HM Revenue & Customs put out a request for feedback on the proposed carried interest policy changes. Carried interest is the profit fund managers make (whether Venture Capital, or growth equity like traditional Private Equity).
In the interest of transparency this is the response in full 7percent Ventures submitted:
Dear Sir/Madam
In October 2024, the UK government released a document titled "The Tax Treatment of Carried Interest: Call for Evidence – Summary of Responses and Next Steps," outlining proposed reforms to the taxation of carried interest.
Key Proposals:
- Capital Gains Tax (CGT) Rate Increase: Effective from 6th April 2025, the CGT rates on carried interest will rise to a unified rate of 32%, replacing the previous rates of 18% and 28%.
- Transition to Income Tax Framework: From April 2026, carried interest will be taxed under the income tax framework, with qualifying carried interest subject to a 72.5% multiplier, resulting in an effective marginal rate of approximately 34.1% for additional-rate taxpayers.
- Consultation on Qualifying Conditions: The government is seeking input on additional conditions for qualifying carried interest, such as minimum co-investment requirements and holding periods, to ensure the tax treatment aligns with the economic characteristics of the reward.
- Qualifying carried interest is carried interest that is not IBCI. As a result, non-UK residents will be subject to Income Tax on carried interest to the extent that it relates to services performed in the UK (subject to the terms of any applicable double tax agreement).
Feedback as a UK investor in >100 early stage deeptech companies:
1. Minimum co-investment requirement is hugely detrimental on an individual-by-individual basis, it devalues the intended incentive of carry for financially constrained members of an investment team. And causes an even bigger diversity gap that already exists in VC and PE.
2. PE and VC should not have the same blanket rules applied - risk vs reward; stage; investment size and focus are not the same. VC stimulates innovation within the economy, something the government should be accelerating The time based provision could take into account the stage of the company at the time of investment, but it's a clumsy mechanic. The real difference between PE and VC is that PE companies buy control of a business, they take a majority (or often 100%) stake in a business. Therefore they CONTROL and own the business, they choose when to realise returns. VC and angel investors almost always do NOT have control of a business. They own minority stakes in startups with almost no control over the destiny of the business. They cannot decide when to liquidate. Often they cannot even realise a secondary sale of shares, because this has to be agreed by the Founders/CEO/Board and usually in any case it is very hard to find a buyer for a small minority stake in an early stage technology business, before the business has reached escape velocity (i.e. before it is worth many $bns and no longer an early stage startup).
The control and majority ownership would be a far better target as a way to differentiate between PE and VC. Along with total revenue or investment size.
3. The reform is encouraging talent to leave the UK and not encouraging anyone to come here. Some in the industry have warned there would be an exodus of top dealmakers from the UK if ministers made Britain an international outlier by lifting tax on carried interest too far. If the US wasn't already tempting the experienced fund managers of the UK, it will now become even more appealing with a rate of just 20% on capital gains for US residents. Jurisdictions such as Luxembourg or Ireland will become even more competitive than the UK.
Haakon Overli, GP at Dawn Capital, said that tax increases to carried interest may mean that “money leaves the UK tech ecosystem”. This is true.
Additionally, VC fund managers can operate in the UK but using funds domiciled elsewhere. While this means startups may still get investment, the RETURNS from that investment, the ultimate tax-take via carried interest or profit to LPs, or the fund manager, will go to the government with the more attractive tax regime. e.g. the U.S, or cyprus, or portugal, or elsewhere.
4. We do not think it’s helpful for the government to set minimum co-investment requirements at fund level, the market dictates what the acceptable rate is. If the government sets an obligatory rate it reduces the diversity in the emerging fund manager space (similarly to the point on individual co-investment requirements).
Additionally, I would suggest that netting off co-investment from management fees be allowable to count towards meeting the required condition.
All of these proposals are what we would describe as "off market". They simply add friction to the VC ecosystem, making it less easy to create, run and deploy a VC fund to back the startups the government says it wants to support in the UK.
In summary:
If fewer VC funds are managed in the UK, there will be negative downstream effects passed to disruptive and transformational startups that rely on venture capital funding to affect positive societal change.
This will hit short term metrics - such as a number of startups, employment rates in the tech sector, and number of "unicorn" type startup successes.
Long term it will be catastrophic, because key technologies which represent the future of how our society with live, but also where vast amounts of economic growth will come from, such as AI, quantum computing, space and robotics, will be lost to other European players or the U.S, having a long term and likely irreversible impact on the UK.
We finish by quoting directly from the government's own AI action plan:
"Be on the side of innovators: In every element of the Action Plan, the government should ask itself: does this benefit people and organisations trying to do new and ambitious things in the UK? If not, we will fail to meet our potential."
None of the proposals around carried interest for Venture Capital, are 'on the side of the innovators'. That is a fact.
Yours sincerely,
Andrew J Scott
Managing Partner, 7percent Ventures