We mentioned Blackstone’s unusual walk between the rock of tax-structure and the hard-place of SEC regulations here a couple of weeks ago. A quick refresher: under our tax-code, master limited partnerships do not pay the 35 percent corporate tax rate. The are pass through entities, and profits are taxed at the much lower, 15 percent capital gains rate on individuals when distributions are made to partners. Blackstone plans to retain this tax treatment after its IPO and so must show at least 90 percent of its income is derived passively—such as income from interest, dividends and gains from selling or holding capital assets.
But under SEC regulations, Blackstone must prove that it is an active manager of its portfolio companies to avoid having to register as a regulated “investment company” under the notorious ’40 Act.
So can Blackstone stay passive for tax reasons but active for regulatory reasons?
One expert Bloomberg quotes sounds a bit skeptical about this passive and active stance.
The trick for Blackstone is to qualify as a partnership with passive investments in the eyes of the IRS while at the same time avoiding regulation as an investment company under a 1940 law, said Victor Fleischer, a law professor at the University of Colorado in Boulder.
“I do believe they are speaking out of both sides of their mouth a little bit,'' said Fleischer, who has drafted a paper on the taxation of partnership profits in private-equity funds -- the so-called carried interest part of a fund manager's compensation. Fleischer reported on Blackstone's proposal on his blog.
But well-respected Lehman Brothers tax analyst Robert Willens seems cautiously optimistic that Blackstone will succeed. He argues that Blackstone’s operations might violate the “spirit” of the rules but are well-within the “letter” of the tax rules. And spirits don’t matter because this ain’t Ghostbusters.
Robert Willens, an accounting analyst at Lehman Brothers Holdings Inc., said Blackstone may be able to accomplish its goal because the tax code clearly identifies the types of income it can earn under the structure it proposes.
“If Blackstone earns the type of income specified in the requisite quantities, then that should be the end of the inquiry,'' he said. “It's not proper, in these cases, as a matter of statutory construction, to inquire into whether the ‘spirit' of the statute has been well served.''
Oh, and just in case you missed him, Willens shows up in Reuters as well.
"They have to kind of walk this fine line between acting like an investment company, but not having to register as one," said Robert Willens, a tax and accounting analyst at Lehman Brothers in New York. "There is a little bit of an uncertainty there. If they had to register as an investment company then they would lose this tax break."
The big risk for Blackstone, then, seem not to be what the IRS or the SEC might do but what might happen on Capitol Hill should lawmakers notice that a firm as big as Blackstone has so easily slipped though this loophole in the tax-regulatory structure.
Blackstone Says IPO Tax Stance May Prompt IRS Action [Bloomberg]
Unusual IPO tax structure may plague Blackstone