OECD: ‘carry should be taxed as income’

The think-tank argues that governments should reform carried interest taxation as a way to reduce rising inequality.

The Organisation for Economic Co-operation and Development (OECD), an economic think-tank based in Paris, has called on governments to rethink their policy on carried interest taxation, as part of their efforts to reduce inequality.

In a paper called, ‘Focus on Top Incomes and Taxation in OECD Countries: Was the crisis a game changer?’, released this week, it outlined a series of policy recommendations that it believes could ensure that top earners contribute their “fair share of tax”.

It recommends the broadening of income tax, suggesting that all remuneration, including fringe benefits, carried interest arrangements and stock options, should be taxed as ordinary income.

The share of the richest one percent’s total pre-tax income has increased in most OECD countries over the past three decades. According to the OECD, this rise is the result of the top one percent taking a disproportionate share of overall income growth over that timeframe: up to 37 percent in Canada and 47 percent in the United States.

“Without concerted policy action, the gap between the rich and poor is likely to grow even wider in the years ahead,” OECD Secretary-General Angel Gurría, said in a statement. “Therefore, it is all the more important to ensure that top earners contribute their fair share of taxes”.

As well as calling for a policy rethink on carried interest, the OECD also called to improve transparency and international cooperation on tax rules to minimize what it called “treaty shopping” – when high-income individuals and companies structure their finances to take account of favorable tax provisions in different countries.

In February, the OECD said it wanted financial institutions, including private equity firms, to report certain tax details on foreign investors to their local tax authority, who would then share that information with their counterparts around the world.

Whether carried interest should be treated as income or capital gains has been a recurring point of discussion ever since the limited partnership model was created. Jonathan Blake, partner and head of the international funds group at King & Wood Mallesons SJ Berwin, helped to negotiate the original arrangement with the taxman in the UK that saw carried interest treated as capital gains.

“It’s very easy to think about it in terms of buyout fund managers that are very rich, and getting richer,” he said. “But the vast majority of VCs are not particularly rich, and they’re putting their own money at risk in setting up a fund. They’re entrepreneurs – so getting a share of the profits they’re generating through their investments seems perfectly reasonable.”

“Despite all the criticism, governments haven’t changed things that much. And that’s a good thing: this is a fantastic industry that does a great deal of good. People tamper it with it at their peril.”