Taxation of US Investment Partnerships and Hedge Funds: Accounting Policies, Tax Allocations and Performance Presentation (Wiley Professional Advisory Services)

Taxation of U.S. Investment Partnerships and Hedge Funds: Accounting Policies, Tax Allocations and Performance Presentation......Page 5
Contents......Page 9
Preface......Page 15
What Is a “Hedge Fund”?......Page 19
U.S. Venture Partnerships......Page 21
Types of U.S. Hedge Fund Entities and the U.S. Tax Code......Page 22
Organizing a Typical U.S. Hedge Fund......Page 24
Investor Clienteles in Hedge Funds......Page 28
Offshore Funds......Page 32
U.S. Investors in Offshore Funds......Page 35
U.S. Investors in Swiss Bank Accounts......Page 37
U.S. Investors in Madoff-Like Managed U.S. Trading Accounts......Page 41
Size of the Global Hedge Fund Industry......Page 43
Fund-of-Funds......Page 46
Incentives of the Hedge Fund Manager and Investors......Page 48
Valuation of a Hedge Fund Management Company......Page 49
Economies of Scale in Hedge Funds......Page 51
Organizing a Typical Offshore Hedge Fund......Page 53
Master-Feeder Structuring of Onshore/Offshore Arms: Organizing a Hedge Fund for Clienteles......Page 57
U.S. Withholding Agent for U.S. Withholding Taxes on Foreign Investors......Page 62
Starting Point: The Partnership Agreement......Page 65
Fund Valuation at Discrete Opening Time Points......Page 66
Calculation of Fixed Fees......Page 67
Calculation of Performance Fees......Page 73
Claw-Back Provision: Performance Fee Returned to Limited Partners......Page 84
Representation of a Fund’s Net Asset Value (NAV) per Share......Page 89
Black-Scholes Formula Valuation of Performance Fees......Page 92
Partnership Accounting for U.S. Funds......Page 97
IRS Tax Return Filings for U.S. Hedge Funds......Page 98
Financial Statements for Hedge Funds and Venture Funds......Page 103
Interim Valuation: The Core of a Hedge Fund’s Accounting Operation......Page 111
Books of Account and Financial Statements for Hedge Funds......Page 114
Audit of an Offshore Fund......Page 115
Audit of a U.S. Fund......Page 116
Capital Account Audit for Both Offshore and U.S Funds......Page 117
U.S. Tax Allocation Rules Governing U.S. Partnerships......Page 119
Tax Components of U.S. Investment Partnership Income......Page 121
Fixed Fees: Income to the General Partner and Expense to the Limited Partners......Page 125
Generalizing the Allocation Formula to Other Components of Income......Page 126
Tax Basis of Partner’s Investment in a U.S. Partnership......Page 127
Tax Allocations of Realized and Unrealized Income to Partners......Page 131
The Tax Allocation Method of Layering......Page 133
Tax Allocation of Interest......Page 136
Tax-Exempt Interest Income, Line 18a......Page 138
Tax Allocation of Fixed Fees Paid by Limited Partners......Page 139
Reporting Subcomponents of Interest Income and Dividends......Page 140
Short Positions: Tax Treatment of Equity Dividends or Bond Coupons Claimed as Interest Expense......Page 141
Distributions from Partnerships Owned......Page 142
Tax Allocation of Unrealized and Realized Capital Gains Using the Method of Layering......Page 145
Ignoring Ambiguity #1 with Layering......Page 150
Work-Around to Fix Ambiguity #2, the Fatal Flaw with Layering......Page 151
The Methods of Aggregation or Netting......Page 155
Partial Netting......Page 156
Full Netting......Page 159
Measures of Book-Tax Disparity across Partners......Page 160
Formulating the Problem for Optimal Partner Tax Allocations under Full Netting......Page 161
Formulating the Problem for Optimal Partner Tax Allocations under Partial Netting......Page 164
Solving the Convex Optimization Problem of Tax Allocation......Page 166
Which Is the Better Method for Allocation of Realized Gains: Layering, Full Netting, or Partial Netting?......Page 171
