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Buyout firms facing tax investigation

Bain Capital and Apollo Global Management among private-equity firms subpoenaed

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Protesters demonstrate in front of the Bain Capital owned Bloomin’ Brand Corporate Headquarters before the start of the Republican National Convention at the Tampa Bay Times Forum
Gulf News

New York: Bain Capital LLC and Apollo Global Management LLC are among private-equity firms subpoenaed by New York’s attorney general in an investigation into whether they are depriving the state of tax revenue, according to two people familiar with the matter.

New York Attorney General Eric Schneiderman is probing a practice that reduces tax liability of the buyout firms by converting management fees paid by their investors into fund investments, which are taxed at a lower rate, said the people, who asked not to be identified because the investigation has not been disclosed publicly.

At least a dozen firms were subpoenaed in July, one of the people said. Other firms that received subpoenas include KKR & Co., TPG Capital, Silver Lake and Providence Equity Partners Inc.

The investigation is being conducted by Schneiderman’s taxpayer protection bureau, the New York Times reported yesterday. Michelle Duffy, a spokeswoman for Schneiderman, declined to comment on the investigation.

Charles Zehren, a spokesman for Apollo at Howard J. Rubenstein Associates, and Kristi Huller, a spokeswoman for KKR, declined to comment. Alex Stanton, a spokesman for Bain at Stanton Public Relations & Marketing; Owen Blicksilver, a spokesman for TPG at Owen Blicksilver Public Relations Inc.; Gemma Hart, a spokeswoman for Silver Lake at Brunswick Group Inc.; and Jonathan Doorley, a spokesman for Providence Equity at Sard Verbinnen & Co., didn’t immediately respond to e-mails yesterday seeking comment.

Private-equity firms raise money from investors such as pension funds and endowments and combine it with loans to acquire companies. Their goal is to improve performance, sometimes by cutting jobs, and sell the companies for a profit within about five years.

The firms collect management fees from investors, usually about 2 per cent of assets, and take a cut of investment profits, known as carried interest, that averages about 20 per cent.

At issue in the New York investigation is that some firms convert the fees, which are taxed as ordinary income at rates as high as 35 per cent, into a stake in a fund whose carried interest is taxed as capital gains at 15 per cent, said the source.

By deferring the receipt of fees, buyout firms get a second benefit by deferring the tax. While the partners are well-positioned to know what investments may be winners, the waiver is irrevocable, meaning the fees disappear if the deals don’t generate profit.

The tactic has not been deemed a violation of federal tax laws.

Bain Capital Fund VII LP disclosed in a 2009 report that the general partner in the fund had in the past waived management fees and converted those fees into an interest in the fund called a “priority profit share”.

Mitt Romney, the Republican presidential candidate, invested in some Bain funds that employed the fee-conversion strategy. Romney, who co-founded Bain in 1984, was able to put money into the funds after he left in 1999 to oversee the Salt Lake City Olympics and later serve as governor of Massachusetts.

Romney’s campaign issued a statement saying he didn’t benefit from the practice, the New York Times reported.