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Private Equity Firms Face Compliance Woes Under ‘GILTI’ Tax Rules

Sept. 17, 2018, 11:01 AM

Small shareholders of U.S. partnerships with overseas interests could get smacked with the 2017 tax overhaul’s levy on global intangible low-taxed income, a development creating a slew of unexpected complexities, particularly for private equity funds.

The Internal Revenue Service’s proposed regulations for the GILTI tax (REG-104390-18) outlining the minority shareholders’ liability could also factor into some funds’ decisions as they weigh whether or not to incorporate, tax professionals told Bloomberg Tax.

“It’s going to be a compliance nightmare for software providers” that manage partnerships’ financial filings “and a compliance nightmare for partnerships that are going to have to deal with this,” said Glenn Dance, a former IRS official and current managing director at Grant Thornton LLP in Washington. “When they do their modeling work, they take into account the law at the time.”

The 2017 tax law (Pub. L. No. 115-97) subjects U.S. shareholders who own more than 10 percent of a controlled foreign corporation to a tax on GILTI, which is the income of the CFC that exceeds 10 percent of the value of its tangible, depreciable assets.

If a U.S. partnership owns at least 10 percent of a CFC, that ownership interest is split among the partners. It doesn’t matter whether the partners themselves, by extension, individually own 10 percent of the CFC, practitioners said, because their income from that indirect ownership of the CFC is still subject to the GILTI tax.

More Conversions, Less Certainty

“I think some of these entities will definitely convert to corporations and/or they’ll convert portions of their tax structures into corporations,” Andrew Silverman, a Bloomberg Intelligence tax policy analyst, said in an email.

Private equity and asset management giants KKR & Co. LP and Ares Management LP have already done so, he said, prompting speculation that others, such as Blackstone Group LP, Carlyle Group LP, and Apollo Global Management LLC, may soon follow. “The impact of GILTI on partnerships,” Silverman said, “could be the deciding factor that pushes them to convert.”

And affected companies are going to make their thoughts loud and clear, practitioners said, as the IRS irons out the final version of those proposed rules—a potential for change that will only heighten uncertainty for businesses.

“This is a first stab at the rules—they’re going to go through a lot of revisions,” said Carl Merino, counsel at Day Pitney LLP in New York. Companies’ financial disclosures, he added “are necessarily going to remain in flux.”

Striking a Balance

In writing the proposed regulations, the IRS sought to reconcile the tax law’s GILTI provision with existing rules governing the income of a CFC, known as Subpart F income, Merino said.

“Since the GILTI rules are generally supposed to track Subpart F, they were trying to be consistent, I think,” said Merino. While the IRS considered two different approaches to the problem of U.S. partnerships with 10 percent or greater interests in CFCs, he said, “any approach produces some distortion.”

Kim Blanchard, a partner at Weil Gotshal & Manges LLP in New York who focuses on private equity partnerships and international tax planning, said the approach the agency chose should hardly be a surprise at all, as the IRS has been tacitly applying it under the Subpart F rules all along. The IRS chose this approach, she said, because otherwise it would have to admit that it was retroactively wrong.

“We’ve done a number of deals with private equity,” she said, in which “we have put domestic corporations on top of foreign targets just for this reason, because it’s a nightmare.”

To contact the reporters on this story: Lydia O'Neal in Washington at loneal@bloombergtax.com; Allyson Versprille in Washington at aversprille@bloombergtax.com

To contact the editor responsible for this story: Meg Shreve at mshreve@bloombergtax.com

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