Private Equity Group Seeks Exception From FBAR Reporting Requirement

Dear Commissioner Shulman:

On behalf of the Private Equity Council, a Washington, D.C. based advocacy, communications and research organization comprised of the nation's leading private equity firms, attached please find a letter requesting that the Internal Revenue Service (the "Commission") issue written guidance to clarify that investments in private equity funds are not considered a "financial account" for purposes of form TD F 90-22.1, the Report of Foreign Bank and Financial Accounts ("FBAR"). Simpson Thacher & Bartlett LLP has worked with the Private Equity Council to prepare the attached letter, which we believe contains comments that are important to developing much-needed guidance on the FBAR.

We appreciate your consideration of these comments. If you would like to discuss this letter further, or if we can otherwise assist you, please contact John C. Hart (Tax) (212-455-2830 or jhart@stblaw.com), Gary Rice (Bank Regulatory) (212-455-7345 or grice@stblaw.com) or Michael W. Wolitzer (Private Funds) (212-455-7440 or mwolitzer@stblaw.com).

The Private Equity Council ("PEC") is a Washington, D.C. based advocacy, communications and research organization established to develop, analyze and distribute information about the private equity industry and its contributions to the national and global economy. The purpose of the PEC is, among other things, to promote a broader understanding and appreciation of the nature and benefits of the private equity industry and to advocate on behalf of the nation's leading private equity firms before U.S. and international regulatory and legislative bodies. The PEC's current members include: Apax Partners, Apollo Global Management LLC, Bain Capital Partners, The Blackstone Group, The Carlyle Group, Hellman & Friedman LLC, Kohlberg Kravis Roberts & Co., Madison Dearborn Partners, Permira, Providence Equity Partners, Silver Lake and TPG Capital (formerly Texas Pacific Group).

We write to request that the Internal Revenue Service ("IRS") issue written guidance to clarify that investments in private equity funds are not considered a "financial account" for purposes of form TD F 90-22.1, the Report of Foreign Bank and Financial Accounts, which is commonly referred to as the "FBAR."

A. Executive Summary

Pursuant to regulations promulgated by the U.S. Department of the Treasury (the "Treasury Department") under the Bank Secrecy Act of 1970, as amended (the "BSA"), U.S. persons are generally required to report certain information regarding foreign financial accounts on the FBAR. Recent revisions to the FBAR, which now includes a reference to a mutual fund in the definition of "financial account," have spawned speculation that other types of funds, including private equity funds,¹ fall within the definition. As explained in this letter, interests in private equity funds should not be considered financial accounts for purposes of the FBAR because, among other things:

• For purposes of the BSA, important distinctions have been made between mutual funds and private equity funds. Unlike private equity funds, mutual funds are required to provide shareholders the right to redeem shares on a daily basis and have been specifically cited by the Treasury Department as attractive vehicles for money launderers. Significantly, while certain BSA requirements are currently applied to mutual funds, none currently apply to private equity funds.

• The recent reference to "mutual funds" in the FBAR instructions as an example of a "commingled fund" is consistent with the Treasury Department's application of other BSA requirements to mutual funds. However, it would be inconsistent with the Treasury Department's general approach to the BSA to interpret "commingled fund" in the FBAR instructions to make the FBAR requirements applicable to private equity funds.

• No tax policy purpose is served by interpreting BSA regulations to require FBAR reporting for U.S. persons holding interests in non-U.S. private equity funds, not least of all because such persons are already subject to extensive U.S. federal income tax reporting requirements that would generally cover the same information.

The statute popularly known as the "Bank Secrecy Act" was enacted in 1970 to address two main problem areas of law enforcement: (i) financial recordkeeping by domestic financial institutions; and (ii) the use by American residents of foreign financial institutions located in jurisdictions with bank secrecy laws.² Section 241 of the statute, which is codified at 31 U.S.C. § 5314, was intended to address the second problem by directing the Secretary of the Treasury to require U.S. persons who engage in transactions or maintain a relationship with a "foreign financial agency" to maintain records, file reports, or both, with respect to such transactions and relationships. The requirement for U.S. persons to file reports with respect to their foreign financial accounts on the FBAR implements this section of the BSA.

The legislative history of the BSA makes plain that a range of criminal activities and abuses, all related to disguising the sources and ownership of funds, were behind both the BSA and the legislative rationale for the FBAR reporting requirement. For example, substantial testimony from the U.S. Department of Justice, the U.S. Attorney for the Southern District of New York, the Treasury Department, the U.S. Securities and Exchange Commission ("SEC"), the U.S. Department of Defense and the U.S. Agency for International Development, as well as the IRS, revealed "[c]ase after case" of "serious and widespread use of foreign financial facilities located in secrecy jurisdictions for the purpose of violating American law."³ In particular, Congress found concerning that:

C. The Controversy Over FBAR Reporting

Other than minor editing in connection with a 1982 recodification of Title 31, Section 5314 is unchanged since its enactment in 1970.

