UK election: Debate on carried interest tax raises stakes for private equity

Private equity and venture capital investment in the UK appeared to be accelerating ahead of an election that could open the door to higher taxes on fund managers.

The Labour Party, holding a substantial lead in polling a week out from the July 4 election, has pledged to increase taxes on the performance-linked pay private equity fund managers earn on profitable investments. The debate over the performance pay, known as carried interest, is building as the UK’s private equity market paces for a rebound year in 2024.

Higher taxes on carried interest "risk damage to the UK’s competitiveness," the British Private Equity & Venture Capital Association, a trade group, warned in a policy document.

The UK has drawn more private equity investment than the three largest European Union economies — Germany, France and Italy — combined since 2021, according to S&P Global Market Intelligence data.

"We will continue to argue strongly for internationally competitive arrangements which attract capital and investment professionals to the UK,” added BVCA Chief Executive Michael Moore in emailed comments.

Closing the 'loophole'

Carried interest in the UK is currently treated as capital gains and taxed at 28%, well below the top income tax rate of 45%. Labour's 2024 election manifesto described the rule on carried interest as a "loophole" that unfairly benefits private equity, but the party now appears unlikely to fully close that loophole.

University of Oxford economist Ludovic Phalippou said Labour had "already watered down their plan," referring to comments by Rachel Reeves, who is likely to serve as the first female chancellor of the exchequer in a Labour government. Reeves told the Financial Times in June that fund managers who put their own capital at risk in a private equity investment should continue to pay the capital gains tax, not the higher income tax rate.

"Smoke in the mirror. Nothing will change," Phalippou predicted.

Recovery brewing

With $32.35 billion in transaction value announced this year through June 19, the UK's private equity market was on track to grow by more than a third year over year in 2024, according to Market Intelligence data. If the trend plays out, it would represent a second consecutive year of growth after the slowdown that gripped the global private equity industry in 2022.

"We’ve by no means turned a sharp corner and everything’s rosy, but the trend is in the right direction," said Daniel Roddick, founder of London-based private equity advisory Ely Place Partners.

With an aggregate announced deal value of $26.63 billion as of June 19, the second quarter was shaping up to be the UK’s best quarter for private equity investment in three years. Four of the 10 largest private equity deals targeting UK-based companies since 2023 were announced in the second quarter, including Energy Capital Partners LLC's $7.87 billion offer for renewable energy company Atlantica Sustainable Infrastructure PLC.

Fundraising picks up

Private equity funds targeting UK investments raised $6.72 billion in aggregate between Jan. 1 and June 21 and were on track this year for their biggest fundraising haul since at least 2018, according to Preqin data.

Michael Henningsen, managing director of Raymond James' private capital advisory in London, said the UK's institutional investors were "still keen to invest in private equity" but grappling with a slowdown in distributions from their private equity fund managers. Managers continue to draw on capital for new investments but have produced fewer exits that return cash to investors, a situation Henningsen noted is hardly unique to the UK.

He said near-record levels of global private equity dry powder mean sponsor-to-sponsor deals, in which one private equity firm acquires another's portfolio company, remain a viable exit route.

"One of the byproducts of having so much capital on the sidelines is, if you have a good company, there is still a healthy exit environment," Henningsen said.

– Download a file of raw data from this story. – Catch up on private equity headlines. – Read about tailwinds for private equity investment in Japan.