Philip L. Stein

July 22, 2009

Philip Stein & Associates Ltd presents:

Hot Topics for Venture Capital Funds

US Tax Compliance• Recent news on carried interest taxation • Foreign Bank Account Report – Especially

following the UBS scandal • Automatic 10K penalty for late filing of Form

5471 – Information report for foreign subsidiaries

• PFIC’s – Reporting of investments in portfolio companies considered passive entities

US Tax Planning

• Structuring foreign subsidiaries to avoid tax pitfalls

• Avoiding multiple subsidiaries and Subpart F Income

• Recent Developments on elimination of the Check-the-box regulations

Obama’s Proposal for Taxing Carried Interest

• A partner’s share of income on a “services partnership interest” (SPI) would be subject to tax as ordinary income, regardless of the character of the income at the partnership level.

• Proposal would require the partner to pay self-employment taxes on such income.

• Gain recognized on the sale of an SPI would generally be taxed as ordinary income, not as capital gain

• To the extent that the partner who holds an SPI contributes “invested capital” and the partnership reasonably allocates its income and loss between such invested capital and the remaining interest, income attributable to the invested capital would not be recharacterized.

Ideas to Consider

• Will Israel still tax Carried Interest as capital gain?

• Will the U.S. consider Carried Interest as effectively connected income?

• Very expensive if partners are US citizens• Consider holding Carried Interest in Israeli

corporation

Form TD F 90-22.1• Disclosure is required when a U.S. person owns the account or holds a beneficial interest in the

account, or has signature authority over the account (ability to direct disbursements from the account).

• A “financial account” is defined by the IRS to include “any bank, securities, securities derivatives or other financial instruments accounts. The term includes any savings, demand, checking, deposit, or any other account maintained with a financial institution or other person engaged in the business of a financial institution.

• Civil and criminal penalties for non-compliance with the FBAR filing requirements are severe. Civil penalties for a non-willful violation can range up to $10,000 per violation (31 U.S.C. Section 5321(a)(5)(B)(i)). A finding of non-willful violation is likely to be found only in those cases where the taxpayer marked the appropriate box on Schedule B and reported the income from the foreign account, had no prior FBAR filing violations and cooperated with the IRS in its investigation.

• Civil penalties for a willful violation can range up to the greater of $100,000 or 50 percent of the amount in the account at the time of the violation. The IRS has six years to impose civil penalties on failure to file an FBAR.

• The FBAR is a no-win proposition for taxpayers. Failure to file leads to confiscatory penalties (50% of account balance for each of the prior 6 years) if the taxpayer is caught with an unreported account. Voluntary disclosure program is somewhat less confiscatory on its face (20% penalty on the last year’s balance in the account, plus back taxes, interest and a negligence penalty).

Implication for VC Funds• Several US Internal Revenue Service (IRS) officials have

recently indicated that TD F 90-22.1 (Report of Foreign Bank and Financial Accounts) (FBAR) should be filed by United States persons that own interests in certain non-US investment vehicles, such as hedge funds.

• The instructions do not define the term “commingled fund,” but given the context, the IRS has apparently interpreted this term broadly, as including all vehicles for which investments are made on a pooled basis (e.g., to include mutual funds and hedge funds). It is also possible that private equity funds and structured finance vehicles are included, but they are not specified in the instructions.

5471 Penalties

• IRS cracks down on late filed forms• 2008 Forms must be filed no later than

9/15/2009• Delaware holding company with Israeli subsidiary• Any US citizen or resident (corporate or non-

corporate) whose shareholdings in certain foreign corporations exceed specified thresholds must file with the IRS an annual form 5471 disclosing certain information.

5471 Penalties• Failure to timely file a form 5471 can result in significant potential

penalties: • (1) a $10,000 penalty for each form 5471 that is filed after the due

date (including extensions) or that does not contain complete and accurate information (Code section 6038(b)(1));

• (2) a potential failure-to-file or failure-to-pay penalty equal to 5 percent of the tax required to be shown on the return for each month during which it is delinquent (up to 25 percent of the tax due) (section 6651(a)(1)); and

• (3) a potential 10 percent reduction in available foreign taxes otherwise creditable under sections 901, 902, and 960 (section 6038(c)). A taxpayer that establishes reasonable cause for its failure to file on time can generally avoid penalties

PFICPassive Foreign Investment Company

• 75% or more of the company's income is passive• 50% of the company's assets exist in investments

earning interest, dividends, and/or capital gains.• US shareholders need to make QEF election• If election not made, investors loses capital gain

treatment• Fund needs to inform investor of PFIC status of

underlying investment

PFICPassive Foreign Investment Company

• First taxable year in which a foreign corporation has gross income (the "Start-Up Year"), the company will not be considered a PFIC. For this to be the case, the following conditions must be met:

• Any predecessors to the company must not have been PFICs.

• The company must establish that it will not be a PFIC for either of the first two taxable years following the Start-Up Year

• The company must not, in fact, become a PFIC during the first two years following the Start-Up Year

More Obama Proposals

• Reforming Deferral Rules• Inability to claim deductions until income

reported• Exception for R&D expenses• Cost plus model may no longer be appropriate

More Obama ProposalsCheck the Box

• Congress will limit the ability to defer income• SubPart F • Foreign Subsidiaries• Doing business in other countries through

Israeli subsidiary• Related Party Transactions