On the basis of Section 5314, the IRS has for many years required U.S. persons to file reports with respect to their foreign financial accounts on the FBAR. Until the instructions to the form were revised late last year, it had never been supposed that the FBAR required reporting of investments in private equity funds, or hedge funds, that are organized under foreign law. Prior to the revision, the instructions described the term "financial account" in pertinent part as follows:

The addition of the reference to mutual funds in the definition of "financial account" and the absence of any definition of "mutual fund" in the FBAR instructions gave rise to speculation that the term now covered other types of funds, including private equity funds.

D. Bank Secrecy Act Treatment of Mutual Funds. Private Equity Funds and Hedge Funds

In 2002, the Treasury Department proposed requiring "unregistered investment companies" to adopt anti-money laundering programs.¹⁹ The proposal defined "unregistered investment company" to include any issuer that would be an investment company for purposes of the Investment Company Act of 1940, as amended, but for the exemptions provided by Section 3(c)(1) and Section 3(c)(7) of that Act. The Treasury Department noted that this definition would include private equity funds and most hedge funds, as well as a vast array of other entities, and stated that it was important to design specific contours to such a term so as to limit the effect on entities that are unlikely to be used for money laundering purposes (e.g., small investment clubs to large corporate holding companies) and not unnecessarily burden the resources of federal regulatory agencies responsible for meaningful and effective oversight of the financial institutions subject to the BSA. For this reason, it proposed that the requirement to establish an anti-money laundering program would apply only to unregistered investment companies that give the investor the right to redeem any portion of its ownership interest within two years after that ownership interest was purchased.²⁰ The stated rationale for excluding investment companies that did not provide such redemption rights is worth quoting at length:

The proposal to require certain unregistered investment companies to establish anti-money laundering programs lay dormant and was ultimately withdrawn on November 4, 2008²³ along with various other proposed BSA regulations, but the language quoted above reveals the key differences between open-end mutual funds, on the one hand, and less liquid investment vehicles, on the other hand, with regard to the objectives of the BSA. We believe that the IRS should also recognize these differences should it decide to issue written guidance concerning the precise scope of the definition of "financial account" for purposes of the FBAR.

In its proposal regarding unregistered funds, the Treasury Department recognized the importance of designing specific definitional contours so as to both limit the effect on entities that are unlikely to be used to disguise the source and/or ownership of funds and not unnecessarily burden the resources of federal regulatory agencies. This consideration is also relevant to Section 5314, which specifically instructs the Secretary of the Treasury to implement FBAR reporting that recognizes "the need to avoid burdening unreasonably a person making a transaction with a foreign financial agency."

As representative of the largest private equity funds, we can attest that, in our membership alone, treatment of a limited partner interest in a private equity fund as a "financial account" in fact would impose a very large burden, requiring literally tens of thousands of additional FBAR filings. Imposing such a burden is "unreasonable" if, in light of their functional characteristics, private equity funds in offshore jurisdictions are unlikely to be used to disguise the source and/or ownership of funds. This seems to us to be extremely unlikely, given that, as discussed above, a private equity fund involves a fixed set of investors, determined at the outset, who have no control over when the fund will draw on their commitments, and who do not have the right to access invested funds for as long as ten years.

Imposing such a burden also seems unreasonable in that the information that FBAR filings from private equity investors would contain is already largely provided in other tax filings.

E. The Term "Commingled Fund" Does Not Mean a Private Equity Fund

The FBAR instructions are silent on the meaning of "commingled fund" in the definition of "Financial Account" and, to date, there does not appear to be any written guidance from the IRS as to why the definition of financial account was amended as early as 2000 to include the reference to a "commingled fund." Based on contemporaneous proposals to bring mutual funds under the coverage of the BSA regulations on the establishment of anti-money laundering programs, as well as the subsequent addition of "(including mutual funds)" in the instructions, we believe that "commingled funds" mean mutual funds, and possibly other types of funds that hold cash or liquid assets and that have a redemption feature that is functionally similar to that of a bank account or mutual fund. Private equity funds do not have such a short-term redemption feature and, accordingly, should not be viewed as "commingled funds" for FBAR purposes.

As discussed above, the Treasury Department has expressed concern with the potential for open-end mutual funds to be used in money laundering activities but has not had the same concerns with private equity funds (and hedge funds not having the same redemption on demand feature as open-end mutual funds).²⁵ The Treasury Department did not ignore these distinctions when it limited certain BSA requirements to mutual funds. In so doing, the Treasury Department has been sensitive to the importance of imposing BSA requirements only where they have, as a practical matter, genuine value for law enforcement purposes.

