5 questions with Shahzad Malik

A little known tax act that is likely to be enacted later this year and have major impact on the private equity industry is the Foreign Account Tax Compliance Act of 2009, which was introduced by Senators Max Baucus (D-MT), John Kerry (D-MA), Richard Neal (D-MA) and Charles Rangel (D-NY). The Act essentially requires foreign financial institutions, which includes private equity and hedge funds, to disclose information about their U.S.-based investors.

PE Week Managing Editor Alastair Goldfisher recently spoke with attorney Shahzad Malik, who advises private equity and hedge funds on tax issues for Los Angeles-based TroyGould, about the impact of the proposed act.

Q: What’s the benefit of the act?

It is expected to generate $8 billion in new revenue, as it creates a new reporting regime that would effectively require non-U.S. financial institutions to provide full disclosure of any U.S. person’s accounts maintained at the institution and annual reporting to the U.S. treasury by the foreign financial institution

Q: How will it impact private equity firms?

The definition of ‘non-U.S. financial institution’ is broad enough to include the majority of foreign investment vehicles, including offshore hedge funds and private equity funds. The tax would effectively force any hedge or private equity fund that does any investment in the United State to enter into an agreement with the IRS to provide extensive U.S. accountholder information.

Q: What if PE firms don’t comply?

Firms that don’t comply are subject to a 30% withholding tax. This tax would make it uneconomic to invest in the U.S. unless the new requirements are complied with.

Q: What will your clients have to do to comply with the Act?

If this act is enacted, foreign funds with any U.S. investments will need to obtain information from each account holder to determine if the account is a U.S. account. In certain circumstances, they may need to obtain waivers in cases where foreign laws would prevent this reporting. This could be a significant problem in many jurisdictions with bank secrecy laws.

Q: What do you think of this act?

These rules are very broad and may be difficult to implement in some cases. For example, a “U.S. account” is a financial account that is owned by U.S. persons or U.S. owned foreign entities. Indirect U.S. ownership of foreign entities can be problematic to figure out. In addition, it is likely that compliance with these rules could be a violation of the laws of other foreign jurisdictions. It is not clear how funds can get around this. An analysis of the different legal regimes that the fund is subject needs to be undertaken.

While I am very sympathetic to the laudable goal of increasing U.S. tax compliance, I am concerned that this Act is too broad and the increased compliance costs of funds investing in the U.S. could raise the cost of capital in the U.S.