June 15 (Bloomberg) -- Blackstone Group LP's planned initial public offering this month may be undermined by Senate legislation that would more than double taxes for the company after five years.

The legislation, introduced late yesterday by the Democratic chairman and ranking Republican on the Senate Finance Committee, would force Blackstone Group LP and Fortress Investment Group LLC to organize as corporations instead of partnerships for federal tax purposes beginning in 2012.

They, and other firms that would copy their tax strategy, may be prevented from taking advantage of a 20-year-old tax provision that allows investors in publicly traded partnerships to pay capital-gains taxes of 15 percent on their share of the firm's income. Companies pay a tax rate of as much as 35 percent. Some experts said the proposed legislation may force Blackstone to restructure or even abandon its IPO.

``If it remains a credible threat, they would probably have to withdraw and rethink how it would be structured,'' said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College's Tuck School of Business.

The measure would give New York-based Blackstone and Fortress five years before being required to pay the higher tax rate. It also aims to prevent rival firms such as Carlyle Group and Apollo Management LP from copying the strategy.

Senate Foray

``If a publicly traded partnership makes its money by providing financial services, that active business should be taxed as a corporation,'' said Finance Committee Chairman Max Baucus, a Montana Democrat.

The Senate measure, released ahead of Blackstone's $4.75 billion initial public offering scheduled for the week of June 25, is the first major foray by the committee into overhauling tax laws that affect hedge funds and private-equity firms after months of study.

``Right now, some businesses are crossing the line between reasonably lowering their tax burdens and pretending to be something they're not to avoid most, if not all, corporate taxes,'' said Iowa Senator Charles Grassley, the top Republican on the panel.

The senators are moving as British lawmakers challenge a similar tax rule in the U.K. that allows private equity dealmakers to pay tax at 10 percent on the profits from their investments, rather than at the top 40 percent rate of income tax. Angela Eagle, a lawmaker from Tony's Blair's ruling Labour party, described the rule this week as ``indefensible.''

`Paying Less'

``They're paying less tax than their cleaners,'' she told reporters after a June 12 hearing of the Treasury Committee. Permira Advisers LLP's managing partner, Damon Buffini, together with executives from Blackstone and Kohlberg Kravis Roberts & Co., face questioning by the same parliamentary committee next week.

Blackstone Chairman Stephen Schwarzman, who may receive as much as $449.2 million for selling some of his holdings in the IPO, interrupted an awards acceptance speech at the New York Stock Exchange yesterday to acknowledge the Senate bill.

``We're having an interesting time with this IPO,'' said Schwarzman, who was receiving the Legend in Leadership Award yesterday from the Yale Chief Executive Leadership Institute when he was informed by telephone that the Finance Committee introduced the legislation. ``There's some concern in Congress this is not an ideal thing for companies like us to do.''

The Senate move came on a day when Schwarzman and other Blackstone executives were pitching the company's IPO to a standing-room-only crowd of about 600 investors at New York's Pierre Hotel, located across from Central Park at 61st Street.

`Thorough Examination'

House Ways and Means Committee Chairman Charles Rangel, a New York Democrat, also voiced support for the measure.

``The Ways and Means Committee intends to follow the legislation in the Senate with its own thorough examination of these issues,'' Rangel said.

Treasury Deputy Secretary Robert Kimmitt said today that ``we at Treasury have been looking at a whole range of issues surrounding the tax treatment, private equity, hedge funds.''

``We'll continue to look at those complex issues also in consultation with the Congress,'' he said in an interview with CNBC television, declining to comment on specific deals or initial public offerings.

Alex Brill, a former senior adviser to then-House Ways and Means Committee Chairman Bill Thomas last year, said Congress is likely to adopt some form of the Finance Committee's proposal.

``There are a lot of people who are concerned about this in both parties,'' said Brill, now a research fellow at the American Enterprise Institute, a Washington research organization. ``I put the odds on them cracking down on it.''

Going Public

Blackstone, manager of the world's second-largest buyout fund, plans to go public after taking part in $199 billion of deals in the past 20 years. The firm, which started with $400,000, was projected to have a market value of $32.4 billion if shares sold for $30, with 12.3 percent of the stock held by the public and China's state investment company buying a 9.7 percent stake in a private transaction.

Blackstone spokesman John Ford and Fortress spokeswoman Lilly Donohue declined to comment. In filings with the U.S. Securities and Exchange Commission that warned of potential congressional action, Blackstone said such legislation would reduce the value of its stock at the offering.

Members of Congress have introduced legislation that ``if enacted, preclude us from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly traded partnership rules,'' Blackstone said in a filing today.

Time to Adjust

``It's great that Congress is announcing its intentions now, before the IPO, so investors can appropriately discount the price of the shares to reflect the tax risk,'' said Victor Fleischer, a University of Illinois law professor who is advising the Finance Committee on the tax treatment of hedge fund and private-equity firms.

Organizing as a limited partnership would allow Blackstone to avoid the 35 percent corporate tax rate on most of its income. Instead, shareholders and executives would pay taxes as low as 15 percent on their share of the firm's income.

The strategy mimics one adopted by Fortress, a private- equity and hedge-fund manager that went public Feb. 8. It hinges on the use of a 1987 exception in the tax code that offers favorable treatment to publicly traded partnerships that earn more than 90 percent of their income from passive investments, including interest, dividends, and capital gains. Shares of Fortress fell $1.64, or 6.5 percent, to $23.47 at 4:20 p.m. in New York Stock Exchange composite trading.

Goldman, Morgan Stanley

Under the proposed Senate measure, Fortress would have to pay taxes at the corporate rate beginning in 2012, said Finance Committee spokeswoman Carol Guthrie.

About half of Blackstone's income comes from so-called carried interest, or the 20 percent share of profits paid to fund managers who are taxed at capital gains rates, filings said.

``Our existing owners who are individuals were generally taxed at a maximum U.S. federal income tax rate of 15 percent,'' Blackstone's filing said.

Fleischer said allowing Blackstone to organize as a partnership would give it an unfair advantage over investment banks such as Goldman Sachs Group Inc. and Morgan Stanley, which do similar work but are taxed as companies.

The Finance Committee also has been studying whether to increase taxes on carried interest. Former Treasury Secretary Robert Rubin this week said many fund managers should pay taxes at ordinary rates as high as 35 percent because they perform services more than risk their own capital.

Rubin Comments

House Speaker Nancy Pelosi called Rubin's proposal to raise taxes on fund managers ``interesting.'' On tax matters, Pelosi defers ``to our distinguished chairman, Mr. Rangel, and what he wants to do is put everything on the table,'' she said in an interview on Bloomberg Television's ``Political Capital with Al Hunt.''

While Baucus said last month that he's ``nowhere close'' to having legislation that would raise taxes on managers' pay, industry experts say Rubin's remarks will increase pressure on Democrats who control Congress to act.

``I think it makes it almost inevitable,'' said Steven Howard, a partner at the New York law firm Thacher Proffitt & Wood LLP who has been advising investment firms for 25 years. ``I think it will have a major impact on the way Congress views this study.''

To contact the reporters on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net; Elizabeth Hester in New York at ehester@bloomberg.net.

Last Updated: June 15, 2007 17:27 EDT