In an unusual accounting move, executives at Blackstone Group LP will get back a big chunk of the taxes they owe on multibillion-dollar profits from the private equity firm’s recent public stock offering.
Blackstone’s tax strategy could be bad for shareholders, experts said Friday, and scrutiny from lawmakers is intensifying.
The New York-based private equity firm, whose holdings include publisher Houghton Mifflin Co. and Universal Studios Florida, disclosed in regulatory filings before its June 22 initial public offering that Blackstone shareholders must relinquish around $1 billion in tax refunds to the company’s executives.
Stephen Schwarzman and Peter G. Peterson, who started Blackstone, took home $2.56 billion in the much-hyped IPO.
Critics in Congress and academia said the tax arrangement, which was reported in Friday’s New York Times, is legal but abuses an accounting loophole.
Blackstone, in a statement released late Friday, said it is “not in any way taking advantage of tax loopholes, but rather is using a standard tax method used widely by private and public companies when business assets are sold.”
Members of the House and Senate said they plan to examine Blackstone’s IPO tax strategy as part of an ongoing inquiry into whether private equity firms, hedge funds, venture capital firms and other investment partnerships are paying their fair share of taxes.
“This isn’t a question of soaking the rich, it’s a question of fairness in the tax code,” Rep. Sander Levin, D-Mich., said in an interview. “It’s not good for all taxpayers. It’s not even good for the shareholders.”
Private-equity powerhouse KKR & Co. LP, in a filling detailing its planned $1.25 billion IPO, disclosed a tax treatment similar to that adopted by Blackstone. So did hedge fund Och-Ziff Capital Management Group, which plans a $2 billion IPO.
A bill introduced last month by Levin and several other House lawmakers would raise the tax rate private equity managers pay on their share of the firms’ profits. A Senate bill is more limited, targeting publicly traded partnerships, but not their managers.
The House proposal would more than double the taxes on the share of profits doled out to private equity, and managers of hedge funds and venture capital firms. At the moment, these rewards, dubbed “carried interest,” are taxed at the capital gains rate of 15 percent.
A new question that lawmakers are likely to ask this summer is whether Blackstone and other private equity giants are pushing the boundaries of tax laws for calculating the value of intangible assets such as brand names and the expertise of executives. In accounting, these assets are referred to as goodwill.
It is common for a company selling shares to the public to allow the value of goodwill to decrease over time because it has the effect of lowering taxes. What is unusual — though not unprecedented — in the case of Blackstone’s IPO, is that the tax benefits are passed along to executives rather than shareholders.
In pre-IPO filings with the Securities and Exchange Commission, Blackstone explained that 85 percent of the tax savings from goodwill, or up to $88.9 million annually for 15 years, will be returned to the company’s executives. Blackstone said Friday that its partners will pay taxes on these payments.
Nevertheless, the tax structure may have shortchanged investors unfamiliar with the intricacies of tax laws, experts said.
“It is a significant wealth transfer from the public investors to the Blackstone founders and managing directors that public investors may not have understood unless they read the fine print of the prospectus,” said Victor Fleischer, a University of Illinois law professor.
Bernard Wolfman, emeritus law professor at Harvard Law School also called the practice inappropriate.
“It’s inconsistent with the notion that all income should be taxed and inconsistent with the way goodwill has been traditionally dealt with,” he said.
However, Robert Willens, chief tax and accounting analyst at Lehman Brothers Holdings Inc. in New York, said that while the structure is somewhat atypical, it was fully disclosed to investors.
“To suggest that this is some kind of tax dodge is ridiculous,” Willens said.
Senators had already been planning to review the treatment of goodwill as part of their study of private equity taxation issues, Sen. Max Baucus, a Montana Democrat and chairman of the Senate Finance Committee said in a statement.
“The tax code is a roadmap for law-abiding citizens and businesses to pay what they fairly owe, not an obstacle course to be gamed and gotten around,” he said in an e-mailed statement. “We will get the facts to determine whether the tax code is being fairly followed.”