Private equity inquiry fails to bite

The Treasury Select Committee conducting an inquiry into the private equity industry will ask HM Revenue and Customs to give oral evidence explaining why buyout barons enjoy favourable tax treatment, and whether it should do more to police the industry.

That is one of the results of a largely toothless 57-page report to be released today by the committee, led by Labour MP John McFall. The interim report comes after contentious public hearings and a fierce campaign waged by unions and some politicians, calling for a regulatory and tax clampdown on the private equity industry. It has grown from relative anonymity to become a major force in the corporate landscape that controls some of the country's most-well known brands, like Alliance Boots.

The committee said, however, that it would not make final recommendations until it collected more evidence at hearings in October.

One of the most controversial aspects of the industry - tax - will again be a primary focus. Private equity professionals, who raise large pools of money to buy, restructure and then sell companies, make most of their money through "carry", or the share of the profits generated when portfolio companies are sold. Carry is treated as capital gain and is taxed at 10 per cent, rather than the typical 40-per-cent income tax rate. This is due to regulations first passed in 1987 to foment entrepreneurism by rewarding individuals who risk capital to start a new business.

Critics say that private equity firms are taking advantage a rule not intended for them. The report stated: "There is a case to answer as to whether carried interest is genuinely a capital gain... Such relief was originally intended to support business start-ups and venture capital which were seen as high-risk ventures, whereas it is difficult to argue that the takeover of a large, established company poses an equivalent risk to the new owners."

HMRC has the power to override this tax treatment in instances that it deems do not adhere to the spirit of the law. The committee said it will ask the HMRC if it has ever exercised its power to override such tax treatment, and to explain "what internal guidance on the exercise of the override has been prepared".

The committee also said it would return to tax relief on debt, on which private equity firms depend heavily to finance takeovers. "Our concerns centre on the impact of highly leveraged buy-ins on UK tax revenues, and the potential for economic distortion if the tax system significantly favours debt over equity as a form of company funding," the report said.

It also highlighted concerns about whether the high level of gearing poses a threat to economic stability; potential abuse by some buyout professionals of non-domicile status to avoid paying UK taxes; and the need for increased transparency.

The body of the report, however, was mainly a summary of the evidence gathered at the hearings and stopped short of suggesting any significant changes. The buyout industry had feared the committee would recommend an overhaul of the tax and regulatory regime, and will be relieved that it has given a temporary reprieve.

Richard Lambert of the CBI, the business lobby group, said: "The committee has rightly steered clear of suggesting knee-jerk changes on issues such as tax deductibility of interest and pensions at this stage, as it recognises there are complex issues involved."

Chancellor of the Exchequer Alistair Darling also warned against major changes that could lead to "unintended consequences".