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News April 18, 2011 Issue

IRS Issues Additional Tax Guidance For Foreign Private Funds

Avoiding taxes is perfectly legal. Evading them however, is not.

The Foreign Account Tax Compliance Act (FATCA) adopted a year ago aims to enlist the aid of advisers managing offshore assets in policing the evasion of U.S. tax payments.

Last week, the Internal Revenue Service issued Notice 2011-34 that sheds a little more light on the entities subject to FATCA, revises certain defined terms and procedures, and describes reporting and other obligations of offshore entities under FATCA.

In general, an offshore private investment fund will be treated as a "foreign financial institution" (FFI) under FATCA. FFIs must comply with certain diligence, reporting and tax withholding obligations with respect to U.S. assets held in the offshore fund.

Essentially, FATCA and the regulations being promulgated by the IRS and Treasury require offshore funds to withhold a 30 percent tax from "passthru" payments – distributions of interest or dividends – from U.S. asset sources such as equity securities, for example.

The regulations also require FFIs to "publish" their passthru payment percentages. The percentage reflects the amount of the fund that holds U.S. assets. This could be on the fund’s web site, or in offering documents, or other means. If an FFI does not publish the percentage, it will be deemed to have a passthru payment percentage of 100 percent.

Certain terms under FATCA, such as what constitutes "U.S. assets" for withholding purposes, remain to be defined. The notice solicits comments and indicates that further guidance will be forthcoming.

FATCA will go into effect January 1, 2013. Between now and then, advisers to foreign funds are trying to determine their status under FATCA, and what U.S. tax obligations they may have. It could be time to dial up your favorite tax attorney and begin to figure it out.