United States: Proposed Tax Legislation Affecting Private Equity

As you may be aware, on November 2 the House of Representatives introduced a comprehensive tax reform bill that could affect private equity sponsors, investors and portfolio companies. On November 9, the Senate Finance Committee unveiled the Senate's version of comprehensive tax reform. Although the Senate Finance Committee did not release draft language of its version of tax reform, it did release a summary of its version. Any or all of these proposals may be substantially modified or eliminated prior to enactment.  

Carried interest: The House bill generally would limit the favorable taxation of carried interest to investments that have a holding period of more than three years, and treat carried interest attributable to gains on investments held for three years or less as short-term capital gain (taxed at the ordinary income tax rates).

The original Senate proposal did not provide for any changes to current law regarding the tax treatment of carried interests; however, as a result of a last-minute amendment, the Senate proposal now includes a provision that is similar to the House bill. The Senate proposal, unlike the House bill, also includes a provision intended to treat the sale by a non-US person of an interest in an operating partnership conducting business in the US as effectively connected income subject to US taxation, effectively overturning a recent Tax Court case, Grecian Magnesite.

Changes in rates and net operating losses

The House bill would reduce the corporate tax rate from 35 percent to 20 percent but would retain 39.6 percent as the highest individual income tax rate. Long-term capital gains rates would not be changed and would remain, in general, at 20 percent. The Senate proposal would retain the top corporate tax rate of 20 percent but would defer the effective date until 2019. It would retain the current seven-tax-rate bracket structure, but several of the rates would be lowered and the maximum tax rate would be reduced to 38.5 percent.

The House bill would, in general, allow for net operating losses (NOLs) carryovers to offset 90 percent of a corporation's taxable income and to be carried forward indefinitely (instead of carried forward for 20 years) but would eliminate, in most cases, the carryback of NOLs (instead of two years). This means that, in general, a private equity fund would not be able to monetize bonus payments made upon the disposition of a portfolio company that had been generating taxable income prior to its disposition other than with respect to the taxable year in which the sale occurs. In addition, the House bill proposes increasing an NOL by an interest factor—the short-term applicable federal rate (AFR), currently 1.38 percent, plus four percentage points—to preserve its value. The Senate proposal is generally the same as the House bill except that it does not provide for an increase in the NOL by an interest factor.

Reduced taxation of certain pass-through income

The House bill would provide for a reduced tax rate on business income derived by individuals through sole proprietorships, partnerships and other pass-through entities. A special 25 percent maximum tax rate would apply to "business income" derived by individuals, subject to rules intended to prevent the conversion of wages and other personal services income into business income. Business income excludes certain categories of passive investment income, such as dividends, interest and gains.

Individual investors in private equity funds who hold investments in portfolio companies that are organized as pass-through entities ("operating partnerships") would generally be eligible for the 25 percent rate with respect to the business income derived from such investments (including in respect of carried interests). Owners of management companies generally would not be eligible for the special 25 percent rate on income received from a management company.

In lieu of a lower tax rate for certain income of pass-through entities included in the House bill, the Senate proposal would permit individuals to deduct 17.4 percent of their domestic qualified business income from a partnership, S corporation or sole proprietorship. The proposal includes limitations and restrictions to limit the deduction so that it does not apply to compensation, guaranteed payments or service providers with incomes in excess of US$150,000.

State and local income taxes

Under the House bill, the deduction for state and local income taxes would be repealed in the case of individual taxpayers. In a letter to Representative Earl Blumenauer, House Ways and Means Committee Chairman Kevin Brady recently clarified that the provision would also apply to deny deductions for state and local income taxes imposed on an individual's share of the income received from an operating partnership or management company. Under the Senate proposal, similar to the House bill, an individual would not be entitled to any state and local income tax deduction.

Interest deductibility

The House bill includes two provisions that would significantly limit deductibility of interest. Existing debt would not be grandfathered.

Limitation on business interest: Under the first provision, every business, regardless of form, would, in general, be limited to deducting "business interest" to 30 percent of the taxpayer's "adjusted taxable income" (ATI) for the taxable year. The limitation is determined at the filer level (e.g., at the partnership level instead of partner level). ATI would be defined to mean taxable income but computed without regard to:

  1. Income not properly allocable to a trade or business
  2. Business interest expense or income
  3. NOLs
  4. Deduction for depreciation, amortization or depletion

The 30 percent limitation would be increased by any business interest income earned by the taxpayer. Any interest that is not deductible under the provision could be carried forward for five years. Specific exceptions apply to small businesses (gross receipts of US$25 million or less) and to real estate businesses.

Special rules are provided for partnerships. In applying the 30 percent limitation to business interest incurred at the partner level, the partner's ATI is generally determined without regard to business-related items allocated to the partner by a partnership, ensuring that net income from a partnership is not double counted at the partner level. Second, if the amount of business interest expense of a partnership is below the 30 percent cap, the cap on business interest deductible by the partners is increased by this excess amount.

