What does the Budget mean for Private Equity?

As investors into business in the UK and beyond, PE houses are interested in the overall effect of UK taxation for business and how this compares with other countries. The market place has been affected by the adverse worldwide economic climate and, in particular, large deals have been temporarily put on hold by the lack of supply of credit. Does the Budget and the current tax arena impact on this?

The changes in taxation of non UK domiciles, the potential changes to the corporate taxation of foreign profits and possible restrictions on interest deductions, and the overall competitiveness of the UK tax system, all affect whether PE funds decide to invest in the UK or outside.

Recently there have been significant changes in other European countries, such as Germany, reducing the ability to claim interest deductions by the introduction of earning stripping rules - it is welcome that the UK is not following those approaches.

The Budget has confirmed that the changes to non-domiciled taxation will be introduced from 6 April 2008, but there are some changes in the detail arising from consultations over the past few months. There was no announcement surrounding the ongoing consultation around the corporate taxation of foreign profits and possible restrictions on interest deductions. Therefore anti-avoidance rules may still be introduced that prevent planning for excess interest costs. However, this will not take effect until April 2009.

Capital Gains Tax

The abolition of taper relief and introduction of a flat 18% rate of capital gains tax have increased the number of small and medium sized deals completing before April. While the reduction in the main rate of corporation tax to 28% may assist tax paying portfolio companies, the reduction in capital allowances to 20% will disadvantage companies with significant fixed assets.

VAT Exemption Amendment

Changes to VAT exemption rules for the provision of fund management investment trusts and VCTs will affect some PE houses and they, in particular, will need to consider their overall VAT position as a result of these changes.

Opportunity to obtain VAT Refunds

Portfolio companies should consider whether there is an opportunity for them to obtain cash refunds of VAT from HMRC. This is not limited to specific transactions or industry sectors.

Additionally, it applies to certain overpayments of VAT on income and all under-claims of VAT on costs which arose before 1997. Claims can potentially go back to 1973 with interest (and potentially compound interest) receivable on any refund obtained.

Businesses will have a limited period until 31 March 2009 to make these VAT claims. Portfolios should be speaking to their VAT advisers to ensure that the opportunity to obtain VAT cash refunds is thoroughly investigated.

Other Changes

There has been a relaxation in the rules relating to companies claiming the small rate of corporation tax (21% from April 2008). The profit limits for this to apply are reduced by the number of associated companies. But calculating the number of associate companies will now not look at the total number of companies controlled by a PE fund, but rather solely the particular portfolio investment structure itself.

Shipbuilders and coal and steel production companies will now not qualify as investments for VCTs.

Conclusion

In all, the announcements in the Budget have not significantly affected the tax arena, although the significant changes announced in last year's Budget and Pre-Budget Report have been in the main confirmed.