United States Tax Court Finally Issues Long-Awaited YA Global Ruling

In a long-awaited opinion released November 15, 2023, the United States Tax Court ruled in favor of the IRS, holding that YA Global, a non-U.S. partnership, was engaged in a U.S. trade or business and was therefore liable for federal tax withholding for its non-U.S. partners.

The salient issues before the Tax Court included determining whether YA Global:

• Was engaged in a U.S. trade or business in the years in controversy,
• Was subject to IRC Sec. 1446 withholding for its foreign investors/partners,
• Was considered a dealer in securities and thus subject to mark-to-market rules under IRC Sec. 475, and
• Had started the statute of limitations running by filing a Form 1065.

Prior IRS Guidance

The IRS previously released limited guidance related to these issues on two occasions. In 2009, the IRS released General Legal Advice Memorandum (GLAM) 2009-010, which addressed when loan origination rose to the level of creating effectively connected income (ECI) not subject to the trading safe harbor in IRC Sec. 864.

In 2015, the IRS released Chief Counsel Advice (CCA) 201501013, which discussed when loan origination activities are deemed to occur such that they create ECI, in the context of a foreign fund that engaged a U.S.-based investment manager. YA Global was not mentioned by name, but the ruling confirmed that YA Global was the subject of the above CCA.

Key Holdings and Takeaways

The key holdings and takeaways from the Tax Court’s decision include:

1. If a U.S. advisor has most of its income derived from one foreign fund, its activities and presence in the U.S. may cause the foreign fund to have a tax presence in the U.S. Specifically, the Court based this decision on the fact that the taxpayer did not establish that the relationship between it and the U.S. advisor was other than a principal-agency relationship. 
2. Fees that are shared by a U.S. advisor with the foreign fund run the risk of taking on the character of service-related fees if they are not of a nature typically found in investment-related fees (such as points, additional interest, or the like), which would mean the foreign fund is earning service fees in the U.S.
3. If the foreign fund engages in enough transactions through its U.S. deemed presence that are in the nature of loans or “loan like,” such as convertible debentures, that activity may rise to the level of “loan origination,” which is not covered in the IRC Sec. 864(b)(2) safe harbors.
4. If the foreign fund subsequently converts many of its loans into shares and sells them on the open market, its activities may rise to the level of becoming a “dealer of securities.” Such activities are clearly excluded from the safe harbor exceptions and mandate IRC Sec. 475 mark-to-market treatment; with all gains being considered ordinary.
5. Filing a Form 1065 does not start the statute of limitations running with regard to a possible IRC Sec. 1446 withholding liability if the foreign fund does not also file Form 8804. Filing protective Forms 8804 should be considered.
6. The “willful” failure to withhold by the partnership causes the partnership itself, and all partners who had the responsibility to withhold, to be liable for the under-withheld taxes. Although the issue is not addressed by the Tax Court, the responsible partners could also be subject to the 100% penalty under IRC Sec. 6672, as the under-withholding is treated the same as “trust fund” withholdings.
7. While only briefly addressed in the case, the foreign partners’ failure to file a Form 1120F results in two draconian outcomes. First, the statute of limitations doesn’t toll, so tax and penalties can be collected forever, and second, no deductions are allowed against the ECI gross income.

The purpose of this article is not to examine and weigh the merits of the case. Instead, it is meant to highlight the less apparent facts and the outcomes of failures to: (i) prudently seek timely tax advice and be conservative in applying it; (ii) take backstop measures to file protective forms, and (iii) modify business practices to avoid the devastating consequences.

The recent ruling deals only with tax years 2006-2008. The Tax Court stated in the opinion that a ruling regarding 2009 will be issued separately.