US Senate Waters Down Fund Manager Tax

by Mike Godfrey, Tax-News.com, Washington

10 June 2010

As expected, the US Senate Finance Committee has watered down proposals that would increase the amount of tax that fund managers pay on their investment gains.

Congress is seeking to raise taxes on 'carried interest' to pay for the temporary reinstatement of various individual and corporate tax breaks which expired at the end of 2009.

Carried interest is the share of fund profits that accrues to the managers of the fund, and in the US is normally taxed as capital gains at 15%, rather than as ordinary income at rates of up to 35%.

Congressional Democrats have long thought that this 'loophole' is unfair on the majority of taxpayers and current proposals seek to increase the proportion of carried interest that is subject to income tax.

Legislation approved last month by the House of Representatives would, to the extent that carried interest does not reflect a return on invested capital, require investment fund managers to treat 75% of the remaining carried interest as ordinary income, a proportion which would fall to 50% for taxable years beginning before January 1, 2013.

However, in a substitute amendment to the American Jobs and Closing Tax Loopholes Act of 2010, the Senate Finance Committee has proposed decreasing the amount of carried interest that is recharacterized as ordinary income from 75% to 65%. The amendment also increases the amount treated as capital gains from 25% to 35% in taxable years beginning after December 12, 2012.

The change further decreases the amount of carried interest that is recharacterized as ordinary income to 55% and increases the amount treated as capital gains to 45% for gains or losses attributable to the sale of an asset which is held for seven or more years.

These changes would reduce the amount of revenues collected over 10 years from USD17.7bn to just over USD14.1bn. The venture capital and private equity industry, however, remains adamantly opposed to any increase in tax on carried interest.

Citing a new study tracking the correlation between tax rates and private equity investment, the US Private Equity Council (PEC) claims that increasing tax on profits earned by investment partnerships could reduce private equity investment in the US by USD7bn to USD27bn a year.

“This data is consistent over two decades and confirms that tax increases reduce private equity investment activity and that the proposed 157% tax increase on investment partnerships would have a harmful effect on the economy, the recovery, and job creation,” said PEC President Douglas Lowenstein. “We have said throughout this debate that private equity will continue, but this will have an adverse economic impact.”

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