September 20, 2007 | Read Time: 2 minutes
TAX WATCH
Congress could change a tax law that has prompted many large foundations and universities to invest billions of dollars in overseas companies as a way to avoid facing large tax bills on hedge-fund income.
Foundation leaders and tax lawyers urged Congress during a hearing this month to change the tax system so that nonprofit endowments would no longer face any incentive to place large investments in so-called offshore blockers.
Nonprofit endowments are taxed just as for-profit businesses if they invest in a type of fund that uses a lot of debt to increase returns, so many use blocker companies overseas to convert taxable profit from hedge funds into dividends, which are not taxed.
“I don’t know of any foundation that wants to invest in offshore blocker corporations,” Janne G. Gallagher, vice president and general counsel of the Council on Foundations, told the hearing of the House Ways and Means Committee. “But current law is such that foundations that elect to invest in hedge funds would not be prudent stewards of their assets if they did not use these corporations to block the application of a tax that we believe Congress never intended to apply to this form of investment.”
That sentiment was echoed by Suzanne Ross McDowell, a Washington tax lawyer who previously worked on issues affecting nonprofit organizations at the Treasury Department.
“If Congress amends the unrelated debt-financed rules as suggested, tax-exempt investors will no longer be forced to invest offshore and use blocker entities to avoid the unrelated debt-financed income rules on legitimate investments,” Ms. McDowell said in testimony to the Ways and Means Committee. “Further, the current disparate treatment between direct borrowing and leverage, and between different types of tax-exempt investors, will be eliminated.”
As a result of the testimony at the hearing, U.S. Rep. Sander Levin, a Michigan Democrat and member of the Ways and Means Committee, introduced legislation that would allow tax-exempt organizations to invest in U.S. hedge funds without having to pay unrelated business income tax.
Mr. Levin said such a change would make the use of overseas blocker companies unnecessary.
