NEW YORK (HedgeWorld.com)–The Managed Funds Association is pushing for change in new rules (Previous HedgeWorld Story) that are meant to identify abusive tax avoidance, but are so broad that they inadvertently impose significant reporting and record keeping requirements on funds.
The association has asked the Internal Revenue Service to exclude hedge funds, futures managers and their investors from temporary regulations related to tax shelters, pointing out that these are not tax shelters in the sense used by the IRS in this matter.
The government has already provided an exception for mutual funds, recognizing that they should not be required to report numerous losses or gains from regular transactions that are not motivated by tax concerns. But the exception, limited to regulated investment companies, does not benefit alternative investment vehicles.
“We would like to see this extended so that it would include hedge funds and commodity funds,” said Stephanie Pries, MFA vice president and senior legal counsel.
Hedge fund industry veterans are expressing concern. The IRS and Treasury wrote all-encompassing regulations to combat the problem of tax shelters, said Leon Metzger, vice chairman of Paloma Partners, New York. “They erred on the side of excess rather than risk omitting transactions that should be covered by the regulations,” Mr. Metzger said.
The rules were not directed at hedge funds, he noted, but this and other industries got caught in the wide net cast to uncover abuse that is difficult to detect.
Under the regulations, taxpayers are required to disclose and maintain records of six categories of transactions, two of which are of particular application to funds. One type of transaction involves a loss of at least US$5 million in any taxable year, the other a difference by more than US$10 million in an item for book purposes. Funds that mark to market would be obliged to report any transaction that generates income or loss which has not yet been realized for tax purposes but is showing up on the books.
MFA argues that these additional disclosure and recordkeeping obligations are unnecessary, as well as burdensome. The data is already provided separately in filings by funds that are taxable as partnerships and the additional reporting adds to compliance costs without adding proportionately to information.
For example, one MFA member, a multi-billion-dollar hedge fund had more than 150 transactions in 2002 in which a loss of at least US$5 million was incurred. Most of these losses were offset by gains in related securities, however, and the fund was profitable for the year. But under the new regulations the loss-generating transactions have to be separately reported.
The rules apply to transactions that take place from Jan. 1 on, but lawyers expect a variety of carve-outs to deal with fallout from the broad scope of the requirements.