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Bush May Veto Fund Tax Increase

by Leroy Baker,, New York

29 June 2007

A senior White House aide has hinted that President Bush would be prepared to veto legislation currently being debated in Congress that would seek to more than double the amount of tax paid by certain funds.

In a press briefing, White House spokesman Tony Snow told reporters when asked to comment on the Democrat proposals, that "this is not an administration that's predisposed toward tax increases".

However, Snow was cautious not to officially reveal the administration's view on the bill recently introduced into the House of Representatives and said that the proposals need to be studied more closely.

"We're going to take a look at what Democrats have to offer. We'll take a look at tax provisions. Let's see what the House does and then we will give you a specific comment," he told the reporters.

However, Treasury Secretary Henry Paulson has expressed more explicit views on the issue, and has warned of the "unintended consequences" of targeting a single industry.

"I don't believe it makes sense to single out one industry," he told a conference hosted by the Wall Street Journal at the New York Stock Exchange. "The reason why we have a tax system as complex as we do is because the government tends to single out companies and industries, or responds to the pressures at the moment."

Calling for a broader approach to the issue, Paulson argued that the type of partnerships targeted by the legislation are a "great structure to promote risk taking and entrepreneurial spirit".

House Democrats have introduced legislation that would ensure that investment fund managers who take a share of fund profits as compensation for investment management services - known as "carried interest" - would be taxed at an appropriate ordinary income tax rate.

Currently, the managers of private investment partnerships are able to receive compensation for these services at the much lower 15% capital gains tax rate, rather than the ordinary income tax rate, by virtue of their fund partnership structures.

The legislation clarifies that any income received from a partnership, capital or otherwise, in compensation for services is ordinary income for tax purposes. As a result, the managers of investment partnerships who receive carried interest as compensation would pay regular income tax rates rather than capital gains rates on that compensation. The capital gains rate would continue to apply to the extent that the managers’ income represents a reasonable return on capital that they have actually invested in the partnership.

Similar legislation has also been introduced in the Senate by Sen. Max Baucus, Chairman of the Finance Committee, who says the proposals are designed to ensure that "tax laws are applied fairly across the board".

Unlike the House bill, the Senate legislation does not address the issue of carried interest, but clarifies a 1987 law that requires corporate taxation of all publicly traded partnerships, affirming that publicly traded partnerships that directly or indirectly derive income from investment adviser or asset management services are not entitled to an exemption from the corporate tax that is available to firms whose income is at least 90% passive – derived from dividends or royalties, for instance.

"With few exceptions, all publicly traded partnerships have been taxed as corporations for the past 20 years," Baucus commented in response to Snow's and Paulson's remarks. "Far from singling out one industry for punishment, we’re simply clarifying that private equity firms and similar businesses should not receive special treatment in the tax code."

He added that: "No one group of businesses should gain an edge over its competitors by claiming a tax status for which they do not qualify. Applying our tax laws fairly and according to precedent will make sure that American business continues to thrive and grow across all sectors.”

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