BVCA response to EU Commission Consultation of the taxation of the financial sector
About the BVCA: The British Private Equity & Venture Capital Association (BVCA) is the industry body and public policy advocate for the private equity and venture capital industry in the UK.
The BVCA Membership comprises over 230 private equity, midmarket and venture capital firms with an accumulated total of approximately £32 billion funds under management; as well as over 220 professional advisory firms, including legal, accounting, regulatory and tax advisers, corporate financiers, due diligence professionals, environmental advisers, transaction services providers, and placement agents. Additional members include international investors and funds-of-funds, secondary purchasers, university teams and academics and fellow national private equity and venture capital associations globally.
As a result of the BVCA's activity and reputation-building efforts, private equity and venture capital today have a public face. Venture capital is behind some of the most cutting-edge innovations coming out of the UK that many of us take for granted: the medical diagnostic services we use in hospitals, the chips in our mobile phones, the manufactured components of our cars, and the bioethanol fuels that may run them in the future. Likewise, private equity is behind a range of recognisable High Street brands, such as Phones4U, Birds Eye, National Grid and Travelodge.
Introduction
As an industry, we recognise the need both in the wake of a financial crisis and going forward, for each sector of society to contribute its fair share to the tax system – the financial services sector is no exception to this. However the Commission’s Consultation and in particular its assessment of the issues and the suggested policy responses should not be applicable to private equity and venture capital. It is worth noting that private equity and venture capital performed well throughout the financial crisis and ensuing recession. Controlling for deal size and industrial sector, PE-backed buyouts completed post-2003 are significantly less likely to enter insolvency than both non-PE-backed buyouts and listed companies, and are not more likely to enter insolvency than matched private companies in the same sector and size bands. [1] Emerging from recession senior managers of private equity backed businesses are confident that their companies will grow significantly over the next year, with almost 70% expecting turnover to increase and over 40% predicting employment growth[2].
Private equity and venture capital played no part in causing the financial crisis and did not need Government help to survive it. As the note below demonstrates, the way the venture capital and private equity industries operate does not lead to short term behaviour but instead rewards long term investments with clear alignment between the investors’ interests and the manager. The investors in venture capital and private equity funds are pension funds, sovereign wealth funds, insurance funds etc and any tax that were to apply to the industry would reduce the returns made by these investors.
The Consultation’s three reasons for addressing the issue
- Substantial public financing support during the crisis
The UK private equity and venture capital industry received no public financing support during the crisis, in fact quite the opposite, as it has significant resources available to invest going forward into businesses that have the potential to grow and drive the European economy forward.
- Undesirable behaviours for society as a whole e.g. excessive risk taking.
Private equity and venture capital played no part in causing the financial crisis with neither the Turner Report[3] nor the De Larosiere report[4] making significant mention. Leverage does not take place at the level of the fund, and on deal average basis leverage tends to be around 3:1 as against Lehmans for example which was leveraged up 32:1. The ECB estimates the aggregate amount lent to private equity-backed companies pre-crisis represented less than 1% of European banks’ assets[5]. Its activity is therefore not significantly interconnected to other parts of the system nor is there significant intra connectedness as neither funds nor portfolio companies are cross-collateralized. With respect to excessive remuneration and ‘rewards for failure’, this notion simply does not apply to venture capital and private equity. We invest in companies over the long term and the managers’ performance returns are only paid once the investors have received back their investment plus a return, normally 8% p.a., in cash. The industry will also be subject to the requirements of the Capital Requirements Directive III as applied by the FSA.
- Lack of coordination across countries
It is the right principle to try to coordinate regulation across different national regimes to avoid where possible regulatory arbitrage. The UK private equity industry has lead the way in Europe with the establishment of the Guidelines Monitoring Group. This group monitors compliance with the Walker Guidelines which seek to increase transparency through the identity of fund managers, information about the board and reporting requirements that bring portfolio companies backed by private equity into line with UK company law[6]. Furthermore, with completion of the Level 1 of the Alternative Investment Fund Managers Directive, it cannot be said that we will be left with an ‘uncoordinated patchwork of national measures’. The merits of the Directive aside, it is comprehensive and universal touching on leverage, capital, transparency and remuneration.
These three principles, whilst sensible in themselves clearly rule out any justification for the application of a Financial Transactions Tax or more likely a Financial Activities Taxto the private equity and venture capital industry.The Commission should give a clear indication that this industry is not within the potential scope of these proposals
On a broader point, the BVCA endorses the approach taken by EU 2020 and the Annual Growth Survey and would stress that if the EU is to return to sustainable economic growth it must attract venture capital and private equity investment which can then be deployed into European businesses to foster growth and create jobs. Either the actual imposition of FAT or FTT or the uncertainty created by speculation therein run contrary to this goal.
Financial Transactions Tax
Our stated position as above is that neither the FTT nor the FAT should be applied to private equity. However were the Commission minded to implement an FTT, rationale aside it would likely not capture private equity transactions and so we will not consider in detail the questions on this subject.
Financial Activities Tax
As stated any FAT would be levied on profits and remuneration. The notion of excess profits and risky activities do not apply to private equity and venture capital. As set out above, our activity poses no systemic risk so tax levied to address that would be disproportionately punitive.
Neither do we engage in excessive remuneration practices. Private equity and venture capital practitioners invest alongside pension funds and other institutions over the long term and are only rewarded as much as the whole investment appreciates. Any tax levied on top of this would be to the detriment of investors and the pension holders they represent.
The three discrete reasons given for the imposition of a FAT are as follows:
(i)Compensation for the VAT exemption in the financial sector
(ii)Taxing economic rents (excess profits)
(iii)Taxation of profits derived through risky activities
We have chosen to respond in detail only to option (i) as again, (ii) and (iii) do not apply to private equity and venture capital. The stated rationale for FAT 3 for example is to tax ‘excess return due to unduly risky activities’. As set out in our opening statement, notions of excessive leverage and systemic risk are not applicable to private equity so we would not expect to be subject to a tax levied on this basis.
FAT 1 – How does venture capital and private equity benefit from the VAT exemption?
In reality, VAT represents a significant cost to the financial services sector. VAT exemptions apply to many financial products (for example, personal loans, mortgages and share dealing) with the effect of minimising the cost to the consumer of buying financial products and services. However, the product / service provider cannot recover VAT incurred in delivering those financial products and services. VAT is paid by the product provider on most capital expenditure and running costs, and so is a significant addition to the underlying cost base, with no means of passing on that cost through the VAT system itself to the end consumer. Therefore, it is wrong to say that the financial services sector is lightly taxed in the form of VAT exemptions; VAT exemptions benefit the end consumer (for example, through there being no VAT on mortgages) with a corresponding VAT cost for the financial services industry as a whole.
This also flows through as a cost to the venture capital and private equity industry, in a similar way. This is because, generally, it means that the funds which are making the investments are unable to recover all of the VAT on the costs they incur. These include transaction costs, management fees, office rent and administration fees. As a result the investors in the funds already suffer lower returns, due to the restriction on VAT recovery, and therefore to impose a further tax on these funds would be both totally unfair and illogical.
[1]
[2] What to business managers think about private equity and venture capital? – BVCA 2010,
[3]
[4]
[5] See
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