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- FOREIGN INCOME & TAXPAYERS
Tax considerations for foreign investment in US private credit

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Private credit as an asset class has undeniably seen tremendous growth over the last two decades. Since 2007, private credit has expanded by more than 10 times, and most large asset managers and private-equity firms are taking part in this growth.1 By 2028, some forecasters are predicting that private credit can become a $2.8 trillion market or more.2
Private credit is generally an encompassing term for different investment strategies that involve some form of nonbank lending. At a very high level, some of the more common private credit strategies that are employed include:
- Direct lending: Senior loans made directly to companies.
- Mezzanine lending: Loans made directly to companies that are generally subordinated. These often come with an equity upside for the risk the lender takes.
- Distressed debt: Loans made to companies in financial distress or purchased from a third party.3
Non-U.S.4 investors are keen on U.S. private credit investment, largely due to the regular, recurring nature of the returns (i.e., primarily interest income). This is especially true compared to less frequent and structured returns seen in the hedge fund and traditional private-equity space. Often, foreign investors will gain private credit exposure through investment in a U.S. institutional asset manager that employs a private credit strategy.
This article seeks to shed light on tax considerations relevant to offshore investment in U.S. private credit. In addition, it discusses pertinent IRS and Tax Court positions on foreign investment in various private credit investment strategies. This article does not discuss strategies to eliminate or reduce tax for offshore investment via structuring, treaty platforms, or otherwise. This article also does not discuss potential tax implications of earning non-U.S.-sourced income.5
Before analyzing offshore investment tax consequences specifically in relation to private credit, it helps to refresh one’s understanding of relevant U.S. tax and withholding regimes on foreigners.
Inbound taxation
A common starting point for foreign investors when conducting U.S. tax due diligence is to consider whether they are “engaged in a U.S. trade or business.” If a foreign individual or corporation (foreigner) is considered engaged in a U.S. trade or business (USToB) at any point during a tax year, generally, they will have to file a U.S. tax return.6 If a foreigner at no point during the tax year was engaged in a USToB and its tax liability was fully satisfied via withholding under Chapter 3 (withholding on fixed, determinable, annual, or periodical income (FDAP)),7 there is generally no filing requirement.8 A nonresident alien individual or foreign corporation shall be considered to be engaged in a trade or business within the United States if the partnership of which such individual or corporation is a partner is so engaged.9
A foreign individual or corporation that is engaged in a USToB is subject to tax on its taxable income that is effectively connected with the USToB under Sec. 1 or 11, respectively.10 This is similar to the tax consequences of U.S. taxpayers. Additionally, foreign corporations may be subject to a 30% branch profits tax (BPT) on their “dividend equivalent amount.”11 The BPT calculation includes a mechanism that results in a greater BPT on a foreign corporation’s effectively connected income (ECI) when the foreign corporation has a decrease in U.S. net equity year over year. Net income tax, as well as the BPT, may be reduced or eliminated via a bilateral tax treaty.
Foreign individuals and corporations are generally subject to U.S. tax at a rate of 30% on gross income not effectively connected with a USToB.12 Income that is not effectively connected to a USToB is generally subject to FDAP withholding, which will be discussed shortly. This withholding tax also may be reduced or eliminated via a bilateral tax treaty. FDAP commonly consists of income that is more passive in nature and relevantly includes interest and dividends.13 FDAP-type income, such as interest, may be considered effectively connected with a USToB if it meets the asset-use or business-activities tests.14 Generally, these tests15 aim to determine whether investment-type income, such as interest, is passive in nature or active, the latter of which is indicative of ECI, as opposed to FDAP.
Secs. 1441 and 1442 provide detailed rules related to the withholding tax imposed on FDAP. Generally, the withholding on this income is done at the source, i.e., the U.S. payer. However, in the case where a nonresident individual or corporation earns FDAP income through a U.S. partnership, the U.S. partnership generally must withhold on the foreigner’s allocable share, and the tax on FDAP is withheld whether or not the income is distributed.16 In the case of a foreign partnership earning FDAP, generally, the U.S.-source payer may look through the foreign partnership to the beneficial owners to determine the ultimate withholding, so long as the proper tax documentation, such as a Form W-8 IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding and Reporting, is provided.17
There is generally no withholding on income earned that is effectively connected with a USToB. This is largely because there is generally a tax return filing requirement when ECI is earned by a foreigner. There are exceptions to this, however, if the ECI is earned through a U.S. partnership. Generally, the U.S. partnership must withhold income tax on any portion of the ECI allocable to a foreign partner under Sec. 704 at the highest corporate rate for foreign partners that are corporations or the highest individual rate for foreign partners that are not corporations.18 In effect, the activities of a U.S. partnership are attributable to its foreign partner.
