Hands off my bonus

In March the US House of Representatives passed a bill that would levy a 90 percent federal rate tax on bonuses, paid after 31 December 2008, by any entity related to a company receiving more than $5 billion in TARP funds. The bill was very clearly targeted at certain individuals at AIG, but it could have a much broader impact than originally intended.

Under the terms of the bill, an entity would be affected if it is in the same “affiliated group” as the TARP recipient, which generally means the TARP recipient owns 80 percent or more of its stock, or if it is a partnership or LLC and more than 50 percent of its capital or profit interests are owned by the TARP recipient, according to a Kirkland & Ellis client memo.

“In its present incarnation, the bill could have significant consequences to a private equity professional who either currently or previously rendered services to a ‘covered TARP recipient’ (including an 80 percent corporate subsidiary),” the memo warns. “It is not uncommon for an institutional private equity firm to be controlled, directly or indirectly, by a bank holding company or investment bank, and for its professionals to be entitled to an incentive payment from the firm years after the payment was earned either by investing in, or exiting, a portfolio investment.”

If that private equity professional's payment is structured as a payment of compensation, rather than a distribution from an equitable interest, it would “very likely” be considered to be an incentive or bonus payment for purposes of the bill, the memo says.

The memo also notes that the bill does not include any grandfathering provisions, so what matters is when the bonus was paid, not when the bonus was earned.

George Clarke, a member of Miller & Chevalier's tax practice, says that this bill could create an interesting situation, in which independent private equity firms have even more of an edge over merchant banking arms of major banks in terms of recruitment.

He has serious doubts about the constitutionality of the bill, however, which other legal experts have voiced as well. “From a tax policy perspective, it makes no sense,” Clarke says. “Why would you try to do this from a tax mechanism? And if anybody needs certainty right now, it's the guys that are taking this [TARP] money, and we can't just keep changing the rules on them.”

Certainly far fewer private equity firms will participate in the TARP and TALF programmes if there's even the slightest chance it could cost them their carry.