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

Exotic Assets: Investing In Rare Violins

Jan 17 2017 | 4:43pm ET

By definition, alternative investments include exotic assets far beyond your typical...

Lifestyle

'Tis the Season: Wall Street Holiday Parties Back In Fashion

Dec 22 2016 | 9:23pm ET

Spending on Wall Street holiday parties has largely returned to pre-2008 levels...

Guest Contributor

The Trump Administration: What It Could Mean for Carried Interest

Jan 19 2017 | 5:25pm ET

The arrival of the Trump administration brings the potential for a repeal of the...

 

From the current issue of

Often seen as a passion project, or part of a philanthropic venture, rare and fine stringed instruments offer an exciting option to diversify one’s investment portfolio while providing an opportunity for an exceptional long-term investment.