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Taxation of U.S. Investment Partnerships and Hedge Funds: Accounting Policies, Tax Allocations, and Performance Presentation

ISBN: 978-0-470-60575-2
304 pages
August 2010
Taxation of U.S. Investment Partnerships and Hedge Funds: Accounting Policies, Tax Allocations, and Performance Presentation (0470605758) cover image
A new, lucid approach to the formulation of accounting policies for tax reporting

Unraveling the layers of complexity surrounding the formulation of accounting policies for tax reporting, Taxation of US Investment Partnerships and Hedge Funds: Accounting Policies, Tax Allocations and Performance Presentation enables your corporation to implement sound up-front accounting and tax policies in order to reduce the overall cost of CFO and legal functions within a U.S. Investment partnership.

  • Understand the pitfalls and optimize across legitimate policies that are consistent with the IRS regulations
  • Presents a clear roadmap for accounting, tax policies, tax filing and performance presentation for US investment partnerships and hedge funds

Providing tremendous understanding to a complex topic, Taxation of US Investment Partnerships and Hedge Funds is guaranteed to demystify the inner workings of the formulation of accounting policies for tax reporting.

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Preface.

CHAPTER 1 The Arcane World of Hedge Funds and Investment Partnerships.

What Is a "Hedge Fund"?

U.S. Venture Partnerships.

Types of U.S. Hedge Fund Entities and the U.S. Tax Code.

Organizing a Typical U.S. Hedge Fund.

Investor Clienteles in Hedge Funds.

Foreign Investors in a U.S. Hedge Fund.

Offshore Funds.

U.S. Investors in Offshore Funds.

U.S. Investors in Swiss Bank Accounts.

U.S. Investors in Madoff-Like Managed U.S. Trading Accounts.

Size of the Global Hedge Fund Industry.

Fund-of-Funds.

Incentives of the Hedge Fund Manager and Investors.

Valuation of a Hedge Fund Management Company.

Economies of Scale in Hedge Funds.

CHAPTER 2 The Structure of Hedge Funds.

Organizing a Typical Offshore Hedge Fund.

Master-Feeder Structuring of Onshore/Offshore Arms: Organizing a Hedge Fund for Clienteles.

U.S. Withholding Agent for U.S. Withholding Taxes on Foreign Investors.

CHAPTER 3 Hedge Fund Fees.

Starting Point: The Partnership Agreement.

Fund Valuation at Discrete Opening Time Points.

Calculation of Fixed Fees.

Calculation of Performance Fees.

Claw-Back Provision: Performance Fee Returned to Limited Partners.

Representation of a Fund's Net Asset Value (NAV) per Share.

Black-Scholes Formula Valuation of Performance Fees.

CHAPTER 4 Hedge Fund Accounting and Tax Filing.

Partnership Accounting for U.S. Funds.

IRS Tax Return Filings for U.S. Hedge Funds.

Financial Statements for Hedge Funds and Venture Funds.

Interim Valuation: The Core of a Hedge Fund's Accounting Operation.

Books of Account and Financial Statements for Hedge Funds.

Audit of an Offshore Fund.

Audit of a U.S. Fund.

Capital Account Audit for Both Offshore and U.S. Funds.

CHAPTER 5 Partner Tax Allocations in U.S. Partnerships.

U.S. Tax Allocation Rules Governing U.S. Partnerships.

Tax Components of U.S. Investment Partnership Income.

Fixed Fees: Income to the General Partner and Expense to the Limited Partners.

Generalizing the Allocation Formula to Other Components of Income.

Tax Basis of Partner's Investment in a U.S. Partnership.

Accountants' Terminology.

Tax Allocations of Realized and Unrealized Income to Partners.

The Tax Allocation Method of Layering.

Tax Allocation of Interest.

Tax-Exempt Interest Income, Line 18a.

Similar Calculation for Tax Allocation of Dividends, Investment Expense, Foreign Tax Paid.

Tax Allocation of Fixed Fees Paid by Limited Partners.

Tax Allocation of Guaranteed Payments (of Fixed Fees) to the General Partner.

