Expert View: Let's explode the myth that private equity is a law unto itself

No special tax deals and no labour law exemptions
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The Independent Online

Let's each hold up a mirror to our businesses. Can you see private equity reflecting shameless advantage not given to other mortals? Or a sparkle that says they are just rather good at what they do?

Trade unions have been whipping up a fury that there are special tax deals for private equity. There are no special deals. When a private equity acquisition is made, the purchaser borrows money and pays interest. For tax purposes, that interest can be set off against income in the target company, subject to a raft of complex "thin capitalisation" rules about the borrowings not being disguised share capital and the interest being non-deductible dividend.

Precisely the same rules apply to all corporate buyers. If BP makes an acquisition, it can borrow and get tax relief for the interest. Come to think of it, if Tony Blair borrows money to buy a house to rent out, he receives tax relief for all the interest against his letting income - and no thin-cap rules apply.

Second myth: private equity managers "unfairly" pay only 10 per cent tax when they sell the "carried interest" shares they acquire. The reality is that if managers pick up carried-interest shares on the cheap, then they have to pay PAYE on the benefit like the rest of us. The UK has a system of taper relief to bring capital gains tax down from 40 to 10 per cent on the sale of private company shares. Is that relief only there for private equity managers? No. It is available to everyone, capitalists and Cabinet ministers alike.

How does 10 per cent taper relief compare with tax on capital gains made by others? Companies selling shares in subsidiaries? No tax. Pension funds selling shares? No tax. Hedge funds? No tax (they are all offshore). Registered trade unions providing benefits to members? No tax. So their special deal puts unions at a considerable advantage to private equity managers, but no one seems to complain.

And does the looking glass reflect a special right for private equity firms to "slash and burn" workforces without having to comply with every aspect of employment law? Self-evidently not. My observation is that their behaviour compares favourably with other purchasers. The financials for a trade buyer usually feature cutting duplicated costs as an element in getting the numbers to work. Cutting duplicated costs involves cutting jobs. Listed and private companies operate in this way; private equity houses are rarely trade buyers and so don't have the opportunity.

If a workforce is bloated, any prudent owner will get rid of some employees. Even trade unions would insist on that, rather than have their members' subs spent on supernumeraries. (I seem to recall that Gordon Brown mentioned reducing the civil service by 70,000...)

A real secret shame is that private equiteers torture the managers of their investee companies. The main method of torture is colloquially referred to as "holding their feet to the fire". This requires managers to put their own money into the business. Real money. And just the right amount to make the pain unbearable if the business does not succeed. This not a game for the faint-hearted.

In listed companies, managers generally have no real skin in the game and so might lose their jobs or reputations if targets are not met, but not the family home.

While the pain persists for their managers, the equiteers dangle before them the hope of eternal relief in the form of life-changing financial rewards.

Chief executives in listed companies are paid pretty well and can earn bonuses that would make most people's eyes water, but they don't have the opportunity to earn amounts over a three- to five-year period that will change their lives for ever. Pain and the prospect of pleasure is a potent mix in driving performance.

So, no special advantages lie in tax. There is no exemption from the rules that others live by in dealing with employees. Hard work and financial risk-taking are choices we could all take. But the private equity sector has one special advantage - leverage - when buying listed groups. Should this be taken away?

The great thing about the UK is that anyone can buy shares in listed companies. That's why the London market is so successful and why those markets where there is government interference have fallen behind. The UK listing authority has rules to make sure that all shareholders are treated fairly, and that is vital. However, to say companies listed in the UK should be protected from a particular type of purchaser on the trade unions' say-so would mean that we no would no longer need mirrors for self-examination. We would no longer have businesses.

Alasdair Douglas is senior partner and head of corporate tax at City Law firm Travers Smith alasdair.douglas@traverssmith.com

Further browsing: For a radical trade unionist view on private equity, go to www.iuf.org/buyoutwatch

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