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Alternatives industry does battle for hearts and minds of legislators

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The alternative investment industry is going into battle on both sides of the Atlantic in a bid to head off a range of legislative moves seeking to raise the level of tax paid by partners

The alternative investment industry is going into battle on both sides of the Atlantic in a bid to head off a range of legislative moves seeking to raise the level of tax paid by partners in hedge fund and private equity management firms. In addition, US hedge funds are also facing the prospect of legislation that would require them to provide regulators with trading records.

Leading private equity figures such as Henry Kravis, the co-founder of Kohlberg Kravis Roberts, and an army of lobbyists have been making efforts to persuade US senators and congressmen that any changes to the way the industry is taxed would not be justified and would ultimately hurt the returns earned by private equity investors such as pension funds.

Last month, senators Max S. Baucus of Montana and Charles E. Grassley of Iowa, the Democrat chairman and senior Republican respectively of the Senate Finance Committee, introduced a bill that would raise the 15 percent tax rate on certain partnerships that go public to the top rate of 35 percent. The legislation has been dubbed the ‘Blackstone Bill’ because its introduction coincided with, and may in part have been prompted by, the USD4.13bn flotation of one of the largest US public equity firms.

In the House of Representatives a week later, Representative Sander Levin introduced another bill tax that would tax the carried interest or performance fee income earned by investment partners as ordinary income at a rate of up to 35 per cent, rather than as capital gains rate taxed at 15 percent. The backers of the bill argue that since carried interest does not result from the investment of the partners, but is a proportion of the profits earned by the partnership as a whole, it should not qualify as a capital gain.

The latest legislation to be introduced that stands to affect the industry is a planned bill to be drafted by the House Financial Services Committee that would require US hedge funds to retain copies of trading data and if necessary turn the records, including trading in formation, e-mails and other documents, over to federal investigators. According to the committee chairman, Representative Barney Frank, the new rule would fill part of the gap left when the courts struck down a requirement for hedge fund managers to register with the Securities and Exchange Commission.

However, the alternative industry still has the backing of the Bush administration. Eric Solomon, an assistant Treasury secretary for tax policy, told the Senate Finance Committee that Congress should be wary of making significant changes to the taxation of partnerships and capital gains tax rules because this might have a negative impact on entrepreneurship. Ands Senator Charles Schumer, who has close ties to the financial industry, said it would be wrong to change the tax rules only for certain types of partnership.

In the UK, where representatives of the private equity industry recently underwent a mauling at the hands of a House of Commons committee scathing about the low tax rate paid by partners, the sector has launched a dialogue with trade unions, which have been among the fiercest critics of private equity ownership of leading companies. The unions claim that their members suffer when privately-owned business cut costs and are starved of investment in order to maximise returns to shareholders.

Concern about the unfairness of private equity returns being taxed at a rate as low as 10 per cent, thanks to so-called taper relief that reduces the capital gains tax on investments held for a longer period, has been expressed by members of all three main UK political parties, as well as by some members of the industry. And Alastair Darling, who became chancellor of the exchequer when Gordon Brown succeeded Tony Blair as prime minister last month, has backed away from suggestions that he was not planning to examine the tax issue.

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