The Hedge Fund Law Report

The definitive source of actionable intelligence on hedge fund law and regulation

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By Topic: Tax

  • From Vol. 11 No.44 (Nov. 8, 2018)

    Harbinger Capital Partners Offshore Manager Settles New York Tax Evasion Case for $30 Million

    The New York Attorney General and New York City Corporation Counsel recently announced the $30‑million settlement of tax evasion charges against Harbinger Capital Partners Offshore Manager LLC (Offshore Manager), the investment manager for New York-based hedge funds run by Philip A. Falcone. This settlement is the latest chapter in a lawsuit that began when a whistleblower alleged that Offshore Manager and related entities and individuals failed to report and pay New York State and City taxes on income from incentive fees earned from successful trading conducted from a New York City office. This recent settlement is the second related to the whistleblower lawsuit. In April 2017, Harbert Management Corporation, the Alabama-based investment management company that sponsored and organized the hedge funds managed by Offshore Manager, and several related parties agreed to a $40‑million settlement. See “New York State Record Tax Whistleblower Settlement Illustrates Pitfalls of Domestic Tax-Shifting Schemes” (Apr. 27, 2017). This article reviews the allegations against Offshore Manager, examines the terms of the latest settlement agreement and provides insight for hedge fund managers on the key takeaways from this case. For other lawsuits stemming from whistleblower complaints, see “Does the Digital Realty Decision Represent a Sea Change for Whistleblowers or Merely More of the Same?” (Mar. 15, 2018); “Former Employee Files Dodd-Frank Whistleblower Suit Against Vertical Capital” (Dec. 18, 2014); and “In Case of First Impression, U.S. District Court Interprets Private Right of Action Under Whistleblower Provisions of Dodd-Frank Act, Limiting Claims of Dismissed Employee of Hedge Fund Technology Vendor” (Jul. 1, 2011).

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  • From Vol. 11 No.44 (Nov. 8, 2018)

    Pepper Hamilton Attorney Discusses Fundamental Structuring Issues for Investment Advisers: Taxation, Organizational Expenses, Redemptions, Publicly Traded Partnerships, Performance Fees and Alternative Structures (Part Two of Two)

    Pepper Hamilton partner Gregory J. Nowak recently examined in a presentation the key regulatory issues an investment adviser faces when developing its advisory business. This article, the second in a two-part series, summarizes the portions of the program that covered taxation issues, organizational expenses, redemptions, publicly traded partnership rules, performance fees and alternative fund structures. The first article covered separately managed accounts, adviser registration and the applicable federal securities laws. For further commentary from Nowak, see our two-part series on how hedge funds can protect their intellectual property: “Trademarks and Copyrights” (Feb. 23, 2017); and “Trade Secrets and Patents” (Mar. 9, 2017).

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  • From Vol. 11 No.29 (Jul. 19, 2018)

    Ropes & Gray Survey and Forum Consider Credit Fund Structures, Leverage, Conflicts of Interest and Challenging Environment (Part One of Two)

    Ropes & Gray recently hosted a program presenting the results of a survey of 100 credit fund managers that it conducted in cooperation with Debtwire. In addition to discussing the results of the survey, the webinar, featuring Ropes & Gray partners James R. Brown, Eva Ciko Carman, Alyson Brooke Gal and Jessica Taylor O’Mary, presented key takeaways from the Ropes & Gray Credit Funds Forum, which took place on May 16, 2018. This two-part series summarizes the report’s findings and the speakers’ insights. This first article discusses the types of credit strategies offered by the survey participants, challenges currently facing credit funds and the types of fund structures adopted by credit fund managers – including “season and sell” structures, treaty funds, business development companies and blockers – when engaging in a direct lending strategy. The second article will examine a variety of conflicts of interest that frequently arise for credit managers, the forms of leverage these managers are using, the types of issues that investors subject to the Employee Retirement Income Security Act of 1974 raise for credit managers and specific issues that arise for these managers when being examined by the SEC. See our three-part series on private funds as direct lenders: “Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies” (Sep. 22, 2016); “Structures to Manage the U.S. Trade or Business Risk to Foreign Investors” (Sep. 29, 2016); and “Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms” (Oct. 6, 2016).

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  • From Vol. 11 No.25 (Jun. 21, 2018)

    The D.B. Zwirn Saga Continues: SEC Settles With Fund Manager’s CFO Over Fraud Claims

    Daniel B. Zwirn’s high-flying hedge fund management firm, D.B. Zwirn & Co., L.P. (DBZ), went into a death spiral in 2007 after Zwirn disclosed to investors certain improper inter-fund transfers that could have subjected one of the offshore funds to a significant U.S. tax liability and exposed the firm’s poor internal control systems. Zwirn blamed Perry A. Gruss, DBZ’s chief financial officer. The SEC apparently agreed, filing a civil complaint against Gruss in 2011, claiming that he had aided and abetted DBZ’s violations of the anti-fraud provisions of the Investment Advisers Act of 1940. In March 2017, the U.S. District Court for the Southern District of New York (Court) granted summary judgment to the SEC on its most serious charges. More recently, in May 2018, the Court entered a final judgment against Gruss, and the SEC subsequently issued a settlement order. This case highlights the need for fund managers to implement carefully crafted internal controls over critical matters like cash movement procedures and the risks of entrusting a single individual with authority over those functions. This article focuses on the details of the Court’s March 2017 opinion deciding the summary judgment motion and explores the terms of the final judgment and the settlement order. For more on internal controls, see “GLG Partners Settlement Illustrates SEC Views Regarding Valuation Controls at Hedge Fund Managers” (Jan. 16, 2014); and “SEC’s Recent Settlement With a Hedge Fund Manager Highlights the Importance of Documented Internal Controls When Managing Conflicts of Interest Associated With Asset Valuation and Cross Trades” (Jan. 9, 2014).

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  • From Vol. 11 No.24 (Jun. 14, 2018)

    How Fund Managers Can Navigate Establishing Parallel and Debt Funds in Luxembourg in the Shadow of Brexit and Proposed E.U. Delegation Rules

    The Association of the Luxembourg Fund Industry (ALFI) recently organized a seminar that examined different fund structures within Luxembourg, as well as political and regulatory developments within Europe. The seminar featured panel discussions with representatives from asset managers, in addition to financial services, legal and accounting firms. This article highlights the portions of the seminar addressing the establishment of parallel E.U. funds and Luxembourg debt funds; Brexit; and the E.U.’s proposed delegation rules. For additional coverage of the ALFI program, including a summary of the keynote address of H.E. Pierre Gramegna, Luxembourg’s Minister of Finance, along with the portions of the seminar that covered marketing funds in the E.U. and setting up an E.U. alternative investment fund manager, see “Luxembourg Remains a Significant Point of Entry for Non-E.U. Managers to Raise Capital in the E.U.” (May 17, 2018). For more on E.U. regulatory developments, see “With Brexit Looming and New Fund Structures Available, U.S. Hedge Fund Managers Face Risks and Opportunities for Marketing in Europe” (Jun. 9, 2016).

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  • From Vol. 11 No.23 (Jun. 7, 2018)

    Planning Strategies for Private Fund Managers Under the Tax Cuts and Jobs Act

    Businesses and individuals continue to struggle to grasp the full impact of – and develop tax-efficient strategies under – the landmark 2017 Tax Cuts and Jobs Act (Tax Act). See “New Tax Law Carries Implications for Private Funds” (Feb. 1, 2018). A recent program presented by Baker Tilly Virchow Krause addressed the key provisions of the Tax Act that affect private fund managers and their principals and offered insight into how they are reacting to the Tax Act. The program featured Baker Tilly senior tax manager Gregory Kastner, and this article summarizes his insights. For additional recent insight from Kastner and Baker Tilly on the Tax Act, see “How the Tax Cuts and Jobs Act Will Affect Private Fund Managers and Investors” (Feb. 22, 2018). For further commentary from Kastner, see “Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers” (Dec. 14, 2017).

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  • From Vol. 11 No.18 (May 3, 2018)

    What Fund Managers Need to Know About the Legislative Response to #MeToo

    As the #MeToo movement presses forward, it has caught the attention of federal and state lawmakers, who have introduced, and in some cases enacted, a range of new legislation to deter and prevent sexual harassment and hold violators accountable. These legislative measures have taken several forms, including legislation (1) prohibiting certain provisions that require the arbitration of sexual harassment claims; (2) prohibiting the use of certain contractual non-disclosure provisions to the extent they cover those claims; (3) requiring firms to adopt sexual harassment prevention policies and training protocols; and (4) expanding coverage of various anti-harassment protections to certain individual contingent workers. In a guest article, Richard J. Rabin and Rachel Wisotsky, partner and associate, respectively, at Akin Gump, explore some of these initiatives, including impactful legislation recently enacted in New York, and discuss the potential consequences for investment managers in the months and years ahead. See “How Investment Managers Can Prevent and Manage Claims of Harassment in the Age of #MeToo” (Dec. 14, 2017). For additional insights from Rabin, see “Evaluating Pay Equality: Steps Investment Managers Should Consider to Avoid Running Afoul of Equal Pay Laws” (Nov. 30, 2017); and “Four Steps NYC-Based Fund Managers Should Take in Light of Newly Enacted Law Prohibiting Compensation History Queries When Interviewing Prospective Employees” (May 11, 2017).

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  • From Vol. 11 No.16 (Apr. 19, 2018)

    Program Highlights Malta’s Fund-Friendly Environment

    A recent program sponsored by FinanceMalta – a public-private venture promoting Malta as a financial center – provided an overview of private fund formation in Malta; the advantages of domiciling funds and managers there; the nation’s regulatory and tax regimes; and its emerging approach to blockchain and cryptocurrency. Thalius Hecksher, global director at TridentTrust, moderated the discussion, which featured Chris Casapinta, executive director of Alter Domus; Adam de Domenico, founder and CEO of Cordium Malta; James Farrugia, partner at GANADO Advocates; Ivan Grech, a representative of FinanceMalta; and Christopher Portelli, associate partner at EY Malta. This article highlights the key points raised by the panelists. For additional commentary from FinanceMalta, see “What Malta Can Offer the Hedge Fund Industry: An Interview With the Chairman of FinanceMalta” (Jan. 26, 2017).

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  • From Vol. 11 No.11 (Mar. 15, 2018)

    Panel Offers Perspectives on Internal Compensation Arrangements for Investment Professionals: Carried Interest and Deferred Compensation (Part One of Two)

    Private equity (PE) firms award carry at the fund level or on a deal-by-deal basis; while the deal-by-deal structure is more flexible, it is also more difficult to properly implement. Recent changes to the taxation of carried interest may further affect how PE firms award carry. In addition, private funds are increasingly deferring compensation to incentivize employees to stay, although significant issues persist over how employment contracts define “cause” and “good reason.” See “Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers” (Dec. 14, 2017). A recent program hosted by Brian T. Davis and Dimitri G. Mastrocola, partners at international recruiting firm Major, Lindsey & Africa (MLA), and featuring McDermott Will & Emery partners Ian M. Schwartz, Evan A. Belosa and Alejandro Ruiz, discussed these and similar issues. This article, the first in a two-part series, discusses carried interest, taxation thereof and deferred compensation arrangements. The second article will explore hedge fund compensation, including profit shares, and restrictive employment covenants. For insight from another McDermott Will & Emery partner, see “Lessons for Hedge Fund Managers From the Government’s Failed Prosecution of Alleged Insider Trading Under Wire and Securities Fraud Laws” (Jul. 21, 2016). For coverage of prior programs hosted by MLA, see “Client Consent and Other Issues Requiring Careful Consideration by Fund Managers Involved in M&A Transactions” (May 18, 2017); and “Former Prosecutors Address Trends in Cybersecurity for Alternative Asset Managers, Diligence When Acquiring a Company and Breach Response Considerations” (Oct. 6, 2016).

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  • From Vol. 11 No.10 (Mar. 8, 2018)

    Interest in Bespoke Fund Structures Surges As Markets Adjust to New Administration and Regulatory Regime

    A little more than a year into the Trump administration, the private funds market displays growing levels of innovation and experimentation. Fund managers are increasingly opting to employ bespoke fund structures, such as first loss capital arrangements, each of which has its own unique set of advantages as well as potentially catastrophic liabilities. Recent changes at the regulatory level – including the newly effective revisions to Form ADV; a heightened regulatory focus on blockchain and the fiduciary responsibilities of legal professionals providing related advice; and a growing emphasis on individual liability, particularly with respect to chief compliance officers – add to the environment’s complexity and may sometimes appear contrary to the administration’s pro-business rhetoric. These factors and trends make the 2018 private funds environment drastically different from that under the previous administration, raising exhilarating and daunting possibilities for fund managers. To help readers understand the unique benefits and potential drawbacks of some of the more popular bespoke fund structures, The Hedge Fund Law Report recently interviewed Peter Bilfield, partner at Day Pitney with experience in this area. This article presents his thoughts. For further commentary from Bilfield, see “What Do the Investor Advisory Committee’s Recommendations Mean for the Future of Marketing of Hedge Funds to Natural Persons?” (Oct. 24, 2014); and “Investments by Family Offices in Hedge Funds Through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two)” (Apr. 1, 2011).

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  • From Vol. 11 No.8 (Feb. 22, 2018)

    How the Tax Cuts and Jobs Act Will Affect Private Fund Managers and Investors

    The recently enacted Tax Cuts and Jobs Act (Tax Act) makes some of the most significant changes to the Internal Revenue Code since 1986. A recent program presented by Baker Tilly Virchow Krause addressed how the Tax Act will affect private fund managers and investors, focusing on deductions related to income from pass-through entities; taxation of carried interest; corporate and international taxation; the business-interest deduction; and other changes relevant to private funds and their managers. The program featured Jean-Paul Schwarz, a Baker Tilly tax principal; and Gregory Kastner and Benjamin Lipman, senior tax manager and senior manager, respectively, at Baker Tilly. This article summarizes their insights. For further commentary on the Tax Act, see “New Tax Law Carries Implications for Private Funds” (Feb. 1, 2018). For additional insight from Baker Tilly, see “How Tax Reforms Proposed by the Trump Administration and House Republicans May Affect Private Fund Managers” (Feb. 9, 2017).

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  • From Vol. 11 No.5 (Feb. 1, 2018)

    How Advisers to Private Funds Can Prepare for Challenges and Opportunities in 2018: Tax Reform, Blockchain Technology and Alternative Fee Structures

    One year into the Trump presidency, advisers to private funds are considerably better informed than they were a year ago about what policies and approaches to expect from the regulatory agencies charged with overseeing the financial sector. But while the legal and compliance sides of the industry settle in to the new normal, 2018 promises to present its own set of challenges and opportunities for private fund managers. The potential impact of the much-heralded Tax Cuts and Jobs Act (Tax Act) – in particular the nuances of the Tax Act’s treatment of carried interest – will continue to be the subject of extensive analysis. Advisers to private funds stand to benefit from an array of opportunities in the bold new field of blockchain technology, one of whose principal applications, bitcoin, surged spectacularly at the end of 2017. Moreover, the poor returns and outflows of capital that plagued hedge funds in 2016 have generally not been a distinguishing feature of 2017 and the new year, leaving open the question of whether advisers will continue to offer alternatives to the “2 and 20” fee structure. To shed light on these crucial market issues, The Hedge Fund Law Report interviewed John P. Broadhurst and James J. Frolik, two partners at Shartsis Friese in San Francisco who are on the front lines of advising managers on the impact of the Tax Act; the spread of blockchain technology and its lures and drawbacks for fund managers; and the trend of alternative fee structures and arrangements. This article presents their thoughts on the foregoing. For more on how blockchain is impacting the private funds industry, see “Private Fund Advisers and Service Providers Must Evolve Their Businesses to Keep Pace With Innovations in Technology, or Risk Becoming Obsolete” (Jan. 18, 2018).

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  • From Vol. 11 No.5 (Feb. 1, 2018)

    New Tax Law Carries Implications for Private Funds

    On December 22, 2017, President Trump signed H.R. 1, the Tax Cuts and Jobs Act (Tax Act), into law. The Tax Act makes the most significant revisions to the Internal Revenue Code (IRC) since the 1986 tax reform. A recent Proskauer program offered an overview of the provisions of the Tax Act most likely to affect private fund managers. The program featured Proskauer partners Arnold P. May and Amanda H. Nussbaum, along with senior counsel Brian D. Huber and Marguerite R. Lombardo. This article highlights the key takeaways from their presentation. For coverage of another recent tax development, see our two-part series on how the new partnership audit regulations affect private funds: “Understanding the BBA and Appointing a Partnership Representative” (Oct. 19, 2017); and “Imputed Underpayments, Push-Out Elections and Fund Document Provisions to Amend” (Nov. 2, 2017).

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  • From Vol. 11 No.4 (Jan. 25, 2018)

    BakerHostetler Briefing Provides Regulatory Update: Developments in SEC Enforcement and Hot Topics in Taxation Affecting Private Funds (Part Two of Two)

    Since the enactment of the Dodd-Frank Act in 2010, compliance officers in the financial services industry have been working franticly to analyze and implement the multitude of rules and regulations that flowed from its passage. Although some in the industry have been hopeful that the Trump administration would herald a regulatory-lite approach by the SEC, only time will tell whether the administration’s anti-regulatory posture will trickle down to the regulatory agencies, their leadership and, in the case of the SEC, the staff of the Office of Compliance Inspections and Examinations. A recent program sponsored by BakerHostetler considered the impact of the new administration, as well as the leadership of SEC Chair Jay Clayton, on the regulation of investment advisers. The program was moderated by Marc D. Powers, partner at BakerHostetler and national leader of the firm’s securities litigation, regulatory enforcement and hedge fund industry practices; and featured Walter Van Dorn, partner and head of BakerHostetler’s international capital markets practice; Jonathan A. Forman, counsel at BakerHostetler; Simcha B. David, partner at EisnerAmper; and Andrew N. Siegel, then-partner, chief compliance officer and chief regulatory counsel at Perella Weinberg Partners. This second article in our two-part series discusses hot topics in the area of SEC enforcement, as well as the tax aspects of loan origination and cryptocurrencies. The first article reviewed recent regulatory initiatives undertaken by the SEC that impact investment advisers, whether the change in leadership at the SEC will affect the examination environment and the implementation of MiFID II. For more from Powers and Forman, see “BakerHostetler Panel Analyzes the Trump Effect on the SEC’s Initiatives and Enforcement Efforts” (May 4, 2017); and “‘Gatekeeper’ Actions by the SEC and Investors Against Administrators Challenge Private Fund Industry” (Sep. 8, 2016).

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  • From Vol. 11 No.2 (Jan. 11, 2018)

    E.U. Publishes Blacklist and Grey List of Non-Cooperative Tax Jurisdictions: Funds Formed in Grey-Listed Bermuda, Cayman Islands, Guernsey, Jersey and Others May Be Affected by Potential Tax Law Revisions

    The European Commission recently published its much-anticipated list of non-cooperative tax jurisdictions. See “How the E.U. Tax Haven Blacklist May Affect Private Funds Formed in Blacklisted Jurisdictions” (Nov. 2, 2017). The list is effectively split in two: 17 non-E.U. jurisdictions are included on a so-called “blacklist”; and a further 47 are included on a so-called “grey list.” Of the two, the grey list is of significantly greater interest and importance to the private funds industry, as it contains a number of jurisdictions in which advisers to private funds frequently elect to form offshore investment vehicles, including the Cayman Islands, Bermuda, Jersey and Guernsey. In a guest article, Will Smith and Caleb McConnell, partner and associate, respectively, at Sidley Austin, review the composition of jurisdictions on the blacklist and the grey list; the impact to private funds that are organized in those locales; and steps that must be taken by grey-listed jurisdictions to avoid future blacklist status. For additional coverage of the U.K.’s approach to combatting tax evasion, see “U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion (Part One of Two)” (Feb. 23, 2017); and “How U.S. Private Fund Managers May Avoid Running Afoul of Proposed U.K. Legislation Criminalizing the Facilitation of Tax Evasion (Part Two of Two)” (Mar. 2, 2017). For further commentary from Smith on tax issues, see “Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers” (Apr. 20, 2017).

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  • From Vol. 10 No.49 (Dec. 14, 2017)

    Ways Fund Managers Can Compensate and Incentivize Partners and Top Performers

    Properly compensating employees is a perpetual issue for fund managers, as they must allocate management fee and performance compensation pools, balancing business and tax considerations while incentivizing and retaining key employees. A recent program sponsored by the New York Alternative Investment Roundtable provided a primer on how private fund managers can use management fee streams and performance fees to incentivize and compensate their partners and employees in a tax-efficient manner. Timothy Frazier, vice president of TriNet, hosted the presentation, which featured Gregory Kastner, senior tax manager for Baker Tilly Virchow Krause, who presented insights from the client alert he wrote on structuring employee compensation plans. This article summarizes the portions of the presentation most relevant to private fund managers. For more on hedge fund compensation, see our two-part series on deferred compensation plans: “Structuring Plans to Retain Top Talent” (Jun. 22, 2017); and “Practical Considerations: Vesting Schedules, Deferral Amounts and Compliance With Section 409A” (Jun. 29, 2017); as well as our two-part interview with David Claypoole: “How Have Industry Developments Affected the Value of Legal and Compliance Staff?” (Feb. 2, 2017): and “Will Industry Deregulation Affect the Value of Legal and Compliance Staff?” (Feb. 16, 2017).

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  • From Vol. 10 No.48 (Dec. 7, 2017)

    Tax Expert Provides Insight Into Recent U.S. Tax Court Decision on Taxation of Foreign Investments in U.S. Partnerships

    The U.S. Tax Court’s recent decision in Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner of Internal Revenue departed from a longstanding Internal Revenue Service (IRS) revenue ruling that made sales of U.S. partnership interests by foreign partners subject to tax in the U.S. See “U.S. Tax Court Ruling May Lead to Increased After-Tax Returns for Foreign Investors That Invest in U.S. Partnerships” (Aug. 3, 2017). A recent webinar offered a primer on U.S. taxation of foreign investors, an analysis of the IRS revenue ruling, an overview of the Tax Court’s reasoning in the Grecian Magnesite decision and its implications. The program was sponsored by The Financial Executives Alliance, a national affinity group administered by First Republic Bank, and featured Pepper Hamilton partner Steven D. Bortnick. This article highlights the principal points from the presentation. For further commentary from Bortnick, see “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015).

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  • From Vol. 10 No.47 (Nov. 30, 2017)

    The Effect of 2017 Tax Developments on Advisers to Private Funds: New Partnership Audit Rules, Tax Reform, Blockers, Discounted Gifting, Fee Waivers and State Nexus Issues

    A recent panel at the ninth annual RSM Investment Industry Summit offered insights into a number of pending tax issues of interest to private fund managers, including the revised partnership audit regime; tax reform; potential benefits of foreign blockers; discounted gifting; IRS regulation and enforcement around private equity fee waivers; and evolving concepts of state tax nexus rules. The program was moderated by RSM tax partner Gennaro (Jerry) Musi and featured tax partner Moshe Metzger and senior tax managers Ashima Arora and Richard Joslin. This article summarizes the portions of the presentation most relevant to private fund managers. For additional commentary from RSM personnel, see “Investor Gatekeepers Advise Emerging Managers on How to Stand Out When Pitching and Marketing Their Funds” (Dec. 15, 2016); “How Investment Managers Can Advertise Sub-Adviser Performance Without Violating SEC Rules” (Dec. 1, 2016); and “HFA Symposium Offers Perspectives From Cybersecurity Industry Professionals on Preparedness, Vendor Management, Cyber Insurance and Cloud Services” (Jul. 7, 2016).

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  • From Vol. 10 No.46 (Nov. 23, 2017)

    U.K. Legislation Imposes Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion

    The previous three years have generally heralded a new approach to combating tax evasion, with a significant international focus on cross-border cooperation and extra-territorial application of tax regimes. The U.K. has been at the forefront of this international action, legislating or proposing a series of new rules and regimes in this area. A particular focus of the U.K. authorities has been to implement legislation designed to change the behavior of individual taxpayers, targeting those directly engaging in tax evasion and individuals who indirectly facilitate or enable it. A new set of rules known as the “failure to prevent the facilitation of tax evasion” rules (UKFP rules) went into effect in the U.K. in September 2017. Designed to prevent tax evasion, the UKFP rules introduce criminal liability for certain companies and partnerships in circumstances where an employee, agent or service provider facilitates the evasion of tax by other persons. In this guest series, Sidley Austin partner Will Smith analyzes the UKFP rules. The first article provides an overview of the UKFP rules. The second article furnishes an in-depth discussion of how the UKFP rules may apply to private fund managers. See also our two-part series “Steps That Alternative Investment Fund Managers Need to Take Today to Comply With the Global Trend Toward Tax Transparency”: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016).

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  • From Vol. 10 No.43 (Nov. 2, 2017)

    How the E.U. Tax-Haven Blacklist May Affect Private Funds Formed in Blacklisted Jurisdictions

    Due to be finalized in late 2017, the European Commission (EC) has proposed a “tax‑haven blacklist” that could have significant implications for current fund structures that contain entities with a connection to “blacklisted” jurisdictions. The initiative is expected to be used as a tool by the E.U. to combat perceived tax evasion and tax avoidance globally. For information on the U.K.’s approach to combatting tax evasion, see “U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion (Part One of Two)” (Feb. 23, 2017); and “How U.S. Private Fund Managers May Avoid Running Afoul of Proposed U.K. Legislation Criminalizing the Facilitation of Tax Evasion (Part Two of Two)” (Mar. 2, 2017). A jurisdiction’s inclusion on the blacklist may also result in E.U. Member States collectively imposing counter-measures against the jurisdiction, potentially including denial of tax deductions or tax exemptions; and imposition of additional withholding taxes. In a guest article, Will Smith and Caleb McConnell, partner and associate, respectively, at Sidley Austin, review the status of the compilation of the blacklist, the criteria being used by the EC to determine which countries to include on the blacklist and the consequences to countries that are eventually included on the blacklist, as well as to funds formed in blacklisted jurisdictions. For additional insights from Smith on tax matters, see “Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers” (Apr. 20, 2017); and our two-part series “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated With Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).

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  • From Vol. 10 No.43 (Nov. 2, 2017)

    Simmons & Simmons Briefing Covers Revisions to U.K. Fund Documents in Anticipation of MiFID II Deadline and the Potential Impact of Pending U.K. Partnership Taxation Rules

    The January 3, 2018, deadline for compliance with the latest revisions to the Markets in Financial Instruments Directive (MiFID II) is quickly approaching. Additionally, a bill pending in the U.K. Parliament could dramatically affect the taxation of pass-through entities in the U.K. A recent Simmons & Simmons briefing offered guidance to fund managers on preparing for MiFID II and how the pending tax changes could affect their operations. The program was moderated by Simmons partner Devarshi Saksena and featured partners Lucian Firth and Martin Shah and senior lawyer Russell Afifi. This article highlights their key insights. For additional commentary from Simmons on MiFID II, see “Simmons & Simmons and Advise Technologies Provide Comprehensive Overview of MiFID II”: Part One (Jun. 18, 2015); and Part Two (Jun. 25, 2015). See also “MiFID II Expands MiFID I and Imposes Reporting Requirements on Asset Managers, Including Non-E.U. Asset Managers” (May 28, 2015). For more from Saksena and Firth, see “FCA Amends Its Position on Annex IV Reporting: U.K. and Non-EEA Managers, Including U.S. Managers, Must Now Report Holdings at Master Fund Level” (Apr. 13, 2017).

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  • From Vol. 10 No.43 (Nov. 2, 2017)

    How the New Partnership Audit Regulations Affect Private Funds: Imputed Underpayments, Push-Out Elections and Fund Document Provisions to Amend (Part Two of Two)

    The new regulations (BBA Regulations) introduced under The Bipartisan Budget Act of 2015 are expected to make it easier for the Internal Revenue Service (IRS) to audit private funds structured as partnerships. Consequently, advisers to these funds should proactively take steps to understand how the BBA Regulations differ from the current partnership audit rules and amend their fund operating documents accordingly. Baker Tilly Virchow Krause recently offered a comprehensive overview of the BBA Regulations and practical ways for managers to address those changes, in a panel moderated by Mark Heroux, principal at Baker Tilly and former trial attorney in the IRS Office of Chief Counsel, and featuring Colin Walsh and Brad Polizzano, Baker Tilly senior manager and manager, respectively. This second article in our two-part series discusses the treatment of underpayments under the BBA Regulations and the option for partnerships to push out the adjustment to those who were partners during the year that was under review; the application of Accounting Standards Codification 740 to partnerships; the ways in which most managers will need to update their partnership agreements; and the effect of the BBA Regulations on the filing of state tax returns. The first article provided an overview of the BBA Regulations, identified key ways in which the BBA Regulations differ from existing partnership audit regulations and explained the new concept of a “partnership representative.” For a comprehensive look at hedge fund taxation, see our four-part series: “Allocations of Gains and Losses, Contributions to and Distributions of Property From a Fund, Expense Pass-Throughs and K-1 Preparation” (Jan. 16, 2014); “Provisions Impacting Foreign Investors in Foreign Hedge Funds” (Jan. 23, 2014); “Taxation of Foreign Investments and Distressed Debt Investments” (Jan. 30, 2014); and “Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles” (Feb. 6, 2014).

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  • From Vol. 10 No.41 (Oct. 19, 2017)

    How the New Partnership Audit Regulations Affect Private Funds: Understanding the BBA and Appointing a Partnership Representative (Part One of Two)

    The Bipartisan Budget Act of 2015 (BBA) sought to replace existing partnership audit regulations with a streamlined set of rules for auditing partnerships and their partners at the partnership level. Under the final proposed audit regulations (BBA Regulations), the Internal Revenue Service (IRS) can now impose an assessment for underpayment of income tax directly on a partnership, marking a significant departure from the current treatment of partnerships as pass-through entities not subject to federal income tax. A recent presentation by Baker Tilly Virchow Krause offered a comprehensive overview of the BBA Regulations and practical ways for managers to address these changes. The program was moderated by Mark Heroux, a principal at Baker Tilly and former trial attorney in the IRS Office of Chief Counsel, and featured Colin Walsh and Brad Polizzano, Baker Tilly senior manager and manager, respectively. This article, the first in a two-part series, provides an overview of the BBA Regulations, identifies key ways in which they differ from existing partnership audit regulations and explains the new concept of a “partnership representative.” The second article will discuss the treatment of underpayments under the BBA Regulations and the option for partnerships to push out the adjustment to those who were partners during the year that was under review; the application of Accounting Standards Codification 740 to partnerships; the ways in which most managers will need to update their partnership agreements; and the effect of the BBA Regulations on the filing of state tax returns. For additional recent insights from Baker Tilly, see “How Private Fund Managers Can Navigate the Hazards of State Income-Sourcing Rules” (Jul. 13, 2017); and “How Tax Reforms Proposed by the Trump Administration and House Republicans May Affect Private Fund Managers” (Feb. 9, 2017).

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  • From Vol. 10 No.39 (Oct. 5, 2017)

    How Recent Developments Under BEPS May Affect Fund Managers’ Ability to Use Special Purpose Vehicles

    The Organisation for Economic Co-operation and Development (OECD) has implemented a number of reforms in an effort to combat tax strategies that exploit mismatches between tax treaties and artificially shift value from high-tax countries to low-tax ones. One of these reforms – the Base Erosion and Profit Shifting (BEPS) initiative – is designed to restrict the ability of companies, including fund managers, to establish investment platforms in jurisdictions with favorable tax treaties in order to take advantage of tax benefits. See “Treaties Offer Fund Managers Means to Reclaim Overpayments but Require Updating to Keep Pace With the Market” (Jun. 15, 2017); and our two-part series “Steps That Alternative Investment Fund Managers Need to Take Today to Comply With the Global Trend Toward Tax Transparency”: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016). In a guest article, Will Smith and Caleb McConnell, partner and associate, respectively, at Sidley Austin, explore recent developments relating to the proposals for implementing Article 6 of the BEPS initiative, which could affect the ability of fund managers to use special purpose vehicles to hold investments for their funds in jurisdictions covered by BEPS. For additional insights from Smith, see “Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers” (Apr. 20, 2017); and our two part series “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated With Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).

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  • From Vol. 10 No.31 (Aug. 3, 2017)

    U.S. Tax Court Ruling May Lead to Increased After-Tax Returns for Foreign Investors That Invest in U.S. Partnerships

    On July 13, 2017, the U.S. Tax Court issued a ruling that when a non-U.S. investor realizes a gain through the disposition of an interest in a partnership engaged in a U.S. trade or business, that gain is not “effectively connected income” (ECI) and therefore is not subject to U.S. federal income tax. The ruling has potentially monumental significance for investors around the world with interests in U.S. partnerships and for U.S. managers seeking to raise capital abroad, as certain investment opportunities may become more attractive from a tax perspective to foreign investors. Conversely, the decision’s future and long-term impact are uncertain, given that the Internal Revenue Service (IRS) will likely contest the ruling and the U.S. Treasury Department may implement regulations that effectively render it meaningless. To help our readers understand the potential impact of the Tax Court’s decision, this article summarizes the ruling and presents insight from attorneys and tax practitioners at the forefront of interactions between the financial services sector and the IRS. For background on ECI, see “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques” (Jan. 22, 2015); and “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four)” (Jan. 23, 2014).

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  • From Vol. 10 No.29 (Jul. 20, 2017)

    Reading the Regulatory Tea Leaves: Recent White House and Congressional Action and Insights From SIFMA and FINRA Conferences

    There has been a great deal of uncertainty concerning the direction of financial industry regulation. To address this unease, a recent MyComplianceOffice (MCO) presentation – hosted by Joseph Boyhan of MCO and featuring Shearman & Sterling partner Russell D. Sacks and counsel Jennifer D. Morton – offered insight into the status of pending legislation, tax reforms, the fiduciary rule and regulatory priorities. This article examines the points from the presentation that are most relevant to private fund managers. For coverage of another MCO overview of SEC and FINRA enforcement updates, see “What the Record Number of 2016 SEC and FINRA Enforcement Actions Indicates About the Regulators’ Possible Enforcement Focus for 2017” (Dec. 15, 2016). For additional insights from Sacks, see “How Can Hedge Fund Managers Structure Their In-House Marketing Activities to Avoid a Broker Registration Requirement?”: Part One (Sep. 12, 2013); Part Two (Sep. 19, 2013); and Part Three (Sep. 26, 2013).

