Chief Counsel Advisory 201501013 Warns Foreign Fund Manager Activity In The U.S. May Constitute Trading In Stock And Securities For The Fund And Its Foreign Investors

In CCA 201501013 (1/2/2015) the Office of Chief Counsel of the IRS ruled that the lending and underwriting (stock distribution) activities of a foreign partnership (Fund) were considerable, continuous and regularly carried on, and therefore that such activities, conducted on its behalf through its U.S. agent (Fund Manager) under the particular facts before it, constituted the carrying on of a U.S. trade or business and the activities. The Fund did not, in its view, qualify under the "trading in stocks and securities" safe harbor exceptions under Section 864(b)(2)(A). This resulted in a foreign corporation that is a partner of the Foreign Feeder Fund as also being engaged in a U.S. trade or business.

Facts Involved

Fund was organized in a State within the U.S. and then in the subsequent year, converted from a State A limited partnership to a foreign jurisdiction exempted limited partnership. During year 1 and 2, the Fund constituted a partnership for U.S. income tax purposes. During the same two years, Foreign Feeder, a foreign entity treated as a corporation for U.S. income tax purposes, was a limited partner in the Fund. The foreign corporation (FC) was organized in a jurisdiction which does not have a bilateral income tax convention with the U.S.

The Fund had no employees during years 1 and 2. The management of Fund was vested exclusively in Fund Manager. Fund and Fund Manager entered into a management agreement pursuant to which Fund appointed Fund Manager as Fund's agent and irrevocable attorney-in-fact with power to buy, sell, and deal in securities and related contracts for the Fund's account. Fund further granted Fund Manager the power and authority to perform every act necessary and proper to be done. Pursuant to that grant of authority, Fund Manager conducted an extensive lending and stock distribution business on behalf of Fund. Fund Manager conducted these business activities and otherwise managed Fund primarily through an office in the United States. Fund Manager provided similar services for other investment entities, and no employees of Fund Manager worked exclusively for Fund.

Fund Manager held Fund out to the markets as a lender and underwriter, generating business for Fund in a variety of ways. Fund Manager had many investment professionals who used their extensive business and personal relationships to generate lending and stock distribution deals for Fund. As a result of the efforts of these investment professionals, accounting firms, securities attorneys, and third-party investment bankers referred potential borrowers and stock issuers to Fund. In marketing materials, Fund touted its Fund Manager also sponsored and attended industry conferences relating to deal origination to generate lending and stock distribution opportunities for Fund.

Fund Manager, acting on Fund's behalf pursuant to the management agreement, committed extensive time and resources to Fund's lending activities. During years 1 and 2, Fund held a redacted number of convertible debt instruments and redacted number of promissory notes. Fund made many of the loans associated with those convertible debt instruments and promissory notes during years 1 and 2. Presumably the scale of the economic activity involved was substantial.

Fund Manager negotiated directly the loan agreements with borrowers. Before agreeing to make a loan, Fund conducted extensive due diligence on each potential borrower. Often, Fund lent borrowers money in return for debt instruments that were convertible into the borrowers' stock at a future date. Typically, the conversion prices were discounted from the trading prices of the borrowers' stock, determined at the time of conversion. After converting a debt instrument into stock at a discount, Fund sought to earn a spread by quickly disposing of the stock. Fund often received other property in connection with its lending...