The following two sections discuss exceptions to FDAP withholding and ECI, respectively. They are relevant to foreign investment in U.S. private credit and current IRS and court positionings on issues surrounding it.
Portfolio interest exception
Of major relevance to foreign investors earning U.S.-source interest income is the portfolio interest exception. The portfolio interest exception applies substantially the same to foreign individuals19 and foreign corporations.20 If interest is considered portfolio interest, no tax is imposed on a foreigner earning such income, and withholding under Secs. 1441 and 1442 is eliminated. General rules that must be met for interest to be considered portfolio interest include:
- The debt must be in registered form;21
- The interest cannot be received by a 10% shareholder. A 10% shareholder is one where the debt holder also holds 10% or more of the voting power of the debtor corporation or 10% or more of the capital or profits interest in the debtor partnership (if either is applicable);22 and
- The interest cannot be contingent on the debtor’s cash flow and/or profits.23 Notably, the portfolio interest exception does not apply to interest income that is effectively connected with a USToB. In other words, if the interest income earned derives from an activity that rises to the level of a trade or business, it is no longer FDAP and thus does not qualify for the exception.24
Trading safe harbor
Trading in stocks or securities is not a USToB, and thus the income from such trading is carved out from being considered ECI, even if the trading activities rise to the level of a USToB. More specifically, trading in stocks or securities through a resident broker, commission agent, custodian, or other independent agent is not considered a USToB,25 as long as the taxpayer does not have an office or place of business in the United States through which, or by the direction of which, the transactions are effected.26
Alternatively, trading in stocks or securities for the taxpayer’s own account, whether by the taxpayer or their employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions, will not be considered ECI.27 However, the rule does not apply if the taxpayer is considered a dealer in stocks or securities.
“Securities” relevantly include notes, bonds, debentures, or other evidence of indebtedness.28 A dealer under Regs. Sec. 1.864-2(c)(2)(iv) is defined as a taxpayer who regularly purchases and sells stocks or securities to customers, similarly to merchants.29
While there is ambiguity regarding exactly how a “dealer” is defined, courts have applied the facts of unique situations to the Code. Largely, the analysis hinges on whether the taxpayer is regularly transacting with customers. For example, the Tax Court30 took the view that dealers may be comparable to merchants, in that they do not buy stocks and securities with the intent to make a profit from a rise in value during the holding period. Instead, dealers make a profit from finding a market of buyers who will purchase at a price more than their cost. This excess, in theory, represents compensation for the dealer’s labor as a middleman, bridging the buyer and seller.31 This is contrasted with a trader, who is not compensated for a service by a markup of the securities sold. Traders also do not transact with customers.
Additionally, the IRS opined that a taxpayer whose sole business consists of trading in securities is not a dealer in securities within the meaning of Sec. 475(c) because that taxpayer does not purchase from, sell to, or enter transactions with customers in the ordinary course of a trade or business.32
Agency
Recall that a foreigner will be considered engaged in a USToB if they are a partner in a partnership that is considered so engaged.33 Similarly, activities of an agent rising to the level of a USToB may be attributable to its principal. Thus, if an agent is conducting private credit strategies on behalf of a foreigner, there may be potential USToB concerns. Generally, if an agent is considered dependent, the chances of USToB attribution to its principal are greater; however, an independent agent’s activities still may cause USToB attribution.34 The following items have been considered in determining whether a service provider is considered a dependent agent and whether the agent’s activities are attributable to its principal:
- The service provider can conclude or sign contracts on behalf of its principal regularly while receiving interim instruction from its principal;35
- Lack of clients in addition to the principal;36 and
- No marketing of services provided to other unrelated parties.37
Recall that should an agent be considered independent, a foreign principal may qualify for the Sec. 864(b)(2)(A)(i) trading safe harbor. Thus, if the above factors apply to an agent acting on behalf of a foreigner, it is possible that the relationship will be considered that of a dependent agent/ principal, and thus the foreigner will be barred from the aforementioned trading safe harbor.
