Private equity's other tax fight
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Private equity is carefully watching the D.C. debate on corporate taxes, in which Senate Democrats seem to be settling on a 25% rate.
Zoom in: Marginal rates obviously matter, but for PE it's just an appetizer before the weedier work begins on issues like corporate interest deductibility.
Why it matters: Corporate interest deductibility is a straw that stirs the PE drink, better enabling buyout firms to finance acquisitions by adding debt to portfolio company balance sheets.
The state of play: Tax treatment of interest deductibility is likely to be addressed in 2021, whether or not President Biden gets a corporate tax rate hike as part of his infrastructure proposal. That's because the current treatment, established via the 2017 tax bill, is scheduled to change at year-end.
- Prior to 2017, companies faced no limits on the amount of debt interest they could deduct.
- Since 2018, deductions have been capped at 30% of EBITDA, which stands for earnings before interest, taxes, depreciation and amortization.
- Beginning next year, it's set to switch to a 30% cap on EBIT — unless it's preemptively addressed, possibly during reconciliation over the infrastructure plan or via tax extenders legislation in Q4.
Biden and his surrogates steered clear of addressing interest deductibility during the campaign, and haven't publicly visited it since.
- As such, it's unclear if the White House favors a renewal of the status quo, a return to the pre-Trump police (better for PE) or deeper cuts to deductibility (worse for PE, first proposed by Obama).
- Jason Furman, an Obama administration economist who's now at Harvard, advocated in a WSJ op-ed last year for "further limiting the deductibility of interest," but tells me via email: "My preference is for making expensing permanent and more aggressively limiting interest deductions. Since Biden is not proposing to make expensing permanent there is no reason for him to propose more aggressive limits on interest deductions than he already has."
Global perspective: Canadian Prime Minister Justin Trudeau on Monday proposed a budget that includes new limits corporate interest deductions
The bottom line: Private equity has thrived in the nascent Biden era, as most recently evidenced by Q1 earnings released this morning by The Blackstone Group. And that's despite the 2017 deductibility cap.
- The question now is how the economics will be calculated for funds currently in market, which may be ultimately invested into a different debt equation.