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  • From Vol. 10 No.28 (Jul. 13, 2017)

    How Private Fund Managers Can Navigate the Hazards of State Income-Sourcing Rules

    Private funds with operations or investors in multiple states face a complex and shifting taxation regime. For example, a manager that derives all of its management fee income from its New York operations may still have to file returns in other states and allocate portions of that income to those states. A recent presentation by Baker Tilly Virchow Krause offered an overview of the rules for sourcing state income; the related filing and apportionment rules; and other state tax issues relevant to private fund managers. The program featured Gregory Kastner, senior tax manager at Baker Tilly; and Michele Gibbs Itri, partner at Tannenbaum Helpern Syracuse & Hirschtritt. The issues addressed in their presentation are particularly timely in light of New York’s recent settlement with Harbinger Capital over its alleged improper shifting of performance fee income from New York to a lower-tax jurisdiction. See “New York State Record Tax Whistleblower Settlement With Harbinger Capital Partners Illustrates Pitfalls of Domestic Tax-Shifting Schemes” (Apr. 27, 2017). For a comprehensive look at hedge fund taxation, see our four-part series: “Allocations of Gains and Losses, Contributions to and Distributions of Property From a Fund, Expense Pass-Throughs and K-1 Preparation” (Jan. 16, 2014); “Provisions Impacting Foreign Investors in Foreign Hedge Funds” (Jan. 23, 2014); “Taxation of Foreign Investments and Distressed Debt Investments” (Jan. 30, 2014); and “Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles” (Feb. 6, 2014).

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  • From Vol. 10 No.26 (Jun. 29, 2017)

    Practical Considerations for Hedge Fund Managers Establishing Deferred Compensation Plans: Vesting Schedules, Deferral Amounts and Compliance With Section 409A (Part Two of Two)

    When designing programs and incentives to attract and retain critical employees, deferred compensation plans warrant thoughtful consideration by hedge fund managers. Individuals who plan to remain with a firm for the long term often welcome these plans as a way to invest a portion of their income on a pre-tax basis and allow it to grow on a tax-deferred basis. Conversely, junior employees or those more fluid in their careers may prefer to receive cash compensation at the time it is earned. This two-part series provides an overview of deferred compensation plans in the hedge fund industry and key factors managers should consider when developing these plans. This second article examines how commonly these plans are adopted; discusses technical aspects of these plans, such as vesting schedules and forfeiture events; identifies categories of employees who are likely to participate in these plans; and reviews Section 409A of the Internal Revenue Code as it relates to these plans. The first article explored the intended goals of these programs and tax consequences associated with pre- and post-tax deferral plans. For discussion of other methods used by hedge fund managers to incentivize employees, see “Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation” (Apr. 18, 2014); “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?” (Aug. 22, 2013); and “Key Considerations for Hedge Fund Managers in Developing a Succession Plan (Part Two of Two)” (Feb. 23, 2012).

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  • From Vol. 10 No.25 (Jun. 22, 2017)

    How Hedge Fund Managers Can Structure Deferred Compensation Plans to Retain Top Talent (Part One of Two)

    It is often arduous and costly for hedge fund managers to build robust management teams with desirable talent in order to meet legal, regulatory and investor demands. Once found, retaining talented individuals becomes the next critical concern for managers, which they frequently address by using deferred compensation plans to delay an individual’s receipt of a portion of his or her compensation until a later point in time. See “Greenwich Associates and Johnson Associates Issue Report on Asset Management Compensation Trends in 2012” (Dec. 13, 2012). This two-part series provides an overview of the use of deferred compensation plans in the hedge fund industry, including the different forms these plans can take and certain tax matters to consider. This first article explores the intended goals of these programs and tax consequences associated with pre- and post-tax deferral programs. The second article will examine how commonly these plans are adopted in the hedge fund industry; discuss technical aspects of these plans, such as vesting schedules and forfeiture events; and identify categories of employees who are likely to participate in deferred compensation plans. For analysis of trends in compensation at hedge fund managers, see “How Much Are Hedge Fund Manager General Counsels and Chief Compliance Officers Paid?” (Jul. 24, 2014); and our two-part series on the market for in-house compensation at hedge fund managers: “What Is the Value of Legal and Compliance Staff?” (Mar. 12, 2015); and “Trends in Legal and Compliance Hiring and Staffing” (Mar. 19, 2015).

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  • From Vol. 10 No.25 (Jun. 22, 2017)

    Hedge Funds’ Image Crisis: Fighting Public Perceptions Against the Backdrop of Potential Financial Sector Reforms

    Despite the generally business-friendly atmosphere of the Trump administration, hedge funds still face an uphill battle when it comes to negative perceptions by the general public and investors. While new SEC Chair Jay Clayton and other top officials have deep and genuine expertise in financial and regulatory topics, much of the public derives its views and attitudes from media reports emphasizing the downside of hedge fund investing. To address its image problem, it behooves the private funds industry to bridge the general public’s knowledge gap. In the background of this battle over the industry’s reputation, reforms that may benefit private funds – including revisions to the business income tax and a consolidation of certain regulatory functions – are potentially on the horizon. All of these points came across in the keynote speech by former SEC Chair Christopher Cox at the tenth annual Advanced Topics in Hedge Funds Practices Conference: Manager and Investor Perspectives recently produced by Morgan Lewis. This article presents the key takeaways from Cox’s talk. For coverage of last year’s conference, see “How Emerging Hedge Fund Managers Can Raise Capital in a Challenging Market Without Overstepping Legal Bounds” (Aug. 4, 2016). For additional insights from Morgan Lewis attorneys, see “Leading Law Firms Discuss Hedge Fund Marketing and Distribution Opportunities in a Post-Brexit World (Part Two of Two)” (Jul. 14, 2016); and “Operational Conflicts Arising Out of Simultaneous Management of Hedge Funds and Private Equity Funds (Part Two of Three)” (May 14, 2015).

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  • From Vol. 10 No.25 (Jun. 22, 2017)

    Anatomy of a Private Equity Fund Startup

    A recent Latham & Watkins program provided a soup-to-nuts overview of the steps to establish a private equity fund, covering the initial planning phase; development of fund infrastructure; and offering and closing process. The program featured David J. Greene and Amy R. Rigdon, partner and associate, respectively, at the firm. This article highlights the key points raised during the presentation, outlining the above three components of forming a private equity fund, along with issues and considerations that may arise during each phase of the process. For another look at the startup process, see “Establishing a Hedge Fund Manager in Seventeen Steps” (Aug. 27, 2015).

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  • From Vol. 10 No.24 (Jun. 15, 2017)

    Treaties Offer Fund Managers Means to Reclaim Overpayments but Require Updating to Keep Pace With the Market

    Due to the inability of some foreign governments to determine beneficial owner identities, many funds undertaking cross-border investments lose more money in tax payments than strictly required by law. Governments have attempted to ameliorate this problem by adopting bilateral tax reclamation treaties with other governments, but this has proved a partial solution at best. Treaty-making is stymied in the U.S. Congress and some foreign legislative bodies, and instances of fraud – including a massive scandal costing the nation of Denmark billions – have soured some to the very idea of tax reclamation. In many instances, the variety and complexity of investment vehicles add further layers of difficulty and opacity to the process. Nevertheless, tax reclamation can be indispensable for funds and investors to regain money that rightfully belongs to them. To help readers understand the myriad issues involved in cross-border tax payment and reclamation, The Hedge Fund Law Report has interviewed Len Lipton, managing director of tax reclamation service provider GlobeTax, and this article presents his insights. For earlier commentary from Lipton on this topic, see “How Can Hedge Funds Recoup Overwithholding of Tax on Non-U.S. Source Interest and Dividends?” (Sep. 12, 2013). For more on tax issues affecting private funds, see “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)” (May 18, 2017).

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  • From Vol. 10 No.23 (Jun. 8, 2017)

    Implications of German Investment Tax Reform for Funds Investing in German Assets or That Have German Investors

    In mid-2016, the German legislature agreed on a fundamental reform of the German Investment Tax Act. The completely revised act – which will affect any fund that invests in German assets or that has German investors – will come into force on January 1, 2018, giving investment fund managers the balance of 2017 to prepare for such changes. In a guest article, Nadine Schader, an attorney at Flick Gocke Schaumburg, provides an overview of the new German tax regime as it relates to investment funds and their investors; clarifies the critical distinction between investment funds and special investment funds, along with how the new regime applies to each category; and provides guidance on the steps that investment managers should take to determine if their funds will be classified as investment funds or special investment funds as it relates to German source income. For more on tax reforms abroad, see “Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers” (Apr. 20, 2017); and “Key Hedge Fund Tax Developments in the U.K., the European Union, Ireland, Germany, Spain, Australia, India and Puerto Rico” (Jun. 27, 2013).

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  • From Vol. 10 No.21 (May 25, 2017)

    How Managers Can Structure Direct Lending Funds to Minimize U.S. Tax Consequences to Non-U.S. and Tax-Exempt Investors: Treaty-Based and Registered Fund Structures (Part Two of Two)

    As investors continue to clamor for direct lending strategies by private fund managers, legal advisers have kept pace by developing sophisticated fund structures to help manage the tax issues prompted by loan origination. For additional considerations when structuring direct lending funds, see part two of our three-part series on hedge funds as direct lenders: “Structures to Manage the U.S. Trade or Business Risk to Foreign Investors” (Sep. 29, 2016). In a recent program, Kramer Levin Naftalis & Frankel partners Barry Herzog, Kevin P. Scanlan and George M. Silfen discussed four structuring options available to managers seeking to launch a fund that will engage in loan origination. This second article in our two-part series examines treaty-based fund structures and privately offered closed-end direct lending funds. The first article discussed common investment terms for direct lending funds; provided an overview of the tax implications of loan origination activity to foreign and U.S. tax-exempt investors; and discussed how the “season and sell” and blocker structures can minimize the potential tax consequences of loan origination. For more on direct lending, see “The Current State of Direct Lending by Hedge Funds: Fund Structures, Tax and Financing Options” (Oct. 27, 2016).

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  • From Vol. 10 No.20 (May 18, 2017)

    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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  • From Vol. 10 No.17 (Apr. 27, 2017)

    New York State Record Tax Whistleblower Settlement Illustrates Pitfalls of Domestic Tax-Shifting Schemes

    In March 2015, an unnamed whistleblower filed a qui tam action in New York State Supreme Court under the state’s False Claims Act against Harbert Management Corporation, Harbinger Capital Partners Offshore Manager LLC and others. The suit asserted that those entities, as well as several affiliated entities and individuals, had failed to report and pay New York State income tax on millions of dollars of performance fee income derived from their fund management activities in New York. For more on the tax treatment of performance fee income, see “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?” (Jun. 13, 2014). Several parties to the action recently entered into a Stipulation and Settlement Agreement (Stipulation) pursuant to which the respondents have agreed to pay over $40 million in the aggregate, including an award of more than $8.8 million to the whistleblower. The settlement is the largest such recovery in New York and serves as an important reminder that fund managers must comply with the tax regime of each jurisdiction in which they operate. This article analyzes the terms of the Stipulation and its potential ramifications on the hedge fund industry. For coverage of actions involving Harbinger, see “Settlement by Harbinger’s Former COO Calls Into Question the Utility for Hedge Fund Manager Executives of Indemnification Provisions in Fund Documents and D&O Insurance Policies” (Aug. 1, 2014); “Important Implications and Recommendations for Hedge Fund Managers in the Aftermath of the SEC’s Settlement With Philip A. Falcone and Harbinger Entities” (Aug. 22, 2013); and “SEC Charges Philip A. Falcone, Harbinger Capital Partners and Related Entities and Individuals With Misappropriation of Client Assets, Granting of Preferential Redemptions and Market Manipulation” (Jun. 28, 2012).

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  • From Vol. 10 No.16 (Apr. 20, 2017)

    Recent Tax Developments May Make U.K. Limited Companies More Favorable Than U.K. LLPs for U.S. Fund Managers

    U.S. fund managers that set up operations in the U.K. have historically tended to favor a U.K. limited liability partnership (LLP) as opposed to a U.K. limited company (LTD). In broad terms, the preference for using an LLP was due to the greater commercial and legal flexibility – and reduced U.K. tax burden – offered by the LLP structure. See “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships” (Mar. 13, 2014). A number of recent U.K. developments, however, are likely to be material to any U.S. fund manager when deciding how to structure a new U.K. presence or when reconsidering any existing U.K. arrangements. In a guest article, Sidley Austin partner Will Smith examines the history of these structures, recent developments impacting their utility and considerations for managers converting from an LLP to an LTD. For additional insight from Smith, see our two-part series on the effect of recent U.K. legislation criminalizing the facilitation of tax evasion: “U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion” (Feb. 23, 2017); and “How U.S. Private Fund Managers May Avoid Running Afoul of Proposed U.K. Legislation Criminalizing the Facilitation of Tax Evasion” (Mar. 2, 2017); as well as our two-part series entitled “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated With Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).

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  • From Vol. 10 No.13 (Mar. 30, 2017)

    Fund Managers Must Address Investors’ Fee and Liquidity Concerns to Maintain Strong Performance in 2017, While Also Preparing for Trump Administration Regulations

    By many indices, the hedge fund industry in early 2017 shows strong signs of recovery after a difficult year marked by heavy outflows. Returns are up and optimism abounds in the midst of the pro-business atmosphere fostered by the new administration of President Donald J. Trump. See “Ways the Trump Administration’s Policies May Affect Private Fund Advisers” (Mar. 2, 2017). This positivity is tempered, however, by concerns over whether fund managers can align their interests with investors’ fee and liquidity concerns, as well as whether funds are making use of an appropriate beta hurdle. Further, there is a great deal of uncertainty about the impact of the Trump administration’s emerging policies and priorities on the SEC’s enforcement efforts, the Dodd-Frank Act, carried interest and the Department of Labor’s fiduciary rule. To cast light on these and other critical issues, The Hedge Fund Law Report recently interviewed Steven Nadel, a partner in the investment management practice at Seward & Kissel and lead author of Seward & Kissel’s recently published “2016 New Hedge Fund Study.” See “Lock-Ups and Investor-Level Gates Prevalent in New Hedge Funds” (Mar. 23, 2017). For additional commentary from Nadel, see “HFLR and Seward & Kissel Webinar Explores Common Issues in Negotiating and Monitoring Side Letters” (Nov. 10, 2016); and “Seward & Kissel Partner Steven Nadel Identifies 29 Top-of-Mind Issues for Investors Conducting Due Diligence on Hedge Fund Managers” (Apr. 4, 2014).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    How U.S. Private Fund Managers May Avoid Running Afoul of Proposed U.K. Legislation Criminalizing the Facilitation of Tax Evasion (Part Two of Two)

    In its latest effort to identify and punish those involved in tax evasion, the U.K. has proposed legislation making it a criminal offence for companies and partnerships to fail to prevent their agents from facilitating tax evasion. The proposed regulations – known as the “failure to prevent the facilitation of tax evasion” rules (UKFP rules) – are broad in nature and will affect a range of businesses, including private fund managers and other financial services firms. In this guest article, the second in a two-part series, Sidley Austin partner Will Smith provides an in-depth discussion of how the UKFP rules may apply to private fund managers, including U.S.-based investment managers that have a link to the U.K. The first article provided an overview of the UKFP rules and discussed the two new criminal offences prescribed therein. For insight from Smith’s partner, Leonard Ng, see “E.U. Market Abuse Scenarios Hedge Fund Managers Must Consider” (Dec. 17, 2015); and “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers From the January 2015 AIFMD Annex IV Filing” (Mar. 27, 2015).

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  • From Vol. 10 No.9 (Mar. 2, 2017)

    Ways the Trump Administration’s Policies May Affect Private Fund Advisers

    With a Republican president and Republican-controlled Congress, there is the possibility for comprehensive changes in several areas of concern to private fund managers, including taxation, regulation and enforcement. In his first weeks in office, President Trump issued a series of sweeping, yet sometimes confusing, orders directed at fulfilling some of his campaign promises. A recent seminar presented by the Association for Corporate Growth (ACG) provided insight on the impact of the Trump executive orders regarding the pending fiduciary rule and other regulatory matters; developments at the SEC; the future of the Dodd-Frank Act and other laws that may affect the private fund industry; proposed tax reform; cybersecurity; and political contributions. Scott Gluck, special counsel at Duane Morris, moderated the discussion, which featured Langston Emerson, a managing director at advisory firm The Cypress Group; Basil Godellas, a partner at Winston & Strawn; Ronald M. Jacobs, a partner at Venable; and Michael Pappacena, a managing director at ACA Aponix. This article summarizes their insights. For coverage of other ACG webinars, see “SEC Staff Provides Roadmap to Middle-Market Private Fund Adviser Examinations” (May 16, 2014); and “SEC’s David Blass Expands on the Analysis in Recent No-Action Letter Bearing on the Activities of Hedge Fund Marketers” (Mar. 13, 2014). 

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  • From Vol. 10 No.8 (Feb. 23, 2017)

    U.K. Proposes Legislation to Impose Criminal Liability on Companies and Partnerships Whose Employees and Other Agents Facilitate Tax Evasion (Part One of Two)

    The previous three years have generally heralded a new approach to combating tax evasion, with a significant international focus on cross-border cooperation and the extra-territorial application of tax regimes. The U.K. has been at the forefront of such international action, legislating or proposing a series of new rules and regimes in this area. A particular focus of the U.K. authorities has been to implement legislation designed to change the behaviour of individual taxpayers, targeting individuals directly engaged in tax evasion or who indirectly facilitate or enable that tax evasion. For a review of U.S. efforts to combat tax evasion, see “What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?” (Feb. 1, 2013); and “U.S. Releases Helpful FATCA Guidance, but the Law Still Remains” (Mar. 8, 2012). The U.K. has proposed a new set of rules that, if enacted, will introduce a new criminal liability for certain companies and partnerships in circumstances where an employee, agent or service provider facilitates tax evasion by other persons. In this guest article, the first in a two-part series, Sidley Austin partner Will Smith provides an overview of these new rules known as the “failure to prevent the facilitation of tax evasion” rules (UKFP rules). The second article will provide an in-depth discussion of how the UKFP rules may apply to private fund managers, including U.S.-based investment managers that have a link to the U.K. For additional insight from Smith, see “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships” (Mar. 13, 2014); and Smith’s two-part series “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated With Hedge Fund Managers”: Part One (Apr. 16, 2015); and Part Two (Apr. 23, 2015).

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  • From Vol. 10 No.6 (Feb. 9, 2017)

    How Tax Reforms Proposed by the Trump Administration and House Republicans May Affect Private Fund Managers

    Tax reform has been a perennial centerpiece of the Republican Party’s agenda, and with the election of Donald Trump and a Republican majority in both houses of Congress, that reform may be more likely than ever. A recent program presented by the New York Hedge Fund Roundtable provided an overview of both the Trump and the House Republican tax proposals as they relate to individual and entity taxes, comparing and contrasting them with each other and the current tax regime and offering key takeaways for fund managers about each proposal. The program was led by Robert E. Akeson, chief operating officer at Mirae Asset Securities, and featured Vadim Blikshteyn, a senior tax manager at Baker Tilly Virchow Krause. This article summarizes the key insights from the program. For more on tax reform, see our two-part series on the global trend toward tax transparency: Part One (Apr. 7, 2016); and Part Two (Apr. 14, 2016); as well as “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers” (Apr. 16, 2015). For a comprehensive look at hedge fund taxation, see our four-part series: “Allocations of Gains and Losses, Contributions to and Distributions of Property From a Fund, Expense Pass-Throughs and K-1 Preparation” (Jan. 16, 2014); “Provisions Impacting Foreign Investors in Foreign Hedge Funds” (Jan. 23, 2014); “Taxation of Foreign Investments and Distressed Debt Investments” (Jan. 30, 2014); and “Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles” (Feb. 6, 2014).

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  • From Vol. 10 No.4 (Jan. 26, 2017)

    KKWC and EisnerAmper Panel Details Benefits, Tax Considerations, Common Structures and Terms of Seed Deals

    A recent panel hosted by EisnerAmper and Kleinberg, Kaplan, Wolff & Cohen discussed the current seeding landscape, focusing on common seed deal structures and terms, the availability of seed capital and common tax considerations in seed deals. For an overview of seeding and seed deal terms, see “Seward & Kissel Private Funds Forum Analyzes Trends in Hedge Fund Seeding Arrangements and Fee Structures (Part One of Two)” (Jul. 23, 2015). The program was moderated by Kleinberg Kaplan partner Eric S. Wagner, and featured his partners Philip S. Gross and Jason P. Grunfeld, as well as Frank L. Napolitani, director in the financial services group at EisnerAmper. This article highlights their insights. For more from Gross, see “Tax Court Decision Upholding ‘Investor Control’ Doctrine May Nullify Tax Benefits for Some Policyholders Investing in Hedge Funds Through Private Placement Life Insurance” (Jul. 23, 2015); and “The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees” (Jun. 19, 2014). 

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  • From Vol. 9 No.42 (Oct. 27, 2016)

    The Current State of Direct Lending by Hedge Funds: Fund Structures, Tax and Financing Options

    A decrease in bank lending to small- and middle-market companies has created opportunities for private fund managers that wish to engage in direct lending. A recent program presented by Dechert explored the current growth in direct lending, focusing on fund structures and strategies, tax implications and debt financing for direct lending funds. The program featured Dechert partners Matthew K. Kerfoot and Russel G. Perkins. This article summarizes the speakers’ key insights. See our three-part series on hedge fund direct lending: “Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies” (Sep. 22, 2016); “Structures to Manage the U.S. Trade or Business Risk to Foreign Investors” (Sep. 29, 2016); and “Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms” (Oct. 6, 2016). For additional insight from Kerfoot, see “Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors” (Jun. 14, 2016); and “Dechert Webinar Highlights Key Deal Points and Tactics in Negotiations Between Hedge Fund Managers and Futures Commission Merchants Regarding Cleared Derivative Agreements” (Apr. 18, 2013). 

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  • From Vol. 9 No.41 (Oct. 20, 2016)

    Seward & Kissel Private Funds Forum Offers Practical Steps for Fund Managers to Address HSR Act Enforcement, Tax Reforms, Brexit Uncertainty, MiFID II, Cybersecurity and Side Letters

    Years after the financial crisis, private funds in the U.S. and Europe continue to be affected by factors as varied as the trends in enforcement of the Hart-Scott-Rodino Antitrust Improvements Act of 1976; reforms to the U.S. tax code; ongoing uncertainty over Brexit, including whether the U.K. will make a “hard” or “soft” departure from the E.U.; cybersecurity risks; and selective disclosure concerns. These issues were the focus of a segment of the second annual Private Funds Forum co-produced by Bloomberg BNA and Seward & Kissel (S&K) on September 15, 2016. The panel was moderated by S&K partner Robert Van Grover and featured James E. Cofer and David R. Mulle, also partners at S&K; Richard Perry, a partner at Simmons & Simmons; Matthew B. Siano, managing director and general counsel of Two Sigma Investments; and Mark Strefling, general counsel and chief operating officer of Whitebox Advisors. This article highlights the salient points made by the panel. For coverage of the first segment of this forum, see our two-part series: “How Managers Can Mitigate Improper Dissemination of Sensitive Information” (Sep. 22, 2016); and “How Managers Can Prevent Conflicts of Interest and Foster an Environment of Compliance to Reduce Whistleblowing and Avoid Insider Trading” (Sep. 29, 2016). On Tuesday, November 1, 2016, at 10:00 a.m. EDT, Mulle and fellow S&K partner Steve Nadel will expand on issues relating to side letters in a complimentary webinar co-produced by The Hedge Fund Law Report and S&K. For more information or to register for the webinar, please send an email to rsvp@hflawreport.com.

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  • From Vol. 9 No.40 (Oct. 13, 2016)

    Luxembourg Fund Structures Evolve to Meet the Needs of the Private Fund Industry

    On October 5, 2016, a seminar organized by the Association of the Luxembourg Fund Industry (ALFI), Luxembourg for Finance and the Luxembourg Private Equity & Venture Capital Association explored Luxembourg’s evolving role in financial markets and the private fund space. H.E. Pierre Gramegna, Luxembourg’s Minister of Finance, provided opening remarks, and a panel of experts from Luxembourg law firms, asset managers, banks, consultants and other firms contributed insights on a variety of issues, including Brexit, the new Reserved Alternative Investment Fund structure, private credit, Luxembourg limited partnerships, tax reforms and management companies. PwC partner Steven Libby moderated the discussion. This article highlights the principal points raised during the program. For coverage of a prior ALFI event, see “NICSA/ALFI Program Considers Impact of AIFMD on U.S. Fund Managers” (Sep. 25, 2014).

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  • From Vol. 9 No.39 (Oct. 6, 2016)

    Hedge Funds As Direct Lenders: Regulatory Considerations of Direct Lending and a Review of Fund Investment Terms (Part Three of Three)

    As lending to U.S. companies has increased in popularity as an investment strategy among hedge and private equity funds, some have voiced concerns about the lack of regulation of these alternative corporate lenders as compared to the capital requirements imposed on traditional lenders. This is in stark contrast to the European alternative lending market, where substantial and varied barriers imposed by some jurisdictions create challenges for alternative lenders originating loans on a cross-border basis. Whether U.S. regulators will adopt a European-style regulatory model of alternative lending to U.S. companies remains to be seen. This final article in a three-part series provides an overview of the current regulatory environment surrounding direct lending by alternative lenders and outlines common fee and liquidity terms of direct lending funds. The first article discussed the prevalence of hedge fund lending to U.S. companies and the primary tax considerations to hedge fund investors associated with this strategy. The second article examined how direct lending can constitute engaging in a “U.S. trade or business” and explored structures and strategies available to minimize this risk to investors in an offshore fund. See also “Permanent Capital Structures Offer Managers Funding Stability and Access to Capital While Granting Investors Liquidity and Access to Managers” (Apr. 9, 2015).

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  • From Vol. 9 No.38 (Sep. 29, 2016)

    Hedge Funds As Direct Lenders: Structures to Manage the U.S. Trade or Business Risk to Foreign Investors (Part Two of Three)

    Investor demand for exposure to lending strategies continues unabated, as allocators seek investment strategies with attractive yields and lower correlation to the broader markets. Much of the demand comes from pension plans and foreign institutions, which often seek to invest through offshore funds. However, an offshore fund originating loans to U.S. companies runs the risk of being deemed to be engaged in a trade or business in the U.S., thus potentially subjecting its investors to an effective tax rate of more than 50 percent. See “IRS Memo Analyzes Whether Offshore Fund That Engaged in Underwriting and Lending Activities in the U.S. Through an Investment Manager Was Engaged in a ‘Trade or Business’ in the U.S. and Subject to U.S. Income Tax” (Jan. 29, 2015). To mitigate this risk, hedge fund managers have taken advantage of various strategies and structures. This article, the second in a three-part series, examines how direct lending can constitute engaging in a “U.S. trade or business” and explores options available to minimize this risk to investors in an offshore fund. The first article discussed the prevalence of hedge fund lending to U.S. companies and the primary tax considerations for hedge fund investors associated with direct lending. The third article will provide an overview of the regulatory environment surrounding direct lending and a discussion of the common terms applicable to direct lending funds. See also “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques” (Jan. 22, 2015).

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  • From Vol. 9 No.37 (Sep. 22, 2016)

    Hedge Funds As Shadow Banks: Tax Considerations for Hedge Funds Pursuing Direct Lending Strategies (Part One of Three)

    Since the 2008 financial crisis, a tangle of regulations has forced banks to step back from providing credit to companies and individuals. Recognizing a market opportunity, other financial intermediaries – including hedge and private equity funds – have stepped in to fill this void. These new lenders are often referred to as “shadow banks” because, although they are not regulated like banks, they perform bank-like activities such as making loans to companies. As asset managers continuously search for yield, the investment strategy of direct lending – generally characterized as “non-bank finance” – has risen in popularity, with alternative lenders typically charging higher interest rates than traditional lenders. However, engaging in these direct lending practices can pose a number of challenges from a tax perspective, particularly for non-U.S. investors, that impact hedge fund managers undertaking these efforts. This article, the first in a three-part series, discusses the prevalence of hedge fund lending to U.S. companies and the primary tax considerations for hedge fund investors associated with direct lending. The second article will explore structures available to hedge fund managers to mitigate the tax consequences of pursuing a direct lending strategy. The third article will provide an overview of the regulatory environment surrounding direct lending and a discussion of the common terms applicable to direct lending funds. For additional insight on the prevalence of direct lending in the hedge fund industry, see “Dechert Panel Discusses Recent Hedge Fund Fee and Liquidity Terms, the Growth of Direct Lending and Demands of Institutional Investors” (Jul. 14, 2016).

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  • From Vol. 9 No.23 (Jun. 9, 2016)

    Practical Issues Faced by U.S.-Based Managers When Establishing U.K.-Listed Funds (Part One of Two)

    U.K.-listed closed-end funds have become an increasingly popular source of permanent capital for the global asset management industry. Used for all manner of investment strategies, these vehicles are ideally suited for illiquid strategies such as private equity, and have also been used as feeder funds into single-manager hedge funds. Over the past several years, U.S.-based managers have been coming to London for the relatively greater regulatory flexibility offered by the U.K.-listed funds markets as compared to U.S. public securities markets. In a two-part guest series, Tim West and Dinesh Banani, partners at Herbert Smith Freehills, provide a practical overview of key issues facing U.S.-based managers considering establishing a fund listed in the U.K. This first article explores listing and eligibility requirements for popular U.K. listing venues; continuing obligations for U.K.-listed funds; structuring and jurisdictional considerations; and marketing under the Alternative Investment Fund Managers Directive. The second article will consider the impact of certain U.S. securities laws that would apply to the U.K. listing of the shares of a closed-end fund offered by a U.S.-based manager. See also “Regulatory and Practitioner Perspectives on Alternative Mutual Fund Compliance Risk” (Feb. 26, 2015).

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  • From Vol. 9 No.22 (Jun. 2, 2016)

    OTC Options on Major Currencies May Be Marked-to-Market for Tax Purposes

    In Wright v. Commissioner, a recent court decision that came as a surprise to many, the Sixth Circuit held that over-the-counter (OTC) options on so-called “major” currencies should be marked-to-market for U.S. federal income tax purposes. This could have significant consequences for investment funds that take positions in options of this type. In a guest article, John Kaufmann of Greenberg Traurig discusses the Wright case; the applicable regulations and legislative history; and the decision’s potential implications for hedge fund managers who take positions in OTC options on major currencies. For additional insight from Kaufmann, see our two-part series on “The New Section 871(m) Regulations: Withholding Law Applicable to Non-U.S. Hedge Funds”: Part One (Jan. 21, 2016); and Part Two (Jan. 28, 2016). For more on mark-to-market accounting, see “Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations” (Feb. 19, 2015).

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  • From Vol. 9 No.18 (May 5, 2016)

    Hedge Fund Managers Must Act Now to Determine Potential Exposure to U.K. Transfer Pricing, “Google Tax” and Disguised Investment Management Fee Regimes

    The transfer-pricing policies adopted by multinationals has been subject to increased scrutiny for a number of years, a trend that promises greater tax transparency and revisions to the international tax framework. However, U.K.-based investment managers are subject to additional layers of regulation that pose a significantly greater risk, not only at a corporate level but also at an investor and personal level. Since April 2015, U.K.-based hedge fund managers have fallen within the scope of the Diverted Profits Tax and the Disguised Investment Management Fee regimes, two pieces of anti-avoidance legislation that pose their own unique set of challenges but also have themes in common with transfer pricing. In a guest article, Michael Beart, a director at Duff & Phelps, focuses on the legislation and its practical implications for hedge fund managers operating in the U.K. For more from Duff & Phelps practitioners, see “What Should Hedge Fund Managers Understand About Transfer Pricing and How to Manage the Related Risks?” (Nov. 1, 2013); and “Duff & Phelps Roundtable Focuses on Hedge Fund-Specific Valuation, Accounting and Regulatory Issues” (Feb. 4, 2010). 

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  • From Vol. 9 No.17 (Apr. 28, 2016)

    A Bipartisan Problem for Private Funds: How Revised Regulations Facilitate IRS Audits of Partnerships (Part Two of Two)

    The Bipartisan Budget Act of 2015 (2015 Budget Act) repealed the long-standing “TEFRA” (Tax Equity and Fiscal Responsibility Act of 1982) rules, small partnership exception and electing large partnership rules. In their place, the 2015 Budget Act streamlines the rules governing federal income audits and judicial proceedings involving partnerships into a single set of rules that generally apply at the partnership level, subject to a limited electable exception. This new “streamlined audit approach” is expected to facilitate IRS audits of large partnerships, including hedge funds and other private funds, starting in 2018. In a two-part guest series, David A. Roby, Jr., a partner at Sutherland Asbill & Brennan, explores the streamlined audit approach and its implications for hedge fund and other private fund managers. This second part examines how the revised partnership audit rules will impact hedge funds and other private funds. The first part discussed current partnership tax principles and audit procedures and explored the reasons for revising the applicable rules. For insight from Roby’s colleague Yasho Lahiri, see our two-part series “How Can Hedge Fund Managers Market Their Funds Using Case Studies Without Violating the Cherry Picking Rule?”: Part One (Dec. 5, 2013); and Part Two (Dec. 12, 2013).