Reporting Subcomponents of Interest Income and Dividends.

Tax Consequences of Shorting.

Short Positions: Tax Treatment of Equity Dividends or Bond Coupons Claimed as Interest Expense.

Distributions from Partnerships Owned.

CHAPTER 6 Tax Allocations of Realized Gains by Layering.

Tax Allocation of Unrealized and Realized Capital Gains Using the Method of Layering.

Ignoring Ambiguity #1 with Layering.

Work-Around to Fix Ambiguity #2, the Fatal Flaw with Layering.

CHAPTER 7 Partial and Full Netting Methods.

The Methods of Aggregation or Netting.

Partial Netting.

Full Netting.

Measures of Book-Tax Disparity across Partners.

Formulating the Problem for Optimal Partner Tax Allocations under Full Netting.

Formulating the Problem for Optimal Partner Tax Allocations under Partial Netting.

Solving the Convex Optimization Problem of Tax Allocation.

CHAPTER 8 Comparative Tax Consequences of Layering and Netting Methods.

Which Is the Better Method for Allocation of Realized Gains: Layering, Full Netting, or Partial Netting?

Layering Examples Showing Earlier Tax Payment.

Full Netting Examples Showing Tax Postponement.

CHAPTER 9 Tax Efficiency of Hedge Funds.

Tax Efficiency Considerations for Offshore Hedge Funds.

Tax Preference Ordering for U.S. Investors.

More Attractive Tax Items to U.S. Investors.

Less Attractive Tax Items to U.S. Investors.

An Exception: Special Tax Preference for Gains from U.S. Exchange-Traded Futures Contracts.

Ambiguities in Tax Preference.

Tax Efficiency Steps for U.S. Hedge Funds.

A Structure for Tax-Exempt U.S. Entities to Recover Foreign Taxes.

CHAPTER 10< Hedge Fund Performance and Risk Presentation.

Performance Presentation: CFA Institute GIPS Verification.

Calculation of Hedge Fund Returns for Performance Presentation.

Facilitating Historical Risk and Return Review for Investors Using GIPS Guidelines.

CHAPTER 11 Mutual Funds and Venture Funds Compared to Hedge Funds.

Tax Return Filing of U.S. Partnerships Is an Involved Task.

Comparison with Tax Allocations Made by Mutual Funds.

U.S. Venture Partnerships (Silicon Valley Venture Funds).

CHAPTER 12 Epilogue.

Economic Accounting Is a Common Denominator for U.S. and Offshore Funds.

Tax Return Filing of U.S. Partnerships Is an Involved Task.

Calculating Partner Allocations Is Most of a U.S. Partnership's Tax Accounting Effort.

Layering and Netting Methodologies for Tax Allocation of Capital Gains.

Example of Tax Allocation of Capital Gains by Full and Partial Netting in a 100-Partner Setting.

Tilting Tax Allocations According to Tax Preferences.

The Crown Jewel: Automated Tax Allocation of All Items of Income.

The End of an Era of Layering.

APPENDIX 1 Excerpts of Key U.S. Statutes Discussed in Chapter 1 That Govern U.S. and Offshore Hedge Funds Venture Funds.

APPENDIX 2 Methodology and Implementation Example of Full Netting.

APPENDIX 3 Methodology and Implementation Example of Partial Netting.

APPENDIX 4 Nonabusive Tilting of Tax Allocations According to Tax Preferences.

APPENDIX 5 Eliminating Layering Entirely, by Allocating Dividends, Interest, Capital Gains, and Expenses in One Step.

Index.

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NAVENDU P. VASAVADA, PhD, has held the positions of investment manager of large institutional investors, manager of private hedge funds, an economic analyst, and writer-at-large. He was formerly a senior investment manager at Aetna Inc. for over a decade, serving as head of quantitative research, risk manager, mortgage securities analyst, and equity/fixed income derivatives quant. He holds a PhD from Wharton, preceded by an engineering MS from the University of Pennsylvania and PGDBA from IIM-A, India.

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