Representative Dave Camp, the chairman of the House Ways and Means Committee, released a draft of tax legislation his committee has been working on for three years. The legislation is no gift to Wall Street, although neither is it especially punitive.
It is notable is that Mr. Camp, a Republican, has made use of several ideas traditionally associated with the left side of the political spectrum, bringing some nonpartisan respectability to the ideas.
One provision buried deep in the legislation is aimed at large private equity firms. Under current law, partnerships with ownership interests that are publicly traded are normally taxed as if they were corporations. This means that these partnerships pay a corporate level tax, and owners are also taxed at the individual level on any corporate distributions. Regular partnerships, by contrast, pay no tax at the entity level, and tax liability is reported on individual partner’s returns.
The energy sector has always enjoyed an exception to the publicly traded partnership rules, allowing firms like Kinder Morgan Energy Partners to avoid paying any corporate tax. Over the last few years, Blackstone, Carlyle, Kohlberg Kravis Roberts and a few other large private equity firms and hedge fund sponsors went public, relying on some clever and aggressive structuring to fit within an exception to the rules for companies that derive most of their income from dividends, interest income and capital gains. This group of firms, sometimes known as “passive income PTPs,†should probably be taxed as corporations.
Section 3620 of Mr. Camp’s bill, on Page 660 of 979, would narrow the exception to the publicly traded partnership rules so that it would apply only to the energy sector. Specifically, the exception would be limited to partnerships with 90 percent or more income and gains derived from the exploration, development, mining or production, processing, refining, transportation (including pipelines transporting gas, oil or related products), or the marketing of any mineral or natural resource (including geothermal energy and excluding fertilizer and timber) or industrial source carbon dioxide. It is hard to see how private equity or financial services firms could squeeze into this exception.
All other publicly traded companies would pay the corporate tax, absent relief elsewhere in the code (such as for mutual funds, real estate investment trusts and other passive investment conduits).
As a result, the publicly traded private equity firms would either have to take themselves private again or pay corporate-level taxes. The investment funds sponsored by these firms are not publicly traded and would not face a corporate-level tax.
The roots of this proposal go back to the spring and summer of 2007, when the Senate introduced legislation that would have had a similar effect. The bill became known in some circles as the “Blackstone Bill†or “Birthday Party Bill,†in reference to the outrage some felt about an extravagant birthday party held by Stephen Schwarzman, the chairman of the Blackstone Group. (The legislation was introduced a week before Blackstone went public.)
The House instead introduced broader legislation targeting carried interest, and the special status of private equity publicly traded partnerships has been largely forgotten amid the heated debate over carried interest.
The legislative proposal to tax these firms is quite sensible despite its arguably ad hominem origins. Blackstone, Carlyle, KKR and other private equity firms are active businesses, not passive conduits for investment. So long as we have a corporate tax, it is important to police its boundaries and prevent erosion of the tax base. The benefit of a broad base, of course, is lower rates over all. The legislation would lower the corporate tax rate generally to 25 percent.
According to estimates from the Joint Committee on Taxation, this part of the legislation would raise more revenue over the 10-year budget window ($4.3 billion) than the proposed change to the carried interest rules ($3.6 billion). Either of these is small beer compared with the excise tax on systemically important financial institutions, also known as SIFIs, which would raise $86 billion over the same period.
The draft legislation has a long road ahead, but one thing is certain: Congress will be looking for ways to raise revenue in a tight budgetary environment. Forcing private equity PTPs to pay the corporate tax will be a tempting one to put in place.
For further reading on the tax treatment of PTPs, see Victor Fleischer, Taxing Blackstone, 61 Tax Law Review 92 (2008).
Victor Fleischer is a professor of law at the University of San Diego, where he teaches classes on corporate tax, tax policy, and venture capital and serves as the director of research for the Graduate Tax Program. His research focuses on how tax affects the structuring of venture capital, private equity, and corporate transactions. Twitter: @vicfleischer