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  • From Vol. 9 No.17 (Apr. 28, 2016)

    New Luxembourg RAIF Structure Offers Marketing Options and Tax Benefits for Non-E.U. Hedge Fund Managers (Part Two of Two)

    The new Reserved Alternative Investment Fund (RAIF) structure unveiled by Luxembourg offers U.S. managers a flexible new option for marketing in the E.U. In addition, the structure allows U.S. managers to take advantage of certain tax benefits. Thus, the RAIF is a game changer for hedge fund managers and can also be a useful vehicle for real estate and private equity funds. At a recent presentation, the Association of the Luxembourg Fund Industry (ALFI) provided a comprehensive overview of the business, tax and regulatory ramifications of the RAIF. This second article in our two-part series explores opportunities presented by RAIFs for U.S. managers – including hedge fund, real estate and private equity managers – as well as tax considerations of the new fund structure. The first article summarized the panel’s discussion of the Luxembourg funds landscape and the key features of RAIFs. For more on the marketing options presented by Luxembourg fund structures, see “Luxembourg Financial Regulator Issues Guidance on AIFMD Marketing and Reverse Solicitation” (Sep. 3, 2015); and “How Can Hedge Fund Managers Use Luxembourg Funds to Access Investors and Investments in Europe, Asia and Latin America?” (Jul. 12, 2012).

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  • From Vol. 9 No.16 (Apr. 21, 2016)

    A Bipartisan Problem for Private Funds: How Current Regulations Complicate IRS Audits of Partnerships (Part One of Two)

    The procedural rules governing federal income tax audits and judicial proceedings of partnerships and other entities classified as partnerships for federal income tax purposes were amended last November under the Bipartisan Budget Act of 2015 (2015 Budget Act). Scheduled to take effect in 2018, this new “streamlined audit approach” is expected to make it easier for the Internal Revenue Service to audit large partnerships, including hedge funds and other private funds. In a two-part guest series, David A. Roby, Jr., a partner at Sutherland Asbill & Brennan, explores the new approach and its implications for hedge fund and other private fund managers. This first part discusses current partnership tax principles and audit procedures and explores the reasons for revising the applicable rules. The second article will examine the revised partnership audit rules under the 2015 Budget Act and their impact on hedge funds and other private funds. For more on the streamlined audit approach, see “How to Draft Key Hedge Fund Documents to Take New Partnership Rules Into Account” (Feb. 11, 2016). For insight from Roby’s colleague John Walsh, see “Current and Former Regulators Advise Hedge Fund Managers on How to Prepare for SEC Exams” (Feb. 18, 2016); “Insights on SEC Priorities for 2015” (Apr. 23, 2015); and “Three Steps in Responding to an SEC Examination Deficiency Letter and Other Practical Guidance for Hedge Fund Managers” (Feb. 13, 2014).

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  • From Vol. 9 No.15 (Apr. 14, 2016)

    Steps That Alternative Investment Fund Managers Need to Consider to Comply With the Global Trend Toward Tax Transparency (Part Two of Two)

    In response to increased demand for transparency and reporting, alternative investment funds (AIFs) and other financial institutions can improve their positions in a competitive market by proactively addressing reporting and planning issues arising from recent global initiatives. In a two-part guest series, Dmitri Semenov, Jun Li, Lucas Rachuba and Carter Vinson of Ernst & Young (EY) highlight challenges and steps that AIFs should consider taking to address the global planning and reporting issues associated with increased transparency demands arising from global initiatives. This second article discusses the planning considerations and other long-term issues for hedge funds and other AIFs to consider. The first article addressed global reporting considerations and areas on which AIFs should immediately focus. For more on tax transparency, see “A Checklist for Updating Hedge Fund and Service Provider Documents for FATCA Compliance” (Feb. 21, 2014). For analysis from other EY professionals, see “Eight Key Elements of an Integrated, Efficient and Accurate Hedge Fund Reporting Solution” (Nov. 13, 2014); and “Daniel New, Executive Director of EY’s Asset Management Advisory Practice, Discusses Best Practices on ‘Hot Button’ Hedge Fund Compliance Issues” (Oct. 17, 2013).

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  • From Vol. 9 No.14 (Apr. 7, 2016)

    Steps That Alternative Investment Fund Managers Need to Take Today to Comply With the Global Trend Toward Tax Transparency (Part One of Two)

    If one word can describe the focus of international tax policy today, that word is transparency. Taxing authorities around the world continue to demand increased levels of transparency and reporting from alternative investment funds (AIFs) and other financial institutions with respect to their investors, business operations and transactions. This increased focus on transparency will affect planning and compliance for AIFs, their management companies and investors. Despite the obvious challenges, taking a proactive approach to reporting and planning issues could enhance an AIF’s position in a competitive market. In a two-part guest series, Dmitri Semenov, Jun Li, Lucas Rachuba and Carter Vinson of Ernst & Young (EY) highlight challenges and recommend steps for AIFs to meet these global planning and reporting challenges. This first article addresses global reporting and areas on which AIFs should immediately focus. The second article will discuss planning and other long-term considerations for hedge funds and other AIFs to consider. For more on tax transparency, see “Understanding the Intricacies for Private Funds of Becoming and Remaining FATCA-Compliant” (Sep. 12, 2013). For commentary from other EY professionals, see “Critical Components of a Hedge Fund Manager Cybersecurity Program: Resources, Preparation, Coordination, Response and Mitigation” (Jan. 15, 2015); and “Considerations for Hedge Fund Managers Evaluating Forming Reinsurance Vehicles in the Cayman Islands” (Sep. 4, 2014).

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  • From Vol. 9 No.13 (Mar. 31, 2016)

    How Hedge Funds Can Mitigate FIN 48 Exposure in Australia and Mexico (Part Three of Three)

    Exposure to withholding taxes and exposure under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), are growing concerns for hedge funds investing in foreign securities. Australia and Mexico, along with other countries, have issued pronouncements on taxation of capital gains for non-residents. However, certain methods can be useful for funds to avoid or reduce exposure to withholding taxes. In this guest three-part series, Harold Adrion of EisnerAmper discusses hedge fund exposure to foreign withholding taxes and FIN 48. This third article explores developments in Australia and Mexico, as well as how hedge funds can minimize exposure to withholding taxes. The first article explained Fin 48 and considered E.U. developments regarding free movement of capital and its impact on funds. The second article addressed the limited exemption to capital gains taxation of non-residents announced by China and other issues for non-resident investors. For more on Australian tax issues, see “What Hedge Funds Need to Know About Tax Relief Under the New Australian Investment Manager Regime” (Jun. 11, 2015). For further insight from EisnerAmper professionals, see our two-part series on “How Can Hedge Fund Managers Structure, Negotiate and Implement Expense Caps to Amplify Capital Raising Efforts?”: Part One (Jun. 20, 2013); and Part Two (Jun. 27, 2013).

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  • From Vol. 9 No.12 (Mar. 24, 2016)

    How Hedge Funds Can Mitigate FIN 48 Exposure in China (Part Two of Three)

    In an increasingly global market, hedge funds must keep up with numerous tax issues when investing in non-U.S. securities, including withholding on interest, dividends and capital gains, as well as the fund’s exposure under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). In addition to regimes developing in the E.U., China has taken positions that are helpful to hedge funds, although significant issues remain for foreign hedge funds investing in Chinese securities. In this guest three-part series, Harold Adrion of EisnerAmper discusses foreign withholding taxes and FIN 48 exposure applicable to hedge funds. This second article focuses on the limited exemption from capital gains taxation for non-Chinese residents and other issues faced by non-resident investors. The first article explained FIN 48 and explored E.U. developments regarding free movement of capital and its impact on funds. The third article will address developments in Australia and Mexico, and how hedge funds can minimize exposure to withholding taxes in those jurisdictions. For more on investing in Chinese securities, see “China Launches Landmark Reforms Impacting Hedge Fund Capital Raising, Investments and Operations” (Aug. 2, 2012); and “Questions Hedge Fund Managers Need to Consider Prior to Making Investments in Chinese Companies” (Jun. 23, 2011). For further insight from EisnerAmper professionals, see “Legal and Accounting Considerations in Connection With Hedge Fund General Redemption Provisions, Lock-Up Periods, Side Pockets, Gates, Redemption Suspensions and Special Purpose Vehicles” (Nov. 5, 2010).

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  • From Vol. 9 No.11 (Mar. 17, 2016)

    How Hedge Funds Can Mitigate FIN 48 Exposure in Europe (Part One of Three)

    Funds that invest in foreign securities face a host of tax issues ranging from withholding on interest, dividends and capital gains to evaluating the fund’s exposure under FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48). In the last several years, there have been significant developments in the treatment of interest, dividends and capital gains derived by funds in non-U.S. securities. In this guest three-part series, Harold Adrion of EisnerAmper discusses issues relating to foreign withholding taxes and FIN 48 exposure applicable to hedge funds. This first article explains FIN 48 and explores E.U. developments regarding free movement of capital and its impact on funds. The second article will address the limited exemption from capital gains taxation of non-residents announced by China, and other issues faced by non-resident investors. The third article will discuss developments in Australia and Mexico, and how hedge funds can minimize exposure to withholding taxes. For additional coverage of withholding tax issues pertaining to hedge funds, see our two-part series on the new Section 871(m) regulations: Part One (Jan. 21, 2016); and Part Two (Jan. 28, 2016). For further insight from EisnerAmper professionals, see “Accounting for Uncertain Income Tax Positions for Investment Funds” (Jan. 14, 2011).

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  • From Vol. 9 No.8 (Feb. 25, 2016)

    Insurance Products Provide Tax-Efficient Means for Investors to Access Hedge Funds

    Certain life insurance products permit policyholders to invest the cash values of their policies in various investment products, including hedge funds. A key benefit of those policies is that such investments can grow on an income tax-deferred or tax-free basis. Katten Muchin Rosenman recently hosted a panel discussion on the use of private placement life insurance (PPLI) and private placement variable annuities (PPVA) as tax-efficient investment vehicles for high net worth individuals. The program, entitled “Tax-Efficient New Products for Sophisticated Investors, Family Offices and Alternative Asset Managers,” featured Katten partners as well as representatives from insurance brokers, investment firms and a Big Four accounting firm. This article examines the key takeaways from the discussion. For more on PPLI and PPVA, see “Insurance Dedicated Funds Offer Hedge Fund Exposure Plus Tax, Underwriting and Asset Protection Advantages for Investors” (Jul. 18, 2013).

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  • From Vol. 9 No.6 (Feb. 11, 2016)

    How to Draft Key Hedge Fund Documents to Take New Partnership Rules Into Account

    On November 2, 2015, new partnership audit rules were enacted as part of The Bipartisan Budget Act of 2015. The new audit rules could significantly impact partnerships generally and investment partnerships in particular. Although the new rules will only become effective for audits of taxable years beginning after December 31, 2017, existing partnership operating agreements, offering memoranda, subscription agreements and side letters should be revised before then to reflect the new audit rules, and new fund documents should be drafted to comport with these new rules. In a guest article, Philip S. Gross and Matthew Tominey, partner and associate, respectively, at Kleinberg, Kaplan, Wolff & Cohen, compare existing partnership audit rules with the new rules under the Bipartisan Budget Act of 2015; explore election options that the new rules allow; and address issues and questions that the new rules present. They also provide strategies for drafting or updating key fund documents so as to take the new rules into account. For additional insight from Gross, see “Tax Court Decision Upholding ‘Investor Control’ Doctrine May Nullify Tax Benefits for Some Policyholders Investing in Hedge Funds Through Private Placement Life Insurance” (Jul. 23, 2015); and “The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees” (Jun. 19, 2014). For more from KKWC, see “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement” (May 7, 2015).

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  • From Vol. 9 No.6 (Feb. 11, 2016)

    Luxembourg Funds Offer Options for Hedge Fund Managers to Access European and Global Investors

    As hedge fund managers look to access investors or investments in Europe, Latin America or Asia, Luxembourg has emerged as a significant domicile for fund formation. With a favorable tax and regulatory regime, along with structures such as UCITS funds, Luxembourg is an increasingly attractive jurisdiction, particularly for non-E.U. hedge fund managers looking to distribute to European investors in the wake of AIFMD. The Association of the Luxembourg Fund Industry (ALFI) recently held a seminar that discussed the country’s growth in the alternative investment funds industry, regulatory updates, global investment opportunities and alternative fund structures available in Luxembourg. This article captures the seminar’s key takeaways on these topics. For more from ALFI, see “NICSA/ALFI Program Considers Impact of AIFMD on U.S. Fund Managers” (Sep. 25, 2014).

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  • From Vol. 9 No.4 (Jan. 28, 2016)

    The New Section 871(m) Regulations: Issues With the Expanding Scope of Withholding Law Applicable to Non-U.S. Hedge Funds (Part Two of Two)

    Most non-U.S. hedge funds take precautions to avoid engaging in a U.S. trade or business; otherwise, they are subject to U.S. federal income tax on net income that is effectively connected with that U.S. trade or business. However, all funds that invest in U.S. debt and equity – as well as in derivatives that reference U.S. debt and equity – may be subject to a 30% withholding tax on gross payments of U.S.-sourced fixed, determinable, annual or periodic income (FDAP). In this two-part series, John Kaufmann of Greenberg Traurig discusses certain ways in which final and temporary regulations recently promulgated under Internal Revenue Code Section 871(m) increase the scope of FDAP withholding, and lists traps for the unwary created by these regulations. This second article explains the scope of the new regulations and the potential complications that they have created. The first article discussed the current law and the issues that the new regulations are intended to address. For additional commentary from the firm, see our series on “Investment Opt-Out Rights for Hedge Fund Investors”: Part One (Nov. 8, 2013); Part Two (Nov. 14, 2013); and Part Three (Nov. 21, 2013).

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  • From Vol. 9 No.3 (Jan. 21, 2016)

    The New Section 871(m) Regulations: Withholding Law Applicable to Non-U.S. Hedge Funds (Part One of Two)

    Non-U.S. hedge funds may be subject to two kinds of United States federal income taxes. Funds that are engaged in a U.S. trade or business are subject to U.S. federal income tax on their net income that is effectively connected with their U.S. trade or business. Funds that are not engaged in a U.S. trade or business are generally subject to a 30% tax imposed on gross payments of U.S.-source fixed, determinable, annual or periodic income (FDAP). Most offshore funds take precautions to ensure that they are not engaged in a U.S. trade or business. However, all funds that invest in U.S. debt and equity – as well as in derivatives that reference U.S. debt and equity – may be subject to withholding tax on FDAP. In this two-part series, John Kaufmann of Greenberg Traurig discusses certain ways in which final and temporary regulations recently promulgated under Internal Revenue Code Section 871(m) increase the scope of FDAP withholding, and lists traps for the unwary created by these regulations. This article addresses the current law and the issues that the new Section 871(m) regulations are intended to address. The second article will explain the scope of the new regulations and the potential complications that they have created. For insight from Kaufmann’s colleague, Scott MacLeod, see “Tax, Structuring, Compliance and Operating Challenges Raised by Hedge Funds Offered Exclusively to Insurance Companies” (Oct. 30, 2014).

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  • From Vol. 8 No.34 (Sep. 3, 2015)

    How Hedge Fund Managers Should Respond to Tax Regulator Attacks on “Disguised Management Fees” (Part Two of Two)

    In an effort to limit arrangements in which hedge fund managers and other private fund managers receive interests in funds in exchange for waiving management fees (thereby deferring recognition of income and changing its character), tax regulators in the United States recently proposed regulations to treat some investment fund management fee waivers and other payments in lieu of management fees as “disguised payments for services,” with immediate income tax consequences.  The U.S. tax authorities are not the only ones trying to strip the disguises from management fees.  In the United Kingdom, the Finance Act 2015 introduced disguised management fee rules to combat creative strategies to convert what is in economic substance a management fee – calculated by reference to funds under management and taxed as income at the rate of 45% – to capital gains taxable at 28%.  A new bill will also change the taxation of “good carry.”  In a guest article, the second in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs outline proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  The first article described common management fee waiver provisions and explained how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  For more on proposals that could affect the taxation of hedge fund managers and their employees, see “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 16 (Apr. 23, 2015); and “Potential Impact on U.S. Hedge Fund Managers of the Reform of the U.K. Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).

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  • From Vol. 8 No.33 (Aug. 27, 2015)

    Tax Regulators Attack Hedge Fund Manager Efforts to Disguise Management Fees (Part One of Two)

    Tax regulators in the United States and United Kingdom are attacking arrangements in which hedge fund managers and other private investment fund managers receive interests in funds in exchange for waiving management fees – or otherwise disguise fixed management fees – thereby deferring recognition of income and changing its character.  The IRS recently issued a notice of proposed rulemaking (Notice) that will treat such arrangements as “disguised payments for services,” resulting in immediate ordinary income for the manager or general partner that waives the fee.  Some fund sponsors will need to alter their current and future fee waivers to avoid this outcome, and they may need to act quickly because the Notice indicates that the IRS believes this reflects current law.  In a guest article, the first in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs describe common management fee waiver provisions and explain how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  The second article in the series will describe similar proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  For more on tax proposals that could affect hedge fund managers and their employees, see “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015); and “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part One of Two),” The Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015).

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  • From Vol. 8 No.32 (Aug. 13, 2015)

    Tax, Legal and Operational Advantages of the Irish Collective Asset-Management Vehicle Structure for Hedge Funds

    The Irish Collective Asset-management Vehicles Act came into operation in March 2015 and allows for the creation of an innovative, tax-efficient corporate structure for Irish investment funds which sits alongside existing Irish fund structures.  See “New Irish Fund Structure Offers Re-Domiciliation Possibilities and Tax Advantages for Hedge Funds,” The Hedge Fund Law Report, Vol. 8, No. 10 (Mar. 12, 2015).  There has been widespread industry interest in the Irish collective asset-management vehicle (ICAV), with a number of leading asset managers such as Permal, Deutsche Bank and Legg Mason already having established ICAVs and a host of other asset managers in the process of either converting to or establishing new ICAVs.  Since the Central Bank of Ireland opened the ICAV register on March 16, 2015, there have been over 30 ICAVs authorized, representing in excess of $30 billion of inflows into Irish funds.  In a guest article, Ian Conlon of Maples and Calder explains the key features and advantages of the new ICAV structure and discusses how hedge fund managers can establish ICAVs, redomicile funds to Ireland and convert existing Irish fund vehicles so they can take advantage of the newly available structure.  For additional insight from Maples and Calder, see “Considerations for Hedge Fund Managers Evaluating Forming Reinsurance Vehicles in the Cayman Islands,” The Hedge Fund Law Report, Vol. 7, No. 33 (Sep. 4, 2014); and “Use by Private Fund Managers of the British Virgin Islands for Private Equity Fund Formation and Private Equity Investments,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).

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  • From Vol. 8 No.31 (Aug. 6, 2015)

    Hedge Funds Are Required to Disclose Basket Option Contracts and Basket Contracts

    The IRS has recently set its sights on “basket option contracts” and “basket contracts,” suspecting that certain hedge funds and other taxpayers have improperly used those structures to defer recognition of ordinary income and short-term gains on assets within the basket, and to claim long-term capital gains treatment on exercise of the option or termination of the contract.  IRS Notice 2015-47 deems basket option contracts to be “listed transactions.”  IRS Notice 2015-48 deems basket contracts to be “transactions of interest.”  The Notices apply to transactions in effect on or after January 1, 2011; taxpayers who were parties to basket option contracts or basket contracts on or after that date will have to report them retroactively, even for years for which they have already filed returns.  This article summarizes the key provisions of each Notice.  For more on taxation of options, see “Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations,” The Hedge Fund Law Report, Vol. 8, No. 7 (Feb. 19, 2015).  For a discussion of other strategies that investors have used to seek long-term gains treatment on investments, see “Tax Practitioners Discuss Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles at FRA/HFBOA Seminar (Part Four of Four),” The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).  The IRS has previously targeted certain swaps.  See “IRS Directive and HIRE Act Undermine Tax Benefits of Total Return Equity Swaps for Offshore Hedge Funds,” The Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010).

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  • From Vol. 8 No.30 (Jul. 30, 2015)

    Seward & Kissel Private Funds Forum Highlights Key Trends in Fund Structures (Part Two of Two)

    As hedge fund managers adapt to changes in the marketplace, they are employing special fund vehicles, such as pledge funds, activist funds and alternative mutual funds, in order to take advantage of special opportunities.  During the recent Seward & Kissel Private Funds Forum, panelists discussed these and other hedge fund industry trends with respect to fund structuring and capital raising.  This article, the second of a two-part series, explores how hedge fund managers are employing such fund structures and strategies.  The first article highlighted current trends in seeding arrangements and fee terms, and examined the impact of ERISA and tax considerations on hedge fund structuring.  For additional insight from the firm, see “The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds,” The Hedge Fund Law Report, Vol. 7, No. 42 (Nov. 6, 2014); and “Private Investment Funds Investing in CLO Equity and CLO Warehouse Facilities,” The Hedge Fund Law Report, Vol. 7, No. 18 (May 8, 2014).

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  • From Vol. 8 No.29 (Jul. 23, 2015)

    Tax Court Decision Upholding “Investor Control” Doctrine May Nullify Tax Benefits for Some Policyholders Investing in Hedge Funds through Private Placement Life Insurance

    Many hedge funds and other investments whose returns are based on short-term trading are tax inefficient.  Good gross returns can be reduced 50% or more by income taxes (including state and local income taxes).  For over 20 years, investors, including hedge fund investors, have used private placement life insurance (PPLI) and private placement variable annuities to eliminate or defer income tax on hedge fund and other tax-inefficient earnings and, with proper estate planning, reduce or eliminate estate tax as well.  PPLI can provide a large tax-free death benefit for a cost that is often much less than the tax savings gained.  After 30 years of uncertainty and speculation, a recent Tax Court decision confirmed the validity of the “investor control” doctrine, potentially allowing the IRS to impose taxes on investment returns from PPLI and annuities.  In a guest article, Jeffrey S. Bortnick and Philip S. Gross, partners at Kleinberg, Kaplan, Wolff & Cohen, discuss this significant Tax Court decision and its potential ramifications on the hedge fund industry.  For further insight from Gross, see “The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees,” The Hedge Fund Law Report, Vol. 7, No. 24 (Jun. 19, 2014); and “Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four),” The Hedge Fund Law Report, Vol. 7, No. 4 (Jan. 30, 2014).  For more from KKWC, see “Recent Cases Reduce the Impact of Newman on Insider Trading Enforcement,” The Hedge Fund Law Report, Vol. 8, No. 18 (May 7, 2015).

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  • From Vol. 8 No.29 (Jul. 23, 2015)

    Seward & Kissel Private Funds Forum Analyzes Trends in Hedge Fund Seeding Arrangements and Fee Structures (Part One of Two)

    A hedge fund manager must keep abreast of current trends in hedge fund structures and terms in order to raise capital from investors, anticipate prospective changes in the marketplace and adapt accordingly.  At the recent Seward & Kissel Private Funds Forum, panelists examined key capital raising and fund structuring trends in the hedge fund industry.  This article, the first of a two-part series, summarizes the panelists’ discussion of seeding arrangements and fee structures as well as ERISA and taxation considerations upon hedge fund structuring.  The second article will explore the use of special fund structures, activist strategies and alternative mutual funds.  For additional insight from the firm, see “Seward & Kissel New Hedge Fund Study Identifies Trends in Investment Strategies, Fees, Liquidity Terms, Fund Structures and Strategic Capital Arrangements,” The Hedge Fund Law Report, Vol. 8, No. 9 (Mar. 5, 2015).  For more on hedge fund seeding arrangements, see “Report Offers Insights on Seeding Landscape, Available Talent, Seeding Terms and Players,” The Hedge Fund Law Report, Vol. 8, No. 1 (Jan. 8, 2015); and “New York City Bar’s ‘Hedge Funds in the Current Environment’ Event Focuses on Hedge Fund Structuring, Private Fund Examinations, Compliance Risks and Seeding Arrangements,” The Hedge Fund Law Report, Vol. 7, No. 11 (Mar. 21, 2014).

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  • From Vol. 8 No.28 (Jul. 16, 2015)

    Hedge Funds Organized as Delaware LLCs May Be Transparent for U.K. Tax Purposes

    A recent U.K. Supreme Court ruling has thrown into question the treatment of Delaware limited liability companies (LLCs) for U.K. tax purposes.  The unanimous final judgment in the case reversed the previous decisions of the Upper Tribunal and the Court of Appeal and upheld the original ruling of the First-tier Tribunal.  The decision addressed the question of whether a member of a Delaware LLC was entitled to double taxation relief on his share of the LLC’s profits, which had been taxed in the U.S. and remitted to the U.K.  This article provides relevant background information; summarizes the Supreme Court’s decision and reasoning; and considers the implications of the judgment for hedge funds organized as Delaware LLCs and investors in such funds.  For more on U.K. taxation, see “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two),” The Hedge Fund Law Report, Vol. 8, No. 16 (Apr. 23, 2015); and “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).

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  • From Vol. 8 No.28 (Jul. 16, 2015)

    How to Structure a Singapore-Based Hedge Fund Manager (Part One of Two)

    In recent years, Singapore has begun to attract hedge fund managers looking to establish a presence in Asia.  In its first presentation in its “Going Global” series on the formation and operation of hedge fund management companies outside the U.S., Morgan Lewis offered an overview of the relevant corporate, employment and tax laws in Singapore; its regulation of managers and fund distribution; and how other countries’ regulatory regimes affect hedge fund managers established in Singapore.  Moderated by Morgan Lewis partner Timothy W. Levin, the discussion featured partners Joo Khin Ng, Wai Ming Yap, Daniel Yong and William Yonge.  This article, the first in a two-part series, summarizes the main points raised during the presentation with respect to Singapore corporate structures, employment laws, tax laws and regulation of financial services activities.  Part two will address Singapore licensing requirements, “dual-hatting” arrangements, product distribution and the impact of U.S. and U.K. regulatory regimes on Singapore-based managers.  For more on the tax and regulatory issues involved in establishing a Singapore-based manager, see “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 31 (Aug. 9, 2012).  For a discussion of the factors to consider in deciding between Hong Kong and Singapore as the location for an Asia-based office, see “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part One of Four),” The Hedge Fund Law Report, Vol. 4, No. 43 (Dec. 1, 2011).  For an overview of the process of opening an office in Singapore, see “Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part Two of Four),” The Hedge Fund Law Report, Vol. 4, No. 44 (Dec. 8, 2011). 

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  • From Vol. 8 No.23 (Jun. 11, 2015)

    What Hedge Funds Need to Know About Tax Relief Under the New Australian Investment Manager Regime

    A new Australian investment manager regime (IMR) is set to take effect on July 1, with possible retroactive effect to 2011.  Following the U.K. Investment Manager Exemption model, the IMR is intended to provide eligible foreign investors with relief from Australian tax with respect to most investments in Australia.  In a guest article, Nikki Bentley and Seema Mishra, partner and special counsel, respectively, at Henry Davis York, discuss the history and current status of the IMR provisions; elements and scope of Australian tax exemptions under the IMR; certain considerations when establishing a hedge fund in Australia under the IMR; the potential impact of the IMR on the hedge fund industry in Australia; and a comparison of the Australian IMR to other similar regimes.  For more on the Australian IMR, see “Key Hedge Fund Tax Developments in the U.K., the European Union, Ireland, Germany, Spain, Australia, India and Puerto Rico,” The Hedge Fund Law Report, Vol. 6, No. 26 (Jun. 27, 2013).

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  • From Vol. 8 No.23 (Jun. 11, 2015)

    IRS Proposes Rules to Limit Reinsurance by Hedge Funds

    The IRS recently issued a notice of proposed rulemaking that, if approved, could make it more onerous for hedge fund managers to establish or operate offshore reinsurance companies.  Although hedge fund managers have taken advantage of a carve-out in the rules regarding Passive Foreign Investment Companies and set up reinsurance structures in no-tax and low-tax offshore jurisdictions, the proposed regulations seek to limit that practice by drawing a distinction between companies engaged in “active” reinsurance and those that are merely vehicles used to defer or reduce the tax that would otherwise be due with respect to investment income.  This article summarizes the proposed regulations.  For more on the intersection of hedge fund management and reinsurance, see “Considerations for Hedge Fund Managers Evaluating Forming Reinsurance Vehicles in the Cayman Islands,” The Hedge Fund Law Report, Vol. 7, No. 33 (Sep. 4, 2014); and “How Can Hedge Fund Managers Use Reinsurance Businesses to Raise and Retain Assets and Achieve Uncorrelated Returns? (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013).

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  • From Vol. 8 No.19 (May 14, 2015)

    K&L Gates Panel Offers Advice on Taxation, Regulatory and Business Integration Issues with M&A Transactions in the Asset Management Industry (Part Two of Two)

    As firms in the asset management industry structure merger and acquisition transactions – including joint ventures, acquisitions of minority interests and lift-outs of teams – they need to be aware of the potential issues that arise with such transactions.  Integrating two businesses may result in tax consequences, regulatory issues or other compliance concerns.  A panel of domain experts from K&L Gates recently discussed current trends in the asset management industry and a number of considerations in planning an acquisition or other deal with an asset manager, broker-dealer or adviser, including choice of partner, due diligence, structuring, taxation and various regulatory and compliance considerations.  Moderated by Michael S. Caccese, a practice area leader, the program featured partners Kenneth G. Juster and Michael W. McGrath; and practice area leaders D. Mark McMillan and Robert P. Zinn.  This article, the second in a two-part series, summarizes the key takeaways from that program with respect to taxation, regulatory and business integration concerns.  The first article addressed asset management industry trends, choosing a partner, due diligence and structuring considerations.  See also “PLI Panel Addresses Recent Developments with Respect to Prime Brokerage Arrangements, Alternative Registered Funds and Hedge Fund Manager Mergers and Acquisitions,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).

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  • From Vol. 8 No.16 (Apr. 23, 2015)

    U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part Two of Two)

    Whilst the U.K. tax treatment of management fees relating to, and performance fees arising from, fund arrangements has been the subject of debate for some time, the recent introduction of new U.K. legislation has brought the issue into sharper focus in the United Kingdom.  Accordingly, hedge fund personnel operating within the United Kingdom may be affected by the new legislation and thus subject to increased taxation on fees and compensation earned with respect to their investment management activities.  In a guest article, the second in a two-part series, Sidley Austin partner Will Smith details exceptions to the application of the new legislation, known as the “disguised fee rules,” and discusses certain practical consequences which may arise under the new legislation.  The first article discussed the background and enactment of the disguised fee rules and provided a summary of their technical application.  For additional insight from Smith, see “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For insight from Smith’s partner Leonard Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Sidley more generally, see “Sidley Partners Discuss Trends in Hedge Fund Seed Deals, Governance, Succession, Estate Planning and Tax Structuring (Part Two of Two),” The Hedge Fund Law Report, Vol. 7, No. 37 (Oct. 2, 2014).

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  • From Vol. 8 No.15 (Apr. 16, 2015)

    U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part One of Two)

    Whilst the U.K. tax treatment of management fees relating to, and performance fees arising from, fund arrangements has been the subject of debate for some time, the recent introduction of new U.K. legislation has brought the issue into sharper focus in the United Kingdom.  Accordingly, hedge fund personnel operating within the United Kingdom may be affected by the new legislation and thus subject to increased taxation on fees and compensation earned with respect to their investment management activities.  In a guest article, the first in a two-part series, Sidley Austin partner Will Smith discusses the background and enactment of the new legislation known as the “disguised fee rules” and provides a summary of their technical application.  The second article in the series will detail exceptions to the application of the disguised fee rules and discuss certain practical consequences which may arise under the new legislation.  For additional insight from Smith, see “Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships,” The Hedge Fund Law Report, Vol. 7, No. 10 (Mar. 13, 2014).  For insight from Smith’s partner Leonard Ng, see “Sidley Austin, Ivaldi Capital and Advise Technologies Share Lessons for U.K. Hedge Fund Managers from the January 2015 AIFMD Annex IV Filing,” The Hedge Fund Law Report, Vol. 8, No. 12 (Mar. 27, 2015).  For insight from Sidley more generally, see “Sidley Partners Discuss Evolving Hedge Fund Fee Structures, Seed Deal Terms, Single Investor Hedge Funds, Risk Aggregators, Expense Allocations, Co-Investments and Fund Liquidity (Part One of Two),” The Hedge Fund Law Report, Vol. 7, No. 36 (Sep. 25, 2014).

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  • From Vol. 8 No.15 (Apr. 16, 2015)

    Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers

    Hedge fund managers need to be constantly aware of new tax regulations or changes in the tax code that could affect the investments they make, the taxes they pay and any flow-through issues that could impact investors.  Under the Economic Growth and Family Fairness Tax Reform Plan (commonly known as the Rubio-Lee plan), taxation of capital income would cease; corporate tax would be based on income earned in the U.S. and interest would no longer be expensed; capital investments would be expensed with no depreciation schedules; and most itemized deductions would end.  The 2016 federal budget proposal would increase the capital gains and qualified dividend rate to 28%; the tax on accrued market discounts would be assessed as it accrues; and carried interest would be taxed as ordinary income.  Under California State law, Sales Sourcing rules may have an impact on the taxation of hedge fund investments from out-of-state managers.  Finally, peer-to-peer lending platforms raise questions regarding proper tax characterization.  During a roundtable discussion on March 24, 2015, Pepper Hamilton LLC partners Gregory Nowak and Steven Bortnick discussed the foregoing issues.  This article summarizes the key points raised during that roundtable.  For a discussion of other proposed tax regulations, see “Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations,” The Hedge Fund Law Report, Vol. 8, No. 7 (Feb. 19, 2015).  See also “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques,” The Hedge Fund Law Report, Vol. 8, No. 3 (Jan. 22, 2015).

