Ever since UK chancellor Rachel Reeves warned of a £22bn “black hole” in the public finances, speculation about where the UK government will look to raise taxes in the upcoming Autumn Budget has been rife.
Amid this, increases in capital gains tax and reforming how private equity and venture capital funds are taxed, with changes to the treatment of carried interest, have been under discussion.
This news was met with alarm by the UK’s technology and VC ecosystem, and with good reason: tax increases targeted at entrepreneurs, early-stage technology companies and their backers will disincentivise start-up creation, small business creation, funding and innovation.
The reverberations would be widely felt. The UK cannot rely on mature but slow-growing industries like real estate and financial services to drive economic growth for the next several decades. We are a knowledge economy, and tech is critical for UK’s long-term prosperity and global geopolitical relevance and influence.
The chancellor stated in the election run-up that she would run “the most pro-growth, pro-business Treasury that this country has ever seen”, but if these tax reforms do go ahead they will do nothing but decelerate a tech sector that is one of the country’s only options for long-term economic growth.
If that is the risk – what are the gains? The only logical conclusion is that the government has calculated the short-term potential tax revenues are worth it.
That is a miscalculation. The Treasury sees little revenue from taxing UK VC profits today because there are hardly any profits to tax, not because the tax rates are too lenient.
The state-backed British Business Bank, which has deployed £2.8bn into 120 UK VC funds since its formation, shows in its 2023 report on VC returns that the median UK VC fund has not delivered positive net returns (also known as distributions to paid-in capital or DPI) since the 2006 vintage.
Only the top quartile performing funds have actually returned any money to investors in any vintages since then (and even the top quartile has not delivered more than 1.5x DPI so far).
VC funds naturally take a long time to generate returns, but even if you look at all UK VC funds that have had a decade or more to mature, considerably fewer than half have generated any profits for the government to tax.
VC is not private equity and the two cannot be conflated; VC is high risk by nature, and most managers are not generating any profits to tax.
So increasing tax rates on capital gains and carried interest would do vanishingly little for the Treasury’s revenues, but would create disincentives to entrepreneurs and investors making the UK their base to build and back the disruptive tech success stories of tomorrow.
The tech market is small and if even a few entrepreneurs or fund managers are drawn to Paris or Berlin, that may mean the UK misses out on being the home of the next Wise, Revolut, Wayve, or ARM.
