US carry debate heating back up

While Republicans have long defended carried interest as a capital gain, one of their own, House Representative Dave Camp, introduced legislation redefining carry under higher ordinary income tax rates.

Camp, who is chairman of the House Ways and Means Committee, the committee responsible for writing the country’s tax code, said he wants to “clean up provisions like ‘carried interest’ that allow certain private equity firms to get the investment-income tax rate on what anyone else would call normal wage income,” in an opinion article for the Wall Street Journal.

Currently carried interest gets treated as capital gains, with a top rate of 23.8 percent as opposed to the ordinary income rate of 39.6 percent.

Steve Judge, president and chief executive of the industry’s trade body, the Private Equity Growth Capital Council, called Camp’s proposal “disappointing.”
“Key policy makers from both parties have already made clear that the discussion around this draft proposal will be brief,” Judge said in a statement. “Nevertheless, chairman Camp’s proposal penalizes long-term capital investment, which he and other members of the House Ways and Means Committee have purported to support.”

This is not the first time increasing the carry tax rate has been on the agenda. Various bills to change the tax designation on carry to ordinary income have been put forward repeatedly over the past years, but none have garnered enough support to become law.

Camp did not just set his sights on carried interest. Buried deep within the draft legislation is a provision that will increase taxes on publicly traded partnerships, such as The Blackstone Group, The Carlyle Group and Kohlberg Kravis Roberts.

Under current tax law, publicly traded partnerships are normally taxed at the corporate level tax, as are owners of the partnership at the individual level on any distributions. By comparison, regular partnerships pay no tax at the entity level, and tax liability is reported on individual partner’s returns.

But over the last few years, Blackstone, Carlyle, KKR and a few other public private equity firms have been benefitting from an exception to the rule as they derive most of their income from dividends, interest income and capital gains, said Victor Fleischer, a professor of law at the University of San Diego, in an article for The New York Times.

Camp aims to narrow the exception, found in Section 3620 on page 660 of the draft bill, so that it would apply only to publicly traded partnerships in the energy sector.

“It is hard to see how private equity or financial services firms could squeeze into this exception,” said Fleischer. “The publicly traded private equity firms would either have to take themselves private again or pay corporate-level taxes.”

But Fleischer adds the investment funds sponsored by these firms are not publicly traded and would not face a corporate-level tax.