structuring foreign ubti blocker corporations for exempt...
TRANSCRIPT
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Structuring Foreign UBTI Blocker Corporations
for Exempt Orgs: Offshore Blockers to
Hold Alternative Investments Nonprofit Entities Owning Private Equity, Hedge Funds and Offshore Funds
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
TUESDAY, DECEMBER 19, 2017
Presenting a live 90-minute webinar with interactive Q&A
Marguerite R. Lombardo, Senior Counsel, Proskauer Rose, Boston
Brian D. Huber, Senior Counsel, Proskauer Rose, Boston
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FOR LIVE EVENT ONLY
Structuring Foreign UBTI Blocker
Corporations for US Tax-Exempt
Organizations
Brian Huber Senior Counsel, Proskauer Rose LLP
Marguerite Lombardo Senior Counsel, Proskauer Rose LLP
Strafford Webinar December 19, 2017
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Not Tax Advice
THE INFORMATION CONTAINED IN THIS PRESENTATION IS FOR INFORMATIONAL PURPOSES ONLY AND IS NOT TAX ADVICE. ORGANIZATIONS SHOULD CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THEIR PARTICULAR SITUATIONS.
December 19, 2017 Strafford Webinar
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Agenda
1. UBTI and UBIT impact on private equity and hedge funds
2. Foreign and Domestic Blocker Corporations
Assets commonly held, capitalization and tax leakage
3. Required US federal income tax filings for US Tax-Exempt
Investors Related to Foreign Blocker Corporations
4. Certain tax and operational risks/considerations
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• US Tax-Exempt Investors: Include US organizations such
as universities, endowments, private foundations, charities
and pension funds
• What about state and local government “super tax-exempt”
pension plans?
Conference Committee Bill*: does not include provision
addressing, although a provision had been included in the
House Bill (but not the Senate Bill)
* Tax Cuts and Jobs Act Bill as released on December 15, 2017
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• US Tax-Exempt Investors are generally exempt from US
federal income tax, but subject to tax (the “unrelated
business income tax” or the UBIT) on “unrelated business
taxable income” (UBTI)
Tax rates that apply are regular graduated corporate or trust
rates depending on whether the US Tax-Exempt Investor is a
corporation or a trust
• UBTI includes “unrelated debt-financed income” (UDFI)
• Charitable remainder trusts (CRTs) instead subject to 100%
excise tax on any UBTI
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Required to file IRS Form 990-T (Exempt Organization
Business Income Tax Return) if $1,000 or more of gross
income from an unrelated business
• State and local taxes and tax filing obligations may also
apply
• UBTI is income “derived by any organization from any
unrelated trade or business…regularly carried on by it.”
§512*
* All § references are to the US Internal Revenue Code of 1986, as amended
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Definition of “unrelated trade or business” has 2 elements:
Trade or business (within the meaning of §162)
o Activity carried on for the production of income
Unrelated to the organization’s exempt purpose
o Not “substantially related” (aside from the production of funds) to the
performance of the charitable, educational or other activities that are
the basis of its exemption. §513
• “Regularly carried on” requirement
• Can arise from trade or business anywhere in world – not
required to be a US trade or business
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Most passive income generally is excluded from UBTI. §
512(b) generally excludes:
Capital gains
Dividends
Interest
Royalties
Loan commitment fees
But see next slide ….
Payments with respect to securities
loans
Annuity payments
Most rents from real property
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• HOWEVER, if the passive income is UDFI, it will be
treated as UBTI
• UDFI is certain income from property with “acquisition
indebtedness.”
