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By Ronald Fink
One way to look at the tax bill that the House passed Wednesday is that it would make PE help GE.
That's because the bill would extend a major tax break that may benefit General Electric more than any other U.S. company. And the bill would offset at least part of the potential drain on federal revenue that break represents by increasing the taxes that partners in private equity firms pay.
GE's tax break involves foreign income from so-called "active financing," which is exempt from the tax that U.S. companies must pay on royalties, rents and other passive income earned abroad even when it's not repatriated. And the vast majority of GE's net income comes from such financing activity.
Of course, other U.S.-based multinationals also benefit from the break. But Robert Willens, a tax and accounting expert in New York City, says GE is clearly the largest beneficiary. According to its 2008 10-K, $16.8 billion of GE's $17.4 billion in net income last year came from financing abroad. And the company's effective tax rate was only 5.5 percent. Without the benefit, its effective rate would have much closer to the top corporate tax rate of 35 percent. The effective rate of GE Capital, which conducts that financing, was 24.9 percent last year.
Meanwhile, the House bill would tax all the income that PE partners earn as ordinary income, which is subject to the maximum personal income tax rate of 35 percent. Currently, a significant portion of that income typically is taxed at capital gains rates of only 15 percent.
The active financing exemption on foreign passive income is scheduled to expire at the end of December, but Willens contends Congress is likely to extend it along with the break for research and development and some 47 other business breaks. The financing exemption has previously been extended five times.
And while the PE tax increase may face tougher going in the Senate than it has in the House, he notes that Congress is under pressure to minimize the impact of business tax breaks on the federal budget deficit even as it tries to encourage job growth. And GE is much more likely to be seen as bigger source of jobs than the PE industry is.
"People in the financial community would be thrilled" to see the financing exemption extended, Willens said, "even if it meant these poor [PE] guys suffer." He added that he used the term "poor" loosely in this context.
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