Category — Tax

What follows is an executive summary of a tax alert released today. Read the full alert here.

On October 3, 2008, new Section 457A was added to the Internal Revenue Code by the Emergency Economic Stabilization Act of 2008. As discussed in our client alert, “New Section 457A, Which Limits Deferral of Offshore Compensation, Is Signed into Law,” Section 457A imposes significant restrictions on the ability of U.S. taxpayers to defer compensation earned from certain tax indifferent parties, including managers of offshore hedge funds. Generally, under Section 457A, taxpayers are required to include in income compensation that is deferred under a “nonqualified deferred compensation plan” of an entity (including both domestic and foreign partnerships and foreign corporations) that is not subject to a general income tax regime (a “nonqualified entity”), provided that the compensation is not subject to a “substantial risk of forfeiture.”

On January 8, 2009, the IRS released Notice 2009-8, which provides interim guidance to assist taxpayers in complying with Section 457A while the Treasury Department and the IRS consider further guidance. The Notice states that any future guidance that would expand the coverage of Section 457A will be prospective.

If you have any questions regarding this alert, please contact—

• Patrick B. Fenn, pfenn@akingump.com, 212.872.1040, New York
• Stuart E. Leblang, sleblang@akingump.com, 212.872.1017, New York
• Bruce E. Simonetti, bsimonetti@akingump.com, 212.872.8023, New York
• Jessica Cherry, jcherry@akingump.com, 212.872.7437, New York
• Joshua R. Williams, jrwilliams@akingump.com, 212.872.8014, New York

The Securities and Exchange Commission (SEC) has taken steps to reassess and refine the application of “mark-to-market” rules, with plans to issue a complete study of fair value accounting practices on January 2, 2009. On December 8, SEC Chairman Christopher Cox shared some preliminary findings of the study, which indicated that fair value accounting measurements would likely be not suspended, despite significant criticism of the rules from many banks, financial regulators and economists.

Chairman Cox stated that, based on recent roundtables with market participants, investors benefited from transparent financial reporting of mark-to-market assets and that, to insure a healthy market, “the content provided to investors should not be compromised to meet other needs.” However, he recognized that fair value measurements of securities traded in inactive or illiquid markets pose a particular challenge to the financial institutions holding them, and that the SEC was investigating more robust guidelines for auditors and statement preparers to apply these rules.

Furthermore, on December 15, the Financial Accounting Standards Board announced that it is examining the possibility of broadly applying mark-to-market rules beyond securities to loans, bonds, derivatives and stocks to create more uniform accounting procedures.

The debate over mark-to-market has, on one side, critics who say this accounting approach ignores long-term values and creates write-down losses that deplete bank capital, while, on the other side, supporters say sufficient and clear information is necessary for investor confidence. In the nearly overnight collapse of insurance giant AIG, many critics faulted mark-to-market rules for quickly exaggerating the company’s unrealized losses and creating market volatility.  Rather than create balance sheets based on mark-to-market assets, financial institutions might value gains and losses over a multi-year period, a historical approach currently taken by pension funds and other conservative investment instruments.

The Securities and Exchange Commission (SEC) recently issued a manual from its Division of Enforcement and a request for public comment on fair value accounting, both of which may clarify the Commission’s actions and decisions.

If you have questions regarding the information in post, please contact-

Enforcement

• Jim Benjamin, 212.872.8091, New York

Fair Value Accounting

• Patrick J. Dooley, 212.872.1080, New York
• Bruce S. Mendelsohn, 212.872.8117, New York
• Eliot D. Raffkind, 214.969.4667, Dallas
• Stephen M. Vine, 212.872.1030, New York
• Richard B. Zabel, 212.872.8060, New York

The SEC Division of Enforcement published its first manual to codify its practices and procedures for investigations. While intended as an internal staff reference, the document will offer insight on how the Commission operates in enforcement matters and what it expects in its requests for information.

The full manual can be found here.