• “Acquisition indebtedness” is indebtedness incurred in the
acquisition or improvement of property; a “but for” and
“reasonably foreseeable” test casts a wider net. §514(c)
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• UDFI includes:
Income from property subject to “acquisition indebtedness” at
any time during the taxable year
Gain from a disposition within 12 months after the “acquisition
indebtedness” was paid off
• Calculation of amount of UDFI is adjusted to take into
account percentage of leverage and length of time
outstanding
• Special exceptions may apply such as “fractions rule” in
certain real estate funds
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• If fund is a partnership for US federal income tax purposes,
any UBTI/UDFI will flow through the fund to US Tax-Exempt
Investors
• This flow through treatment applies regardless of:
how many tiers of tax transparent entities for US tax purposes
whether entities are formed under US or non-US law
December 19, 2017 Strafford Webinar
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Tax Legend
Partnership for US tax purposes
Corporation for US tax purposes
Investor Grouping
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• UBTI/UDFI Flows
Through Tiers of Tax
Transparent Entities
for US Tax Purposes
Fund
(US or Non-US)
Holding
Vehicle
UBTI UDFI
Operating
Restaurant LLC
Operating Business Acquisition Indebtedness
US Tax-Exempt
Investors
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Two common sources of UBTI in private equity or hedge
funds:
An equity investment in a partnership for US tax purposes that is
engaged in a trade or business (Operating Flow Through)
UDFI as a result of borrowing directly by the fund or through a
lower tier partnership for US tax purposes
• May also be other sources of UBTI (e.g., fees for services)
• Funds of funds – remember, UBTI/UDFI flows through tiers
of tax transparent entities for US tax purposes
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Fund agreement may or may not have an undertaking to
avoid or minimize UBTI/UDFI depending on fund strategy,
intended investments and whether the fund is offering a
blocker structuring option for US Tax-Exempt Investors
• If there is an undertaking, consider whether there are
carveouts
December 19, 2017 Strafford Webinar
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
UBTI/UDFI Consequences in an Unblocked Structure
Fund
(US or Non-US)
US Tax-Exempt
Investors
Portfolio
Investment
Other
Investors Consider:
• Operating Income
• Treatment of sale of portfolio
investment by Fund
• Treatment of sale of interest in
Fund by US Tax-Exempt
Investor
- IRS TAM 9651001 Operating Flow
Through
December 19, 2017 Strafford Webinar
Acquisition
indebtedness
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UBTI and UBIT Impact on Private Equity and
Hedge Funds
• Net gains from one unrelated trade or business against
losses from another?
Conference Committee Bill:
o UBTI determined on a business-by-business basis; cannot
use losses from one business to offset gains from another
o Effective for taxable years beginning after December 31, 2017
o Special transition rule for net operating losses arising in a
taxable year beginning before January 1, 2018
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
• Foreign Blocker Corporations typically used:
Where fund expects to use leverage as part of its investment
strategy and expects to give rise to UDFI
Material US taxes are not expected on the Foreign Blocker
Corporation
Common in hedge funds
Also see in private equity funds
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
• Legal form of Foreign Blocker Corporation may or may not
be a corporation, but it is a corporation for US tax purposes
IRS Form 8832 “check the box” elections
• Blocker Corporations can be structured different ways, but it
is common for a Foreign Blocker Corporation implemented to
block UDFI to be either a feeder fund or a parallel fund
• US Tax-Exempt Investor might form its own Foreign Blocker
Corporation
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
• US Tax-Exempt Investors typically own equity interests in the
Foreign Blocker Corporation
Leverage capitalization generally not used
• Non-US Investors often participate in structure with US Tax-
Exempt Investors
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
Foreign Blocker Corporation – Feeder Fund
Fund
Feeder Fund
Foreign Blocker
Corporation
Acquisition
Indebtedness
Other
Investors
US Tax-Exempt
Investors
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
Foreign Blocker Corporation – Parallel Funds
Fund - A
Fund -B
Foreign Blocker
Corporation
Acquisition Indebtedness
Other
Investors US Tax-Exempt
Investors
Acquisition Indebtedness
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to US Tax-Exempt
Investor of Investing in Foreign Blocker Corporation*
• Blocked from receiving UBTI/UDFI
• Dividends paid by the Foreign Blocker Corporation not
treated as UBTI/UDFI
• Gain on sale of Foreign Blocker Corporation shares/upon
liquidation of shares not treated as UBTI/UDFI
* Assumes US Tax-Exempt Investor did not borrow to acquire its interest in the
Foreign Blocker Corporation/interest is not debt-financed
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to US Tax-Exempt
Investor of Investing in Foreign Blocker Corporation*
• No UBTI under “passive foreign investment company” (PFIC)
rules
• No UBTI under “controlled foreign corporation” (CFC) rules
Exception for insurance income
Expansion of CFC rules under Conference Committee Bill
* Assumes US Tax-Exempt Investor did not borrow to acquire its interest in the
Foreign Blocker Corporation/interest is not debt-financed
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to Foreign Blocker
Corporation
• Assuming the Foreign Blocker Corporation is not treated as
engaged in a US trade or business:
Capital Gains: Not subject to US tax
US Source Dividends: 30% US withholding tax
US Source Interest: 30% US withholding tax
