A blocker corporation is a type of C Corporation in the

United States The United States of America (U.S.A. or USA), commonly known as the United States (U.S. or US) or America, is a country primarily located in North America. It consists of 50 states, a federal district, five major unincorporated territori ...

that has been used by tax exempt individuals to protect their investments from taxation when they participate in

private equity In the field of finance, the term private equity (PE) refers to investment funds, usually limited partnerships (LP), which buy and restructure financially weak companies that produce goods and provide services. A private-equity fund is both a t ...

or with

hedge funds A hedge fund is a pooled investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction, and risk management techniques in an attempt to improve performance, such as sho ...

. In addition to tax exempt individuals, foreign investors have also used blocker corporations.

Application

Most private equity funds and hedge funds are composed as limited partnerships, or as LLCs (

Limited Liability Company A limited liability company (LLC for short) is the US-specific form of a private limited company. It is a business structure that can combine the pass-through taxation of a partnership or sole proprietorship with the limited liability of ...

) which for tax purposes is considered a Limited Partnership, unless the fund formally elects to be taxed as a corporation. This allows the fund itself to avoid taxation, as each of the individual investors is taxed as a partner with respect to the share of profits attributable to the partner's personal equity interest. By comparison, a fund set up as a C Corporation would be subject to tax for its earnings, and then the limited partners would be subject to tax when they received their profit in the form of dividends distributed by the corporation. Thus, the LLC or LP format allows a fund to avoid double taxation. When there are tax exempt investors in a fund, they are not subject to U.S. income tax, but are still required to declare and pay taxes on " Unrelated Business Taxable Income" or " UBTI".26 USCA 513
/ref> For tax exempt investors,

dividend A dividend is a distribution of profits by a corporation to its shareholders. When a corporation earns a profit or surplus, it is able to pay a portion of the profit as a dividend to shareholders. Any amount not distributed is taken to be re-i ...

s, royalties, rents, capital gains and

interest income Passive income is unearned income that is acquired automatically with minimal labor to earn or maintain. It is often combined with another source of income, such as a side job. In the United States, the IRS divides income into three categories ...

are not considered UBTI, but any money earned from conduct unrelated to the entity's tax exempt purpose is considered UBTI. However, if a foreign investor conducts a trade or business within the United States, it is required to file a U.S. tax return and pay taxes on the same terms as a U.S. individual or corporation. In both cases, because partners are treated as earning their share of the partnership's income on a flow-through basis, they are treated as engaged in a U.S. trade or business or an unrelated business to the extent that the partnership is so engaged. To address these issues, a

fund can set up a U.S. feeder corporation known as a blocker corporation. The foreign and tax exempt investors can invest through the blocker corporation, and then they are no longer personally considered to be partners, as it is the domestic corporation that is the owner of equity in the fund. For tax exempt investors, their share of the blocker corporation is considered dividend income, and thus they are not subject to tax.US House Ways and Means Committee Testimony
Foreign investors similarly avoid U.S. trade or business income tax (although they will be subject to tax in their home country on any dividends received). The blocker corporation itself is subject, however, to tax on its share of the partnership's income.

References

{{DEFAULTSORT:Blocker Corporation Corporate taxation in the United States Types of business entity Financial services in the United States Tax avoidance

Application

See also

References