Push and pull

The US House of Representatives has narrowly passed a bill that aims to raises taxes on private equity and hedge fund managers by roughly $48 billion. The bill now heads to the Senate, and if approved, is likely to be vetoed by President Bush.

Tax legislation that includes more than doubling the tax rate on carried interest has been approved by the US House of Representatives, by a vote of 216-193.

?The relatively small margin by which the House today passed legislation raising taxes on private equity, venture capital and real estate partnerships demonstrates widespread concern about this new investment tax,? the Private Equity Council, an industry lobbying group, said in a statement. ?The Private Equity Council will continue its efforts to persuade the Senate that the House bill could dampen economic growth at a time of an unsettled economy and gyrating financial markets.?

Introduced by House Ways and Means Committee chairman Charles Rangel, the bill would increase taxes on fund managers by $48 billion (€34 billion). Rangel characterized the legislation as ?the most comprehensive overhaul of the US tax code introduced since the Tax Reform act of 1986.?

The nucleus of the proposed sweeping reforms is the abolishment of the Alternative Minimum Tax act, which was introduced in the 1960s to tax a small number of wealthy families, but because it is not indexed for inflation now affects millions of middle class Americans.

Rangel's bill proposed to counterbalance the some $48 billion in tax revenue that would be lost from the act's repeal by increasing taxes of the alternative investment industries. The bill would cause carried interest to lose its capital gains tax treatment, a rate of 15 percent, and be taxed as ordinary income at a rate as high as 35 percent. Rangel said raising the tax on carry would generate $25.7 billion over a 10-year period. The bill also would force hedge fund managers to pay tax on any compensation deferred to offshore bank accounts.

?We are not raising taxes,? Rangel said at a news conference when the bill was introduced. ?We are restructuring the rates of taxes so that at the end of the day 90 million taxpayers will walk away saying, ?I've got a decrease in taxes.??

Rangel, a Democrat from New York, had previously endorsed a bill introduced by fellow committee member Sander Levin that proposes treating carried interest as ordinary income.

The Private Equity Council, National Venture Capital Association and the International Council of Shopping Centers have come out in opposition to the legislation, which Republicans including New York Congressman Thomas Reynolds and Missouri Congressman Roy Blunt, the House's second-ranking Republican and party whip, are calling ?the mother of all tax hikes.?

The ICSC said in a statement: ?This legislation robs from Peter to pay Paul. Chairman Rangel views this proposal as ?closing a loophole? targeted at private equity and hedge fund managers, but fails to recognize that this significant tax increase will dismantle the partnership business model by more than doubling the tax on the general partner's capital gains.?

The House vote was for the most part along party lines, with all Republicans and eight Democrats voting against the bill. It now heads to the Senate, whose finance committee has held numerous hearings on private equity and carried interest taxation, and thus far failed to reach a consensus that its designation should be changed to ordinary income.

Should the Senate pass the bill, the Bush administration has indicated it would likely veto it to keep it from becoming law.

The White House Budget Office said in a statement: ?The administration does not believe the appropriate way to protect 21 million additional taxpayers from Alternative Minimum Tax liability is to impose a tax increase on other taxpayers. The president's senior advisers would recommend he veto the bill? if it also passes in the Senate.

President George Bush said in August that he would consider using a veto on any new bills raising taxes and made several allusions to the economic benefits of venture capital.

?Our economy is growing in large part because America has the most ambitious, educated and innovative people in the world ? men and women who take risks, try out new ideas, and have the skills and courage to turn their dreams into new technologies and new businesses,? Bush said. ?To stay competitive in the global economy, we must continue to lead the world in human talent and creativity.?

Bush continued: ?I recognize the Democrats control the Congress, and with it, the power of the purse,? Bush said. ?I also have some power, and it's called the veto.?

John Snow, chairman of US buyout firm Cerberus Capital Management and former US Treasury Secretary, has also attacked the proposed legislation.

?I think raising taxes now when there are these problems with the American economy is not good medicine,? Snow recently told UK newspaper the Financial Times. ?I don't think that when there are these signs of slowing you want to weaken the engine. I think you want to keep the engine performing well.?

SEC approves fairness opinion rule
The Securities and Exchange Commission has approved new procedural and substantive rules by the Financial Industry Regulatory Authority (FINRA) for fairness opinions. Rule 2290 is meant to address concerns that disclosures in fairness opinions do not sufficiently inform shareholders about potential conflicts of interest between the issuer of a fairness opinion and the parties in the transaction, but its disclosure requirements largely overlap with current federal securities laws. According to an analysis by the M&A Law Prof Blog, the ruling has been ?watered down into meaninglessness? because FINRA ?did not go so far as to require member investment banks to disclose ?any significant conflicts of interest? as it initially considered.? One new aspect of the rule is its requirement for member firms to disclose whether or not the fairness opinion takes a position on the amount or nature of the transaction's compensation to the company's officers, directors or employees relative to the compensation to the public shareholders of the company.

IRS extends deferred comp deadline
The US Internal Revenue Service has extended the deadline for compliance with a rule governing ?nonqualified? deferred compensation plans. According to a client alert from law firm Latham & Watkins, the news on Section 409A of the Internal Revenue Code will ?generally be welcome news for companies that maintain nonqualified deferred compensation plans.? Compliance has been deferred until December 31, 2008. The Latham & Watkins memo, however, cautions clients that they still may need to identify agreements that may be deemed nonqualified plans under Section 409A; assess the time and form of such payment elections; and determine the operational compliance requirements for each nonqualified deferred compensation plan. A nonqualified deferred compensation plan is a plan that means any plan that provides for the deferral of compensation with specified exceptions.

Blackstone seeks to soften ?Blackstone Bill?
The Blackstone Group and other private equity firms are working behind the scenes in Washington, DC to change a proposed piece of legislation affecting publicly traded partnerships. The bill has been dubbed the ?Blackstone Bill,? because it was drafted in response to Blackstone's initial public offering structure as a publicly traded partnership. The bill, spearheaded by Senate Finance Committee heads Charles Grassley and Max Baucus, would seek to exclude financial firms from the favorable tax status enjoyed by publicly traded partnerships. The current legislation includes a five-year grace period for firms that have already gone public, such as Blackstone, Fortress Investment Group and Oaktree Capital Management. According to a report in Bloomberg, the senators are considering extending the grace period to ten years. The change would not affect any private equity firms that go public in the future. None of these would receive a grace period.

MiFID poses problems, say firms
A new study indicates that 64 percent of financial firms ?have a problem? with Article 51 requirements of Europe's Markets in Financial Directive Instruments Directive (MiFID). Article 51 gives regulators across Europe the right to reconstitute the key stages of the trade for each transaction. The study, conducted by think-tank JWG-IT, found that 64 percent of financial firms ?cannot reconstruct events after the fact in reasonable timeframes or at cost levels.? MiFID sets a series of rules for financial firms operating across Europe. The rules apply to private equity firms. Article 51 says that incorrect recordkeeping around transactions could result in fines or other penalties.