Other US Source Fixed Determinable Annual or Periodical
Income (FDAP): 30% US withholding tax
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to Foreign Blocker
Corporation
• Assuming the Foreign Blocker Corporation is not treated as
engaged in a US trade or business:
Foreign Blocker Corporation may be eligible for “portfolio
interest exemption” which provides for a 0% rate of withholding
on interest if certain requirements are met, including that the
Foreign Blocker Corporation owns (i) in the case of an obligor
that is a corporation, less than 10% of the total combined voting
power of all classes of stock of such corporation entitled to vote
or (ii) in the case of obligor that is partnership, less than 10% of
the capital and profits in the partnership
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to Foreign Blocker
Corporation
• Assuming the Foreign Blocker Corporation is not treated as
engaged in a US trade or business:
Unlikely that the Foreign Blocker Corporation is eligible for a
reduction or exemption from US withholding tax under a US tax
treaty since the Foreign Blocker Corporation is typically formed
in a jurisdiction that does not have an income tax treaty with
the US
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
US Federal Income Tax Consequences to Foreign Blocker
Corporation
• If the Foreign Blocker Corporation is engaged in a US trade
or business/receives income treated as “effectively
connected income” (ECI):
Gain from the disposition of a “United States real property
holding corporation” (USRPHC) or other “United States real
property interest” (USRPI) under Code Section 897: subject to
tax at regular graduated US corporate rates
Operating Income: subject to tax at regular graduated US
corporate rates
Additional 30% “branch profits tax” may apply
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
If the Foreign Blocker Corporation is engaged in a US trade
or business/receives income treated as “effectively
connected income” (ECI):
• Gain from the disposition of an interest in a US Operating
Flow Through - Conference Committee Bill:
Codifies Rev. Rul. 91-32, thereby reversing the recent Tax Court
decision in Grecian Magnesite;* gain on sale of a US Operating
Flow Through treated as ECI; applies to sales, exchanges and
dispositions on or after November 27, 2017
10% buyer withholding tax obligation unless buyer receives
affidavit from seller that it is not a foreign person; applies to
sales, exchanges and dispositions after December 31, 2017
*Grecian Magnesite Mining, Industrial & Shipping Co., S.A., v. Commissioner, 149 T.C. No. 3
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
• Will the Foreign Blocker Corporation be subject to non-US
tax?
Foreign Blocker Corporation typically is organized in a
low/no tax jurisdiction
If non-US investments will be made, consider whether Foreign
Blocker Corporation may be subject to any non-US withholding,
capital gains or other taxes
• Foreign Blocker Corporation might be subject to tax on
income that US Tax-Exempt Investor would not have been
subject to if invested directly (not through the Foreign Blocker
Corporation)
December 19, 2017 Strafford Webinar
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Blocker Corporations – Foreign
• Also consider:
FATCA Compliance
CRS Compliance
December 19, 2017 Strafford Webinar
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Blocker Corporations – Domestic
• Domestic Blocker Corporations are typically used to block
UBTI from operating income, such as an investment in a US
Operating Flow Through
• Domestic Blocker Corporations can be structured in many
different ways including:
Above the Fund
Below the Fund
Outside the Fund through Alternative Investment Vehicle
Structures
December 19, 2017 Strafford Webinar
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Blocker Corporations – Domestic
US Federal Income Tax Consequences to US Tax-Exempt
Investor of Investing in Domestic Blocker Corporation*
• Blocked from receiving UBTI/UDFI
• Dividends paid by the Domestic Blocker Corporation not
treated as UBTI/UDFI
• Gain on sale of Domestic Blocker Corporation shares/upon
liquidation of shares not treated as UBTI/UDFI
* Assumes US Tax-Exempt Investor did not borrow to acquire its interest in the
Domestic Blocker Corporation/interest is not debt-financed
December 19, 2017 Strafford Webinar
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Blocker Corporations – Domestic
US Federal Income Tax Consequences to Domestic
Blocker Corporation
• Subject to tax at regular graduated US corporate rates
• If Domestic Blocker Corporation sells portfolio investment,
any gain on sale will be subject to blocker level tax
• If exit is through sale of Domestic Blocker Corporation stock,
then capital gain is exempt from UBTI (assuming not UDFI)
December 19, 2017 Strafford Webinar
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Blocker Corporations – Domestic
US Federal Income Tax Consequences to Domestic
Blocker Corporation
• Domestic Blocker Corporation may be capitalized with both
debt and equity
Interest deductions related to debt reduce taxable income of
Domestic Blocker Corporation, subject to applicable limitations
on interest deductions
Interest payments on shareholder debt to US Tax-Exempt
Investor generally exempt from UBTI, unless Blocker
Corporation is a “controlled entity” under § 512(b)(13)
December 19, 2017 Strafford Webinar
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Blocker Corporations – Domestic
US Tax-Exempt Investor is a Controlling Entity
AIV
Domestic
Blocker
Corporation
Controlled
Entity
Controlling US Tax Exempt Investor
Owns more than 50% of vote or value
Other Investors
US Operating Flow Through
Capitalized with
Shareholder loans and Equity
Interest received or accrued by
controlling US Tax-Exempt Investor
from Controlled Entity treated as UBTI
to the extent it reduces the net
unrelated income, or increases the net
loss, of the Controlled Entity.
