Tax Break on Interest Reconsidered

Change in tax treatment of debt could make life difficult for private equity.

The fight over how private equity managers’ compensation should be taxed obscures other breaks that are central to the buyout industry’s business model.

President Barack Obama and other Democrats have spent several years arguing for higher taxes on the carried interest earnings of private equity executives. What makes private equity deals so profitable, though, is the tax deductibility of interest.

Cost of Financing

“A reduction in interest deductions could increase our tax rate and thereby reduce cash available for distribution to investors or for other uses by us,” wrote Washington-based Carlyle, which is preparing for an initial public offering. “Such a reduction could also increase the effective cost of financing by companies in which we invest, which could reduce the value of our carried interest in respect of such companies.”

‘Good Balance’

“At least let’s take away the automatic escalator for debt,” said Wyden, whose proposal would prevent companies from receiving a deduction for the portion of interest expense that reflects inflation. “I think it strikes a good balance.”

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