The SEC is also requesting public comment until November 13 on fair value (or “mark-to-market”) accounting, for its study mandated by the Emergency Economic Stabilization Act of 2008. The Commission also welcomes public comments on the issues, point-of-view, research and opinions it should consider in conducting the study.

More information on submitting public comments can be found here.

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What follows is an excerpt from a client alert published by Akin Gump’s tax and investment funds practices. To download the full alert click here.

For more information on this alert please contact-

Tax:

• Patrick Fenn 212.872.1040 New York
• Stuart Leblang 212.872.1017 New York
• Bruce Simonetti 212.872.8023 New York
• Kevin Rowe 212.872.8064 New York
• Josh Williams 212.872.8014 New York

Investment Funds:

• Stephen Vine 212.872.1030 New York
• Prakash Mehta 202.887.4248 Washington, D.C.
• Mark Barth 212.872.1065 New York

On October 1, 2008, the Senate passed a bill that would add new Section 457A to the Internal Revenue Code (the “Code”). As discussed below, Section 457A would impose significant restrictions on techniques commonly used by managers of offshore hedge funds to defer fee income. The restrictions would generally apply to deferred compensation attributable to services rendered after 2008.

The Senate bill contains limited transition relief for deferred compensation attributable to services performed before January 1, 2009. Although some aspects of the bill are unclear (particularly with respect to side pockets), the transition relief would generally allow continued deferral of pre-2009 deferred compensation amounts until 2017.

The Senate bill combines the financial sector bailout bill that was rejected by the House on September 29, 2008 with a highly popular package of extensions for expiring tax cuts, which would be partially paid for by Section 457A. Thus, although there have been differences of opinion between the Senate and the House over how the bailout should be structured and the extent to which extensions of tax cuts should be paid for, it seems likely that the combined legislation will pass the House. The House is expected to bring the Senate bill to the floor for a vote on October 3, 2008. Assuming the House passes the bill, the White House has indicated that President Bush will sign the combined legislation.

Because it seems likely that Section 457A will be signed into law in 2008 and will impose significant restrictions on deferred compensation arrangements attributable to services rendered after 2008, we think it may be prudent for fund managers to consider before year end certain planning techniques to take maximum advantage of the transition relief provided in Section 457A and to consider compensation arrangements going forward to address the new challenges posed by Section 457A.

In a July 2007 client alert, we reported on an Internal Revenue Service (IRS) effort to investigate the use of derivative transactions by hedge funds and other foreign investors to avoid U.S. withholding tax on U.S. source dividends and certain other types of income. At the time, the scope of the IRS investigation was unclear, but we noted then that it appeared to be focused on so-called “dividend enhancement” trades, such as total return swaps over U.S. publicly traded stock and similar derivatives. In addition, we noted that it remains to be seen whether the investigation would lead to tax audits of foreign funds that entered into tax-advantaged derivative transactions.

The attack on these types of transactions seems to be intensifying. On September 11, 2008, the U.S. Senate Permanent Subcommittee on Investigations, a subcommittee of the Committee on Homeland Security and Governmental Affairs, held a hearing on the transactions; in advance of the hearing, the subcommittee released a staff report entitled “Dividend Tax Abuse: How Offshore Entities Dodge Taxes on U.S. Stock Dividends.” The report and hearing were the subject of numerous high-profile news articles, including articles in the Wall Street Journal and New York Times. A number of speakers, including IRS Commissioner Douglas Shulman, Professor Reuven S. Avi-Yonah and executives of certain financial institutions and investment funds, testified at the hearing.

See the full alert here.

If you have questions regarding this alert, please contact—

• Patrick B. Fenn, 212.872.1040, New York
• Stuart E. Leblang, 212.872.1017, New York
• Robert Rothman, 212.872.7411, New York
• Peter J. Guy, 212.872.1024, New York
• Stephen M. Vine, 212.872.1030, New York
• Prakash H. Mehta, 202.887.4248, Washington, D.C.
• Mark H. Barth, 212.872.1065, New York