Johannesburg – In the recent budget, the treasury said it would examine the taxes paid by companies bought out in private equity deals to determine whether the fiscus was losing out on revenue.
The SA Venture Capital and Private Equity Association was quick to respond, saying it had been in talks with the treasury about regulation and taxation of the industry since early last year. It did not give details.
South Africa’s concern on the issue is not isolated. In the US and the UK, legislators are also irked by the low taxes paid by private equity managers and are determined to plug loopholes in their tax laws.
US presidential hopeful Hillary Clinton entered the fray last July, when the Democratic senator joined other legislators in a drive to raise the tax rate on carried interest, the chief benefit for fund partners.
“It offends our values as a nation when an investment manager making $50 million [R390 million] can pay a lower tax rate on earned income than a teacher making $50 000,” she said in a campaign statement.
Clinton continued: “As president, I will reform our tax code to ensure that the carried interest by some multimillionaire Wall Street managers is recognised for what it is: ordinary income that should be taxed at ordinary income tax rates.”
Her rival, Barack Obama, agreed on this point, saying: “We need to close the loophole that allows managers … to unfairly cut their tax bills more than in half by treating regular service income as capital gains.”
The remarks add fuel to a debate that has raged in congress. Several bills have been tabled that would sharply raise tax on some of the financial world’s most savvy, and secretive, operators.
There is no doubt private equity managers arouse strong feelings. Some detractors call them locusts, and one British trade union leader has even branded them racketeers.
Defenders of buyout firms claim that higher taxes would destroy an industry that benefits the economy.
Private equity funds, also known as buyout firms or venture capital, depend largely on debt financing to acquire companies. One benefit of using leverage is that interest costs can be deducted from the profits of portfolio companies, effectively reducing their taxable income.
In public firms, shareholders often oppose aggressive leveraging. The tax advantages of debt funding also allow buyout firms to bid more aggressively for acquisition targets.
The primary source of revenue for a successful private equity fund is the percentage of profits it earns when portfolio companies are sold. This carried interest of up to 20 percent is their performance reward.
The fund’s founders and senior partners, who take a lion’s share of the “carry”, do not pay income tax of 35 percent on it, but instead pay capital gains tax of 15 percent.
Democrats are pushing to more than double the tax rate on the carry, while buyout firms have raised campaign contributions and lined up business allies for a lobbying blitz.
In the UK, MPs on the treasury select committee have sent out strong signals that they want to lift the tax rate on the carry from 10 percent.
Tax Research UK notes that private equity firms are often registered in offshore tax havens. The pressure group says: “Tax relief is obtained in the UK on the cash flows going offshore but no tax is paid when they get there. This means the UK government is subsidising the market to transfer wealth out of the UK.”
Even Nick Ferguson, the head of SVG Capital, has said it was unfair that partners paid less tax than their cleaners. He said the generous tax breaks were intended “not to make executives very rich but to encourage investment and entrepreneurship”.