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  • From Vol. 8 No.10 (Mar. 12, 2015)

    New Irish Fund Structure Offers Re-Domiciliation Possibilities and Tax Advantages for Hedge Funds

    The Irish Parliament recently passed legislation to provide for a structure specifically tailored to meet the needs of the global funds industry.  The legislation creates a new form of corporate vehicle for funds, known as the Irish Collective Asset-Management Vehicle (ICAV).  In addition to minimizing the administrative complexity and cost of establishing and maintaining a collective investment scheme in Ireland, the ICAV will be an “eligible entity” for U.S. tax purposes, allowing it to “check the box.”  It is anticipated that the ICAV will make it increasingly attractive for fund promoters to establish new corporate funds in Ireland or, allied with the user-friendly Irish re-domiciliation mechanism, to re-domicile offshore funds to Ireland.  See “Redomiciling Offshore Investment Funds to Ireland, the European Gateway,” The Hedge Fund Law Report, Vol. 4, No. 8 (Mar. 4, 2011).  The Central Bank of Ireland has recently confirmed that it stands ready and able to accept applications for ICAV structures within two weeks of the legislation being enacted.  In a guest article, Vincent Coyne, a Senior Associate in William Fry’s Asset Management and Investment Funds Department, first focuses on key tax considerations of the ICAV and the opportunities this creates for re-domiciling to Ireland, then examines the practical legal benefits of the new regime.

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  • From Vol. 8 No.7 (Feb. 19, 2015)

    Tax Practitioners Discuss Taxation of Options and Swaps and Impact of Proposed IRS Regulations

    The IRS is nudging hedge funds and other market participants toward mark-to-market accounting for many swaps and other derivatives.  Some rules, such as those for Section 1256 contracts, are already in place, while other regulations are in the works.  At a recent presentation, leading tax practitioners offered an overview of the current regime of taxation of swaps and options and insights into how proposed IRS regulations may affect that regime.  See also “Tax Practitioners Discuss Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles at FRA/HFBOA Seminar (Part Four of Four),” The Hedge Fund Law Report, Vol. 7, No. 5 (Feb. 6, 2014).

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  • From Vol. 8 No.4 (Jan. 29, 2015)

    IRS Memo Analyzes Whether Offshore Fund That Engaged in Underwriting and Lending Activities in the U.S. through an Investment Manager Was Engaged in a “Trade or Business” in the U.S. and Subject to U.S. Income Tax

    An unnamed offshore fund engaged in certain lending and underwriting activities in the U.S. through an independent investment manager.  The fund asked the IRS whether its activities constituted a “trade or business” in the U.S., such that its U.S. income that was effectively connected to that trade or business would be subject to U.S. income tax.  The IRS’ Office of Chief Counsel issued a memorandum (Chief Counsel Advice Memorandum) in response to that inquiry addressing: (1) when an offshore hedge fund is deemed to be engaged in a U.S. trade or business; and (2) the application to offshore hedge funds of the safe harbors for “trading in stocks or securities.”  This article provides a detailed discussion of the Chief Counsel Advice Memorandum.  For a discussion of another Chief Counsel Advice Memorandum relating to the U.S. tax implications of offshore lending, see “Implications of Recent IRS Memorandum on Loan Origination Activities for Offshore Hedge Funds that Invest in U.S. Debt,” The Hedge Fund Law Report, Vol. 2, No. 41 (Oct. 15, 2009).

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  • From Vol. 8 No.3 (Jan. 22, 2015)

    Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and “Season and Sell” Techniques

    The U.S. imposes tax on U.S.-source income payable to foreign persons and entities, including offshore hedge funds and foreign investors.  Under that regime, a person or entity that pays or receives “effectively connected income” (ECI) or “fixed, determinable, annual or periodical” income (FDAPI) may be subject to withholding and reporting requirements.  This article offers an overview of ECI and FDAPI, the related reporting and withholding requirements, and the key exceptions to those requirements available to private fund managers.  For a discussion of the flip side of this issue, i.e., taxation of investments outside the U.S., see “Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four),” The Hedge Fund Law Report, Vol. 7, No. 4 (Jan. 30, 2014); and “How Can Hedge Funds Recoup Overwithholding of Tax on Non-U.S. Source Interest and Dividends?,” The Hedge Fund Law Report, Vol. 6, No. 35 (Sep. 12, 2013).

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  • From Vol. 7 No.47 (Dec. 18, 2014)

    What Hedge Fund Managers Need to Know About Year-End Tax Mitigating Strategies

    Because hedge fund managers are almost invariably tasked with understanding and executing sophisticated investment strategies on behalf of investors, the assumption might be that they need less assistance in assessing personal income and other tax strategies.  However, experience does not bear this assumption out.  Managers are often so focused on fiduciary, operational and compliance responsibilities that their own family wealth strategy is comparatively neglected.  A robust family wealth strategy covers at least wealth creation, tax planning, asset protection, generational transfer and charitable initiatives; sustainable wealth creation is limited without the other components of a well-developed strategy.  Accordingly, in a guest article, Alan S. Kufeld, partner at Flynn Family Office, highlights some of the pillars of a well-developed strategy for hedge fund managers, focusing specifically on those most relevant to year-end tax planning.  In particular, Kufeld’s article discusses the minimum viable tax planning horizon; gifting of a “vertical slice” of fund interests; trust and estate structuring and planning; structuring around the 3.8% Medicare surtax; use of insurance structures to mitigate tax; the looming requirement to repatriate previously deferred compensation; charitable activities; and the role of family offices in perpetuating wealth generated from hedge fund activities.  See “Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions,” The Hedge Fund Law Report, Vol. 5, No. 40 (Oct. 18, 2012).

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  • From Vol. 7 No.46 (Dec. 11, 2014)

    A Roadmap for Hedge Fund Managers in Preparing For, Negotiating and Surviving IRS Partnership Audits

    A recent program offered a roadmap for hedge fund managers in preparing for, handling and surviving IRS partnership audits.  The program specifically focused on trends, statistics and mechanics of partnership audits; partnership audit procedures and IRS staffing; five of the most important issues in current partnership audits; and best practices in preparing for an audit.  Many domestic hedge funds and management companies are structured as partnerships or other pass-through entities.  Accordingly, the discussion of IRS partnership audit issues has direct relevance to U.S. hedge fund managers, hedge funds and hedge fund investors.  This article summarizes the most noteworthy insights from the program.  See also “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).

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  • From Vol. 7 No.46 (Dec. 11, 2014)

    Experts Discuss Viability and Use of Hedge Fund Appreciation Rights in Light of Revenue Ruling 2014-18

    Section 457A of the Internal Revenue Code, enacted in 2008, generally prohibits deferral of compensation paid by entities that are not subject to U.S. tax.  The tax risk created by that section caused private fund managers to avoid performance fees payable in respect of multi-year measurement periods, which could be considered to be deferred compensation.  Earlier this year, the IRS issued Revenue Ruling 2014-18, which generally confirms that fund managers may use fund appreciation rights (analogous to stock appreciation rights) to provide performance-based compensation on a tax-deferred basis.  A recent program considered the impact of that ruling, with an emphasis on the benefits that fund appreciation rights may provide as a compensation vehicle.  The program was moderated by COOConnect founding partner Dominic Hobson.  The speakers were David E. Francl, Director, Hedge Funds and Operations, in Intel’s Treasury Department; Andrew L. Oringer, a Partner at Dechert LLP; and Thomas M. Young, a Managing Director at Optcapital LLC.  For more on Revenue Ruling 2014-18, see “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).

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  • From Vol. 7 No.44 (Nov. 20, 2014)

    Examinations, the AIFMD, International and Tax Issues: An Interview with Brian Guzman, Partner and General Counsel at Indus Capital Partners, LLC (Part Two of Two)

    The HFLR recently interviewed Brian Guzman, Partner and General Counsel at Indus Capital Partners, LLC, on various top-of-mind issues for hedge fund manager general counsels.  Our interview generally covered valuation, cybersecurity, examinations, the AIFMD, and international and tax issues.  This article, the second in a series, conveys Guzman’s insights on the latter four topics.  In particular, this article discusses the SEC’s top three focus areas in examinations of hedge fund managers; the key differences between SEC and NFA examinations; the chief conflicts in side-by-side management of hedge funds and alternative mutual funds; how the AIFMD has affected marketing by U.S. hedge fund managers to European institutions; challenges in filing Annex IV; achieving consistency across disclosures; notable differences and similarities between international insider trading regimes; transfer pricing issues for hedge fund managers; and post-409A tax deferral strategies.  The first article in this series relayed Guzman’s thoughts on valuation and cybersecurity.  This interview was conducted in connection with (1) the Regulatory Compliance Association’s Compliance, Risk and Enforcement Symposium, which took place on November 4 in New York City – Guzman participated in that Symposium and we will cover it in subsequent issues of the HFLR – and (2) the RCA’s upcoming Regulation, Operations and Compliance (ROC) Symposium, to be held in Bermuda in April 2015.  For more on ROC Bermuda 2015, click here; to register for it, click here.  For additional insight from Guzman, see “FCPA Compliance Strategies for Hedge Fund and Private Equity Fund Managers,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014); “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).

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  • From Vol. 7 No.43 (Nov. 13, 2014)

    Ten Steps That Hedge Fund Managers Can Take to Maximize the Tax Deductibility of Settlement Payments (Part Two of Two)

    Tax structuring is a concept more often associated with business transactions than with legal settlements.  But in a recent presentation, Shearman & Sterling partner Lawrence M. Hill highlighted the fundamental role of tax in the net economics of legal settlements.  Informed tax structuring can dramatically reduce the dollars that go out the door in a legal settlement, and tax counsel (like litigation counsel) can powerfully affect the economics of settlements.  In his presentation, Hill discussed ten specific strategies that private fund managers and other business entities can use to maximize the tax deductibility of legal settlements.  This article – the second in a two-part series – describes those ten strategies in detail.  The first article in this series offered a comprehensive overview of the law governing taxation of settlements.  For private fund managers, understanding these principles and implementing them during settlement negotiations can conserve resources, preserve reputation, save time, limit the use of directors and officers and other insurance and avoid the use of indemnification and exculpation provisions in governing documents.

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  • From Vol. 7 No.42 (Nov. 6, 2014)

    The First Steps to Take When Joining the Rush to Offer Registered Liquid Alternative Funds

    The registered liquid alt rush continues unabated.  Since 2008, there has been a 116% increase in the number of registered liquid alternative funds (Alt Funds) and a 360% increase in Alt Fund assets.  Sponsors have now created 468 Alt Funds with $172 billion of assets.  Before stepping on the gas to join this rush, you should start by answering a simple question – is it viable for my organization to offer an Alt Fund?  In a guest article, Bibb L. Strench, Counsel in the Washington, D.C. office of Seward & Kissel LLP, addresses the chief legal and practical factors that hedge fund managers should consider in answering that question.  In particular, Strench discusses strategic eligibility, liquidity, leverage, derivatives, valuation, tax, “strategy engineering” (e.g., via use of commodity mutual funds), closed-end funds, ETFs, entry points into the registered alternative fund business (including umbrella alternative funds), registered alternative fund fees and expenses, advertising and marketing possibilities, and operational and compliance considerations.  See also “Five Key Compliance Challenges for Alternative Mutual Funds: Valuation, Liquidity, Leverage, Disclosure and Director Oversight,” The Hedge Fund Law Report, Vol. 7, No. 28 (Jul. 24, 2014).

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  • From Vol. 7 No.42 (Nov. 6, 2014)

    Are Legal Settlements Tax Deductible?  (Part One of Two)

    Whether or not legal settlements, or parts of them, are tax deductible can materially affect the net economics of such settlements.  And settling entities – for example, hedge fund managers in insider trading, employment or other civil actions – can influence the deductibility of settlements through structuring, drafting of settlement agreements and other actions.  In a recent presentation, Shearman & Sterling tax partner Lawrence M. Hill provided an overview of key concepts, best practices and applicable case law bearing on the deductibility of settlements.  In particular, he discussed the differing tax treatment of the following categories of settlement amounts: compensatory damages, punitive damages, multiple damages, damages not specified as compensatory or punitive in the relevant settlement agreement, relator’s fees, legal fees, restitution, disgorgement, fines, penalties and civil forfeiture.  He also offered tips on drafting settlement agreements to maximize the proportion of settlements that validly may be characterized as deductible.  This article, the first in a two-part series, examines the law governing tax deductibility of settlements, as explained by Hill in his presentation.  The second article in the series will relay Hill’s specific guidance on taxation of damages in practice and how a company can make its case that a settlement should be deductible.  For more on tax issues relevant to hedge fund managers, see “Internal Memo Describes IRS Position on Whether Limited Partner Exemption from Self-Employment Tax Is Available to Owners of an Investment Management Company,” The Hedge Fund Law Report, Vol. 7, No. 35 (Sep. 18, 2014); and “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).

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  • From Vol. 7 No.41 (Oct. 30, 2014)

    Tax, Structuring, Compliance and Operating Challenges Raised by Hedge Funds Offered Exclusively to Insurance Companies

    Insurance dedicated funds (IDFs) are hedge funds offered exclusively to insurance companies and indirectly capitalized by the insurers’ life insurance or annuity policyholders.  For hedge fund managers, IDFs offer tax advantages, a niche marketing opportunity and a resilient investor base.  In connection with a Hedge Fund Association Symposium on the topic being held today in Fort Lauderdale, The Hedge Fund Law Report recently interviewed Greenberg Traurig shareholder Scott MacLeod on structuring, operational, tax, compliance, marketing and related considerations in connection with IDFs.  Specifically, MacLeod addressed salient tax considerations from the perspectives of investors, insurance companies and managers; hedge fund strategies that lend themselves to IDFs; relevant control and diversification requirements; redemption and liquidity issues; consequences of insurer insolvencies; material terms of governing documents; differences between IDFs and reinsurance vehicles launched by hedge fund managers; IDF platforms; private placement variable annuities; and compliance challenges specific to IDFs.  See also “Investments by Family Offices in Hedge Funds through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 11 (Apr. 1, 2011).

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  • From Vol. 7 No.39 (Oct. 17, 2014)

    Ackman’s Pershing Square Public Offering Features Novel Performance Fee Mechanism

    Following in the footsteps of other private fund managers who have sought permanent capital through public offerings, activist investor Bill Ackman’s Pershing Square Holdings, Ltd. has raised about $2.7 billion through a recent offering of its shares on Euronext Amsterdam.  Prior to the offering, the company converted into a closed-end investment vehicle; its shareholders will be able to achieve liquidity by selling their shares on that exchange.  This article focuses on the novel approach to the company’s calculation of performance fees and on the tax treatment of the entity and its investors in Guernsey, where it is organized, and the Netherlands, where its shares now trade.  For discussions of other fund managers who have gone to the public markets for permanent capital, see “Anatomy of a Blank Check IPO by a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 7, No. 13 (Apr. 4, 2014); and “Prospectus for Suspended Ellington Financial IPO Details Mechanics of a Hedge Fund Permanent Capital Vehicle,” The Hedge Fund Law Report, Vol. 2, No. 50 (Dec. 17, 2009).  Other managers have used public offerings to monetize the value of their businesses, to provide capital for expansion and to create liquidity for founders and employees.  See “Ares Management IPO Raises Permanent Capital and Creates Liquidity for Founders’ Interests,” The Hedge Fund Law Report, Vol. 7, No. 14 (Apr. 11, 2014); and “Mechanics of a Hedge Fund Manager IPO,” The Hedge Fund Law Report, Vol. 5, No. 16 (Apr. 19, 2012).

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  • From Vol. 7 No.37 (Oct. 2, 2014)

    Sidley Partners Discuss Trends in Hedge Fund Seed Deals, Governance, Succession, Estate Planning and Tax Structuring (Part Two of Two)

    This is the second article in a two-part series examining the more notable takeaways from the 2014 edition of Sidley Austin’s annual private funds event in New York City.  This article focuses on the discussion during a panel entitled, “Operating a Fund Manager: Opportunities and Pitfalls,” featuring Sidley partners Christian Brause, David R. Sawyier, Kathleen O’Hagan Scallan, Michael J. Schmidtberger and Daniel F. Spies.  The partners discussed capital markets as a source of liquidity for fund managers, evolving trends in seed deals, succession considerations, the challenges of business and personal divorces as they relate to structuring and succession, trust and estate considerations and fund- and management company-level tax developments.  The first article covered evolving fee structures, seed deal terms, single investor hedge funds, risk aggregators, expense allocations and co-investments, among other issues.

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  • From Vol. 7 No.35 (Sep. 18, 2014)

    Internal Memo Describes IRS Position on Whether Limited Partner Exemption from Self-Employment Tax Is Available to Owners of an Investment Management Company

    The Office of Chief Counsel of the Internal Revenue Service (IRS) recently released a Memorandum that considers whether members of a limited liability company that serves as an investment manager to several investment funds are entitled to rely on the exemption from self-employment taxes afforded to “limited partners” under §1402(a)(13) of the Internal Revenue Code.  The IRS’ position is important because the federal Medicare tax applies to all self-employment earnings; there is no income limit, as there is for social security tax.  See also “Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions,” The Hedge Fund Law Report, Vol. 5, No. 40 (Oct. 18, 2012).

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  • From Vol. 7 No.33 (Sep. 4, 2014)

    Considerations for Hedge Fund Managers Evaluating Forming Reinsurance Vehicles in the Cayman Islands

    There has been much talk recently about the formation of reinsurance companies by hedge fund managers.  Indeed, in the Cayman Islands (Cayman), there has been significant increase of interest in the establishment of reinsurance vehicles.  The first open market reinsurance vehicle with a physical presence was established in Cayman in 2004, and now, several years later, conditions are such that others are following suit.  Anecdotal evidence shows that many service providers across the financial services community in Cayman have been advising or otherwise speaking with fund manager clients about setting up reinsurers in Cayman.  This article highlights some key reasons driving interest in Cayman as a domicile for the establishment of reinsurance vehicles.  The authors of this article are Tim Frawley, a partner in the Cayman Islands office of Maples and Calder, and Karey B. Dearden, an Executive Director in Ernst & Young LLP’s Financial Services Office, International Tax Services practice in New York City.  For background on the opportunities and risks associated with hedge fund managers establishing reinsurance vehicles, see “How Can Hedge Fund Managers Use Reinsurance Businesses to Raise and Retain Assets and Achieve Uncorrelated Returns? (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 3 (Jan. 17, 2013).

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  • From Vol. 7 No.24 (Jun. 19, 2014)

    The Impact of Revenue Ruling 2014-18 on Compensation of Hedge Fund Managers and Employees

    The IRS recently issued Revenue Ruling 2014-18, addressing the application of certain anti-deferral provisions of the Internal Revenue Code to nonqualified stock option and stock appreciation right plans (together, Option Plans).  See “Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?,” The Hedge Fund Law Report, Vol. 7, No. 23 (Jun. 13, 2014).  In a guest article, Philip S. Gross and James D. McCann, both Members of Kleinberg, Kaplan, Wolff & Cohen, P.C., discuss some of the potential benefits and detriments of Option Plans from the perspectives of hedge fund managers and investors, and the potential impact of the Revenue Ruling on hedge fund manager taxation, structuring and compensation practices.

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  • From Vol. 7 No.23 (Jun. 13, 2014)

    Are Compensatory Options on Offshore Hedge Fund Shares Subject to the Anti-Deferral Provisions of Internal Revenue Code Section 457A?

    For years, hedge fund managers and investors have discussed the possibility of structuring the performance allocation payable by an offshore fund to its manager as an option on or appreciation right with respect to shares of the offshore fund.  The benefits of structuring the performance allocation as an option or appreciation right include tax deferral, an implicit clawback and a multi-year measurement period.  See “Hedge Fund Managers Considering Fund Appreciation Rights Compensation Structures to Defer Tax on Performance Compensation and to Better Align Manager and Investor Incentives,” The Hedge Fund Law Report, Vol. 2, No. 45 (Nov. 11, 2009).  However, implementation of such structures has been held up by tax risk: The IRS had not opined on whether options or appreciation rights in this context are subject to the anti-deferral provisions of Internal Revenue Code (IRC) Section 457A.  That ambiguity was resolved, in large measure, by a recent IRS revenue ruling.  This article identifies the specific issue addressed by the revenue ruling; summarizes relevant IRC provisions and Treasury Regulations; details the IRS’ analysis in the revenue ruling; and restates the revenue ruling’s conclusion.  Subsequent articles in the HFLR will delve into the consequences of the revenue ruling for structuring hedge fund performance compensation.

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  • From Vol. 7 No.21 (Jun. 2, 2014)

    Estate Planning Tips for Hedge Fund Managers

    In 2013, Congress made permanent a generous estate and gift tax regime, which permits an individual to transfer more than $5.3 million to children and other beneficiaries free of estate and gift taxes.  Even so, the interests of hedge fund principals in their fund businesses routinely exceed that exemption amount.  A recent program presented by Ropes & Gray LLP outlined the current estate and gift tax regime and explored ways in which hedge fund principals may make lifetime gifts that maximize the value of their gifts while minimizing the estate and gift tax consequences.  For more on estate planning with hedge fund interests, see “Simple Goals in a Complex World: Estate Planning for Hedge Fund Interests,” The Hedge Fund Law Report, Vol. 3, No. 11 (Mar. 18, 2010).

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  • From Vol. 7 No.15 (Apr. 18, 2014)

    Use by Hedge Fund Managers of Profits Interests and Other Equity Stakes for Incentive Compensation

    Private fund management companies, which are typically taxed as partnerships, often wish to incentivize key people with equity or equity-like interests in the management company.  A recent event examined the key elements of partnership taxation and considered the four available means of providing equity interests to employees and other service providers: profits interests, capital interests, options and phantom interests.  The discussion chiefly focused on profits interests, as such interests receive the most favorable tax treatment.  For discussion of another presentation on this topic, see “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).

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  • From Vol. 7 No.12 (Mar. 28, 2014)

    IRS Clarifies that Bitcoin and Other Virtual Currencies Are Treated as Property for U.S. Federal Tax Purposes

    Bitcoin is a virtual currency whose “supply” is determined by a preset computer algorithm and whose value is determined based on trading on dedicated exchanges.  (One notable Bitcoin exchange – Tokyo-based Mt. Gox – filed for bankruptcy protection in February of this year, claiming that 850,000 Bitcoins, worth about $500 million, were “stolen” by computer hackers.)  Hedge fund managers, manager principals and other types of investment managers (notably, venture capital fund managers) are interacting with the Bitcoin ecosystem in various ways.  For such managers and persons, a recently-issued IRS notice helps clarify the application of general tax principles to transactions using virtual currency.  For a related discussion of the role of different currencies in hedge fund structuring and marketing, see “Local Currency Hedge Funds Expand Marketing and Investment Opportunities, but Involve Currency Hedging and Other Challenges,” The Hedge Fund Law Report, Vol. 3, No. 1 (Jan. 6, 2010).

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  • From Vol. 7 No.11 (Mar. 21, 2014)

    New York City Bar’s “Hedge Funds in the Current Environment” Event Focuses on Hedge Fund Structuring, Private Fund Examinations, Compliance Risks and Seeding Arrangements

    On March 5, 2014, the New York City Bar held the most recent edition of its annual “Hedge Funds in the Current Environment” event.  Panelists at the event – including general counsels and chief compliance officers (CCOs) from leading hedge fund managers and partners from top law firms – addressed hedge fund structuring considerations (including the purposes and mechanics of mini-master funds); the myth of the unregulated hedge fund; analogies between regulatory examinations and investor due diligence; seven key areas of regulatory interest in hedge fund examinations; five headline issues confronting CCOs; four pros and seven cons of hedge fund seeding arrangements; and a structuring alternative to seeding ventures.  This article highlights the salient points from the event.  For our coverage of the 2012 edition of this event, see “Davis Polk ‘Hedge Funds in the Current Environment’ Event Focuses on Establishing Registered Alternative Funds, Hedge Fund Manager M&A and SEC Examination Priorities,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).

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  • From Vol. 7 No.10 (Mar. 13, 2014)

    Potential Impact on US Hedge Fund Managers of the Reform of the UK Tax Regime Relating to Partnerships and Limited Liability Partnerships

    Both UK limited partnerships (LPs) and UK limited liability partnerships (LLPs) have, for some years, been widely utilised as part of international investment and management structures of both US sponsors and US managers.  Whilst UK LPs have been widely used as investment vehicles within the private equity industry and, to a lesser extent, in connection with other illiquid investment strategies, the UK LLP has become the vehicle of choice for US managers who have established a presence in the United Kingdom.  The attractions of the UK LLP have been clear, combining the advantage of being taxed as a partnership, whilst still offering limited liability, corporate personality and – importantly – organisational and structural flexibility.  However, as the popularity of the UK LP and, in particular, the UK LLP has increased, so has the level of scrutiny applied by the UK tax authority (HMRC).  Following the conclusion of a 2013 public consultation on measures designed to reform certain aspects of the UK tax regime relating to LPs and LLPs, HMRC have now published draft legislation for inclusion in the UK Finance Bill 2014.  The areas which are subject to the new UK tax legislation can be broadly placed into three categories: (1) countering the use of UK LLPs to disguise what HMRC consider should be employment relationships (and, thereby, avoid certain employment and payroll taxes); (2) countering arrangements whereby economic interests and other entitlements are allocated to or transferred between members of LPs and LLPs; and (3) amending certain aspects of the UK tax regime relating to LPs and LLPs to take account of the remuneration deferral requirements under the EU Alternative Investment Fund Managers Directive.  In a guest article, Will Smith, a partner in the London office of Sidley Austin LLP, discusses the anticipated impact on US hedge fund managers of the draft legislation.

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  • From Vol. 7 No.10 (Mar. 13, 2014)

    Six Challenges in Connection with FATCA Compliance by Hedge Fund Managers

    The Foreign Account Tax Compliance Act (FATCA) aims to combat tax evasion by providing the IRS with information about U.S. accounts held at foreign financial institutions (FFIs) and imposing a 30% withholding tax on payments to FFIs that fail to register with the IRS by April 25, 2014.  For hedge fund managers, FATCA creates a broad new registration, compliance and reporting regime.  In a guest article, Rod White, Regional CEO of Equinoxe Alternative Investment Services for Bermuda and U.S. operations, identifies six of the primary challenges that hedge fund managers and their service providers face in complying with that new regime.  See also “A Checklist for Updating Hedge Fund and Service Provider Documents for FATCA Compliance,” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).

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  • From Vol. 7 No.8 (Feb. 28, 2014)

    Co-Investments in the Hedge Fund Context: Structuring Considerations and Material Terms (Part Two of Three)

    Co-investments have been a regular feature of private equity investing for decades but historically have played a smaller role in the world of hedge funds.  However, as the range of strategies pursued by hedge funds increases – in particular, as more hedge fund assets are committed to activism, distressed and other illiquid strategies – co-investments are assuming a more prominent place in the hedge fund industry.  In an effort to help hedge fund managers assess the role of co-investments in their investment strategies and operating frameworks, The Hedge Fund Law Report is publishing a three-part series on the structure, terms and risks of hedge fund co-investments.  This article, the second in the series, describes the three general approaches to structuring co-investments; discusses the five factors that most directly affect management fee levels on co-investments; outlines the applicable incentive fee structures; details common liquidity or lockup arrangements; and highlights relevant fiduciary duty and insider trading considerations.  The first article in this series discussed five reasons why hedge fund managers offer co-investments; two reasons why investors may be interested in co-investments; the “market” for how co-investments are handled during the negotiation of initial fund investments; investment strategies that lend themselves to co-investments; and types of investors that are appropriate for co-investments.  See “Co-Investments Enable Hedge Fund Managers to Pursue Illiquid Opportunities While Avoiding Style Drift (Part One of Three),” The Hedge Fund Law Report, Vol. 7, No. 7 (Feb. 21, 2014).  The third article will discuss regulatory and other risks in connection with co-investments.

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  • From Vol. 7 No.7 (Feb. 21, 2014)

    A Checklist for Updating Hedge Fund and Service Provider Documents for FATCA Compliance

    The Foreign Account Tax Compliance Act (FATCA) established a broad registration, compliance and reporting regime designed to combat tax evasion by providing the IRS with information about U.S. accounts held at foreign financial institutions (FFIs).  The regime imposes 30% withholding on payments to FFIs that have failed to register with the IRS and provide information on U.S. account holders.  The first step in FATCA compliance is for FFIs to register with the IRS and obtain a global intermediary identification number, without which the FFI will be subject to withholding as of July 1 of this year.  In that regard, the April 25 deadline for inclusion in the initial IRS list of registered FFIs is fast approaching, and hedge fund managers with offshore funds or that have non-U.S. investors need to assure that they are fully compliant with FATCA.  A recent presentation covered the critical steps that funds should be taking to prepare for FATCA’s July 1 effective date and the compliance mechanisms they will need to implement to assure compliance with FATCA.  This article summarizes the key takeaways from that presentation.  See also “Understanding the Intricacies for Private Funds of Becoming and Remaining FATCA-Compliant,” The Hedge Fund Law Report, Vol. 6, No. 35 (Sep. 12, 2013); and “What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 7 No.5 (Feb. 6, 2014)

    Tax Practitioners Discuss Taxation of Swaps, Wash Sales, Constructive Sales, Short Sales and Straddles at FRA/HFBOA Seminar (Part Four of Four)

    As a general matter, investors prefer long-term capital gains over ordinary income and, when faced with losses, short-term losses over long-term capital losses.  Investors and tax professionals are constantly seeking to optimize their tax results, in part by seeking to assure the most favorable tax treatment available when trading.  In some circumstances, such as those involving total return swaps, the IRS has simplified matters by predetermining a fixed percentage of gains and losses that are entitled to short-term or long-term treatment.  The IRS has also adopted several rules in response to trades that generated tax benefits but that did not result in a change of economic position for the investor.  In that regard, two presentations given as part of the 15th Annual Effective Hedge Fund Tax Practices seminar, co-hosted by Financial Research Associates and the Hedge Fund Business Operations Association, covered the fundamentals of the taxation of swaps and the tax treatment of wash sales, constructive sales, short sales and straddles.  This article, the last in our four-part series covering the seminar, summarizes the key takeaways from those presentations.  The first article in this series covered three sessions addressing contribution and distribution of property to fund investors, allocation of investment gains and losses to fund investors and preparation of Forms K-1.  See “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).  The second article discussed issues impacting foreign investors in foreign funds, including basics of withholding with respect to fixed or determinable annual or periodic gains, profits, or income (FDAPI); the portfolio interest exemption from FDAPI withholding; the pitfalls of effectively connected income (ECI) for offshore hedge funds; and the sources of ECI.  See “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).  The third article addressed taxation of foreign investments, including withholding at the source, rules regarding controlled foreign corporations and issues concerning taxation of distressed debt investments.  See “Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four),” The Hedge Fund Law Report, Vol. 7, No. 4 (Jan. 30, 2014).

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  • From Vol. 7 No.4 (Jan. 30, 2014)

    Tax Practitioners Discuss Taxation of Foreign Investments and Distressed Debt Investments at FRA/HFBOA Seminar (Part Three of Four)

    During the 15th Annual Effective Hedge Fund Tax Practices seminar sponsored by Financial Research Associates and the Hedge Fund Business Operations Association, tax experts at two separate sessions addressed the taxation of foreign investments, including withholding at the source, rules regarding controlled foreign corporations and issues concerning the taxation of distressed debt investments.  This article, our third in a four-part series covering the seminar, summarizes salient points from those two sessions.  Panelists for the “Working Through Tax Implications of Foreign Investments” session included, among others, Len Lipton, a managing director at GlobeTax Services and Philip S. Gross, a partner at Kleinberg, Kaplan, Wolff & Cohen, P.C.  The session entitled “Tax Considerations for Distressed Debt Transactions” was presented by David C. Garlock, Director of Financial Services at Ernst & Young LLP.  The first installment in this series covered three sessions addressing the contribution and distribution of property to fund investors, the allocation of investment gains and losses to fund investors and the preparation of Forms K-1.  See “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).  The second installment discussed issues impacting foreign investors in foreign funds, including basics of withholding with respect to fixed or determinable annual or periodic gains, profits or income (FDAPI); the portfolio interest exemption from FDAPI withholding; the pitfalls of effectively connected income (ECI) for offshore hedge funds; and the sources of ECI.  See “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four),” The Hedge Fund Law Report, Vol. 7, No. 3 (Jan. 23, 2014).

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  • From Vol. 7 No.3 (Jan. 23, 2014)

    Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four)

    Offshore hedge funds, whether structured as corporations or partnerships, are subject to the provisions of the U.S. Internal Revenue Code (IRC) that govern taxation of nonresident aliens and foreign entities.  Generally, a foreign person is subject to U.S. taxation on its U.S.-source income.  Taxable U.S.-source income generally falls into two categories: (1) effectively connected income (ECI), which is income earned in connection with a U.S. trade or business, and (2) “fixed or determinable annual or periodic gains, profits, or income” (FDAPI).  ECI is subject to U.S. taxation in the same manner as income earned by U.S. citizens and residents: recipients are required to file U.S. tax returns.  In contrast, IRC Sections 1441, 1442 and 1443 provide for taxation of FDAPI that is not ECI, and that is payable to foreign individuals, corporations and tax-exempt entities, at the flat rate of 30% of the gross amount payable (or lower treaty rate, if applicable).  The 30% tax must be withheld at the source (i.e., by the payer).  This second installment in our series covering the 15th Annual Effective Hedge Fund Tax Practices seminar, sponsored by Financial Research Associates and the Hedge Fund Business Operations Association, summarizes key lessons learned from a session entitled “Handling Issues Relative to Inbound Tax Matters.”  That session outlined the basics of withholding with respect to FDAPI; the portfolio interest exemption from FDAPI withholding; the pitfalls of ECI for offshore hedge funds; and the sources of ECI.  The speakers included Jill E. Darrow, Partner and head of the New York tax practice of Katten Muchin Rosenman LLP.  The first installment covered three sessions addressing the contribution and distribution of property to fund investors, the allocation of investment gains and losses to fund investors and the preparation of Forms K-1.  See “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” The Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).

