By Jenny Stratsburg and Jesse Drucker
The Wall Street Journal
July 26, 2009
The Internal Revenue Service is demanding that hedge-fund and private-equity investors disclose hundreds of billions of dollars they have invested offshore, boosting scrutiny of accounts popular for tax advantages.
The move comes as regulators and lawmakers are seeking to crack down on questionable use of offshore tax havens and could uncover sources of income that aren't being taxed but should be.
Those efforts include the investigation into clients of UBS AG, some of whom the Justice Department alleges used offshore bank accounts to evade U.S. income taxes.
Investors keep funds offshore for a variety of reasons, and while some offshore investments aren't taxable, others are. It isn't clear if the new disclosure requirements will lead to additional tax revenue.
The ramped-up disclosure requirements reflect broader government steps to increase oversight of hedge funds and private-equity funds. The Securities and Exchange Commission and Congress are proposing that hedge fund managers register with the agency. The Obama administration is proposing to end a tax break on compensation for private-equity managers.
In past years, a so-called FBAR report, or "Report of Foreign Bank and Financial Account," has been filed by U.S. taxpayers with foreign bank and brokerage accounts. Until now, however, hedge-fund and private-equity investors were advised by their lawyers that they didn't have to worry about it.
Earlier this month, investors and their fund managers went into a scramble over the disclosure requirement after an IRS lawyer stated on a June 12 conference call with industry lawyers and accountants that investors in offshore funds must file an FBAR with a June 30 due date.
On Wednesday afternoon, in apparent response to an uproar from tax advisers and investors, the IRS said it would offer an extension of the deadline to Sept. 23 for filers who "only recently learned" they needed to file the reports and who have paid all their taxes.
An IRS official on Wednesday confirmed that offshore-fund investors must file, but said that the requirement wasn't new. It reflects "a much stronger emphasis on international matters," the official said. "So I wouldn't say we weren't enforcing it in the past, but we're now turning to issues that hadn't been emphasized in the past."
FBARs for those who haven't previously reported must be filed for six years, dating back to 2003.
Hedge-fund assets in offshore tax havens such as the Cayman Islands and Bermuda represent more than two-thirds of the roughly $1.3 trillion industry, according to Hedge Fund Research Inc.
Of those offshore assets, industry insiders estimate, between $400 billion and $500 billion belongs to U.S. investors, with tax-exempt foundations, endowments and pension funds accounting for about half of that. Investors from outside the U.S. make up the rest.
The FBAR change is now being interpreted by lawyers to include hundreds of billions of dollars more invested in offshore private-equity vehicles. Lawyers are afraid to give incorrect guidance. "With blurry areas, when a few people react it spreads like wildfire through the industry," said fund attorney Marco Masotti with Paul, Weiss, Rifkind, Wharton & Garrison LLP. "This caught us by surprise."
In the fall, the IRS issued new FBAR instructions, and the language spurred questions about whether the forms applied to investors in offshore hedge funds.
"If rules or interpretations are changing, we would expect an agency like the IRS to provide definitive guidance. So far the silence has been deafening," said Greg Dowling, a managing principal overseeing hedge-fund investments at Cincinnati-based Fund Evaluation Group LLC.
