In a recent Chief Counsel Advice, in an extended analysis the IRS determined that an offshore partnership with a U.S. manager that was engaged in the finance transactions was determined to be engaged in a U.S. trade or business. This conclusion subjects the non-U.S. partners to U.S. income taxes.
The partnership had no employees, and conducted all of its activities through a U.S. manager. The partnership, through the manager, engaged in commercial lending transactions and stock distribution (underwriting) activities. The CCA is interesting both to its in-depth analysis of the trade or business issues, and its conclusions.
In finding taxability, the CCA found:
a. The U.S. activities of the manager were attributable to the partnership. This is in line with general authority that agent activities are attributable to principals in determining the trade or business status of a foreign principal. This is a typical fatal flaw in the desire to set up a business in a tax haven jurisdiction and avoid U.S. income taxes, while running the business with people in the U.S.
b. The level of activities of the partnership were significant enough to cross the line from investment activities to trade or business activities. Generally, to be a trade or business the activities must be considerable, continuous and regular. Here, there were “numerous loans” and “dozens of underwriting agreements” justifying trade or business status.
c. The partnership then sought the protection of Code Section 864(b) which has two safe harbors against trade or business status for the effecting of transactions in stocks or securities. The IRS first found that the lending and underwriting activities were not “the effecting of transactions in stocks or securities” and thus could not use the safe harbors. But even if that was not the case, it went on to pronounce:
1. The first exception for trading through an independent agent if the taxpayer does not have a U.S. office does not fly here because an agent with “discretionary authority” is not an independent agent. The CCA went through the history of the exception in making this conclusion as to discretionary agents.
2. The second exception, which allows the use of a non-independent agent, and which relates to trading for one’s own account, was swatted down because the CCA viewed the partnership as a “dealer” – dealers cannot use this exception.
Now a CCA is not law, just the IRS’ view on the law. Nonetheless, taxpayers with similar structures should be alerted to potential challenges to any filing positions that are inconsistent with these conclusions.
Chief Counsel Advice 201501013