General partners in the US used to file section 83(b) because their tax lawyers told them to. Soon they’ll file section 83(b) because the Internal Revenue Service will compel them to.
In May, the IRS proposed new rules governing, among other things, the tax treatment of carried interest. The proposed rules affect the GPs of most private equity and real estate partnerships in the US.
According to David Schnabel, a partner in the New York office of law firm Debevoise & Plimpton LLP, the IRS is now setting forth in writing what tax attorneys used to recommend as being merely reasonable tax policy, given the lack of specific guidelines.
The proposed rules set forth technical requirements that GPs must follow in order for them to continue achieving favorable tax treatment with regard to carry. First, GPs will need to include language in future fund (and GP) agreements ensuring that the elected tax treatment is enforceable against all the partners, including the LPs. ?There will be a process of educating LPs about what the language means. Once that occurs, the language will probably become just more tax boilerplate,?says Schnabel.
The rules also will make it necessary, in most cases, for the individual GPs to make an 83(b) election, which allows the recipient of carried interest to ?vest?at the creation of the fund. This allows the GP to treat future distributions of carry as capital gains for tax purposes, instead of ordinary income, which is taxed at a much higher rate.
Filing for an 83(b) election requires that the filer assign a fair-market value to that interest, meaning the value of the share of carry if the partner in question immediately sold the interest after receiving it. Traditionally, says Schnabel, a share of carried interest at the outset of a fund has been valued at zero, since that is what it would be worth if the fund were immediately dissolved, and the new rules allow GPs to continue using this ?liquidation value? approach. However, if a partner joins a private equity fund after its formation and receives a share of the carried interest with ?built-in appreciation?, the partner will recognize income upon receipt of the interest. Although the partnership will have a current deduction, the new rules prohibit the partnership from allocating the deduction to the new partner, as is the practice of some GPs now.
The new rules also impact how members of the GP will be taxed if they leave and forfeit some of their carried interest.?In some cases, the net income of a departing partner may exceed the cash received from the GP, which will obviously be unwelcome news,?says Schnabel.
Further guidance is expected from the IRS before the new rules are made effective.
ILPA endorses new international guidelines
The Institutional Limited Partners Association has officially endorsed the International Private Equity Valuation Guidelines, a set of suggested standards for valuing private companies developed jointly by the Association Francaise des Investisseurs en Capital, the British Venture Capital Association and the European Private Equity & Venture Capital Association. Prior to the endorsement, members of the ILPA’s research, benchmarking and standards committee compared the International Guidelines with US guidelines issued by an independent industry group, the Private Equity Industry Guidelines Group, endorsed by the ILPA in 2004. According to an ILPA press release:?While there are apparent differences in style and form between the two sets of [g]uidelines, the ILPA concluded after careful consideration thatUS Valuation Guidelines and International Valuation Guidelines are not inconsistentwith one another.?The announcement noted that members of ILPA continue to work with the NVCA, The CFA Institute (formerly AIRM, the AFIC, the BVCA, the EVCA, as well as industry associations in Australia (AVCAL) and Canada (CVCA) to arrive at a ?single set of consolidated valuation guidelines that conform with the accounting principles of GAAP and IAS.?
France plans employment boost scheme
The new prime minister of France, Dominique de Villepin, recently outlined a plan to help reverse the country’s high unemployment rate, estimated to be more than 10 percent. The plan allows small businesses, starting September 1, to hire new staff under a two-year probationary scheme. Small business advocates in France have long complained of the expense and hassle of firing workers (see p. 19). The plan also reportedly calls for certain tax breaks designed to encourage the hiring of domestic workers, as well as a €1,000 bonus for anyone who takes a job after being unemployed for more than a year. The proposed job stimulation effort is expected to cost roughly €4.5 billion ($5.5 billion).
Taiwan set to ease takeover rules
The government of Taiwan is set to make buyouts in the country easier, according to reports. According to an official at the Financial Supervisory Commission, quoted in a Wall Street Journal article, financial holding companies will in the near future be allowed to buy a 5 percent stake in a targeted company prior to initializing takeover talks. The current rules call for a firm to first acquire 25 percent of a company before such a move is allowed.?We’ll allow them to test the water with a 5 percent purchase first,?the official was quoted as saying.?If the response [from the target] is positive, then they can proceed with the deal.?The official added that the potential buyer must first seek approval from the target’s board members and then from financial authorities.
Bush SEC candidate has VC credentials
President Bush last month named California congressman Christopher Cox as the White House nomination for the new head of the Securities and Exchange Commission. Cox, a Republican in the House of Representatives for Orange County, has long been involved with technology, venture capital and tax issues. Cox’s nomination follows the resignation of current SEC chairman William Donaldson. Early in his pre-congressional career, Cox was an attorney in the Orange County office of law firm Latham & Watkins, where he ?specialized in venture capital and corporate finance?, according to his official biography. In congress, Cox has championed issues of interest to his district’s high-tech and biotech industries. In 2003, he authored legislation that would make permanent a temporary ban on Internet commerce taxes. Cox’s interest in technology extends to national security issues. He is the author of the well known Cox Report, released in 1999, which claimed that citizens of mainland China were active in Silicon Valley technology startups and engaged in the transfer of sensitive technology back to China.
Korea makes concession on startup management
South Korea’s ministry of finance has announced that private investment firms will now have greater leeway in taking the reins of a young company. According to reports, venture capital firms will now be able to take management control of technology startups, defined as businesses that have been in operation less than seven years. Under current rules, investors are barred from taking control of their portfolio companies, a system that critics say prevents venture capital from finding its way to technology startups in the country. The South Korean government has recently made a major push to develop its private equity industry. Last month, the operator of the country’s public pension plan, the National Pension Corporation, announced that it would invest up to 6.6 trillion won ($6.6 billion; €5.4 billion) in private equity funds by 2010 as part of an effort to diversify its portfolio and increase overall returns. The decision was made by the 21-person committee that oversees the pension plan, headed by the Minister of Health and Welfare, Geun-Tae Kim.
KKR preps $839m REIT listing
New York-based Kohlberg Kravis Roberts & Co. is offering stock in a new real estate investment trust that features a 25 percent carried interest term. Shares of the REIT are set to be priced between $23 and $25 each and listed on the New York Stock Exchange, according to documents filed with the Securities and Exchange Commission. The REIT, called KKR Financial Corp will be based in San Francisco and managed by KKR founders Henry Kravis and George Roberts, as well as by Paul Hazen, the former chief executive officer of Wells Fargo. KKR has some real estate-related experience through its investments in the hotel industry, notably Red Lion Hotels and KSL Resorts. A year ago the firm attempted to take public an affiliated ?business development company? put pulled the offering in the wake of weak investor demand. The firm subsequently formed a private REIT placed by Friedman Billings & Ramsey, an offering that is now being taken public.
Intel Capital launches China fund
The venture capital division of Silicon Valley chip maker Intel has launched a $200 million fund to make investments in Chinese hardware, software and technology services companies. Investments will compliment Intel’s technology initiatives, according to the company. Intel Capital has been investing in China since 1998 and has investment professionals in Hong Kong, Shanghai and Beijing. The firm currently has roughly 50 portfolio companies across nine cities in China, including in Hong Kong. Intel Capital is led by president Arvind Sodhani, who said in a statement:?Companies around the world should look beyond China’s purchasing power and view the country’s innovators as potential suppliers.?