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New Clause 11


Private equity

‘It shall be the duty of the Treasury to prepare and lay before the House of Commons a report setting out the annual and
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cumulative cost to the Exchequer of—

(a) implementing the Memorandum of Understanding between the British Venture Capital Association and the Inland Revenue dated 25th July 2003 on the tax treatment of carried interest; and

(b) the deductibility of interest payable on loans for the purposes of calculating corporation tax liability.’.— [Mr. Hoban.]

Brought up, and read the First time.

Mr. Hoban: I beg to move, That the clause be read a Second time.

Judging from the number of Members present, this is going to be quite a short debate, but I hope that it will achieve something. I hope that we will move the debate on so that we are all able to take a view about private equity based on the facts, rather than supposition.

By way of background to the debate, it is worth highlighting some of the benefits of private equity to the economy as a whole. Companies backed by private equity firms have increased their work force by an average of 9 per cent. each year for the past five years, whereas FTSE 100 companies increased their work force by an average of only 1 per cent. a year over the same period. Companies backed by private equity firms have increased their sales by 9 per cent. per year—almost double the average for FTSE mid-cap companies. The private equity industry has invested more than £60 billion in 24,000 UK companies over the course of the past 20 years. So, the record is impressive. The value that is created is one of the reasons why many pension funds choose to invest in private equity funds. The returns that they offer help millions of people across the country to receive a decent income in retirement.

It is important that we put the current debate in that context. Over the course of the past few months that debate has been in two stages. In the earlier part of the year, there were concerns about the transparency of private equity—

Madam Deputy Speaker: Order. I remind the hon. Gentleman that this cannot be a general debate about private equity, despite the debates that have taken place here and elsewhere.

Mr. Hoban: Indeed, Madam Deputy Speaker. I thought that it was important, for the sake of those taking an interest in the debate, to set the context in terms of some of the remarks that have been made in recent weeks. Against that clear background, there have been a number of calls from different sources for reviews of private equity and the way in which some of the tax structures work.

Let me quote one example. I hope that the new Prime Minister—as of Wednesday afternoon—has read the remarks about private equity made by the new deputy leader of the Labour party, the right hon. and learned Member for Camberwell and Peckham (Ms Harman). I am sure that she is looking forward to working closely with him. She said—

Madam Deputy Speaker: Order. I have already ruled that this is not a general debate about private equity. The hon. Gentleman’s remarks must be related to the new clause.


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Mr. Hoban: Indeed, Madam Deputy Speaker. The right hon. and learned Member for Camberwell and Peckham called for action on taxation, which is the point that I am coming to. Several people have called for action on taxation over the past few weeks. Indeed, members of the Treasury Committee have made that a feature of their inquiry on private equity.

New clause 11 would give the Treasury the opportunity to produce information to help to bring clarity to the debate on private equity. It is important to know the Treasury’s estimate of the cost of the tax relief granted to private equity companies and venture capital funds through the application of taper relief on carried interest. The matter is not straightforward, which is why we have asked the European School of Management to examine carefully not only the broad question of private equity, but some of the tax issues. We realise that taper relief is an incentive for people to make long-term investment decisions and to be rewarded for the risk that they have taken.

The treatment of carried interest stems from a memorandum of understanding between the British Private Equity and Venture Capital Association and the Government. The MOU is referred to in the first part of the new clause. That treatment is applied to the carried interest, which is described in the MOU as

Super-profit occurs when the return from a fund exceeds various thresholds. In effect, the MOU disapplies income tax rules under the Income Tax (Earnings and Pensions) Act 2003 that usually apply to securities that are acquired as part of employment.

We have a problem understanding the amounts involved. For example, during last week’s Prime Minister’s questions, the right hon. and learned Member for North-East Fife (Sir Menzies Campbell) said

I was not quite sure what he meant by that. While the Red Book gives that figure as the value of taper relief, that relief applies to a wide range of transactions and people. Last week, the managing director of Gala Bingo highlighted the fact that all his employees who invest in shares in the business benefit from that taper relief. As part of the debate on private equity, it is important that we get information about the value of tax relief, which would be the purpose of the first part of new clause 11.

I would be keen for the Treasury to publish how much it has raised through private equity in capital gains tax in each year since 1997 and the impact that the MOU has had on the amount taken. Given that the Treasury is conducting a review on carried interest, I assume that it has such information at its fingertips. It would be beneficial to the entire debate on private equity if that information was published so that people could gain an understanding of the true extent of the problem. It would also be helpful if there was a way of analysing from the Government’s figures the time that the carried interest had been held to determine whether private equity investors hold for the long term. At the moment, the taper relief kicks in after two years. The period for which private equity holders are holding
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carried interest beyond that cut-off point is a matter of contention. Will the Economic Secretary share with us the terms of reference of the Treasury’s review of the matter?

