Private equity fights back on US tax reforms
Industry hardest hit by plans to curtail deductibility of interest payments
Private equity firms are preparing to unleash a “lobbying bonanza” in Washington in an attempt to push back against the parts of proposed US tax reforms that are expected to cause severe disruption for the buyout industry.
The sweeping Republican tax reform package first floated two weeks ago has panicked private equity executives who claim the changes will make buying and selling US companies harder and deter some companies from investing in the country.
The reforms are part of a broader package that would lower the corporate tax rate to 20 per cent from 35 per cent and allow companies to immediately deduct the costs of new investments in equipment for a period of five years.
Among the provisions is a proposed cap on the tax deductibility of interest payments exceeding 30 per cent of income, which will hurt buyout firms that primarily use debt to finance acquisitions, and those holding heavily indebted companies.
James Maloney, vice-president of public affairs at the American Investment Council, an association representing private equity firms, said: "The proposed limitation to full interest deductibility . . . impacts not only the private equity industry, but every industry — from agriculture to telecommunications — that utilises debt financing in order to make new investments and manage day-to-day operations."
"There is no particular logic to the reforms. This is really frightening," said one London-based private equity manager with international holdings, including in the US.
Another British industry source said: "On the basis of the proposed tax reforms alone, the US private equity landscape looks less attractive."
James Wickett, a partner at Hogan Lovells, the law firm, said he expected a “lobbying bonanza” to hit Washington in response to the tax plans. “[Private equity] associations and just about every Fortune 500 company will have someone in Washington representing their needs,” he said.
Additional changes put forward by Republican lawmaker Kevin Brady last week, and a senate version of the bill published on Thursday, have further troubled the private equity industry.
Mr Brady’s proposal would prevent private equity managers from enjoying a tax advantage known as “carried interest” if they hold a company for less than three years. At present, profits generated by private equity and hedge fund managers are taxed at the lower capital gains rate of 23.8 per cent on investments that are held for at least a year, rather than the income rate of 39.6 per cent.
Critics of the Republican reforms say, however, that they fall far short of the tough crackdown on carried interest that Donald Trump promised during his presidential campaign. They argue the overall tax package is heavily skewed to big business and the richest in US society. Analysis by the Tax Policy Center has showed that nearly half of the fruits of the House tax reforms would go to the richest 1 per cent of Americans.
The controversy played out on Sunday on the weekly political talk shows. Both the White House and Republican leaders have said the planned corporate tax rate cut would help middle-class Americans by leading to further economic growth, even though it may lead to a higher individual tax bill for some of them.
Steven Mnuchin, Treasury secretary, said he believed fewer middle-class Americans would see a tax rise once the diverging House and Senate tax reform bills were actually brought together. “We’ll have a conference and we’ll fine tune this,” Mr Mnuchin told CNN.
Tim Wach, managing director at Taxand, an international network of tax advisers, said the corporate tax changes “will likely make investments into the US less attractive”. He said: “[These rules] will give rise to lots of challenges when trying to structure cross-border investments from a private equity perspective.”
The Senate version of the bill has intensified these fears as it implied a bigger change to the deductibility of interest against corporate tax bills than the earlier reforms put forward in the House, according to analysts. The two chambers need to harmonise their approach for tax reform to proceed.
The Senate version appears to use a different definition of business earnings in its cap on the ability of companies to deduct their net interest expense. Alec Phillips, an analyst at Goldman Sachs, said this suggests “corporate interest deductibility would be restricted more than under the House version”.
The result is that the Senate measure would raise more money than the House one. A score of the proposals from the Joint Committee on Taxation, a Congressional watchdog, showed that the Senate proposal on business interest would raise $308bn over 10 years, compared with $172bn in the House.