The toothless tiger of carry tax reform

Phew. For a minute there it looked like the taxation of carried interest – a political football that feels so old it was probably made from inflated pig’s bladder – looked like it had been taken off the agenda.

Ever since Mitt Romney embarked on his presidential run in 2012, the fact that carried interest  is taxed as capital gains rather than the higher rate of ordinary income has never been far from the political lexicon. At the height of the Romney-inspired public debate, this publication even argued that carried interest should indeed be taxed as income, at least when the general partner’s own capital is not at risk. This would allow the industry to take a front foot stance and “end this futile debate,” we argued. Needless to say, the article did not garner universal support among our readers.

Carried interest has since been the subject of tax changes in multiple jurisdictions. Last year the UK excluded carry from an 8-percentage point reduction in capital gains tax and began taxing it wholly as income if the investment was held for less than three years, and partly if groups withdraw from them within 40 months. Firms in Sweden are facing up to a change that will see a proportion of carry taxed as salary at 60 percent, potentially with retrospective effect. Italy, meanwhile, has shifted in the other direction.

So imagine the sigh of relief when the US Government released the nine-page US Tax Reform Framework last week and carried interest – a prominent element of Trump’s campaign – was not mentioned. More worrisome was confirmation that restrictions will indeed be placed on interest deductability. Then on Thursday, White House economic advisor Gary Cohn confirmed that the President is still “committed to ending the carried interest deduction,” in an interview with CNBC.

“That was his position during the campaign and he continues to support the position that carried interest is one of those loopholes that we talk about when we talk about getting rid of loopholes that affect wealthy Americans,” he told the network.

Treasury Secretary Steve Mnuchin has previously said that the carried interest tax break would continue to apply to “job creators.” We are on relatively safe ground if we assume this refers to venture capital, and most likely wider private equity and real estate firms. In the firing line, then, are hedge funds. The irony to this last point is that those hedge funds that hold assets for less than 12 months do not qualify for the lower rate of carried interest tax anyway, and hence will feel little or no impact. In the words of one tax adviser, the rule change would be “a toothless tiger”.

A change to the taxation of carried interest is still technically on the cards in the US. Private fund managers, however, should not be losing sleep over it.