Corporate Reaction: Sea change in CGT may spur sale of companies

City bankers were rubbing their hands with glee yesterday at the prospect of a rush of company sales and corporate activity in response to a radical change to the treatment of capital gains tax.

In his pre-Budget report, the Chancellor of the Exchequer, Alistair Darling, announced the abolition of "taper relief", the tax condition that allows investors to pay just 10 per cent capital gains tax on investments held for more than two years. The rule was a boon to private equity executives, most of whose compensation qualifies for the loophole as it comes through "carry", or their share of the profits made when portfolio companies are sold.

Mr Darling said that taper relief would be eliminated as of next April. In its place, he introduced an across-the-board 18 per cent capital gains tax. Bankers are anticipating a wave of deals in the next six months as buyout firms try to unload businesses and pocket returns before the new tax regime takes effect. "Deals will be pushed forward. Eight per cent is a lot of money," said one banker.

The private equity industry's use of taper relief, which was originally introduced to encourage entrepreneurialism, had unions and politicians crying foul. The vast sums reaped by Permira and CVC, due in no small part to the current tax regime, from the AA, the roadside assistance group which they took over, became a cause célèbre for the industry's detractors. Most in the buyout world were girding for a more draconian reaction from the Government so there was a general sense of relief that the increase was not more drastic.

Deals that may have been on the back-burner are likely now to be pursued with greater urgency.

"Where private equity houses are considering a divestment of portfolio entities in any event, [they] may be incentivised to sell portfolio entities before 6 April 2008 to benefit from a 10 per cent tax rate," said Lee Jefferson of BDO Stoy Hayward, the accountancy firm. He added that sellers may cut sale prices if it helps get deals done before the deadline. "Current owners and management may look to... obtain access to the 10 per cent effective tax rate. This could mean vendors are willing to sell before 6 April 2008 at a discount in order to access a 10 per cent rate of tax."

But Stephen Alambritis, head of parliamentary affairs at the Federation of Small Businesses, warned that small and medium-sized business owners could be hurt. He said: "What this will mean is people who have run long-established small businesses will see an 80 per cent increase in their tax when they retire. They are hitting our members so they can clobber private equity."

The CBI business lobby group also hit out at the Chancellor's move. John Cridland, CBI deputy director general, said: "Changing capital gains tax rate to a flat rate of 18 per cent will adversely affect the balance between risk and reward, both for entrepreneurs and for the UK's vital private equity industry. This move is disappointing and may lead to a reduction in investment in start-up and growing businesses."

Private equity executives, however, broadly supported the new tax rules. Peter Taylor, head of Duke Street Capital, said: "We waste so much time and money on tax accountants structuring things with great complexity that we can really do without. The 18 per cent rate is very simple and straightforward. I think it will help on that account."