Private-Equity Firms Have a Beef with Tax Bill -- but Things Could Be Worse

By Miriam Gottfried Features Dow Jones Newswires

House Republicans' tax proposal faces stiff opposition from private-equity firms that say it threatens to disrupt their business model, which often relies on ladling debt onto acquisition targets.

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Still, this version of the bill is more positive for the industry than a previous plan that may have had more dire consequences for firms' returns. And they are holding out hope that more concessions are yet to come, as the bill has a long way to go before becoming law.

The version of the bill released Thursday, titled the Tax Cuts and Jobs Act, would limit businesses' ability to deduct interest from their taxes with a cap of 30% of earnings before interest, taxes, depreciation and amortization. The prior version would have done away with interest deductibility entirely.

Private-equity firms say a cap would limit the amount of debt they could pin to companies, curbing potential returns. Private-equity firms typically purchase companies using a relatively small amount of equity and cover the remainder by heaping additional debt onto their targets.

The number of big leveraged buyouts has fallen dramatically since the financial crisis, though leverage on private-equity deals has been creeping higher in recent months.

"Any limitation on the deductibility of interest is a limitation on a businesses' ability to grow," said James Maloney, vice president of public affairs for the American Investment Council, the main advocacy organization for private-equity interests in Washington.

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Curbing interest deductibility will increase the cost of capital, he said. The House proposal would particularly hurt private-equity backed businesses during an economic downturn when having the cushion of the full deduction is most valuable, Mr. Maloney said.

Still, many private-equity portfolio companies would also benefit from the bill's headline move to lower the corporate tax rate to 20% from 35% on a permanent basis.

"People are going to have to run the math," said Jerome Schwartzman, head of M&A tax services at Houlihan Lokey Inc. He said private-equity firms may end up using more preferred stock in place of debt.

Changes to private equity's tax credit "will provide a lot of interesting opportunities for people that get ahead of that and adjust to it," said Joshua Harris, senior managing director of Apollo Global Management LLC and a co-founder of the firm on a call Wednesday to discuss the firm's quarterly results. "And I don't think that it will fundamentally change the private-equity model."

Shares of three of the four largest publicly traded private-equity firms -- Apollo, Blackstone Group LP and KKR & Co. -- fell on Thursday. Shares of Carlyle Group LP finished the day up.

Private equity isn't the only industry that has been advocating against the cap on interest deductibility. The AIC is part of a coalition called Businesses United for Interest and Loan Deductibility, or BUILD, which includes representatives from real estate, telecommunications, manufacturing and health care, among other industries.

The version of the bill released Thursday makes some concessions to those groups. In addition to allowing some interest deductibility for all corporations, it exempts real-estate firms and small businesses from the 30% limit. It also contains a new provision allowing companies that exceed the 30% threshold to carry the excessive interest forward for five years. That provision could theoretically be used to offset the impact of the limits, although it is unclear how much.

The bill also appears to skirt another previous concern for the industry. President Donald Trump has said he plans to close the so-called carried interest loophole that would tax carried interest at regular income-tax rates instead of the current lower rate. The bill makes no direct mention of carried interest.

The House proposal is still subject to more changes. And the Senate tax proposal, which is expected as soon as next week, could end up differing in key ways. Either way, many in private equity don't appear to expect a resolution out of Washington soon.

"None of our clients are asking about tax reform," Mr. Schwartzman said. "What that tells me is, as with what happened with the ACA, people don't think it's going to happen this year."

Write to Miriam Gottfried at Miriam.Gottfried@wsj.com

(END) Dow Jones Newswires

November 03, 2017 05:44 ET (09:44 GMT)