TAX NEWS - June 2010
Investment Pros Still Hoping For Better Terms On Carry Tax
An amendment introduced by Sen. Max Baucus (D-Montana) suggests that beginning in 2013, 65% of carried interest would be taxed at normal income rates, while 35% would be taxed as capital gains. The House proposal set a 75%-25% split.
Unlike the House version, the Senate version also offers incentives for fund managers who hold investments for the long term, reducing the percentage of carry taxed as ordinary income to 55% for investments owned for at least seven years.
Both versions of the bill would phase in the higher tax rate, taxing 50% of carried interest as ordinary income in 2011 and 2012.
Carried interest has long been taxed at capital gains rates, currently around 15%. The normal income tax rate, in contrast, is currently around 35%.
The private equity industry has been lobbying heavily against the higher tax rates, and some senators have expressed concern the changes could stymie investment.
The Senate amendments are aimed at addressing those concerns, particularly as regards the venture industry, which tends to hold its early-stage investments for long periods of time.
One venture investor said the tax break for a longer hold period doesn't go far enough to distinguish among the different sorts of investment firms, like hedge funds, real-estate partnerships and buyout firms.
"It shows the absurdity of our politicians that they are unwilling or unable to separate elephants, giraffes and hens in the barn," said James Garvey, founder of SV Life Sciences. "We buy non-control portions in companies that wouldn't exist without early-stage high-risk money. If that's not capital gains, nothing is."
Opinions vary on its impact on the industry if the bill passes.
Garvey estimated that if all of the tax increases in the bill are factored in, the taxes levied on $10 million of hypothetical carried interest earned over a 20-year period would increase to $5 million from $1.5 million currently
Garvey believes that in its current form, the bill will eventually drive people out of the venture business, particularly the oldest and youngest professionals. "You'll see senior people be tempted to retire earlier or leave sooner," Garvey said. "People in their 40s and 50s will fight it out because they're already heavily invested. The tension will be on the barbell curve of the older partners and the younger [professionals]."
Tom Danis, a cofounder of fund-of-funds manager RCP Advisors, had a different opinion. Speaking at the SuperReturn conference in Boston last week, he said he believes most investment professionals will "stay in private equity."
"It's just going to be more expensive," he said. "I don't' think you'll see private equity professionals throw up their hands and say, 'If I'm getting taxed like this I'm getting out of the business'."
Others say the Senate version doesn't do enough to encourage investors to continue doing riskier early-stage deals.
"In the near term our behavior will not change, but in the long term our business may shrink and/or have to adapt to the new reality," said Deepak Kamra, a general partner at venture firm Canaan Partners. "It diminishes the incentive to think long-term versus short-term in our investment strategy."
Still others believe there may be ways around the provisions in the bill. Pamela Hendrickson, chief operating officer at buyout firm Riverside Co., said attorneys and accounting firms are already contemplating fund structures that would mitigate the impact of the higher tax structure
The bill is not expected to come to a vote until Friday at the earliest, according to two Washington insiders. In the meantime, the industry continues to lobby against it.
The Private Equity Council released a study Tuesday contending that higher taxes would cut private equity investment by at least $7 billion annually, and possibly by as much as $27 billion per year.
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