Compliance & Regulation

Private equity reprieve from FBAR

US investors in offshore private equity and hedge funds will not have to make potentially time-consuming FBAR filings for their interests in 2009 and earlier, but whether they will get a similar reprieve for 2010 and beyond is still up in the air.

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Private equity funds received some welcome short-term relief from the Internal Revenue Service, which said recently that LPs do not have to file a Report of Foreign Bank and Financial Accounts (FBAR) form for interests in offshore funds for 2009 and earlier. However, uncertainty remains over whether such filings will be required for 2010 and beyond.

US taxpayers have long been required to file the FBAR form if they have holdings of more than $10,000 in foreign banks. This requirement hasn’t traditionally been enforced for holdings in foreign hedge funds and private equity funds – tax attorneys typically advised offshore hedge and private equity investors that they didn’t have to file an FBAR form.

They let everybody off the hook retrospectively for prior years, but in the context of private equity funds they really took a pass on answering the harder questions.

Leonard Schneidman
However, statements made by the IRS last year led to confusion among investors about whether they were now caught up in the FBAR requirements. The FBAR form 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 a fairly straightforward form, it can lead to time constraints for large, complex funds that have to make multiple filings, and also carries fines and potential jail time for those who miss the filing deadline.

After investors complained about a lack of guidance over who had to file, the IRS pushed last year’s deadline to 30 June 2010 and sought out industry feedback before announcing late last month that private equity and hedge fund investors would get a reprieve.

“You don’t have to report for 2009 and prior years if you have an interest in an offshore private investment vehicle like a hedge fund or private equity fund unless you own over 50 percent of the fund, which is a tiny subset of filers under the prior guidance,” said Brendan Radigan, corporate law partner at Edwards Angell Palmer & Dodge. “Prior to this very welcome clarification, advisors were unsure whether to advise minority investors in foreign hedge funds and private equity funds to file reports.  More definitive guidance will presumably be issued before reports are due for 2010.”

Among the developments that had previously caused the most confusion was the inclusion of commingled funds, such as a hedge or private equity funds, under the definition of affected financial accounts. However, the IRS has clarified that it will not interpret the term “commingled fund” to apply to funds other than mutual funds for the purposes of FBAR filings for 2009 and earlier.

It also said that those with signature authority over, but no financial interest in, a foreign financial account for which an FBAR filing would otherwise have been due on 30 June of this year now have until the same date next year to file.

However, while they have been given short-term clarity, investors are still awaiting regulations, expected to be released later this year, which would provide guidance for filing in 2010 and later years. 

“They let everybody off the hook retrospectively for prior years, and they answered some questions, but in the context of private equity funds they really took a pass on answering the harder questions,” said Leonard Schneidman, Of Counsel at Pepper Hamilton.

He says in particular that future regulations could change whether offshore private equity and hedge funds are considered pooled investment vehicles and thus subject to FBAR requirements. He also says there may be an “FBAR-lite” provision passed as part of recent tax compliance proposals that would require reporting on a schedule to your tax returns ownership of offshore funds in excess of $50,000.

“You don’t have an FBAR obligation with regard to the fund interest you might own, but you may well end up with a reporting obligation on your tax return, but that is easier to deal with,” Schneidman said. “This will not get caught up in the morass of unanswerable FBAR questions with huge penalties attached. In terms of what the government did it was very helpful, but I don’t think it’s the end of the story.”

Radigan, meanwhile, believes that based on the recent guidance, the IRS and Treasury Department recognise the inconvenience and difficulty for private equity investors in filing FBAR forms, and will likely shape rules for 2010 and beyond accordingly.