On January 17, 2024, Senate Finance Committee Chairman Ron Wyden (D-Ore.) and House Ways and Means Committee Chairman Jason Smith (R-Mo.) released a bill, the “Tax Relief for American Families and Workers Act of 2024” (“TRAFA” or the “bill”). All of the provisions in the bill are taxpayer favorable, except
David Miller is a partner in the Tax Department. David advises clients on a broad range of domestic and international corporate tax issues. His practice covers the taxation of financial instruments and derivatives, cross-border lending transactions and other financings, international and domestic mergers and acquisitions, multinational corporate groups and partnerships, private equity and hedge funds, bankruptcy and workouts, high-net-worth individuals and families, and public charities and private foundations. He advises companies in virtually all major industries, including banking, finance, private equity, health care, life sciences, real estate, technology, consumer products, entertainment and energy.
David is strongly committed to pro bono service, and has represented more than 200 charities. In 2011, he was named as one of eight “Lawyers Who Lead by Example” by the New York Law Journal for his pro bono service. David has also been recognized for his pro bono work by The Legal Aid Society, Legal Services for New York City and New York Lawyers For The Public Interest.
On November 15, 2023, the U.S. Tax Court held in YA Global Investments v. Commissioner that a non-U.S. private equity fund (YA Global) with a U.S. asset manager that bought equity and convertible debt of U.S. portfolio companies was engaged in the conduct of a trade or business within the United States for U.S. federal income tax purposes, all of its income was “effectively connected” to that trade or business, and the fund (which was treated as a partnership for U.S. federal income tax purposes) was liable for penalties and interest for failing to withhold with respect to its non-U.S. corporate feeder fund partner.
- YA Global made loans and convertible loans and entered into standby equity distribution agreements (“SEDAs”) to purchase equity. It entered into hundreds of these transactions over the years in question. YA Global described itself as providing underwriting services, its manager received structuring fees and banker’s fees, and YA Global itself received commitment fees. The Tax Court held that YA Global provided services, and therefore was engaged in a trade or business in the United States for tax purposes.
- The case provides a reminder that labels matter and taxpayers should not assume that they will be able to assert a substance argument which conflicts with their own form. For example, the outcome of the case may have been different had YA Global received all of the fee income that was paid to its manager and if the upfront payments had not been labeled as “fees”. It certainly would have been easier to argue such income was earned for the provision of capital rather than for services if the income actually had been earned by the entity providing the capital and if the income was not called “fees”. Where it is not possible to adopt a corporate form that is consistent with the intended tax treatment, it also can be helpful for the parties to agree on the tax treatment of the payment and explicitly state that agreed intention in the transaction documents.
- The IRS argued that YA Global’s manager should be treated as YA Global’s agent merely because it was acting on behalf of YA Global. However, the court declined to adopt such a broad standard, instead holding that it is the power to provide interim instructions that made the manager YA Global’s agent. The court found that YA Global had that power based on a provision in its governing documents requiring it to promptly advise its manager of any relevant investment restrictions. It is doubtful that future courts will follow this very narrow view of agency, and, therefore, funds should not rely on it. However, funds whose managers have full discretion to invest on their behalf will have a second defense against an assertion that they are engaged in a U.S. trade or business.
- YA Global held many of its securities for 12-24 months, told its investors that it sought “capital appreciation”, and had returns similar to venture capital funds (some investments doubled in value and a large number experienced losses). Despite this, the court held that YA Global was a “dealer in securities” for purposes of section 475, and that its portfolio companies were “customers”. Again, YA Global’s characterization of its own business to these portfolio companies as being a low-risk spread business likely worked against it.
Section 1402(a)(13) of the Internal Revenue Code provides that the distributive share of “limited partners, as such” from a partnership is not subject to self-employment tax. Managers of private equity and hedge funds are routinely structured as limited partnerships to exclude management and incentive fees from self-employment…
On July 11, 2023, the Senate Finance Committee released an open letter to the Digital Asset Community asking a variety of questions in connection with possible future legislation. Public comments must be emailed to the Senate Finance Committee staff at email@example.com by September 8, 2023. The questions are related to the following nine general areas.
- Marking-to-market for traders and dealers;
- Trading safe harbor;
- Treatment of loans of digital assets;
- Wash sales;
- Constructive sales;
- Timing and source of income earned from staking and mining;
- Nonfunctional currency;
- FATCA and FBAR reporting; and
- Valuation and substantiation.
The balance of this blog describes each area, lists each question, and discusses certain of them.
