Blockers are an integral part of international tax planning, particularly in inbound transactions where foreign persons participate in U.S. businesses. Blockers are U.S. or foreign entities that are classified as corporations for U.S. income tax purposes. If they are formed in the United States, they are usually established as state law corporations. On the other hand, offshore blockers may check the box under Regs. Sec. 301.7701-3 to elect their classification for federal tax purposes, or they may, under Treasury regulations, be classified as corporations under the default rules.
Blockers often show up in the investment fund context, although they are helpful in other contexts as well. They can be formed below the fund (i.e., between the portfolio company and the fund) or above the fund (e.g., as feeder blockers). They can be single or multipurpose. A single-purpose blocker, as its name suggests, holds an interest in a single U.S. business. Conversely, a multipurpose blocker participates in several U.S. businesses.
The blocker does several things. It blocks potential U.S.-source effectively connected income at the blocker level and makes any required tax filings with respect to such income. In other words, the blocker itself, and not the owners of the blocker, is subject to U.S. tax. Similarly, the character of income is also blocked because the corporate entity is simply not flowthrough for purposes of U.S. tax law. Foreign persons invested in the United States through a blocker would not be required to file a U.S. tax return.
Moreover, blockers prevent attribution of a U.S. trade or business up the chain to the fund (if the blocker is below the fund) and to the foreign investors (if the blocker is below or above the fund). Foreign investors dread the attribution of a U.S. trade or business because it could cause income that otherwise would not be taxed in the United States to be subject to U.S. taxation. Such attribution would also cause the foreign investor to be subject to U.S. tax filing obligations. Thus, a blocker eliminates both the risk of filing a U.S. tax return and the risk that a foreign investor may be deemed to be engaged in a U.S. trade or business.
The blocker tax guide illustrates the U.S. income tax consequences of operating and disposing of a domestic or foreign blocker under several common scenarios. 1 This guide is intended to describe, in general terms, the U.S. tax consequences of various blocker structures. It does not recommend any particular structure. The structure of any investment by a fund in the United States must be made on a case-by-case basis and depends on the specific deal facts presented. Foreign taxpayers should consult U.S. tax counsel early on in any discussions of a proposed U.S. investment.
1 To learn more about blockers, see Mitev, The Private Equity and Venture Capital Tax Manual (ABA Book Publishing 2011).
Michael Kosnitzky is a partner in Boies, Schiller & Flexner LLP in Miami, FL. Ivan Mitev is an associate with Boies, Schiller & Flexner LLP in New York, NY. For more information on this article, contact Mr. Kosnitzky at email@example.com.