The private equity tax row continues as lobbyists and one of the richest men in the US lash the Australian Taxation Office’s attempts to levy income tax on certain private equity profits. The dispute stems from the ATO’s attempt to collect $678 million in tax from the former vendors of the Myer department store, TPG Capital.

The ATO, which acted a little late (sadly for taxpayers, TPG had cleared its bank accounts of all but $45, the equivalent of police bursting into a room only to find the safe empty), is claiming that the profits made are ordinary income, rather than capital gains. TPG, being a foreign entity, would need to pay tax on the profits if it is deemed “ordinary income”, but not if the gains were deemed to be “capital” in nature.

The ATO’s argument, which makes a lot of sense (to everyone except private equity investors) is that private equity firms are not long-term holders of assets. Rather, they acquire assets with the sole intention of selling that asset in a relatively short period (in TPG’s case, it held Myer for only three years). This is no different to a trader purchasing inventory and selling it years later.

This claims attacks one of the key premises of private equity — its considerable tax advantages. PE purchases are usually made with a large amount of debt — that means the firm will pay little or no tax while the hold the asset (as the bulk of accounting “gross profits” are usually paid as interest charges, which are tax-deductible). When they sell the asset, they pay either a discounted rate of capital gains tax (for Australian-domiciled owners)  or no CGT at all (foreign-domiciled entities). This means that PE investors (and PE managers, who usually receive 20% of any out-performance) are able to make over-sized profits at the expense of other businesses (who are required to pay tax) and the federal Government, which loses tax revenue.

It is no surprise that PE investors are unhappy with the ATO’s decision. Stephen Schwarzman, who is the CEO of the publicly listed Blackstone Group, told the World Economic Forum last week that “what [the ATO decision] will do, of course, will be to dramatically chill any future investment until this matter is resolved one way or the other”.

The Australian Private Equity and Venture Capital Association (which is the paid lobbyist of private equity firms) was even more damning — in a submission to the ATO, it claimed that the ATO’s position “represents a change in application and interpretation of previously accepted practice which undermines confidence for future investment”.

The claims of the private equity lobby are based on what appears to be a somewhat flawed premise — that private equity investment is, on balance, a good thing for Australia’s economy. That is not to say there are no benefits from PE investment — for one, privately managed businesses will usually be more efficiently run than public companies, with better remuneration structures and less administrative red tape. (Stephen Bartholomuez in Business Spectator took an even more supportive line, ostensibly agreeing with the lobby’s claims that PE firms domicile in tax havens to “to enable the funds to marshal and deploy funds efficiently around the globe. The Cayman Islands, or Guernsey, are staging points and conduits, not end destinations”.)

However, the benefits of private equity are often outweighed by the enormous leverage used (which increases the risk of the business going bankrupt) and inevitable job losses that result from taking a business “private”. Under TPGs control, Myer sacked 6000 of its 22,000-strong workforce. That is despite increasing its store numbers from 59 to 65. Not only did thousands of relatively low-paid Australians lose their jobs, but Myer customers experienced far worse service. This human misery, however, allowed TPG to walk away with a $1.5 billion profit.

Meanwhile, the use of (mostly foreign-sourced) debt with minimal equity contributions means that the “investment” has less of a benefit to Australia. Private equity firms buy an asset with the intention of selling it for a higher price in 3-5 years. They have no intention (and no incentive) to make long-term efficiency gains or invest in research and development that will provide sustained benefits to the economy. Their business model is the high-finance equivalent of a used-car dealer buying a car, giving it a new paint job and selling it a short time later for a windfall, ignoring the fact that the engine didn’t work before, and still doesn’t when it is re-sold.

Meanwhile, it is not merely Australian taxpayers (and workers) who suffer from private equity investments — those who purchased shares in Myer when it was floated in November 2009 are already realising why it is often foolish to purchase shares from a private equity vendor. As this column foreshadowed before Myer’s float, an investment in the retailer has proved, so far, to have been a complete disaster. Yesterday, Myer’s shares slumped to $3.25 after the retailer released disappointing sales results for December. Myer shares have slumped by more than 20% since its IPO — slicing almost $500 million from its market value in a little over three months (over that period, the All Ordinaries index fell by less than 1%).

That investors in the Myer float have lost a bundle shouldn’t have come as a surprise to Crikey readers, well aware that buying as asset from private equity (like buying something from the Packers) is almost always a bad idea (JB Hi-Fi being one notable exception). Quite simply, private equity managers exist to make as much money from buying and selling businesses as possible. To do so, they will seek to profit at the expense of taxpayers and any future owners of the business.

Caveat emptor indeed.

Myer isn’t the only private equity debacle currently transpiring. The Financial Times yesterday reported that Terra Firma, the firm that recently acquired EMI, is begging investors for more capital after admitting that it won’t be able to pay the interest on its massive loan from Citigroup.

EMI, the record label responsible for the Beatles and Coldplay, was purchased by Terra Firms, a private equity firm run by former Goldman Sachs banker Guy Hands for £4.2 million at the height of the credit bubble in 2007. Last year, EMI’s EBITDA was negative £1.5 billion — with Terra Firma writing off 90% of its investment.