Rangel tries to tax hedge pay - again

Date: Wednesday, May 14, 2008
Author: Doug Halonen, Pensions & Investments

WASHINGTON — Proposed legislation hammering the deferred compensation of many hedge fund managers is expected to be resurrected on Capitol Hill as soon as this week — and this time around some industry lobbyists are betting the measure will become law.

The proposal, championed by House Ways and Means Committee Chairman Charles Rangel, D-N.Y., would shut a loophole allowing some hedge fund managers to defer taxes on billions of dollars of their compensation from offshore funds.

The provision would essentially require fund managers to pay taxes immediately on income that is now tax-deferred.

Mr. Rangel attempted to win approval of a similar provision late last year by including it in a major bill to extend relief from the alternative minimum tax for many U.S. citizens. But the Senate refused to accept Mr. Rangel's version of the AMT relief bill.

Now, however, lobbyists said Mr. Rangel is planning to introduce the provision again — this time as part of a package that would extend several popular tax programs, including one that allows U.S. companies to take a tax credit for research and development.

The Ways and Means Committee plans to vote on the legislative package this week, said Matthew Beck, a committee spokesman. Mr. Beck said details of the provisions that would be included in the bill were still under consideration.

But key lobbyists said the deferred compensation provision — which the House Ways and Means Committee has said would add $23.7 billion to the U.S. Treasury over 10 years — is likely to be enacted because it's extremely difficult to argue publicly in favor of a special tax break that favors a wealthy elite.

“It (the loophole) is perceived as a bad thing,” said Bill Sweetnam, a partner at Groom Law Group, Washington. “There's a really high likelihood that this will go through.”

Industry opposes proposal

The hedge fund industry's Managed Funds Association, Washington, has vowed to fight the tax proposal.

“The MFA has opposed previous efforts to halt the use of deferred compensation in offshore funds and we will continue to oppose such efforts this year,” Richard H. Baker, MFA president and chief executive officer, said in an e-mail response to questions.

“Hedge funds have been the most reliable source of market liquidity in the midst of the current credit and liquidity crisis,” Mr. Baker added. “The offshore funds are active providers of liquidity for U.S. and global investments, including pension fund investments. This tax proposal, by raising over $20 billion of revenue from the hedge fund community at this turbulent time, is inconsistent with the continued need for hedge funds to invest in the marketplace.”

Other financial industry lobbyists have been urging Mr. Rangel to provide a safe harbor for tax-deferral arrangements in countries that have bilateral tax treaties with the U.S.

When Mr. Rangel's legislation was drafted last year, lobbyists said the safe harbors would have been available in countries that have tax treaties with the U.S. only if they also have a system substantially similar to the U.S. one for dealing with compensation-related tax deductions. Some lobbyists are concerned the restrictions on the safe harbors in Mr. Rangel's bill could put a damper on deferred compensation arrangements not just for hedge fund managers but also for a wide swath of U.S. citizens in numerous countries not usually perceived as tax havens.

“Without modifications, the provision will have unintended consequences on U.S. taxpayers,” said Elizabeth Varley, managing director for government affairs for the Securities Industry and Financial Markets Association, Washington.

Key concern

Andrew Oringer, an ERISA attorney with White & Case LLP, New York, said a key concern of legislators is that the tax laws in some countries — even countries that have tax treaties with the U.S. — do not provide the same disincentive to deferred compensation that U.S. tax law does.

Under the U.S. tax law, companies can't deduct deferred compensation until it is paid. So, there's a tension between an executive's desire to defer as much compensation as possible and the company's desire to claim compensation as a deduction — and that tension is perceived as keeping the amount of tax-deferred compensation in check in the U.S., Mr. Oringer said.

The problem for U.S. lawmakers is that in some other countries, even those with bilateral tax treaties, the rules may not include provisions that would similarly discourage tax deferral. That could spur companies based in those countries to allow as much deferred compensation as their executives want.

“There'd be a disproportionate impact on hedge funds because they are often organized offshore and sometimes provide for extremely large amounts of deferred compensation,” Mr. Oringer said.

Mr. Oringer also said another concern for U.S. policy-makers is that neither the deferred compensation nor the investment earnings on compensation in offshore tax-haven accounts is subject to U.S. tax as long as they remain in the offshore account.

“So the (U.S.) Treasury is being whipsawed,” Mr. Oringer said.

MFA's Mr. Baker, however, said offshore funds established by hedge funds attract capital from non-U.S. investors and non-profit institutions.

In addition, when hedge fund managers invest their deferred compensation in the offshore funds, it aligns the interests of the managers with their investors, Mr. Baker said.

“It is that alignment of the interests between the investor and the hedge fund manager that has resulted in the growth and success of hedge funds as an alternative investment for pension funds and other institutions,” Mr. Baker said.

“If, as a result of this tax proposal, fund managers are forced to reduce their own holdings in those funds, it changes that basic business model. So this issue is not just about how much tax a hedge fund manager pays and when they pay it. This proposal could change an otherwise sound and proven business model, which is not warranted,” he said.

Contact Doug Halonen at dhalonen@pionline.com