In March we advised our clients and friends that Senator Carl Levin had introduced a bill aimed at restricting the use of offshore companies for purposes of U.S. tax planning (http://www.paulweiss.com/files/upload/5Mar09TB.pdf ). One consequence of the proposal would be to encourage hedge funds organized as offshore corporations to restructure themselves as passthrough vehicles. If this were done, however, pension funds and other tax exempt investors would be subject to substantial tax on debt financed income under the UBTI rules. Since the proposal only applies to certain offshore entities managed from the U.S., it seemed well, if unintentionally, designed to force tax exempt investors into the arms of London money managers.

We have now learned that Rep. Sander Levin (the Senator's older brother and the sponsor of the most recent anti-carried interest legislation (http://www.paulweiss.com/files/upload/6Apr09TB.pdf)) plans to reintroduce a bill that would address the UBTI concern. The proposal would exempt from the debt financed income rules acquisition indebtedness incurred to purchase securities and commodities, as well as options and derivatives with respect thereto. We understand, however, that the proposal will only apply to tax exempt investors that invest as partners with limited liability in an entity that is treated as a partnership. Thus, it should apply to limited partnerships and LLC's, as well as trusts and non-U.S. corporations that have checked the box to be treated as partnerships. But it would not apply to tax exempts investing directly for their own account.

To be clear, Rep. Levin's proposal is not tied to Senator Levin's proposal. Indeed, since it simplifies structuring by acknowledging what everyone has known for a long time--the debt financed income rules don't apply as a practical matter to investments in securities and commodities--it's easy to imagine its being enacted even if Senator Levin's bill goes nowhere.

Nevertheless, it provides those who were concerned about the consequences of the Senator's bill some reassurance that U.S. tax exempts won't be forced to chose between utilizing the services of U.S. money managers and paying taxes.