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GOP tax plan cuts corporate interest deductibility

Photo: Evan Vucci / AP

President Trump and Congressional Republicans plan to front-stab private equity later this morning, by unveiling a tax plan that multiple sources say will include a partial cut to corporate interest deductibility. But don't expect to hear any specific percentages, as it hasn't actually been worked out yet.

Why it matters: Private equity returns arguably are driven more by debt than by equity, given that buyout firms often finance the majority of an acquisition with bank loans.

Those loans are put onto the books of the purchased company, which currently gets to deduct 100% of the interest. Or, put another way, 100% deductibility cheapens debt capital for private equity and lowers financial sponsor risk.

Why is this happening? Because Republicans need to come up with some big revenue generators in the absence of the Border Adjustment Tax and the collapse of ACA repeal/replace.

Wait, no numbers? Nope. What's coming out today is more detailed than that one-pager back in April, but not by too much. Ways and Means will need to hammer out the specifics on this piece, as the Big Six is now effectively defunct. One source says that talk is either for a 20-30% reduction in the deductibility, or perhaps a play on debt-to-EBITDA caps that are employed in several European countries. Expectations also are that interest on existing loans would be grandfathered in.

Bigger picture: I'm focusing on private equity here, but the issue is obviously much broader as it affects any company that takes out loans to do such things as buy equipment or build new facilities. It also would have a major impact on the commercial real estate sector.

The BUILD coalition, a pro-biz lobbying group organized around this issue, analyzed corporate earnings calls between July 2016 and February 2017. It found that interest deductibility was mentioned in 16.6% of calls, whereas tax repatriation — an issue that gets a lot more political and media attention — was mentioned in just 14.9% of calls.

Caveats: To be sure, there are going to be plenty of tax carrots today for private equity, including a lowering of the statutory rate to 20% and the likely lack of broad-based carried interest reform. There also will be intense lobbying to minimize the reduction as much as possible, and skepticism remains over tax reform actually getting done in 2017 ("needing a win" doesn't necessarily mean much... just ask Cleveland Browns fans).

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