Tax Issues of Private Equity & Hedge Funds

New taxes in health care act impact California Medical Device Manufacturers

2012-09-11T17:34:00.004-07:00

My most recent article appears in the Los Angeles Daily Journal dated August 31, 2012. It deals with the new medical device tax and what manufacturers need to do in order to plan for it. There are lots of subtle issues to be addressed regarding the implementation of this tax, including transfer pricing issues. Well advised medical device manufacturers should speak to their counsel regarding such tax. A link to the article appears here.

Estate Tax Situation - What were they smoking

2010-09-28T09:53:00.000-07:00

The Orange County Business Journal wrote an excellent article on the estate tax situation and the number of high profile people who recently died when there was no estate tax. The article discusses whether a retroactive estate tax could be constitutional. I commented on this issue for the article noting that while the law was murky, it was practically impossible to collect such a tax, so the point may be moot. The article is quoted here

SEC says US unable to meet EU equivalence criteria

2010-06-10T10:55:00.000-07:00

This is potentially very big news. The Hedge Funds Review is reporting that senior regulators at the SEC have stated that the U.S. is unlikely to be able to comply with the equivalence criteria proposed by the European Union (EU) parliament. This could mean that US hedge funds may not be able to market to European investors. Obviously this is a developing story and it is extremely unlikely that the European markets would ever be closed to US funds, however, this is very significant news and needs to be continually monitored.

2010-04-15T09:29:00.000-07:00

Reuters is reporting that four more UBS clients have been charged with tax evasion. One of the cases involved $20 M in assets hidden at UBS. We should expect even more cases to be announced in the coming months, especially, when and if the U.S. government receives the majority of the data that UBS has agreed to provide in its agreement with U.S. federal prosecutors In recent months, the provision of such data was put in doubt by a finding by the Swiss Federal Court that such a disclosure is illegal. The Swiss parliament is currently considering legislation to permit UBS to disclosure such data. Given the political climate in the US and in Switzerland generally, it is likely that the U.S. government will be successful in obtaining such data. . Given the scope of the potential cases, the U.S. government does not have the resources to prosecute everyone so it is likely that they will pick the largest and most egregious caes.

HSBC Data Theft Affects 24,000 Swiss Accounts

2010-03-23T15:50:00.000-07:00

Reuters is reporting that HSBC's private banking arm has announced that a previously reported theft of client data from its Swiss branch involved far more accounts than it had previously acknowledged. The story is here

Stolen data has played a significant role in government crackdowns on tax evaders. Many governments, will pay for stolen data about such taxpayers., e.g., the LGT bank account crackdown by numerous governments including the German and U.S. governments, were propagated primarily based upon stolen data purchased by German tax authorities.

This story could get very dramatic very quickly. Any HSBC customers with Swiss accounts are well advised to consult their tax advisers if they are concerned that they have not correctly reported the income and assets of such accounts.

Redomiciliation of Cayman Island Parent into Switzerland or Ireland

2010-03-23T15:17:00.000-07:00

I am quoted a recent article in Portfolio magazine on the Garmin transaction. Garmin was a multinational corporation doing business in the U.S. and elsewhere. Its parent corporation was incorporated in the Cayman Islands. Garmin recently announced that it was changing the jurisdiction of its parent's incorporation to Switzerland. Publicly filed documents gave several reasons for this transaction including the advantageous tax treaty network in Switzerland, a perceived closeness to European customers and the negative public perception regarding Cayman Island companies and the (realistic) possibility of adverse legislation in the U.S. and elsewhere directed at such companies.

International tax practitioners both in-house and outside are noting a trend towards such redomiciliation transactions. The public perception of Cayman Island corporations and potential adverse legislation cannot be dismissed. In the case of many multinationals, the tax treaty network, low corporate tax rates and potential tax holidays could make Ireland or Switzerland even more attractive than the Caymans. It is a worthwhile exercise for multinationals to evaluate whether redomiciliation could work to their advantage.

