Corporate Interest Deduction Proves Sacred Amid Reformers: Taxes

Photographer: Andrew Harrer/Bloomberg

Leaders of the congressional tax-writing committees have said they intend to press ahead with tax reform in 2013 and consider it their top priority even amid inquiries into the Internal Revenue Service’s practices with applications for tax-exempt status from some small-government groups. Close

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Photographer: Andrew Harrer/Bloomberg

Leaders of the congressional tax-writing committees have said they intend to press ahead with tax reform in 2013 and consider it their top priority even amid inquiries into the Internal Revenue Service’s practices with applications for tax-exempt status from some small-government groups.

A newly formed coalition of businesses is stepping up efforts to protect interest deductions as tax reform advances in Congress.

Interest on debt has been fully deductible for 100 years -- encouraging factory expansions and hiring for new initiatives, and fueling a spate of private equity takeovers. The deductions totaled more than $8.5 trillion in a decade by one estimate. As part of tax reform and discussions about the U.S. debt, both Democratic and Republican lawmakers are calling for limits.

A group of businesses in industries from real estate development and housing to finance started last week to push back, Bloomberg BNA reported. The BUILD Coalition, an acronym for Businesses United for Interest and Loan Deductibility, says capping the deduction may damp willingness to borrow for capital improvements or other expenses.

“Any limitation to interest deductibility will only serve to raise costs on growing businesses and slow job growth,” said Jeffrey D. DeBoer, chief executive officer of the Real Estate Roundtable, a member of the new group.

By deducting interest expenses, companies can reduce the amount of income that’s available to be taxed. That makes borrowing a more attractive option for businesses to finance operations or capital investments. In turn, additional borrowing supports the $5.9 trillion market for dollar-denominated corporate debt by supplying investors with interest-bearing securities. In 2013, JPMorgan Chase (JPM) & Co. and Apple Inc. (AAPL) lead borrowers in dollar-denominated bonds.

Investment firms such as Blackstone Group LP (BX), KKR & Co. and Carlyle Group (CG) LP use interest deductions as a cornerstone of their private-equity business model. Leveraged buyouts use a combination of cash, also known as equity, and borrowed money to fund a corporate takeover.

Proposed Caps

The Obama administration in February 2012 proposed limits on deductibility as part of a framework for tax reform, saying a scaled-back deduction could help toward a lower overall corporate tax rate.

The deductions totaled $422.7 billion in 2009, according to a December report from Tax Notes. Between 2000 and ’09, non-financial company deductions reached $5.7 trillion and financial firms deducted $2.8 trillion.

The authors of the Tax Notes study, Robert Pozen and Lucas Goodman, said that a 65 percent deduction cap for non-financial firms could pay for lowering the corporate tax rate to 25 percent from 35 percent.

Vulnerable Now

Robert Terra, a spokesman for the BUILD Coalition, told BNA that several legislative moves in the past two years suggest interest deductibility is vulnerable.

In Congress, Republican Senator Rob Portman from Ohio in 2012 proposed limits on corporate interest deductibility. Representative Devin Nunes, a Republican from California, has proposed eliminating the interest deduction and imposing a consumption tax on businesses instead.

Senators Ron Wyden, a Democrat from Oregon, and Dan Coats, a Republican from Indiana, proposed legislation in 2011 to cut the value of inflation from the deduction, among other provisions for broad tax reform.

“Cutting the value of this tax deduction will reduce a company’s financial incentive to take on debt,” the senators said in a 2011 news release.

Nunes, who was chairman of the House Ways and Means Committee’s tax reform working group on international taxes, and other congressional critics say the deduction favors accumulation of debt over equity.

Debt’s Role

In April, the Organization for International Investment -- which represents foreign-owned companies doing business in the U.S. -- wrote to the working group, urging lawmakers to preserve the interest deduction.

“The longstanding ability to deduct interest as an ordinary business expense is directly linked to critical economic activities and provides essential flexibility in a company’s capital structure,” the group wrote. “Debt finance plays an important role in facilitating investments by all types of U.S. companies -- including those headquartered abroad.”

Members of the coalition include the National Association of Development Companies, Small Business Entrepreneurship Council, Real Estate Roundtable, Private Equity Growth Capital Council, Expedia, National Association of Homebuilders and the National Multi-Housing Council. Terra said the organization expects to expand as the issue gains visibility.

Leaders of the congressional tax-writing committees have said they intend to press ahead with tax reform in 2013 and consider it their top priority even amid inquiries into the Internal Revenue Service’s practices with applications for tax-exempt status from some small-government groups.

Doing Business

“Interest is a normal cost of doing business and is often used to finance day-to-day operations and fundamental business activities like meeting payroll, buying raw materials, making capital expenditures, and building new facilities that allow firms to expand and help the economy grow,” DeBoer said in a statement last week.

The Private Equity Growth Capital Council, the industry’s chief lobbyist, released an Ernst & Young report last year that argued a reduction of the corporate tax rate funded by limiting deductibility of interest would increase the marginal tax rate by 6.7 percent, to 33.1 percent from 31 percent.

Private-equity firms, which on average funded their takeovers of companies last year using half cash and half debt, would see their costs soar if the tax deduction on interest is limited or eliminated. The cash tax rate is typically 5 to 10 percentage points lower for a private equity-backed company than for a similar private company, according to Brad Badertscher, an accounting professor at the University of Notre Dame in Indiana who researches the topic.

Carlyle’s Risks

Carlyle, the world’s second-biggest buyout firm, said in March that the administration’s tax framework reflects Obama’s attempts to “change the tax law in ways that could be adverse to us.” Limiting the tax deductibility of interest would reduce the amount of cash it can distribute to investors, the firm said.

The change “could also increase the effective cost of financing by companies in which we invest, which could reduce the value of our carried interest,” Washington-based Carlyle said in the March 14 filing with regulators, referring to the share of profits it keeps for itself after monetizing its deals.

Still, some executives don’t expect a change any time soon. Tony James, president of Blackstone, the largest private-equity firm, said this month that he doesn’t see much risk specific to the industry from “the whole tax thing,” which he referred to as a lot of talk. David Rubenstein, Carlyle’s co-CEO, said this month on a conference call with investors that he doesn’t expect tax reform in the near term.

Though, he said: “At some point in our lifetime, those issues might get faced by Congress.”

To contact the editor responsible for this story: Cesca Antonelli at fantonelli@bloomberg.net

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