It is not expected that this provision would apply to debt borrowed at the fund level since the interest on such debt would generally be considered investment interest rather than business interest.

It is not clear how this provision would apply to the debt of a "blocker corporation," the sole asset of which is an interest in an operating partnership conducting business within the United States. In such case, which is a typical private equity structure, the blocker corporation would have no income other than income derived from such partnership. Under this provision, the blocker corporation's ATI would be zero because the blocker corporation's only income (its distributive share of the partnership's income) would be disregarded in determining the blocker corporation's ATI. Therefore, although not clear, assuming that the interest with respect to the debt of the blocker corporation is treated as business interest under this provision and that the business interest at the partnership level equals or exceeds the cap (as determined at the partnership level), the blocker corporation would not receive a current tax benefit for any interest paid or incurred on the debt of the blocker corporation.

Under the Senate proposal, for businesses with average annual gross receipts of more than US$15 million, business interest expense would generally be limited to 30 percent of ATI. As described above, the House bill has a similar limitation, although the House provision would not apply to businesses with US$25 million or less in average annual gross receipts. Unlike the House bill, which would allow excess business interest to be carried forward five years, the Senate proposal would allow such interest to be carried forward indefinitely.

Limitation of deduction of interest by US corporations that are members of an international financial reporting group: The second limitation applies to US corporations that are members of an "international financial reporting group," generally defined as any group of entities that includes at least one non-US corporation engaged in a US trade or business or at least one US corporation and one non-US corporation, prepares consolidated financial statements and earns annual gross receipts in excess of US$100 million. This provision would limit the corporation's deduction for net interest expense to the extent the US corporation's share of the group's global net interest expense exceeds 110 percent of the US corporation's share of the group's global earnings before interest, taxes, depreciation and amortization. This limitation would apply in addition to the limitation described above.

Taxpayers would be disallowed interest deductions pursuant to whichever provision denies a greater amount of interest deductions. Any disallowed interest deductions would be carried forward for up to five taxable years.

The Senate proposal is similar to the House bill. The proposal addresses base erosion that results from excessive and disproportionate borrowing in the United States by limiting the deductibility of interest paid or accrued by certain US corporations that are members of a "worldwide affiliated group." The proposal would reduce the deduction for interest paid or accrued by a US corporation that is a member of a worldwide affiliated group by the product of the net interest expense of the US corporation multiplied by the "debt-to-equity differential percentage" of the worldwide affiliated group. There does not appear to be a gross receipt exception similar to the House bill.

Deferred compensation

The initial version of the House bill would have effectively ended the ability to structure compensation in a manner that allows a service provider to defer income beyond when the income vests. However, an amendment to the House bill released on November 9 eliminated these provisions.

The Senate proposal would provide that compensation deferred under a nonqualified deferred compensation plan is includible in the gross income of the service provider when there is no substantial risk of forfeiture of the service provider's rights to compensation. Under this proposal, a condition related to a purpose of the compensation other than the future performance of substantial services (such as a condition based on achieving a specified performance goal) does not create a substantial risk of forfeiture. The Senate proposal effectively reinstates the changes to deferred compensation proposed in the initial House bill.

Stock options and RSUs issued by certain private corporations

The House bill (as amended) contains a provision that would allow employees (at their election) holding stock options or restricted stock units (RSUs) issued by certain private corporations to defer income resulting from the exercise of the options or settlement of the RSUs for five years after the date on which the options or RSUs vest or, if earlier, the date when:

  1. The stock becomes transferable (including to the employer)
  2. Stock of the issuing corporation becomes publicly traded
  3. The employee becomes an "excluded employee," or
  4. The employee revokes the election

This rule would not be available to an employee (i) who was a one-percent or greater owner of the corporation at any time during the 10 preceding calendar years, (ii) who is or was at any time the corporation's CEO or CFO (including any individual acting in such capacity or a related person), or (iii) who was at any time during the previous 10 taxable years one of the four highest compensated officers of the corporation. The deferral election would be available with respect to corporations that, pursuant to a written plan, grant stock options or RSUs to at least 80 percent of their US employees in the calendar year in which the relevant options or RSUs were granted. Note that the second amendment to the House bill clarifies that Section 83 of the Internal Revenue Code of 1986, as amended ("tax code"), other than this special election pursuant to this provision, does not apply to RSUs.

The Senate proposal does not provide for a similar proposal.

International tax changes

The House bill includes several changes to US international tax rules that would impact multinational groups that have either a US parent or a US subsidiary. Although the Senate proposal is similar in many ways, it would make more extensive changes to the US international tax rules than would the House bill. The Senate proposal borrows more heavily from former Ways and Means Committee Chairman Dave Camp's 2014 tax reform bill.

Dividends-received deduction for distributions from non-US subsidiaries: The House bill introduces a modified "territorial" system of tax (in lieu of the current worldwide tax system) in which income earned by non-US subsidiaries is not subject to tax when repatriated to the United States. Specifically, the House bill provides for a participation exemption system whereby a US corporation would receive a dividends received deduction for dividends received by it from a 10 percent–owned non-US corporation. However, US persons would continue to be subject to US tax on their share of certain income from non-US subsidiaries, including passive (subpart F) income (as revised by the House bill) and "foreign high return" income (described below). The Senate proposal is similar to the House bill.

