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Practical Tax Considerations for Sovereign Wealth Fund Investments in the United States

Author(s): Rufus Rhoades and Alexey Manasuev
Date: December 2011


This Emerging Issues Analysis (EIA) reviews certain tax considerations for sovereign wealth funds (generally referred to as “SWFs”) in view of recent regulatory developments.

Recently (November 3, 2011), Treasury and the Internal Revenue Service (IRS) have issued proposed regulations that addressed various issues SWFs have been facing. [Prop. Treas. Reg. §§ 1.892-4 and 1.892-5.] Those regulations partly supplement and partly replace the current temporary regulations under IRC section 892 that have been in place since 2002 (and earlier).

Importantly, the proposed regulations offer a few planning opportunities for SWFs and provide long awaited guidance on certain areas that have been neglected by the government since 1988 and 2002, when the temporary regulations, currently in effect, were promulgated.

Notwithstanding the new regulations’ status as proposed (possibly subject to change before being finalized), the preamble explicitly allows taxpayers to rely on provisions contained in those regulations, effectively trumping the temporary regulations to the extent there is any conflict.

A Brief Background.

Sovereign wealth fund investment in the United States has more than quadrupled over the last decade. More recently, SWFs have been especially active during the economic downturn by injecting funds in U.S. financial institutions and continually expanding their investment portfolios to equity investments. Some estimate that SWFs’ investments in the United States will reach over $15 trillion by 2015. Sovereign wealth fund investments came and they came for good; they see appealing opportunities to earn a healthy return on U.S. investments without being subject to U.S. tax. But, along with opportunities, SWFs have been facing significant uncertainties under the current tax regime, in many cases leading to traps for the unwary or unnecessary administrative burdens for knowledgeable taxpayers.

The recently issued proposed regulations contain favorable provisions for SWFs and address some of the pressing issues faced by SWFs, but, at the same time, the regulations fall short in addressing various important concerns.

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