Question

Share about the taxation of carried interests. How would you explain them to a person without a business background? Should it be allowed or encouraged? Can you think of an alternative method to tax these investments?

Answer 1

About taxation of carried intrest

Carried interest is a contractual right that entitles the general partner of an investment fund to share in the fund’s profits. These funds invest in a wide range of assets, including real estate, natural resources, publicly traded stocks and bonds, and private businesses. Hedge funds, for example, typically trade stocks, bonds, currencies, and derivatives. Venture capital funds invest in start-up businesses. And private equity funds invest in established businesses, often buying publicly traded companies and taking them private.

Depending on the investment, the general partner’s share of the profits can take a variety of forms: interest, royalties, long- or short-term capital gains, and dividends. There is ongoing debate about whether partners receiving long-term capital gains and qualified dividends as carried interest should receive the preferential tax rates accorded to regular investors.

The preferential tax rate is especially important for a private equity fund and its managers

should it be Encouraged or allowed

If you are being paid a fee for managing other people’s money and have no capital at risk on the carried interest, I don’t understand how it can be considered a capital gain.

It may be good economic policy to incentivize people to manage other people’s money and maybe there should be some tax break for doing so. That is a different conversation in my view. Though I don’t buy that one either.

But capital gains tax rates should only be available to those who put their own capital at risk. Many VCs do that in their funds. The partners at USV make up a sizeable portion of our funds. We should and do get capital gains treatment on those investments.

But we also get capital gains treatment on the carried interest and I’ve never understood why. I think it’s wrong.