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The UK's pre-budget report30/11/2005. Source: SJ Berwin. Simon Witney 
The British Chancellor will deliver his pre-Budget report on 5 December, and the private equity industry is hoping for a seasonal boost from the door of Number 11 Downing Street, says SJ Berwin. Removal of tax anomalies is what is on the agenda of the UK private equity sector. Ending weeks of suspense for a wide range of interested parties, the UK Government announced last week that the Chancellor will deliver his "pre-Budget report" on 5 December. This relatively new tradition - a pre-cursor to the main event in the spring - has become established as a time for important announcements of future intentions.
This year, those active in the property sector are hoping for some positive news on UK REITs - "real estate investment trusts", which could have significant advantages over existing property investment vehicles.
But the private equity industry is also hoping for a boost from the Chancellor. This week, the British Venture Capital Association (BVCA) published its pre-Budget submission. This argues for removing many tax anomalies that currently disadvantage certain private equity structures, for extending some existing tax breaks, and for introducing some new ones. The BVCA submission follows hard on the heels of representations from the UK employers' association - the CBI - which has also made some useful suggestions to the Government.
One anomaly that the BVCA would like sweep away is the current operation of a rule designed to prevent large corporate groups that are organised into many smaller units from taking advantage of the lower rates of corporation tax available to "small companies". Qualifying companies can pay at the rate of 19% (instead of 30%) if their profits fall below a certain threshold.
But the rule says (sensibly) that "associated companies" have to share that threshold, so that none of them can take advantage of the lower rate unless the whole group's profits fall below the given level. The problem is that a venture backed company will rarely be able to benefit from the lower rates of corporation tax because it will be "associated" with the fund that has backed it - effectively treating the portfolio company as if it were a member of a corporate group. That is wrong in principle, and puts the company at a disadvantage to competitors simply because of its funding structure.
Both the BVCA and the CBI have made a similar point on the definition of an "SME" - a small or medium sized enterprise. This definition has become increasingly significant, but again its narrowness (based on a European Commission recommendation) is causing problems. Venture backed companies cannot be SMEs if they are treated as controlled by the manager of the fund that invests in them, denying them some important tax advantages.
To revitalise the Venture Capital Trust (VCT) industry, and following discussions between the BVCA, the Treasury and the tax authorities in 2004, income tax relief for investment in a VCT was temporarily doubled to the top rate of tax, 40%, and the threshold for the maximum amount of investment was raised to £200,000.
To sustain momentum in the VCT industry, the BVCA is seeking to persuade the Treasury of the positive impact of the higher rate relief on new funding. It argues for an extension of the 40% relief for a further year, as this is likely to give rise to substantial fund raising for investment in smaller high-growth companies, and to create a larger "investment infrastructure" for the future.
The BVCA once again urges simplification of the capital gains rules. While "taper relief" (which over time can reduce the effective rate of capital gains tax to 10%) has been a significant benefit since its introduction in 1998, and particularly following the changes made to it since, it remains complex, and, as the BVCA points out, can give rise to some curious results. The BVCA's suggested solution is to adopt a two tier system of taper relief, with the effect that gains on "business assets" (including shares in private companies) held for more than one year would bear tax at an effective rate of 10%.
There is no shortage of good ideas for the Chancellor to consider, most of which would benefit business as a whole, and not just the private equity industry. If the rhetoric is to be believed, the Government will take them seriously. We will find out soon, or perhaps in the spring Budget, whether they are going to take them forward.
Simon Witney
SJ Berwin is a pan-European law firm with a particular focus on private equity. It has offices in London, Frankfurt, Munich, Berlin, Madrid, Paris and Brussels. If you would like further information on our services to the private equity industry please contact Simon Witney in our London office 020 7533 2222 or visit our website at www.sjberwin.com
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