IRS Announcement 2010-9 Introduces New Tax Reporting Transparency Standards

2010-03-16T14:54:00.000-07:00

My recently published article, “Announcement 2010-9 Introduces New Tax Reporting Transparency Standards,” concerns IRS Announcement 2010-9, which proposes additional reporting requirements with respect to uncertain tax positions of certain business taxpayers. This generally includes taxpayers who are subject to Fin 48 or other similar international accounting standards. The IRS is in the process of developing a schedule, which must be filed with such taxpayers’ returns, in which the taxpayers would disclose their uncertain tax positions. Many practitioners have expressed concern that such a schedule could require taxpayers to disclose otherwise privileged information and could create an audit roadmap. The potential application of 2010-9 in the investment funds context could raise additional issues.

Until recently, the IRS has exercised a "policy of restraint" with respect to tax accrual work papers, except in the case of "listed transactions." Many practitioners believe that 2010-9 is a sign that this "policy of restraint" is beginning to change. It is possible that 2010-9 is a result of the Textron decision, which is currently being appealed to the U.S. Supreme Court, which addressed whether tax accrual work papers were privileged.

The article focuses on these issues and poses some additional issues and clarifications that will hopefully be addressed in future guidance.

Levin Bill would exempt most unrelated debt financing income from taxation

2010-03-04T17:32:00.000-08:00

I was extensively quoted in an article appearing in the March 4 Hedge Fund Law Report which discusses the Levin bill (HR 3497) to (largely) eliminate taxation on debt financed income of U.S. tax-exempts investing in private equity and hedge funds.

In general, tax-exempts are subject to U.S. federal income tax on their unrelated trade or business income (UBTI.) UBTI includes debt financed income (UDFI.) UDFI arises principally in two ways: (1) the tax-exempt borrows to purchase an investment or (2) in the case of an investment in a partnership, LLC or other tax pass-through, the pass-through itself is leveraged, so that the tax-exempt is deemed to have borrowed its pro rata share of the debt of the pass-through for purposes of the UDFI rules.

Many tax-exempts invest through foreign blocker corporations, which effectively blocks the UDFI. However, as discussed at length in the article, foreign blockers also have their drawbacks. For example, if the fund engages in a U.S. trade or business, the blocker could be subject to U.S. taxation (ECI risk) and blockers are not typically entitled to tax treaty benefits.

The Levin Bill would change the definition of UDFI to render blockers unnecessary solely for UDFI blocking. There are, however, numerous circumstances where blockers are still useful.
In this article, I (and other commentators) discuss typical UDFI blocker structures including master feeder structures, as well as parallel and hybrid structures and the advantages and disadvantages of each.

The article is available here

Islamic Finance Article from today's WSJ

2010-03-01T18:09:00.000-08:00

Doing God's Work Islamic finance is meant to reconcile both commercial and religious ideals. It's a tall order.

This article briefly discusses Islamic finance, Islamic Project Finance and the inconsistencies in what different Shariah Boards deem to be Islamic. There is a brief discussion of the Dubai debacle.

Although this article is very brief, it does pose important questions about Islamic finance structures without rigorously analyzing them. A longer follow up article would be a great idea.

Senate Passes the HIRE Act

2010-02-25T14:16:00.000-08:00

The Senate passed the Hiring Incentive to Restore Employment Act (HIRE), H.R.2847 on February 24, 2010. It is unclear whether the House will pass this legislation. This is a stripped down version of the Reid jobs bill that includes:

a $5000 payroll tax credit for companies that hire long unemployed workers
a one year extension of the increased current expensing of capital expenditures (section 179 extension)
an expansion of the Build American Bonds program
a 2 year deferral of the worldwide interest allocation provisions
the 30 % withholding tax on foreign banks, trusts, and corporations that fail to identify U.S. account holders (see prior coverage of the Foreign Account Tax Compliance Act and related provisions).

