The YA Global decision by the United States Tax Court
Ulises Ruiz
by Jorge Ulises Ruiz
Summary
The decision of the United States Tax Court in YA Global v. Commissioner[1] raises issues for foreign funds investing in the US. The opinion released on 15 November 2023 held that YA Global, a foreign investment fund, was engaged in a US trade or business because of the activities of its investment manager. The foreign partners of the fund were deemed to be engaged in a US trade or business.
When a foreign person has a US trade or business it is deemed to have a taxable presence in the United States and is required to file tax returns and pay income tax. The controversial decision by the tax court could have broad implications for foreign investors, funds, and the private equity industry among others. Non-US investors may need to assess carefully how to invest in US partnerships.
The decision also underscores the limits of the trading safe harbour for investing in stocks and securities when a foreign person becomes a dealer by conducing underwriting activities.
Discussion
YA Global Investments LP, a Cayman Island investment fund with no offices or employees in the US invested in securities in the United States. It appointed Yorkville Advisors, LLC, one of the fund sponsors, as its agent and investment manager. The US tax court opinion attributed the activities of Yorkville Advisors to YA Global, and hence, it was deemed to be engaged in a US trade or business.
Yorkville Advisors, LLC was deemed to be an agent for YA Global because it had the right to buy and sale securities, and YA Global had the right to give investment advice to Yorkville. Yorkville was deemed to be an agent under agency law that earned commissions. Further, Yorkville conducted extensive underwriting and lending business for YA Global and negotiated terms with the borrowers. As a consequence of these arrangements, YA Global received significant commitment, structuring, and due diligence fees paid by issuers of stock and securities. The US tax court rejected the argument that Yorkville Advisors was merely a service provider.
Under US tax law, if a partnership is engaged in a US trade or business, the foreign partners are deemed to be engaged in the US trade or business and are therefore liable for income tax. That is, the foreign partners are also deemed to have a taxable presence in the US. The partnership is required to withhold tax on the foreign partner’s share of income from the US trade or business and the foreign partners are required to file an income tax return in the US.
The tax court considered that YA Global did not meet the trading safe harbour definition, and was acting more like a merchant bank.
As part of the holding, the tax court held that filing the partnership return (Form 1065) was not sufficient to start the running of the statute of limitations on assessment because YA Global did not file Form 8804 with the partnership return. Form 8804 is filed to report the effectively connected taxable income of a partnership and the tax withheld to the foreign partners. Failure to file Form 8804 means that the statute of limitations on the foreign partner withholding tax does not start running.
Foreign investors in funds and other foreign persons investing in US partnerships should assess whether there is a US trade or business, that is, a taxable presence, when the fund or partnership has an agent or investment manager in the United States doing activities that amount to lending, banking, or charging fees to security issuers when capital is provided to customers, or in general when advertising or acting as a capital provider.
In some instances, filing a protective Form 8804 is recommended to start running the statute of limitations on assessment even if activities in the US do not amount, in principle, to a trade or business. Protective filings are allowed in the US to take the position that a tax is not due, and they involve filing a form or a return in zeros to inform the Internal Revenue Service that the taxpayer is taking the position that no tax is due.
When a foreign person or a partnership with foreign partners merely invests or trades in securities there is no US trade or business regardless of how large the investment is or the intensity of the work, but lending and underwriting activities may result in the creation of a taxable presence in the US and the activities of the agents conducting those activities may be imputed to the foreign taxpayer.
The Large Business and International Division of the IRS has a compliance campaign focused on determining if foreign companies have a trade or business in the US because of lending activities.
While YA Global did not act like a typical fund, this case illustrates the vanishing border between activities that can be conducted in the US without adverse tax implications and those that create a taxable presence in the US, with the role of the managers and advisors located in the US at the centre.
[1] 161 T.C. No. 11, November 15, 2023.
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Ulises Ruiz is the Principal-In-Charge for the International Tax Department of Prager Metis, a member of Prager Metis International Group. He has more than 25 years of experience in the accounting industry and has earned his Juris Doctorate and LLM degree.Contact Ulises.
