Hedge Fund Managers Face Congressional Grilling On Tax

by Mike Godfrey, Tax-News.com, Washington

14 November 2008

With Barack Obama soon to be installed in the White House, and with the Democrats in control of Congress, hedge funds can expect a less-than-easy ride on the tax front in the coming years.

This was the message that was underlined during a hearing by a House of Representatives oversight panel on Thursday, in which five of the world's wealthiest hedge fund managers were asked to explain why they should not pay higher rates of tax on their remuneration.

The hedge fund managers in question included: John Alfred Paulson, President, Paulson & Co.; James Simons, President, Renaissance Technologies; Philip A. Falcone, Senior Managing Partner, Harbinger Capital Partners; Kenneth C. Griffin, Chief Executive Officer and President, Citadel Investment Group; and, perhaps the most famous hedge fund manager of them all, George Soros, Chairman of Soros Fund Management.

"The five witnesses we will hear from today earned on average over USD1bn last year. Yet the tax law allows them to treat the vast majority of their earnings as capital gains. That means that at least some portions of their earnings could be taxed at rates as low as 15%. That’s a lower tax rate than many school teachers, firefighters, or plumbers pay," said Rep. Henry Waxman, Chairman of the House Committee on Oversight and Government Reform, in his opening statement.

Currently hedge fund and private equity managers pay tax at the long-term capital gains tax rate (15%) on their 'carried interest' in an investment partnership. This is a situation that many Democrats in Congress think is unfair given that American wage earners must pay ordinary income tax at rates of up to 35%.

In their testimony, the hedge fund managers differed in the issue of taxation, although the majority seemed to accept that they should pay more tax, in particular George Soros, who said that he would have "no problem" with it. However, John Paulson argued in his testimony that the comparison between the two forms of income was unfair, pointing out that all stock investors qualify for the preferential 15% capital gains tax rate if they hold onto the investment for more than a year.

The House has previously tried to pass a legislative amendment that would treat carried interest as ordinary income, but the initiative stalled in the Senate under the threat of a veto by President Bush. However, the proposal forms a prominent part of Obama's tax manifesto, and it seems more likely that the initiative will succeed with more Democrats set to take their seats in Congress in January.

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