Wall Street Sales Tax Reintroduced on Capitol Hill: Likely a Significant Impact on Private Investment Funds

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On April 17, 2013, U.S. Rep. Keith Ellison (D-Minn.) reintroduced the Inclusive Prosperity Act of 2013 (H.R. 1579) (the "Bill"), a financial transaction tax that, according to its supporters, would provide the federal government between $150 billion and $340 billion of revenue per year. The Bill is, essentially, a sales tax on large Wall Street banks; however, its provisions seem to impact hedge funds and private equity funds.

Specifically, the Bill imposes a tax on the transfer of ownership in each "covered transaction" with respect to any "security."

Under the Bill, a covered transaction includes any purchase of a security if such purchase occurs or is cleared on a facility located in the United States or the purchaser or seller is a U.S. person.

A security includes: (i) shares of stock of a corporation; (ii) any partnership or other beneficial interest in a partnership or trust; (iii) any note, bond, debenture or other evidence of debt other than tax-free state or local bonds; (iv) any derivative financial instrument with respect to any currency or commodity; or (v) any derivative financial instrument, any payment of which is calculated by reference to any specified index.

The tax is generally based upon the "specified base amount" of the security, which is generally defined to mean the fair market value of the security determined at the time of the covered transaction. The tax is assessed irrespective of whether there is any gain or loss on the covered transaction. The tax rates are: (i) 0.5 percent on the fair market value of stocks in a corporation, (ii) 0.1 percent on the fair market value of bonds and (iii) 0.005 percent on the fair market value of derivatives and other instruments.

The Bill provides for certain exceptions related to initial issuances of any security (e.g., IPOs), transactions in which debt instruments are actively traded but have maturity dates of not more than 60 days, and certain securities lending arrangements in which gain or loss is not recognized. Further, the Bill provides tax credits for the taxes paid under these rules for individuals whose annual income does not exceed $50,000 or married individuals filing jointly whose joint annual income does not exceed $75,000. Finally, the Bill would allow for the imposition of penalties for failing to report any covered transactions on any return.

In his prepared statement, U.S. Rep. Ellison said that "[t]he American public provided hundreds of billions of dollars to bail out Wall Street during the global fiscal crisis, yet bore the brunt of the crisis with lost jobs and reduced household wealth." He continued that "[t]his is a phenomenally wealthy nation, yet our tax and regulatory system allowed the financial titans to amass great riches while impoverishing the systems that enable inclusive prosperity. A financial transaction tax protects our financial markets from speculation and provides the revenue needed to invest in the education, health and communities of the American people."

Supporters of the Bill contend that the tax would bring real and enduring recovery to Main Street and provide significant revenue to fund jobs, improve housing, permit affordable healthcare, improve education, clean up the environment and allow the United States to provide greater support for the international efforts to end HIV/AIDS. Additionally, supporters of the Bill maintain that the Bill would slow the growth of automated high-frequency trading, thereby avoiding market bubbles that destabilize the markets and sideline capital and also reduce speculative trading on commodities, such as food and gas, that artificially drive up prices for those products. Thus, supporters contend that the small tax will protect the stock market and the economy from computer-generated collapses.

If passed, the tax would likely change how speculative investors such as hedge funds operate on a day-to-day basis. Many hedge funds and other investors trade large volumes opportunistically, with relatively nominal returns on a per-transaction basis. The tax would significantly reduce and possibly eliminate their returns, which likely would result in less frequent trading and possibly less investing. Investment managers who manage "quant funds" likely will have to rethink and revise their models, as the tax would have a significant influence on the returns the model expects to generate. Further, the provisions of the Bill also appear to tax transactions relating to the securities of private companies. This is because the definitions of a covered transaction and security are not limited to purchases and sales of publicly traded securities. If so, this would potentially have a far-reaching impact on the private equity universe that likely transcends the intent of the Bill.

As we learn more about the Bill and its impact on hedge funds and private equity funds, we will provide updates to this Alert. For now, hedge fund managers, private equity fund managers and investors should take note of the Bill and its broad support, as well as Congress' overall plan to raise revenue with initiatives focused on the investment community.

For Further Information

If you would like more information about the Inclusive Prosperity Act of 2013, please contact David A. Sussman, any member of the Corporate Practice Group or the attorney in the firm with whom you are regularly in contact.

As required by United States Treasury Regulations, the reader should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.