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  • From Vol. 7 No.2 (Jan. 16, 2014)

    Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four)

    Most U.S.-domiciled hedge funds are organized as partnerships for tax purposes, which gives them flexibility in structuring the economic terms of investments in a fund, including through the allocation of gains and losses.  Fund income, expenses, gains and losses are allocated to investors periodically and passed through to them annually on Schedule K-1 of the fund’s partnership tax return.  Those allocations and contributions of property to, and distributions of property from, partnerships have important tax ramifications for fund investors.  Against this backdrop, three presentations during the 15th Annual Effective Hedge Fund Tax Practices seminar, co-hosted by Financial Research Associates and the Hedge Fund Business Operations Association, covered the fundamentals of the tax treatment of partnership contributions and distributions, special rules on deductibility of fund expenses and the allocation of fund gains and losses, as well as how those items will be reflected on the Form K-1 delivered by a fund to its investors.  See “What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).  This article summarizes the key lessons from those three presentations.

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  • From Vol. 6 No.48 (Dec. 19, 2013)

    Akin Gump Partners Present Overview of Recent Developments in Fund Taxation, Fund Manager Transactions and Hedge and Private Equity Fund Investment Terms

    Akin Gump Strauss Hauer & Feld LLP (Akin Gump) recently presented its annual Private Investment Funds Conference.  During the conference, Akin Gump partner Stuart E. Leblang presented the annual tax update; partners Stephen M. Vine, Ackneil M. (Trey) Muldrow III and Stephen M. Jordan discussed recent trends in transactions involving equity stakes in fund manager businesses; and partners Blayne A. Grady and Burke A. McDavid addressed the current environment for hedge fund and private equity fund terms.  This article details salient takeaways from each of these sessions.

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  • From Vol. 6 No.47 (Dec. 12, 2013)

    U.S. Tax Court Decision Highlights the Quantitative and Qualitative Factors Considered in a “Trader” vs. “Investor” Analysis, with Implications for the Deductibility of Fund Expenses by Hedge Fund Investors

    Earlier this year, the U.S. Tax Court issued a decision that provided insight on when a person engaged in trading securities would be deemed a “trader” as opposed to an “investor.”  The distinction is important in the hedge fund space: Investors in “trader funds” are able to deduct a greater portion of the fund’s expenses on their personal income tax returns.  Generally, expenses passed through to investors from an “investor fund” are capped at two percent of the investor’s adjusted gross income, while expenses passed through by a “trader fund” are fully deductible against hedge fund income by investors.  See “What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).  This article summarizes the factual background of the case, including a discussion of the taxpayer’s trading activities, the Court’s legal analysis and its decision.  See also “U.S. Tax Court Decision Considering ‘Investor’ vs. ‘Trader’ Status Could Impact the Tax Status of Hedge Funds and the Deductibility of Fund Expenses by Hedge Fund Investors,” The Hedge Fund Law Report, Vol. 6, No. 40 (Oct. 17, 2013).

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  • From Vol. 6 No.43 (Nov. 8, 2013)

    Investment Opt-Out Rights for Hedge Fund Investors: Rationales, Mechanics, Regulatory Risks and Operational Challenges (Part One of Three)

    Investment products and services exist along a spectrum of customization, and, as a general matter, the bigger the investment ticket, the more customized the investment experience.  At the least customized end of the spectrum are mutual funds, effectively adhesion contracts in which investors typically have discretion over price, quantity and timing, but little else.  See “PLI Panel Addresses Recent Developments with Respect to Prime Brokerage Arrangements, Alternative Registered Funds and Hedge Fund Manager Mergers and Acquisitions,” The Hedge Fund Law Report, Vol. 6, No. 41 (Oct. 25, 2013).  At the most customized end of the spectrum are family offices, and, just short of that, individual hedge fund style investment vehicles such as “funds of one” and managed accounts.  See “RCA Symposium Clarifies Current Market Practice on Side Letters, Conflicts of Interest, Insider Trading Investigations, Whistleblowers, FATCA and Use of Managed Accounts Versus Funds of One (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 24 (Jun. 13, 2013).  Even within commingled hedge funds, the rights and obligations of investors are typically not uniform.  Smaller investors generally get the default terms of the PPM, while larger investors sometimes customize their deal by side letter or otherwise.  Side letters often modify default fund terms relating to liquidity and transparency.  Liquidity relates to the right to redeem from a fund, in whole or in part, and transparency relates to the right to know what’s going on in a fund.  But sometimes investors will wish to avoid a specific investment while not redeeming from the fund, in whole or even in part.  That is, investors sometimes want (or need) investment-specific liquidity rather than fund-level liquidity.  In practice, managers can grant investment-specific liquidity by offering investors the right to opt out of designated investments.  The concept of investment opt outs originated (at least within the private fund space) in private equity and still looms larger in private equity funds than hedge funds.  However, as hedge funds pursue an ever-expanding range of investment strategies – some of which resemble classic private equity – more and more managers are being confronted with requests from investors for investment opt-out rights.  Accordingly, The Hedge Fund Law Report is undertaking a three-part series analyzing the rationales for opt-out rights in the hedge fund context, and the legal and operational challenges involved in granting and implementing such rights.  This article, the first in the series, explores eight reasons why investors may demand and managers may grant opt-out rights.  The second installment will address the structure and exercise of opt-out rights, as well as regulatory risks associated with offering such rights.  The third installment will continue the discussion of risks associated with opt-out rights, focusing on regulatory and other risks, and will conclude with a discussion of best practices for implementing such rights.

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  • From Vol. 6 No.42 (Nov. 1, 2013)

    What Should Hedge Fund Managers Understand About Transfer Pricing and How to Manage the Related Risks?

    Hedge fund firms with multinational operations should understand the implications of transfer pricing for their operations.  Transfer pricing establishes the price charged between controlled parties involved in cross-border transfers of goods, intangibles and services, as well as financial transactions (e.g., loans).  While transfer pricing is most often applicable to international transactions involving distinct legal entities within a global group, the concept of “controlled parties” can extend to entities involved in domestic transactions, as well as partnerships and individuals.  Taxing authorities around the world have enacted transfer pricing rules to ensure that income is not arbitrarily shifted to other taxpayers or jurisdictions, and that reported profits are aligned with functions, assets and risks.  The arm’s length standard is the fundamental basis of most transfer pricing law, and seeks to price a transaction between controlled parties as if it occurred between two unrelated parties.  Many countries require taxpayers to maintain documentation to demonstrate that intercompany transactions comply with the arm’s length standard and can impose significant penalties absent this documentation.  As a matter of course, many taxing authorities (including the Internal Revenue Service in the U.S.) request this documentation at the outset of an audit.  In a guest article, Jessica Joy, Stefanie Perrella and Matt Rappaport – Managing Director, Vice President and Analyst, respectively, at Duff & Phelps – present an overview of transfer pricing and relevant U.S. laws.  Further, the authors discuss current events that may be indicative of how lawmakers and regulators will approach transfer pricing for hedge fund firms going forward, and present illustrative transfer pricing issues of particular relevance to hedge fund firms.

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  • From Vol. 6 No.42 (Nov. 1, 2013)

    Hedge Funds Realize Material Return by Funding Litigation Over a Tax Refund in a Bank Holding Company Bankruptcy

    Litigation funding – generally, debt, equity or other investments in third-party legal cases – can offer absolute and uncorrelated returns.  See “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).  In a recent example of a successful execution of such a strategy, several hedge funds funded litigation on behalf of a bankrupt bank holding company involving a tax refund dispute with the Federal Deposit Insurance Corporation (FDIC).  Those funds are poised to profit handsomely following a decision by the U.S. Bankruptcy Court for the District of Delaware (Court) in favor of the bank holding company.  The four hedge funds financed the tax refund litigation on behalf of the bank holding company after the bankruptcy trustee ran out of money to finance continuing litigation.  The hedge funds also held notes issued by the bank holding company.  At issue was whether a huge tax refund was owned by the bank holding company or by a bank subsidiary.  If the bank subsidiary owned the refund, its receiver, the FDIC, would take it all.  However, if the bank holding company owned the refund, the FDIC would have to share it with other creditors of the bank holding company, including the hedge funds and other noteholders.  This article summarizes the facts of the case, the Court’s legal analysis and the anticipated distribution of the tax refund.  This article also identifies an ongoing bankruptcy that is factually similar (i.e., a bank holding company bankruptcy involving a dispute over a sizable tax refund) and may therefore lend itself to a similar litigation funding strategy.

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  • From Vol. 6 No.40 (Oct. 17, 2013)

    U.S. Tax Court Decision Considering “Investor” vs. “Trader” Status Could Impact the Tax Status of Hedge Funds and the Deductibility of Fund Expenses by Hedge Fund Investors

    Whether a hedge fund is deemed to be an “investor fund” or a “trader fund” can have a significant financial impact on its investors because investors in trader funds are able to deduct a greater portion of the fund’s expenses on their personal income tax returns.  Expenses passed through to investors from an investor fund are capped at two percent of the investor’s adjusted gross income, while expenses passed through by a trader fund are fully deductible against hedge fund income.  See “What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).  A recent U.S. Tax Court decision involving an individual who traded stocks and call options provides an excellent overview of the criteria the Internal Revenue Service considers in determining whether an individual or entity is a “trader.”  Although the decision involves an individual, the criteria considered by the Court are likely to apply to the tax status of hedge funds.  This article summarizes the factual allegations as well as the Court’s legal analysis and holding in the case.

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  • From Vol. 6 No.35 (Sep. 12, 2013)

    How Can Hedge Funds Recoup Overwithholding of Tax on Non-U.S. Source Interest and Dividends?

    Many hedge fund managers may be surprised to learn that their funds and investors are overpaying on taxes levied in relation to cross-border investment income earned by their funds.  Foreign governments often withhold taxes on income earned from such investments at higher rates than are delineated in tax treaties because they cannot ascertain the ultimate beneficial owners of such investments.  Nonetheless, the process to recoup such overpayments – dubbed tax reclamation – is complex and varies widely from jurisdiction to jurisdiction.  To help our subscribers understand the benefits, process and intricacies of tax reclamation, The Hedge Fund Law Report recently conducted an interview with Len Lipton, Managing Director at GlobeTax, a tax reclamation services provider.  Specifically, our interview with Lipton covered, among other topics: what tax reclamation is; general steps in the tax reclamation process; statutes of limitations for filing reclaims; the feasibility of self-filing; operational, legal and other challenges fund managers face in the tax reclamation process; the decision whether to self-file or to outsource tax reclamation to a third-party service provider; conducting due diligence on third-party tax reclamation service providers; whether certain fund structures increase tax reclamation challenges; types of information to be disclosed to file a reclaim; whether the type of investor impacts the tax reclamation process and recovery; whether a fund must disclose its portfolio to file for a reclaim; and whether there are regulatory or other drawbacks facing managers pursuing tax reclamation.  This article contains the full transcript of our interview with Lipton.

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  • From Vol. 6 No.35 (Sep. 12, 2013)

    Understanding the Intricacies for Private Funds of Becoming and Remaining FATCA-Compliant

    The Foreign Account Tax Compliance Act (FATCA) heralds a new world order for the disclosure of tax information related to offshore accounts.  FATCA requires Foreign Financial Institutions (FFIs), including offshore private funds, to provide tax information on accounts maintained by specified U.S. persons, recalcitrant investors or nonparticipating financial institutions.  Given the IRS’ unprecedented extraterritorial powers to gather information on FFIs operating as private funds, FATCA will impose tremendous burdens (both in terms of time and cost) on such offshore private funds.  Yet, the law offers little practical guidance on how managers can establish and maintain programs to become and remain FATCA-compliant.  With this in mind, this guest article – authored by Peter Stafford, an Associate Director at DMS Offshore Investment Services – is designed to help offshore private funds identify and address some of the challenges they face in becoming FATCA-compliant.  Among other things, this article, organized in a question and answer format, addresses: the timeline for FATCA compliance; steps necessary to register with the IRS; whether certain funds are exempt from FATCA; the roles and responsibilities of the FATCA Responsible Officer (FRO); who should serve as the FRO; FATCA reporting to regulators; components of an effective FATCA compliance program; effective investor due diligence procedures; FATCA disclosures in fund documents; insurance coverage for and indemnification of the FRO; and allocation of FATCA-related expenses between the fund and the manager.  For more background on FATCA and its obligations, see “What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 6 No.34 (Aug. 29, 2013)

    Massachusetts Appeals Court Holds That Hedge Fund Investors Can Sue Hedge Fund Auditor Based on Payment of Taxes on Fraudulent “Phantom Income”

    Can a hedge fund investor sue the hedge fund’s auditor if the fund turns out to be a fraud?  While courts have come down on both sides of this question, the thrust of the caselaw has thus far been unfavorable to investors and favorable to auditors and other service providers seeking to avoid liability.  See, e.g., “When Can Hedge Fund Investors Bring Suit Against a Service Provider for Services Performed on Behalf of the Fund?,” The Hedge Fund Law Report, Vol. 6, No. 18 (May 2, 2013).  However, the Massachusetts Appeals Court (Court) recently upheld a trial court decision allowing investors in a fraudulent hedge fund to proceed with a suit against the funds’ auditor.  In particular, the Court identified various direct claims available to the hedge fund investors based on (among other things) the passing through of profits and losses to investors and the payment of taxes by investors on phantom income that did not exist.  For more on phantom income and the tax consequences of it, see “How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?,” The Hedge Fund Law Report, Vol. 6, No. 33 (Aug. 22, 2013).  The Court’s decision may create opportunities for investors in similar factual scenarios (and in disputes governed by Delaware law) to take direct action against auditors and other hedge fund service providers, at least where investors suffer a harm independent of any harm suffered by the fund.  This article summarizes the factual background of the case, the Court’s legal analysis and the implications of the Court’s decision.

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  • From Vol. 6 No.33 (Aug. 22, 2013)

    How Can Hedge Fund Managers Use Profits Interests, Capital Interests, Options and Phantom Income to Incentivize Top Portfolio Management and Other Talent?

    The competition for key talent among hedge fund managers is fierce, and many have resorted to offering their key employees a stake in the manager’s business to attract the best and the brightest.  “Equity” compensation has become so prevalent that more than one-quarter of hedge fund manager employees have reported owning an equity interest in their firms.  See “Hedge Fund Manager Compensation Survey Addresses Employee Compensation Levels and Composition Across Job Titles and Firm Characteristics, Employee Ownership of Manager Equity and Hiring Trends,” The Hedge Fund Law Report, Vol. 6, No. 8 (Feb. 21, 2013).  The forms of equity compensation that hedge fund managers can offer include profits interests, capital interests, options and phantom income in the firm.  Each of these options has economic and other ramifications, both for the offering firm and the offeree.  A recent program provided an overview of the various forms of equity participation that a hedge fund manager can offer its personnel.  Among other things, the panelists discussed the intricacies of profits interests; the current status of carried interest legislation; four different types of equity compensation that managers can offer personnel (including profits interests, capital interests, options and phantom income); tax consequences of becoming a “partner” as a result of the receipt of equity participation in the firm; and the applicability of Section 409A of the Internal Revenue Code to various forms of equity compensation offered by managers.  This article summarizes the key takeaways from the program.

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  • From Vol. 6 No.32 (Aug. 15, 2013)

    Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part Two of Two)

    Employee compensation clawbacks can help hedge fund managers deter bad acts, preserve reputation and demonstrate a commitment to compliance.  However, compensation clawbacks are only effective if properly structured, carefully drafted and consistently enforced.  This is the second article in a two-part series designed to help hedge fund managers think through the pros and cons of implementing compensation clawbacks.  In particular, this article starts by exploring some of the cons, including those relating to federal employment and tax law; state wage, labor and tax law; whistleblower issues; and logistical concerns.  This article then identifies four best practices for structuring and implementing clawbacks, and concludes with an appendix including three sample clawback provisions provided by sources and actually used by hedge fund managers, and one definition of “cause” used in connection with a clawback provision.  The first installment in this series provided an overview of employee clawbacks at hedge fund managers; discussed the types of employees, misconduct and triggering events covered by clawbacks; and highlighted the benefits of implementing clawbacks.  See “Structuring, Drafting and Enforcement Recommendations for Hedge Fund Managers Considering Employee Compensation Clawbacks (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 31 (Aug. 7, 2013).

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  • From Vol. 6 No.30 (Aug. 1, 2013)

    Tax and Structuring Considerations for Funds Organized to Invest in Master Limited Partnerships

    Many businesses that operate in the energy and natural resources sector are organized as master limited partnerships (MLPs) due to favorable tax treatment, including income tax deferral for investors in the early years of their MLP investments.  Funds established to own MLPs can provide diversified exposure to the MLP sector for investors.  While many of these funds are organized as registered funds, hedge fund managers willing to establish such registered funds may be positioned to capitalize on the opportunity to attract investors interested in tax-efficient energy and natural resource investing.  See generally “How Can Hedge Fund Managers Organize and Operate Alternative Mutual Funds to Access Retail Capital (Part Two of Two),” The Hedge Fund Law Report, Vol. 6, No. 6 (Feb. 7, 2013).  A recent panel discussion sponsored by Ropes & Gray LLP discussed various options that are available to fund managers interested in establishing an MLP-focused fund.  Panelists, including Michael Doherty and Amy Snyder, both partners at Ropes & Gray LLP, as well as guest speaker Robert Prado, a director at PricewaterhouseCoopers LLP, addressed the tax benefits provided by MLPs and tax and structuring considerations for funds seeking to invest in MLPs.  This article summarizes the primary lessons from the panel discussion.

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  • From Vol. 6 No.28 (Jul. 18, 2013)

    Insurance Dedicated Funds Offer Hedge Fund Exposure Plus Tax, Underwriting and Asset Protection Advantages for Investors

    Variable universal life insurance enables policy purchasers to invest the cash values of their policies in different investment products.  A primary benefit of such policies (in addition to the insurance) is that the income the investments generate can grow tax-free, and the death benefit on the policy is not subject to income or capital gains tax.  Because those investments are considered securities, most offerings of variable life insurance are registered with federal and state securities regulators.  Private placement life insurance is variable life insurance that, as its name suggests, is only offered through private placements to sophisticated investors.  Purchasers of private placement life insurance can get exposure to hedge funds through funds known as “insurance dedicated funds” (IDFs).  Because these IDFs may provide tax benefits for investors, they present an opportunity for managers willing to organize such funds to raise capital from investors desiring tax-efficient strategies.  However, managers aiming to organize IDFs face some strategy and liquidity constraints and must be sensitive to other structuring considerations.  To help managers understand IDFs, Kleinberg, Kaplan, Wolff & Cohen, P.C. recently hosted a webinar that provided an overview of the structure of IDFs, their benefits to investors and the requirements for setting up IDFs and assuring favorable treatment.  This article summarizes the key take-aways from that discussion.

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  • From Vol. 6 No.26 (Jun. 27, 2013)

    Key Hedge Fund Tax Developments in the U.K., the European Union, Ireland, Germany, Spain, Australia, India and Puerto Rico

    Tax considerations have a powerful impact on hedge fund manager compensation and investor returns.  Accordingly, tax considerations are front and center when managers select domiciles for their funds and management entities; structure funds and related entities; and enter and exit positions.  Hedge fund taxation is inherently complicated and continuously changing; and the complexity is compounded for managers investing and operating globally.  To bring some clarity and coherence to this challenging subject, a recent program examined completed and pending changes to relevant tax laws in the U.K. (including the “reporting fund” regime), the European Union (including the financial transaction tax), Germany, Ireland, Spain, Australia, India and Puerto Rico.  Participants in the program provided detailed explanations of the current state of the tax law in each jurisdiction, how the law is likely to change and best practices for structuring and investing around current and anticipated tax law.  This article memorializes the insights from the program, focusing in particular on practical consequences for hedge fund managers of tax law changes.  For more on tax reporting considerations relevant to hedge fund managers, see “What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?,” The Hedge Fund Law Report, Vol. 6, No. 11 (Mar. 14, 2013).

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  • From Vol. 6 No.26 (Jun. 27, 2013)

    CLO 2.0: How Can Hedge Fund Managers Navigate the Practical and Legal Challenges of Establishing and Managing Collateralized Loan Obligations? (Part Two of Two)

    CLO deal volumes in 2012 and the first quarter of 2013 clearly indicate that investor appetite for CLO investments has returned.  At the same time, establishing and managing CLOs can present attractive revenue-generating opportunities for fund managers.  Nonetheless, these opportunities are accompanied by new challenges for managers, which are outlined in this two-part series of articles.  This second article in the series presents a brief overview of various legal developments that have altered or may alter the CLO management landscape, including (1) risk retention rules, the Volcker Rule and various Commodity Futures Trading Commission requirements under the Dodd-Frank Act, (2) enhanced registration requirements under the Investment Advisers Act of 1940, (3) the implementation of the Foreign Account Tax Compliance Act provisions of the Internal Revenue Code (Code), and (4) Sections 409A and 457A of the Code.  The first installment of the series touched upon several of the practical challenges CLO managers can expect to encounter in establishing a CLO in the current market environment.  Specifically, the first article addressed a number of common documentation requests by anchor investors in the most senior and subordinated (or equity) classes of the CLO capital structure and explored certain inherent difficulties in obtaining warehouse financing in connection with the ramp up of the CLO portfolio prior to the initial issuance of CLO notes.  See “CLO 2.0: How Can Hedge Fund Managers Navigate the Practical and Legal Challenges of Establishing and Managing Collateralized Loan Obligations (Part One of Two),” The Hedge Fund Law Report, Vol. 6, No. 25 (Jun. 20, 2013).  The authors of this series are Greg B. Cioffi and Jeff Berman, both partners in Seward & Kissel’s Structured Finance and Asset Securitization Group, and David Sagalyn, an associate in the group.  See also “Key Legal and Business Considerations for Hedge Fund Managers When Purchasing Collateralized Loan Obligation Management Contracts,” The Hedge Fund Law Report, Vol. 3, No. 13 (Apr. 2, 2010).

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  • From Vol. 6 No.24 (Jun. 13, 2013)

    Rothstein Kass Provides Roadmap for FATCA Compliance by Hedge Fund Managers

    The final regulations governing implementation of the Foreign Account Tax Compliance Act (FATCA), while significant in length, provide little practical guidance to hedge fund managers, who face myriad challenges in determining how to comply with the daunting new legislation.  Yet the failure to comply with the legislation’s detailed and wide-ranging requirements can have severe economic consequences for hedge funds and their investors.  To fill the information gap left by the absence of explicit regulatory guidance, Rothstein Kass recently hosted a webinar providing hedge fund managers with practical insight on preparing for FATCA, including, among other things, a checklist of steps that hedge fund managers should take to begin preparing for FATCA as it is phased in over the next few years.  This article summarizes the key insights from the webinar.  See also “What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?,” The Hedge Fund Law Report, Vol. 6, No. 5 (Feb. 1, 2013).

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  • From Vol. 6 No.14 (Apr. 4, 2013)

    Former Deputy U.S. Attorney and WilmerHale Partner Boyd M. Johnson III Addresses Risk Management Imperatives for Hedge Fund Managers: Insider Trading, Defense Strategy, Crisis Management, Money Laundering, Cyber Security and Tax Shelters

    Risk plays a different role in investments and operations.  In investments, as a general matter, returns are broadly correlated with risk.  In operations, on the other hand, quality tends to be inversely related with risk; there is no greater upside potential from increased operational risk, just a greater likelihood of fundamental error.  At the same time, operational risk is generally more dangerous to hedge fund managers than investment risk.  Investors understand that generating returns inevitably involves mistakes, but operational failures call into question a manager’s basic competence as a steward of capital.  Managing and mitigating operational risk are thus increasingly critical aspects of the hedge fund business.  But doing so is easier said than done.  In the first instance, it is challenging to identify the full range of operational risks facing a manager.  There is a group of usual suspects, but the less obvious and more insidious risks are unique to a manager’s strategy and operations.  Once risks are identified, best practices for addressing risks are hard to come by.  In an effort to assist hedge fund managers on both counts – identifying relevant risks and deciding what to do about them – The Hedge Fund Law Report recently interviewed Boyd M. Johnson III, a partner in the Litigation/Controversy Department and member of the Investigations and Criminal Litigation Practice Group and the Business Trial Group at WilmerHale.  Prior to joining WilmerHale, Johnson served as Deputy U.S. Attorney in the Southern District of New York with supervisory authority over 230 Assistant U.S. Attorneys.  As Deputy U.S. Attorney, Johnson managed the largest crackdown on Wall Street insider trading in history, including the prosecution of Raj Rajaratnam of the Galleon Group; criminal prosecutions and civil forfeiture proceedings related to the Bernard Madoff fraud; the investigation and prosecution of individuals and entities responsible for structuring and promoting international tax shelters; and numerous cyber security and other investigations.  For our interviews with other leading prosecutors in the Rajaratnam insider trading case, see “Former Rajaratnam Prosecutor Reed Brodsky Discusses the Application of Insider Trading Doctrine to Hedge Fund Research and Trading Practices,” The Hedge Fund Law Report, Vol. 6, No. 13 (Mar. 28, 2013); and “Rajaratnam Prosecutor and Dechert Partner Jonathan Streeter Discusses How the Government Builds and Prosecutes an Insider Trading Case against a Hedge Fund Manager,” The Hedge Fund Law Report, Vol. 5, No. 45 (Nov. 29, 2012).  The bulk of our interview with Johnson covered various aspects of insider trading – not surprising, given that insider trading remains primus inter pares among the various risks faced by managers in many strategies.  Specifically, with respect to insider trading, we discussed with Johnson: challenges in defending simultaneous civil and criminal insider trading actions; challenges in coordinating defenses to insider trading charges levied by multiple jurisdictions; considerations in evaluating an insider trading plea deal; strategies for obtaining prosecutorial leniency in insider trading cases; addressing insider trading risks from communications among investment professionals at different managers; maximizing the effectiveness of insider trading training; insider trading crisis management; and strategies for documenting findings from insider trading internal investigations.  Beyond insider trading, we also covered: anti-money laundering and cyber security risks confronting managers; identifying risky tax shelter pitches; and navigating fraud risks in healthcare investing.  This interview was conducted in connection with the Regulatory Compliance Association’s upcoming Regulation, Operations & Compliance 2013 Symposium, to be held at the Pierre Hotel in New York City on April 18, 2013.  That Symposium is scheduled to include a panel covering government investigation and prosecution of hedge fund and private equity fund managers entitled “Post SAC Capital – Investigation, Enforcement & Prosecution of Hedge & PE Managers.”  For a fuller description of the Symposium, click here.  To register for the Symposium, click here.  Subscribers to The Hedge Fund Law Report are eligible for a registration discount.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    What Critical Issues Must Hedge Fund Managers Understand to Inform Their Preparation of Schedules K-1 for Distribution to Their Investors?

    Most hedge funds are taxed as partnerships and therefore pass through items of income, gains and losses to their fund investors, rather than facing taxation on such items at the partnership level.  As a result, hedge fund managers are responsible for preparing and distributing to their investors a Schedule K-1 to Form 1065, which shows an investor’s share of a fund’s income, gains, losses, credits and other items for each tax year that must be reported to the Internal Revenue Service on the investor’s individual income tax return.  Nonetheless, preparation of this schedule can present a litany of challenges which can confound many hedge fund managers.  Moreover, preparation of K-1s cannot be entirely outsourced to an accounting firm; a manager must understand what the accounting firm is doing and be able to evaluate its work.  Recognizing the complexity and importance of this topic, a recent webinar provided a top-level refresher course on the tax considerations that influence the structuring of hedge funds and addressed numerous issues involved in the preparation of Schedule K-1, such as the difference between “trader funds” and “investor funds,” and allocation and adjustment rules that have tax consequences for hedge fund investors.  This article summarizes key takeaways from that program.

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  • From Vol. 6 No.11 (Mar. 14, 2013)

    U.K. Tax Tribunal Overturns Hedge Fund Manager’s Attempt to Avoid Tax on Hedge Fund Profits through the Acquisition and Disposition of Film Distribution Rights

    On February 13, 2013, a U.K. tax tribunal (Tribunal) overturned a tax avoidance scheme in which a prominent hedge fund manager attempted to create artificial losses through the acquisition and disposition of film distribution rights to shelter millions of pounds in personal income generated from his hedge fund.  This case is the latest victory for Her Majesty’s Revenue and Customs in its recent vigorous enforcement against aggressive tax avoidance schemes by hedge fund managers.  See “U.K. Hedge Fund Manager Taxed on Bonuses Delivered Through Tax-Avoidance Scheme,” The Hedge Fund Law Report, Vol. 5, No. 34 (Sep. 6, 2012).  This article summarizes the Tribunal’s factual findings and legal analysis in this case.

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  • From Vol. 6 No.7 (Feb. 14, 2013)

    FATCA Implementation Summit Identifies Best Practices Relating to FATCA Reporting, Due Diligence, Withholding, Operations, Compliance and Technology

    On December 6, 2012, the Hedge Fund Business Operations Association and Financial Research Associates, LLC jointly sponsored a “FATCA Implementation Summit” in New York City (Summit).  Participants at the Summit discussed compliance requirements, recommendations and strategies in connection with the Foreign Account Tax Compliance Act (FATCA), in particular with respect to registration, reporting, due diligence and withholding.  Participants also addressed the operational and technological demands presented by FATCA, and best practices for meeting those demands.  This article summarizes the practical takeaways from the Summit and offers recommendations that hedge fund managers can apply directly to their FATCA compliance programs.

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  • From Vol. 6 No.5 (Feb. 1, 2013)

    What Impact Will FATCA Have on Offshore Hedge Funds and How Should Such Funds Prepare for FATCA Compliance?

    The Foreign Account Tax Compliance Act (FATCA) will begin to impact the offshore investment fund industry in 2013, requiring a “foreign financial institution” (FFI) to enter into an agreement with the Internal Revenue Service (IRS) and disclose certain information regarding its U.S. account holders on an annual basis.  FFIs are broadly defined to include offshore hedge funds or other offshore private investment funds, and compliance with FATCA may be difficult for many of these funds.  The principal goal of FATCA is to prevent U.S. taxpayers from using foreign accounts and investments to hide income from the IRS and evade payment of U.S. tax.  As the penalties for failure to comply with FATCA are harsh – including the imposition of a 30 percent withholding tax on certain U.S. source payments – managers of offshore hedge funds should begin to prepare for FATCA and its due diligence reporting requirements.  On January 17, 2013, the IRS issued long-awaited final regulations under FATCA, clarifying many of the items left open by the proposed regulations released in February of 2012 and previously issued IRS guidance.  In a guest article, Michele Gibbs Itri, a partner at Tannenbaum Helpern Syracuse & Hirschtritt, LLP, discusses the impact that current FATCA rules will have on offshore investment funds and describes the steps that fund managers can take now to comply with these rules to avoid any FATCA tax on the funds’ U.S. investments.

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  • From Vol. 5 No.43 (Nov. 15, 2012)

    Understanding the Benefits and Uses of Series LLCs for Hedge Fund Managers

    Hedge fund managers are continually striving to maximize the advantages available through their choice of legal entity for structuring their funds and management companies.  The series limited liability company (Series LLC) offers a relatively new variation on the traditional limited liability company structure that provides not only liability protection for members vis-à-vis non-members, but also liability protection for members of a given series of interests within the Series LLC vis-à-vis members of other series of interests within the same Series LLC.  In a guest article, Yehuda M. Braunstein, a Partner at Sadis & Goldberg LLP, and Todd K. Warren, Of Counsel at Sadis & Goldberg LLP, discuss: the history and evolution of the Series LLC; the various structural requirements and issues to be considered; the advantages and challenges that are presented by the Series LLC; practical tips regarding how to utilize the Series LLC; and potential uses of the structure by hedge fund managers.

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  • From Vol. 5 No.40 (Oct. 18, 2012)

    Tax Efficient Hedge Fund Structuring in Anticipation of the New 3.8% Surtax on Net Investment Income and Proposals to Limit Individuals’ Tax Deductions

    In the current political environment, high income U.S. persons are likely to see their income tax rates on investment income rise and their ability to deduct investment-related expenses further curtailed.  Consequently, such investors and their advisors are likely to become more concerned about the difference between pre-tax and after-tax returns from competing investment alternatives.  It is generally known that hedge funds are somewhat tax-inefficient investments for U.S. high income individual investors.  Some funds often employ trading strategies that generate attractive pre-tax returns, but often generate income taxed at the highest rates.  Although the mutual fund industry has rolled out many new funds for the general public that are marketed as “tax managed” or “tax efficient” funds, the same trend has not been as evident in the hedge fund world.  This fact is a bit unusual since, as discussed in this article, individual investors in hedge funds organized as tax partnerships face a much greater risk of tax inefficiency than investors that invest in shares of corporations that are mutual funds (regulated investment companies under the Internal Revenue Code).  Given the increasing competition for assets under management as well as the factors described above, hedge fund managers should engage in tax planning throughout the tax year to make their funds more tax-efficient and should consult with their tax advisors with respect to the tax changes which will surely come in the future.  In some cases, fund managers should reconsider the structures of their funds that are available to such U.S. individual investors.  In a guest article, A.J. Alex Gelinas, a tax partner at Sadis & Goldberg LLP, analyses tax changes relevant to hedge fund managers and investors that are about to go into effect, or that are likely to go into effect in the future as Congress faces the need to increase tax revenues, and the effect such tax law changes may have on the marketing of hedge funds to U.S. high income individuals.  The article provides concrete tax structuring suggestions and also serves as a comprehensive overview of fundamental principles of tax structuring for hedge funds.

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  • From Vol. 5 No.35 (Sep. 13, 2012)

    AIMA Canada Handbook Provides Roadmap for Hedge Fund Managers Doing Business in Canada

    Pershing Square’s successful proxy contest for control of Canadian Pacific Railway is the most prominent recent example, but by no means the only example, of the increasing importance of Canada for hedge fund managers.  See also “Ontario Securities Commission Sanctions Hedge Fund Manager Sextant Capital Management and its Principal for Breach of Fiduciary Duty,” The Hedge Fund Law Report, Vol. 5, No. 24 (Jun. 14, 2012).  Specifically, Canada is growing in importance as a place where hedge fund managers may invest, raise capital and recruit talent.  In an effort to assist hedge fund managers in navigating the Canadian tax and regulatory landscape, AIMA Canada, a chapter of the Alternative Investment Management Association (AIMA), recently published the AIMA Canada Handbook (Handbook).  This article summarizes the key topics covered in the Handbook, including a background discussion of the Canadian securities industry; registration requirements for fund managers operating in Canada; regulations applicable to registrants; exemptions from fund manager registration; tax consequences for hedge funds and investors; structuring Canadian hedge funds; and the outlook for the Canadian hedge fund industry, including an update on the capital raising environment.

