Prepare for the worst

New rules targeting US tax preparers are bringing grief to private equity partners.

In May, new legislation in the US was introduced to crack down on tax avoidance, with an onus on the tax preparers, not the taxpayers.

As a prominent West Coast lawyer explains, tax preparers are now subject to new rules which require them, before they sign the tax return form, to state a level of personal confidence with respect to each and every issue on the tax return that the positions being taken are more likely than not to succeed if challenged. As the lawyer says: ?The IRS [Internal Revenue Service] has essentially outsourced its enforcement to preparers.?

An income tax return preparer is defined as any person who prepares taxes for compensation, or who employs other people to prepare for compensation, all or a substantial portion of an income tax return or claim refund. Under the present law, the definition does not include a person preparing non-income tax returns, such as estate and gift, excise or employment tax returns. But the new law has broadened the scope of the present preparer penalties to include those categories which were formerly excluded.

For any position that doesn't meet the test, tax preparers are required to attach a disclosure statement, typically using IRS Form 8275. Private equity partnerships, which use mazes of tax vehicles, are worried that preparers are now incentivized to raise red flags without good reason.

One general partner admitted that the new legislation has hit the West Coast venture capital firm in a ?big way.?

Experts advise private equity partners to consult with tax preparers early so there will be no unpleasant surprises come March 30. One area the industry should look out for, says the lawyer, has to do with interest-free loans. Preparers who fail to make proper disclosures on this and other issues face stiff penalties. The new provision increases the first-tier penalty from $250 to the greater of $1,000 or half of the preparer's total fee, whichever is larger. Second-tier penalty has been increased from $1,000 to the greater of $5,000 or half the preparer's total fee, whichever is larger.

What that means for private equity is twofold. One, it is likely to lead to more paperwork and higher fees for some taxpayers. Two, expect a more conservative stance from tax preparers. A tax lawyer says: ?My experience is tax preparers can be worse than the IRS. It's almost like your audit happens but you have to clear the preparer hurdle, it's smooth sailing from thereon out. Some people are bringing in preparers up front to sniff at this before it goes out because preparers are generally very, very conservative.?

Global regulator casts wary eye on PE
A special task force of the International Organisation of Securities Commissions (IOSCO) has found after nine months of study that private equity may have adverse effects on financial markets. The IOSCO will continue its investigation, specifically analyzing conflicts of interest and issues relating to leverage in buyouts. Led by Hector Sants, the chief executive of the UK regulator Financial Services Authority (FSA), the task force said heightened leverage may increase risk of defaults and subsequently ?be felt in both public and private markets.? The regulator also raised concerns about possible conflicts of interest in private equity transactions, for example, management involved in a buyout ?may not always have an incentive to act in the best interests of existing shareholders by recommending a sale at the highest possible sale price, despite a fiduciary duty to do so,? its report said.

Majority of PE pros ?unhappy? with pay
Some 75 percent of private equity professionals are ?unhappy with their pay packages,? according to research from Private Equity Search Digest's 2007 Private Equity and Venture Capital Compensation Survey. Standing in contrast to contentions from some critics of the private equity industry that it is filled with overpaid and under-taxed professionals, the Digest found that only 2 percent of people in the industry receive compensation in the ?seven figures.? Other findings of the survey include that 28 percent of industry pros will see their compensation remain the same in 2007 from the year prior and that, on average, UK pros earn $10,000 per year more than US counterparts and receive nearly five weeks of vacation time to the 3.5 weeks in the US, on average.

Cabot Square wins $10m from Credit Suisse
In a rare private equity court case, UK firm Cabot Square Capital has come out on top after a four-year argument over fees relating to the liquidation of a Credit Suisse-backed fund. A New York jury has awarded UK private equity firm Cabot Square Capital $10 million from Credit Suisse, concluding a four-year legal battle stemming from a 2003 no-fault divorce. Credit Suisse was a cornerstone investor in a ten-year, $275 million fund in 2003, according to Kenneth Van Deventer, the Riker Danzig Scherer Hyland & Perretti attorney who represented Cabot Square in the case. After liquidating the fund, Credit Suisse refused to pay a contractual break-up fee, according to Cabot Square. Credit Suisse also said that the fund had incurred a loss, and took possession of $8 million held in escrow as security for a potential clawback liability. Credit Suisse was ultimately unable to convince the jury that the fund had actually incurred a loss, Van Deventer said, and so Cabot Square was awarded the $8 million, plus the break fee and statutory interest.

Study finds PE's negative impact on employment
In another study examining the impact of private equity on job losses, University of Chicago Graduate School of Business professor Steven Davis presented preliminary findings from a new study at the American Enterprise Institute's November conference on private equity. The study examined US buyouts from 1980 until 2000, and found that private equity ownership of companies, on average, is followed by job losses, and disproportionately so relative to non-private equity-backed companies. But Davis stressed that the results are just ?the early installment of one piece of a broader research agenda,? which will be completed early next year. He also noted that the results are biased by the fact that private equity firms target companies whose employment numbers are already shrinking faster than their peers prior to the buyout. The final report is reportedly scheduled to be published in January.