Blocker corporation
Encyclopedia
A blocker corporation is a type of C Corporation
in the United States
that has been used by tax exempt individuals to protect their investments from taxation when they participate in private equity
or with hedge funds. In addition to tax exempt individuals, foreign investors have also used blocker corporations.
s, or as LLC's (Limited Liability Company
) which for tax purposes is considered a Limited Partnership, unless the fund formally elects to be taxed as a corporation. This allows the fund itself to avoid taxation, as each of the individual investors is taxed as a partner with respect to the share of profits attributable to the partner's personal equity interest. By comparison, a fund set up as a C Corporation would be subject to tax for its earnings, and then the limited partners would be subject to tax when they received their profit in the form of dividends distributed by the corporation. Thus, the LLC or LP format allows a fund to avoid double taxation.
When there are tax exempt investors in a fund, they are not subject to US income tax, but are still required to declare and pay taxes on "Unrelated Business Taxable Income" or "UBTI". For tax exempt investors, dividends, royalties
, rents, capital gains and interest income are not considered UBTI, but any money earned from conduct unrelated to the entity's tax exempt purpose is considered UBTI.
Foreign investors, similarly, are not generally subject to U.S. income tax. However, if a foreign investor conducts a trade or business within the United States, it is required to file a U.S. tax return and pay taxes on the same terms as a U.S. individual or corporation. In both cases, because partners are treated as earning their share of the partnership's income on a flow-through basis, they are treated as engaged in a U.S. trade or business or an unrelated business to the extent that the partnership is so engaged.
To address these issues, a private equity
fund can set up an offshore feeder corporation known as a blocker corporation. The foreign and tax exempt investors can invest through the blocker corporation, and then they are no longer personally considered to be partners, as it is the foreign corporation that is the owner of equity in the fund. For tax exempt investors, their share of the blocker corporation is considered dividend income, and thus they are not subject to tax. Foreign investors similarly avoid US trade or business income tax (although they will be subject to tax in their home country on any dividends received). The offshore blocker corporation itself is subject, however, to tax on its share of the partnership's income.
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C corporation
C corporation refers to any corporation that, under United States income tax law, is taxed separately from its owners. It is distinguished from an S corporation, which is not taxed separately. Most major companies are treated as C corporations for U.S. income tax purposes.-C corporation vs...
in the United States
United States
The United States of America is a federal constitutional republic comprising fifty states and a federal district...
that has been used by tax exempt individuals to protect their investments from taxation when they participate in private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
or with hedge funds. In addition to tax exempt individuals, foreign investors have also used blocker corporations.
Application
Most private equity funds and hedge funds are composed as limited partnershipLimited partnership
A limited partnership is a form of partnership similar to a general partnership, except that in addition to one or more general partners , there are one or more limited partners . It is a partnership in which only one partner is required to be a general partner.The GPs are, in all major respects,...
s, or as LLC's (Limited Liability Company
Limited liability company
A limited liability company is a flexible form of enterprise that blends elements of partnership and corporate structures. It is a legal form of company that provides limited liability to its owners in the vast majority of United States jurisdictions...
) which for tax purposes is considered a Limited Partnership, unless the fund formally elects to be taxed as a corporation. This allows the fund itself to avoid taxation, as each of the individual investors is taxed as a partner with respect to the share of profits attributable to the partner's personal equity interest. By comparison, a fund set up as a C Corporation would be subject to tax for its earnings, and then the limited partners would be subject to tax when they received their profit in the form of dividends distributed by the corporation. Thus, the LLC or LP format allows a fund to avoid double taxation.
When there are tax exempt investors in a fund, they are not subject to US income tax, but are still required to declare and pay taxes on "Unrelated Business Taxable Income" or "UBTI". For tax exempt investors, dividends, royalties
Royalties
Royalties are usage-based payments made by one party to another for the right to ongoing use of an asset, sometimes an intellectual property...
, rents, capital gains and interest income are not considered UBTI, but any money earned from conduct unrelated to the entity's tax exempt purpose is considered UBTI.
Foreign investors, similarly, are not generally subject to U.S. income tax. However, if a foreign investor conducts a trade or business within the United States, it is required to file a U.S. tax return and pay taxes on the same terms as a U.S. individual or corporation. In both cases, because partners are treated as earning their share of the partnership's income on a flow-through basis, they are treated as engaged in a U.S. trade or business or an unrelated business to the extent that the partnership is so engaged.
To address these issues, a private equity
Private equity
Private equity, in finance, is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange....
fund can set up an offshore feeder corporation known as a blocker corporation. The foreign and tax exempt investors can invest through the blocker corporation, and then they are no longer personally considered to be partners, as it is the foreign corporation that is the owner of equity in the fund. For tax exempt investors, their share of the blocker corporation is considered dividend income, and thus they are not subject to tax. Foreign investors similarly avoid US trade or business income tax (although they will be subject to tax in their home country on any dividends received). The offshore blocker corporation itself is subject, however, to tax on its share of the partnership's income.
See also
- Individual retirement accountIndividual Retirement AccountAn individual retirement arrangement is the blanket term for a form of retirement plan that provides tax advantages for retirement savings in the United States...
- Foundation (nonprofit organization)
- International taxationInternational taxationInternational taxation is the study or determination of tax on a person or business subject to the tax laws of different countries or the international aspects of an individual country's tax laws. Governments usually limit the scope of their income taxation in some manner territorially or provide...
- Pension fundPension fundA pension fund is any plan, fund, or scheme which provides retirement income.Pension funds are important shareholders of listed and private companies. They are especially important to the stock market where large institutional investors dominate. The largest 300 pension funds collectively hold...
External links
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