The IRS's recent reference to mutual funds in the revised FBAR is consistent with how the Treasury Department has treated mutual funds for other BSA reporting and recordkeeping requirements. Since the Treasury Department issued regulations in 2002 applicable to mutual funds, the IRS has linked mutual funds with commingled funds. For example, as early as 2005, and before the most recent revision to the FBAR, the definition of "financial account" was annotated in an IRS advisory memorandum, dated September 1, 2005, to make reference to mutual funds as an example where equity interests would be held in a commingled fund.²⁶ Most recently, in June 2009, the IRS also updated its Frequently Asked Questions to include the question "What's meant by the term 'commingled funds'?", with the IRS responding that: "

F. No Tax Policy Purpose Would Be Served By Extending the FBAR Reporting Requirement in Such a Broad Manner

As discussed, the Treasury Department has expressed an inclination not to unreasonably burden persons that engage in transactions with entities that are unlikely to be used for money laundering purposes. Moreover, Section 5314, which is the statutory basis for the FBAR reporting requirement, specifically directs the Treasury Department to implement the requirement in a way that does not unduly burden legitimate business. In our view, no tax policy (or other) purpose would be served by interpreting BSA regulations to require FBAR reporting for U.S. persons holding any interest in a private equity vehicle formed outside of the United States. The imposition of such additional reporting in the form of an FBAR filing would also be unlikely to provide the IRS with additional information that is not otherwise required to be disclosed pursuant to other reporting requirements.

U.S. persons holding interests in non-U.S. investment funds are already subject to extensive U.S. federal income tax reporting requirements so that subjecting such persons to new FBAR reporting is unnecessary. For example, a U.S. person owning an interest in a non-U.S. investment fund that is treated as a partnership for U.S. federal income tax purposes is generally required to file Form 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships) in certain circumstances, including if the person either (a) owns an interest above a threshold (generally an interest of at least 10% of the partnership) and makes transfers to the partnership or (b) transfers property to the partnership having a value over $100,000. Moreover, a non-U.S. partnership that has one or more U.S. partners must file a federal tax return (Form 1065) identifying the U.S. partners if the partnership has U.S. source income, and capital gain derived by the partnership from the sale of securities generally has a U.S. source for U.S. resident partners, thereby obligating the non-U.S. partnership to file. Furthermore, a U.S. person owning an interest in a non-U.S. investment fund that is treated as a corporation for U.S. federal income tax purposes is generally subject to filing requirements applicable to shareholders of passive foreign investment companies," or "PFICs," including the requirement to file Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund). A U.S. person that transfers property to a foreign corporation is generally required to file information on Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation) if the person has an interest of at least 10% in the corporation or transfers more than $100,000, and in certain circumstances U.S. persons may be required to file Form 5471 (Return of U.S. Persons With Respect to Certain Foreign Corporations) with respect to their interests in foreign corporations. While it is true, as discussed above, that FBAR reporting seeks to curtail a broad range of criminal activities (e.g., money laundering, tax evasion, theft from U.S. defense and foreign aid funds), these disclosure requirements imposed by U.S. tax laws already provide an information reporting framework that would render additional disclosures unduly burdensome and duplicative.

The requirement that a U.S. investor make an FBAR filing with respect to any equity interest in a foreign fund, as opposed to an ownership level of more than 50%, is also at odds with the approach being taken in other aspects of tax policy. For example, a recent proposal by the Obama Administration would require transfers of over $10,000 (not simply account balances, as in the case of FBAR requirements) by a U.S. person to a foreign entity to be reported. However, the proposal, which is intended to address tax evasion concerns, would limit the scope of the tax reporting requirement to those entities that are more than 50% owned by a U.S. person. Thus, U.S. persons holding a minority stake would not be subject to such reporting. In the case of FBAR reporting, the highly unlikely possibility that a U.S. minority investor would try to use an investment in a foreign private equity fund to disguise the source and/or ownership of funds provides insufficient justification for requiring FBAR reporting of such an investment.

Finally, if the term "commingled fund" in the FBAR instructions is to be interpreted broadly enough to apply to illiquid, private, closed-end investment partnerships, then it would appear that a wide variety of other entities, such as operating subsidiaries, business joint ventures, real estate partnerships and the like, also would be covered by FBAR reporting requirements.

We appreciate your consideration of the issues raised in this letter and would welcome an opportunity to discuss them further at your earliest convenience. Please feel free to contact me at (202) 465-7713 if you have any questions.

