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Dan Neidle’s foolishness

He’s just abolished sweat equity.

On the carried interest being taxed as a capital gain idea:

I’ve just had a lengthy peer-reviewed paper published in the British Tax Review concluding that there is, in fact, no loophole. Private equity’s nifty tax treatment works only if private equity funds are regarded as passive investors, in the same way as unit trusts or other mutual funds. But if they are carrying on a financial trade, like an investment bank, the executives would have to pay tax at the same rate as everybody else.

Unlike a mutual fund, private equity funds are far from passive investors. They enter into complex acquisition agreements to acquire companies. They actively manage those companies, often restructuring them from top to bottom. They run elaborate auctions to dispose of the companies. And they repeat the whole process again and again.

The level of activity suggests that many funds are carrying on a financial trade, which means HMRC should look carefully at each private equity fund, and apply the law, and not stick to a very political agreement from the 1980s.

Well done, well done. So the management of a start up firm. They gain equity for the work they’re going to over the next few years of building that company. Which, under Neidle’s reading, means that equity must pay income tax rates.

Way to go Danny.

4 thoughts on “Dan Neidle’s foolishness”

  1. I haven’t read the BTR paper, but I’ve read his summary on Twitter. My understanding of his argument is that he’s not saying it *ought* to be taxed as income, but that that is what the law currently says. HMRC are treating it as capital based on a paper prepared by – surprise, surprise – the venture capital industry, which has no legal status. Neidle is saying that HMRC should apply the law as it is written, not as interpreted by the industry, and that if government really wants it to be treated as capital, they should change the law.

    Jolylolyon is on board, which is good reason to be suspicious, but it does seem a reasonable argument.

  2. Abolishing sweat equity is very likely to be a feature rather than a bug. The equity in a business is supposed to be invested capital (plus undistributed profit thereon) at risk but “sweat equity” is really deferred remuneration like the employer’s contribution to the pension scheme.
    The government has decided to encourage entrepreneurs by charging a lower rate of tax on the rewards for their initial investment and this deferred remuneration: I believe that the benefits to private equity executives were unintended even if not totally unforeseen. Those who hate entrepreneurs will join Dan Neidle in seeking to deprive them of the fruits of their labour by taxing this deferred remuneration at the highest possible rate of income tax and NI rather than the average rate applying during the years during which it was earned.

  3. This paper?

    Most private equity funds are structured as limited partnerships. Executives in the investment management team often receive an interest in the partnership—“carried interest”—which, if the fund proves successful, will frequently become extremely valuable. The private equity industry takes the position that UK resident executives’ carried interest returns are normally taxed as a capital gain, rather than as income, on the basis that the funds are typically not trading, and HMRC generally accept this. That results in a marginal tax rate of 28 per cent rather than 45 per cent. There has been considerable public discussion as to whether this is a fair result, and whether the law should be changed, with the amount of tax at stake being approximately £600 million. This article, however, takes a descriptive rather than normative approach, and queries whether capital treatment is in fact correct under current law. The conclusion is that it is not: in practice most private equity funds are buyout funds, and the nature of those funds means that in many cases it is likely that they are trading. It follows that the correct result under current law will often be that carried interest is taxed as income. If policymakers wish to preserve the status quo, then the law should be changed to specifically tax carried interest as capital. If that does not happen, then HMRC’s current practice may, in the author’s view, be ultra vires, and therefore susceptible to judicial review by a campaign group or other interested body.”

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