USA Law and Practice Contributed by: Scott Naidech, Basil Godellas, Olga Loy and Beth Kramer, Winston & Strawn
Tax Considerations for Non-US Managers Whether a non-US manager will be subject to US fed - eral income tax will depend on whether the manager is engaged in a trade or business in the United States. Whether a manager is engaged in a trade or busi - ness in the United States is heavily dependent on the applicable facts and circumstances, but two impor - tant factors in such determination are whether the activities conducted in the United States are essential and directly related to the production of income, and whether the manager has a physical presence, such as an office or employees, in the United States. A non- US fund manager may find it beneficial to form a US subsidiary that is taxed as a corporation for US federal income tax purposes to conduct managerial activities in the United States, rather than exposing the non- US fund manager itself to any US federal income tax liability or reporting obligations. 3.5 Rules Concerning Permanent Establishments If a fund has a US-based general partner or invest - ment manager, such general partner or investment manager’s US presence should generally not cause a non-US fund or a non-US investor in a fund to be sub - ject to US federal income tax as long as the activities of the fund consist predominately of passively invest - ing in securities. However, if a fund acts as a dealer in securities, the fund will be deemed to generate ECI for its non-US investors and UBTI for its US tax-exempt investors if such dealing activities occur in the United States. Additionally, activities, such as loan origination and investing in real estate and certain so-called “US real property holding corporations” can also be expected to generate ECI and UBTI for non-US investors. 3.6 Taxation of Carried Interest Carried interest is a tax-efficient way to compensate principals of the general partner of the fund. Carried interest reflects a right to future undetermined profits of the fund above a certain performance threshold, and accordingly is not taxable upon grant by the gen - eral partner of the fund. Furthermore, carried interest allocations are not taxed as compensation. Instead, the character (as ordinary income, short-term capital gain or long-term capital gain) of amounts allocated
the SEC or an exemption from registration is avail - able. Generally, a broker is a person engaged in the business of effecting transactions in securities for the account of others for a commission, and a dealer is a person engaged in the business of buying and sell - ing securities for such person’s own account through a broker or otherwise. For the most part, an issuer of securities (such as a fund) should not be deemed to be a dealer since it is not both buying and selling its securities. Furthermore, an issuer (such as a fund) should not be considered a broker because the secu - rities it is selling are not being sold for the “account of others”; rather, they are being sold by the issuer for its own account. Unlike an issuer, however, an issuer’s employee or its general partner’s employees may be deemed to be selling securities for the account of others for a commission. See 4.7 Compensation and Placement Agents . Rule 10b-5 under the Exchange Act provides for liabil - ity for any material misstatement or omission in con - nection with the purchase or sale of a security involv - ing the use of US jurisdictional means. 3.4 Tax Regime for Managers Tax Considerations for US Managers Fund managers are generally formed as limited part - nerships or LLCs and are pass-through entities for US federal income tax purposes. As such, these entities are not subject to entity-level federal income taxes but are subject to the special carried interest rules dis - cussed under 3.6 Taxation of Carried Interest . Addi - tionally, US fund managers often utilise two entities: a “management company” to receive the management fee, and the general partner of the fund to receive the carry. This has several benefits for US managers, including providing flexibility as to who participates in the economics of each entity as well as minimis - ing state tax consequences to the principals. The management company can be structured as an LLC, an S corporation or as a limited partnership. Various tax considerations (including US self-employment tax considerations, desire to treat equity owners as employees, etc) affect which structure should be used by any given fund.
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