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Private Equity Tax Loopholes Coming Under International Pressure

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Calls are growing to raise taxes on private equity honchos.
Calls are growing to raise taxes on private equity honchos.

With each passing day comes new evidence that the world is starting to shine a bright light on how the private equity industry does its business. The latest is a growing chorus of European governments considering raising taxes on private equity profits, according to The Financial Times.

In Germany, the FT reports, regional governments are looking into a plan that would remove a tax exemption from private equity managers' income, potentially bumping their effective tax rate above 60 percent. In Sweden, where profits from private equity transactions are reportedly taxed at 30 percent right now, the FT says authorities are looking to raise the rate for large Swedish firms to 56 percent, and implement a 40 percent penalty on all back private equity investment profits.

In the U.S., the drumbeat for higher rates on investment income (including profits from private equity transactions) is audible, though slightly more muted. Since Mitt Romney's presidential campaign brought both the industry--and the effective tax rate its leaders pay--into wide view, there have been calls from some government officials, including President Obama and business leaders like Warren Buffett to raise rates, as the FT notes.

As it stands now, a private equity manager's income from private equity transactions is taxed at the capital gains rate of fifteen percent (Most of Mitt Romney's income over the past two years has reportedly come from his investments as opposed to earned income). President Obama has proposed a budget plan that would raise the tax on investment dividends for individuals earning more than $200 thousand from 15 percent it stands at now to nearly 40 percent. The budget proposal would also raise taxes on capital gains to 20 percent from its current 15 percent. A recent New York Times/ CBS News poll suggests that a little over half of Americans thinks capital gains should be taxed like earned income.

Even if these proposals don't end up making it through a divided Congress, they come at a time when federal regulators are beginning to take a close look at the private equity industry's business practices.

Recently, the Securities and Exchange Commission reportedly sent letters notifying top private equity firms that it had launched an informal inquiry into how these firms value the companies they invest in. That letter came on the heels of a new requirement -- part of the 2010 Dodd-Frank financial reform bill -- that private equity firms register with the SEC.

It all amounts to an unprecedented degree of public and regulatory attention on an industry that had, for decades, pretty much been left to its own devices. How these firms and their captains will react to this new scrutiny remains to be seen.

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