25 Annual Health Sciences Tax Conference - EY · PDF file25th Annual Health Sciences Tax...

25th Annual Health Sciences Tax ConferenceAlternative investments – avoiding unpleasant surprises

December 7, 2015

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Disclaimer

► EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US.

► This presentation is © 2015 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party.

► Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP.

► This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

► These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice.

Alternative investments – avoiding unpleasant surprises

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Presenters

► Bob VuillemotErnst & Young LLPPittsburgh, [email protected]+1 412 644 5313

► Jennifer RichterErnst & Young LLPSt. Louis, [email protected]+1 314 290 1024

► Jim ZiescheErnst & Young LLPPittsburgh, [email protected]+1 412 644 0659


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Agenda

► Why alternative investments?► UBTI implications and common pitfalls► Foreign and other informational filings and common

pitfalls► Best practices


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Why alternative investments?


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Alternative investments

► Why invest in alternatives?► Diversification► Investment return

► Use of blocker corporations► Domestic► Foreign

► Master limited partnerships (MLPs)► Publicly traded like stock► Significant unrelated business taxable income (UBTI) exposure


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► Direct investment structure► Hedge funds► Private equity funds► Real estate funds► Venture capital ► Co-investments

► Indirect investment structure► Fund of funds► Pooled investment portfolios

Alternative investments


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UBTI implications and common pitfalls


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UBTI information provided by partnerships

► Section 6031(d) of the Internal Revenue Code states:

“… the information required … to be furnished to its partners shall include such information as is necessary to enable each partner to compute its distributive share of partnership income or loss … in accordance with Section 512(a)(1) …”


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Unrelated business income concepts

► Three typical ways that a fund organized as a partnership may generate UBTI:► Operation of a trade or business

► Borrowing to make investments

► Flow-through from other investments


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Identification of federal UBTI

► Total UBTI should be disclosed and marked with appropriate code (Schedule K-1, box 20, code “V”).*

► Frequently, UBTI is disclosed in whitepaper detail to the Schedule K-1 rather than in box 20.

* Prior to 2006, code “P”


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Tax-exempt trusts vs. tax-exempt corporations

► Form 990-T (corporation) due November 15 (calendar-year filers)

► Form 990-T (trust) due October 15 (calendar-year filers)*► Tax brackets are different► Trusts are eligible for reduced rates on long-term capital

gains and qualified dividends► Taxation of UBTI differs by type of income (passive vs. non-

passive vs. portfolio)► Section 514(c)(9) exclusion► The Employee Retirement Income Security Act of 1974

(ERISA) rules

* Note that the Highway Tax Bill (passed July 31, 2015) changed the final due date for calendar-year trusts to September 30, but it is unclear whether this applies to tax-exempt trusts filing Form 990-T.


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States that tax UBTI

► 40 states, including the District of Columbia, tax corporation UBTI.► Delaware, Kentucky, Nevada, New Jersey, Ohio, Pennsylvania, South

Dakota, Texas and Wyoming specifically exempt UBTI from taxation.► New Hampshire and Washington do not have specific exemptions, but the

taxes under which UBTI could be taxed are structured so that alternative investment UBTI taxation is unlikely.

► 34 states, including the District of Columbia, tax pension trust UBTI.► Alaska, Arkansas, Delaware, Kentucky, Massachusetts, Minnesota,

Nevada, New Jersey, New Mexico, Ohio, Pennsylvania, South Dakota, Texas, West Virginia and Wyoming specifically exempt UBTI from taxation.

► New Hampshire and Washington do not have specific exemptions, but the taxes under which UBTI could be taxed are structured so that alternative investment UBTI taxation is unlikely.


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Unrelated debt-financed income

► 514(c)(9) exception► Debt-financed income from real property is excluded from UBTI for

“qualified organizations.”► Qualified organizations:

► Section 170(b)(1)(A)(ii) educational organizations and their Section 509(a)(3) supporting organizations

► Section 401 qualified trusts► Section 501(c)(25) multiple parent title holding organizations


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IRC §469 – passive activity losses

► Section 401(a) trusts are subject to §469► Net losses from a taxpayer’s passive activities (PALs) generally

may not be used to offset net income from the taxpayer’s non-passive activities.

