'The AA; Rescue or Wrong Turn?' highlights the advantages of private equity to at least some stakeholders. Whilst the private equity takeover of the AA has not been a good experience for all employees, or even customers, private equity investors have already got their investment capital back, and are looking forward to billions of pounds of profit when they sell the AA on. How did they do it?
Firstly, by taking advantage of the glut of money around the world. Banks are falling over themselves to lend money, at ultra-low interest rates and with no strings attached. And the private equity firms do not even need to have a good credit rating. They secure the debt they borrow on the assets of the companies they buy. With pre-determined debt interest costs, any increase in profits from reducing staff numbers, for example, goes straight to the private equity investors.
But there is another reason why private equity is a ‘no brainer’. Debt interest payments, and not equity dividends, are tax deductible for corporation tax purposes. All private equity investors have to do is to buy a company, load it with debt, and benefit from reduced tax bills. The stakeholders who pay for this are a country’s taxpayers. Lower corporation tax receipts usually mean higher taxes elsewhere. This has had such a major impact that some countries have changed their tax laws.
For example, the private equity purchase of the main Danish telecoms operator, TDC, in early 2006 for 13bn euros (with a special dividend of nearly half that paid to private equity investors less than six months later) was 90% debt funded. It is estimated that this private equity financing alone has reduced Danish corporation tax revenues by more than 12%, and the recent private equity takeover of Danish cleaning company, ISS, will have made matters even worse for the Danish government – and for Danish taxpayers. The Danes are currently conducting a review of the tax deductibility of debt payments. And the German government is reforming its corporation tax rules, also with a view to limiting the tax deductibility of debt. However, Ed Balls, Economic Secretary to the UK Treasury, said recently that the government had no plans to review the tax deductibility of debt principle as far as UK-based firms were concerned.
This tax game is nothing new. Leveraged buyouts in the 1980s aimed to exploit exactly the same tax relief. That boom ended when interest rates went sky high, and a recession meant interest payments had no profits against which to be offset. If interest rates go up this time, or if there is a recession, we will experience a sense of déjà vu. But the secretive nature of private equity companies will make it much harder to find out exactly who is bearing the pain this time around.
- The AA: rescue or wrong turn? - are private equity investors saving or savaging The AA? The Money Programme investigates.
- The private equity rollercoaster - 2005 was a record year for UK private equity deals, but many in the industry see dark clouds on the horizon.
- Corporate accountability and ethics - a disregard for ethics can lead to trouble: remember the Enron saga.
- Tax shelters - nobody likes paying tax, but how far would you go to avoid it? Liberia? Monaco?
- Is tax avoidance only for the rich? - can everyone pay less tax? Or is it a rich man's game?