Tax and the City: Four private equity chiefs appear before angry MPs

It is a long time since Gordon Brown pledged to end "the tax abuses which reach to the heart of our public finances by indulging the super-rich at the expense of the rest of us". More than a decade later, there is a growing sense that the Brown promise has not been kept. Today will see the latest phase in a ferocious row breaking out over the privileges of a select group of multi-millionaires who dominate the financial affairs of London.

Damon Buffini, 44, head of the private equity group Permira, is to appear before the Treasury Select Committee to defend his industry from allegations of excessive profiteering. Three other senior members of the industry will also be required to testify before MPs. The interrogation comes as the Liberal Democrats call for the abolition of a series of tax concessions currently exploited by some of the wealthiest businessmen in Britain.

Mr Buffini is thought to be worth about £150m, while Permira has bought businesses ranging from New Look to Little Chef and Holmes Place and made a 600 per cent return from its £900m sale of a revamped Homebase group.

Apart from the sheer disruptive scale of modern private equity activity on big employers - J Sainsbury and Jaguar/ Land Rover have recently been real or potential targets - Mr Buffini, and three other representatives of the industry, will have to satisfy MPs on two counts. First, he will be required to address the advantageous treatment given to companies that borrow money rather than raise it through issuing shares. Although such tax reliefs are available to all, private equity is often funded by huge levels of borrowings to take advantage of low interest rates, and thus has been the most spectacular beneficiary of the current rules.

Second, and less defensibly, private equity has exploited a measure introduced by Mr Brown in his 1998 Budget aimed at rewarding small businesses by allowing them to keep 90 per cent of the capital gains on their assets after only two years. With a little financial engineering that can be converted into an effective income tax rate of 10 per cent. This was not intended to apply to the vast fortunes generated by private equity.

Nicholas Ferguson of SVG Capital candidly remarked that he was concerned at the low rates of tax paid on large deals in the City. He said he felt uncomfortable paying lower taxes than his cleaner.

The private equity boom is only one source of income for the super-rich who are turning London into one of the most expensive cities on Earth. According to property experts, a tiny number of extremely rich individuals is having a disproportionate effect on the London property market, helped by the exploitation of another tax loophole.

More than half of London's multimillion-pound houses are being bought by "non-doms", that is technically "non-domiciled" persons who are resident in this country and whose anomalous status allows them to avoid taxation on their non-UK earnings, usually the vast bulk of their income.

For those fortunate few who can demonstrate that they have some connection, family or business, with a foreign country, the UK is one of the more desirable places to work, rest and play. In the case of those buying a £5m or £10m family home with a smart address, stamp duty can be reduced from 4 per cent to the 0.5 per cent paid on share purchases by placing the house in an offshore company (thus allowing the buyer to purchase shares in the company/house rather than the property itself).

The general effect has been to see prime London property continue to rocket in value, with knock-on effects through rest of the property market in London and the South-east.

Non-domiciled status completely removes the risk that any tax might be incurred. Ownership of multiple properties and the use of offshore trusts also effectively insulate the super-rich against the vagaries of capital gains tax and inheritance tax. A study by the International Monetary Fund ranked Britain alongside Switzerland, Bermuda and the Cayman Islands as an "offshore financial centre", in effect a tax haven.

Vince Cable, the Liberal Democrats' Treasury spokesman, attacked the current arrangements as blatantly unjust. "There is a growing sense of unfairness in the tax system with millions of people paying increasing amounts of tax. This includes people paying 40 per cent tax on relatively moderate incomes who will also pay inheritance tax at 40 per cent and stamp duty at 3 to 4 per cent, but who are discovering that the super-rich pay none of these things... The current system is creating a corrosive sense of unfairness."

Throughout his chancellorship, Mr Brown has shared Tony Blair's reluctance to alienate big business or jeopardise the pre-eminence of the City in world money markets. The kid-gloves treatment of private equity funds has reflected that approach.

In July 2003 a memorandum of understanding between the British Venture Capital Association and the Inland Revenue established a "safe harbour" for capital gains - even when fund managers have not risked their own money.

Stuart Adam of the independent Institute for Fiscal Studies says the generosity of tax breaks available in such cases is "difficult to justify". One estimate puts the cost to the exchequer of these tax breaks at £6bn per year.

The advantages of wealth

Stamp Duty

Levied at 4 per cent on properties worth £500,000 or more,it can be reduced to 0.5 per cent if the house is placed in an offshore company.

Capital Gains Tax Taper Relief

Privately held business assets sold on after two years can attract a mere 10 per cent tax; much lower, say, than on gains from property or quoted shares or indeed on income.

Non-domiciled Status

Provided you can prove some family or business link in foreign country, you are effectively free of virtually all UK tax on non-UK income.

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