When the Senate added a new minimum corporate tax to the Inflation Reduction Act (IRA), it almost added a clarification that private equity is the business that will be subject to the new tax. But two key senators blocked the clarification.
Now that the Treasury is writing the rules accompanying the new law, it must decide whether private equity is a business. The legal answer is simple: yes, private capital is a business. But the political answer is more complex: Does the Treasury want to potentially impose a minimum tax on thousands of small companies that are privately owned?
But the Treasury also has a solution: It could require private equity firms to combine the many small companies in their portfolios into one tax return and collect a new tax on their owners, private equity funds.
Starting next year, a corporate minimum tax will apply to any corporation with a balance sheet income of more than $1 billion on its financial statements. The new tax will also apply to affiliated corporations with balance sheet revenues that collectively exceed $1 billion. The corporate holding company usually owns these businesses and files a single consolidated tax return on their behalf.
But partnerships, such as private equity funds, also own and manage sprawling groups of corporations that, collectively, can have book profits in excess of $1 billion. And partnerships, unlike corporations, do not file consolidated tax returns. Thus, it remains an open question whether the Treasury will treat many corporations owned by a private equity firm as affiliated and subject to minimum corporation tax. And this question depends on whether the fund is a business or just a passive investor.
While private equity funds view themselves as passive investors, Congress has tried to make the definition of business clear so that their companies are subject to the new tax. However, Senators Kristen Cinema (D-AZ) and John Thune (R-SD) blocked the effort, leaving the current law in place.
But the proposed clarification was redundant, since the current legislation establishes that private capital is a business. Private equity funds acquire, develop and eventually sell the businesses they own. Fund operations meet the general definition of a business: they are continuous, regular and material. And their large fees and huge profits reflect the size of their enterprises.
A few years ago 1st. The circuit court of appeals expressly rejected the funds’ position. He cited the previous decision 7th A scheme that: “It seems highly unlikely that a formal business entity would not qualify as a trade or business under Grotzinger test [which is the applicable Supreme Court precedent]”. For private capital 1st. The chain supported the view that “[i]It’s one thing to manage your business investments. Another thing is to manage the business in which you invest.”
Given this case law, it is simply implausible to argue that private equity funds are not a business.
But by taking a position, they are just passive investors, private equity funds, their investors and the companies they own, enjoy a wide range of tax benefits. Exempting foundations and their companies from the minimum tax would add another. As Lee Sheppard, a leading tax analyst, noted, “Private investment groups can compete with publicly traded corporate groups. Private equity funds already have tax advantages as business owners; they don’t need a new one.”
The Treasury can and should make it clear that private capital is a business subject to minimal taxation. In doing so, the Treasury may treat a private equity fund’s portfolio company group as a holding corporation group of companies for tax purposes.
But imposing a tax on a large group of corporations can cause administrative and practical problems. An ill-conceived tax meant to be applied to 150 corporations could potentially hit thousands.
However, Congress gave the Treasury the right to develop a “simplified method” for determining the amount of the new tax. The Treasury can solve administrative problems by allowing private equity funds to combine their portfolio companies into one and pay the corresponding tax. These elections will respect both law and politics. And, if a fund prefers its corporations to be taxed separately at the minimum, it could still do so.