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Wednesday, 27 August 2014

The price of success

U.S. buyout barons have new tax-dodge rivals: MLPs

U.S. buyout barons have new tax-dodge rivals: master limited partnerships. The low tax rates on private equity bosses’ so-called carried interests save them $1.3 billion a year, according to the U.S Treasury, an advantage critics want wiped out. But new data show investors in energy partnerships are now costing Uncle Sam a similar amount thanks to an outdated Internal Revenue Service perk from the 1980s. Both loopholes should be closed.

Lobbyists for MLPs have claimed that the sector’s exemption from corporate income tax costs the Treasury only pocket change - about $300 million annually. But as the sector has grown, so has the amount the Treasury misses out on. The bipartisan Joint Committee on Taxation now reckons the annual bill will reach $1.6 billion by 2016. That’s a big enough chunk of change to attract the attention of deficit hawks in Congress.

Given the sector’s expansion, the tax cost of MLPs is likely to rise further. Since the start of 2006 the market value of the top 50 partnerships has climbed fourfold to around $312 billion - far outperforming the S&P 500 Index along the way - and the number of MLPs overall has nearly doubled. The tax break has also encouraged the sector to spread beyond its roots in pipelines into oil refining and even mining the sand used in hydraulic fracturing.

The MLP exemption may have looked sensible when it was adopted in 1987 to help stem declining U.S. oil production. With oil output booming and MLPs starting to sprawl, it now seems a wasteful subsidy. MLP supporters argue that taking away the break would slow energy production and infrastructure building. But just as private equity chiefs are unlikely to cut back their activities if forced to pay somewhat higher taxes, there are still adequate economic returns available on energy-related activities without extra help from the IRS.

Scrapping both tax perks would only bring in about $3 billion a year - around 0.4 percent of the $845 billion budget deficit forecast by the Congressional Budget Office. But it would be a start, with little downside. And with a shortfall this big, every little counts.

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The tax break on master limited partnerships in the energy sector will cost the U.S. government $7 billion in lost tax revenue by 2016, four times last year’s estimate, the non-partisan Joint Committee on Taxation said in a report published on Feb. 1.

The committee increased its prediction for lost corporate income tax revenue for the year ending in September from $300 million to $1.2 billion.

The U.S. Treasury estimates that the so-called carried interest used in the private equity industry - the method by which buyout firms and their principals receive a share of investments made rather than fees and pay tax at capital gains, not income, rates - cost about $1.3 billion in lost tax income in 2013 and will cost $13.5 billion over the coming decade.

The Alerian 50 index of the top MLPs has a market capitalization of around $312 billion, compared with $74 billion at the start of 2006. The index has provided investors with a total return of 106 percent over the past five years, compared with 25 percent for the S&P 500.

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