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Unusual IPO tax structure may plague Blackstone

NEW YORK, March 30 (Reuters) - As Blackstone Group [BG.UL] plans to go public, prospective investors may find themselves paying as much attention to the U.S. tax code as the private equity firm’s prospectus.

Blackstone filed last week to take about 10 percent of itself public for about $4 billion through a unique master limited partnership structure that allows it to retain many private partnership benefits and qualify for hefty tax breaks.

But its master limited partnership format raised eyebrows among those who say it has few precedents in the financial services industry and leaves the door open for the Internal Revenue Service (IRS) to challenge its tax law assumptions.

“Usually when an entity goes public, you know exactly how it is going to be treated for tax purposes,” said Victor Fleischer, an associate professor at the University of Colorado Law School. “In this case, I think there is ... a little uncertainty under current law and there’s a ton of uncertainty about what’s going to happen in the future.”


Under U.S. tax law, master limited partnerships do not pay the 35 percent corporate tax rate, but rather distribute nearly all their profits to common unit-holders who individually are allowed to pay 15 percent capital gains tax on the income.

To retain this status, Blackstone must prove it is primarily an asset management company and that at least 90 percent of its income is derived passively from interest, dividends and gains from selling or holding capital assets.

“They have to kind of walk this fine line between acting like an investment company, but not having to register as one,” said Robert Willens, a tax and accounting analyst at Lehman Brothers in New York. “There is a little bit of an uncertainty there. If they had to register as an investment company then they would lose this tax break.”

Like most private equity firms, Blackstone buys companies with mostly borrowed money, restructures them, and then sells them a few years later.

In its filing with regulators, Blackstone says it is “primarily in the business of providing asset management and financial advisory services and not in the business of investing,” and believes its income “is properly characterized as income earned in exchange for the provision of services.”

This kind of tip-toeing allows it to avoid registering as an investment company, but the company description of itself as a services provider seems at odds with its suggestions that its income is passive enough to qualify for the tax exemptions, Fleischer said.

Blackstone warned in its filing that while it believes it will be treated as a partnership and not a corporation, “the IRS may challenge this conclusion and a court may sustain such a challenge.”

A Blackstone spokesman said he would not comment on the technical aspects of its IPO.

FORTRESS EXAMPLE The master limited partnership format has historically been most popular among energy and natural gas companies such as Sunoco Inc. SUN.N. However, Blackstone is not the first financial services company to go public with a unique format.

Hedge fund manager Fortress Investment Group LLC FIG.N, whose structure relied on the same 1987 tax rules for publicly traded partnerships that earn 90 percent of their income through passive investments, raised $634 million in its initial public offering last month.

Blackstone is “breaking a little bit of new ground here, but I believe it’s do-able,” Lehman’s Willens said. “We have Fortress as a precedent ... but it’s a little early to know whether Fortress has done this successfully yet. The IRS hasn’t had occasion to look at their situation just yet.”

Despite its unique structure, Fortress shares are up about 57 percent since its IPO priced.


Fortress’s success strengthens the case for Blackstone’s structure, but it does not necessarily insulate the firm from political pressure.

The $4 billion price tag on Blackstone’s IPO and its 2006 net profit of $2.3 billion may be enough to boost interest among U.S. lawmakers in changing the rules, Colorado’s Fleischer said.

According to media reports this month, U.S. lawmakers are already reviewing whether to change the tax on profits made by private investment funds to the regular 35 percent rate.

“I think (private equity is) something that Congress didn’t contemplate when they wrote these rules in 1987,” Fleischer said. “There’s some risk the IRS could rule against Blackstone and say that the structure isn’t any good, and I think there’s a significant risk that Congress could change the rules.”

((Editing by Braden Reddall; Reuters Messaging: rm://;Tel: +1 646 223 6114)) Keywords: COLUMN LIFTING/

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