Efforts by the US government to crack down on the questionable use of offshore tax havens has created much confusion about who is affected. The bottom line is most private equity investors should be prepared to do extra paperwork or else face consequences.
US taxpayers have long been required to file a “Report of Foreign Bank and Financial Account” (FBAR) form if they have holdings of more than $10,000 in foreign banks. In the past, this requirement hasn’t traditionally been enforced for holdings in foreign funds, including hedge funds and private equity funds. However, as part of an effort to stop “tax haven abuse”, the Internal Revenue Service has issued a “clarification” that investors in foreign funds are required to fill out an FBAR as well – a move that has taken many LPs by surprise.
While the IRS had previously stated unofficially that foreign private investment funds would not be treated as reportable foreign “financial accounts”, and tax attorneys had advised offshore hedge and private equity fund investors that they didn’t have to file an FBAR, the agency recently changed course and announced it is requiring such disclosures.
This has led to confusion over the scope of the filings, but it appears that among those required to file now include US investors in an offshore investment fund, US investment funds with an ownership interest in an offshore investment fund and US investment funds that maintain an offshore bank or brokerage account. The inclusion of commingled accounts under the designation of “financial accounts” also means that investors in hedge and private equity funds organized under foreign law are also required to file.
The deadline for this year was originally set for 30 June, but was extended to 23 September after the recent changes led to an uproar among hedge fund and private equity investors who complained about a lack of guidance from the IRS. Those filing on the new deadline will have to include a letter of explanation for why they were not able to gather the proper information sooner, as well as a copy of their tax returns, which were not required for the 30 June deadline.
Such additional work can be a burden for funds whose size requires multiple filings, while typically the more complicated the fund the more complicated the FBAR questions. While the FBAR form itself is pretty straightforward – requiring information such as the type of account and maximum account value – a fund with a complex structure of accounts will need more time to gather the information.
However, that is preferable to the alternative, including potential criminal prosecution and a fine of $100,000, or half the value of the account, for those who don’t file. The FBAR has become a key investigative tool for the IRS in the post-Madoff era, so while funds and investors may not like it, they are going to have to adjust to the fact that the FBAR is here to stay.