Tax Implications of New Rules Under the Advisers Act | USA

The US Securities and Exchange Commission (SEC) has adopted new rules under the Investment Advisers Act that are intended to protect investors but also significantly increase the regulation of private fund sponsors. These rules have important implications for tax structuring and compliance matters for private funds.

Unlike earlier proposed rules, the SEC’s final rules do not prohibit advisers from calculating clawbacks on an after-tax basis as long as advisers satisfy certain disclosure requirements. Andrew Morris explains some of these new requirements in detail.

Originally, the SEC proposed a strict prohibition on charging any fees and expenses on a non-pro rata basis, reasoning that it would create a conflict of interest. However, the final SEC rules allow for the non-pro rata charge or allocation of fees and expenses, including taxes. The requirement is that the relevant non-pro rata charge has to be fair and equitable under the circumstances, and prior to charging on a non-pro rata basis the sponsor should distribute to each investor a written notice setting out the details of that charge or allocation.

The SEC originally proposed a complete ban on borrowings by an adviser from a fund on the basis that this presents a conflict of interest, as the adviser would essentially be on both sides of the transaction – ie, as the borrower and as the manager of the lender. However, such borrowing is permitted under the final rules, provided that the fund manager distributes a written notice to investors detailing the material terms of the borrowing and that the fund adviser obtains written consent from at least the majority of the unrelated investors.