Carry tax is ‘alive and well’

A proposal to treat carried interest in the US as ordinary income rather than capital gains is “alive and well,” said Private Equity Council president Doug Lowenstein at ACG InterGrowth Wednesday in Miami.

The US Senate is feeling pressure to pass the measure, despite having previously resisted, Lowenstein said. Though few in Congress want to pass the measure on principle, Congress is “desperately searching for ways to pay for things,” and a measure the Senate has previously rejected twice could finally be approved.

Mel Schwarz, a partner at Grant Thornton who was on a conference panel with Lowenstein, said the government is under “enormous pressure” to find revenue to keep the deficit from rising uncontrollably. “Virtually everything that is on the table will need to be passed,” Schwartz said.

The carry tax hike was already approved by the House of Representatives. Once the Senate passes its own version of legislation, the two bills will be reconciled in committee, then signed into law or vetoed by President Barack Obama, who has said he supports taxing carry as ordinary income.

I feel much more positive about financial regulation. Very little is in those bills the way they are written right now which is especially alarming. Doug Lowenstein

But because the carry tax hike is being viewed as a revenue raiser rather than an ideological move, it’s possible that once Congress determines how much money it needs to raise, the private equity industry could negotiate a lower “hybrid” tax rate for carry, Lowenstein said.

The conference panel talked about other regulatory issues that could affect private equity. Lowenstein said he is less concerned with the possibility that private equity partnerships will have to register as investment advisors with the Securities and Exchange Commission – a move that has been written into the House of Representative’s version of financial reform regulation. The Senate version would require hedge funds of a certain size to register, but exempts private equity and venture capital.

“I feel much more positive about financial regulation,” Lowenstein said. “Very little is in those bills the way they are written right now which is especially alarming.”

The PEC supports registration for the biggest private equity firms, many of which are already registered, but is working hard to convince lawmakers to exempt the smaller private equity firms, Lowenstein said.

In the longer term, Lowenstein said he is more concerned that pension funds will come under pressure – or regulation – to stop investing in private equity.

“Pensions are under tremendous pressure to be more discriminatory about where they invest,” he said. Pension funds, because they control the retirement savings of public sector workers, and often have labor union representation on their board, are politicised entities, he said.

Lowenstein said he is also concerned about talk that Congress will change the treatment of debt in the tax code. Currently, interest payments on debt are tax deductible, giving debt an advantage over equity. But after the financial crisis, that tax advantage may be taken away, he said.

Lowenstein pointed out that in the UK, even the Conservative party has said it would eliminate the preference for debt in the tax code.

“This is not wacky left wing kind of talk – it’s people all across the spectrum,” he said.