The deferred interest tax break for private equity survives another attempt to kill it.



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US President Joe Biden

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A key tax break for private equity and hedge fund managers, which has been targeted for elimination by every president since George W. Bush, has just survived the latest attempt to kill him.

Last week, the House Ways and Means Committee voted to preserve the low tax rate that fund managers enjoy on their top salaries: the compensation known as “deferred interest”.

President Joe Biden had proposed removing the favorable tax treatment enjoyed by managers of alternative investment partnerships on their pay-for-performance, generally set at 20% of the returns they generate for their investors. Since deferred interest is taxed at the 20% capital gains rate rather than the regular income rate of up to 37%, investment managers pay lower rates than many employees. This annoys observers.

In August, a bill to completely ban the treatment of capital gains for deferred interest was introduced by Senate Finance Committee Chairman Ron Wyden (D., Oregon), who claimed he would raise $ 63 billion over 10 years. “One of the tax code‘s most indefensible loopholes allows wealthy private equity managers to be taxed at lower rates than nurses treating COVID patients and avoid paying taxes year after year. It is a matter of fairness, ”said Senator Wyden.

The Biden administration is not backing down, either. On Thursday, he released a study opposing the treatment of capital gains for the income of any high net worth investor.

But the recommendations handed over last week [NOTE: SEPT. 13] by the House Ways and Means Committee would leave tax relief on the books, while limiting its use and increasing the rate of all long-term capital gains to 25%.

The private equity industry is by no means appeased by the fact that the deferred interest break has survived. In 2017, the Trump administration and Congress extended the required holding period for deferred interest for capital gains treatment to three years instead of one. Ways and Means has just proposed a five-year holding requirement, along with other provisions that the industry says could amount to an eight-year freeze to evade regular tax rates. The new holding period will not apply to individuals with taxable income of less than $ 400,000, nor to certain real estate partnerships.

“As legislation progresses, we will continue to ensure that members of Congress understand how important private investment has been to their local communities throughout the pandemic,” said Drew Maloney, CEO of the American Investment Council private equity industry trade group. “Instead of moving forward with a 98% tax increase on private investment, Congress should encourage more private capital that supports jobs, small businesses and pensions across America.

The deferred interest debate is part of a larger argument about a system where the country’s wealthiest get most of their money from capital gains, taxed at rates below wages. But increasing taxes on deferred interest also has an impact on state-owned companies that manage private equity, hedge funds and real estate. These include Blackstone (ticker: BX), BlackRock (BLK),

Brookfield Asset Management

(BAM), KKR & Co. (KKR), on

CBRE Group


Blue Owl Capital


Boston Properties

(BXP), the Carlyle Group (CG) and

Global management of Apollo

(APO). Their public market capitalizations exceed half a trillion dollars, much of which is a multiple of the earnings carried forward. Inquiries to these companies have been referred to the American Investment Council Trade Group.

Performance fees are important to public shareholders of an asset manager, says Andrew Kuske, analyst at Credit-Suisse Securities, because carry fees mean that partnered investors have met their return targets and are likely to lose. ‘commit more dollars to the funds. Assets under management and revenues evolve in a virtuous circle.

“Carry generation is proving to be a validation of investment strategy and performance,” says Kuske. “The managed dollars and the charges generated on the managed dollars are a major driver of the assessment.”

Performance-based income, including deferred interest, is supposed to align the interests of managers with those of their investors. In carry funds managed by the private equity sector, managers are generally allocated 20% of the gains made in the years when the fund has exceeded an annual return threshold ranging from 4% to 9% (depending on the time horizon). investment of the fund). After years of underperformance, investors can recoup fees previously paid.

It is a primary source of income for the alternative asset industry. A third of Blackstone’s $ 6.1 billion in revenue in 2020 came from “performance allowances.” Of the $ 15.6 billion in investments recorded on the company’s balance sheet at the end of 2020, $ 6.9 billion came from accumulated performance allowances (of which approximately $ 2.9 billion was due to employees).

At BlackRock, performance fees were only 7% of its 2020 revenue. But at KKR, deferred interest contributed 40% of the company’s $ 4.2 billion in revenue in 2020. Deferred interest unrealized on KKR’s balance sheet at the end of 2020 exceeded $ 4 billion.

The ways and means proposal is far from the finish line which is beyond the House, the Senate and the White House. The Treasury regulations must then implement any modification of the tax law: the tax modification of the law of 2017 for deferred interest was only put into effect this year. Alternative investment managers will have plenty of time to talk to their tax advisors. Regardless of the tax rate, returns on private equity and venture capital should remain attractive to investors.

Write to Bill Alpert at [email protected]



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