Proposed New York City Audit Position Can Increase the Amount of Unincorporated Business Tax Paid by New York Hedge Fund Managers
Hedge Fund Law Report
Facing budget deficits and rising debt levels, federal, state and local government authorities have ratcheted up efforts to raise revenues, and one of the constituencies in their crosshairs has been hedge fund managers. While proposals have been put forward at the federal and state level to raise revenues by taxing the carried interest received by hedge fund managers at ordinary income tax levels instead of at the favored long-term capital gains rates, New York City has seemingly opted for another approach by proposing to disallow some expense deductions claimed by hedge fund management entities that are subject to the New York City unincorporated business tax (UBT). Specifically, the New York City Department of Finance (Department of Finance) has recently asserted a new proposed audit position (Proposed Audit Position) to require that a portion of the expenses of an investment manager entity be reallocated to a general partner entity because it believes that certain of those expenses are incurred in generating the incentive allocation received by the general partner entity. This feature-length article begins by explaining in detail the UBT and what entities are subject to the UBT. The article then explains how the UBT applies to hedge fund managers. The article then moves to a discussion of the Proposed Audit Position, including a discussion of the potential application of the Proposed Audit Position to future audits. Next, the article explains how audit positions are promulgated and identifies the sources of authority for the Department of Finance’s assertion of the Proposed Audit Position. The article continues with a discussion how hedge fund managers can respond if the Department of Finance asserts the Proposed Audit Position in disallowing certain investment manager expenses during the course of an audit. The article closes with a discussion of recommended courses of action for hedge fund managers that seek to mitigate the adverse tax impact of the Proposed Audit Position on their businesses.