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Carried interest could be at risk as UK reviews capital gains tax

Facing its worst budget deficit in decades, the UK announced an investigation into its capital gains tax system that could have a significant impact on private equity’s carried interest income.

Rishi Sunak, the UK's chancellor of the exchequer, asked that the investigation include allowances and exemptions within the capital gains tax structure. (Leon Neal/Getty Images)

Private equity executives receiving carried interest could be in for a significant tax hike after the UK announced an investigation into the country’s capital gains tax system.

Under the current rules, carried interest—an individual fund manager’s enhanced share of profits realized from investments—is taxed as capital gains at 28%, while income is taxed at a rate of at least 40% for those making above £50,000 (about $63,000).

Rishi Sunak, the chancellor of the exchequer, requested that an independent body of the Treasury examine whether the current rules are adequate as is or could be simplified. He expressed particular interest in how the country’s capital gains tax compares to other types of levies, sparking fears that there could be a raise in capital gains rates.

“The government has been keen to clarify that this is just an ongoing review, but if they level up, the capital gains element will no longer be favorably taxed at all,” said Eli Hillman, funds tax director at accounting firm Grant Thornton. “There will be demands from some to ensure that if there are any changes, it falls on those with broader shoulders, so there will likely be some political pressure in that direction.”

The UK is set for its biggest budget deficit since World War II.

According to the Office for Budget Responsibility, government borrowing is expected to reach £322 billion this year because of the pandemic. The OBR said in a recent report that tax increases of £60 billion or dramatic spending cuts will be needed to stabilize the UK’s public finances.

Hillman said that in the event of a tax hike, the final impact will be on executives’ pockets, but it could have ramifications for the wider private equity sector.

For solely UK-focused firms, Hillman thinks that it would be unlikely to change the way they operate. But for those that invest more internationally, the tax increase could lead them to locate more of their activities abroad.

“It’s of concern, but to think that the UK is the only country that will be looking to increase taxes on higher earners in the current situation is highly unlikely,” he said. “I’m not sure anyone will want to be voting with their feet at this stage.”

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