global Tax Impact of the Tax Reform on Private Equity March 27, 2018 The new tax legislation, the Tax Cuts & Jobs Act (TCJA) has a host of provisions important to the private equity community, including the corporate tax reduction. Read on. The Tax Cuts and Jobs Act, signed into law December 22nd poses many opportunities and challenges for businesses in every industry. While most of the provisions are set to go into effect for the 2018 tax year, it’s important for private equity firms to review the changes now to understand the impact to their funds and portfolio companies. 7 tax law changes that impact PE firms Corporate tax cut- The reduced corporate tax rate (21%) may alleviate some of the added expense from the limitation of interest rate deductibility. It could also cause portfolio companies operating as C corporations to have more capital to enhance operations or expand. Conversely, the cut gives strategic investors more bargaining power in competitive auctions, potentially making them an even more aggressive competitor for deals vs. private equity firms. Pass-through income rule applying to private equity funds- The deduction was raised to 20% for pass through filers, which is a positive change for the industry- eligible partners in portfolio companies that generate “qualified business income” subject to this deduction would benefit as it could reduce the amount of income taxed at ordinary rates. However, management fees charged by private equity firms may not qualify for this deduction under the guise that it is considered service income. We anticipate further guidance from IRS and Treasury on this question, as well as the implementation of the 20% deduction on pass-through income in general. Look- through rule when applied to gain on sale of a partnership interest- The gain from the sale of a stake in a partnership in a U.S. trade or business by a non-U.S. person will be treated as effectively connected income, which would impact foreign partners engaged (directly or indirectly) through one or more partnerships. Partnerships would be required to treat the appropriate amount of gain or loss as effectively connected to a U.S. trade or business and withhold on this amount. Limited deductibility of interest for financing of portfolio companies- The interest deduction has been capped to the sum of business interest income plus 30% of the adjusted taxable income of the taxpayer for the taxable year. Adjusted taxable income is defined similar to EBITDA for taxable years beginning after December 31, 2017 and before January 1, 2022. This is projected to have a negative impact on the PE industry. Interest expense ceiling could be problematic to highly leveraged PE-backed companies. Limitations on Excess Business Loss- Excess business losses of non-corporate taxpayers are no longer allowed and permitted only when carried forward as NOLs. This is expected to be a negative change for the industry, as taxpayers other than C corps would not be able to take business deductions. Immediate expensing of certain capital expenditures- Companies are able to deduct capital expenditures in full in 2018, which might encourage PE companies to engage in more capital spending. Deduction for dividends from foreign corporations- This would allow some U.S. corporate shareholders to a 100% deduction for any dividends received from foreign corporations—a helpful deduction for the industry. However, the new law also imposes new US taxes on foreign profits generated by controlled foreign corporations. It is suggested that a careful analysis of current foreign structures be done in order to better understand the impact of these new taxes. Private equity and venture capital professionals have special tax needs, which makes tax reform compliance slightly more complicated. We will continue to keep you updated going forward, as these changes gradually get implemented. Contact us for further information.