Levin Bill would exempt most unrelated debt financing income from taxation

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

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

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

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

The article is available here