► PALs may be carried forward and used to offset passive income in future years and may be deducted fully when the taxpayer disposes of their interest in the passive activity.

► This idea is clarified in the 2013 Form 990-T instructions.


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Publicly traded partnerships – §469(k)

► What is a publicly traded partnership (PTP)?► Any partnership if:

► Interests in the partnership are traded on an established securities marketOr

► Interests in such partnership are readily tradable on a secondary market (or substantial equivalent)


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Publicly traded partnerships – general rules

► Passive loss from a PTP can only be offset against passive income from the same PTP.

► Passive losses are carried forward to be offset against future income from the PTP.

► Suspended passive losses are fully deductible when the entire PTP interest is disposed.

► MLPs almost always report substantial amounts of UBTI and Section 751 ordinary gains.


Page 18 Alternative investments – avoiding unpleasant surprises

► Identifying alternative investments and obtaining the information necessary to fulfil federal income tax requirements is not always straightforward.► Internally, it may not be clear whether investments are considered

“alternative.”► E.g., publicly traded partnerships are classified as equities, not

alternative investments, for financial statement purposes.► Also, funds may not automatically provide tax information, or may

provide incomplete tax information, to investors.► E.g., foreign entities may not be required to provide Schedules K-1 or

other tax information.

Common pitfalls

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Common pitfalls

► The provided tax information is sometimes incomplete or unclear.► UBTI is frequently not reported on the face of the K-1 and is

“buried” in whitepaper detail.► State-specific UBTI reporting is spotty.► Rules related to tax-exempt trust compliance are complex and

require familiarity with many different areas, including trust, corporate, partnership, state and local, and oil and gas taxes.


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Foreign and other informational filings and common pitfalls


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► File when a US “person” owns or transfers property to a foreign corporation

► Must aggregate all transfers to the corporation, regardless of whether direct or indirect

► Filing responsibility is by shareholder (or partner if indirect)

► Penalty for failure to file – 10% of transfer, max $100,000► Statute of limitations – open for the entire return until filing

is made unless reasonable cause can be shown

Form 926 filing requirements


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What triggers Form 926?

► Certain transfers of property (e.g., Section 351) to a foreign corporation

► Ownership of at least 10% by vote or value, or amount of cash transferred during the prior 12-month period exceeds $100,000

► If you do not have enough information to determine whether the transfer meets the conditions above, the conservative approach is to file Form 926


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► Activities of a controlled foreign corporation (CFC) are reported on Form 5471 by certain shareholders

► Certain information on acquisitions, dispositions or reorganizations are reported on Schedule O of Form 5471

► Penalty for non-filing of Form 5471 is $10,000 per filing, per year, with potential additional penalties for certain filers

► Statute of limitations – open for the entire return until filing is made unless reasonable cause can be shown


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► The five requirements of a CFC are:► Any foreign corporation► Of which more than 50% of the combined voting or value► Is owned or considered as owned► By a 10% voting US shareholder► On any day during the taxable year of such foreign corporation

► Stock options are considered ownership

What is a CFC?


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► File when a US “person” owns or transfers property to a foreign partnership

► Filed by the partners, not the partnership► Penalties are similar to Forms 926 and 5471 depending

on the partner’s filing type► Range from $10,000 to $100,000 and can include reduction of

foreign tax credit



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► Who must file Form 8621?► A US person who is a shareholder of a passive foreign investment

company (PFIC) who:► Receives certain distributions from a PFIC► Recognizes gain on disposition of PFIC stock► Is making certain elections/reporting income pursuant to such elections

Or► Is required to file an annual report pursuant to §1298(f)

► When does this impact exempt organizations?► When PFIC stock is debt-financed► When Form 8621 has not already been filed by the partnership (or other

US investor) related to a qualified electing fund► General underpayment penalties apply► Statute of limitations – open for the entire return until filing is made

unless reasonable cause can be shown


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Reportable transactions

► There are five categories of reportable transactions:► Listed transactions► Confidential transactions► Contractual protection transactions► Loss transactions► Transactions of interest


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Loss transactions

► Section 165 losses► Reporting thresholds

► Corporations – $10 million in any single tax year; $20 million in any combination of tax years

