Tuesday, June 07, 2011

Hedge Fund Industry Asks IRS for Guidance on Safe Harbors for Passive Non-US Investors

The hedge fund industry has asked the IRS to place on its forthcoming 2011-12 Guidance Priority List guidance for Section 864(b) of the Code, which provides safe harbors for proprietary trading in stock, securities, and commodities by passive non-U.S. investors, including private investment funds. In a letter to the IRS, the Managed Funds Association said that guidance under Section 864(b) will resolve significant issues relevant to many taxpayers and promote sound tax administration by providing objective guidance that will promote general uniformity of taxpayer practice.

Noting that funds typically commit to their investors that they will not knowingly make investments that will fall outside these safe harbors, the hedge fund group is concerned that the absence of guidance under Section 864(b) on whether activities by otherwise passive non-U.S. investors, including the acquisition of loans and other debt securities as well as the receipt of certain types of fees, will be treated as falling outside the safe harbors. The MFA cautioned that uncertainty regarding the status of these types of investments results in numerous economically desirable transactions not being consummated out of concern that they would expose investors to unnecessary and serious tax risk, even though many believe that those transactions should properly be within the parameters of the safe harbors.

The MFA and others, including the New York City Bar, have for several years encouraged the Treasury and the IRS to provide such guidance, noting that its continuing absence has caused many non-U.S. investors to refrain from providing capital needed by U.S. businesses, including in cases involving nonperforming debt and bankruptcy proceedings where workout activities and perhaps new investment capital are required by those businesses. For example, in its letter of April 9, 2008 to Treasury and the Service, the MFA formally requested that guidance be issued on certain issues arising under section 864(b) with respect to so-called distressed debt situations. The MFA emphasized that the need is even greater today given the significant changes that have occurred in the U.S. credit markets in the aftermath of the financial crisis of 2008.