Furthermore, the Treasury Department has noted that private equity funds "usually have a limited lifespan of 8 to 12 years, and investors are only able to redeem their investments when the funds liquidate." Id. Private equity funds have a number of other characteristics that make them ill-suited for money laundering: they generally involve a finite group of investors that is fixed at the time the fund is organized; the investment of funds occurs over time, as the general partner draws on commitments, and is not controlled by investors; and committed funds typically cannot be withdrawn by investors for ten years or more. After an initial commitment, an investor in a private equity fund cannot typically transfer its interest therein without the consent of the fund's general partner. Further, there is typically no established secondary market (or the equivalent) for such interests even in those circumstances where consent is granted.

² H.R. Report No. 91-975 (1970) at 2; reprinted in U.S.C.C.A.N., at 4394-4395.

³Id. at 4397.

⁴Id

⁵Id. at 4408.

⁶ TD F 90-22.1 (rev. July 2000).

⁷ There is no definition of "commingled fund" in TD F 90-22.1. It appears that the term was first used in the instructions to Form TD F 90-22.1, as revised in July 2000, because the term "commingled fund" is not found in the statute or regulations under the BSA. Section E of this memorandum explains that the term should not be viewed with the same lens that the Treasury Department has viewed certain mutual funds, with the practical implication being that commingled funds should not be viewed as covering private equity funds.

⁸ TD F 90-22.1 (rev. October 2008).

⁹ Internal Revenue Service, "FAQs Regarding Report of Foreign Bank and Financial Accounts" (Page Last Reviewed or Updated by the IRS on June 30, 2009) (emphasis added).

¹⁰ 31 U.S.C. § 5312(a)(1).

¹¹ 31 U.S.C. § 5312(a)(2).

¹² For purposes of FBAR filing requirements, the Treasury Department's interpretive authority flows from Section 5314(b) of the BSA. Accordingly, FBAR reports are required to contain certain information "in the way and to the extent the [Treasury Department] prescribes." 31 U.S.C. § 5314(b). However, it is the IRS, not the Treasury Department, that has primary enforcement responsibility. In 2003, pursuant to a memorandum of agreement between the Treasury Department and the IRS, the Treasury Department expressly re-delegated its enforcement authority to the IRS. See Financial Crimes Enforcement Network; Delegation of Enforcement Authority Regarding the Foreign Bank Account Report Requirements, 68 Fed. Reg. 26489 (May 16, 2003) (codified at 31 C.F.R. § 103.56(g)).

¹³ This is true of the following: the requirement that mutual funds establish anti-money laundering programs; the requirement to establish a customer identification program; and the requirement of mutual funds to report suspicious transactions. See note 14 and accompanying text for citations to these provisions.

¹⁴ 31 C.F.R. § 103.131(a)(1)(5) (customer identification programs for mutual funds). The same definition is used for the requirement of mutual funds to report suspicious transactions. 31 C.F.R. § 103.15(a)(1). The definition used for the regulation that requires mutual funds to have an anti-money laundering program is similar, but omits the reference to registration. 31 C.F.R. § 103.130(a).

¹⁵ Financial Crimes Enforcement Network; Anti-Money Laundering Programs for Mutual Funds, 67 Fed. Reg. 21117 (Apr. 29, 2002).

¹⁶ 67 Fed. Reg. 21118.

¹⁷Id.

¹⁸ Many private equity funds have an explicit "lock-up" provision; others simply do not provide for withdrawals, in which case investors have no right of redemption prior to the termination of the fund.

¹⁹ 67 Fed. Reg. 60617.

²⁰ 67 Fed. Reg. at 60619.

²¹Id. (footnotes omitted).

²² We note that a two-year lock-up period would include a conventional private equity fund with no specific date when funds can be withdrawn.

²³ 73 Fed. Reg. 65569 (Nov. 4, 2008).

²⁴ H.R. Report No. 91-975 (1970) at 2; reprinted in U.S.C.C.A.N., 4397-4398.

²⁵ Outside of mutual funds, the Treasury Department has also been concerned with the exploitation of financial institutions' "concentration accounts" for money laundering purposes. Such accounts, which generally commingle funds belonging to several customers, had been used by money launderers to move illicit funds into, out of, or through a financial institution usually on a daily basis and without easy detection. For purposes of money laundering, it is notable that concentration accounts, like mutual funds, involve in-and-out flows of cash relatively quickly. In this critical respect, they differ from private equity funds and those hedge funds that do not provide short-term liquidity.

²⁶ Memorandum of Sara M. Coe, Assistant Division Counsel, SB/SE Division Counsel, Office of Chief Counsel, Internal Revenue Service, No. 200603026 (Sept. 1, 2005) (annotating the definition of "financial account" in the instructions to the previous version of the FBAR with the following: "[as would be the case with a mutual fund account]").