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  • From Vol. 5 No.34 (Sep. 6, 2012)

    U.K. Hedge Fund Manager Taxed on Bonuses Delivered Through Tax-Avoidance Scheme

    On July 16, 2012, the First-Tier Tribunal of the U.K. Tax Chamber issued a decision rejecting an appeal by hedge fund manager Sloane Robinson Investment Services Limited of a tax imposed on bonuses it delivered to its director-employees through a tax avoidance scheme.  This article summarizes the decision, including the factual findings, the parties’ arguments and the Tribunal’s legal analysis.  This article also provides insight on what the decision means for tax and compensation structuring for U.K. hedge fund managers.

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  • From Vol. 5 No.32 (Aug. 16, 2012)

    Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part Two of Two)

    Over the past several years, U.S. investors have broadened their alternative investment horizons by exploring investment opportunities with Asia-based fund managers.  Asia-based fund managers provide a unique perspective on alternatives which translates to differing investment strategies that appeal to U.S. investors seeking uncorrelated returns or “alpha.”  Nonetheless, Asia-based fund managers that seek to attract U.S. investor capital must recognize the intricate regulations that govern investment manager and fund operations in the U.S. and other jurisdictions, such as the Cayman Islands where many funds are organized to attract U.S. investors.  This is the second article in a two-part series designed to help Asia-based fund managers navigate the challenges of structuring and operating funds to appeal to U.S. investors.  The authors of this article series are: Peter Bilfield, a partner at Shipman & Goodwin LLP; Todd Doyle, senior tax associate at Shipman & Goodwin LLP; Michael Padarin, a partner at Walkers; and Lu Yueh Leong, a partner at Rajah & Tann LLP.  This article describes in detail a number of the key U.S. tax, regulatory and other considerations that Asia-based fund managers are concerned with or should consider when soliciting U.S. taxable and U.S. tax-exempt investors.  The first article described the preferred Cayman hedge fund structures utilized by Asia-based fund managers, the management entity structures, Cayman Islands regulations of hedge funds and their managers and regulatory considerations for Singapore-based hedge fund managers.  See “Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part One of Two),” The Hedge Fund Law Report, Vol. 5, No. 31 (Aug. 9, 2012).

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  • From Vol. 5 No.31 (Aug. 9, 2012)

    Structuring, Regulatory and Tax Guidance for Asia-Based Hedge Fund Managers Seeking to Raise Capital from U.S. Investors (Part One of Two)

    U.S. hedge fund investors are continuously seeking attractive investment opportunities and are increasingly expanding their search to incorporate Asia-based hedge fund managers.  At the same time, Asia-based hedge fund managers are navigating the challenging capital raising environment by reaching beyond their borders to attract U.S. investors.  However, Asia-based fund managers seeking to attract capital from U.S. investors must contend with a plethora of U.S. and foreign regulations in raising and managing such capital.  As such, Asia-based fund managers must work closely with U.S., Cayman and local counsel to develop a cohesive and carefully thought out fund and management structure, intertwining the various regulatory requirements of the applicable jurisdictions, all of which must be adhered to by the fund manager, any sub-advisers and their respective affiliates.  This is the first in a two-part series of guest articles designed to help Asia-based fund managers navigate the challenges of structuring and operating funds to appeal to U.S. fund investors.  The authors of this article series are: Peter Bilfield, a partner at Shipman & Goodwin LLP; Todd Doyle, senior tax associate at Shipman & Goodwin LLP; Michael Padarin, a partner at Walkers; and Lu Yueh Leong, a partner at Rajah & Tann LLP.  This first article describes the preferred Cayman hedge fund structures utilized by Asia-based fund managers, the management entity structures, Cayman Islands regulations of hedge funds and their managers and regulatory considerations for Singapore-based hedge fund managers.  The second article in the series will detail a number of the key U.S. tax, regulatory and other considerations that Asia-based fund managers should consider when soliciting U.S. taxable and U.S. tax-exempt investors.

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  • From Vol. 5 No.29 (Jul. 26, 2012)

    The Nuts and Bolts of FATCA Compliance: An Interview with James Wall of J.H. Cohn Concerning Due Diligence, Document Collection, Reporting and Other Operational Challenges

    The Foreign Account Tax Compliance Act (FATCA) has that unfortunate combination of qualities that strikes fear into the hearts of hedge fund managers and investors: ambiguity and significant penalties.  FATCA is set to become effective as of January 1, 2013, but final rules have not yet been promulgated by the U.S. Department of the Treasury.  At the same time, sizable financial penalties can be imposed for noncompliance.  Accordingly, the hedge fund industry is paying close attention to FATCA developments.  Given the serious ramifications of non-compliance with FATCA and the significant uncertainty regarding the details of final regulations, The Hedge Fund Law Report conducted an interview with James K. Wall, a Principal and International Tax Director at J.H. Cohn LLP, concerning FATCA and its implications for hedge fund managers and investors.  Our interview with Wall covered various topics, including key questions hedge fund managers still face relating to FATCA compliance; due diligence and compliance measures that hedge fund managers must take; operational challenges in becoming FATCA compliant; whether the hedge fund or the manager should be responsible for bearing costs and expenses in connection with FATCA compliance; dealing with recalcitrant investors; policies and procedures that hedge fund managers should consider adopting for FATCA compliance; what to communicate to fund investors about FATCA; and whether fund governing documents must be amended to include FATCA-related provisions.  This article contains the transcript of our interview with Wall.  See also “U.S. Releases Helpful FATCA Guidance, But the Law Still Remains,” The Hedge Fund Law Report, Vol. 5, No. 10 (Mar. 8, 2012).

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  • From Vol. 5 No.25 (Jun. 21, 2012)

    European Court of Justice Invalidates French Withholding Tax that Applied Only to Dividends Paid to Non-Resident Open-End Investment Funds

    One of the fundamental goals of the European Union (EU) is to reduce barriers to economic activity between and among member states.  Barriers can include tax policies designed to advantage certain member states over other member states.  In that vein, the European Court of Justice (ECJ) recently considered whether France’s policy of imposing a 25% withholding tax on dividends payable by French companies to non-resident investment funds while exempting resident investment funds from withholding violates Article 63 of the Treaty on the Functioning of the European Union and thus creates an impermissible barrier to economic activity among member states.  This article summarizes the background and the ECJ’s analysis in this case.  The petitioners in the case are global investment managers that manage funds organized as Undertakings for Collective Investment in Transferable Securities (UCITS).  Thus, the ECJ’s analysis is directly relevant to UCITS managers, and it is also relevant to managers of non-UCITS investment vehicles with any nexus to Europe.

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  • From Vol. 5 No.22 (May 31, 2012)

    Rothstein Kass Report Discusses Marketing, Structuring, Tax, Leverage, Due Diligence, Hiring and Other Dominant Concerns for Hedge Fund Managers in a Competitive Capital Raising Environment

    The 2012 version of Rothstein Kass’ annual hedge fund industry survey assessed manager sentiment and trends across a wide range of relevant areas, including: structuring and choice of entity; ownership and management of hedge fund firms by women and minorities; seeding; consolidation and chief business concerns among manager principals; use of leverage; the interaction among leverage, tax and capital raising; sources of capital and expectations with respect to investor sentiment; length of the due diligence process; fee and other concessions in exchange for investments; technology; lock-ups; outsourcing; gates; hiring expectations with respect to CCOs, CFOs and CTOs; family office conversions; investor qualification; and Form PF.  This survey results were explained in a report (Report), which also included insight from Rothstein Kass principals.  This article provides a detailed summary of the key points of the Report.

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  • From Vol. 5 No.13 (Mar. 29, 2012)

    Managing Risk in a Changing Environment: An Interview with Proskauer Partner Christopher Wells on Hedge Fund Governance, Liquidity Management, Transparency, Tax and Risk Management

    The Hedge Fund Law Report recently interviewed Christopher M. Wells, a Partner at Proskauer Rose LLP and head of the firm’s Hedge Funds Group.  Wells has decades of experience advising hedge funds and their managers, and a broad-based practice that touches on substantially every aspect of the hedge fund business.  Our interview with Wells was similarly wide-ranging, covering topics including: hedge fund governance; investor demands for heightened transparency; co-investment opportunities; liquidity management issues; side pocketing policies and procedures; holdbacks of redemption proceeds; tax issues, including preparations for compliance with the Foreign Account Tax Compliance Act (FATCA) and the electronic delivery of Schedules K-1; and risk management, including practical steps to prevent style drift and unauthorized trading.  This interview was conducted in conjunction with the Regulatory Compliance Association’s Spring 2012 Regulation & Risk Thought Leadership Symposium.  That Symposium will be held on April 16, 2012 at the Pierre Hotel in New York.  For more information, click here.  To register, click here.  (Subscribers to The Hedge Fund Law Report are eligible for discounted registration.)  Wells is expected to participate in a session at that Symposium focusing on hedge fund governance and related issues.

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  • From Vol. 5 No.12 (Mar. 22, 2012)

    IRS Introduces New Disclosure, Consent and Notice Procedures to Govern the Electronic Delivery of 2011 Schedules K-1 by Partnerships, Including Many Hedge Funds and Hedge Fund Managers

    On February 13, 2012, the Internal Revenue Service (IRS) issued new procedures for partnerships to provide Schedules K-1 to their partners electronically.  Among other things, the new procedures introduce rigorous consent and disclosure procedures that govern the electronic delivery of Schedules K-1 by partnerships, including limited partnerships, such as many hedge funds and hedge fund managers.  As such, hedge funds and hedge fund managers that wish to provide electronic delivery of their Schedules K-1 to fund investors or partners in the management company, respectively, should promptly and carefully evaluate the new procedures and their potential impact on the processes they are currently following to obtain consent to electronic delivery of such Schedules K-1.  In a guest article, Roger Wise and Kenneth Wear, Partner and Associate, respectively, at K&L Gates LLP, discuss the mechanics and implications of the new K-1 procedures.

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  • From Vol. 5 No.10 (Mar. 8, 2012)

    U.S. Releases Helpful FATCA Guidance, But the Law Still Remains

    The United States announced an unprecedented multi-country agreement and published detailed proposed regulations addressing implementation of the Foreign Account Tax Compliance Act (FATCA) on February 8, 2012.  In a guest article, Michael Hirschfeld, a Partner at Dechert LLP, explains the details of the agreement and proposed regulations and their impact on hedge fund managers.

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  • From Vol. 5 No.6 (Feb. 9, 2012)

    Hedge Fund Managers May Be Required to File TIC Form SHC by March 2, 2012

    Hedge fund managers should consider as soon as possible whether they are required to file Treasury International Capital (TIC) Form SHC, Report of U.S. Ownership of Foreign Securities, Including Selected Money Market Instruments.  Basically, Form SHC requires the reporting of information regarding foreign securities owned by U.S. residents.  A hedge fund manager is required to file Form SHC if it meets a $100 million threshold for “reportable securities” determined on an aggregate basis for all funds under management.  For 2011, Form SHC is due by March 2, 2012, and reporting is based on the fair value of assets determined as of December 31, 2011.  In a guest article, Philip Gross and Allison Bortnick, Member and Associate, respectively, at Kleinberg, Kaplan, Wolff & Cohen, P.C., discuss the parameters of Form SHC, including a discussion of who must file Form SHC and what securities are covered; the composition of Form SHC; and the approach that hedge fund managers may take to determine whether they must file Form SHC, and, if reporting is required, how to complete Form SHC.

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  • From Vol. 5 No.5 (Feb. 2, 2012)

    How Safe Is It to Ignore Foreign Tax Claims or Judgments Against Cayman Islands Hedge Funds in the Context of a Winding Up of the Fund?

    Cayman Islands hedge funds are subject to no Cayman Islands tax of any nature, but they may become liable to foreign tax claims – for example through trading swaps – or they may become subject to judgments for tax imposed against them in other jurisdictions.  How should such claims and judgments be regarded by liquidators in the context of winding up the fund, whether in a liquidation imposed by the court, or in a voluntary liquidation?  Must effect be given to such claims or judgments, or can such claims and judgments simply be ignored, and the winding up completed without regard to them?  Or should the winding up only be completed once the tax claim or judgment has been abandoned by the foreign tax authority, or only with Cayman court sanction that the claim or judgment be disregarded for the purposes of the winding up?  In a guest article, Christopher Russell, Partner and head of the litigation and insolvency department of Ogier, Cayman Islands, and Shaun Folpp, a Managing Associate in the litigation and insolvency department of Ogier, Cayman Islands, address these and related questions.

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  • From Vol. 5 No.2 (Jan. 12, 2012)

    Proposed New York City Audit Position Can Increase the Amount of Unincorporated Business Tax Paid by New York Hedge Fund Managers

    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.

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  • From Vol. 5 No.1 (Jan. 5, 2012)

    Legal and Operational Due Diligence Best Practices for Hedge Fund Investors

    In the wake of the financial crisis in late 2008, many investors were left trapped in suspended, gated or otherwise illiquid hedge funds.  Unfortunately, for many investors who had historically taken a passive role with respect to their hedge fund investments, it took a painful lesson to learn that control over fundamental fund decisions was in the hands of hedge fund managers.  Decisions such as the power to suspend or side pocket holdings were vested in managers either directly or through their influence over the board of directors of the fund.  In these situations, which were not uncommon, leaving control in the hands of the manager rather than a more independent board gave rise to a conflict of interest.  Managers were in some cases perceived to be acting in their own self-interest at the expense, literally and figuratively, of the fund and, consequently, the investors.  The lessons from the financial crisis of 2008 reinforced the view that successful hedge fund investing requires investors to approach the manager selection process with a number of considerations in mind, including investment, risk, operational and legal considerations.  Ideally, a hedge fund investment opportunity will be structured to sufficiently protect the investor’s rights (i.e., appropriate controls and safeguards) while providing an operating environment designed to maximize investment returns.  Striking such a balance can be challenging, but as many investors learned during the financial crisis, it is a critical element of any successful hedge fund program.  The focus on hedge fund governance issues has intensified in the wake of the financial crisis, with buzz words such as “managed accounts,” “independent directors,” “tri-party custody solutions” and “transparency” now dominating the discourse.  Indeed, investor efforts to improve corporate governance and control have resulted in an altering of the old “take it or leave it” type of hedge fund documents, which have become more accommodative towards investors.  In short, in recent years investors have become more likely to negotiate with managers, and such negotiations have been more successful on average.  In a guest article, Charles Nightingale, a Legal and Regulatory Counsel for Pacific Alternative Asset Management Company, LLC (PAAMCO), and Marc Towers, a Director in PAAMCO’s Investment Operations Group, identify nine areas on which institutional investors should focus in the course of due diligence.  Within each area, Nightingale and Towers drill down on specific issues that hedge fund investors should address, questions that investors should ask and red flags of which investors should be aware.  The article is based not in theory, but in the authors’ on-the-ground experience conducting legal and operational due diligence on a wide range of hedge fund managers – across strategies, geographies and AUM sizes.  From this deep experience, the authors have extracted a series of best practices, and those practices are conveyed in this article.  One of the main themes of the article is that due diligence in the hedge fund arena is an interdisciplinary undertaking, incorporating law, regulation, operations, tax, accounting, structuring, finance and other disciplines, as well as – less tangibly – experience, judgment and a good sense of what motivates people.  Another of the themes of the article is that due diligence is a continuous process – it starts well before an investment and often lasts beyond a redemption.  This article, in short, highlights the due diligence considerations that matter to decision-makers at one of the most sophisticated allocators of capital to hedge funds.  For managers looking to raise capital or investors looking to deploy capital intelligently, the analysis in this article merits serious consideration.

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  • From Vol. 4 No.43 (Dec. 1, 2011)

    Primary Regulatory and Business Considerations When Opening a Hedge Fund Management Company Office in Asia (Part One of Four)

    Over the past 24 months, many articles have been written about global hedge fund managers expanding into Asia.  Indeed, with global markets continuing to experience volatility and Western governments facing significant challenges, many are looking East.  In the current environment, there are many reasons why a U.S.- or European-based manager may choose to open an office or offices in Asia, including, among other things, access to an abundance of Asian investment opportunities and favorable regulatory treatment in certain Asian jurisdictions.  See “AsiaHedge Study Finds That a Growing Proportion of Hedge Funds with Asia-Focused Strategies are Managed from Asia,” The Hedge Fund Law Report, Vol. 4, No. 36 (Oct. 13, 2011).  Establishing an office in Asia can also facilitate tax-efficient deployment of certain Asia-focused investment strategies.  For these and other reasons, many international hedge fund managers have established satellite offices in Asia.  Before embarking on this venture, however, a manager should carefully evaluate the host of considerations critical to determining whether and how to accomplish this task.  Hong Kong and Singapore remain the two most common destinations for offices in Asia; Mumbai, Beijing and Sydney are also home to fund managers, but generally host country-specific strategies.  In this guest article, Maria Gabriela Bianchini, founder of Optionality Consulting, a Singapore-based consulting firm specializing in assisting hedge funds with regulatory and operational issues, provides a roadmap for opening up a subsidiary office in Hong Kong or Singapore.  In particular, Bianchini discusses the impact of the following factors, among others, in determining whether to open an office in Hong Kong or Singapore: composition of the manager’s portfolio; tax treaty status in light of the manager’s investment strategies; whether the purpose of the office is investment or marketing; licensing and regulatory issues; number of people in the office; whether the manager focuses on fixed income, equities, illiquid assets or other strategies; access to deal and information flow; access to talent; and personal decisions (such as housing, schools for children and related considerations).  This article is the first in a four-part series by Bianchini to be published in The Hedge Fund Law Report.  Part two will discuss practical considerations and guidance with respect to opening an office in Singapore and Hong Kong, Part three will discuss the changing regulatory landscape affecting managers in Singapore and Part four will conclude with a discussion of Hong Kong.

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  • From Vol. 4 No.38 (Oct. 27, 2011)

    The Impact of Asymmetric Information, Trade Documentation, Form of Transfer and Additional Terms of Trade on Hedge Funds’ Trade Risk in European Secondary Loans (Part Two of Two)

    Although certain distressed debt investors in the European markets would like to believe that senior secured bonds can provide easier and more liquid access to the rights and influence of senior secured lenders, this is not the current reality.  Though both bonds and bank debt may have “senior secured” preceding their title, the rights and influence afforded to investors can vary significantly among instruments.  While many on the buy side are fighting to bring the senior secured bond structure more in line with bank debt on the premise that a Euro worth of senior secured bonds should be a Euro worth of senior secured bank debt, it remains to be seen when and if this will happen.  In most instances, the ability to quickly access the senior secured facility agreement and ancillary documents as well as steer a borrower’s proposed restructuring will continue to be driven initially by the senior bank debt lenders.  A misstep in trading bank debt while building a portfolio position could therefore shut an investor out from discussions.  This makes for a bitter pill to swallow if the investment strategy behind the debt purchase from the outset is to be active in restructuring talks.  Access by an investor to the traditionally “club” world of European bank debt, especially in middle market private situations, can come with challenges.  This is especially true for investment funds looking to trade across a borrower’s capital structure and seeking liquidity and a quick settlement if things don’t go according to plan.  In Part 1 of this two-part article series, David J. Karp, a Special Counsel at Schulte Roth & Zabel LLP (SRZ), and leader of the firm’s Distressed Debt and Claims Trading Group, Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, examined regulatory and tax issues that may impact on an investor’s recovery; identified certain restrictions in the underlying credit documentation that could prohibit an investor from assuming a direct lender of record position; and discussed perfection issues that may affect a lender’s recovery in a borrower insolvency scenario.  See “Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two),” The Hedge Fund Law Report, Vol. 4, No. 37 (Oct. 21, 2011).  In this article, Part 2 of the series, the authors, joined by their colleague Neil Robson (a Senior Associate in SRZ’s London office) touch upon issues relating to confidential information in the European secondary loan market and trading where a disparity of information exists between syndicate members and restructuring committee members under a credit agreement.  Additionally, the authors discuss the different forms of documentation available for trading bank debt, the various options for purchase of bank debt and the risks associated with each method of settlement.

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  • From Vol. 4 No.37 (Oct. 21, 2011)

    Regulatory, Tax and Credit Documentation Factors Impacting Hedge Funds’ Trade Risk in European Secondary Loans (Part One of Two)

    For the majority of 2011, European secondary loan markets had buy-side traders frustrated by low liquidity, volume and deal flow, and sell-side traders were left to wonder if and when they do source, will enough friends come out and play.  Is this the calm before the storm?  Many in the distressed community believe it is, and that loans will play a significant role in the corporate distressed wave expected to hit shore in 2012 as part of €221 billion worth of European leveraged loans set to mature between now and through 2015.  The high yield market was a savior in 2011 for many borrowers whose loans were set to mature in 2013 and 2014.  However, with some of these deals already having gone sour and the pool of remaining loans deteriorating, the high yield market is not likely to save the day again.  Regardless of the capital market options, when the refinancing peak reaches its heights in Europe and the U.S. in 2014, bad loans will likely be left behind in droves.  To assist investment funds in filling their proverbial sandbags and preparing to pick up potentially lucrative pieces in the aftermath, David J. Karp, Special Counsel at Schulte Roth & Zabel LLP (SRZ), Roxanne Yanofsky, an Associate at SRZ, and Erik Schneider, also an Associate at SRZ, are publishing in The Hedge Fund Law Report a two-part series on trade risks specific to loans in the European market.  This first article will focus on certain macro issues arising in the context of European secondary loan trading, through analyzing regulatory, tax and credit documentation factors which can impact the success of a trade.  In particular, this article analyzes, among many other relevant issues: what jurisdictions and applicable lender restrictions play into a trade; whether a debt purchase subjects an investor to a withholding tax, and, if so, whether the investor can obtain the benefit of an exemption or a reduced rate of withholding tax; the requirements to accede as a lender of record under a loan agreement, including eligibility requirements, minimum thresholds and borrower consent rights; and any additional steps an investor must take to perfect its debt transfer and consequences for failing to take the requisite action.  The second article, to be published in an upcoming issue of The Hedge Fund Law Report, will look at trade issues affecting an investor at time of trade and on a more micro level, covering transfer perfections, LMA transparency guidelines, trade documentation, form of transfer and additional terms of trade.

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  • From Vol. 4 No.17 (May 20, 2011)

    Eight Refinements of the Traditional “2 and 20” Hedge Fund Fee Structure That Can Powerfully Impact Manager Compensation and Investor Returns

    In the depths of the credit crisis, investors began to question hedge funds’ traditional claims to fame.  Negative returns undermined the promise of absolute returns across market environments, and a collective downward movement in NAV challenged the notion that hedge funds consistently deliver uncorrelated returns.  Questions about fees followed promptly and inexorably from questions about returns; and a collective expectation developed that the traditional “2 and 20” hedge fund fee structure – a 2% management fee and a 20% performance allocation – would come under pressure and emerge from the crisis slimmed down to something like “1 and 10.”  But a funny thing happened on the road to recovery: the 2 and 20 model remained more or less intact.  Perhaps it was the overall robust returns of hedge funds from late 2009 through late 2010?  Or perhaps it was the argument – difficult to rebut and persuasively made by managers – that reducing fees can lead to a talent exodus and inadequate infrastructure investment, and thus works to the detriment of investors?  Or perhaps it was a combination of these and other factors?  But regardless of the reason, the fact remains: according to a recent survey by SEI and Greenwich Associates (citing data from Hedge Fund Research Inc. (HFRI)), the median management fee for single-manager hedge funds is 1.5% across all major strategies, and 40% of all hedge funds (and 100% of hedge funds following a “macro” strategy) still have a 2% management fee.  The SEI survey also found that performance fees typically remain unchanged at 20% for all major strategies.  However, fee levels are just one part of the picture of manager compensation and investor economics.  The other major determinant of what investors pay and what managers take home is fee structures.  And unlike fee levels, which have remained relatively stable, fee structures have been subject to considerable negotiation.  This article starts by discussing the structure, purpose, taxation and resilience of management fees and performance allocations.  The article then discusses in detail eight ways in which investors and managers have negotiated or renegotiated performance allocation structures.  The article concludes with a discussion of the role of investor size in negotiating for customized fee terms, and how regulation will impact such negotiations.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    Ten Steps That Hedge Fund Managers Can Take to Avoid Improper Transfers among Funds and Accounts

    On April 8, 2011, the SEC filed a complaint in the U.S. District Court for the Southern District of New York against Perry A. Gruss, the former chief financial officer of D.B. Zwirn & Co., L.P. (DBZ).  The complaint generally alleges that Gruss inappropriately authorized the transfer of cash from hedge funds and accounts managed by DBZ for four purposes: investments by the onshore fund with cash from the offshore fund; repayment of debt of the onshore fund with cash from the offshore fund; early payment of DBZ’s management fees by various funds and accounts; and purchase of an aircraft with funds from the onshore fund and a managed account.  The complaint relates a tale of meteoric growth at DBZ from October 2001 through October 2006.  By our reckoning based on figures in the complaint, DBZ’s AUM grew by $2.74 million per day during that five-year period.  However, the complaint also illustrates the fragility of even the most successful hedge fund management businesses.  DBZ was a great business that was laid low by alleged legal violations that in retrospect appear pedestrian and preventable.  This article relates the factual and legal allegations in the SEC’s complaint, then offers 10 detailed suggestions on how hedge fund managers can avoid the adverse consequences of violations such as those alleged against Gruss.

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  • From Vol. 4 No.13 (Apr. 21, 2011)

    Recent U.S. Tax Court Decision Suggests That Partners of Hedge Fund Management Companies Organized As Limited Partnerships May Be Subject to Self-Employment Tax

    The U.S. Tax Court has ruled against a law firm limited liability partnership that had taken the position that its partners were not subject to self-employment tax on their respective shares of partnership income.  The case is relevant to the hedge fund industry because some fund management companies are organized as limited partnerships whose individual limited partners also work for the partnership and render management services.  We summarize the Court’s decision, emphasizing the self-employment tax discussion.

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  • From Vol. 4 No.11 (Apr. 1, 2011)

    Investments by Family Offices in Hedge Funds through Variable Insurance Policies: Tax-Advantaged Structures, Diversification and Investor Control Rules and Restructuring Strategies (Part One of Two)

    Variable insurance policies are an often utilized structure through which family offices and other high net worth investors invest in hedge funds and other private investment funds.  One of the primary advantages of investing in hedge funds and other private investment funds through variable insurance policies is the deferral of income taxes.  However, policy holders must first satisfy two important tests – the “diversification rules” and the “investor control” rules – in order for the policies to qualify for favorable income tax treatment.  This article is the first in a two-part series of guest articles in the HFLR by James Schulwolf and Peter Bilfield, both Partners at Shipman & Goodwin LLP, and Lisa Zana, a Senior Associate at Shipman.  This article describes the mechanics of investing in an insurance dedicated fund through variable insurance policies and offers a roadmap for satisfying the two tests to ensure the variable insurance policies maintain their tax-advantaged status.  The second article in this series will describe in detail a recent restructuring transaction in which the authors participated and provide the key terms in the transaction documents applicable to the diversification and investor control rules.

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  • From Vol. 4 No.8 (Mar. 4, 2011)

    Redomiciling Offshore Investment Funds to Ireland, the European Gateway

    Alternative investment managers have increasingly chosen to domicile their funds in European jurisdictions in recent years rather than the Caribbean islands which have traditionally been the home domiciles for hedge funds.  Ireland has been a particularly significant beneficiary of this trend and the percentage of global hedge fund assets domiciled in Ireland has more than doubled over the last 18 months alone so that it now exceeds that of both Bermuda and the BVI.   Furthermore, recent industry statistics showed that 63 percent of European hedge funds were domiciled in Ireland, and this position as the dominant jurisdiction in Europe is continuing to grow.  In a guest article, Mark Browne, a Partner in the Financial Services Department of Mason Hayes+Curran, explores the key drivers behind the movement of offshore funds to Ireland and details the practical steps involved where an asset manager decides to redomicile an existing fund to that jurisdiction.

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  • From Vol. 4 No.7 (Feb. 25, 2011)

    Hedging into Africa through Cayman and Mauritius

    For decades, much of the African continent has been afflicted by political instability, war, famine and poverty.  Although these problems still remain for many in Africa, a number of African countries are beginning to see real economic growth and development.  Whilst it is uncertain whether events such as the current political upheaval along much of the Mediterranean coast of northern Africa or the vote for an independent state of South Sudan will hinder or spur economic growth in these particular areas, many African countries are nevertheless enjoying real economic growth and development.  As investors look to invest into Africa, they want to do so in a secure and tax efficient manner and are likely to seek out and rely on investment routes structured through reputable and internationally recognised jurisdictions.  The Cayman Islands and Mauritius tick these boxes, with both jurisdictions playing an important role in the investment process.  In a guest article, Kieran Loughran and Sonia Xavier, Partner and Associate, respectively, at Conyers Dill & Pearman, discuss, among other topics: the Cayman Islands as an efficient choice of domicile for hedge funds; Mauritius as a treaty-based jurisdiction; structuring and substance for Mauritius entities; tax advantages of Mauritius entities; and investment protection provided by Mauritius.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    IRS Enhancing Its Scrutiny of Tax Shelter Disclosures by Hedge Funds

    In late 2010, the IRS Office of Chief Counsel issued a memorandum indicating that some common “protective” disclosures that are made by hedge funds and other investment partnerships are inadequate.  This could result in significant penalties for a fund as well as its investors.  In a guest article, Joseph Pacello, a Tax Partner at Rothstein Kass, discusses: the legal and accounting background of the IRS memorandum, including relevant tax disclosure requirements; the IRS Office of Chief Counsel’s analysis in the memorandum; penalties for failure to properly disclose a reportable transaction; and the likely impact of the IRS memorandum for both funds of funds and direct trading funds.

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  • From Vol. 4 No.4 (Feb. 3, 2011)

    How Can Liquid Hedge Funds Be Structured to Accommodate Investments in Illiquid Assets?

    During the past decade, an increasing volume of hedge fund dollars has poured into traditional liquid strategies.  As a result, market inefficiencies have narrowed or vanished, and opportunities for arbitrage – and the alpha it can generate – have grown fewer and farther between.  In response, some hedge fund managers that traditionally focused on liquid strategies started investing at least part of their funds’ capital in private equity and other illiquid securities and assets.  However, using liquid fund vehicles to invest in illiquid assets has presented a variety of problems, including those relating to: taxation, liquidity, valuation, manager compensation, strategy drift, due diligence, expectations regarding returns and regulatory scrutiny.  While there has been considerable discussion regarding the convergence of hedge funds and private equity funds, the experience and aftermath of the credit crisis indicate that the convergence discussion should be more refined.  Convergence at the fund level is problematic because illiquids do not fit naturally into a liquid fund.  Convergence at the manager level – for example, the same manager managing both private equity funds and hedge funds – is marginally more palatable, but by and large, institutional investors have demonstrated a preference for managers who stick to their knitting.  In a guest article, Philippe Simoens, Senior Manager in Tax and Strategic Business Services for Weaver, an independent certified public accounting firm, addresses some of the reasons why illiquid assets present problems when housed in liquid funds – even liquid funds purportedly structured to accommodate illiquid investments via mechanisms such as side pockets.  In the course of doing so, this article explains traditional liquid fund structuring and taxation; characteristics and taxation of marketable securities versus private equity; and structures employed by liquid funds to accommodate illiquid assets (including side pockets, lock-ups, gates and redemption suspensions).  The article concludes with thoughts on structuring for managers who traditionally have focused on liquid strategies, but who are exploring illiquid opportunities.

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  • From Vol. 4 No.2 (Jan. 14, 2011)

    Accounting for Uncertain Income Tax Positions for Investment Funds

    FIN 48, now included in ASC Topic 740 (Income Taxes) under the Financial Accounting Standards Board’s Codification, was issued in 2006 and after two one-year deferrals became effective for all entities issuing financial statements under Generally Accepted Accounting Principles (GAAP) for years beginning after December 15, 2008.  FIN 48 was issued as an interpretation of FASB Statement 109, Accounting for Income Taxes, with the intent of reducing the diversity of practice in financial accounting for income taxes, including U.S. federal, state and local taxes as well as foreign taxes.  A major component of FIN 48 is that its reach includes all statutory open tax years, not just the accounting reporting year.  This requires that each year is looked at on a cumulative basis.  Entities that report on a non-GAAP basis, such as International Financial Reporting Standards (IFRS), are not subject to FIN 48.  FIN 48 has become a hot topic for fund managers and their auditors.  Given the complicated nature of fund structures, global investment strategies and the variety of financial products that managers invest in, it is an important area, and one to which managers should allocate sufficient resources.  In a guest article, Michael Laveman, a Partner at EisnerAmper LLP, discusses in detail the four-step process for adoption of and compliance with FIN 48.