The remainder of this article takes the cumulative preceding information and applies it to foreign investment in private credit and the IRS and court positions surrounding it.
Lending (loan origination)
The most common private credit strategy employed by asset managers is lending. Frequently, one hears tax advisers refer to this activity as “loan origination,” due to an IRS memorandum that ruled on lending activities in the United States by a foreign corporation.38
Chief Counsel legal memorandum
In Chief Counsel legal advice memorandum AM 2009-010 (the AM), a foreign corporation, which was wholly owned by foreign persons, outsourced loan origination activity to a U.S. corporation under a service agreement. Under the service agreement, the foreign corporation would pay the U.S. corporation an arm’s-length fee for its services. The U.S. corporation would solicit potential borrowers, negotiate terms of the loans, and perform credit analyses of the borrowers on behalf of the foreign corporation on a “considerable, continuous, and regular” basis. The U.S. corporation was not authorized to conclude contracts on behalf of the foreign corporation.
The Chief Counsel’s Office advised that the foreign corporation was, through the attribution of its agent’s (the U.S. corporation’s) activities, engaged in a USToB. Thus, the interest income earned by the foreign corporation was ECI.
Agency: The Chief Counsel’s Office found that the U.S. corporation’s activities were a component of the foreign corporation’s lending activities and thus the U.S. corporation was an agent of the foreign corporation. This was true regardless of whether the agent was dependent or independent.
Lending USToB: The Chief Counsel’s Office noted that a foreign individual or corporation will be considered engaged in a (lending) USToB if, on a considerable, continuous, and regular basis, it carries on, at some point during the tax year, banking, financing, or a similar business activity.39 In the case in the AM, the Chief Counsel’s Office found that, through attribution of the U.S. corporation’s activities, the foreign corporation was engaged in a lending USToB. It is important to note that the IRS relied on a specific regulation in drawing its conclusion, Regs. Sec. 1.864-4(c)(5). Even if it is not considered to be in a lending business under the special Regs. Sec. 1.864-4(c)(5) regime, the taxpayer still may have ECI from interest income under the asset-use or business-activities tests.40
U.S. office: Any U.S.-source interest income from a banking, financing, or similar business will be treated as effectively connected only if the securities giving rise to such income are attributable to the U.S. office through which such business is carried on and were acquired as a result of making loans to the public.41 The Chief Counsel’s Office advised in the AM that the office of the U.S. corporation was attributable to the foreign corporation because “the day-to-day activities required of Foreign Corporation’s lending business take place from the office of [the U.S. corporation].” Additionally, the income earned was attributable to the U.S. corporation’s office because the U.S. corporation actively negotiated with borrowers from that location.
Trading safe harbor: The Office of Chief Counsel advised that because the foreign corporation engaged in lending activities on a regular and continuous basis, its activities did not constitute trading or investing activities for purposes of Sec. 864. Thus, the foreign corporation did not qualify for the Sec. 864(b)(2) trading safe harbor.42
Banking, financing, or similar activity: Regs. Sec. 1.864-4(c)(5)(i)(b) provides that making personal, mortgage, industrial, or other loans to the public constitutes a banking, financing, or similar business activity. Relevantly and to be discussed further below, in a recent decision,43 the Tax Court mentioned that what constitutes the public according to the regulations “seems to contemplate retail operations.” Thus, if a lender does not make itself available to the entire public borrowing base, this may be one indication highlighting it is not a banking, financing, or similar business activity specifically under Regs. Sec. 1.864-4(c)(5).44
In terms of when lending rises to the level of a USToB, the bad debt rules under Sec. 166 may be one barometer used. As mentioned in the AM, the lending activities took place on a “considerable, continuous, and regular” basis. In terms of the quantity of loans made, one may look to bad debt cases to be informative.45 In Owens,46 the Tax Court found that at least 89 loans made over the course of 14 years constituted a lending business. In Serot,47 the Tax Court found that 55 loans over approximately a 10-year period constituted a lending business.
