How Managers Can Structure Direct Lending Funds to Minimize U.S. Tax Consequences to Foreign and U.S. Tax-Exempt Investors: “Season and Sell” and Blocker Structures (Part One of Two)

As banks focus on making large loans to corporations, some fund managers are stepping into the void and offering loans to small- and mid-sized businesses. Unlike investments in traded securities, loan origination in the U.S. raises tax issues for certain U.S. tax-exempt and foreign investors. See parts one and three of our series on hedge funds as direct lenders: “Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies” (Sep. 22, 2016); and “Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms” (Oct. 6, 2016). A recent seminar featuring Kramer Levin partners Barry Herzog, Kevin P. Scanlan and George M. Silfen provided a roadmap for managers seeking to form direct lending funds that minimize the adverse tax consequences to investors not otherwise subject to U.S. tax. This first article in our two-part series discusses common investment terms for direct lending funds; provides an overview of the tax implications from loan origination activity to foreign and U.S. tax-exempt investors; and discusses the tax mitigation benefits of “season and sell” and blocker structures. The second article will delve into treaty-based fund structures and privately offered closed-end direct lending funds as additional potential solutions to these direct lending tax concerns. For additional insights from Scanlan, see our three-part series on “Closing a Hedge Fund to Outside Investors”: Factors to Consider (Jan. 21, 2016); Operational Considerations (Jan. 28, 2016); and Mechanical Considerations (Feb. 4, 2016).

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