► Trusts – $2 million in any single tax year; $4 million in any combination of tax years► Exception – Section 988 foreign currency losses – $50 thousand

threshold for any single tax year


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Form 5713, International Boycott Report

► US persons with operations in or related to a boycotting country, including: ► Member of a controlled group, a member of which has such

operations► US shareholder of a foreign corporation with such operations► Partner in a partnership with such operations

Or► Owner of a trust with such operations

► “Operations” – all forms of business or commercial activities and transactions

► Note – US-approved boycotts are not required to be reported on Form 5713


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Form 5713, International Boycott Report

► Penalties for not filing:► $25,000 fine► Imprisonment for up to one year► Loss of foreign tax credit

► Boycotting countries (as of March 2015):► Iraq► Kuwait► Lebanon► Qatar► Saudi Arabia► Syria► United Arab Emirates► Yemen


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FinCEN Form 114 (f/k/a FBAR or TD F 90-22.1)

► US persons with a financial interest or signature authority over foreign financial accounts greater than $10,000

► File electronically through Financial Crimes Enforcement Network (FinCEN) BSA E-Filing System

► Always file based on calendar year► No penalty for not filing if reasonable cause► Other penalties not specified as “civil or criminal or both”► New – Per H.R. 3236 signed by President Obama on

July 31, 2015, due April 15 (formerly June 30); can extend to October 15 (formerly no extension allowed)


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► Who must file:► US persons who are tax owners of Foreign Disregarded Entities► Form 5471 Category 4 and 5 filers► Form 8865 Category 1 and 2 filers► Multiple filer rules of Forms 5471 and 8865 apply

► Penalties for not filing:► Range from $10,000–$50,000 and can include reduction of foreign

tax credit► Criminal penalties



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Delinquent foreign filings

Offshore Voluntary Disclosure Program (OVDP)► Provides for reduced penalties for taxpayers with undisclosed income from offshore

accounts► Renewed in 2012 and updated in 2014► Continuation of 2009 and 2011 programs but with higher rates (27.5% to 50% penalty)► Open-ended

Streamlined Filing Compliance Procedures► Alternative to OVDP available to taxpayers certifying that their failure to report foreign

financial assets and pay all tax due in respect of those assets did not result from willful conduct on their part

► Only for individual taxpayers (including estates of individual taxpayers)► Tax returns submitted under the Streamlined Filing Compliance Procedures will be

processed like any other return submitted to the IRS► Created in 2012 and updated in 2014► There are different program criteria for US persons residing in the US vs. those residing

outside the US as well as a difference in the application of penalties


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Delinquent International Information Return Submission Procedures► For taxpayers that have not filed one or more required international

information returns but who do not need to use the OVDP or the Streamlined Filing Compliance Procedures

► Announced on June 18, 2014, and different from the procedures described in 2012 OVDP FAQ 18 ► Taxpayers who have unreported income or unpaid tax are not precluded from filing

delinquent international information returns► Penalties may be imposed if the IRS does not accept the explanation of

reasonable cause► Requirements

► Reasonable cause for not timely filing the information returns► Not under a civil examination or a criminal investigation by the IRS► Have not already been contacted by the IRS about the delinquent

information returns


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Delinquent International Information Return Submission Procedures► The delinquent foreign information returns (other than Forms 3520 and

3520-A) should be attached to an amended return (e.g., Form 990-T) and filed according to the applicable instructions for the amended return – this does not mean that a complete return be refiled, but any changes to income, expense and tax liability must be explained.

► A statement must be included with the amended return that includes:► Taxpayer certification that any entity for which the information returns are being filed

was not engaged in tax evasion► All facts establishing reasonable cause for the failure to file

► If a reasonable cause statement is not attached, penalties may be assessed in accordance with existing procedures.

► The long-standing authorities regarding what constitutes reasonable cause apply, and existing procedures concerning establishing reasonable cause, including requirements to provide a statement of facts made under the penalties of perjury, apply.


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Delinquent International Information Return Submission Procedures► According to the IRS website: “Information returns filed with amended returns

will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.”


