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Private Equity Eyes Next Tax Move by Congress

Tuesday, 19 June 2007 12:00 AM

WASHINGTON -- Private equity industry lobbyists were working on Tuesday to undercut a move in the U.S. Congress to close the industry's access to one tax loophole, while awaiting what many expect will be action on another.

The leaders of the Senate Finance Committee last week introduced bipartisan legislation that would sharply raise the taxes for private equity firms that go public, as industry giant Blackstone Group LP proposes to do.

But lobbyists and lawyers in the industry said they also expect an eventual attempt in Congress to raise taxes on all private equity firms, not just those going public, by redefining "carried interest" -- the 20 percent cut of profits normally kept by the firms from sales of companies.

"The legislation that came out on Thursday wasn't necessarily what the market was expecting," said Bob Kennedy, a partner at New York law firm Jones Day.

"There is still potentially another shoe to drop, which would be legislation that looks to increase the tax on the carried interest and that presumably would affect not just publicly traded partnerships, but all private equity firms."

The head of the U.S. Securities and Exchange Commission, Christopher Cox, said on Tuesday that lawmakers' concerns about Blackstone's $4 billion initial public offering, expected to be priced on Thursday, were also of interest to the regulator.

For more on Cox's comments, double-click on

Private equity firms are investment funds. But they do not just buy shares in companies, they buy control of companies outright, usually specializing in under-performers.

After improving their performance, the firms then sell the companies at profit. Most of the carried interest cut of the gains goes to the firm's senior partners.

But under present tax law, private equity partners do not have to pay normal, 35 percent income tax on carried interest. Instead, they pay the 15 percent capital gains tax rate.

The Senate Finance Committee has been looking at carried interest. Chairman Max Baucus, a Montana Democrat, said last month he wanted to do "what's right" on the issue.

The committee has talked privately with Victor Fleischer, an associate professor of law at the University of Illinois, who has written a paper on tax treatment of carried interest.

"We ought to have a baseline rule that treats all carried interest distributions as ordinary income," Fleischer said in an interview, arguing that the work done by fund managers is an active business, not a passive investment.

The United Kingdom is moving toward changing tax treatment of carried interest.

"It seems likely that we're going to see a change sooner or later" in the United States, as well, Fleischer said.

For now, Congress is focused on a more limited effort to close what some lawmakers see as a loophole letting investment funds go public without paying corporate income taxes.

Baucus and senior Senate Finance Committee Republican Chuck Grassley, of Iowa, last week introduced a bill to more than double the tax rate on publicly traded partnerships to as much as 35 percent from the 15 percent level now paid by partners.

The Baucus/Grassley bill alarmed the booming private equity industry. Attention had been drawn to the publicly traded partnership tax structure by Blackstone's IPO.

The Baucus/Grassley bill would tax publicly traded partnerships at corporate rates effective in mid-June, but not for Blackstone and another firm that has gone public, Fortress Investment Group. Both are grandfathered and would not face the higher tax for five years.

A lobbyist for the investment fund industry who asked not to be named said passage of the Baucus/Grassley bill was by no means certain, with initial excitement over it subsiding.

Congressional aides, asked about support among lawmakers for the bill, have been noncommittal in recent days.

At a gathering with reporters on Tuesday, House Majority Leader Steny Hoyer, of Maryland, was asked about the Senate bill. "It hasn't been an item of big discussion," he said.

© reuters 2007. All Rights Reserved.

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WASHINGTON -- Private equity industry lobbyists were working on Tuesday to undercut a move in the U.S. Congress to close the industry's access to one tax loophole, while awaiting what many expect will be action on another. The leaders of the Senate Finance Committee last...
Private,Equity,Eyes,Next,Tax,Move,Congress
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2007-00-19
Tuesday, 19 June 2007 12:00 AM
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