The other aspect of tax relief that has recently caused concern, which has been cited by the Transport and General Workers Union in the context of the acquisition of Boots by Kohlberg Kravis Roberts, is the fact that interest paid on money used to fund an acquisition is subject to tax relief, as is any money borrowed by companies. It is important that we know the extent to which private equity is using a relief that is available to all businesses that are owed money. Such information would bring clarity to the debate that is taking place not only in the House, but elsewhere. While the Red Book tells us the value of the taper relief, it does not give information about the general tax relief or the extent to which the private equity industry takes advantage of that. However, earlier this year, the Economic Secretary announced a Treasury review on the interest treatment of certain loans, so perhaps he will be able to share information with the House to inform the broader debate on that tax relief.

As you indicated, Madam Deputy Speaker, this is a narrow debate. However, it is important that we have such information so that the wider debate, which has been characterised by generating more heat than light, can take place in the context of that information.

Dr. Vincent Cable (Twickenham) (LD): I support new clause 12, which seems helpful. It cannot be wrong to request information about a matter that is a little obscure and not especially transparent. I thus welcome the search for entitlement.

The measure is brave, in a Sir Humphrey way, given that the Conservative shadow Chancellor gave a pretty robust defence of the tax privileges of private equity firms at their annual dinner. Some Conservative Members really know about the business. The hon. Member for Hammersmith and Fulham (Mr. Hands) wrote a toughly worded letter to the Financial Times last week in which he defended the status quo. I do not know whether the purpose of the new clause is to row back from that. However, as I understand it, the starting point of the Conservative party is that it wishes to defend the existing regime.

On the other hand, there is some consensus that things are happening that need to be looked at again. I certainly interpreted the Economic Secretary’s comments, when he spoke at the London School of Economics at the beginning at March, as showing a willingness to consider at least the second issue raised in the new clause—interest relief. I am sure that the Economic Secretary will not mind me quoting what he said—in fact, I am sure that he will say it again:

That is half of the problem that is described in the new clause, and I am sure that we would all agree about that. The meat of the problem, and the area that I think that we are debating, is the bit of the tax-privileged status of private equity that relates to taper relief.


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8.30 pm

Of course, as the hon. Member for Fareham (Mr. Hoban) acknowledged, those concerned with private equity are merely one group of people who currently benefit from that relief, and I am inclined to ask, “Why pick on them?” After all, there are other groups who benefit from the relief in a similar way, and no more or less reputably. I read in the Evening Standard today that Madonna has just bought her sixth £1 million-plus house. I do not know what her tax status is; if she is a British taxpayer, she will presumably be able to benefit from taper relief, if she holds that property as an investment for a period of years. It is not just those with private equity who benefit from taper relief.

To understand the nature of the problem that the hon. Member for Fareham raised, we need to go back to Parliament’s decision, in 1998, to introduce such an approach to capital gains tax. I think that I have the advantage of being the only person in the Chamber who took part in that debate; it was opened by the hon. Member for Coventry, North-West (Mr. Robinson), and the reply was given by the Conservative spokesman, the then Member for Arundel and South Downs, who left the House in unfortunate circumstances, and the right hon. Member for Wells (Mr. Heathcoat-Amory). As I remember it, I said pretty much the same as the Conservatives at the time, which was that we had a good system of capital gains tax, which was introduced by the noble Lord Lawson. It was simple and clear, and it applied the same rate for capital gains tax and for income tax. It was straightforward, so why introduce complicated taper provisions that could eventually be taken advantage of by the group that we are discussing and others?

Several arguments were advanced. The first was that if we create a differential, and if there is a 40 per cent. rate on one hand and a 10 per cent. rate on the other—that is roughly the magnitude of the difference between income tax and capital gains tax—of course people will look for ways of exploiting that, and that is exactly what the British Private Equity and Venture Capital Association sought to do in its memorandum. If it had not done it, other groups would have done it in a different way. Moreover, the Conservatives and my party argued that there was no justification for the suggestion that the measure would change business behaviour. Indeed, what was forecast by the Opposition parties is exactly what has happened. Groups of people have taken advantage of that very generous provision, which, as the hon. Member for Fareham says, has cost more than £6 billion, and there is not a great deal of evidence that it has changed business behaviour in any way that has contributed to national economic welfare.

It is absolutely right that we look afresh at the relief, not simply in relation to private equity, but in relation to the whole, large-scale, far-reaching and extremely generous tax concession. In my view, we should go back to the regime that applied in 1997, which was perfectly satisfactory. That is the basis on which we have argued for getting rid of the whole taper relief arrangement, rather than simply singling out the part of it that applies to private equity. I suspect that I would go a great deal further in reforming the system than the Conservative Front-Benchers would, but none
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the less, their new clause, which I understand to be probing and a pursuit of information, seems entirely sensible and worth supporting.