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Delinquent FBAR Submission Procedures► For taxpayers that have not filed a required Report of Foreign Bank

and Financial Accounts (FBAR) (FinCEN Form 114 previously Form TD F 90-22.1) but do not need to use either the OVDP or the Streamlined Filing Compliance Procedures to file delinquent or amended tax returns to report and pay additional tax

Requirements► Not under a civil examination or a criminal investigation by the IRS ► Have not already been contacted by the IRS about the delinquent

FBARs► Properly reported on US tax returns, and paid all tax on, the income

from the foreign financial accounts reported on the delinquent FBARs


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Delinquent FBAR Submission Procedures► Procedures

► File the delinquent FBAR electronically according to the FBAR instructions► On the cover page of the electronic form, select the “other” block reason for filing

late and explain that you meet the Delinquent FBAR Submission Procedure requirements

► No separate statement can be attached► According to the IRS website:

► “The IRS will not impose a penalty for the failure to file the delinquent FBARs if you properly reported on your U.S. tax returns, and paid all tax on, the income from the foreign financial accounts reported on the delinquent FBARs, and you have not previously been contacted regarding an income tax examination or a request for delinquent returns for the years for which the delinquent FBARs are submitted.”

► “FBARs will not be automatically subject to audit but may be selected for audit through the existing audit selection processes that are in place for any tax or information returns.”



► Identifying foreign investments is not always straight-forward. ► Foreign investments may not provide annual tax information such

as a Schedule K-1 or Schedule K-1 equivalent.► Details regarding an investment’s “underlying assets” may be

incomplete or unclear.► E.g., if a US-exempt organization directly invests in a foreign

corporation, and the foreign corporation then invests in another foreign entity, the US-exempt organization could have a filing requirement for the second-tier foreign investments.

Common pitfalls

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Common pitfalls

► When tax information is provided, it can be incomplete or unclear.► The entity type for US tax purposes (e.g., corporation, partnership,

trust) may not be clear.► The entity classification for US tax purposes (e.g., CFC, PFIC)

may not be clear.► Debt financing and other activities may be unknown.► Transaction details may be incomplete or unclear.

► E.g., contribution dates may be needed to determine foreign filing requirements, which are aggregated on a 12-month period and not by calendar year.


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Best practices


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Best practices

► Start the annual compliance process as early as possible► Tax department communication with the treasury

department and investment personnel► Tax department communication with funds

► Ongoing► Situational

► Tax department involvement in investment decisions


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Example

► A US hospital’s (Hospital) investment team coordinates all of Hospital’s investment matters and provides Hospital’s tax department with the information that it needs to complete Hospital’s tax returns each year.

► With respect to Hospital’s alternative investments, such tax information primarily consists of Schedules K-1 from funds organized as limited partnerships.

► The tax department is preparing its Form 990-T. Similar to prior years, the investment department provides the tax department with the Schedules K-1.

► The tax department notices that there are several new Schedules K-1 and that Hospital is not named as the limited partner. Rather, it is a foreign entity with a name that contains Hospital’s name.

► After numerous discussions with the investment team and the Hospital’s outside investment and tax advisors, it is determined that the investment related to these new Schedules K-1 is structured as shown on the following slide.


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Example


United States

Cayman Islands

501(c)(3) Hospital

Delaware LLC

Cayman Islands LP

Delaware LP

Delaware LP

Delaware LP

1%General Partner

99%Limited Partner

<10%Limited Partner

<10%Limited Partner

<10%Limited Partner

Corporation√

Page 45

Example

► Federal income tax implications► Form 5471 – Cayman Islands LP is a foreign corporation that is

considered a “controlled foreign corporation”► Form 926 – To the extent that Hospital makes contributions to

Cayman Islands LP of $100,000 or more in any one-year period► Form 1120-F – Because Cayman Islands LP’s underlying

investments are Delaware LP’s, Cayman Islands LP will likely be considered to have US income

► Who’s responsible for all of this?


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Other considerations

► Unreported foreign income to foreign taxing authorities► Permanent establishment – engaged in trade or business► Tax on realized capital gains

► Financial statement issue► Deferred tax asset/liability on unrealized losses/gains

► Recovery of incorrectly withheld tax► Form 990, Schedule F► Application for treaty benefits

► US residency certificates to prime brokers► Reduced rate of withholding – dividends



Questions?

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