A story of private equity GPs selling stakes for high sums, minting a new crop of billionaires, threatens to provoke political pushback against certain tax rules.
"Carried interests are incredibly difficult to tax; the previous attempts by the Treasury were so over-broad that nearly every conduit entity could be improperly punished; consequently, the last round of proposed regulations were highly criticized by absolutely everyone (including me). It will be very challenging to sharpen the pen here even if Congress or Treasury take this on,” he said.
Thayer argued that an even more important tax concern centers on estate tax. Private equity managers often transfer their GP interest or part of it into a Dynastic Trust for the benefit of grandchildren and future descendants, thus avoiding gift taxes by making the transfer before the fund has raised any money. Therefore they avoid estate taxes in perpetuity by using such a trust parked in a state/country that has repealed the Rule Against Perpetuities. Furthermore, the principals can retain “access” through using a family office/family holding company structure while safely keeping these assets out of their taxable estates, he said.
Michael Zeuner, managing partner at WE Family Offices, said an important question is how investors’ interests fit with those of GPs.
“While on the one hand these transactions appear to increase alignment as the general partners invest the proceeds into their funds, on the other does bringing a third party investor into the ownership structure of the fund change the general partner’s agenda with respect to delivering a return to those investors vs a return to their limited partners?”, he said.
“It’s important for families investing as limited partners in funds to understand during their diligence process if a fund they are investing in has sold a portion of its management fees to a third-party and, if so, what the implications of that sale are and how that might change the general partners alignment of interest with their limited partners,” Zeuner added.
(Editor's view: There is nothing necessarily wrong of course with a GP selling a stake in his or her firm to another and pocketing a profit. Welcome to capitalism, everyone. The point, however, is that if firms are able to exploit a large differential between the tax treatment of income and capital, that is on the face of it unfair, and that makes it politically radioactive.)