Carried interest

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The carrying interest , or carry , in finance, is part of the investment return paid to the investment manager exceeding the amount given by the manager to the partnership, especially in the alternative investment (private equity and hedge funds). This is a performance cost, rewarding managers for improving performance.

The manager's interest-subordinate allocation varies depending on the type of investment fund and the demand for funds from the investor. In private equity, the standard interest interest interest is historically 20% for funds making purchases and business investments. A well-known example of private equity firms with interest carrying between 25% to 30% includes Bain Capital and Providence Equity Partners.

In private equity, the interest distribution is carried by the waterfall distribution: to receive the carrying interest, the manager must first return all capital donated by the investor and, in certain cases, the agreed rate of return ("barrier" rate " or "preferred return") to the investor The private equity fund distributes the interest brought to the manager only after it gets out of the investment, which may take years.the level of customary barriers in private equity is 7-8% per annum.

In a hedge fund environment, the carrying interest is usually referred to as "performance cost" and because investment in liquid investments, it can often pay interest carry over each year if the fund has made a profit. They have historically centered on 20%, but have greater variability than private equity funds. In extreme cases, the cost of performance reaches as high as 44% of the fund's profit but is usually between 15% and 20%.

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Definition and history

The interest brought is part of the investment return paid to the investment manager exceeds the amount given by the manager for the partnership, especially in alternative investments namely, private equity and hedge funds. This is a performance cost that is useful for managers to improve performance.

The origins of interest brought can be traced back to the 16th century, when European ships crossed into Asia and America. The captain of the ship will take a 20% share of the profits from the goods carried, to pay for transportation and risk sailing over the ocean.

Cost Management

Historically, the carrying interest has served as a major source of income for managers and companies in both private equity and hedge funds. Both private equity and hedge funds tend to have an annual management cost of 1% to 2% of annual capital commitments; the cost of management is to cover the investment costs and manage the funds. Some have suggested that management fees in hedge funds should be treated as ordinary income rather than capital gains treated with lower tax rates. Since the size of both private equity and hedge funds has increased, the cost of management has become a more meaningful part of the value proposition for fund managers as evidenced by the 2007 Initial Public Offering of Blackstone Group.

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Taxation

The taxation on interest rates has been a problem since the mid-2000s, mainly because the compensation received by certain investors increases with the size of private equity and hedge funds. Historically, the carrying interest has been treated as a capital gain for tax purposes in most jurisdictions. The reason for this treatment is that an investment manager will make a substantial commitment of his own capital into the fund and bring interest will represent a portion of the manager's profits on the investment. While hedge funds usually trade their investments actively, private equity firms tend to withhold their investments for years. Thus, capital gains from private equity funds typically qualify as long-term capital gains, which receive favorable tax treatment in many jurisdictions. Criticism of this tax treatment is trying to sort out the results directly related to the capital contributed by the fund manager of the interest that is allocated from other investors in the fund to the fund manager.

United States

Because managers are offset against carrying interest, most of their income from funds is taxed as a return on investment and not as compensation for services. This tax treatment came from the oil and gas industry in the early 20th century, when actual oil exploration companies, using the investment of financial partners, posted their profits at the rate of capital gain. This is lower than the ordinary income level for most of the 20th century, to encourage risk and entrepreneurship. The logic is that the financial partner's sweat equity carries a risk of loss, if their exploration does not go well.

Typically, a partner is not taxed upon receiving the carrying interest because it is difficult to measure the present value of a future interest. In 1993, the Internal Revenue Service adopted this approach as a general administrative rule, and again in the proposed legislation in 2005. In contrast, partners are taxed because the partnership generates revenue. In the case of hedge funds, this means that the counterpart refuses taxation of the income generated by the hedge fund, which is usually an ordinary income or perhaps a short-term capital gain, taxed equally as ordinary income because of the nature of most hedge fund investments makes. Private equity funds, however, usually invest on a longer horizon, with the result that their income is long-term capital gain, taxed to individuals at a maximum rate of 20%. Because this compensation can reach large numbers in the case of the most successful funds, concerns have been raised in the US Congress and the media, that managers are taking advantage of tax loopholes to accept what is effectively a payroll without paying the usual 39.6%. the marginal income tax rate of the high income person must pay for the income. As of September 2016, total gap tax benefits for private equity partners are estimated at about $ 2 billion annually to 14 or 16 billion dollars.

Recent settings settings

To solve this problem, US Representative Sander M. Levin introduced H.R. 2834 on June 22, 2007, which would eliminate the ability of investment advisers to receive capital-gains tax treatment on their income. On June 27, 2007, Henry Paulson said that changing the tax treatment of an industry raises fears of tax policies, and that changing the way partnerships are generally taxed is something that should only be done after careful consideration, even though it does not speak only about the interest it carries. In July 2007 the US Treasury was asked to testify before the US Senate Finance Committee. US Representative Charles B. Rangel incorporated a revised version of H.2.834 as part of the "Parent Tax Reform" and the 2007 House extension package.

In 2009, the Obama Administration included a line item on taxes made at regular income levels in the 2009 Budget Blueprint. On April 2, 2009, Congressman Levin introduced a revised version of the interest legislation he presented as H.R. 1935. The proposal was made by the Obama Administration for the 2010, 2011, and 2012 budgets.

The favorable taxation on the carrying interest becomes a problem during the Republican presidential race in 2012 for the president, as 31% of Mitt Romney's 2010 and 2011 presidential revenues are rolled out. On May 28, 2010, the House of Representatives approved the proposed interest law as part of an amendment version endorsed by the Senate of H.R. 4213. On February 14, 2012, Congressman Levin introduces H.R. 4016.

On February 26, 2014, House Committee on Cara and Sarana led by Dave Camp (R-MI) released a draft law to raise taxes on interest carrying from the current 23.8 percent to 35 percent. In June 2015, Sander Levin (D-MI) introduced the Justice Act of Interest Taken by 2015 (H.R. 2889) to taxation advisors with the usual income tax rate.

By 2015, some in the private equity sector and the hedge fund industry have been lobbying against change, becoming one of the largest political donors on either side of the aisle. while during the presidential election, Wall Street only supports Hillary Clinton.

In June 2016 Hillary Clinton said that "if Congress does not act, as president he will ask the Treasury to use its regulatory authority to end tax profits".

United Kingdom

The 1972 Financial Law states that the acquisition of investments obtained for reasons of rights or opportunities offered to individuals as directors or employees, subject to exceptions, is taxed as income rather than capital gain. This may actually apply to the interests of many venture capital executives, even though they are partners and not employees of investment funds, as they often become directors of investment companies. In 1987, the Inland Revenue and the British Venture Capital Association (BVCA) signed an agreement stating that in many circumstances the profit on the carrying interest is not taxed as income.

The 2003 Financial Law extends the circumstances under which investment returns are treated as work-related and therefore taxed as income. In 2003, Mainland and BVCA revenues entered into new agreements that have the effect that, in spite of the new law, most of the profits carried forward continue to be taxed as a capital gain rather than income. Such capital gains are generally taxed at 10% compared to a 40% rate on income.

In 2007, the favorable tax rate on interest carrying attracted political controversy. It is said that janitors pay taxes at a higher rate than private equity executives whose offices they clean. The result is that the capital-gains tax rule is reformed, raising the rate on profits to 18%, but the interest brought on is taxed as a profit rather than income.

Investors Are Overpaying for Bad Private Equity Funds

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References

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Carried interest

Kamis, 07 Juni 2018

Carried interest

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