US Senate bemused by Blackstone ‘pretending’(3)

Concerned by the upcoming Blackstone IPO structure, the US Senate Finance Committee today introduced legislation that, if made law, would prevent alternative investment firms from claiming partnership tax structures when going public. The proposed change would not affect Blackstone for five years, but, according to a legal source: ‘Everyone else gets hosed’.

The US Senate Finance Committee today introduced proposed legislation that committee leaders say is inspired by private equity firms and hedge funds “pretending to be something they’re not to avoid most, if not all, corporate taxes”.

The bill, introduced by committee chairman Max Baucus and ranking member Chuck Grassley, is a proposed amendment to the Internal Revenue Code of 1986, which was created to crack down on publicly traded partnerships that avoided corporate taxes. The bill introduced today would prevent investment advisors from claiming an exception within 1986 amendment, as The Blackstone Group has done for its upcoming IPO.

According to the bill, because Blackstone has already registered with the SEC to go public, the proposed rule would not apply to the firm until 2012. But the amendment, if enacted, will dash the hopes of any private equity firm or hedge fund hoping to list itself as a partnership on a US market – the bill applies to all public partnerships that are were not already trading or in registration before today.

“Blackstone will be fine, but everybody else gets hosed,” said a legal source, noting that several large private equity firms are pondering moves similar to Blackstone’s. But none of these have yet registered to go public.

The 1986 amendment allows a publicly traded partnership to avoid corporate taxes if at least 90 percent of its income is “passive”, meaning in the form of dividends, interest, royalties and capital gains, rather than because of the provision of services or products.

Blackstone has structured its upcoming IPO to be that of a partnership defined for tax purposes under the 90 percent passive-income exception. The two senators noted in a joint statement that the “Finance Committee staff has met at length with representatives of Blackstone and reviewed the relevant documents and filings. After careful consideration, we believe that these IPOs raise serious tax questions that if left unaddressed have the potential to jeopardize the integrity of the tax code and the corporate tax base over the long term.”

In an additional statement of introduction to the bill, Senator Baucus writes: “Recently, some private equity and hedge fund entities have sought to go public without paying corporate tax. The bill that we introduce today would treat all publicly traded partnerships that directly or indirectly receive income from providing investment advisory or asset management services as corporations” and therefore subject to corporate taxes.

In a press release today, Senator Grassley announced: “Right now, some businesses are crossing the line between reasonably lowering their tax burden and pretending to be something they’re not to avoid most, if not all, corporate taxes. . . If left unaddressed, the tax concerns presented by the public offerings of investment managers, like private equity and hedge fund management firms, could fundamentally erode the corporate tax base.”

Today’s announcement will create nervousness within the industry because the Senate Finance Committee is also looking into the issue of the tax characterisation of carried interest. Senator Grassley in particular is concerned that the low capital gains rate applied to carried interest is not appropriate, according to a lobbying source. However, tax experts say they believe it will be difficult for legislators to quickly introduce legislation that successfully carves out carried interest as a distinct form of income to which to apply higher taxes.