Private Equity and Controlled Group Rules and ACA ALE Determination

[Chaz]

Traditionally, private equity firms have taken the position that they do not operate a "trade or business" and as such, Code Section 414's controlled group rules do not apply to their portfolio companies.

There have been, however, a few recent court decisions, most notably the Sun Capital case, that have held that a private equity firm that has the requisite ownership and control over its portfolio companies, can be held responsible for withdrawal liability if a portfolio company leaves a multiemployer plan because the PE firm is in the same controlled group as the portfolio company.

My question is whether a court (or regulator) can use this rationale in other contexts, specifically whether the portfolio companies need to be aggregated for purposes of determining whether the entity is an applicable large employer under the employer shared responsibility provisions of the ACA.

For instance, a PE firm establishes a fund that has two portfolio companies, one with 30 employees and one with 45.  If the PE exercise the requisite ownership and control, do the entities need to aggregate because they are within the same control group under Code Section 414?

I have not seen any discussion of this anywhere and I welcome any thoughts.  This also has application to other retirement and welfare plan scenarios.  

Thanks!

[Peter Gulia]

The more careful private-equity shops consider what you mention, and more.

Some use lawyering to evaluate risk exposures.

Most use lawyering to design investment structures that lessen risks of a finding that investing is a trade or business.

Beyond the cases about withdrawal liability to a multiemployer pension plan, maybe not much has seen full litigation.

Among other reasons, the Internal Revenue Service might not detect, and might not pursue, potentially taxable situations as vigorously as some multiemployer pension plans pursue withdrawal liability.

Or, maybe the facts often show that investing is not a trade or business.

This is not advice to anyone.

[bp parv]

3 hours ago, Chaz said:

My question is whether a court (or regulator) can use this rationale in other contexts, specifically whether the portfolio companies need to be aggregated for purposes of determining whether the entity is an applicable large employer under the employer shared responsibility provisions of the ACA.

Can they? Sure, it always possible. Will they (in particular the IRS)? My opinion (and my opinion only) is no: Given that the Treasury Regulations do not directly address the PE issue and that PE firms have historically taken the reasonable stance that they are not a "trade or business" for Section 414 purposes without any pushback from the IRS (that I am aware of), I think the IRS would currently be reluctant to take on this issue. The IRS is quite aware of which law firms represent PE and also understands that taking such a stance could create major headaches for the PE sector.  Given the stakes, PE would fight very hard on this issue. So, from the IRS' point of view (in my opinion) it would not be a winning strategy without clear Treasury Regulations. 

[Artie M]

I agree with the others.  The IRS could make use of the SC arguments but aggressive IRS enforcement or application these arguments/rules is highly unlikely at this time.  I mean SC was pretty fact specific, the IRS has not issued any guidance even insinuating its adoption or application of SC, and the consequences of adopting this stance would be enormous. If applied aggressively, the IRS would actually have to come up with some of its own standards just to administer its application.  In discussions I have heard many practitioners state their view that the 414 regs would have to be rewritten to apply SC rules to regular retirement plans.  That said, we have adjusted our due diligence when dealing with PE-backed clients to include a focus on who are the management/GP entitles, affiliated investment vehicles, level of operational control etc. noting a risk of potential future application. A low risk assessment (other than in multiemployer plans, PBGC issues, DOL investigations, and transactional due diligence) however is based on the typical structures being used currently.  We all know that there are those out there who work day in and day out looking for an angle.  I don't believe that PE groups are thinking about putting all their HCEs in one entity and all their NHCEs in another.... but who knows.  If that were to happen, one could easily see the IRS pulling this nary used arrow out of its quiver.