On July 26, 2023, Senate Finance Chairman Ron Wyden (D-OR) introduced the Ending Tax Breaks for Massive Sovereign Wealth Funds Act (the “bill”), which would deny the benefits of section 892 of the Internal Revenue Code to sovereign wealth funds whose foreign government holds more than $100 billion of investable assets, and either (i) is not a party to a free trade agreement or income tax treaty in effect with the United States or (ii) is North Korea, China, Russia, or Iran. If the bill is passed, it would deny the benefits of section 892 to several of the largest sovereign wealth funds by assets.
Section 892 generally exempts foreign governments (including “integral parts” of foreign governments and foreign governments’ sovereign wealth funds and other “controlled entities”) from U.S. federal income tax on income received from investments in U.S. stocks, bonds, and other securities, financial instruments held in the execution of governmental financial or monetary policy, and interest on deposits in banks in the United States. However, section 892 does not exempt from U.S. federal income tax any income that is derived from the conduct of a “commercial activity”, income received by a “controlled commercial entity” or received (directly or indirectly) from a “controlled commercial entity”, and income derived from the disposition of any interest in a controlled commercial entity.
The bill would generally apply to income received after December 31, 2023. However, the bill contains three grandfather provisions that would apply until 2026.
First, any investment made before the enactment of the bill would be grandfathered until 2026.
On May 3, 2023, the United States Tax Court held in ES NPA Holding, LLC v. Commissioner, T.C. Memo. 2023-55, that the taxpayer’s receipt of interests in a partnership in exchange for services rendered to the sole owner of the business before it became a partnership was for the benefit of the future partnership and, therefore, was a profits interest (rather than a capital interest). The taxpayer did not provide ongoing services to the partnership.
This blog post summarizes recent federal bills that have been introduced (but not yet passed), proposals by the Biden Administration, and guidance issued by the Internal Revenue Service with respect to the taxation of digital assets.
Summary of the Guidance:
The Responsible Financial Innovation Act (the “RFIA”) introduced…
On March 9, 2023, the Biden Administration released the Fiscal Year 2024 Budget, and the “General Explanations of the Administration’s Fiscal Year 2024 Revenue Proposals,” which is commonly referred to as the “Green Book.” The Green Book summarizes the Administration’s tax proposals contained in the Budget. The Green Book is not proposed legislation, and each of the proposals will have to be introduced and passed by Congress. Most of this year’s proposals were previously proposed by the Biden Administration. However, there are a number of notable new proposals, including proposals to increase the stock buyback tax to 4%, increase the net investment income tax (“NIIT”) rate and additional Medicare tax rate from 3.8% to 5% for certain high income taxpayers, apply the wash sale rules to digital assets, and implement several changes to the international tax laws. This blog post summarizes some of the Green Book’s key proposals.
On December 27, 2022, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury (the “Treasury”) released Notice 2023-2 (the “Notice”), which provides guidance regarding the application of the 1% excise tax on corporate stock buybacks under recently enacted section 4501 (the “Tax”). Taxpayers may rely on the Notice until proposed regulations are published. The Notice also contains a request for comments on the rules included in the Notice and rules not included in the Notice.
The Treasury and the IRS took a literal interpretation of the statute; thus, the Tax applies broadly to stock repurchases and other transactions that are not traditionally viewed as stock buybacks, including a repurchase of mandatorily redeemable preferred stock (even if such stock was issued before January 1, 2023). Special purpose acquisition companies (“SPACs”) will need to analyze whether a transaction is subject to the Tax under the general rules as the Notice does not include any special guidance for SPACs. However, SPACs did receive comfort that redemptions that take place in the same year as a “complete liquidation” under section 331 are not subject to the Tax.
On December 28, 2022, the Internal Revenue Service (the “IRS”) and the Treasury Department released proposed regulations (the “Proposed Regulations”) under sections 892 and 897 of the Internal Revenue Code (the “Code”). If finalized as proposed, the Proposed Regulations would prevent a non-U.S. person from investing through a wholly-owned U.S. corporation in order to cause a real estate investment trust (“REIT”) to be “domestically controlled”. The ability of a non-U.S. person to invest through a U.S. corporation to cause a REIT to be domestically controlled had been approved in a private letter ruling, and is a structure that is widely used. The Proposed Regulations would also apply to existing REITs that rely on a non-U.S. owned U.S. corporation for their domestically-controlled status, and suggest that the IRS could attack such a structure under current law (i.e., even if the Proposed Regulations are not finalized).
The Proposed Regulations also clarify that in determining a REIT’s domestically controlled status, a foreign partnership would be looked through and “qualified foreign pension funds” (“QFPFs”) and entities that are wholly owned by one or more QFPFs (“QCEs”) would be treated as foreign persons. Lastly, the Proposed Regulations also provide a helpful set of rules for sovereign wealth fund investors that indirectly invest in U.S. real estate.