Monumental tax change afoot for US PE firms

Interest paid on new loans will be taxable under reform proposals, but the rules are unlikely to apply to existing loans.

US tax reform could force private equity firms to change strategy, as proposals include a tax on interest paid on new loans.

Speaking at a tax event on Thursday, House Ways and Means Committee chairman Kevin Brady said limiting interest deductibility would be a “significant change” but the rules would likely allow existing loans to be grandfathered.

Brady has been working with Treasury secretary Steve Mnuchin and other Republican leaders on the framework which they expect to deliver by 25 September. The official line is that the reforms will be completed by the end of the year, but there is widespread skepticism the party will be able to achieve this.

The shift has huge implications for private equity. Under current rules private funds can deduct interest expense from taxable income, contributing substantially to the attractiveness of the leveraged buyout model.

In its annual report, Blackstone, the world’s largest private equity firm, said a change to the rule could force it to adjust its funds’ investment strategies and potentially lower returns for investors.

The increased likelihood of change may push some firms into action now, to mitigate the impact of the change.

“In the case new rules are grandfathered and do not apply to existing debt, businesses could be encouraged to do a recapitalisation,” Jeffrey Chazen, tax partner at EisnerAmper, told sister publication Private Funds Management earlier this year.

But acting before the rules are finalised could be risky.

“[Businesses that recapitalised] could be left exposed if the law is not grandfathered and there is not enough cash flow to pay taxes due to the recapitalisation and loss of the deduction,” Chazen added.

Earlier in the week it emerged that tax on carried interest paid by private fund managers in unlikely to increase, despite it being a key election pledge of President Trump, as reported by pfm.