The private equity model: how borrowing to buy a company turns its tax bill into a deduction

Private equity buys a company, usually with a large amount of borrowed money, improves or strips it, and sells it on. The tax advantages of this model operate at three levels at once: the company that gets bought, the fund that buys it, and the managers who run the fund. None of the core moves is illegal. Together they make the model an efficient engine for moving value out of a business and into the fund, with the tax system quietly subsidising the borrowing that makes it work. Here is each layer.

Layer one: debt-loading the company you just bought

The signature move is the leveraged buyout. The fund buys a target company using mostly debt, and then pushes that debt down onto the target's own balance sheet, often secured against the target's assets. The company now owes the money that was borrowed to buy it.

The tax mechanic is the point. Interest on that debt is deductible against the company's profits, which cuts its corporation tax bill. The acquired company has been pre-loaded with a cost that strips out its taxable profit, and the benefit of that tax relief flows into the fund's return. This is the same lever explained on our debt and interest page, applied to a whole company at the moment of purchase.

The clearest documented example is a private equity group's 2007 take-private of a major UK pharmacy chain. The acquired company took on around £9 billion of buyout debt. Between 2007 and 2013, a report by Unite the union, War on Want and Change to Win estimated the arrangement avoided at least £1.12 billion in UK tax through interest deductions, while roughly 40% of the chain's UK revenue came from the NHS, that is, from taxpayers. Those figures are union and campaign-group estimates, and we flag them as such; the £9 billion debt and the NHS revenue share are not in dispute.

The UK has since tightened the rule. The Corporate Interest Restriction caps tax-deductible interest at the greater of £2 million or 30% of a company's EBITDA, in line with the 10% to 30% range the OECD recommended globally. It limits the lever; it does not remove it.

Layer two: how the managers are paid

The fund's managers are rewarded mainly through carried interest, the profit share that was taxed as a capital gain rather than as income from 1987 until the reforms now phasing in. The full detail, the dispute over whether it is a loophole, and the move to an effective rate of about 34.1% from April 2026, is on the non-dom and carried interest page. In one line: the managers' performance reward was taxed at 28% as a gain rather than at up to 47% as pay, a difference the Good Law Project estimated at around £600 million a year in foregone UK revenue, a figure that remains contested.

Layer three: management fee waivers and the offshore fund

Two further techniques sit around the edges. The first is the management fee waiver, used mainly in the United States. A manager waives part of the fixed management fee, which would be taxed as ordinary income at up to 37% federal, in exchange for a priority share of the fund's capital gains, taxed more lightly. The US tax authority requires genuine economic risk for the conversion to stand, but structured correctly it turns ordinary income into a capital gain. The UK moved against this directly: the Disguised Investment Management Fee rules, in force from 6 April 2015, tax such fees as income.

The second is the fund's own home. UK and US private equity funds are typically built through Cayman Islands or Luxembourg vehicles, with the general partner, the management entity, often incorporated offshore. This lets non-UK and non-US investors take their gains largely free of source-country tax, supports treaty-shopping through favourable double-tax treaties, and reduces the managers' domestic tax exposure on fees.

Why the whole thing is built for extraction

Put the layers together and the shape is clear. The borrowing used to buy the company becomes a tax deduction inside the company. The managers' reward is taxed gently. The fund itself sits offshore. Richard Murphy of Tax Research UK characterises private equity as "a mechanism for financial extraction," dressing "financial engineering, debt loading and short-term extraction" as entrepreneurial dynamism; that is his stated view, and we attribute it as such. The neutral, arithmetic version is this: a model that pays for acquisitions with tax-deductible debt, rewards its principals with lightly taxed carry, and books its profits through low-tax jurisdictions, is a model the tax system actively cheapens. A business that funds itself out of retained profit and pays its people in salary gets none of those reliefs.