Senate Finance Committee Will Study the Taxation of Sovereign Wealth Funds

As the assets controlled by sovereign wealth funds increase dramatically, leaders of the Senate Finance Committee have asked the Joint Committee on Taxation to analyze the current federal tax rules, and underlying policy, applicable to U.S. investment by sovereign wealth funds. The report must be provided by June 16, 2008. A letter requesting the report was signed by committee chair Max Baucus and ranking member Charles Grassley.

The federal tax code has long exempted from taxation passive income from U.S. investments made by foreign governments. The dual reasons for the exemption in Section 892 are sovereign immunity and to keep the U.S. economy open to foreign investment. The United States does not exempt a foreign government’s income earned from commercial activities in the U.S. market because to do so would give them a competitive advantage over non-governmental market participants. There are also issues related to the transparency of sovereign wealth funds and the political concerns that might develop without such transparency.

Specifically, the senators asked the joint committee to provide information on trends in the level and types of U.S. investment by foreign governments, in absolute terms and relative to non-governmental pools of capital, and factors contributing to these trends. Similarly, the committee wants to know about trends in the level and types of investments (U.S. and foreign) by domestic public funds, such as state pension funds and other investment funds controlled by federal or state governments. The joint committee should also report on the techniques used by sovereign wealth funds to invest in U.S. corporations, referencing Revenue Ruling 2003-97.

More broadly, the joint committee will detail the present law and background regarding the federal taxation of U.S. income derived by sovereign wealth funds, including the history of the federal income taxation of U.S. income derived by foreign governments. Also to be examined is the scope of the Section 892 exemption; as well as the application of Section 892 to recent SWF investments in U.S. financial institutions and how income from those investments would be taxed in the absence of Section 892;

The joint committee will also compare the federal tax treatment of US income derived by foreign governments with the tax treatment of U.S. investment by non-governmental
foreign residents and tax-exempt entities. The committee wants information on any filing, third party tax reporting and withholding requirements associated with U.S. income derived by foreign governments.

Finally, the joint committee will provide information on the applicability of income tax treaties or other international agreements to U.S. income derived by foreign governments, as well as any policy considerations regarding the current tax treatment of U.S. investment by foreign governments. Finally, the tax treatment in other major OECD countries of investment by foreign governments will be examined.