Please enable JavaScript to view this website.

Private Equity Shares the Spotlight with Tax Reform

Post-2012 Presidential Election, the private equity industry is in the public spotlight simultaneously with the tax reform proposals. Throughout the election, private equity was a constant topic of conversation – especially Bain Capital. Acknowledging the media attention received from the election, Bain Capital addressed its investors in a formal letter thanking them for their support despite the increased scrutiny.[1] In this letter, Bain Capital attempted to portray the positive aspects of the business outside of its profits by asserting its creation of hundreds of thousands of jobs and support of hundreds of charities in its 28-year history. [2] These reassurances acknowledge the added scrutiny to the private equity industry that may not disappear post-election.

Tax reform is one topic that has emerged in response to the perceived inequities in the tax code and the need to reduce the national deficit. Earlier this year, President Obama proposed changes to the tax code to end corporate tax breaks and decrease the corporate tax rate from 35% to 28%. [3] Similarly, the top House Republican tax writer, Dave Camp, has vowed to pass tax reform legislation in 2013.[4]

With the private equity industry comprising a significant amount of the U.S.’s economic activity, this industry is not likely to avoid the effects of tax reform. Venture capital, one subset of private equity, alone provides 21% of the U.S. GDP.[5] If these efforts to close the gaps in the tax code are successful, private equity’s increased media attention comes at an inopportune time in light of the industry’s favorable “carried interest” rates.

Under the “carried interest” rule, private equity firms, alongside real estate and mining partnership structures, could lose its favorable tax treatment. In this provision, private equity firms are able to pay the capital gains tax rate, 15%, on a third of its profits rather than the income tax rate, 35%, paid on the remaining two-thirds of payments made on the guaranteed annual management fees. [6] Supporters of the favorable tax treatment argue that the private equity firms should be viewed as entrepreneurs whose risk-taking should be encouraged by this favorable tax rate.[7] Yet, some critics of the favorable tax rate state argue that private equity funds should be treated like investment bankers who use individual investor funds in these risky investments and retain approximately a 2% management fee and a 20% profit if they reach their target.[8]

Congress estimates that eliminating this favorable tax rate could generate up to $2 billion in tax revenues, increasing the attraction to close this provision. [9] Despite objections from the industry that investors would not receive adequate returns on their investments in this risky industry, there are admissions of some industry members that the “carried interest” provisions are generous.[10]

As the public and Congress continue to look more closely into the private equity industry, the favorable tax provision in private equity will not likely avoid review following the election. Consequently, as the support for tax reforms increases in the upcoming year, the media attention provided to the private equity industry makes the industry a prime candidate for tax reform in 2013, decreasing or eliminating the “carried interest provision”.

_____________________________________________
[1] Greg Roumeliotis, Bruised by Romney criticism, Bain Capital thanks investors, Reuters (Nov. 8, 2012, 8:31PM), http://www.reuters.com/article/2012/11/09/us-usa-campaign-bain-idUSBRE8A804220121109.

[2] Id.

[3] See, Kevin Drawbaugh & Patrick Temple-West, Top U.S. House tax writer vows tax reform in 2013, Reuters (Nov. 15, 2012, 8:26 PM), http://www.reuters.com/article/2012/11/16/us-usa-tax-camp-idUSBRE8AF00620121116; Zachary A. Goldfarb, Obama proposes lowering corporate tax rate to 28 percent, The Wash. Post (Feb. 22, 2012), http://www.washingtonpost.com/business/economy/obama-to-propose-lowering-corporate-tax-rate-to-28-percent/2012/02/22/gIQA1sjdSR_story.html.

[4] Id.

[5] Brian McCann, Private Equity Searches for its Public Identity After the US Election, Opalesque (Nov. 15, 2012), http://www.opalesque.com/private-equity-strategies/2/private-equity-searches-for-identity-after-the.html .

[6] An end to the carry on, Buy-out firms face the prospect of a bigger tax bill, The Economist (Nov. 17, 2012), available at http://www.economist.com/news/finance-and-economics/21566647-buy-out-firms-face-prospect-bigger-tax-bill-end-carry.

[7] Id.

[8] Id.

[9] Id.

[10] Id.

The following two tabs change content below.

Stephanie Cunningham

Latest posts by Stephanie Cunningham (see all)