Chorus of PE tax critics grows

Two former US Treasury secretaries have joined the mounting criticism of carried interest’s tax treatment. ‘[N]o one would want to defend’ GP carry tax status, Lawrence Summers said.

Robert Rubin and Lawrence Summers, both former US Treasury secretaries in the Clinton administration, have this week joined the growing chorus of criticism over carried interest tax rates.

Legislators in the US and UK are collecting information related to the tax treatment of carried interest. In the US, carry is taxed at the capital gains rate of 15 percent, rather than as ordinary income at 35 percent, and in the UK, capital gains taper relief allows carry to be taxed at 10 percent for two years, as opposed to 40 percent.

At a tax reform conference hosted by economic policy group the Hamilton Project, Rubin and Summers expressed concern over the current US tax policy applied to private equity carry.

Rubin argued that carry is essentially a general partner’s payment for services rendered. “Basically I think what they’re doing is getting paid for running other people’s money,” he said. “I think at core there’s a very good argument to be made for treating this as ordinary income.”

Summers believes there are “surely some abuses that are involved with stuff that gets capital gains taxation that no one would want to defend. Beyond that there are very difficult questions of line drawing – if you’re going to have a capital gains treatment and you’re going to have partnership structures – in how the tax law should be written and designed if you’re going to have fairness. And I’m not enough of an expert to know where the lines should be drawn.” This job should fall to Congress, he said.

US legislators will continue to look at the issue, said Mark Prater, deputy staff director and chief tax counsel for the Senate Committee on Finance – the legislative committee that has been most active in looking into private equity.

“There’s a lot of different features to private equity and hedge fund issues that we’ve discovered in our examination,” Prater said at the Hamilton Project conference. “All of those things require a lot of research and activity. It is something that we always struggle with in the policy area because markets evolve, business practices evolve, things get more complicated, and legislative and administrative activities have to catch up with it.”

Prater said legislators aren’t likely to rush toward determining the best course of action, but that “pieces of the issues” will likely be addressed.

The ongoing debate mirrors that in the UK, where the government’s Treasury Select Committee is conducting an enquiry into the tax treatment of carried interest. The debate was sparked by a comment from Nick Ferguson, chairman of SVG Capital, that some leading industry executives pay “less tax than a cleaner”. This tax break was the focus of the Select Committee’s first meeting this week, where representatives of the BVCA trade body were given a verbal mauling by politicians on the issue. Today, the BVCA’s chief executive has resigned, while industry veteran Sir Ronald Cohen has also come out in support of higher tax rates for the larger buyout firms.

In the US Senate Finance Committee, staffers are studying academic literature that argues carried interest is mischaracterised as capital gains. The National Venture Capital Association, a trade body and lobbying group for the US venture capital industry, is currently preparing a rebuttal to these assertions.

View the Hamilton Project’s tax conference here.