Real Estate Revitalization Act of 2010

2010-02-18T15:40:00.001-08:00

A relatively obscure piece of proposed legislation could have a dramatic impact on foreign investment in U.S. real estate and in REITS - making such investments much more attractive to foreign investors.

Non-U.S. persons are not generally subject to tax on U.S. source capital gains. A major exception to this rule is capital gain resulting from the sale of U.S. real estate, which is subject to tax as if it were U.S. effectively connected income, pursuant to the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).

The Real Estate Revitalization Act would exempt a sale of the stock of a United States real property holding corporation (USRPHC) from such taxation. A USRPHC is a U.S. corporation if the fair market value of its United States real property equals 50% or more of its aggregate value. Under current law, by contrast, interests in such domestic corporations, including real estate investment trusts (REITs), generally could not be sold by non-U.S. persons without imposition of U.S. federal income or withholding taxes

In addition, dividends and liquidating distributions paid by REITs that are attributable to gains derived by the REIT from the sale of US real property would no longer be subject to U.S. federal income tax (or the U.S. federal branch profits tax applicable to non-U.S. corporations) under FIRPTA.

Thus, as currently proposed, the Act would provide significant benefits to non-U.S. persons who invest in U.S. real estate through a U.S. corporation, including a REIT. Investors could sell shares of such entities without U.S. federal income or withholding tax. Moreover, as is currently the case for 5% or lesser investments in public REIT securities, non-U.S. investors would be subject to U.S. federal withholding tax on REIT capital gain dividends and liquidating distributions at ordinary income rates (generally, at a rate of 30% or a lower treaty rate). Certain classes of investors, such as foreign pension funds in designated treaty jurisdictions and sovereign wealth funds, would be exempt from U.S. federal income and withholding taxes on REIT capital gain dividends and liquidating distributions, provided that certain requirements are met.

It is unclear whether this Act will be enacted into law. It does not appear in the most recent Reid Bill.

Accounting Firm Tied to Rothstein Slams Suit as Smear Campaign

2010-02-18T11:24:00.000-08:00

It is a really scary time for all professional advisers, especially those of us who advise private equity and hedge funds. I would put fund-to-fund advisers into this category of those who should be scared. Defrauded investors are now looking to sue the accounting firm that apparently prepared the tax returns for Scott Rothstein's law firm. Mr. Rothstein is the latest power-broker/attorney accused in a $1.2B Ponzi scheme. While it remains to be seen who knew what information and when, most tax return preparers are focused primarily on getting the tax numbers correct and not on whether their client is defrauding investors. Return preparers seldom do much diligence on whether their client may be OVERstating their income. However, a tax return preparer does have access to significant financial information and could, under some circumstances, detect financial fraud.

Should all professional advisers be concerned about trying to detect financial fraud during the course of rendering their professional services?

Virginia Doctor Pleads Guilty to Conspiracy Involving Undeclared Swiss Bank Account

2010-02-17T10:39:00.000-08:00

A Virginia doctor, Dr. Andrew Silva, pleaded guilty in connection with a $250,000 bank account that he inherited from his mother. While the facts of the case are unremarkable, the fact that he was criminally prosecuted for a relatively small foreign account and that a bank other than UBS was involved (the bank name wasn't released) may be indicative of more aggressive and wider scope of criminal investigations by the IRS. From the limited information provided in the DOJ news release, it appears that there was active concealment by Dr. Silva, including setting up a sham Liechtenstein trust and carrying $235,000 in cash. Tax practitioners advising foreign account holders should consider carefully whether they think criminal charges are a possibility in a given fact pattern, especially when there is any evidence of active efforts to conceal.

Many investor clients of private equity firms have had to deal with foreign account issues recently. In this climate of active criminal prosecution, it may be prudent to refer all such clients to legal counsel, even where the facts are seemingly very benign.