Other strategies
Private credit strategies, in addition to traditional lending, may include purchasing debt in various forms. Notably, YA Global Investments, LP, a recent Tax Court decision, relevantly involved a fund (YA Global) that primarily provided funding to various companies in the form of purchasing convertible debt, standby equity distribution agreements (SEDAs),48 and other securities through its U.S. agent, Yorkville Advisors LLC (Yorkville).49 Often, in exchange for entering into these purchase agreements and buying convertible notes, companies would be required to pay Yorkville upfront fees.50 YA Global was originally formed as a U.S. partnership and converted to a foreign partnership during the years at issue (applicable period).51
Tax Court holdings in YA Global
The court held that YA Global was engaged in a USToB through its agent’s activities and a dealer in securities. Thus, YA Global’s income was ECI, and it was required to withhold on the portion of the income allocable to its foreign partners.
Agency: The court held that Yorkville, a U.S. entity, was YA Global’s agent during the applicable period. The primary reason behind the court’s finding was that YA Global, the principal, had the ability to give interim instructions to Yorkville. That is, YA Global was able to instruct Yorkville on investments and certain restrictions throughout the applicable period, as opposed to setting guidelines at the start of the relationship and sticking with them, the latter of which is indicative of a traditional service provider.
Engaged in a USToB: The court found that YA Global was engaged in a USToB through Yorkville. Yorkville’s activities were continuous, regular, and made to earn a profit.52 Additionally, the court found that the fees paid to Yorkville were more than simply payment for the use of capital. Yorkville did not fund the purchases of convertible notes or SEDAs; that was YA Global. Yet Yorkville received fees from the companies entering these transactions with YA Global, sometimes before the companies sought any draws on the SEDAs. Fees were also received in connection with the convertible debt transactions, such as transactional and structuring fees. This, in the court’s words, indicated “the portfolio companies received something of value from Yorkville Advisors above and beyond the capital they received from YA Global.”53
The court found that YA Global did not qualify for the trading safe harbor largely because of the fees Yorkville received for entering transactions. These fees could in theory be attributed to the efforts that Yorkville exerted, such as negotiation and sourcing the transactions. As the court noted, “Because the portfolio companies compensated Yorkville Advisors and the partnership for benefits that went beyond the use of invested capital, YA Global was neither an investor nor a trader.”
Dealer in securities: YA Global was found to be a dealer in securities under Sec. 475 and subject to the mark-to-market rules. The primary driver behind the court’s finding was that YA Global regularly held itself out as being willing to provide capital to portfolio companies via convertible debt purchases and SEDAs. Yorkville and YA Global had garnered a reputation as being willing to do so, and that reputation resulted in companies contacting Yorkville directly for deals. The court found that the companies that entered these transactions with YA Global were its “customers” under Sec. 475(c)(1)(A).54
Closing thoughts
Looking holistically, the determination of whether a foreigner is considered engaged in a USToB is a crucial component of tax planning in the private credit space. If it is considered to be engaged in a USToB, generally, the foreigner will have both a U.S. tax return filing requirement as well as tax liability on its net ECI.
Compare this to a scenario where a foreigner is not considered engaged in a USToB. The foreigner generally will not have a U.S. tax return filing requirement, and interest income earned will often be exempt from U.S. taxation under the portfolio interest exception. Also, any sale resulting in capital gain from a private credit strategy on an asset not effectively connected with a USToB will generally not be subject to U.S. taxation.
With thorough tax planning and analysis, foreigners can be better prepared to understand the tax implications of investing in U.S. private credit.
Contributor
Eric Homsany, CPA, is a senior tax associate with Arena Investors LP in New York City. For more information about this article, contact thetaxadviser@aicpa.org.
Footnotes
1Madigan, “The Inexorable Rise of Private Credit,” BNY Mellon Insights (June 27, 2024).
2“Understanding Private Credit,” Morgan Stanley Insights (June 20, 2024).
3Id.
4For the purposes of this article, non-U.S. investors will be referred to as, and be synonymous with, “foreign investors.”
5Sec. 864(c)(4).
6Regs. Secs. 1.6012-1(b)(1) and 1.6012-2(g)(1).
7To be discussed shortly.
8Regs. Secs. 1.6012-1(b)(2) and 1.6012-2(g)(2).
9Sec. 875.
10Secs. 871(b) and 882(a).
11Sec. 884.
12Secs. 871(a) and 881(a).
13Id.
14Sec. 864(c)(2).
15Broadly, the asset-use test is met if income is associated with U.S. assets used in, or held for use in, the conduct of a U.S. trade or business. The business-activities test is met if the activities of a trade or business conducted in the United States are a material factor in the realization of the income.
16Regs. Sec. 1.1441-5(b)(2).
