|Jim Fuller||David Forst|
The IRS legal memorandum addressed three issues: (1) did Fund engage in a trade or business within the United States; (2) were Fund's lending and stock distribution activities "trading in stock or securities" within the meaning of the trading safe harbours of § 864(b)(2)(A); and (3) if Fund's lending and stock distribution activities were treated as "trading in stock or securities" for purposes of the trading safe harbours, would Fund be eligible for those trading safe harbours?
Fund had no employees. The management of Fund was vested exclusively in Fund Manager. Fund and Fund Manager entered into a management agreement pursuant to which Fund appointed Fund Manager as Fund's agent with full power to buy, sell and otherwise deal in securities and related contracts for Fund's account. Fund Manager provided similar services for other investment entities, and no employees of Fund Manager worked exclusively for Fund.
Fund Manager committed extensive time and resources to Fund's lending activities. Fund held convertible debt instruments and promissory notes and made many of the loans associated with those instruments. On behalf of Fund, Fund Manager negotiated directly with borrowers concerning all key terms of the loans. Fund conducted extensive due diligence of a potential borrower.
Fund Manager also committed extensive time and resources to conducting Fund's stock distribution, or underwriting, activities. Fund entered into distribution agreements with unrelated issuers. Fund Manager negotiated the terms of each distribution agreement directly with the issuers.
Fund Manager also conducted marketing for Fund in respect of Fund's lending and underwriting. Whether an income-producing activity rises to the level of a trade or business in the US is based on the nature and the extent of the activity required to conduct that activity. In one case, a non-resident alien's management of real estate constituted a trade or business within the US rather than "investment and re-investment of funds in real estate" based on the nature and degree of activity necessary to manage real estate. The court stated that the taxpayer's management activity "required regular and continuous activity of the kind which is commonly concerned with the employment of labour, the purchase of materials, the making of contracts, and many other things which come within the definition of business … and within the commonly accepted meaning of that word".
In determining whether a foreign person is engaged in a US trade or business activities undertaken on behalf of the foreign person by an agent are considered to be performed by the foreign person, regardless of the degree of control the foreign person exercises over the agent. For example, in one case the Tax Court held that a non-resident alien individual was engaged in a trade or business in the US when the non-resident alien acquired real property through a real estate agent and managed the properties through other local real estate agents. The non-resident alien engaged in considerable, continuous and regular activities though his agents in the US.
The Service stated that the nature and extent of Fund's lending and underwriting, which were conducted by Fund Manager acting as Fund's agent, caused Fund to be engaged in a trade or business within the US. Fund's activities were not sporadic and occasional. Fund made numerous loans to borrowers and entered into dozens of distribution agreements with issuers. Fund (through the Fund Manager) dedicated significant time, resources and effort to these activities.
Two statutory safe harbours treat certain trading activities conducted by or for a foreign person as not constituting a trade or business within the US. One requires the foreign person not to conduct those activities through an agent who has been granted discretionary authority or through a US office of the foreign person. The other permits trading through an agent with discretionary authority or through the foreign person's US office but requires that the foreign person not be a dealer.
The Service concluded that Fund's lending and underwriting activities did not constitute "trading in stock or securities" for purposes of the safe harbours. Among other things, the Service noted the Fund's active solicitation of business, and concluded that the Fund's lending and underwriting are distinctive activities that go beyond the "effecting of transactions in stocks and securities".
The legal memorandum also stated that even if Fund's lending and stock distribution activities were treated as "trading in stocks or securities" for purposes of the safe harbours, the Fund would have been ineligible for those safe harbours in any event. Fund was ineligible for the first safe harbour because Fund granted discretionary authority to Fund Manager. Fund did not qualify for the second safe harbour because Fund acted as a dealer.
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