No ordinary rumor

Should US lawmakers characterize carried interest as ordinary income, GPs would face a steep tax hike. Little wonder the mere rumor causes such a commotion.

Last month, client memos from a pair of law firms warned that US law makers were examining carried interest as a potential source of new tax revenue. These new revenues, according to the thinking, would be generated by a reclassification of carried interest as ordinary income, which is taxed at a substantially higher rate than capital gains. Given the hefty role carry plays in a partner's compensation, even the faintest whiff of such a large tax hike is going to command attention.

One of the memos, from the law firm Paul, Weiss, Rifkind, Wharton & Garrison, reported a number of tax proposals currently under review by the Senate Finance Committee. The memo stated: ?Significant consideration is also being given to carried interest issues, with the focus on whether to characterize that income as compensation for services, and not as long-term capital gains.?

Long term capital gains are taxed at 15 percent, while tax on ordinary income goes as high as 35 percent. Supposing, for example, that a partner earned $3.6 million (€2.7 million)from carried interest one year, the tax bill would swell from $540,000 to $1.2 million if this tax change were to go through.

The memo goes on to warn that more proposals may be on the way concerning whether certain types of income should be viewed as capital gains or ordinary income. Word of the memos spread throughout the industry like wildfire, and one lawyer noted a third of his email one day was dedicated to the issue.

A similar client memo from the law firm Debevoise & Plimpton noted that also under congressional consideration are management fee deferrals, the mechanism whereby partners place their shares of management fee value into the fund capital account for long term appreciation. The Debevoise memo also stressed that the firm had no additional details concerning the proposals, and could not predict whether any would result in actual legislation.

One legal source offered more specific doubts concerning the rumors. The source noted, ?It's not very often that things get recharacterized.? He explained that, in general, US tax law tends to treat taxable income according to the ?underlying character? of the income. So, for example, when a partnership entity has realized a capital gain, the carried interest generated by that capital gain is characterized as a capital gain.

More at risk of being recharacterized may be the widely practiced technique of diverting the GP management fee into the fund. Policy makers may ultimately view the underlying character of this income as ordinary income, and tax it accordingly, regardless of whether it ultimately ends up as capital at risk in a partnership interest.

In any case, at this point the idea that Congress may revisit the taxation of carried interest remains just that: an idea. The only reports out on the subject note that the staff of one Senator?Chuck Grassley of Iowa? have included it on a list of ideas to generate tax revenue.

However, the legal source says, ?This is something that people have worried about in general for a long time.? He adds, ?When we structure funds, we structure them so that no IRS agent will say, 'Wait a minute, what's the difference between management fee and carried interest?'? That may prove of little value if the issue holds the attention of Senator Grassley.

GMB calls ?truce? with Permira
The UK's GMB trade union, the private equity industry's most vocal opponent, has said it plans to ?build a constructive dialogue? with Permira, after holding its first meeting with the buyout firm in London last month. Following a two and a half hour discussion, Permira and the GMB issued a joint public statement, saying that the two had held ?constructive discussions about the AA and GMB's role as an independent union.? The statement added: ?The parties have agreed to consult further and to seek to build a constructive dialogue.? The statement is the first conciliatory sign from the GMB, which has made Permira?and its boss Damon Buffini?the focus of its recent attack on the private equity industry. The row first began over job cuts at AA, a vehicle breakdown service owned by Permira, where the GMB was the official trade union before being derecognized last year. However it has since escalated to take in the whole industry after the GMB's campaign received political support from several candidates in Labour's deputy leadership election.

Blair defends UK private equity
UK Prime Minister Tony Blair came to the defense of Britain's private equity industry following a barrage of criticisms from unions and members of his own Labour Party. Saying private equity played an ?important function? in the economy he continued: ?It is important that everyone behaves responsibly; but you have just got to be very careful of these issues, otherwise you end up in circumstances where concerns about maybe a minority of specific issues in specific circumstances end up tarring a whole sector, and I don't think that would be fair at all.? The statement followed a series of organised protests against private equity firms including 3i Group and Permira led by the GMB union, as well as support for the GMB's position from Labour Party politicians Alan Johnson and Jon Cruddas, who are both jostling for the position of Deputy Prime Minister.

HM Capital GC leaves for executive search firm
Executive search firm Russell Reynolds Associates hired Eric Allen to be its general counsel in March. Allen will also serve as a managing director for the company and will work from its New York office. Allen joins Russell Reynolds from private equity firm HM Capital Partners, formerly Hicks, Muse, Tate & Furst, where he served as the firm's general counsel. Prior to that, Allen was the internal counsel for two public companies: petroleum company Phillips Petroleum and natural gas conversion company Syntroleum Corporation. Founded in 1969, Russell Reynolds has 37 global offices and more than 275 associates worldwide.

CEO joins calls to end buyout tax break
Rupert Soames, chief executive of UK energy equipment rental business Aggreko, joined a row about private equity taxation by saying that buyout firms do not pay their ?fair share of corporation tax?. He added that UK taxpayers would end up footing the bill for the industry's recent success on the grounds that ?if large swathes of the UK economy pay less tax, other companies and individuals pay more?. Under the current tax regime, 40 percent corporation tax is only levied on profits after interest payments on outstanding debt have been deducted. Since buyout firms usually finance their acquisitions using a substantial amount of debt, the companies they buy will usually face a hefty interest bill. This can often mean they pay less tax as a result. The GMB union had already written to 100 Labour MPs asking for this tax relief to be withdrawn. The BVCA issued a statement saying that private equity-backed firms enjoyed no special treatment.