News that the UK Government is looking again at the tax treatment of "employment related securities" has hit the headlines this week. Whilst such a review may incorporate private equity related issues and, in particular, management equity and "carried interest", reports that the industry was being specifically targeted seem premature. Certainly, the industry will be hoping that the reports were over-done - but the wider UK economy should hope so too.
The tax (and regulatory) treatment of venture capital and private equity in Britain was agreed in 1987, when the British Venture Capital Association (BVCA - whose team was led by SJ Berwin), the Inland Revenue and the Department of Trade and Industry (DTI) published a statement and detailed guidelines applying to UK-based limited partnership funds. At the time, the European private equity industry was in its infancy, but many of the funds that had been established were located offshore. Talks were initiated by the DTI rather than by the private equity industry because there was a clear political imperative to bring private equity funds on-shore, and the Government recognised the importance of the emerging industry and the benefits to the economy that would flow from making the UK an attractive home for fund managers.
Of course, the tax and regulatory environment was not the only reason that the UK quickly established itself as the leading European jurisdiction for funds - but it was an important one. And as the tax regime has evolved, and the industry itself has developed into an established asset class and a critical part of the economy, the Government's commitment to maintain that position has remained. The present Chancellor has himself made clear his support for the British private equity industry.
Discussions with the BVCA since 1987 have led to further clarification of the application of new tax rules to investors in unquoted companies, and on the whole these have preserved the spirit of the 1987 statement. The most notable in recent years were the "Memoranda of Understanding" reached over new rules on the taxation of management equity and carried interest in 2003, often referred to as "Schedule 22". HM Revenue and Customs (the combined body of the former Inland Revenue and HM Customs & Excise) has confirmed that it is reviewing the practical impact of the entire regime (only part of which relates to private equity) and, in the process, may want to look at those specific agreements again.
It is appropriate - and not at all surprising - that the tax authorities should review the operation of their rules. At the same time, however, the Treasury has re-affirmed its belief in the industry's importance and indicated that there will be a period of industry consultation before any decisions are taken.
A constructive approach to private equity is vital, and it is important that it continues. It would be ironic indeed if - just when other European countries (including France, Germany, Italy and Spain) are bending over backwards to become more attractive to private equity fund managers - the UK took a retrograde step. There is a very real risk that funds would choose to locate elsewhere if radical changes were made to the UK rules, and that would be bad news for Britain.
24 February 2006