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  • From Vol. 3 No.43 (Nov. 5, 2010)

    Structuring, Valuation, Fee Calculation and Other Legal and Accounting Considerations in Connection with Hedge Fund General Redemption Provisions, Lock-Up Periods, Side Pockets, Gates, Redemption Suspensions and Special Purpose Vehicles

    Due to the recent financial crisis, the hedge fund industry has experienced significant investor redemptions along with reduced availability of credit and leverage from prime brokers and other financial institutions.  As a result, certain shortcomings have been revealed in the way hedge funds have been managed, including liquidity mismatches identified between investment portfolio assets and liabilities and redemption restriction provisions contained in fund offering documents.  The liquidity mismatch dilemma was quite a shock for many hedge fund investors who were unable to withdraw capital according to required redemption terms upon the freezing of the credit markets.  Redemption restriction provisions such as lock-ups and gates have become commonplace as hedge funds have evolved from traditional strategies which primarily invested in liquid securities.  Hedge fund offering documents generally contain multiple liquidity provisions that enable fund managers to manage the liquidity needs of investors without selling assets at distressed prices or disposing of liquid assets while leaving the most illiquid investments to remaining investors.  Financial statements of hedge funds prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) usually contain disclosures of liquidity provisions specified in the fund offering documents.  In a guest article, Fredric S. Burak and Cindy Shen, both partners at EisnerAmper LLP, generally discuss the various liquidity provisions contained in hedge fund offering documents as well as the relevant accounting and financial statement reporting requirements and practices related to such provisions.  Specifically, Burak and Shen describe market practice regarding structuring of redemption provisions, including discussions of Accounting Standards Codification Topic 480 (formerly FAS 150), frequency of permitted redemptions, holdback provisions and in-kind distributions; lock-up periods, including discussions of “hard” and “soft” lock-ups and the use of sub-accounts within capital accounts; investor-level and fund-level gates and related disclosure considerations; suspensions of redemptions; side pockets and designated investments (i.e., investments placed in side pockets); the interplay between valuation of designated investments, US GAAP and the Custody Rule; calculation of management and performance fees with respect to designated investments; reporting performance of designated investments; structuring, fees and books and records considerations in connection with special purpose vehicles; and market color with respect to: typical length of lock-up periods, the relationship between strategy and length of lock-up; investor receptivity to various lock-up period lengths, percentage of assets typically subject to a gate on any redemption date, the “market” for the number of successive redemption dates to which excess redemptions may be carried over, opt-out rights with respect to side-pockets and renewed SEC attention on disclosure relating to side pockets.

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  • From Vol. 3 No.34 (Aug. 27, 2010)

    Foundation for Accounting Education’s “2010 Hedge Funds and Alternative Investments” Conference Focuses on Taxation of Hedge Funds and Hedge Fund Managers, Structuring, Valuation, Risk Management, Due Diligence, Insurance and Regulatory Developments

    On July 29, 2010, the Foundation for Accounting Education (FAE) presented its 2010 Hedge Funds and Alternative Investments Conference in New York City.  Speakers at the one-day event focused on a range of issues impacting the hedge fund industry, including: FIN 48 (which relates to accounting for uncertain tax liabilities); ASU 2010-10 (which amends Statement of Financial Accounting Standards No. 167, which in turn requires nonpublic companies to publicly disclose their interests in variable interest entities in a similar manner to the disclosure provided by public entities); carried interest taxation developments; state and local tax developments relevant to hedge fund managers; tax implications of globalization of the hedge fund industry; special purpose vehicles; blockers; unrelated business taxable income and effectively connected income; mini-master funds; master-feeder and side-by-side structures; International Financial Reporting Standards; valuation trends; risk management; due diligence; insurance; and regulatory developments.  This article details the key points discussed during the conference.

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  • From Vol. 3 No.31 (Aug. 6, 2010)

    IRS Private Letter Ruling Offers Guidance to Hedge Funds Investing in Auction Rate Preferred Shares

    The classification of interests issued by closed-end funds as debt or equity for tax purposes has significant ramifications for hedge funds that invest in such funds.  Interests that are classified as debt generally allow holders to treat payments received from the fund as interest income and nontaxable principal repayments.  By contrast, interests that are classified as equity generally allow investors to receive dividends, capital gains or a mixture of the two.  A recent private letter ruling (PLR) issued by the Internal Revenue Service (IRS or Service) addressed the classification of preferred stock issued by a closed-end fund as debt or equity.  The IRS determined that the preferred stock should be classified as equity for federal tax purposes.  The PLR is significant for a variety of reasons.  First, the fact that the PLR was issued at all represents a change in procedure for the IRS, which previously declined to issue rulings on the classification of financial instruments as debt or equity because of the fact-specific nature of such classifications.  Second, the PLR has implications for hedge funds interested in the auction rate preferred shares market.  This article examines the PLR, its background and its potential significance for hedge funds invested or considered an investment in auction rate preferred shares.

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  • From Vol. 3 No.26 (Jul. 1, 2010)

    Potential Changes to Partnership Income Allocation Rules May Alter the Timing and Manner of Receipt of Income by Key Personnel at Hedge Fund Managers

    On April 13, 2009, the Internal Revenue Service proposed regulations under Section 706(d) of the Internal Revenue Code (IRC) that could affect the timing and manner of receipt of income, gains and losses by key personnel at hedge fund management companies organized as partnerships or limited liability companies taxed as partnerships.  The proposed regulations will become effective upon adoption, but no earlier than the first partnership taxable year beginning in 2010.  Generally, the proposed regulations would require partnerships to take into account variations in partners’ interests during a taxable year and would prescribe two methods for doing so – an “interim closing of the books” method and a “proration” method.  In addition, the proposed regulations provide guidance on the appropriate allocation of “extraordinary items” and the effect on allocations of changes to partnership agreements.  Finally, the proposed regulations contain a safe harbor for services partnerships and publicly traded partnerships, clarify the allocation of deemed dispositions and amend the minority interest rule.  This article discusses the current “varying interest rule” under IRC Section 706 and details the ways in which the proposed regulations would change the current allocation regime.  In particular, this article discusses the mechanics of the two alternative allocation methods provided in the proposed regulations, timing conventions, changes in partnership allocations among contemporaneous partners, safe harbors, deemed dispositions and the minority interest rule.  This article also discusses the implications of the proposed regulations for hedge fund managers and hedge funds.  In brief, the proposed regulations are likely to have a greater impact on managers than funds because variations in interests of limited partners in hedge funds are and are accounted for as ordinary course events, while variations in interests of partners in hedge fund management companies are non-ordinary course.  That is, subscriptions to and redemptions from a hedge fund occur routinely, whereas the admission of a new partner to a management company, or the termination of such a partner, occur only once in a while.  It is the admission or termination of such key hedge fund manager personnel, or changes in interests of existing key personnel, that could be more directly impacted by the proposed regulations.

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  • From Vol. 3 No.16 (Apr. 23, 2010)

    Single Investor Hedge Funds Offer the Benefits of Managed Accounts and Additional Tax and Other Advantages for Hedge Fund Managers and Investors

    Managed accounts started 2010 as the ostensible antidote to many of the more egregious evils experienced by hedge fund investors over the last two years.  Managed accounts offer transparency, liquidity, control and risk management, whereas during the credit crisis, many hedge funds and other investment vehicles offered opacity, gates, lack of control and increased risk.  While the case for managed accounts is not without valid objections – including administrative cost, allocation issues and other issues discussed more fully below – managed accounts are an increasingly popular method of accessing hedge fund strategies and managers while avoiding the downsides of commingled funds.  According to a February 2010 survey conducted by Preqin, the alternative investment data provider, 16 percent of institutional investors have a current allocation to managed accounts and a further 23 percent of institutional investors are considering an initial allocation to a managed account during 2010.  Similarly, 65 percent of fund of funds managers surveyed by Preqin either operate a managed account currently or are considering doing so during 2010.  Preqin also found that larger investors are more likely to demand, and larger managers are more likely to offer, managed accounts, and that the proportion of fund of funds managers operating managed accounts is greatest in North America (60 percent), followed by Asia and rest of world (including Hong Kong, Singapore, Japan and Israel, at 44 percent) then Europe (40 percent).  Recently, various hedge fund managers have been exploring an alternative structure that effectuates many of the goals of managed accounts, while offering a number of additional benefits and avoiding at least one of the chief downsides.  That alternative structure is the single investor hedge fund – as the name implies, a hedge fund with one outside investor (in addition to the manager’s investment).  To assist hedge fund managers and investors in evaluating whether a single investor hedge fund may be an appropriate alternative to a traditional hedge fund, on the one hand, or a managed account, on the other hand, this article discusses: the definition of a managed account; the six chief benefits and eight primary burdens of managed accounts versus hedge funds; the definition of a single investor hedge fund; the six chief benefits of single investor hedge funds over managed accounts; and the two primary downsides of single investor hedge funds versus managed accounts.

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  • From Vol. 3 No.12 (Mar. 25, 2010)

    IRS Directive and HIRE Act Undermine Tax Benefits of Total Return Equity Swaps for Offshore Hedge Funds

    As explained more fully below, total return equity swaps (TRSs) generally are contracts, often between a financial institution and a hedge fund, whereby the financial institution agrees to pay the hedge fund the total return of the reference equity during the swap term (including capital gains and dividends), and the hedge fund agrees to pay the financial institution the value of any decline in the price of the reference equity and interest on any debt embedded in the swap.  In other words, the financial institution pays the hedge fund any upside, and the hedge fund pays the financial institution any downside plus interest.  In this sense, the financial institution is the short party to the swap, and the hedge fund is the long party.  Traditionally, hedge funds have used TRSs for three principal purposes, among others.  First, hedge funds have used TRSs to gain economic exposure to companies without obtaining beneficial ownership of the stock of those companies, thereby avoiding the obligation to file a Schedule 13D and preserving the secrecy of incipient activist campaigns.  Second, offshore hedge funds have used TRSs to obtain economic exposure to dividend-paying U.S. stocks while avoiding the 30 percent withholding tax typically imposed on dividends paid by U.S. public companies to non-U.S. persons.  Offshore hedge funds have been able to use TRSs to avoid such withholding tax because, until recently, dividends were subject to withholding but “dividend equivalent payments” – the amount paid by a financial institution to a hedge fund under a swap by reference to the dividend paid by the relevant equity – were not.  Third, hedge funds have used TRSs to obtain leverage.  That is, the traditional way to get exposure to the total return of a stock was to buy it.  However, TRSs enable hedge funds to get exposure to the total return of a stock by entering into a contract with a financial institution and posting initial and variation margin (which, even taken together, often constitute only a fraction of the market price of the stock).  The first two of those purposes have been dramatically undermined by judicial and legislative action.  Specifically, with respect to the use of TRSs in activist campaigns, in June 2008, the U.S. District Court for the Southern District of New York held that two hedge funds that had accumulated substantial economic positions in publicly-traded railroad operator CSX Corporation, principally via cash-settled TRSs, were deemed to have beneficial ownership of the hedge shares held by their swap counterparties.  Accordingly, the court found that one of the hedge fund group defendants, The Children’s Investment Fund Management (UK) LLP and related hedge fund and advisory entities, violated Section 13(d) of the Securities Exchange Act of 1934 by failing to file a Schedule 13D within ten days of the date on which its beneficial ownership exceeded five percent.  See “District Court Holds that Long Party to Total Return Equity Swap May be Deemed to have Beneficial Ownership of Hedge Shares Held by Swap Counterparty,” The Hedge Fund Law Report, Vol. 1, No. 14 (Jun. 19, 2008).  With respect to the second purpose described above, in January of this year, the IRS issued an industry directive (Directive) outlining TRS structures that, in the agency’s view, may be used to improperly avoid withholding tax on dividends.  See “New IRS Audit Guidelines Target Equity Swaps with Non-U.S. Counterparties,” The Hedge Fund Law Report, Vol. 3, No. 3 (Jan. 20, 2010).  More recently, on March 18, 2010, President Obama signed into law the Hiring Incentives to Restore Employment (HIRE) Act (H.R. 2847), which contained provisions originally proposed as part of the Foreign Account Tax Compliance Act of 2009.  See “Bills in Congress Pose the Most Credible Threat to Date to the Continued to the Continued Tax Treatment of Hedge Fund Performance Allocations as Capital Gains,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).  Among other things, the HIRE Act will impose a 30 percent withholding tax on dividend-equivalent payments made to non-U.S. persons on or after September 14, 2010 on certain TRSs or pursuant to securities loans and “repo” transactions.  While there is significant overlap between the TRSs targeted in the Directive and those for which withholding will be required under the HIRE Act, the HIRE Act covers a broader range of TRSs.  While the third purpose of TRSs identified above – providing leverage – remains reasonably intact, the CSX case, the Directive and the HIRE Act collectively challenge the utility of TRSs for hedge funds, pose unique structuring challenges and change market dynamics that have existed for 20 years.  Yet the Directive and HIRE Act may also, like other facially adverse actions or events, offer opportunities.  With the goal of helping hedge fund managers navigate the changing tax consequences of TRSs, this article describes: the mechanics of TRSs in greater depth; the business benefits and burdens of TRSs; the Directive, including the specific scenarios identified by the IRS as meriting further attention from field agents; the relevant provisions of the HIRE Act; the likely market impact of the Directive and HIRE Act, including the specific impact on financial institutions, master-feeder hedge fund structures and TRSs written on a “basket” of equities; and potential structuring alternatives to avoid the adverse tax consequences of the Directive and HIRE Act.

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  • From Vol. 3 No.11 (Mar. 18, 2010)

    Simple Goals in a Complex World: Estate Planning for Hedge Fund Interests

    In a guest article, Steven D. Leipzig and Lori I. Wolf, both Members of law firm Cole, Schotz, Meisel, Forman & Leonard, P.A., and Steven M. Saraisky, an Associate at Cole Schotz, provide an introduction to estate planning considerations for hedge fund managers and hedge fund interests.  The authors first describe some fundamental concepts of sophisticated estate planning, and the typical structure of a hedge fund investment.  They then discuss certain approaches to estate planning with both a new hedge fund investment and an existing hedge fund investment.  The authors’ goal is to provide subscribers to The Hedge Fund Law Report with an understanding of the family planning and tax savings results that can be achieved with this kind of estate planning.

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  • From Vol. 3 No.9 (Mar. 4, 2010)

    Bill Redefining “Acquisition Indebtedness” for UBTI Purposes Could Diminish, But Likely Would Not Eliminate, Utility of “Blockers” in Hedge Fund Structures

    A significant and growing proportion of the assets invested in hedge funds globally come from U.S. tax-exempt entities such as endowments, foundations, state pension funds and corporate pension funds that are “qualified” under Internal Revenue Code (IRC) Section 501(a).  Mechanically, tax-exempt entities generally invest in a corporation organized in a low-tax or no-tax, non-U.S. jurisdiction, which in turn invests in an entity that buys and sells securities and other assets.  The buying and selling entity is often organized in a tax-advantaged, non-U.S. jurisdiction as a corporation that “checks the box” for partnership treatment for U.S. tax purposes (although other structures and entity types are also used).  See “Implications of Recent IRS Memorandum on Loan Origination Activities for Offshore Hedge Funds that Invest in U.S. Debt,” The Hedge Fund Law Report, Vol. 2, No. 41 (Oct. 15, 2009).  Tax-exempt hedge fund investors go through these contortions to avoid paying tax, at corporate tax rates, on so-called Unrelated Business Taxable Income (UBTI).  As explained in more detail in this article, the portion of interest, dividends and capital gains generated by a domestic hedge fund in a tax year based on “acquisition indebtedness” will constitute UBTI on which U.S. tax-exempt investors in that fund will owe tax at corporate rates.  Specifically, a domestic hedge fund’s UBTI for a tax year generally is equal to the fund’s total interest, dividends and capital gains for the tax year times a percentage, the numerator of which is the fund’s average acquisition indebtedness and the denominator of which is the average cost basis of the fund’s investments.  For example, if a domestic hedge fund had a total return (including interest, dividends and capital gains) for the tax year of $20 million, an average cost basis of $100 million and average acquisition indebtedness of $30 million, the fund would have $6 million of UBTI for the tax year.  That UBTI would be allocated pro rata to the fund’s tax-exempt investors for tax purposes.  So if the fund had two tax-exempt investors with equal investments, at a corporate tax of 35%, each would owe tax of $1.05 million on its distributive share of the fund’s UBTI for the tax year.  By contrast, if a tax-exempt investor invests in a corporation that in turn invests in a lower-tier trading entity, the UBTI created by the trading entity’s acquisition indebtedness will not flow through to the tax-exempt investor, and the investor will not owe tax on the UBTI (unless the investor’s purchase of shares in the corporation was itself financed by acquisition indebtedness).  This is because the Internal Revenue Service respects the ability of corporations to “block” UBTI.  See “IRS ‘Managed Funds Audit Team’ Steps Up Audits of Hedge Funds and Hedge Fund Managers, and Investigations of Hedge Fund Tax Compliance Issues,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  On July 31, 2009, Rep. Sander Levin (D-MI) introduced H.R. 3497, a bill that would revise the definition in the IRC of “acquisition indebtedness” to exclude debt incurred by a U.S. partnership for investments in “qualified securities or commodities.”  (Levin had introduced similar legislation in 2007.)  In short, if Levin’s bill were to become law, it would diminish the rationale for investments by U.S. tax-exempt investors in hedge funds via offshore corporations.  However, offshore corporations exist in hedge fund structures for reasons other than blocking UBTI, so even if Levin’s bill were to become law, the case for offshore corporations could remain compelling.  This article offers a more comprehensive discussion of the taxation of UBTI; tax-exempt investor attitudes towards UBTI; structuring of hedge funds to enable tax-exempt investors to avoid UBTI; the mechanics of the Levin bill; the potential impact of the Levin bill if enacted on tax-exempt hedge fund investors as well as non-U.S. investors; and the likelihood of enactment of the Levin bill.

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  • From Vol. 3 No.5 (Feb. 4, 2010)

    Offshore Fund Vehicles: Do U.S. Investment Managers Need Them?

    With the green shoots of recovery beginning to emerge in the U.S. and significant amounts of capital withdrawn during the last twelve months beginning to be redeployed back into fund structures, should U.S. investment managers now be looking to establish offshore fund vehicles?  If so, what sources of capital should U.S. investments managers be looking to attract to invest into these offshore fund vehicles?  Additionally, with offshore jurisdictions subjected to more scrutiny than ever before, which jurisdictions should U.S. investment managers be looking to go to in order to domicile their offshore fund vehicles?  These are all important questions which U.S. investment managers and their advisors are frequently asking and which are worthy of consideration and analysis.  In a guest article, Ogier Partner Simon Schilder addresses these questions and discusses: the rationale for organizing offshore investment vehicles; potential changes to the unrelated business taxable income rules; the Alternative Investment Fund Manager Directive in the European Union; and considerations when selecting an offshore jurisdiction for organization of a hedge fund.

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  • From Vol. 3 No.4 (Jan. 27, 2010)

    What Effect Will the Carried Interest Provision in the Tax Extenders Act Have on Hedge Fund Managers that Are or May Become Publicly Traded Partnerships?

    On December 9, 2009, the U.S. House of Representatives passed legislation that includes a provision that would tax as ordinary income any net income derived with respect to an “investment services partnership interest.”  This carried interest provision in the Tax Extenders Act of 2009, H.R. 4213, would change the tax treatment of the performance allocation that, in years in which a hedge fund has positive investment performance, constitutes the bulk of a hedge fund manager’s revenue.  Currently, most managers structure performance allocations so that all or most of such compensation is taxed as long-term capital gains at a rate of 15 percent.  The carried interest provision would subject such compensation to tax at ordinary income rates, which for hedge fund managers generally would be at a marginal rate of approximately 35 percent.  For more discussion of the Tax Extenders Act, see “Bills in Congress Pose the Most Credible Threat to Date to the Continued Tax Treatment of Hedge Fund Performance Allocations as Capital Gains,” The Hedge Fund Law Report, Vol. 2, No. 52 (Dec. 30, 2009).  The Extenders Act also contains a provision that would effectively cause any publicly traded partnership (PTP) that derives significant income from investment advisory or asset management services to be treated, for tax purposes, as a corporation.  This is because the provision would treat carried interest income as non-qualifying income for purposes of determining whether a PTP meets the 90 percent “good income” test.  That test specifies that partnerships that (1) satisfy the 90 percent good income test (described in more detail in this article) and (2) are not registered under the Investment Company Act of 1940 will, in general, continue to be treated as partnerships and not as Subchapter C corporations for federal income tax purposes.  This article examines the federal tax treatment of the carried interest received by hedge fund managers, as well as the tax treatment of PTPs.  The article also outlines the likely effects of the Extenders Act on the tax treatment of both, and explains tax planning steps that hedge fund managers may take to avoid some of the adverse tax consequences of the bill.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    IRS Issues Guidance on Compliance with Section 409A Requirements Applicable to Deferred Compensation Plans of Hedge Fund Managers

    In 2004, as part of the American Jobs Creation Act, Congress amended the Internal Revenue Code to include Section 409A, which generally requires recipients of deferred compensation to elect the time and form of deferred compensation payments in a manner that complies with Section 409A and Sec. 1.409A-1(c) of the Income Tax Regulations.  Failure to elect time and form properly, or utilizing an acceleration of deferred compensation payments, can subject the employee, director, independent contractor or other “service provider,” which may be an individual, corporation, partnership or limited liability company, to an additional 20 percent income tax, accelerated taxation of the deferred payments and heightened interest assessments.  Section 409A was enacted in response to the corporate scandals of the early Naughts, such as Enron, Tyco and WorldCom, and was intended to curb the practice of executives deferring large amounts of compensation and to eliminate the ability of executives to vary the payment schedule by which they received deferred compensation.  In attempting to curb these perceived “evils,” Congress, in enacting Section 409A, created a statute that is hyper-technical in its application, with harsh penalties for noncompliance.  Hedge fund managers, who may be considered “service providers” under the statute, should examine compensation plans that include any form of deferred compensation, including deferral of management or performance fees, for compliance with Section 409A.  Because the penalties for noncompliance are harsh, the Internal Revenue Service (IRS) has issued guidance on correcting plan failures.  In 2008, the IRS provided guidance on operational failures.  However, on January 5, 2010, the IRS issued Notice 2010-6, which provides guidance on correcting document failures.  Both notices provide guidance relevant to hedge fund managers and should be closely examined.  This article examines the scope of Section 409A and Notice 2010-6 and details the applicability of both to hedge funds and hedge fund managers.

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  • From Vol. 3 No.3 (Jan. 20, 2010)

    New IRS Audit Guidelines Target Equity Swaps with Non-U.S. Counterparties

    On January 14, 2010, the Large and Mid-Scale Business division of the IRS issued its “Industry Directive on Total Return Swaps Used to Avoid Dividend Withholding Tax” (Swap Audit Guidelines).  In addition to providing audit guidance to IRS field agents auditing U.S. financial institutions and U.S. branches of foreign financial institutions, the Swap Audit Guidelines contain six Information Document Requests for agents to use to solicit information from financial institutions that have equity swap operations.  The new guidance is substantially more detailed than the previous guidance.  As a result, IRS audits of financial institutions undertaken in accordance with the Swap Audit Guidelines are likely to impose a significant compliance burden on affected companies.  The purpose of the Swap Audit Guidelines is to assist IRS agents in “uncovering and developing cases related to total return swap transactions that may have been executed in order to avoid tax with respect to U.S. source dividend income” paid to non-U.S. persons.  The Swap Audit Guidelines posit four different transaction structures involving equity swaps.  If an IRS agent uncovers one of these fact patterns, he is encouraged to “develop facts supporting a legal conclusion that the Foreign Person retained ownership of the reference securities.”  In a guest article, Greenberg Traurig, LLP Shareholder Mark Leeds examines those four transaction structures in depth, and discusses the implications of the Swap Audit Guidelines for over-the-counter derivatives markets participants.

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  • From Vol. 2 No.52 (Dec. 30, 2009)

    Bills in Congress Pose the Most Credible Threat to Date to the Continued Tax Treatment of Hedge Fund Performance Allocations as Capital Gains

    On December 9, 2009, the U.S. House of Representatives passed the Tax Extenders Act of 2009 (Extenders bill), H.R. 4213.  The bill, if it were to become law, would extend through the end of 2010 a package of tax relief provisions that otherwise would expire at the end of 2009.  Of particular interest to hedge fund managers are several provisions of the Extenders bill included with the goal of raising revenue to offset extended tax relief measures.  Specifically, the bill includes a provision that would tax as ordinary income any net income derived with respect to an “investment services partnership interest.”  The bill defines “investment services partnership interest” as a partnership interest held by a person where it is reasonably expected that the partner or a person related to the partner will provide substantial investment services to the partnership.  The result of this provision would be to change the tax treatment of the performance allocation that constitutes, in up years, the bulk of hedge fund manager revenue.  Currently, most managers structure performance allocations so that all or most of such compensation is taxed as long-term capital gains at a rate of 15 percent.  The Extenders bill would tax such compensation as ordinary income, generally for hedge fund managers at a marginal rate of approximately 35 percent.  In addition, as ordinary income, such compensation would be subject to any applicable self-employment taxes and state and local taxes.  See generally “IRS ‘Managed Funds Audit Team’ Steps Up Audits of Hedge Funds and Hedge Fund Managers, and Investigations of Hedge Fund Tax Compliance Issues,” The Hedge Fund Law Report, Vol. 2, No. 34 (Aug. 27, 2009).  As discussed in more detail in this article, the Extenders bill also includes provisions that are similar to the reporting provisions in the proposed Foreign Account Tax Compliance Act of 2009 (FATCA), introduced in the Senate as S. 1934 and in the House (with the same name) as H.R. 3933.  With the support of President Obama and Treasury Secretary Geithner, FATCA was introduced on October 27, 2009 as a means of combating overseas tax havens.  FATCA would affect all foreign financial institutions (FFIs) that invest in U.S. stocks and securities.  Complying FFIs would be required to report financial account information of all U.S. persons to the Internal Revenue Service or subject all payments of U.S. source passive income and gross proceeds from the sale of U.S. securities to a 30 percent withholding tax.  This article details and analyzes the provisions of the Extenders bill and FATCA that are most relevant to hedge fund managers.  Where provisions of the two bills are similar, this article compares specific mechanics.  This article also highlights the differences between the two bills, and discusses, with the benefit of insight from leading practitioners, the implications of the bills for hedge fund manager compensation, tax planning, domicile, structuring, reporting, treatment of so-called “recalcitrant account holders” and more.

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  • From Vol. 2 No.50 (Dec. 17, 2009)

    Implications of the New U.K. Offshore Funds (Tax) Regulations for U.K. and Global Hedge Fund Managers and Investors

    On November 12, 2009, the new Offshore Funds (Tax) Regulations 2009 were enacted in the United Kingdom (U.K.).  At a general level, the new U.K. tax regime may have a profound effect on the tax rate paid by U.K.-based investors in offshore hedge funds.  Specifically, the new regime has the potential to narrow the circumstances in which U.K.-based investors in offshore hedge funds are required to pay tax on most returns at higher income tax rates, as opposed to lower capital gains tax rates.  Next year, the highest marginal income tax rate in the U.K. may rise to 50 percent, while the capital gains rate for individuals is likely to remain at 18 percent.  While the new regulations remain subject to final legal and technical checks, they will be effective for accounting periods beginning on or after December 1, 2009.  For several years, the U.K. government has been working on replacing the “distributing funds” tax regime with a “reporting funds” regime; the new regulations embody a “reporting funds” regime.  Although the general purpose of both regimes is the same – to prevent investors from rolling up income offshore and paying tax at a lower capital gains rate when the relevant investment is sold – the change in regime may affect the type of fund that may generate returns subject to capital gains treatment for U.K. investors.  This article outlines the mechanics of the new regulations and examines their likely effect on U.K. and global hedge fund managers and investors.  In particular, this article details: the definition of “offshore fund” under the new regulations; reporting versus distributing funds; the new rules with respect to investments by offshore funds in other offshore funds; transitional arrangements; cross investments; the white list of qualifying transactions that will be treated for tax purposes as investment activities as opposed to trading activities; and administrative and legal consequences of the new tax regime.

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  • From Vol. 2 No.45 (Nov. 11, 2009)

    Hedge Fund Managers Considering Fund Appreciation Rights Compensation Structures to Defer Tax on Performance Compensation and to Better Align Manager and Investor Incentives

    In the public company context, before stock options got a bad name via backdating scandals and unintended consequences (a skewing of incentives towards the short-term, unintended windfalls, etc.), they were seen as a potent tool for mitigating the adverse effects of the oft-bemoaned separation of ownership and control.  Executive compensation debates, however, are not the exclusive province of commentators on public companies.  The credit crisis focused the attention of hedge fund investors on executive compensation at hedge fund managers in a way that good times never could.  See “Addressing (and Resisting) Demands for Changes in Hedge Fund Manager Compensation,” The Hedge Fund Law Report, Vol. 2, No. 16 (Apr. 23, 2009).  As distinct from discussions of executive compensation at public companies, where the chief criticism often relates to the absolute level of compensation, hedge fund manager compensation discussions more often relate to the structure of compensation.  In particular, one of the primary criticisms leveled during the credit crisis was that measuring performance fees over one year failed adequately to reflect the reality of most hedge fund investment strategies, which require more than one year for realization.  Similarly, the idea of measuring performance compensation over a single year has been criticized as incentivizing managers to take undue risks and for potentially rewarding negative performance over multiple years.  In an effort to better align the incentives of managers and investors, hedge fund managers have been evaluating the viability of fund appreciation rights (FARs), which offer a mechanism of manager compensation analogous to stock options.  This article explores this provocative compensation structure, and includes analysis of: the mechanics of FARs; the analogy to call options; how FARs may offer the potential to better align the incentives of managers and investors; the clawback mechanism often built into FARs; a numerical example of how a FARs structure could operate in practice; how FARs can help retain talent, especially in lean years; whether FARs can be used in existing funds in addition to new funds; whether FARs can be used in domestic funds in addition to offshore funds; the tax consequences of FARs; and the market interest in FARs.

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  • From Vol. 2 No.42 (Oct. 21, 2009)

    How Will the New Cayman Islands Insolvency Regime Affect the Winding-Up of Cayman Islands Hedge Funds?

    On March 1, 2009, the Cayman Islands Legislative Assembly implemented a new insolvency regime applicable to, among others, hedge funds organized there.  Market participants surveyed by The Hedge Fund Law Report agree that the new regime does not dramatically change the insolvency regime applicable to hedge funds, but may empower liquidators and courts to pursue claims by insolvent companies of fraudulent pre-petition trading.  This article reviews the mechanics of the new insolvency regime that are relevant to hedge funds (including providing statutory language); the new regime’s effect on the powers of liquidators and courts; whether the outcome in the case In the Matter of Strategic Turnaround Master Partnership Limited (12 December 2008) would have been different had the new regime been in effect in December 2008, when the case was decided; the “cash flow” definition of insolvency in the Cayman Islands; when a Cayman Islands hedge fund investor becomes a creditor of the hedge fund from which the investor has redeemed; the anticipated impact of the legal changes on the number of hedge funds domiciled in the Caymans; the effect of the law on in-kind redemptions; and the likelihood that the Caymans will impose an income or capital gains tax on hedge funds or their managers to make up a budget shortfall.

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  • From Vol. 2 No.41 (Oct. 15, 2009)

    Implications of Recent IRS Memorandum on Loan Origination Activities for Offshore Hedge Funds that Invest in U.S. Debt

    On September 22, 2009, the Internal Revenue Service (IRS) Office of Chief Counsel issued a memorandum concluding that “interest income received by a foreign corporation with respect to loans that it originated to U.S. borrowers constitutes income effectively connected” with the conduct of a U.S. trade or business and is subject to net income tax in the U.S.  Some hedge fund managers – especially those with funds focused on credit or lending – are concerned that the memo presages more focused attention by the IRS on investments by offshore hedge funds in U.S.-based debt.  Other managers think the memo’s effect on hedge funds may be limited because it addresses a narrow fact pattern that differs in important ways from the typical approach taken by offshore funds to investments in U.S. debt.  However, even those that distinguish the memo on its facts concede that, at a broader level, the memo may indicate a disposition on the part of the IRS to take a harder look at lending activities by offshore entities in general.  The concern here is that even if this memo does not capture typical hedge fund investments within its purview, another memo that does may be in the offing.  This article details the fact pattern and legal conclusions of the memo, then analyzes the potential implications of the memo for offshore hedge funds.  In particular, the article explores: the extent to which the fact pattern in the memo resembles and departs from the typical structure of investments by offshore hedge funds in U.S. debt; efforts by offshore funds to structure debt investments to fit within the securities trading safe harbor; the components of lending activities that typically are and are not carried on by offshore hedge funds; secondary market purchases of U.S. debt by offshore hedge funds; whether the memo applies with greater or lesser force to the purchase by offshore hedge funds of loan portfolios; the leveling effect of the memo on the difference between independent and dependent agents; the effect of the memo on the tax concept of an “office” in the U.S.; and how the memo has already and is likely to, going forward, affect the structuring of offshore hedge funds.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    Key Tax Considerations for Hedge Funds When Investing in Life Settlements

    As discussed in an article last week’s issue of The Hedge Fund Law Report, life settlements offer hedge funds an uncorrelated investment category in an era when even assets heretofore considered uncorrelated have fallen in unison.  That article, the first in a three-part series, provided a detailed overview of the primary legal and business considerations applicable to hedge funds when investing in life settlements.  See “Hedge Funds Turning to Life Settlements for Absolute, Uncorrelated Returns,” The Hedge Fund Law Report, Vol. 2, No. 39 (Oct. 1, 2009).  As in any investment, tax can have a profound effect on the economic return of life settlement investments.  Accordingly, this article, the second in the three-part series, focuses on the tax considerations relevant to hedge funds, hedge fund managers and hedge fund investors in connection with investments in life settlements, including: taxation of life settlements (including income versus capital gains treatment of the “gain” on life settlements); varying tax consequences for domestic and offshore hedge funds and hedge fund investors; the impact of recent Internal Revenue Service (IRS) Revenue Rulings on the tax consequences of life settlement investments; relevant tax rules for offshore hedge funds (including “limitation of benefits” provisions, treaties, “effectively connected income” considerations, relevance of the jurisdictions of investors and “anti-avoidance” rules); the special cases of Ireland and Luxembourg, and the “double taxation” treaties between those jurisdictions, on the one hand, and the U.S., on the other hand (and the absence of such treaties between the U.S. and other jurisdictions, notably the Cayman Islands); the utility of the UCITS structure for investing in life settlements; tax consequences of premium financing arrangements; and the future of life settlement taxation in light of certain items in President Obama’s proposed budget.  Part three in this series will focus in more depth on securitization of life settlements.

