Publicly Traded Partnership

In the past few months, two hedge fund or private equity firms (Fortress and Blackstone) have become the publicly traded partnerships. Since their IPOs, many discussions have been about their potential tax liability changes. One side of the discussions wanted to treat these two firms with the same tax liability as other corporations. Another side of the discussion would like to keep their tax status unchanged. All these discussions will not result any real changes in the tax codes just for them.

Publicly traded partnerships are very popular in recent years, especially among the energy companies. The National Association of Publicly Traded Partnerships, or NAPTP, formerly the Coalition of Publicly Traded Partnerships, is much better organized than before. The number of PTPs has almost doubled in the past three years. Now there are about half a dozen closed-end funds which are entirely for the PTPs. I personally do not think it is very easy to change the legal structure just because two firms have taken the advantages of the legal system.

There are publicly trusts, such as the real estate investment trust, or REIT, which started on shaky ground in the 1970. But over the last several decades, the REIT structure has been completely accepted in the United States. There are about 10 ETFs dedicated entirely to REITs. Its popularity is clear to investors. Its acceptance has gone beyond the United States. Its legal structure has expanded to other countries, such as in the Europe, Japan, and Hong Kong.

Why the REITs and PTPs are increasingly become accepted as normal business entities? I think the current unfair tax structure is the main reason. President’s tax changes for dividend tax have been fully integrated into the system over the last several years. It was said to reduce double taxes. REITs and PTPs are set up entirely based on the elimination of double taxation.

For regular corporations, their earnings can not be fully passed to the investors unless the corporations paid corporate income tax first. That is why there are lots of buybacks of profitable companies using their earnings. Since buybacks (to reduce available shares and therefore to increase share prices) are a good way to return corporate earnings indirectly to investors. One big difference is that corporations can retain their earnings for corporate expansions.

For REITs or PTPs, they can not retain their earnings. They have to pay out at least 90% of their earnings regularly to keep their trust or partnership status. If they need additional capital for expansions, they have to re-raise funds from the general public.

It is obvious to me that the REITs or PTPs are much better legal structure than regular corporations. It put investors at the driver seat to make new investment decisions rather to let the corporations to make the re-investment decisions. Failed companies like ERON or Worldcom were direct results of mismanaging their corporate earnings.

I feel that the PTPs just like the REITs are here to stay. Any changes to this old legal structure will only make them better for investors.