Annual Letter: 2018
This is our annual letter briefly reviewing various issues that our investment adviser clients should consider over the next few weeks.
Tax Changes
1. Tax Reform Bill. The Tax Cuts and Reform Bill changes the treatment of the “carried interest” allocable to some investment advisers to investment funds, and will particularly affect hedge fund managers. It provides that long-term capital gain treatment (a maximum of 20%) within the carried interest generally will only be available for gains from assets held for at least three years. In addition, investment expenses (such as management fees) are generally no longer deductible. Managers should consider whether to change what type of entity the management company is for tax purposes (such as partnerships, C corporations or S corporations), and whether to charge the carried interest as a profit allocation or a fee. Managers should consult us, their accountants or other tax advisers early in 2018 to determine what actions might be advisable.
2. Audit of Tax Returns. An audit adjustment to the U.S. tax return of any entity taxed as partnership for any tax year beginning after 2017 could cause a tax liability (including interest and penalties) to be imposed on the partnership for the year during which the adjustment is determined. This liability generally is determined using the highest tax rates under the Internal Revenue Code applicable to U.S. taxpayers, although the partnership may be able to use a lower rate by taking into account that it has tax-exempt partners. The partnership may be able to elect to pass through such adjustments to the partners who participated in the partnership during the applicable year, in which case each such partner, and not the partnership, would be responsible for the payment of any tax deficiency. If a partnership makes such an election, interest on any deficiency will be two percentage points higher than the otherwise applicable rate on tax underpayments. If it does not make such an election, the current partners may bear the tax liability (including interest and penalties) arising from audit adjustments at significantly higher rates and in amounts that are unrelated to their economic interests in the items that are adjusted. Similar principles may apply to audits of any master fund.
A partnership will no longer have a “Tax Matters Partner” for audits beginning with the 2018 tax year, but will now have a “partnership representative.” The general partner or its delegate will act as the partnership representative and will have the authority to bind the partnership under the audit procedures becoming effective then. You should consult us as to whether you should amend your fund documents to reflect the new rules.
Changes to Form ADV
The SEC amended Form ADV, Part 1A to: (1) formalize an “umbrella” registration option for multiple advisers that operate a single advisory business; (2) require additional information about separately managed accounts (“SMAs“); (3) require additional information about advisers; and (4) clarify certain technical questions and requirements.
Some of the material requirements of these amendments are described in more detail
below. The entire adopting release is at https://www.sec.gov/rules/final/2016/ia-4509.pdf.