Private Equity Tax Practices Face Scrutiny

Sep 4 2012 | 10:21am ET

New York's two previous attorneys general have been thorns in the side of Wall Street, and the office's current occupant is proving no different.

Eric Schneiderman's office is investigating whether private equity firms are improperly using two controversial methods to reduce, delay or avoid paying some taxes. Among the firms potentially in the crosshairs is Bain Capital, the p.e. shop founded by Republican presidential candidate Mitt Romney.

At issue are several practices. In fee-waiver conversions, private equity firms or managers waive management fees, instead having investors put the saved money into a firm's fund. The move turns management fees, usually taxed as ordinary income, into capital-gains, taxed at less than half the ordinary rate. Schneiderman's office is also looking into whether some firms have claimed that such income wasn't income at all, but return of capital, which would be entirely untaxed.

Several firms, including Bain, have utilized fee-waiver conversions. No firms are known to have employed the latter tactic. But even fee-waiver conversions are controversial in the academy and in the industry, where some top firms, including the Blackstone Group and the Carlyle Group, have never used them.

Still, the Internal Revenue Service has not taken issue with the conversions, which Steve Judge of the Private Equity Growth Capital Council called "legal, widely-recognized and often part of negotiated agreements between the alternative investment community and investors." The IRS did look into them, calling conversions an area of "possible noncompliance," but appears to have taken no action.

Some have questioned Schneiderman's motivations, noting that the Democrat launched the investigation at the same time that the matter became an issue in the press and the presidential campaign. But his office has said that the probe emerged from a newly-created taxpayer protection unit and that it subpoenaed 13 firms in July, before the issue broke.

In addition to Bain, New York has subpoenaed Apollo Global Management, Clayton Dubilier & Rice, Crestview Partners, H.I.G. Capital, Kohlberg Kravis Roberts, Providence Equity Partners, Silver Lake Partners, Sun Capital Partners, TPG Capital and Vestar Capital Partners. And a 2009 Dow Jones survey showed 40% of buyout firms have employed the practice. For his part, Romney has denied ever using conversions to cut his tax bill.


In Depth

Q&A: Brevan Howard’s Charlotte Valeur Talks Strategy

Sep 18 2014 | 11:18am ET

Charlotte Valeur chairs the board of Brevan Howard Credit Catalysts, an LSE listed...

Lifestyle

Hedgies Rock Out For Children's Charity

Sep 15 2014 | 8:40am ET

It's that time of year again—when hedgies trade in their spreadsheets for guitars...

Guest Contributor

Volkered: How Financial Sector Reforms are Creating Opportunities for Hedge Funds

Sep 16 2014 | 11:28am ET

New regulations have dramatically curtailed proprietary trading activity in investment...

 

Editor's Note

    Get A Sneak Peak Of The Alpha Pages

    Aug 25 2014 | 11:21am ET

    As many of you know, FINalternatives was recently acquired by the owners of Futures magazine, a firm called The Alpha Pages LLC. Today marks the soft-launch of a new sister site for both publications. As its name suggests, The Alpha Pages will cover all types of alternative investments, going far beyond the more well-known ones such as hedge funds and private equity. Read more…

 

Futures Magazine

September 2014 Cover

The London Whale: Rogue risk management

Credit default swaps brought down the London Whale and cost JPMorgan $6.2 billion. Here is how it happened.

The Alpha Pages

TAP July/August 2014 Cover

The Alpha Pages Interview: Senator Rand Paul

Senator Paul sat down in the debut series of the Alpha Pages Interview to discuss the broken tax code, regulation surrounding Bitcoin, and his plans for the 2016 Presidential election.