17Regs. Sec. 1.1441-5(c).
18Sec. 1446.
19Sec. 871(h).
20Sec. 881(c).
21Secs. 871(h)(2) and 881(c)(2).
22Secs. 871(h)(3) and 881(c)(3).
23Secs. 871(h)(4) and 881(c)(4).
24Private credit activities earning interest income, including direct lending, that rise to the level of a trade or business will be discussed in detail later.
25Sec. 864(b)(2)(A)(i).
26Sec. 864(b)(2)(C).
27Sec. 864(b)(2)(A)(ii).
28Regs. Sec. 1.864-2(c)(2)(i)(c).
29Dealers are technically defined differently for purposes of Sec. 864 and Sec. 475. Regarding the Sec. 864 trading safe harbor, a taxpayer needs to regularly buy and sell securities. Under Regs. Sec. 1.475(c)-1(a)(2), a taxpayer needs to regularly hold itself out to enter into either side of a transaction (buying or selling). See also YA Global Investments, LP, 161 T.C. No. 11 (2023), for a court decision that emphasizes this point.
30Kemon, 16 T.C. 1026 (1951).
31Id.
32Rev. Rul. 97-39.
33Sec. 875.
34See Rev. Rul. 80-225, citing Amodio, 34 T.C. 894, 906 (1960). Also see Chief Counsel legal advice memorandum AM 2009-010.
35See Regs. Sec. 1.864-7(d)(1)(i) and U.S. Model Income Tax Convention 2016, Article 5, Section 5, for sources explaining when a dependent agent’s office may be attributable to its principal for foreign-sourced ECI and determination of a permanent establishment, respectively. Also, see YA Global Investments, LP, 161 T.C. No. 11 (2023).
36YA Global Investments, LP, 161 T.C. No. 11 (2023).
37Id.
38AM 2009-010.
39Regs. Sec. 1.864-4(c)(5)(i). This includes making personal, mortgage, industrial, or other loans to the public (Regs. Sec. 1.864-4(c)(5)(i)(b)).
40Regs. Sec. 1.864-4(c)(5)(vi)(a).
41Regs. Sec. 1.864-4(c)(5)(ii). A stock or security shall be deemed to be attributable to a U.S. office only if such office actively and materially participated in soliciting, negotiating, or performing other activities required to arrange the acquisition of the stock or security (Regs. Sec. 1.864-4(c)(5)(iii)).
42The IRS cited both InverWorld, Inc., T.C. Memo. 1996-301, and Regs. Sec. 1.864-2(e) in drawing this conclusion.
43YA Global Investments, LP, 161 T.C. No. 11 (2023).
44It is important to note that in YA Global the Tax Court explicitly did not decide on whether the companies the taxpayer lent to constituted the “public.”
45The IRS has also mentioned this in Chief Counsel Advice (CCA) 201501013. This CCA memorandum was related to the same taxpayer as in YA Global.
46Owens, T.C. Memo. 2017-157. Also, in Owens, the court found that the lender had “a reputation in the community as a lender and was very well respected,” which pointed to his being in the business of lending.
47Serot, T.C. Memo. 1994-532.
48SEDAs were an agreement wherein YA Global would agree to purchase a certain amount of a company’s stock over a certain period. Generally, YA Global would make these purchases at a discount to fair market value and keep the spread of profit when sold.
49During a portion of the years at issue, Yorkville was YA Global’s sole general partner. Additionally, investment management agreements were entered into in which YA Global retained Yorkville to render investment management services and manage YA Global’s securities investment account.
50These fees were generally intended to pay Yorkville’s overhead costs. Fees in excess of expenses were allowed to be remitted to YA Global or offset the expense Yorkville charged YA Global for its services.
51For the purposes of this article, the “applicable period” is being used to illustrate the large point of contention in the case. That is, the taxpayers were arguing the fund was not engaged in a USToB, and the IRS was arguing the opposite.
52Yorkville’s office was also located in the United States.
53Perhaps the companies received a service from Yorkville, such as the bridging of them with YA Global.
54It is important to note that the court relied upon Regs. Sec. 1.475(c)-1(a)(2) in drawing its conclusion. In effect, this regulation claims that a taxpayer that regularly enters into either side of a transaction with customers may qualify as a dealer in securities. Customers are people with whom the taxpayer does what it “regularly holds itself out” to do.
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