Congressional coup

The millions of dollars that private equity firms have poured into lobbyists' coffers appear to have paid off, as US legislators have – for now – relented on legislation that would have more than doubled the tax on carried interest.

The lobbyists that have been blanketing Capitol Hill for most of 2007 were likely celebrating last month, as Congress looked poised to drop its carried interest taxation debate amid its battle over how best to fix an outdated tax act.

In December, the US Senate passed a bill to temporarily fix the Alternative Minimum Tax (AMT). But unlike a similar bill passed weeks prior in the House, it did not call for resulting lost revenue to be counterbalanced by treating carry as ordinary income rather than capital gains, thus more than doubling the tax, and by taxing hedge fund income deferred to offshore accounts.

In order to generate a bill that both the Senate and House will approve, House Ways and Means Committee chairman Charles Rangel said he would draft new legislation without the controversial carry provision, but that the committee would ?continue to pursue this issue.? Rangel's statement indicated the key tax writing committee was more interested in pursuing the hedge fund/offshore accounts issue than the carried interest tax designation.

The events on Capitol Hill can be chalked up to ?either a fortunate confluence of factors or brilliant lobbying ? maybe both,? says Mary Kuusisto, a tax partner at law firm Proskauer Rose.

?It was a given that Congress was going to pass something on the AMT political hot potato,? Kuusisto explains. ?The only question was whether they would have to or be able to do it without ?payas-you-go? revenue offsets. The Republicans didn't want offsets ? to them, the government was never entitled to the AMT revenues from middle class taxpayers. To get the Democrats to pay for it with carry was attractive, but if AMT is a political hot potato, we saw that [maintaining capital gains treatment of] carried interest has even more powerful proponents.?

Offshore structures used by hedge fund are easier to attack ? and are perhaps still in Congress' sights ? because it's an issue that almost exclusively applies to hedge funds, whereas carried interest is used in partnership structures across all industries, Kuusisto says.

?It looks unfair to tax just those partnerships in the investment fund industry,? says Kuusisto. ?But even more important, the private investment funds lobbied hard and effectively. Some did that with dollars, others by instilling genuine fear that the US was risking its enviable position in the world economy.?

An informal tally of mid-year disclosure reports from lobbying firms found that from January to June, they'd been paid more than $4 million (€2.7 million) to lobby on tax issues on behalf of some of the US' biggest private equity players. But buyout firms were by no means the only ones hiring lobbyists ? the National Association of Realtors, the International Council of Shopping Centers, and the US Chamber of Commerce are among the groups that have been knocking on Congressional doors with increasing vigor since introduction of the Rangel bill.

?The carried interest provision is probably the most lobbied tax provision that I have seen since 1986,? says Mel Schwarz, legislative affairs partner in the US National Tax Office of global accounting firm Grant Thornton. ?There definitely has been an extraordinary effort.?

But lobbyists' efforts are likely far from over.

?This will continue to be a live issue if it's not included in legislation this year,? Schwarz says. He and Kuusisto both note that the some $25.7 billion in estimated revenue that would be raised by taxing carry as ordinary income is simply too large for a revenue-seeking Congress to ignore.

?The old joke is there's nothing in the tax code that hasn't been talked about for 10 years before they put it in,? Schwartz says. ?Once one of these things comes on the table, it's very difficult to get it off the table. You can beat it back, but anytime they're looking to raise revenue, it's going to come back.?

Kuusisto anticipates carried interest taxation will become a campaign issue in 2008; already many Democratic presidential candidates have spoken out against carry being treated as capital gains.

?Whether it will pass ? and I don't think it will ultimately come to vote again until after the election ? depends on who gets in office,? she says.

For more on this issue, turn to ?Carry Crossfire? on page 20.