The Chancellor should use Monday's Pre Budget Report to reverse the clampdown on taxation that is hitting private equity deals like management buyouts, it was claimed today.
Linda Marston-Weston, Birmingham-based transaction partner with accountants Ernst & Young, said in recent years there had been "an unwelcome tax clampdown, with the potential to damage private equity deals across the board".
The HM Revenue & Customs' hard line was affecting highly leveraged MBOs and secondary buyouts, which had seen a resurgence of activity over recent months.
"MBO teams often think that the growth in value of their shares will ultimately be taxed at an effective capital gains tax rate of ten per cent thanks to taper relief," said Ms Marston-Weston.
"Unfortunately, gains on these shareholdings can now be reclassified as 'earnings from employment', thanks to a tightening of the rules for employee/director shareholders.
"Now, unless the shares are acquired at market value, income tax and national insurance will be payable at a rate of 41 per cent and the company may also have to pay employers' national insurance at 12.8 per cent
" Large figures can be involved, given the potential for MBOs to boost shareholder value in quite a short period of time, and what constitutes market value is a complex area in the context of employee/director shareholdings. This whole area requires careful consideration by tax advisers early in the deal process."
Ms Marston Weston said the clampdown was also hitting secondary buyouts.
In a typical deal of this type, the existing private equity investors look to realise their stake, effectively to be replaced by another.
The new investor sets up a new company and, once it has been financed with a mixture of debt and equity, it will then buy out the existing shareholders, both the private equity backers and management.
In most cases, the management shareholders receive a share in the new company, as well as some cash or loan notes as part of the deal.
But Ms Marston-Weston said such deals could now create large tax bills.
"If the shares were not originally issued at market value, then income tax/national insurance consequences will follow for the employee and company. But with secondary buyouts, there can be additional problems. Where management's equity interest in the buyout vehicle remains the same, or even in some instances where the shareholding reduces and that reduction is not significant, HMRC may argue that management shareholders who realise value as part of the secondary buyout process are merely selling their shares to themselves for a capital sum.
"Anti-avoidance provisions could apply and any cash/loan note consideration received by management shareholders could be taxed as if it were dividend income, at an effective tax rate of 25 per cent (for higher rate taxpayers), rather than at capital gains tax rates, often effectively at ten per cent due to taper relief.
"The effects of leverage on the value of the equity are clearly ignored by HMRC in such deals.
" Unfortunately, the changes have had the effect of making more complications for deals and this is not good news for the economy or for enterprise.
"They are problems we could all do without.
"I would like to see the Chancellor row back from the attacks on deals and those who make them work."