TAX NEWS - June 2010

Blackstone, Fortress Shareholders Face Tax in Buyout Firm Bill

Legislation intended to raise taxes on managers of private equity firms like Blackstone Group LP would also impose higher levies on their shareholders, a move that's sparking protests from the buyout funds.

Under the measure, shareholders of publicly traded partnerships would pay ordinary tax rates on a portion of any profits when they sell shares, rather than the lower capital gains rates they pay now. If passed, the bill would take effect in 2011, when top ordinary rates are scheduled to be 39.6 percent and capital gains rates 20 percent.

Blackstone and other firms are pressing U.S. House and Senate lawmakers to revise the measure, which would help pay for a jobs bill Congress is considering. Still, a tax expert said the levy "is consistent with the spirit of the bill."

"The investors have simply purchased monetized streams of services income from the selling partners," said Victor Fleischer, a University of Colorado law professor who advises Congress on ways to change how buyout firm managers are taxed.

At issue is what is known as carried interest, the share of profits that fund executives charge as the largest part of their compensation for managing investors' money. That income often qualifies for capital gains tax treatment under current law; the legislation would more than double the tax by applying higher rates to a large share of the fee.


Hot Assets

Blackstone and similarly structured firms such as Fortress Investment Group LLC and Oaktree Capital Management LLC sold interests in their management companies when they went public in 2007, rather than in the investment funds themselves. Shareholders get a piece of the management company's carried interest. Oaktree is traded on a private exchange operated by Goldman Sachs Group Inc.

Under a separate partnership tax law, certain firm resources, known as hot assets, must be taxed at ordinary tax rates when stakes are liquidated. In an analysis of the House legislation, the Joint Committee on Taxation concluded that carried interest is a hot asset and would taint capital gains treatment when investors sell their share.

The joint tax committee's analysis alarmed the National Association of Publicly Traded Partnerships, said its director, Mary Lyman. Lyman said her group is lobbying the Senate to fix the problem. "I personally don't think that any public unit holder should have to pay the consequences for what management does," she said.


Shares Fall

To be certain, few investors in Blackstone and Fortress have many profits to realize. Blackstone's share price has fallen about 28 percent to $10.40 and Fortress has dropped about 32 percent to $3.59 since early last month, when the Senate signaled it would back a tax increase on carried interest for the first time.

"I fail to understand why a business like ours has attracted so much opprobrium, so we are being punished in this fashion," said Blackstone spokesman Peter Rose. Fortress spokeswoman Lilly Donohue declined to comment.

The higher tax burden might also apply to investors in about 125 publicly traded partnerships in energy and natural resources such as Kinder Morgan Energy Partners LP in a House version of the bill.

Senate Finance Committee Chairman Max Baucus, a Montana Democrat, responded with a substitute measure this week that exempts the energy partnerships while leaving the tax in place for investors of Blackstone. House Ways and Means Committee Chairman Sander Levin objected to any exemptions.

"I am opposed to carving out," Levin, a Michigan Democrat, told reporters. "I want a generic bill."

Baucus said he is still working to try to address Levin's concerns.