2023 08:29

Justin Bryant wrote:

Actually you're wrong yet again, as I have commended some of DN's stuff here (

Got a link?

Given I've seen you making posts condemning him in threads where he isn't otherwise mentioned, this is an exceptional claim that requires exceptional proof.

Thanks (2)
Replying to AndyC555:
Andrew Jackson
By Andrew Jackson
18th Oct 2023 10:02

I also note that carried interest ranks with residential property as being subject to the higher rate of CGT.

That is, it's already being penalised compared to other chargeable gains. The Good Law Project are simply trying to argue that the specific treatment should go beyond slapping a higher rate of tax on the gains, in that they should be deemed to be trading income even if they're not.

I can see a sort of logic there, if one goes by analogy with employment-related securities, but arguing that investment gains which are somehow related to one's trading income should be taxed as revenue rather than capital is a huge leap on to a very slippery slope. Even with ERS the investment gains are subject to CGT rather than IT.

Thanks (2)
Replying to AndyC555:
By Justin Bryant
18th Oct 2023 12:25

And from the horse's mouth here:

Not impressive journalism from Aweb to not mention all that when the above TJ article is around a week old.

Thanks (0)
Replying to Justin Bryant:
Amy Chin
By Amy Chin
18th Oct 2023 13:10

Thank you for your comments, Justin. I believe I did highlight HMRC's position that the GLP's legal challenge has not succeeded and that HMRC's response (quoting myself) "renders the legal challenge redundant and the carried-interest loophole a figment of the imagination".

I had read the TJ article linked in your comment before writing my article, as well as a great deal of other sources. My article seeks to explain the treatment currently applied to carried-interest and how carried-interest should be treated per the legislation. It was never intended, and nor does it come across as, a he-said-she-said between DN, GLP and HMRC - there's plenty of that elsewhere on the web.

Thanks (5)
By Ermintrude
18th Oct 2023 10:01

The Good law Project is always claiming success even though it has a record of complete failures.
It is very good at avoiding tax however. All of the income to the company is by way of donations, which are exempt from tax. A prime example of this is the legal challenge mounted by the "trans" charity "Mermaids" - against the LGB Alliance (LGB - Lesbian Gay Bisexual) arguing they are a "hate" group. The logical route would have been for Mermaids to have raised the funds to pay the fees of the GLP (owned exclusively I believe by Jolyon Maugham) - but that fee income would then have been taxable. Clever eh? Well not so clever as cunning and sly - the same characteristics attributed to the fox, a creature which Maugham literally beat to death with a stick.

Thanks (2)
Replying to Ermintrude:
By Justin Bryant
18th Oct 2023 10:06

That's right. They all have an irony/hypocrisy bypass. Just look at what DN's old law firm, CC, got up to re DoTAS tax avoidance schemes when he worked there.

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By Markcairns67
18th Oct 2023 10:25

I think it's a decent outcome for GLP (and tax fairness in general) as HMRC have stated that there isn't any set 'guidance' (which is contrary to what advisors were claiming) and that each case needs to be treated on the facts.

That by itself *should* lead to reduced use of this loophole, even absent any specific actions from an HMRC that can't even perform bare basic functions of a public facing department, let alone try to police the activities of moneyed and litigation-happy PE firms.

Thanks (2)
By B-free2016
18th Oct 2023 10:26

It’s all about favouritism and loop holes in our tax system to avoid the standard taxation which so many have become experts of. I don’t mind GLP but ultimately these fat cats have been reaping hefty rewards for way too long.
Quite few of them have a side hustle which has been profitable no doubt and have not paid a penny of tax. Hence they work with selected few companies who abide by the same loopholes and everyone is winning. HMRC needs to really have an independent investigator that is going to historically penalise all these companies, Mazars being number one

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By 2TunTed
18th Oct 2023 10:38

No bad thing if this 'loophole', is closed. The regrettable point is that HMRC does not have the resources to deal with the underlying issues properly or take action against those who tax return might be incorrect or indeed tackle all the other tax issues that are kicking about, many as a result of badly thought out tax-grab legislation.

Thanks (1)
JD Portrait
By John Downes
18th Oct 2023 11:21

'This, says the GLP, has cost the government “hundreds of millions of pounds a year – enough to pay the salaries of more than 10,000 nurses”.'
Well whoop te do. It's much more likely those hundreds of millions will be 'invested' in a couple of hundred yards of HS2, or gold-plated pensions for a handful of Permanent Secretaries.

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