Interesting article in today’s New York Times: Tax Loopholes Sweeten a Deal for Blackstone, by David Cay Johnston:
The Blackstone Group, the big buyout firm, has devised a way for its partners to effectively avoid paying taxes on $3.7 billion, the bulk of what it raised last month from selling shares to the public. Although they will initially pay $553 million in taxes, the partners will get that back, and about $200 million more, from the government over the long term. The plan, laid out in the fine print of Blackstone’s financial documents, comes as Congress debates how much managers at private equity firms like Blackstone and hedge funds should pay in taxes on their compensation. …
Blackstone’s tax maneuver hinges on its use of good will, an accounting term for the value of the intangible assets, like a well-known brand name, that are built up by a company over time. That value is part of the reason a company is worth more than the sum of its physical parts, like buildings and equipment. Individuals who create good will cannot deduct it. But when good will is sold the new owners can because its value is assumed to erode. The Blackstone partners sold the good will from their left pocket to their right. In simplest terms, the Blackstone partners paid a 15% capital gains rate on the shares they sold last month in the initial stock offering to outside investors (those shares represented a stake in the Blackstone management company, not its funds). Blackstone then arranged to get deductions for itself for the $3.7 billion worth of good will at a 35% rate. This is a twist on the “buy low, sell high” stock market adage; in this case it would be “tax low, deduct high.”
The deductions must be spread out over 15 years. And the original Blackstone partners are getting just 85 percent of the tax savings, leaving the other 15% percent to outside investors. The deductions on the $3.7 billion to the partners are $1.1 billion over 15 years. If these tax savings were paid as a lump sum this year, the partners would get about $751 million, which is $198 million more than the taxes the partners will pay on the $3.7 billion of good will. …
How can those deductions be worth almost as much, or more, than the taxes paid? The ability to provide answers to such questions is why tax lawyers can typically charge $700 an hour or more. Just as fashion designers blend textures, colors and shapes, tax experts mix and match elements of partnerships and corporations, and bits and pieces of the tax code, securities laws, accounting rules and economics principles.
The tax maneuver starts with Blackstone partners selling to a newly created subsidiary corporation $3.7 billion worth of good will. Such entities are known within the tax trade as blocker corporations, because they help block taxes from reaching the Treasury. Here is how the structure works [click on chart to enlarge]:
For other coverage, see:
