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Source: Daily Tax Report: News Archive > 2014> February > 02/27/2014> Lead Tax Report > Carried
Interest: Camp's Tax Plan Hits Wall Street With Change in Carried Interest Treatment
39 DTR GG-3
Carried Interest
Camp's Tax Plan Hits Wall Street
With Change in Carried Interest Treatment
By Brett Ferguson
Investment fund managers would take a hit on their tax bills under House Ways
and Means Committee Chairman Dave Camp's (R-Mich.) proposal to dramatically
reshape the treatment of carried interest income.
Under current law, the share of long-term investment gains that fund managers
are allowed to keep for themselves as compensation is treated as capital gains and taxed at about half
the rate of ordinary income. President Barack Obama has called for that income, known as carried
interest, to be taxed at ordinary income tax rates, saying the payments are more like income from a
service performed than a return on investment.
Camp, while taking a softer line than the president, says he agrees.
"A partnership (e.g., private equity fund) that is in the business of raising capital, investing in other
businesses, developing such businesses, and ultimately selling them, is in the trade or business of selling
businesses. The businesses bought and sold by the partnership are its inventory," according to a detailed
summary of Camp's proposal.
The summary said to apply the tax law consistently, the profits derived by such an investment
partnership and paid to its managing partners through management fees and a profits interest in the
partnership should be treated as ordinary income.
But the Camp proposal also takes into account the technicalities of such businesses, excluding
partnerships engaged in the real estate business, and applying a recharacterization formula to partners
earning carried interest to take into account any share of invested capital they may own.
According to the proposal, an applicable partnership interest would include any interest transferred,
directly or indirectly, to a partner in connection with the performance of services by the partner,
provided that the partnership is engaged in a trade or business conducted on a regular, continuous and
substantial basis consisting of raising or returning capital, identifying, investing in, or disposing of other
trades or businesses, and developing such trades or businesses.
Recharacterization Formula Applied
The recharacterization formula "generally would treat the service partner's applicable share of the
invested capital of the partnership as generating ordinary income by multiplying that share by a specified
rate of return (the Federal long-term rate plus 10 percentage points), intended to approximate the
compensation earned by the service partner for managing the capital of the partnership," the proposal
said.
Under the plan, the recharacterization amount would be determined, but not realized, on an annual basis
and tracked over time.
"To the extent a service partner contributes capital to the partnership, the result would be less capital
gain being characterized as ordinary income. Any distribution or gain from the sale of a partnership
interest (i.e., a realization event) then would be treated as ordinary to the extent of the partner's
recharacterization account balance for the tax year. Amounts in excess of the recharacterization account
balance would be capital gain," the proposal said.
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Tax and Accounting Center http://taxandaccounting.bna.com/btac/display/batch_print_display.adp
In a Feb. 25 article written for the Wall Street Journal, Camp said the proposal "can clean up provisions
like 'carried interest' that allow certain private-equity firms to get the investment-income tax rate on
what anyone else would call normal wage income."
Benchmark for Future Bills?
The carried-interest proposal comes on top of a Camp plan to impose a tax on the assets of the largest
U.S. banks and insurers. Even though his plan faces long odds in Congress this year, the proposal will
become a benchmark for tax policy.
Under current law, carried interest, or the profits share received by private equity managers, gets
treated as capital gains, with a top basic rate of 20 percent as opposed to the ordinary income rate of
39.6 percent.
Obama and other Democrats have been trying since 2007 to change that law with little success. Camp is
wrapping a change to carried interest inside a reconstruction of the tax code that would lower tax rates
and broaden the tax base.
Steve Judge, president and chief executive officer of the Private Equity Growth Capital Council, an
industry trade group, said Camp's proposal was "disappointing."
"Key policy makers from both parties have already made clear that the discussion around this draft
proposal will be brief," Judge said in a statement Feb. 25. "Nevertheless, Chairman Camp's proposal
penalizes long-term capital investment, which he and other members of the House Ways and Means
Committee have purported to support."
With assistance from Richard Rubin in Washington.
To contact the reporter: Brett Ferguson in Washington at bferguson@bna.com
To contact the editor responsible for this story: Cheryl Saenz at csaenz@bna.com
For More Information
Texts of the discussion draft and the section-by-section summary are in TaxCore.
Contact us at http://www.bna.cornicontact/index.html or call 1-800-372-1033
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J.S. Private-Equity Tax Change Doubtful This Year, Says Carlyle Co... http://online.wsj.com/news/articles/SB100014240527023038013045...
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MARKETS
U.S. Private-Equity Tax Change Doubtful This Year,
Says Carlyle Co-Founder
Suggested Reform Could Increase Taxes on Private-Equity Profits
By MIKE SPECTOR
Feb. 26, 2014 5:06 a.m. Er
BERLIN— Carlyle Group LP co-founder David Rubenstein said U.S. lawmakers are "unlikely" to take up
legislation this year that could potentially increase taxes on deal profits reaped by private-equity
managers.
Mr. Rubenstein's comments came after the chairman of the U.S. House Ways and Means Committee,
Republican Dave Camp of Michigan, said Congress should "clean up" the treatment of private-equity
firms' share of deal profits, called "carried interest." These profits are currently treated as capital gains and
taxed at a lower rate than ordinary income.
"We can clean up provisions like carried interest that allow certain private-equity firms to get the
investment-income tax rate on what anyone else would call normal wage income," Mr. Camp said in an
opinion piece published on Wednesday in The Wall Street Journal outlining a series of tax-reform
proposals.
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But Mr. Rubenstein, often viewed by private-equity watchers
as an authority on national politics since his firm is based in
Washington, said various factors would likely prevent any
measures affecting buyout firms from taking hold any time
soon.
Montana Democrat Max Baucus, previously the chairman of the Senate Finance Committee, was just
confirmed as the U.S. ambassador to China, lowering the chances that chamber will take up such
legislation, Mr. Rubenstein said. In addition, a term limit will force Mr. Camp to relinquish his committee
chairmanship in the House next year, he said.
"It's unlikely that will get into law," Mr. Rubenstein said of Mr. Camp's proposal before an audience at the
SuperReturn International private-equity conference in Germany's capital. "I don't think there is likely to be
any tax reform legislation passed by this Congress at all."
Private-equity firm managers, including Mr. Rubenstein and founders of other large buyout firms, have
argued that carried interest they receive after investing in a company and later selling it should be treated
as a capital gain. Proponents of taxing these profits at a higher rate contend the money is compensation
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for services private-equity managers render when working on companies they take private.
The carried interest debate bubbled up in the wake of the recession and financial overhaul law later taken
up on Capitol Hill. But the issue so far hasn't been addressed in any legislation passed by Congress and
for the most part hasn't gained traction amid other issues lawmakers are tackling. Still, many leading
private-equity managers expect at some point to receive the more stringent tax treatment.
Meanwhile, Mr. Rubenstein said sovereign-wealth funds will soon become the largest contributors of
investment capital to private-equity firms, surpassing giant pension funds. Sovereign-wealth funds
currently manage about $5.4 trillion, a number that will exceed $8 trillion by 2020, he said.
Mr. Rubenstein said he expected investment allocations to private-equity firms will continue increasing as
investors seek higher returns and buyout firms focus more on operational improvements to companies to
drive profits.
"It's not a financial engineering game as people thought in the early days," he said. "Operational
improvements are where the bulk of returns are coming from."
Write to Mike Spector at mike.spector@wsj.com
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