December 19, 2017 Strafford Webinar
Required US Federal Income
Tax Filings for US-Tax Exempt
Investors Related to Foreign
Blocker Corporations
46
Foreign blocker corporation – US Federal
Income Tax Filings Requirements of US
Tax-Exempt Investors
• Circumstances in which an IRS Form 926 (Return by a US
Transferor of Property to a Foreign Corporation) must be
filed include:*
A US person who transfers cash to a foreign corporation must
report the transfer if:
o immediately after the transfer the person holds directly or
indirectly at least 10% of the total voting power or the total
value of the foreign corporation or
o the amount of cash transferred by the person to the foreign
corporation during the 12-month period ending on the date
of the transfer exceeds $100,000
*Does not describe all circumstances in which an IRS Form 926 must be filed
December 19, 2017 Strafford Webinar
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Foreign blocker corporation – US Federal
Income Tax Filings Requirements of US
Tax-Exempt Investors
• Circumstances in which an IRS Form 5471 (Information
Return of US Persons With Respect to Certain Foreign
Corporations) must be filed include:*
A US person who acquires stock in a foreign corporation which
either by itself, or when added to any stock owned on the date of
acquisition, equals:
o 10% or more of the total value of the foreign corporation’s
stock or
o 10% or more of the total combined voting power of all
classes of stock with voting rights
*Does not describe all circumstances in which an IRS Form 5471 must be filed
December 19, 2017 Strafford Webinar
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Foreign blocker corporation – US Federal
Income Tax Filings Requirements of US Tax-
Exempt Investors
• IRS Form 8621 (Information Return by a Shareholder of a
Passive Foreign Investment Company or Qualified Electing
Fund) generally should not be required to be filed by a US
Tax-Exempt Investor unless US Tax-Exempt Investor
borrows to acquire its interest in the Foreign Blocker
Corporation/interest is debt financed
• IRS Form 8938 (Statement of Specified Foreign Financial
Assets) generally should not be required to be filed by a US
Tax-Exempt Investor
December 19, 2017 Strafford Webinar
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Foreign blocker corporation – US Federal
Income Tax Filings Requirements of US
Tax-Exempt Investors
• Circumstances in which a FinCEN Form 114 (Report of
Foreign Bank and Financial Accounts – “FBAR”) must be
filed include:*
The Foreign Blocker Corporation has a financial account
(including a securities, brokerage or checking accounting)
located outside of the United States and the US person owns,
directly or indirectly:
o more than 50% of the total value of shares of stock or
o more than 50% of the voting power of all shares of stock
Aggregate value of the US person’s applicable foreign financial
accounts exceeds $10,000 at any time during the calendar year
December 19, 2017 Strafford Webinar
*Does not describe all circumstances in which an FBAR must be filed
51
Certain Tax and Operational
Risks/Considerations
• Is filing US tax returns, including state tax returns, with
respect to UBTI a problem for the US Tax-Exempt Investor?
If yes, then US Tax-Exempt Investor has less flexibility
• If US Tax-Exempt Investor can choose between investing
through a Blocker Corporation vs. investing unblocked, then
generally an economic decision
December 19, 2017 Strafford Webinar
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Certain Tax and Operational
Risks/Considerations
• Blocker Structures can be complex – internal resources
required to review structures
• Consider Blocker Corporation costs in addition to any tax
leakage
• Will the Blocker Corporation be respected?
IRS Private Letter Rulings with respect to Foreign Blocker
Corporations
• Risks related tax treatment of debt capitalization
• Uncertainty in tax laws
December 19, 2017 Strafford Webinar
Thank You
Brian Huber Senior Counsel, Proskauer Rose LLP
617-526-9675
Marguerite Lombardo Senior Counsel, Proskauer Rose LLP
617-526-9472
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