US: IRS Steps Up Scrutiny of Offshore Funds

The Internal Revenue Service is demanding that hedge-fund and private-equity
investors disclose hundreds of billions of dollars they have invested offshore,
boosting scrutiny of accounts popular for tax advantages.

The move comes as regulators and lawmakers are seeking to crack down on
questionable use of offshore tax havens and could uncover sources of income that
aren't being taxed but should be.

Those efforts include the investigation into clients of UBS AG, some of whom
the Justice Department alleges used offshore bank accounts to evade U.S. income
taxes.

Investors keep funds offshore for a variety of reasons, and while some
offshore investments aren't taxable, others are. It isn't clear if the new
disclosure requirements will lead to additional tax revenue.

The ramped-up disclosure requirements reflect broader government steps to
increase oversight of hedge funds and private-equity funds. The Securities and
Exchange Commission and Congress are proposing that hedge fund managers register
with the agency. The Obama administration is proposing to end a tax break on
compensation for private-equity managers.

In past years, a so-called FBAR report, or "Report of Foreign Bank and
Financial Account," has been filed by U.S. taxpayers with foreign bank and
brokerage accounts. Until now, however, hedge-fund and private-equity investors
were advised by their lawyers that they didn't have to worry about it.

Earlier this month, investors and their fund managers went into a scramble
over the disclosure requirement after an IRS lawyer stated on a June 12
conference call with industry lawyers and accountants that investors in offshore
funds must file an FBAR with a June 30 due date.

On Wednesday afternoon, in apparent response to an uproar from tax advisers
and investors, the IRS said it would offer an extension of the deadline to Sept.
23 for filers who "only recently learned" they needed to file the reports and
who have paid all their taxes.

An IRS official on Wednesday confirmed that offshore-fund investors must
file, but said that the requirement wasn't new. It reflects "a much stronger
emphasis on international matters," the official said. "So I wouldn't say we
weren't enforcing it in the past, but we're now turning to issues that hadn't
been emphasized in the past."

FBARs for those who haven't previously reported must be filed for six years,
dating back to 2003.

Hedge-fund assets in offshore tax havens such as the Cayman Islands and
Bermuda represent more than two-thirds of the roughly $1.3 trillion industry,
according to Hedge Fund Research Inc.

Of those offshore assets, industry insiders estimate, between $400 billion
and $500 billion belongs to U.S. investors, with tax-exempt foundations,
endowments and pension funds accounting for about half of that. Investors from
outside the U.S. make up the rest.

The FBAR change is now being interpreted by lawyers to include hundreds of
billions of dollars more invested in offshore private-equity vehicles. Lawyers
are afraid to give incorrect guidance. "With blurry areas, when a few people
react it spreads like wildfire through the industry," said fund attorney Marco
Masotti with Paul, Weiss, Rifkind, Wharton & Garrison LLP. "This caught us
by surprise."

In the fall, the IRS issued new FBAR instructions, and the language spurred
questions about whether the forms applied to investors in offshore hedge
funds.

"If rules or interpretations are changing, we would expect an agency like the
IRS to provide definitive guidance. So far the silence has been deafening," said
Greg Dowling, a managing principal overseeing hedge-fund investments at
Cincinnati-based Fund Evaluation Group LLC.

Exacerbating the confusion, some hedge-fund investors such as college
endowment chiefs have started summer vacations.

Some tax experts say extending FBAR requirements to hedge fund investors
makes sense. "It's a good idea," said Reuven Avi-Yonah, the head of the
international tax program at the University of Michigan's law school. "UBS is an
indicator there is a lot of untaxed income overseas."

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