Layering Examples Showing Earlier Tax Payment......Page 172
Full Netting Examples Showing Tax Postponement......Page 176
Tax Efficiency Considerations for Offshore Hedge Funds......Page 179
Tax Preference Ordering for U.S. Investors......Page 181
More Attractive Tax Items to U.S. Investors......Page 185
Less Attractive Tax Items to U.S. Investors......Page 187
Tax Efficiency Steps for U.S. Hedge Funds......Page 188
A Structure for Tax-Exempt U.S. Entities to Recover Foreign Taxes......Page 191
Performance Presentation: CFA Institute GIPS Verifi cation......Page 193
Calculation of Hedge Fund Returns for Performance Presentation......Page 197
Facilitating Historical Risk and Return Review for Investors Using GIPS Guidelines......Page 201
Comparison with Tax Allocations Made by Mutual Funds......Page 209
U.S. Venture Partnerships (Silicon Valley Venture Funds)......Page 214
Economic Accounting Is a Common Denominator for U.S. and Offshore Funds......Page 221
Calculating Partner Allocations Is Most of a U.S. Partnership's Tax Accounting Effort......Page 222
Example of Tax Allocation of Capital Gains by Full and Partial Netting in a 100-Partner Setting......Page 223
The Crown Jewel: Automated Tax Allocation of All Items of Income......Page 224
The End of an Era of Layering......Page 225
Exemption from Registration of Securities with the SEC under Rule 506 of Regulation D of the Securities Act of 1933......Page 227
Mathematical Translation of the Treasury Regulations......Page 247
Translating the Treasury Term “Book-Tax Disparities”......Page 248
Relating the Treasury Regulations on Full Netting to a Mathematical Problem......Page 249
Choice of Convex Objective Function......Page 250
Magnitude Constraints......Page 251
Additivity Constraints Simplify Magnitude Constraints......Page 252
Verifying Convexity......Page 253
The Hessian Matrix That Establishes Convexity Is a By-Product for Practical Computer Implementation......Page 254
Solving the Full Netting Problem with 3 Alternate Solvers......Page 255
Open-Source R Solved 100-Partner Problem in 40 Milliseconds......Page 256
Matlab Solved the 100-Partner Problem in 6.60 Seconds......Page 260
Open-Source CVX Solved the 100-Partner Problem in 0.78 Seconds......Page 263
Second-Pass Procedure to Derive a Unique, Robust, and Efficient Solution......Page 267
Partial Netting Implementation Example......Page 271
CVX Solved the 100 -Partner Partial Netting Problem in 0.88 Second......Page 273
Second Pass to Derive a Unique Solution for Partial Netting......Page 274
Treasury Regulations Forbid Outright Tax Preference Tilting......Page 277
The Unique Optimum Scaled Solutions in Appendixes 2 and 3 Also Minimize Tax Preference Tilts across Partners......Page 278
The Scaled Tax-Neutral Allocations in Appendixes 2 and 3 Are a Gold Standard for Tax-Neutral Allocations......Page 279
Nonabusive Allocations That Consider Tax Preferences......Page 280
Further Minimizing the Dispersion of All Partner Tax Allocations from the Target Optimum......Page 282
Making All Allocations, Including Dividends and Interest, by Using Netting Methodology......Page 285
Generalizing the Partial Netting Methodology to Include Allocations of Dividends, Interest, Investment Expense, and Foreign Taxes......Page 286
Formulating the Grand Problem of Simultaneously Allocating Dividends, Interest, and Capital Gains under Netting Methodology......Page 287
Second Pass to Derive a Unique, Robust, and Tax-Neutral Solution......Page 291
The End of the Era of Layering......Page 292
Summary of the Results in Appendixes 2, 3, 4, and 5......Page 293
Acknowledging the Originators of the Front-End Convex Optimization Software CVX and Its Back-End Algorithm SDPT3......Page 294
Index......Page 295