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Private equity hopes for favorable tax treatment under Trump
March 1, 2017 / 9:51 PM / 6 months ago

Private equity hopes for favorable tax treatment under Trump

BERLIN, March 1 (Reuters) - Executives from some of the world's largest buyout funds said on Wednesday they were hoping for lenient treatment in tax reforms spearheaded by U.S. President Donald Trump.

The new administration in Washington has said it wants to reform tax rules that could lead to higher bills for private equity firms and their managers.

"Trump is very accessible for business. He is very accessible for private equity. I have met him before and after he was elected," Carlyle Group LP co-founder David Rubenstein told Reuters at the sidelines of the industry's annual gathering, the SuperReturn private equity conference.

The investment firms are concerned most about two tax issues: higher taxation of their performance fees known as carried interest, and removing the benefits of debt interest expense tax deductibility.

The way in which the share of profits from an investment paid to managers of private equity funds – generally among the richest Americans – is taxed, has been a U.S. political issue for years and made headlines in the election campaign.

The current carried interest tax arrangement allows partners at private equity funds to treat their profits as capital gains rather than ordinary income, and pay a rate of about 20 percent. That compares with a rate of up to roughly 40 percent for top salaried workers.

Efforts to change the tax treatment nationally have failed to gain traction for nearly a decade. But both Trump and Democratic presidential candidate Hillary Clinton vowed in the election campaign to close the loophole.

The planned inclusion of private equity tycoon Wilbur Ross in Trump's new administration as commerce secretary and the appointment of Blackstone's CEO Steve Schwarzman as head of a new council to advise Trump on job creation has raised the hopes of some investment managers of being heard when taxation reform is discussed.

Top executives from KKR & Co LP and Cerberus Capital Management LP have also been among recent White House visitors.

The private equity industry argues the current tax system encourages the kind of risk-taking needed to grow companies, and its lobby group the American Investment Council has spent millions trying to influence lawmakers to retain the status quo.

"Keeping the entrepreneurial incentive is a good thing," Rubenstein said.

Critics point out that private equity managers largely invest other people's money rather than their own. Funds collected from investors such as pension funds usually make up 90 percent or more of the money a private equity manager puts to work.

At the same time, the private equity partners usually take a cut of 20 percent on any profit they make in selling an asset after having restructured and grown it, which is then taxed using the lower capital gains rate. Unrelated to performance, they book a management fee of typically two percent annually of assets under management.

"Expertise and talent (in managing a fund), no matter how great is a service," said John Hooker from the Patriotic Millionaires, a group of 200 wealthy Americans lobbying to close the carried interest loophole.

"Every other American in this country is taxed for their services, or labor, as ordinary income. That is what carried interest is, or should be - ordinary income," he said earlier this month.

Many private equity managers, General Atlantic's William Ford, believe that the days of the current treatment are numbered.

"We've had 5-10 years extra time... I think it's the most likely (change) tomorrow."

INTEREST DEDUCTIBILITY

Trump and Republican lawmakers' plans to slash tax rates for U.S. companies but at the same time end the deductibility of interest payments in the calculation of a company's tax bill is an even bigger concern to some private equity managers.

The likes of Blackstone, KKR and Carlyle typically finance acquisitions with two thirds in debt, meaning that disallowing the deduction of interest payments for tax purposes would directly weigh on their profits.

"It will absolutely change the calculus for private equity," said Ares Management LP co-founder Michael Arougheti.

The impact would, however, likely be mitigated by a lower corporate tax rate that Trump has promised.

"The net effect could be positive," said KKR manager Johannes Huth. (Reporting by Arno Schuetze and Dasha Afanasieva in Berlin; editing by John Stonestreet)

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