What's Happening?
New York City is reportedly employing a strategic audit approach to increase tax revenue from private equity and hedge funds through the Unincorporated Business Tax (UBT). The city's Department of Finance is focusing on the allocation of expenses between
management companies and carry companies within private funds. Typically, management companies are subject to UBT on service income, while carry companies, which receive a share of investment profits, are not. The audit strategy involves scrutinizing whether expenses claimed by management companies should be partially allocated to carry companies, thereby increasing the taxable income of the management companies. This approach does not directly tax carried interest but affects the deductions that management companies can claim, potentially leading to higher UBT liabilities.
Why It's Important?
The audit strategy could have significant implications for New York City's financial sector, a key industry for the city. By indirectly targeting carried interest through expense allocation, the city risks discouraging private funds from operating within its jurisdiction. The UBT is unique to New York City and does not have equivalents in other states, making the city less attractive for private capital and financial talent. This could lead to a relocation of funds and personnel to more tax-friendly environments, impacting the city's economy and its status as a financial hub. The strategy also highlights the ongoing debate over the taxation of carried interest, a contentious issue in U.S. tax policy.
What's Next?
Fund managers with exposure to New York City may need to reassess their expense allocations to ensure compliance with the city's audit focus. This involves maintaining detailed documentation, such as management agreements and expense-sharing arrangements, to justify the allocation of expenses. The city's approach may prompt discussions among policymakers and industry stakeholders about the fairness and effectiveness of the UBT and its impact on the financial sector. Additionally, the strategy could lead to legal challenges from affected funds, seeking to protect their interests and clarify the application of the UBT.