Deemed repatriation: In order to implement the territorial system, the House bill provides for a one-time transition tax that would require US shareholders owning at least 10 percent of a non-US subsidiary that is a "controlled foreign corporation" (CFC) to include in income the non-US subsidiary's previously untaxed post-1986 accumulated earnings and profits (E&P) even for periods where the US person owned less than 10 percent (including zero percent) of the non-US subsidiary. The House bill specifies a 14 percent tax rate on cash or cash equivalents and a seven percent tax rate on non-cash amounts, and the tax can be paid in equal installments over eight years.

The Senate proposal is similar, except that it provides for a 10 percent rate on cash or cash equivalents and a five percent on illiquid assets and it applies only with respect to previously untaxed post-1986 E&P for the period in which a US person held a 10 percent interest in the non-US subsidiary.

Tax on "foreign high return" income: The House bill would require US shareholders owning at least 10 percent of a CFC to pay tax on 50 percent of its "foreign high returns," generally the excess of the non-US subsidiary's aggregate net income over a determined return (seven percent plus the short-term AFR) on such subsidiaries' aggregate adjusted bases in depreciable property, adjusted downward for interest expense. Special foreign tax credit rules are provided. The intent of the provision is to subject the non-US subsidiary's foreign high returns to a minimum 10 percent tax in the United States.

The Senate proposal does not have the "foreign high returns" provision in the House bill, but it has a similar provision: the "global intangible low-taxed income" (GILTI), which taxes at a 10 percent tax rate foreign earnings that exceed 10 percent of the aggregate of depreciable property used in a trade or business. Like the House bill, the provision applies to all US shareholders, including individuals. The Senate proposal pairs this provision with new incentives to develop (or bring back) intellectual property and export its usage.

Section 956 limited to non-corporate shareholders: Due to the inclusion in the House bill of the dividend exemption for foreign source dividends from a non-US subsidiary to a US corporation, there would not be a US tax avoided by a US parent corporation reinvesting its non-US earnings into the US. Thus, the House bill would eliminate the application of Section 956 of the tax code (which taxes undistributed non-US earnings that are reinvested, or deemed to be reinvested, in the US). In the context of a US borrower, Section 956 of the tax code effectively limited the ability of the non-US subsidiary to provide a guarantee of the US borrower's debt or to allow for a pledge of more than 65 percent of the voting stock of the non-US subsidiary. This change may cause lenders to now seek changes in credit agreements going forward.

The Senate proposal includes a similar provision.

20 percent excise tax on payments to non-US affiliates: The House bill would impose a 20 percent excise tax on certain tax deductible amounts (not including dividends or interest) paid by US corporations to non-US affiliates that are members of the same "international financial reporting group" unless the non-US affiliate elects to treat the payment as effectively connected income within the US. The principal purpose of this provision is to prevent non-US-parented multinationals from eroding the US tax base by shifting profits to non-US affiliates.

The Senate proposal does not include this provision. However, it does have a provision intended to reach a similar result: the "base erosion minimum tax." This base erosion minimum tax effectively requires a US corporation that makes deductible payments to a non-US affiliate to pay the higher of (i) a tax equal to 10 percent of its income without any deduction for such otherwise deductible payments to its non-US affiliate ("base erosion payments"), or (ii) its regular corporate tax liability (reduced only by the R&D tax credit). The base erosion minimum tax applies to US corporations that have annual gross receipts equal to at least US$500 million and that have a "base erosion percentage" of four percent or higher for the taxable year (the "base erosion percentage" is the domestic corporation's total base erosion payments divided by its total deductible payments).

State pension plans

The House bill proposes to make clear that all entities exempt from tax under Section 501(a) of the tax code to the unrelated business income tax (UBTI) rules, notwithstanding an entity's exemption under any other provision of the tax code. This provision is to make clear that state and local government–sponsored entities—such as public pension plans—that are exempt under Section 115(1) of the tax code are subject to the UBTI rules. This provision may cause some state pension plans to seek to restructure their interest in existing portfolio investments in "operating partnerships" or for which there is "acquisition indebtedness."

The Senate proposal does not appear to have a similar provision.

Dentons is the world's first polycentric global law firm. A top 20 firm on the Acritas 2015 Global Elite Brand Index, the Firm is committed to challenging the status quo in delivering consistent and uncompromising quality and value in new and inventive ways. Driven to provide clients a competitive edge, and connected to the communities where its clients want to do business, Dentons knows that understanding local cultures is crucial to successfully completing a deal, resolving a dispute or solving a business challenge. Now the world's largest law firm, Dentons' global team builds agile, tailored solutions to meet the local, national and global needs of private and public clients of any size in more than 125 locations serving 50-plus countries. www.dentons.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions