Offshore relief as IRS extends deadline

Investors in offshore hedge funds and private equity firms are likely breathing a sigh of relief, as the US Internal Revenue Service has extended a fast-approaching deadline to file the 2008 Report of Foreign Bank and Financial Accounts (FBAR) form, which has had many LPs scrambling to make the necessary disclosures or face stiff penalties.

The previous deadline had already been pushed back from to 22 September of this year from June, and will now be extended again to 30 June 2010 for those with a signature authority over, but no financial interest in, offshore accounts, as well as those with a financial interest or signature authority over foreign commingled funds such as a hedge or private equity funds.

The IRS had previously stated unofficially that foreign private investment funds would not be treated as reportable foreign “financial accounts”, while tax attorneys had advised offshore hedge and private equity investors that they didn’t have to file an FBAR. This all changed during a recent conference call in which the IRS abruptly changed course and announced it would require such disclosures from these entities, which caught many investors off guard.

The IRS and Treasury Department are stepping up the use of the FBAR in order to more heavily scrutinise foreign holdings and combat alleged tax haven abuse, including an ongoing investigation of UBS AG.

“People have been scrambling. The guidance has been so poor and so weak that lots of very important questions have been unanswered, which is why there was so much controversy and confusion,” said Leonard Schneidman, Of Counsel at Pepper Hamilton. “There are no regulations and no real guidance similar to what you would expect on a tax law item. It’s an example in my mind of how not to administer a tax requirement.”

The FBAR form, which can be found at the IRS’ website (www.irs.gov/pub/irs-pdf/f90221.pdf), requires information about each financial account an investor owns either separately or jointly, including maximum account value, the type of account and the account number. While it is fairly straightforward form, it can lead to time constraints for large, complex funds that have to make multiple filings.

Of greater concern, though, has been the potential penalties for missing the deadline, including criminal prosecution, jail time and steep fines. Those that fail to file could be hit with a fine of $100,000 or half the value of the account, whichever is larger.

This has led to an uproar among groups such as the Managed Funds Association (MFA), which includes a number of major hedge funds and which has been lobbying for its members to be excluded. During the moratorium the IRS will be seeking comments and feedback from the industry on a number of issues, and may end up excluding private equity and hedge funds from the definition of “financial accounts”, as well as exempting certain investors from filing the FBAR.

“This is just giving the IRS the chance to produce real guidance on who has to file this thing and how,” Schneidman said. “The IRS usually asks for comments but in a much more rational manner, not with a month to go before doomsday. They may now put out something resembling regulations like the typical tax guidance that people can read and interpret. No one is going to do anything until some guidance comes out, so this is a real break for the taxpayers who didn’t know what to do or how to do it, and had only until September to figure it out.”