Equity finance: Taxes can be deferred on cancelled debt

The Congress is taking another industry under its wing and is planning to bail them out. This time the lucky ones are the private equity firms. As per the stimulus package, companies would be allowed to stay without paying taxes on their own debt that has been repurchased at a discount. This is from the portion dealing with tax of the stimulus package proposed b y the Obama headed government. The author of this provision is Senate Finance Committee Chairman, Mr. Max Baucus.

If this provision becomes a bill then it would prove very beneficial to many companies and industries but would be a windfall for private equity firms. Private equity firms have many companies that have been acquired by taking money from investors. The main aim here is to make huge profits for the investors. But unfortunately, due to the economic recession, many of the deals are running into trouble and firms are looking for refinancing them.

The tax relief provision is getting a lot of support and lobbying from the companies that are owned by private equity firms. It is estimated that this measure wouldn’t cost the government any less. This provision if implemented would cost around twenty six billion dollars spanning a period of three years. As per expectations the recovery of this cost would be done over following 7 years. All this planning and estimation is being done by the Joint Committee on Taxation.

Private equity firms are finding themselves neck deep in debt. To keep from becoming delinquent and committing defaults the firms are trying to reduce their debts. They have requested many of their investors to change their bonds with ones with lesser values and longer term periods. There have been moves to settle some of the debt with cash too. The problem that they are encountering here in spite of reducing their debts is the huge tax bill that accompanies the reduction. Taking for example if a one billion dollar debt that has been issued by the company is exchanged for a six hundred million dollar new debt, then the four hundred million dollars that is the balance is taxable income under law.

Coming back to tax provision bill, in cash back buy backs, the company concerned would be able to spread the bill for a period of eight years and would resume tax payment only from 2011. This provision known as the Montana Democrat’s provision is valid only on repurchases during the period 2009 - 2010. The bill has yet to become a law. The bill has to be discussed and debated over in the House and Senate for the final verdict.

Data provided by Boston Consulting Group declares that sixty percent of the 328 private equity portfolio companies had distressed levels of debt tradings. Harrah’s Entertainment Inc. which is owned by TPG and Apollo carried out an exchange offer dealing with both cash and debt in December. Manor Care which is owned by Carlyle Group is planning to buy a part of its debt for cash.