As the debate continues about the proper taxation of hedge and equity fund managers' management services income, Congress has scheduled another hearing on September 6 and the Joint Committee on Taxation has issued a two-part report on carried interest taxation. See "Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues Part I and Present Law and Analysis Relating to Tax Treatment of Partnership Carried Interests and Related Issues Part II. Part I presents background information on the current treatment of carried interests and going-public transactions of partnerships in the financial services business, describes the current treatment of profits interests (as evolved through litigation and administrative development of interpretations) and publicly traded partnerships and other relevant partnership rules, sets out current legislative proposals, and discusses the primary issues of concern. Part II discusses offshore structures for these financial services partnerships and deals primarily with related unrelated business income taxation for charities, international taxation, and deferred compensation issues.
Part I of the report ends with a fairly comprehensive discussion of the various arguments for and against taxing carried interests as compensation at ordinary income rates. In my quick reading, I'd say the arguments come out fairly heftily on the side of taxing carried interests as compensation. They include many of the arguments made and positions taken in my earilier postings on this blog.
In addition, Part I of the report includes a number of interesting statistics on hedge and equity funds. I've picked out a few here for readers' quick perusal.
- partnerships control $13.7 trillion of assets
- 78.4% of those assets are in finance/insurance or real estate partnerships, with the largest concentration in securities/commodities financial partnerships
- On hedge funds:
- since the first hedge fund was launched in 1949 with about $100,000 of funds to "hedge" long stock positions with leverage and short positions, hedge funds have grown to a staggering $1.4 trillion of assets under management, with enormous concentration, since the largest 100 funds control about $1 trillion of assets
- the main investors in hedge funds are high net worth individuals and institutional investors like pension funds, endowments and foundations
- one thing driving pension fund investment in risky hedge funds is a desire for the claimed high returns because pensions have projected returns higher than can be achieved with a standard mix of stock and debt assets (in spite of the fact that only 20% of hedge funds have returns after fees above the average S&P return-- see earlier posting on New Yorker article on Harry Kat: John Cassidy, Hedge Clipping, The New Yorker, July 2, 2007, at 28)
- In the US, half of all endowment and foundations invested in hedge funds, and 10% of corporate defined benefit plans did so by end of 2005
- hedge funds are highly leveraged, and leverage is continuing to rise
- hedge fund performance is not transparent, for a number of reasons, though the JCT concludes that hedge funds outperform S&P 500 and that net of fees, they deliver returns at least as good as alternative investments with similar risks (for some information on the low after-fee returns of most hedge funds, see earlier posting on New Yorker article on Harry Kat: John Cassidy, Hedge Clipping, The New Yorker, July 2, 2007, at 28)
- on private equity funds:
- the thirteen largest private equity funds manage about $350 billion in assets
- buyout funds are the largest segment of the equity funds, and are highly leveraged
- not all capital commitments for funds are called, because the funds do not find suitable investment targets (there goes the so-called "laffer curve" proponents' that economic growth is always helped with lower capital gains taxes because it makes more capital available which is used to make more investments which determined growth)
- public, corporate and union pension funds accounted for about 40% of private equity capital in 2006, and about another 35% was from wealthy individuals and wealthy families' investment arms, financial institutions, and insurance companies
- for venture capital funds, for every $100 invested, managers will earn approximately $24 present value; for buyout funds, for every $100 invested, managers will earn approximately $17 present value
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