Revenue clamps down on leveraged deals

Industry experts warned yesterday that the UK's vibrant private equity market could be knocked sideways by an Inland Revenue decision to stop the sector from offsetting the interest charged on leveraged deals against their profits to cut their tax bills.

The changes, which took effect yesterday, are likely to put future takeover deals of public companies, such as Apax's proposed bid for Woolworths, under pressure, analysts warned. One private equity executive said: "We'll fight the Revenue on the beaches about this. I question the whole premise of their attack and I'm not sure it will stand up to scrutiny."

The changes will stop private equity-owned companies from offsetting the interest on loans provided by their private equity investors if the loan terms are judged not to be "arm's length". This will hit the profitability of buyouts conducted by some of the City's big names, including Guy Hands, at Terra Firma, and Jon Moulton, at Alchemy.

Dawn Primarolo, the paymaster general, said the new measures would ensure companies "cannot increase tax relief for their financing costs simply by arranging their finance through a different structure, ensuring a level playing field for all businesses."

Cazenove, the broker, said: "It will clearly be unhelpful for sentiment in the short term, and might lead buyout houses to be marginally less aggressive in terms of their bid prices and deal structures."

The British Venture Capital Association, the trade body, said: "It is a shame to see what seems to be an attack on an industry that makes a major contribution to the UK economy but if that is Government policy then we must work within or seek to get the policy changed."

The new regime will not be applied retrospectively, as some had feared, but it will close a loophole by also applying to deals where investors have clubbed together to buy companies.

Paul Megson, UK head of private equity tax at KPMG, said: "Private equity groups have now been put at a disadvantage to strategic buyers. Logically it will be harder for them to raise bank debt because the bank will see that there is less cash flow available to service the debt."

Analysts warned the changes could puncture the valuation bubble that kept the retail sector aloft, despite one of the worst Christmases in recent years. Shares in groups from J Sainsbury and MFI, to Marks & Spencer and French Connection have been buoyed by speculation that they are probably venture capitalist targets.

Simon Witney, a partner at the law firm SJ Berwin, said the changes would "affect the economics of most deals".