The Reid Jobs Bill

2010-02-16T11:02:00.000-08:00

A new version of the job creations bill introduced by Senate Majority Leader Harry Reid on February 11 slims down many of the provisions previously introduced in the Baucus-Grassley bill.
The Reid bill would:

Fund highway and transit programs through 2010

Exempt employers from Social Security payroll taxes on new hires who were previously unemployed

Extend (section 179 expensing) tax break for businesses that spend money on capital investments

Expand the use of the Build America Bonds program

Many of the provisions of the Baucus-Grassley bill are not included, such as:

Extending the deadline to file for federal unemployment insurance

The subsidy for Cobra health insurance, which expires Feb. 28

The biodiesel provisions

An important "offset" provision includes a 30 percent withholding tax on payments to foreign banks, trusts, and corporations that fail to identify U.S. accounts, their owners, and assets to the IRS. See prior posts in this column and related podcast by me on the Foreign Account Tax Compliance Act.

Foreign Account Tax Compliance Act Podcast

2010-01-26T18:22:00.000-08:00

I discuss the Foreign Account Tax Compliance Act and comparable provisions in the Tax Extenders Bill in this podcast. This sweeping legislation, if enacted, would impose a 30% withholding tax on payments from any U.S. source to any foreign financial institution (including private equity and hedge funds) and to most other persons, unless such foreign persons agree to enter into an agreement with the IRS to provide detailed information about their U.S. account holders.

The House of Representatives has already passed the legislation. I highlight issues and concerns regarding this legislation including potentially increasing the cost of capital in the U.S. and violating U.S. tax treaties.

This podcast highlights issues discussed in greater detail in my article titled "Foreign Account Tax Compliance: Problems and Complications."

Foreign Account Tax Compliance Act: Problems and Complications

2009-12-11T18:18:00.000-08:00

My recently published article,"Foreign Account Tax Compliance Act: Problems and Complications" concerns the Foreign Account Tax Compliance Act and related provisions introduced as part of the Tax Extenders Act by Charles Rangel, both of which are currently pending in Congress and could have a significant impact on many aspects of the financial services industry, including private equity and hedge funds.

Private Equity Week Interview

2009-11-30T18:29:00.000-08:00

I was interviewed recently by the editor of Private Equity Week on the topic of the Foreign Account Tax Compliance Act, which is currently pending in Congress and which could have a significant impact on many aspects of the financial services industry, including private equity and hedge funds.

The interview is available here.

EC Cross-Border Tax Withholding Relief

2009-11-09T18:03:00.001-08:00

EC Cross-Border Tax Withholding Relief

I was quoted extensively in a recent article in Securities Operations Week on the European Union's efforts to streamline the tax-withholding system on securities dividends and interest. The article is available here.

NOL Carrybacks Extended to Five Years

2009-11-09T18:03:00.000-08:00

The Worker, Homeownership and Business Assistance Act of 2009, which became effective on November 6, 2009, provides that taxpayers may elect to carry back net operating losses for the 2008 and 2009 tax years for up to five years.

Generally, net operating loss can only be carried back two years preceding the loss year (three years in the case of losses that arose before August 6, 1997). The Act could enable businesses that have had significant losses from the recent recession to carry back losses from the current recession for up to five years and receive a tax benefit from prior taxes paid.

Here are some highlights of the Act:

The Act generally applies to all taxpayers; however, the Act does not generally apply to certain TARP recipients, the Federal National Mortgage Association, or the Federal Home Loan Mortgage Corporation.

A taxpayer who makes this election may extend the net operating loss carryback period up to three, four, or five years. If a taxpayer elects a five-year carryback period, the net operating loss carryback deduction for the fifth taxable year will be limited to 50% of the taxpayer's taxable income for such preceding year. Losses not utilized by the carrybacks may still be carried forward.

The alternative minimum tax limitation that normally limits a net operating loss to 90% of a taxpayer's alternative minimum taxable income is eliminated with respect to the election under the Act.

A similar election was available under the Emergency Economic Stabilization Act of 2008 (EESA), but only to taxpayers with gross receipts of $15 million or less. Taxpayers who benefited from the EESA may have a carryback with respect to two separate taxable years due to an overlap between the EESA and the Act.

