Foreign Account Tax Compliance Act: Problems and Complications

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

Private Equity Week Interview

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

The interview is available here.

EC Cross-Border Tax Withholding Relief

EC Cross-Border Tax Withholding Relief

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

NOL Carrybacks Extended to Five Years

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

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

Here are some highlights of the Act:

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


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


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


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

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

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

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

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

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

The full article is available here.

I am quoted in UBS Case

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

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

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

IRS Issues Important Guidance on Foreign Lending Activities

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

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

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



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



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



• Various hybrids of this strategy.

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

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

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

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