Blackstone Group LP and other firms protesting a plan by Congress to increase taxes on executives of investment partnerships are focusing on what they say is an exemption for family farmers.
The farm provision, characterized by the U.S. House Ways and Means Committee as a “clarification,” was inserted by the Rules Committee in broader jobs legislation just hours before the House approved the bill May 28.
Buyout firms, venture capitalists and real-estate partnerships, whose fund managers in some cases would have their taxes raised by more than 150 percent, said the change violates pledges by House Speaker Nancy Pelosi and Ways and Means Committee Chairman Sander Levin that the tax would apply to all investment partnerships.
“It’s a carve-out in the bill, there’s no question about it,” said Mark Heesen, president of the National Venture Capital Association, an Arlington, Virginia-based trade group that is lobbying the Senate for its own exemption. “It shows that they are not being upfront.”
The legislation for the first time would make general partners in investment partnerships pay ordinary tax rates as high as 39.6 percent on three-quarters of their profit shares charged as incentive fees, known as carried interest. Currently, as much as 100 percent of that carried interest can qualify for lower capital-gains tax rates of 15 percent.
The higher tax is designed to affect financial firms. The new language creates an exception for family farms that explicitly says any tax increase won’t apply to carried interest earned in partnerships held “by members of the same family.”
Just a Clarification
“This would indicate that the issue is not so much about tax policy but to indicate which industries are currently in favor and which are seen to be in disfavor,” Peter Rose, a spokesman for New York-based Blackstone, said of the exemption for farmers.
Matthew Beck, a spokesman for the Ways and Means Committee, said the family farm language “simply clarifies what would have been the result of the bill anyway.”
Lobbyists for affected firms are vowing to make an issue of the family farm language this week as the Senate returns to consider the legislation.
New York Senator Chuck Schumer, a Democrat who sits on the Finance Committee and is a deputy of Majority Leader Harry Reid’s, has also said any carried-interest tax measure in the Senate shouldn’t contain carve-outs. Schumer declined to comment, spokesman Brian Fallon said.
‘Extremely Broad Bill’
“The carve-out raises the specter of what a number of us have been saying for a long time now: That this is an extremely broad bill,” said Jeff DeBoer, president of the Washington- based Real Estate Roundtable. “It should raise a very serious question: What is the difference between a family farm and a family real estate business?”
The bill would also make publicly traded private-equity firms such as Blackstone and Fortress Investment Group LLC begin paying corporate-level taxes in 10 years in addition to the higher tax on carried interest earned by fund executives.
At the same time, it exempts from the same treatment other publicly traded partnerships, including about 125 firms organized around energy and natural resources investments commonly known as Master Limited Partnerships.
The different treatment stems from efforts by Senate Finance Committee Chairman Max Baucus, a Montana Democrat, and Iowa Senator Charles Grassley, the panel’s top Republican, to shut down a tax-saving strategy used by Blackstone, Fortress and other financial partnerships, including Lazard Ltd. and KKR Financial Holdings LLC to go public.
Businesses that produce goods and services are ordinarily taxed as corporations before distributions are made to shareholders as dividends. Partnership income flows directly to shareholders without intermediary taxation.
Under the tax-saving technique, first used by Fortress and Blackstone, the firms seek to qualify as a partnership with passive investments in the eyes of the Internal Revenue Service, while at the same time avoiding regulation as an investment company. Victor Fleischer, a University of Colorado tax law professor, has called the strategy “regulatory arbitrage.”
Under the legislation, private-equity firms could continue to use the strategy for 10 years after the bill is enacted. Then they must start paying taxes as corporations. The 10-year grace period was a minor victory for the firms because the Baucus and Grassley legislation originally had a five-year transition rule.
Still Go Public
“They can still go public and get pass-through treatment for 10 years,” Fleischer said. “It’s not just a grandfathering clause.”
The bill’s requirement to pay corporate-level tax wouldn’t apply to publicly traded partnerships in the energy, pipeline, and natural resources industries. Those firms, also known as “Energy REITs,” include Linn Energy LLC and Quicksilver Gas Services LP.
“This bill was not an attempt to repeal publicly traded partnership status for oil and gas partnerships, which have historically been the only active businesses that are allowed to be taxed as partnerships even after going public,” Beck said.