The Economic Secretary to the Treasury (Ed Balls): I am happy to respond to the debate on the new clause, and on proposals for a report to Parliament on the costs to the taxpayer of the tax treatment of carried interest and the deductibility of interest payable on loans. I am happy to respond in the spirit in which the hon. Member for Fareham (Mr. Hoban) spoke to his new clause. I think that he was seeking to probe our thinking on some tax issues in advance of the pre-Budget report, while trying to avoid being drawn into too wide a discussion on the merits or otherwise of private equity, and the views of deputy leadership candidates—or victors—on the subject. I am happy to respond in that spirit.

The hon. Member for Twickenham (Dr. Cable) quoted from a speech that I gave in March, in which I set out in detail our views at the time on the private equity debate. Since then, there has been a great deal of further debate in the newspapers, and there looks set to be a very interesting report from the Treasury Committee, which held its evidence-gathering sessions in recent weeks. I will read just one quote from that speech, as it will set the context, and show that I accept and agree with many of the points that the hon. Member for Fareham made. I said:

Everything that we are doing in the field of private equity is in the context of that overall objective.

The hon. Member for Fareham will not be surprised that I am not going to support his proposals for a further report. That is not because I am averse to reports but because rather a lot of reports on this issue are already on the table or being prepared. I have already referred to the forthcoming report by the Treasury. In my speech in March, I mentioned a report already provided by the Financial Services Authority into private equity’s potential systemic implications for the stability of financial markets. On disclosure and transparency, Sir David Walker is chairing an independent working party to develop a voluntary “comply or explain” code to improve private equity’s transparency and levels of disclosure. The hon. Gentleman mentioned a review that I have promised for the pre-Budget report of the rules that apply to the use of shareholder debt where it replaces the equity element in highly leveraged deals. There is also the forthcoming report on improving the UK environment for enterprise and venture capital commissioned by the shadow Chancellor from the European School of Management, which is to report by early autumn before the Treasury taxation reviews conclude.


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In other words, there are a rather a lot of reports coming up. Before the pre-Budget report and following the shadow Chancellor’s review, we will want to take stock across the piece and respond properly to recommendations by the Treasury Committee, as we always have in other policy areas. I am not sure that another report is necessary.

The hon. Member for Fareham tried to draw out some of our thinking on these tax issues. Both aspects of the new clause relate to the tax treatment of the private equity industry. As I have already said, the Government do not believe that one form of ownership should be inherently preferred over another. Rather, our aim should be to support economic dynamism and long-term investment and job creation. That is also the objective of our tax system. We do not believe that private equity should be favoured in a particular way, including in tax terms. Therefore, the capital gains tax treatment available for gains arising from carried interest and corporate tax deductions for interest—the two aspects mentioned in the new clause—is available to all taxpayers, not only to private equity investors in any preferential way compared with any other investor.

Let me deal first with carried interest. The hon. Member for Fareham referred to a memorandum of understanding published in 2003. To set that properly in context, a previous memorandum of understanding had been produced in 1987 by the Inland Revenue and the British Private Equity and Venture Capital Association, which made it clear that carried interest would continue to be taxed to capital gains, not income. During the 2003 Finance Bill debate on this issue, which neither I nor the hon. Member for Fareham will remember—I am sure that my hon. Friend the Member for Wolverhampton, South-West (Rob Marris) was not only there but commented on the explanatory notes—concern was expressed, particularly by the former Member for Arundel and South Downs, that changes being introduced to schedule 22, covering the whole range of employment-related securities, might have a negative impact on the capital gains tax treatment of venture capital.

As a result of those debates, the memorandum of understanding that had been agreed in 1987 was re-examined and a new one, again agreed between the Revenue and the British Private Equity and Venture Capital Association was published. It provided guidance to the industry, but, importantly, did not affect the operation of the law in the Finance Act 2003.

That memorandum of understanding confirms that returns received through carried interest should, in law, in the circumstances that it sets out—in plain vanilla form, which is a technical tax term that means “in a simple and straightforward way”—be taxed as capital gains. No concessions were made to the private equity industry at the time, but the memorandum of understanding clearly set out how the underlying legislation applied in the case of carried interest. It set that out in a way that would apply to any taxpayer who received such employment-related securities.

Rob Marris: Is my hon. Friend saying that the memorandum of understanding of 25 July 2003 was instigated or drawn up at the behest of Howard Flight, who was then the hon. Member for Arundel and South Downs?


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