Select Committee on Treasury Written Evidence

Memorandum submitted by HM Treasury

  The Government welcomes the Treasury Committee's inquiry into this important subject. Private equity remains a relatively small, although a growing, part of our economy and the Government's approach was set out fully in a speech given by the Economic Secretary on 8 March 2007.

  2.  The Government's starting-point is that any particular form of ownership is not inherently to be preferred to any other. Private equity, like any other form of ownership, has good and bad aspects. The Government's objectives in this field should be no different from that in relation to any other form of ownership: to promote high and stable levels of growth and employment through an environment of long-term, sustainable business success, underpinned by a strong culture of clear disclosure to, and engagement with, underlying investors.

  3.  The impact and role of private equity transactions vary widely in their nature. Moreover the available evidence base remains quite limited and results are to some extent conflicting and mixed.

  4.  Nevertheless, there is a reasonable consensus in the evidence available that private equity investment has a positive impact on productivity. Moreover, the evidence suggests that private equity firms do own companies for significant periods, on average around three years, which is 20% longer than the average length of time institutional investors hold shares.

  5.  One potential advantage of the private equity model is that the chain of ownership and communication is relatively short, giving the owners of capital much clearer direction of the businesses which they are financing than under some other forms of ownership. The advantages of a shorter chain of ownership, with clearer targets and accountabilities, will in some cases outweigh the benefits of public market ownership. Nevertheless, investors need to be vigilant about any potential for misalignment of incentives within the private equity model.

  6.  As the private equity model becomes an increasingly important component of UK capital markets, it is essential that the regulatory environment is appropriate. This is the responsibility of the FSA who regulate private equity firms who engage in these financial activities. The FSA issued an important discussion paper on its regulatory approach to the sector last November and a response is expected in the coming months.

  7.  Transparency and disclosure have also been important issues for the industry. The Government welcomes the establishment of a working group chaired by Sir David Walker, which is currently working to develop a voluntary comply-or-explain code to improve transparency and disclosure. The Government will watch developments in this area very closely.

  8.  The Government is strongly committed to a competitive tax environment that promotes enterprise. There has been some debate in recent months about a range of tax related issues, including the tax-deductibility of interest payments, shareholder debt and carried interest/management equity.

  9.  There is no special tax relief for interest paid by private equity-owned companies. Interest is in general is treated as a business expense for tax purposes. Most major tax systems adopt the same approach and international capital markets and global businesses are structured on this basis. There are no plans to review this fundamental principle.

  10.  The Government has, however, announced that it is reviewing one specific aspect of the current rules that apply to the use of shareholder debt where it replaces the equity element in highly leveraged deals. The outcome of this review will report back by the Pre-Budget Report 2007.

  11.  There has also been some discussion on the tax treatment of gains made by individuals on private equity fund managers' carried interest and management equity participation in private equity firms. The Government keeps all tax policies under review and has for some time been actively reviewing the taxation of a range of employment-related securities.

June 2007

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