Congress Considers New Taxes on Private Equity Industry

Published July 23, 2010

The U.S. private equity industry has seen its total funds raised drop from $139 billion in 2000 to $45.1 billion in the first half of this year (compared with $61.2 billion in the first half of 2009), yet Congress is moving to impose new punitive taxes on private equity.

The private equity industry helps turn around many of the nation’s underperforming companies and create new businesses.

Alan Patricof, founder of private equity firm Greycroft, LLC, is firmly against Congress’s proposals to impose additional taxes on the industry. The inventory of startup companies Greycroft has helped fund includes the highly successful Huffington

No Understanding
Patricof says Congress does not understand how weak the U.S. private equity industry is because of the recession that has lasted since the end of 2007, nor how taxing enterprise value and carried interest in private equity funds will further damage this core job-creating sector of the nation’s economy.

He notes the enterprise value tax singles out for punitive tax treatment the 10 million Americans in investment partnerships.

“I don’t think they have clearly thought it out. I do not think they understand what they are doing. They are not geniuses down there [Washington, DC]. They really don’t understand how people run their businesses,” Patricof said.

“They don’t understand that carried interest works in promoting partnerships,” he added. “Most partnerships distribute carried interest through individual partners at the onset of a new private equity fund. They have a practice of normally keeping half of the carried interest in the fund to invest [in new job-creating companies], and the other half goes to the individual investors.

“They really don’t understand,” he continued. “They are confused. If this gets passed it is going to have all sorts of unintended consequences and we are going to find out that this law has more implications than they are bargaining for.”

‘Outrageous’ Tax
Patricof said he doesn’t think lawmakers “know what exactly they are doing” because it is such a complicated issue, adding the “proposed enterprise value tax is just outrageous. I don’t think it is an appropriate tax: To tax someone’s interest in their company? And also, if, say, the interest in any of these investment partnerships is owned by a corporation, a corporation is already subject to ordinary tax rates, so why hit them again with another tax?”

American Enterprise Institute Senior Scholar Alan Viard said there are several “myths” concerning carried interest, including it’s taxed at the capital gains rate, receives a special tax break, and is a means of tax avoidance.

He said if a fund sells a portfolio it has held for more than a year, the resulting profit would be taxed at the 20 percent capital gains rate. But interest income from bonds that fund managers receive – as well as the fees they are paid – are taxed at the 39.6 percent income tax rate.

Robert Stewart, a spokesman for the Private Equity Council in Washington, DC, said if Congress intends the private equity industry taxes as a means of going after financial service companies that helped break the America economy in late 2007, they are targeting the wrong industry.

‘Nothing to Do With Meltdown’
He said none of the equity industry firms “had anything to do with any of the companies implicated in the financial meltdown. These [anti-private equity industry] taxes apply against investment partnerships like family businesses and family partnerships, and these taxes against them will have wide-reaching effects on the economy.

“The enterprise value tax, too, singles out these investment partnerships and says if the business is sold they no longer get capital gains treatment but [instead] income tax treatment [which has higher tax rates than capital gains], unlike all other companies that are sold,” he added.

Stewart said the result will be to hurt the small business investor.

“That’s the unintended consequence. All I know is this is going to put considerable pain on our small businesses,” he said.

Patricof stresses that he has no stake in whether the enterprise value tax passes or not but is speaking out because he finds the enterprise value tax unfair to the nation’s owners of and investors in real estate, energy, farming, and other companies.

Two Real Targets
Patricof says he believes the real targets of the proposed taxes are the Blackstone Group, an alternative asset management and financial services company, and Kohlberg Kravis & Roberts (KKR), a global asset manager. Both are prominent Wall Street companies.

“I am not fighting for myself here; I am not going to be touched by this, and my company owns no carried interest,” Patricof said. “But these [proposed] taxes are totally related to [Washington, DC’s] need for income. They are just trying to go after Blackstone and KKR, but they are going to hurt all the other people [in investment partnerships] in doing these taxes, and frankly I do not think it is fair to tax someone like this.”

Congress’s Joint Committee on Taxation has estimated an $18 billion increase in federal tax revenue if the private equity tax changes go through.
“It’s a punitive tax,” Stewart stresses. “It will have significant effects on investment. The enterprise value tax singles out all investment partnerships of all sizes.”

Thomas Cheplick ([email protected]) writes from Cambridge, Massachusetts.