On December 9, 2009, the U.S. House of Representatives passed H.R. 4213, the Tax Extenders Act of 2009 (the “Bill”), by a vote of 241 to 181. In addition to extending various tax relief provisions, the Bill includes revenue generating provisions which: (1) increase withholding and reporting obligations on payments made to certain non-U.S. persons, including investment funds, (2) subject certain gross payments to non-U.S. persons made on specified notional principal contracts to a 30% withholding tax, and (3) tax at ordinary income rates, instead of capital gains rates, income earned on “incentive allocations” or “carried interest” by partners providing investment management services to certain partnerships.

Taxes to Enforce Reporting on Certain Non-U.S. Investment Vehicles

Under the Bill, any “withholdable payment” made to a non-U.S. person will be subject to a 30% U.S. withholding tax unless such person enters into an information-sharing agreement with the U.S. Treasury Department and complies with U.S. reporting requirements. Withholdable payments for these purposes are: (1) any gross proceeds from the sale or other disposition of any property of the type which can produce interest or dividends from sources within the United States, and (2) any U.S. source payment of interest (including original issue discount and “portfolio interest”), dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments and other fixed or determinable annual or periodical gains, profits and income, if such payment is from sources within the United States.

The proposed withholding and reporting requirements apply to payments made after December 31, 2012, and, at least in the case of debt instruments, only with respect to payments made on obligations issued two years after the enactment of the Bill.

The proposed withholding and reporting requirements distinguish payments made to a foreign financial institution (an “FFI”) from payments made to non-financial institutions. FFIs generally include any non-U.S. entity that: (1) accepts deposits in the ordinary course of a banking or similar business, (2) is engaged in the business of holding financial assets for the account of others, or (3) is engaged (or holding itself out to be engaged) primarily in the business of investing, reinvesting or trading in certain securities, partnership interests or certain commodities or any interest (including a futures or forward contract or option in such securities, partnership interest or commodities) (an “Investment Vehicle”). Offshore investment funds, including master funds, will generally be treated as Investment Vehicles.

In order to avoid the proposed withholding tax on withholdable payments, a non-U.S. Investment Vehicle must agree with the Treasury Department (an “Agreeing FFI”) to, among other things, (i) obtain information regarding each of its investors regarding their direct or indirect U.S. ownership of their interest in the Investment Vehicle, and employ due diligence/verification procedures as required, (ii) annually provide to the Treasury Department detailed information (e.g., name, address, tax identification number, account number, account balance, gross receipts, gross withdrawals and payments) with respect to any such U.S. interest, (iii) withhold 30% of any U.S. source payment to an investor who fails to provide the necessary information (a “Recalcitrant Account Holder”), and (iv) obtain waivers of foreign law confidentiality protection from such investors. The Agreeing FFI may, as an alternative to (iii) above, elect to be withheld upon and provide sufficient information to the agent making the payment so the agent can determine how much of the payment is allocable to a Recalcitrant Account Holder. The Agreeing FFI would not be required to “look through” an investor that is itself an Agreeing FFI.

Under the Bill, almost every offshore investment fund would be required to enter into the agreement described above; otherwise, 30% of the gross proceeds, not just income, in respect of its U.S. stocks and debt investments, among other U.S. source payments, would be withheld as U.S. tax. If an FFI is the beneficial owner of a payment that has been withheld on, where such FFI is not resident in a treaty jurisdiction, the withholding tax is nonrefundable and noncreditable. As most offshore investment funds are resident in tax haven jurisdictions, treaty benefits are not likely to apply.

The U.S. accounts on which an Agreeing FFI is required to report are any held by one or more U.S. persons or “U.S. owned foreign entities,” subject to certain exceptions (tax-exempt entities are among those excepted). A foreign entity is considered “U.S. owned” when (i) any part of such entity is owned by certain U.S. persons and such entity is an Investment Vehicle, or (ii) such entity is more than 10% owned by certain U.S. persons.

The Bill impacts any non-U.S investor in U.S. securities, even offshore investment funds advised by non-U.S. managers. Financial institutions and investment fund managers who invest in U.S. securities should keep track of the Bill’s development because its enactment will impose a significant information collection and compliance burden not previously undertaken.

Substitute Dividend and Dividend Equivalent Payments Received by Foreign Persons Treated as Dividends

The Bill also expands the definition of U.S.-source dividends to include payments of “Dividend Equivalents.” Dividend Equivalents include payments made on specified notional principal contracts (“NPCs”) and payments of substitute dividends. Dividends from U.S. sources currently are subject to tax at a 30% rate for most non-U.S. persons. This provision, which would become effective 90 days after the enactment of the Bill, includes factors that would classify payments made on certain specified NPCs as Dividend Equivalents subject to withholding for a two-year period following the enactment of the Bill. Following such two-year period, Dividend Equivalent payments on any NPC will be considered a U.S.-source dividend subject to withholding unless the Treasury Secretary specifically determines such NPC does not have a potential for tax avoidance.

Partnership Interests Held by Partners Providing Services

The Bill will treat income derived from a service provider’s “incentive allocation” or “carried interest” in an investment partnership as ordinary income that is subject to self-employment taxes. This new requirement only applies to the extent an incentive allocation or carried interest relates to income earned through investment management activities, unrelated to any income or gain that reflects a reasonable return on investments. Partners will fall under this provision if they advise a partnership as to investment decisions regarding certain assets, manage certain assets, arrange financing to acquire such assets, or otherwise support the provision of such services. The types of assets include securities, real estate held for rental or investment, interests in other partnerships, and commodities and option or derivative contracts issued in connection with such assets. This provision generally will apply to taxable years ending after December 31, 2009, with certain sections becoming effective on other dates.

Other Provisions

In addition to the provisions discussed above and the extension of numerous tax relief provisions that were set to expire at the end of this year, the Bill contains numerous other provisions that increase reporting obligations for certain taxpayers and that could raise additional revenue. The Bill disallows the deduction of interest with respect to any obligation not issued in registered form, repealing a previous exception for certain foreign obligations. The Bill also changes the reporting rules for U.S. investors in passive foreign investment companies, requiring annual reporting instead of reporting only when certain triggering events occur. Also included in the Bill are new reporting requirements for U.S. persons holding foreign financial assets, similar to the FBAR reporting requirements, as well as penalties for failing to file and disclose such assets.

It is not clear whether the Act will be passed by the Senate before the end of 2009, or whether the provisions of the Act will be included in any final bill.