As Rachel Reeves spoke with buyout bosses and venture capitalists in Leeds earlier this month, the mood was warm.
Investors around the table laid out a boosterish pitch for private capital and its role in the economy and the Shadow Chancellor was equally glowing in her response.
“The private equity and venture capital sector is incredibly important for fulfilling our mission to grow the economy,” Reeves told those around the table, according to a post from the British Venture Capital and Private Equity Association, which organised the meeting.
But the cordial tone of the meet-and-greet belies something of an elephant in the room in Labour’s current pitch to the City.
Top private equity bosses around the country are beginning to fret about a potentially punitive tax measure from Labour that threatens to eat into their earnings and blow the party’s Square Mile offensive off course.
Carried interest, or ‘carry’, is one of the primary ways that private equity bosses make money. It allows private capital managers to pocket a share of the profits of asset sales while paying a tax rate of 28 per cent, in line with capital gains tax.
Labour, however, is intending to change that. The party has so far remained steadfast on a commitment to ramp up the tax rate on carry to as high as 45 per cent, in line with the higher level of income tax.
The policy, first tabled in 2021, is now putting the party on a collision course with the sector even as it tries to woo the wider City with an all out offensive, and senior figures in private equity are already warning of a bruising impact.
“It’s a bit like Brexit,” says Jonathan Blake of Herbert Smith Freehills, dubbed the ‘father of private funds’, who was instrumental in drawing up the current carry regime in the 1980s.
“We’ve been saying for some time that people will move, but these things happen slowly. There has been a Brexit toll on London as a financial centre, and the same could happen with carry.”
“We’ve been saying for some time that people will move, but these things happen slowly. There has been a Brexit toll on London as a financial centre, and the same could happen with carry.”
Jonathan Blake, Herbert Smith Freehills
While London’s private equity industry has “been head and shoulders above other European countries, other countries are trying very hard,” he adds.
The tax is a big earner for those at the top of the UK’s buyout giants. Research from law firm Macfarlanes found that 255 private equity executives earned £2.7bn in carried interest for the tax year 2020/2021.
Central to the warning from dealmakers and advisers is that hiking the rate would put the UK out of step with international peers and push those same dealmakers overseas. France, Italy and Germany for instance tax carry between 26 and 34 per cent, and in the US, the level sits at 20 per cent.
However, debates over the carry threshold have raged in those countries too. As part of his re-election platform, President Biden has pledged to scrap the 20 per cent lower capital gains rate on carry and hike it to 37 per cent in line with the upper band of income tax.
Back in 2012 in France, Francois Hollande also proposed slapping a 75 per cent tax rate on carry, prompting warnings of an exodus of dealmakers.
However, none have so far acted.
Blake says he is “perplexed” as to why the UK would be the first to do so. “These fund managers are mobile,” he warns.
The prospect of a hike in the rate is already prompting action in some quarters. The BVCA, which convened the meeting in Leeds earlier this month, has been discussing the plans with Reeves.
In a statement shared with City A.M., Michael Moore, the chief of the BVCA and former Lib Dem MP, said the group “will work to maintain the internationally competitive arrangements which attract capital and investment professionals to the UK”.
“Labour have set out their taxation position. And we have shown the party how much the industry contributes to the UK,” Moore added.
For Labour, the debate is proving a tricky one to navigate optically as it mounts an effort to win round the financial services sector. As one industry source describes it, back in 2021 the party may have been framing it as the “asset strippers and their Mayfair tax loophole” but that “rhetoric just isn’t there anymore.”
“There has definitely been a shift in the perspective of the industry in that respect,” the person added.
Another senior industry adviser says that the Shadow City minister Tulip Siddiq seemed to “get it” at a recent meeting with private equity bosses.
However, the political situation is also stacked against Reeves and Starmer. The party has just had one of its key revenue raisers robbed by Jeremy Hunt in the scrapping of non-dom tax status in the budget and it is now looking for tax measures to fund its manifesto plans.
Suggestions Labour might consider watering down its proposals did emerge in recent months – but it seems a broadly fair assumption they might be less likely to do so now.
George Dibb, head of the Institute for Public Policy Research (IPPR)’s Centre for Economic Justice, argued that while Labour’s “first consideration appears to be the stability of the system” in a bid to spark growth, the party is also juggling “wider economic fairness issues”.
“They’re balancing those different things; not wanting to make major changes to the tax system that might cause instability, and where there is unfairness addressing that, and the politics of it,” he told City A.M. “All changes to the tax system create winners and losers.”
A Labour spokesperson said: “Labour has worked hand-in-glove with the financial services sector and is proud to have recently published our Financial Services Review this year after consulting extensively with the sector. The financial services industry is one of Britain’s greatest assets and Labour’s plan promises to build on this success, unlock investment and drive growth.
“The only risk to the UK economy is five more years of this tired Tory government who have taken a sledgehammer to the UK economy and plan to unleash further chaos with the Chancellor’s £46bn unfunded tax cut.”