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Friday, August 2, 2013

Fleischer: 1st Circuit Trade or Business Ruling Threatens Structure of Private Equity

NY Times DealBookNew York Times DealBook:  Sun Capital Court Ruling Threatens Structure of Private Equity, by Vic Fleischer (San Diego):

Last week, the United States Court of Appeals for the First Circuit issued a ruling that will make it harder for private equity funds to walk away from the unfunded pension liabilities of companies they have bought if the company goes bankrupt.

Specifically, the court ruled that one of Sun Capital’s private equity funds was “not merely a ‘passive’ investor” but actively involved in the operations of Scott Brass Inc., a portfolio company that went bankrupt in 2008. The case was brought by the New England Teamsters and Trucking Industry Pension Fund.

The case is undoubtedly important for private equity deals. Firms must consider the greater risk of unfunded pension liability when valuing targets. Portfolio companies may be grouped together to take advantage of certain pension qualifications. But the implications of the case potentially go beyond pension law.

The taxation of private equity funds is built on the premise that the funds are merely investors in portfolio companies and are not engaged in a “trade or business” for tax purposes – in other words, they are not actively involved in the business. But the court found in the Sun Capital case that a private equity fund was engaged in a trade or business for purposes of the Employee Retirement Income and Security Act, also known as Erisa. It is not a big leap to argue that the fund was engaged in a trade or business for tax purposes. And then it gets really interesting.

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Comments

Contrary to Fleischer, it is a big leap to argue that the First Circuit's analysis in the Sun Capital case implies that private equity funds are engaged in a trade or business for tax purposes generally. Legislative and policy reasons for holding a private equity fund liable for unfunded pension liabilities do not align well with the tax considerations of treating such funds as trades or businesses for income tax purposes. That aside, tax lawyers will generate billable hours distinguishing Sun Capital.

Posted by: Jake | Aug 2, 2013 12:32:49 PM

"It is not a big leap to argue that the fund was engaged in a trade or business for tax purposes. And then it gets really interesting. - See more at: http://taxprof.typepad.com/taxprof_blog/2013/08/fleischer-.html#comments"

What a cliffhanger ending! I look forward to the next episode.

Posted by: Eric Rasmusen | Aug 2, 2013 4:50:02 PM

Fleischer is overselling this big time. It was a case that turned on pension law, not tax law.

Posted by: jpe | Aug 3, 2013 6:18:33 AM

Are these the same PE companies who claim to be adding management expertise?

Maybe the days of the strip-and-flip will come to an end.

Posted by: save_the_rustbelt | Aug 5, 2013 7:56:56 AM