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  • From Vol. 2 No.40 (Oct. 7, 2009)

    How Can Hedge Fund Managers Minimize Tax on Deferred Compensation from Offshore Hedge Funds?

    Hedge fund managers are painfully aware of the U.S. government’s efforts to eliminate the tax benefits associated with their foreign deferred compensation plans.  In 2004, Congress amended the Internal Revenue Code by adding Section 409A, which prohibited the use of foreign trusts in connection with deferred compensation plans.  More recently, in 2008, Congress enacted IRC § 457A, which makes foreign deferred compensation plans fully income taxable as of January 1, 2017.  As a result, the tax bar has been working overtime to develop tax compliant strategies that would mitigate the disastrous effects of Congress’ campaign to increase taxes on hedge fund managers’ income.  Tax attorneys’ efforts have, however, been largely unsuccessful – until now.  In a guest article, Kenneth Rubinstein, Senior Partner at Rubinstein & Rubinstein, LLP, details one strategy that has been developed that will significantly minimize the income tax payable on foreign deferred compensation and blunt the effect of IRC § 457A in a tax compliant manner.  Based on the use of a “hybrid” trust that avoids the prohibitions of IRC § 409A and utilizing the long-standing tax advantages that Congress and the Internal Revenue Code bestow upon life insurance, this strategy will allow early access to the majority of deferred compensation assets on a tax-free basis and eliminate estate tax on plan assets upon the death of the manager.

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  • From Vol. 2 No.39 (Oct. 1, 2009)

    Hedge Funds Turning to Life Settlements for Absolute, Uncorrelated Returns

    Among other lessons, the recent recession taught that the returns on many assets are more correlated than previously assumed.  From late 2007 through early 2009, it seemed that everything moved in the same direction: down.  Or almost everything.  A few asset classes – or more appropriately, investment categories – remained, during the recession and beyond, resolutely uncorrelated.  Litigation funding is one such investment category, as we discussed in a previous issue of The Hedge Fund Law Report.  See “In Turbulent Markets, Hedge Fund Managers Turn to Litigation Funding for Absolute, Uncorrelated Returns,” The Hedge Fund Law Report, Vol. 2, No. 25 (Jun. 24, 2009).  Another such category is life settlements.  In a nutshell, a life settlement is the process by which an investor (often a hedge fund) purchases a life insurance policy from the person who originally purchased the policy – the so-called “insured.”  Specifically, the hedge fund or other investor generally pays the insured an amount greater than the cash surrender value of the policy, but less than the death benefit, in exchange for the right to collect the death benefit and the obligation to continue paying premiums for the life of the policy (and the insured).  For insureds, especially those that need money today, life settlements represent an opportunity to “cash out” of a policy for an amount often greater than what an insurance company will pay.  For hedge funds, life settlements offer an investment, the returns on which are driven largely by the fund manager’s ability to accurately predict the life expectancy of a group of insureds.  In other words, the success of a strategy focused on life settlements has less to do with microeconomic variables (such as corporate earnings) or macroeconomic variables (such as interest rates), and more to do with demographics.  It’s a different ball game, and a different skill set – the quintessential uncorrelated investment category.  Not surprisingly, hedge funds are becoming increasingly interested in life settlements.  Accordingly, this is the first part of a three-part series in which The Hedge Fund Law Report will provide a detailed analysis of the key legal and business considerations for hedge funds investing in life settlements.  In this part, we discuss: state and federal regulation of life settlements; premium financing; pricing of life settlements; advantages to hedge funds of investing in life settlements (including lack of correlation with other assets); concerns of which hedge funds should be cognizant when investing in life settlements (including illiquidity and longevity risk); structuring of hedge funds to invest in life settlements; cash management and adequate capital considerations; specific recommended items for disclosure in the private placement memorandum of a fund organized to invest in life settlements; due diligence considerations; a brief overview of the relevant tax considerations, including the recommended jurisdictions for organizing life settlement hedge funds; the tertiary market and securitization; and opposition from the insurance industry.  Part two in this three part series will focus in more depth on tax considerations relating to life settlement investing, and part three will focus in more depth on securitization of life settlements.

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  • From Vol. 2 No.38 (Sep. 24, 2009)

    Holtz Rubenstein Reminick Hosts Conference on “Uncovering Foreign Income: The Implications and Consequences of Foreign Bank Account Reporting”

    On September 16, 2009, the accounting firm Holtz Rubenstein Reminick (HRR) hosted a seminar on reporting of foreign bank accounts, for both income tax and anti-money laundering purposes.  Reporting on foreign income has become headline news of late.  Notably, in February 2009, UBS, the largest Swiss bank by assets, reached a settlement with the U.S. Internal Revenue Service (IRS) in which UBS agreed to give the IRS hundreds of names of Americans suspected of using UBS accounts to evade U.S. income taxes.  Several UBS clients have been prosecuted. The HRR seminar was chiefly designed to address the issue of whether people who have accounts with UBS or other foreign banks should make voluntary disclosure to the IRS of the existence of such accounts and other data with respect to such accounts.  Panelists also briefly discussed the still-undecided issue of whether an interest in an offshore hedge fund must, under the Bank Secrecy Act, be reported in a Report of Foreign Bank and Financial Accounts (FBAR).  See “IRS Indicates that U.S. Persons May be Required to Report Interests in Offshore Hedge Funds in Reports of Foreign Bank and Financial Accounts,” The Hedge Fund Law Report, Vol. 2, No. 26 (Jul. 2, 2009).  We detail the relevant points from the conference.

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  • From Vol. 2 No.35 (Sep. 2, 2009)

    Will Increased Tax Rates and More Onerous Regulation Cause Hedge Fund Managers to Leave London?

    London is one of the world’s premier centers of hedge fund management.  A recent ranking of the world’s 11 most successful hedge fund managers listed two headquartered in London: Winton Capital Management and Brevan Howard Asset Management.  But there has been, for months now, a good deal of talk about an exodus of hedge fund managers from the U.K.  That talk has been fueled by two factors: recent tax law changes and the European Commission’s proposed Alternative Investment Fund Managers Directive (Draft Directive).  We detail the tax law changes, and analyze whether they and the Draft Directive really have the potential to engender the much-discussed flight, or whether such flight constitutes an exaggerated threat.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    IRS “Managed Funds Audit Team” Steps Up Audits of Hedge Funds and Hedge Fund Managers, and Investigations of Hedge Fund Tax Compliance Issues

    The hedge fund industry has found itself in the crosshairs of various regulators and legislators recently, with a spate of bills and proposed regulations relating to governance of the industry.  What’s less known, yet equally if not more relevant, is that the Internal Revenue Service (IRS) has a managed funds audit team that was created two years ago and is currently stepping up its audits of hedge funds and hedge fund managers and its investigations of hedge fund tax compliance issues.  (The unit also focuses on private equity funds and their managers.)  The IRS noted in a statement: “The service seeks to identify any areas of possible non-compliance in the income tax reporting of hedge fund and private equity fund investors and managers, as well as possible non-compliance in the reporting of withholding obligations.”  The managed funds audit team focuses on areas such as compliance with filing requirements, income recognition, characterization of income as ordinary or capital gains, the flow of funds between onshore and offshore entities, the allocation and timing of incentive payments and other income and the accounting methods used to reflect and record income.  The IRS has focused significantly on training auditors on tax issues related to the hedge fund industry.  Within the hedge fund industry, tax audit activity has increased in the last year.  In September 2008, hedge funds experienced the team’s first real push to conduct audits.  We discuss the formation of the managed funds audit team; what actions may trigger an audit; key areas of focus in audits (including a discussion of the wash sale and straddle tax rules); offshore concerns (including deferral and UBTI issues); violations and remedies; how to prepare for an IRS audit; differences between IRS audits and SEC or financial audits; and the length of audits and appeals.

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  • From Vol. 2 No.34 (Aug. 27, 2009)

    How Are Hedge Fund Managers Handling Expense Pass-Throughs?

    Investors are aware that investing in a hedge fund comes at a cost and that certain expenses of the fund will be passed through.  However, there is no set rule for what expenses are passed through and some funds have or are developing unique strategies to deal with expenses.  Most hedge funds have implemented arrangements that permit the manager to pass certain expenses through to the fund and to investors, as add-ons to the management fee.  Other funds have included some or all of these costs into the management fee itself.  Still others have or are exploring the use of an expense pass-through in lieu of a fixed management fee.  While the approaches may be different, the goal of most hedge funds is the same: to retain investors and cover expenses.  In good times, investors tend to look less at the actual cost of fees and expenses, and focus more on the returns.  But, after a year and change of generally poor performance, more focus has been placed on expenses and how expenses affect returns.  We detail what expenses are and are not being passed through; soft dollar considerations; treatment and amortization of organizational expenses; tax implications of various approaches to expense pass-throughs; and the negotiability of management fees in the current investment environment.

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  • From Vol. 2 No.29 (Jul. 23, 2009)

    Andrew Baker, CEO of the Alternative Investment Management Association, Discusses the AIFM Directive, UK Tax, Short Selling and Other Topics with The Hedge Fund Law Report

    Andrew Baker, formerly Chief Operating Officer for Schroder Investment Management, became the Deputy Chief Executive of the Alternative Investment Management Association (AIMA) in August 2007, and the Chief Executive Officer in December 2008.  In those capacities, he has played a key role in shaping the AIMA’s response to recent developments in international hedge fund law and regulation.  On July 17, 2009, The Hedge Fund Law Report spoke to him about current and potential regulatory changes in Europe and the U.S., the tax climate in the UK, “grey” tax havens and laws and proposals that have or would mandate transparency with respect to short positions.  A full transcript of that interview is included in this issue of The Hedge Fund Law Report.

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  • From Vol. 2 No.22 (Jun. 3, 2009)

    Hedge Fund Managers Using “Mini-Master Funds” to Retain Favorable Tax Treatment of Performance-Based Revenue from Offshore Funds

    With the passage last year of legislation eliminating the ability of U.S. hedge fund managers to defer taxes on fee income from their offshore funds, managers are increasingly employing so-called “mini-master funds” to obtain a different kind of favorable tax treatment for the same revenue.  Traditionally, in a master-feeder structure, managers would enter into an investment management agreement with the offshore fund, which in turn would invest substantially all of its assets (from non-U.S. and U.S. tax-exempt investors) in a master fund.  The investment manager would charge the offshore fund a “performance fee” of 20 percent of the gains on its investment in the master fund.  Before last year, managers were able to defer tax on the performance fee by reinvesting it in the offshore fund.  However, Internal Revenue Code Section 457A, adopted as part of the Emergency Economic Stabilization Act of 2008, disallows such fee deferrals and requires hedge fund managers to take all existing deferrals into income by 2017.  Mini-master funds seek to circumvent this rule by converting the performance “fee” into a performance “allocation.”  We explain precisely how mini-masters can accomplish this, and in the course of our discussion explore traditional fee deferrals, the operation of Section 457A, the tax effect of mini-masters, jurisdictional issues and what proposals relating to the taxation of carried interest may mean for the continued utility of mini-masters.  See “IRS Releases Further Guidance Affecting Offshore Hedge Fund And Other Pooled Investment Vehicle Deferrals,” The Hedge Fund Law Report, Vol. 2, No. 6 (Feb. 12, 2009).

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  • From Vol. 2 No.21 (May 27, 2009)

    The Future Will Be Better Tomorrow: The Obama Tax Agenda Is Released

    On May 12, 2009, the Treasury Department released President Obama’s fiscal 2010 tax and revenue proposals in a lengthy book with a green cover.  Accordingly, everyone is calling the list of proposals, the “Green Book.”  President Obama did not desire to raise taxes during the worst recession in the last 80 years.  As a result, most of the revenue proposals would not be effective until 2011, when the current economic crisis is expected to abate.  The Green Book proposals have yet to be introduced as formal legislation.  The current political climate and President Obama’s extraordinary popularity make the introduction and passage of the bulk of the proposals extremely likely.  In a guest article, Mark Leeds and Diana Davis, Shareholder and Counsel, respectively, at Greenberg Traurig LLP, discuss in detail the Green Book, and its potential implications for hedge funds and their managers.

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  • From Vol. 2 No.19 (May 13, 2009)

    Providing Certainty on Death and Taxes: The IRS Issues Initial Guidance for Sellers and Purchasers of Life Insurance Policies

    On May 1, 2009, the Internal Revenue Service (IRS) issued two Revenue Rulings.  In the first of these Rulings, Revenue Ruling 2009-13, the IRS addressed three different situations in which a U.S. individual insured disposed of his rights under a life insurance policy.  In the second of these Rulings, Revenue Ruling 2009-14, the IRS addressed three separate situations in which a third party investor acquired the rights under a life insurance policy from the original owner and insured.  While neither Ruling addresses all of the issues presented by the burgeoning life settlement industry in the United States, each does provide some much needed guidance in the area.  In a guest article, Mark Leeds, a Shareholder with Greenberg Traurig LLP, provides a detailed discussion of the IRS guidance.

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  • From Vol. 2 No.15 (Apr. 16, 2009)

    Hedge Fund Managers Contemplate Alternative Fee Structures in Anticipation of Passage of Federal and State Bills to Tax Carried Interest as Ordinary Income

    For years now, bills introduced at the federal and state levels have sought to tax carried interest earned by hedge fund managers – traditionally, 20% of any gains made by the fund – as ordinary income.  To date, none of those bills has gained sufficient traction to become law.  However, the appearance of a line in President Obama’s budget relating to carried interest; a bill recently proposed by Rep. Sander Levin (D-Michigan) addressing and remedying some of the shortcomings that prevented past bills from becoming law; and various New York State and City efforts on the topic all have increased both the momentum and viability of increased tax on carried interest.  In anticipation of such tax changes, hedge fund managers and academic tax experts are thinking about how to revise fee structures to mitigate the adverse impact of such new taxes on net income, returns and incentives.  We detail the relevant provisions in the Obama budget, Rep. Levin’s bill, ideas from various academic experts on how fees might evolve in response to tax law changes and relevant New York State and City proposals.

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  • From Vol. 2 No.14 (Apr. 9, 2009)

    Congress Introduces Legislation That Would Tax Offshore Hedge Funds as U.S. Corporations

    On March 2, 2009, Senator Carl Levin (D-Michigan) introduced the Stop Tax Haven Abuse Bill of 2009 (the Bill).  A similar bill was introduced in the Senate in 2007 (co-sponsored by then-Senator Barack Obama), but was not acted upon.  The Bill, like its 2007 predecessor, contains numerous provisions generally intended to prevent U.S. taxpayers from holding assets in accounts of financial institutions located in so-called tax havens without disclosing the existence of those accounts to the Internal Revenue Service.  The Bill, however, also contains an onerous provision (Section 103) which would cause hedge funds incorporated outside the United States, but managed from within the United States, to become subject to full U.S. corporate income tax.  In a guest article, Jeremy Naylor, a Partner at White & Case, explains the mechanics of the bill, its potential effect on offshore hedge funds and why Senator Levin’s rationale in proposing the Bill may be at odds with the reality of the current tax law as applied to hedge funds.

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  • From Vol. 2 No.14 (Apr. 9, 2009)

    Seward & Kissel Attorneys Propose Alternatives to Hedge Fund Taxation Regime in Obama Budget

    The delivery of the Obama Administration’s first budget at the end of February heralded the end of an era for the U.S. hedge fund industry.  Among its many proposals to sweep away the era of Reaganomics, the new Administration launched a plan to tax carried interest (also known in the hedge fund context as performance fees) at ordinary income rates.  Peter Pront, a Partner at Seward & Kissel LLP and head of the firm’s Tax Group, and his colleague Ronald Cima, also a Partner in Seward’s Tax Group, recently sat down with The Hedge Fund Law Report to discuss their suggestions on hedge fund tax law changes that they think should be considered by the Obama Administration as alternatives to the Administration’s current proposals.  We report on our conversation with Pront and Cima.

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  • From Vol. 2 No.13 (Apr. 2, 2009)

    Should Hedge Funds Participate in the Public-Private Investment Program?

    On March 23, 2009, the Treasury Department announced the Public-Private Investment Program (PPIP), a collaborative initiative among the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), on the one hand, and private investors, on the other hand, to create $500 billion to $1 trillion in buying power for the purchase from financial institutions of “legacy” (formerly known as “toxic”) loans and securities.  Loans eligible for purchase likely will include primarily residential and commercial mortgages and leveraged loans used to fund buyouts, and eligible securities are likely to include securities backed by eligible loans and certain consumer loans.  The goals of the PIPP include (1) creating a market for currently illiquid assets, thus enabling financial institutions to value and sell those assets, which in turn will enable the institutions to make new loans, raise new capital and repay TARP loans; and (2) reopening the securitization markets, which, at least prior to the credit crisis, generally expanded (some would argue over-expanded) the availability of consumer credit and reduced its cost.  Many of the details of the PPIP remain to be provided.  In the meantime, prior to the provision by the Treasury, Federal Reserve Board or FDIC of further guidance and clarification, hedge and other private fund managers are evaluating the advisability of participation based on the announced parameters of the PPIP.  In particular, hedge fund managers are analyzing the following issues, among others:

     

    1. The scope of the FDIC’s oversight of various aspects of the PPIP, and the role of the Treasury as an equity co-investor and, in the case of the Legacy Securities Program, a lender.
    2. With respect to the Legacy Loans Program, the design of the auctions in which assets will be sold, and the timing of the FDIC’s leverage determinations (i.e., the extent to which the FDIC can, as a practical matter, provide clarity with respect to the amount of leverage it can offer prior to commencement of an auction).
    3. Any limits that may be imposed on hedge fund manager compensation as a result of participation.
    4. How participation may be structured, i.e., whether current funds can invest or whether new dedicated funds have to be organized.
    5. Tax issues, including the structures that will be permitted or required for PPIFs, the ability of tax-exempt or non-U.S. investors to invest in PPIFs via offshore feeder funds (likely structured as non-U.S. corporations) and the characterization of income from PPIFs as ordinary income or capital gain.
    6. Adverse selection issues, i.e., whether banks will only seek to sell their worst assets under the program (and if so whether appropriate pricing can mitigate the gravity of this concern).

     

    Our article addresses each of these issues in detail.

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  • From Vol. 2 No.11 (Mar. 18, 2009)

    Proposed Tax Legislation Affecting Hedge Funds

    Bills introduced this month in both the House and the Senate contain two provisions that are of particular significance to hedge funds.  One provision would materially alter the tax treatment of offshore hedge funds with U.S.-based managers, and the other provision would change the tax treatment of “dividend equivalent” payments made on notional principal contracts (or “swaps”) that reference U.S. stocks.  The proposed legislation, which was introduced by Senator Carl Levin (D-Michigan) and Representative Lloyd Doggett (D-Texas), contains various other provisions, including the addition of certain reporting requirements, as well as certain presumptions to be applied in judicial and administrative proceedings, with respect to amounts derived by U.S. persons from offshore entities.  In a guest article, Mary Conway, Lucy W. Farr and Rachel D. Kleinberg, all partners of Davis Polk & Wardwell’s Tax Department, explain the two provisions and the implications of the provisions for hedge funds.

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  • From Vol. 2 No.11 (Mar. 18, 2009)

    IRS Guidance and Two House Bills Offer Tax Relief for Investors in Ponzi Schemes

    On March 17, 2009, the Internal Revenue Service issued Revenue Ruling 2009-9 (Revenue Ruling) and Revenue Procedure 2009-20 (Revenue Procedure) which together provide additional guidance for taxpayers who have lost money in the Ponzi scheme orchestrated by Bernard Madoff and other Ponzi-type investment frauds.  The Revenue Ruling generally provides that losses from Ponzi schemes are theft losses, and not capital losses; that such losses are not subject to the $3,000 annual limitation on capital loss deductions or the limitations on personal casualty and theft losses; and that the amount of loss can include “phantom income” received by the investor from the scheme, not just the principal invested by the investor.  The Revenue Procedure provides a uniform approach for determining the proper time and amount of the theft loss.  Generally, the Revenue Procedure deems a loss to be the result of theft if the promoter was charged with fraud or similar crimes; it does not require a conviction.  Also, the Revenue Procedure generally permits taxpayers to deduct in the year of discovery up to 95 percent of their net investment, less certain actual and expected recoveries.  We describe in detail both items of guidance, as well as two related House bills.

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  • From Vol. 2 No.8 (Feb. 26, 2009)

    Stimulus Bill Permits Deferral of Cancellation of Debt Income Arising out of Repurchases by Issuers of their Distressed Debt

    On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009, containing the American Recovery and Reinvestment Tax Act of 2009 (2009 Tax Act), which provides for, among other things, deferral of recognition of certain cancellation of indebtedness income (CODI).  That is, under tax law prior to the 2009 Tax Act, a taxpayer generally had to recognize income in the year in which it repurchased, cancelled or modified its debt, to the extent that the adjusted issue price of the old debt exceeded the amount of the new debt.  Under the 2009 Tax Act, taxpayers are allowed to defer recognition of CODI until a five year period starting, for calendar year taxpayers, in 2014; deferred CODI has to be included ratably in income during that five year period.  We explain the mechanics of the 2009 Tax Act, the effect on “deemed exchanges,” the consequences for deductibility of original issue discount in various circumstances and the applicable high yield debt obligation rules.  We also highlight the potential pitfalls for hedge funds, especially those employing a distressed debt strategy.

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  • From Vol. 2 No.7 (Feb. 19, 2009)

    Climate in Washington Warms to Proposals to Tax Carried Interest as Ordinary Income, as Prospect for Material Revenue from Such Tax Wanes

    In a series of exclusive interviews with members of both houses of Congress from both sides of the aisle, and members of their staffs, The Hedge Fund Law Report has determined that the appetite among Democratic legislators for taxing carried interest as ordinary income remains high, while opposition among Republicans to increasing taxation of carried interest remains equally vigorous.  In this climate of negative returns, the sizes of both management and performance fees are under pressure (primarily from hedge fund investors as opposed to regulators), and many managers will not earn a performance fee until they exceed their “high water mark” – the highest level their funds previously reached – which in many cases appears to be a far-away prospect.  Accordingly, for practical purposes, the level of taxation of hedge fund manager carried interest may be moot for the time being, since for the foreseeable future there will not be any carried interest to tax.  Nonetheless, in this dour economic environment, legislators may look to placate their Main Street constituents with actions targeting “executive compensation,” very broadly understood.  So, even though increasing taxation of carried interest may have only a minor near-term economic benefit, it may have a symbolic resonance.  That is, the setting may be ripe for finalizing a legislative item at precisely the time when it will yield the least revenue.  We bring you insight directly from Capitol Hill, including quotes from Rep. Charles Rangel (via a spokesman), Rep. Elijah Cummings, Senator Orrin Hatch and the office of Senator Mike Crapo.

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  • From Vol. 2 No.6 (Feb. 12, 2009)

    IRS Releases Further Guidance Affecting Offshore Hedge Fund And Other Pooled Investment Vehicle Deferrals

    On January 8, 2009, the Internal Revenue Service issued interim guidance (Notice 2009-8) under Internal Revenue Code Section 457A.  Enacted in October 2008, Section 457A largely eliminates compensation deferrals by nonqualified entities – in general, tax-indifferent non-U.S. corporations or partnerships (U.S. or non-U.S.) with tax-indifferent partners.  In a guest article, Jonathan M. Zorn, Brett A. Robbins and Lucas Rachuba describe the mechanics of the interim guidance – including a discussion of the treatment of deferrals attributable to periods before and after January 1, 2009 – and explain how the interim guidance may impact hedge funds and their managers.

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  • From Vol. 2 No.4 (Jan. 28, 2009)

    Holtz Rubenstein Reminick LLP Hosts “Town Hall Meeting” on Madoff Matters, Including: Filing of SIPC Claim Forms, Redress Via Tax Refunds, Insurance Claims and More

    On January 21, 2009, accounting firm Holtz Rubenstein Reminick LLP (HRR) hosted at the Jumeirah Essex House a town hall-style meeting on “Implications and Consequences of the Alleged Fraud of Bernard Madoff.”  The panel included three HRR partners, a securities lawyer and the CEO of an investment adviser.  We report on the key ideas discussed at the meeting, including practical recovery and tax tips for investors affected by the alleged Madoff Ponzi scheme.

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  • From Vol. 2 No.2 (Jan. 15, 2009)

    Can Madoff Investors Claim “Theft Loss” Tax Deductions?

    If there’s a silver lining to the alleged Madoff Ponzi scheme, it may be the ability of defrauded investors to take “theft loss” deductions for their losses.  Generally, a theft loss deduction is limited to the tax basis of the investment minus previous deductions, depreciation or amortization, plus any commissions or transaction costs.  In other words, as a general matter, the IRS will not permit theft loss deductions with respect to purported “gains” or “income” from a Ponzi scheme or other investment fraud – amounts referred to, in this context, as “phantom income.”  We explain the mechanics of the relevant Internal Revenue Code Provisions and Treasury Regulations, detail relevant precedent and offer a “to do” list for Madoff investors considering claiming a tax loss deduction with respect to their Madoff-related losses.

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  • From Vol. 1 No.25 (Nov. 26, 2008)

    House Hearings on Hedge Funds’ Role in the Financial Crisis

    The heads of five of the most successful U.S. hedge funds testified on November 13 before the House Committee on Oversight and Government Reform.  In the course of the hearings, Committee members evidenced concern about systemic risk posed by hedge funds, and expressed interest in greater government oversight of hedge fund operations, investments and taxation.  The hearing offered a foreshadowing of heightened government scrutiny that hedge funds are likely to face when the 111th Congress convenes in January under substantially increased Democratic majorities in both houses.

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  • From Vol. 1 No.23 (Oct. 28, 2008)

    The End of Deferral As We Know It: The New Rules Prohibiting the Deferral of Compensation Paid to U.S. Managers By Off-Shore Hedge Funds

    On October 3, 2008, Congress enacted, and President Bush signed, legislation that will curtail deferral of compensation payable by off-shore funds to U.S. managers beginning in 2009, and require that income previously deferred be recognized no later than 2017. In a guest column, Mark Leeds and Yoram Keinan, Partner and Of Counsel, respectively, at Greenberg Traurig, LLP, offer a thorough analysis of the mechanics of the new legislation and what it means for hedge fund managers in structuring their funds and compensation arrangements.

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  • From Vol. 1 No.22 (Oct. 10, 2008)

    New Tax Law Restricts Hedge Fund Fee Deferral Arrangements

    The $700 billion “bailout bill” signed into law on October 3, 2008 contains changes to the U.S. tax code that will effectively eliminate the ability of U.S. hedge fund managers to defer paying tax on fee income from their offshore hedge funds.  The new law, enacted as part of the same bill that contained the Emergency Economic Stabilization Act of 2008, will impose U.S. tax on a current basis on deferred compensation from offshore entities that are not subject to U.S. tax or to a comprehensive non-U.S. income tax, with the principal target being U.S. managers of offshore hedge funds.  In a guest article, Kirkland & Ellis partner Andrew Wright provides a lucid analysis of the relevant provisions of the new law.

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  • From Vol. 1 No.19 (Aug. 21, 2008)

    Quick, Easy and Wrong: Congress Considers Legislation to Curtail Energy Trading and the Use of Off-shore Blockers

    On August 1, 2008, Senators Ron Wyden (D-Ore.) and Charles Grassley (R-Iowa) proposed legislation that would make the tax code even more complicated and obtuse and would curtail the use of so-called “foreign blockers” by tax-exempt investors.  The one sentence take-away on the Wyden-Grassley bill is that it would eliminate long-term capital gains treatment, as well as preferential treatment for tax-exempt entities, on profits from investments in the oil and gas markets, beginning in 2008.  In this article, guest contributors Mark Leeds and Rita Cameron, shareholder and associate, respectively, at Greenberg Traurig, provide a lucid, informed and critical analysis of the proposal.  In their view, the proposal could have a profound and adverse effect on tax-exempt US investors in offshore hedge funds.  In the worst case scenario, it could even trigger provisions sometimes found in offshore feeder documents that allow tax-exempt investors to redeem if there is a change in law (or in some cases even a proposed change in law) that would adversely affect the tax treatment of their investments.  On the positive side, the proposal has only a slim chance of becoming law, at least in its current form.

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  • From Vol. 1 No.19 (Aug. 21, 2008)

    UK Treasury Proposes Tax Exemptions to Support Competitiveness of its Asset Management Industry

    With the goal of ensuring that the UK remains a competitive place for funds to locate and to enable investment funds to market themselves more competitively, the British Treasury recently proposed a new tax regime for the UK’s US$7.6 trillion asset management industry.  Generally, the new proposal lifts several levies and reduces certain compliance obligations for investors.  The proposal, which was laid out in three consultation papers, introduces two main changes: first, it puts forward an elective direct tax exemption for Authorized Investment Funds, and second, it replaces the substantial holding rule for Qualified Investor Schemes, which effectively removes an important tax barrier for these investment vehicles.

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  • From Vol. 1 No.19 (Aug. 21, 2008)

    Taxing Speculation?

    A new proposal to control oil and gas speculation through increased taxation of capital gains made through offshore hedge funds, index funds and various other investment vehicles has sparked concern among an array of energy and tax-policy experts who monitor Capitol Hill.  An energy policy expert interviewed by The Hedge Fund Law Report expressed doubts about whether such legislation would have any effect on gas prices, and a Washington lawyer suggested that flaws and complexity would undermine the likelihood of the proposal becoming law.  Others identified additional problems with the proposal.

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  • From Vol. 1 No.18 (Aug. 11, 2008)

    Senate Proposals and GAO Report Focus on Taxation of Cayman Islands Accounts

    On the heels of continued congressional concern about tax evasion among offshore accounts, including offshore hedge funds, a spokesman for the Senate Finance Committee told The Hedge Fund Law Report that lawmakers will attempt to “move legislation this year” addressing the issue. At a recent hearing on Cayman Islands accounts, Sen. Max Baucus, chairman of the Finance Committee, outlined a series of proposals centering on strengthening rules relating to Reports of Foreign Bank and Financial Accounts. The Finance Committee hearing focused on a recent Government Accountability Office report titled “Cayman Islands: Business and Tax Advantages Attract U.S. Persons and Enforcement Challenges Exist.” The GAO report found that for many hedge funds, a primary purpose of establishing a Cayman Islands domicile is tax minimization. The GAO report noted that efforts to prevent illegal tax avoidance are hindered by the IRS’s “lack of jurisdictional authority to pursue information, difficulty in identifying beneficial owners due to the complexity of offshore financial transactions and relationships among entities,” and other factors. Cayman attorneys, however, remain confident in the robust legal and regulatory structure in the Cayman Islands and, in fact, read the GAO report as complimentary of the Cayman system.

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  • From Vol. 1 No.16 (Jul. 22, 2008)

    An IRS Trifecta: Three Public Releases Affecting Hedge Funds and Funds of Funds Issued on One Day

    A triumvirate of IRS releases all issued on July 3, 2008 clarify the deductibility of hedge fund investment interest expenses by hedge fund investors, and the tax treatment of fund of funds management fees. Guest contributor Mark H. Leeds, a Shareholder of Greenberg Traurig LLP, explains the releases in a lucid, insightful and timely article.

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  • From Vol. 1 No.15 (Jul. 8, 2008)

    IRS Rules that Long Position in a Swap Referencing a Broad-Based U..S Real Property Index Is Not a U.S. Real Property Interest for FIRPTA Purposes

    On June 12, 2008, the IRS published Revenue Ruling 2008-31, holding that a long interest in a swap referencing a broad-based index of U.S. real property is not a U.S. real property interest within the meaning of the Foreign Investment in Real Property Tax Act of 1980. Good news for offshore hedge funds looking for broad-based exposure to U.S. real property; even better news for index publishers.

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  • From Vol. 1 No.12 (May 20, 2008)

    House Passes Tax Provision Targeting Hedge Fund Fee Arrangements

    • Legislation that would eliminate the ability of US hedge fund managers to defer paying tax on management and performance fees from offshore hedge funds cleared the House of Representatives on May 21, 2008.
    • Disputes over PAYGO in the Senate and a threatened White House veto likely will impede passage of this particular bill. However, the appearance in Congress of multiple legislative proposals targeting offshore fee deferrals, combined with the current media spotlight on hedge fund fee arrangements, increase the likelihood of passage of legislation curtailing offshore fee deferrals.
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  • From Vol. 1 No.11 (May 13, 2008)

    MFA Presses for Guidance on Securities Trading Safe Harbor

    In a letter to the Treasury and IRS, MFA took the position that an offshore hedge fund’s restructuring of previously acquired debt and workout negotiations in connection with that debt should fall within the securities trading safe harbor, and therefore should not be treated as a US trade or business and should not be subject to US tax.

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  • From Vol. 1 No.4 (Mar. 24, 2008)

    Prepaid Forward Contracts - Debt, Equity or a Hybrid?

    • Treasury Tax Legislative Counsel Michael Desmond testified before a Subcommittee of the House Ways and Means Committee.
    • Noted current regulatory ambiguity as to whether prepaid forward contracts should be taxed as debt, equity or a hybrid.
    • As more such instruments migrate into retail investors’ portfolios, the Treasury Department has increased its scrutiny of tax ramifications.
    • Desmond illustrated inconsistencies in alternative tax treatment based on structure of prepaid forward contracts.
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  • From Vol. 1 No.2 (Mar. 11, 2008)

    Third Circuit upholds Treasury Regulation providing that a foreign corporation, to be eligible to claim tax deductions in connection with real property activities in the United States, must file its tax return within 18 months of the filing deadline set forth in Internal Revenue Code Section 6072

    • In a recent decision, the Third Circuit Court of Appeals held that for a non-US corporation to claim tax deductions in connection with its US real property activities, it must file its tax return within 18 months of the year in which income was earned.
    • In so holding, the Circuit Court upheld the validity of Treasury Regulation 1.882-4(a)(3)(i).
    • Court analyzed the IRS regulation under Chevron, and found that it was within the scope of Congress’s delegation of rulemaking authority to the IRS.
    • Case suggests that Courts will give heightened deference to IRS rulemaking, because tax is “complex and highly technical.”
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