Protecting
U.S. Innovation & Job Growth:
Venture Capital and the Taxation of Carried Interest
Debate
Background
Within
the past year the world of private equity has become
much more public. With buyout transactions becoming
extremely sizable and involving public companies
such as Chrysler, Dunkin Donuts, and Hertz, private
equity firms have garnered the interest of the mainstream
media. Coupled with the growing size and influence
of another branch of private equity – hedge
funds – this awareness led to an examination
in Congress of partnership tax rules and how they
apply to firms that make these investments. In turn,
the tax writing committees in Congress began an
examination of a host of tax policies, including
whether or not the “carried interest”
or profit from private equity investments is appropriately
taxed on a flow-through basis, generally at the
long-term capital gains rate, or should instead
be taxed as ordinary income.
On
October 25, 2007, House Ways & Means Committee
Chairman, Charles Rangel of New York released a
comprehensive tax reform bill which, among many
provisions, includes changing the tax rate for carried
interest to an ordinary income rate – effectively
more than doubling the taxes paid on this incentive.
Although
some have focused on carried interest as a tax issue
for the private equity or buyout community, carried
interest is of equal concern to the venture capital
community and its entrepreneurs because VC firms
are also structured as partnerships and employ carried
interest as a means to reward long term investors.
Why
the Venture Capital Community is Concerned:
The National Venture Capital Association and its
members have deep concerns over the impact of proposed
legislation to increase taxes on venture capitalists
who successfully build new companies. The NVCA believes
that by restructuring taxes in this manner, Congress
will ultimately hurt the start-up community which
has been responsible for creating more than 10 million
jobs and driving innovation for decades.
The
NVCA believes that eliminating the capital gains
incentive for venture investing would discourage
long term, high risk investment and that the consequences
would be extremely harmful to US economic growth.
NVCA and its members strongly disagree with the
characterization of venture capital as an investment
management service. The legislation proposes increasing
the capital gains tax rate for carried interest
from 15% to as much as 35% which represents a dramatic
shift in the risk-return ratio that would clearly
impact investment decisions, most likely discouraging
the riskiest early stage start-up investment. At
a time when we should be investing in more start-ups
– building companies to meet new energy challenges
or even to be the next Google – NVCA believes
this change would move us in the wrong direction
and harm long-term U.S. economic growth.
The
capital gains tax rate was designed to help promote
long-term investments in value creation. No other
group embodies that spirit more than venture capital.
As Congress engages in this tax debate, it should
look at specific industries and make policy determinations
based on finding the right balance between achieving
the goal of tax fairness and promoting small, start-up
companies that truly drive the ground-breaking ideas
that fuel our economy and create millions of jobs.
In
this debate, a few important points must be remembered:
Venture capital is the only industry
in the proposed carried interest legislation that
creates new companies, industries, technologies
and communities:
