Taxation
Tax obligations and exemptions
Is a credit fund vehicle formed in your jurisdiction subject to taxation there with respect to its income or gains? Is the fund required to withhold taxes with respect to distributions to investors? Are there any applicable tax exemptions?
Credit funds formed in the United States typically are tax transparent and generally not subject to income taxation. If tax opaque, such funds generally seek to qualify for a special regime that allows them to operate without incurring fund-level taxation through reliance on a dividends-paid deduction. Tax-opaque credit funds are required to ‘backup withhold’ tax from taxable distributions paid to certain categories of US investors that fail to report investment income on their tax returns or make certain required tax certifications. Whether tax transparent or tax opaque, a credit fund that is formed in the United States must withhold tax on the gross amount of certain categories of US source income (including dividends, certain dividend-equivalent payments and interest) that are paid or allocated to a non-US investor. Exceptions apply to a non-US investor that is eligible for an exemption pursuant to an applicable treaty or, in the case of US source interest, a statutory ‘portfolio interest’ exemption. The portfolio interest exemption is subject to certain conditions, including that the beneficial owner not be deemed a ’10 per cent shareholder’ of the obligor. A tax transparent credit fund also must withhold tax on net income that is ‘effectively connected’ with a US trade or business (including US-based loan origination activity) and allocable to a non-US investor. Certain trading safe harbours enable non-US investors and tax transparent funds through which they invest (but not dealers) to trade in securities (including debt obligations acquired in the secondary market) for their own account without being deemed to be engaged in a US trade or business. The conduct of financing activity from within the United States does not fall within the safe harbours.
Tax structuring
What range of downstream tax structures are available and commonly used in your jurisdiction to mitigate any tax leakage?
Certain asset-specific structures that can avoid entity-level taxation if various conditions are satisfied include real estate investment trusts, real estate mortgage investment conduits and regulated investment companies. US taxable entities that are treated as corporations for US tax purposes are also used to shield non-US investors from direct taxation. US taxable entities that are treated as corporations for US tax purposes are subject to federal income taxation at a maximum rate of 21 per cent. Additional state and local taxes may apply. Subject to certain limitations, such entities can be capitalised in part with debt to reduce entity-level corporate taxation. Payments of US source dividends and interest made by a US taxable corporate entity to a non-US investor generally will be subject to gross withholding at source at a rate of 30 per cent, unless a reduced treaty rate or other exemption applies.
Local taxation of non-resident investors
Are non-resident investors in a credit fund subject to taxation or return-filing requirements in your jurisdiction?
Non-US investors that are deemed to be engaged in a US trade or business either directly or through investment in a tax transparent entity that is so engaged are subject to US return filing obligations. Non-US investors are taxable at the same rates applicable to US taxpayers in respect of income that is ‘effectively connected’ with a US trade or business (including income from US-based loan origination activity and certain US real property disposition gains derived either directly or through a tax transparent fund vehicle). The maximum federal income tax rate currently is 37 per cent (in the case of individual US citizens and residents) and 21 per cent (in the case of US entities that are treated as corporations for US tax purposes). Additional state and local taxes and return filing obligations may also apply. Non-US corporate taxpayers that are engaged in a US trade or business are subject to an additional branch profits tax (at a 30 per cent or lower treaty rate) on effectively connected earnings deemed repatriated from the United States. Certain categories of US source income (including dividends, dividend-equivalent payments and interest) that are not effectively connected with a US trade or business and are paid or allocable to a non-US investor are subject to withholding at source on a gross basis at a rate of 30 per cent, unless a lower treaty rate or exemption applies.
Local tax authority ruling
Is it necessary or desirable to obtain a ruling from local tax authorities with respect to the tax treatment of a credit fund vehicle formed in your jurisdiction, or the services provided by the investment manager or investment adviser? Are there any special tax rules relating to investors that are residents of your jurisdiction?
Generally, rulings are not necessary or feasible given the time, expense and inability to obtain rulings on certain highly factual topics (such as whether a non-US investor is deemed to be engaged in a US trade or business). Entity classification elections may be desirable. US investors (including US citizens and residents) are subject to US taxation on worldwide income. Long-term capital gains (in general, from the disposition of capital assets having a holding period of more than one year) and certain ‘qualified dividends’ of individual taxpayers generally are subject to a maximum federal income tax rate of 20 per cent, rather than the maximum 37 per cent rate applicable to ordinary income. An additional 3.8 per cent tax applies to certain investment income of non-corporate taxpayers having income levels that exceed certain thresholds. US tax-exempt investors generally are taxable only on income derived from (1) a business that is unrelated to their exempt purpose (with certain exclusions) or (2) debt-financed property. Non-corporate US investors are unable to deduct certain investment expenses (including management and performance fees) incurred directly or through a tax transparent fund unless attributable to active trade or business activity and allowable as an ordinary and reasonable business deduction.
Special tax considerations for sponsors
Are there any special tax considerations for credit fund sponsors?
Fund sponsors generally seek to structure carried interest as a profit share, rather than a fee. A profit share allows the character of any long-term capital gain to flow through to the carry recipient. Also, in contrast to a fee, a profit share does not carry the same risk of being taxable to investors with no offsetting deduction for non-corporate investors. In the case of a carry recipient, the holding period required for disposition gains to qualify for reduced long-term capital gain rates for individual taxpayers is increased to more than three years (as opposed to the general long-term holding period of more than one year).
Tax treaties
Are there any relevant tax treaties to which your jurisdiction is a party? How do such treaties apply to the fund vehicle or any downstream structure?
The United States has income tax treaties in force with many jurisdictions. Such treaties generally include stringent anti-treaty shopping provisions and provide relief only for otherwise eligible residents. For this purpose, a tax transparent US fund would not be considered an eligible treaty resident, though otherwise treaty-eligible investors could claim relief in respect of income derived through a tax transparent US fund, provided that their jurisdiction of residence (if other than the United States) also views the US fund as fiscally transparent.
Other significant tax issues
Are there any other significant tax issues relating to credit funds organised in your jurisdiction?
Generally, no.
