US carried interest tax change may still be on the cards

Changes to US tax on private equity carried interest may still materialize, despite being excluded from the tax reform framework released by the government at the end of September, experts predict.

Speaking at sister title Private Equity International’s Private Fund Finance and Compliance Forum in San Francisco last Thursday, a panel of tax partners and chief financial officers said a proposal to tax carried interest as income rather than capital gains tax could be used as a “bargaining chip” by Republicans as they attempt to get the package through the Senate.

“Both candidates promised to change the tax rate on carried interest, which is widely considered a loophole, so I feel it will be discussed,” one of the panelists said.
A second added that they believed the issue was still on the horizon, it had simply been “kicked down the road” for the time being.

Generally the panel agreed that there is currently “limited guidance” on how the final tax reform package could look, although it is “starting to take shape.”

“It’s unknown what the ultimate outcome will be, the current nine-page framework will grow into an 800-1,000 page document, but momentum around a lower corporate tax rate at least looks like it will hold,” the chief financial officer of a private equity firm said.

Lower rates may result in fewer firms using a flow-through model, and instead structuring as a corporation. Not only will this reduce taxes paid, it will also lessen the administrative burden; operating as a limited liability company requires many state filings compared with being a corporation.

“We are considering our investment structures, but will not start modelling until the rates are finalised,” a second CFO on the panel said.

A change in the tax treatment of interest on loans also has the potential to impact investment structures, as reported by pfm. The panellists said firms have already started to look at recapitalizing in order to benefit from the grandfathering of the rule.
“Our firm may accelerate any new loans that we take out to avoid being affected by the interest deductability tax,” the first CFO said.

Deadlines for the reform package to be passed depend on who is asked, but it can only be passed through the political system after a fiscal-year budget. This is because the blueprint contains a legislative tool that would let the Republicans pass a tax bill by a simple majority vote in the Senate, where they hold 52 of the 100 seats, allowing them to bypass the Democrats that are expected to vote against it.

The spending budget was approved by the Republican-controlled House of Representatives in a 219-206 vote on Thursday.