Financial Disclosure Deadline looms for Americans to disclose accounts in foreign tax havens

2009-10-13T18:31:00.000-07:00

I was quoted extensively in a Los Angeles Times article on the IRS's amnesty program allowing taxpayers to avoid prosecution for failing to report accounts in foreign tax havens. The deadline to avoid possible criminal prosecution is October 15.

Following UBS's agreement to disclose the names of 4,450 American clients, many U.S. residents are voluntarily disclosing their foreign bank accounts. I stated, "You have a lot of people in the entertainment industry, movie producer types; they do business everywhere and have royalties coming to them internationally. I've had to clean up a lot of those."

"Some people have called me and asked, 'How likely is it the government is going to get my name?' " I said. "I say, 'I simply can't handicap that.… But if you want me to fix it, I can.' "

Once the amnesty deadline passes, U.S. tax evasion cases may follow. Some UBS clients have already faced criminal prosecution.

The full article is available here.

I am quoted in UBS Case

2009-10-13T18:23:00.000-07:00

I was recently quoted in the Wall Street Journal, the Los Angeles Times, the Chicago Tribune, MarketWatch.com , the Hedge Fund Manager Blogspot and a number of other media outlets on the the agreement between the U.S., Swiss authorities and the Swiss bank UBS.

Under the August 19, 2009 settlement, U.S. tax authorities will gain access to 4,450 accounts of Americans who have accounts with UBS, in exchange for dropping a lawsuit against UBS demanding the names of 52,000 holders.

Under a voluntary disclosure amnesty program, U.S. taxpayers have until September 23 to reveal the existence of foreign bank accounts to avoid potential criminal prosecution. Many have already done so, and because of this agreement. I believe that many more will start coming forward on their own.

IRS Issues Important Guidance on Foreign Lending Activities

2009-09-23T18:01:00.000-07:00

The IRS has released a chief counsel memorandum on September 22, 2009 describing a hypothetical situation in which a foreign hedge fund uses a U.S. corporation to be its agent for originating loans in the U.S. The IRS concludes that the foreign corporation is itself engaged in a foreign lending business, even though it has no direct presence or activities in the U.S., because of the agent's activities. The fact pattern described is not atypical for foreign hedge funds and other lenders. This may be indicative of a more aggressive enforcement stance by the IRS with regards to foreign lenders.

Mezzanine funds who engage in loan type activities have historically sought to avoid "loan origination" for U.S. tax purposes because it results in U.S. effectively connected income (and 35% taxation). Funds have historically adopted a number of strategies, including:

A "season and sell" strategy where they buy loans from related or unrelated funds

A strategy where they limit the number of loans that they themselves will originate so that their activities are not deemed to be carried on as a regular business

An independent agent strategy where they purchase loans from other parties, but the decision making (and for the well advised taxpayer, substantially all the negotiating) is done by offshore persons

Various hybrids of this strategy.

The IRS concluded that a foreign hedge fund that did not have a U.S. office, but used an exclusive independent agent, had a U.S. trade or business (and therefore, effectively connected income). They applied agency principles to treat the activities of the origination company as attributable to the foreign fund. In this case, the fund had a formal approval process outside of the United States; however, substantially all of the negotiating was done by the exclusive agent loan origination company.

There are many funds in the marketplace that have used exclusive origination companies and taken the position that the fund did not have a U.S. business because the funds themselves did not have a U.S. office and the independent agent did not have authority to bind the fund.

In addition, the IRS made a blanket statement that they are aware that other hedge funds may have used other loan origination strategies that may have resulted in ECI and they are standing by ready to analyze them (phrasing this positive, not negative).

Beyond the specific scope of this memorandum, it is indicative that the IRS may be taking a more aggressive stance with non-U.S. hedge funds and loan origination generally. It is possible that the IRS will issue similar guidance on "season and sell" strategies or other similar issues.