Tax Regulators Attack Hedge Fund Manager Efforts to Disguise Management Fees (Part One of Two)

Tax regulators in the United States and United Kingdom are attacking arrangements in which hedge fund managers and other private investment fund managers receive interests in funds in exchange for waiving management fees – or otherwise disguise fixed management fees – thereby deferring recognition of income and changing its character.  The IRS recently issued a notice of proposed rulemaking (Notice) that will treat such arrangements as “disguised payments for services,” resulting in immediate ordinary income for the manager or general partner that waives the fee.  Some fund sponsors will need to alter their current and future fee waivers to avoid this outcome, and they may need to act quickly because the Notice indicates that the IRS believes this reflects current law.  In a guest article, the first in a two-part series, George J. Schutzer and Timothy Jarvis of Squire Patton Boggs describe common management fee waiver provisions and explain how the U.S. proposals would limit fee waivers that would be respected for tax purposes.  The second article in the series will describe similar proposed actions in the U.K. and suggest steps for hedge fund managers and others to take in response to the rules in place and the proposed new rules in the U.S. and the U.K.  For more on tax proposals that could affect hedge fund managers and their employees, see “Tax Proposals and Tax Reforms May Affect Rates and Impose Liabilities on Hedge Fund Managers,” Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015); and “U.K. Disguised Fee Rules May Result in Increased U.K. Taxation of Investment Fees to Individuals Affiliated with Hedge Fund Managers (Part One of Two),” Hedge Fund Law Report, Vol. 8, No. 15 (Apr. 16, 2015).

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