USA Law and Practice Contributed by: Bill Sturman, Matthew Holt, Steven Starr and Cliff Cone, Clifford Chance
the alternative fund generates certain “qualified business income”. US tax-exempt investors are generally exempt from US federal income tax except for income generated (i) from a business that is unrelated to the US tax-exempt investor’s exempt purpose or (ii) from an investment that is debt-financed (such income, UBTI). Non-US investors treated as engaged in a US trade or business are required to file US tax returns and are subject to US federal income tax for any income that is treated as “effective - ly connected” with that US trade or business (such income, ECI). ECI recognised by a non- US investor, including through a tax-transparent vehicle, will be taxed on a net basis at the same rates applicable to US taxpayers and will subject a non-US investor to a US tax return filing obli - gation. Non-US corporate taxpayers are subject to a branch profits tax (currently at a 30% rate) on effectively connected earnings and profits, which may be lowered by an applicable dou - ble tax treaty. US source income that is not ECI (such as US source dividends or interest) is gen - erally subject to US federal withholding tax on a gross basis at a 30% rate, which may be lowered by an applicable double tax treaty. To mitigate the recognition of ECI to non-US investors and UBTI to US tax-exempt investors, alternative funds often “block” such income by interposing entities treated as corporations for US federal income tax purposes between an alternative fund’s ECI or UBTI-generating assets and the alternative fund’s non-US and US tax- exempt investors. Alternative funds may also provide for parallel and feeder vehicles in order to accommodate the needs of different categories of investors
and, in addition to potentially making invest - ments through holding vehicles treated as cor - porations for US federal income tax purposes, may also make investments through other hold - ing vehicles subject to special tax regimes, such as US “real estate investment trusts” for real estate funds and “regulated investment compa - nies” for credit funds. The disposition of interests in an alternative fund held for investment will generally result in a capital gain or loss (which will be long-term or short-term depending on the holding period of the seller). A special withholding tax regime applies to non- US investors who dispose of partnership inter - ests. Special considerations apply to non-US sover - eigns that invest in US alternative funds.
3. Retail Funds 3.1 Fund Formation 3.1.1 Fund Structures
There are three main types of retail funds: open- end funds, closed-end funds, and unit invest -
ment trusts (UITs). Open-End Funds
Open-end funds consist mostly of mutual funds and exchange-traded funds (ETFs). Mutual funds pool investor money and offer daily pric - ing, sales and redemptions of shares to inves - tors. All mutual funds transactions are made directly with investors or through investment professionals such as brokers (and not on a listed securities exchange). Mutual funds may not offer preferred shares but may offer differ - ent share classes with different investment mini -
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