Private Equity Demystified: If not tax avoidance, then what are all those tax havens for?
In the comments section below any Financial Times story on Private Equity you will find people with pitch forks and torches screaming about: tax avoidance, asset stripping, dividend recaps, short termism and some random undefined things usually captured by pejorative terms such as “rapacious fraudsters” or some such considered term.
In our book we try to guide the interested reader through the mob to take a closer look at what is actually going on in the rapidly growing world of private equity and debt.
Whenever I hear the word “complex” I mentally put it in the box labelled “Too Hard to Understand Without a Towel on my Head”, and I, like most people, move on to something else. Complexity suggests a difficulty in mapping cause and effect, butterflies flutter and storm clouds gather over far flung places. But in the case of PE it is not complex, so much as “intricate”. It is the fine details that matter when you are asking why you observe the structures you do in PE owned corporations, and it is these fine details that rarely get examined, considered and discussed, especially in the comments section of the FT.
International tax is a big area and probably too big for a short thought piece, but I’ll have a go!
All cross-border investment is made more difficult by the differing tax codes of the investor and the investment if they are not in the same country. Think about the transactions that go on between a US investor in a UK managed fund that buys a Norwegian company with operating businesses in America, Germany and Japan.
One way to simplify the problem is to put a tax transparent collective vehicle, usually a partnership of some kind, in a place where it will pay no tax – a tax haven will do nicely – and then to pay the investors in whatever tax jurisdiction they happen to be in, from the tax free haven and let them get on with their own tax affairs in their own country. The alternative is to have a different set-up for each investment that crosses an international border that will need to take account of each international tax treaty. PE funds do deals all the time so they use tax havens to simplify tax. I know it sounds counter intuitive when you see the complex structure to argue that it is to simplify things, but what you are often looking at is the complexity of the global tax system reflected in a corporation’s structure.
This isn’t tax avoidance. It is a pragmatic solution to the dog’s dinner that the politicians made of taxation during the globalisation of business in the past 25 years.
Of course, in the mess there are opportunities – or loopholes as they are known. In the UK there is a legal obligation to disclose any tax mitigation strategy. This was a very smart move by the master of the dark arts, one Gordon Brown. Because you must disclose what you are doing, HMRC get to automatically see every tax structure as it is created and therefore have a free warning system on every loophole that is out there. Similar rules exist in many, but not all, countries. Some countries have traditions and laws that assert a right to financial secrecy. Germany is the country that most people don’t think of as being secretive about money, but it is. There are slow moving attempts to bring all this together, but guess what? Politicians don’t like to co-operate on taxation because it impacts “sovereignty”. Now where have I heard that before?
Of course there are aggressive tax strategies and even fraudulent ones out there. But the general picture is not one of wholesale tax avoidance, but rather opportunism based on regulatory failure.
So, who is to blame? In the UK the legal position is clear – nobody has an obligation to maximise their tax payment, but everyone must obey the tax rules that are made in parliament and be open about what they are doing. This is why the view that we put forward in “Private Equity Demystified” is not that people should put down their pitch forks and put out their torches. We suggest, to borrow a phrase, that the Barbarian mob ought to be gathering at the gates of the global tax authorities who actually create and manage the mess – now that would be an interesting sight to see.
“Private Equity Demystified: 4th Edition” by John Gilligan & Mike Wright will be Published by Oxford University Press on 4th November 2020.
https://www.amazon.co.uk/Private-Equity-Demystified-Explanatory-Guide/dp/0198866992