This memorandum describes the typical entity structures used when launching a new private fund. Although various factors influence the choice of entity structures used for a private fund, this memorandum will discuss the most basic considerations - namely preferences of the fund's investors and the manager. It should be noted at the outset that different structures will involve different costs and complexities. Thus, it is important to take time and care when initially selecting the fund's entity structures. The following discussion is provided as a source of information only and is not intended to be comprehensive or constitute legal advice. We recommend that you consult competent legal and other advisers in connection with starting any private fund.

I. Introduction to Basic Entity Private Fund Structures

Private funds can take on four possible forms under U.S. federal income tax laws: (1) onshore entities classified as corporations (rarely used), (2) onshore entities classified as partnerships (the most common), (3) offshore entities classified as corporations (the most common offshore structure) and (4) offshore entities classified as partnerships (less common as a choice of investment vehicle for offshore structuring).

Managers rarely organize their funds as onshore entities classified as C-corporations for U.S. federal income tax purposes. This is because C-corporations are subject to an entity- level tax and are not eligible for favorable tax rates on long-term capital gains or qualified dividend income. In addition, domestic and foreign shareholders of C-corporations generally are subject to a second level of income tax on dividends arising from the C-corporation. Similarly, although S-corporations provide for only one level of tax, the significant ownership restrictions that apply to S-corporations make them a poor vehicle for private funds.

II. Investor Classifications and Preferences

Determining the fund's target investor group is a threshold question in entity structuring decisions. Fund investors fall into one of three classes: (1) U.S. taxable investors, (2) U.S. tax-exempt investors (such as government or corporate pension plans, HR-10 plans, individual retirement accounts, charities or private university endowment funds), and (3) non-U.S. investors. U.S. taxable investors are best served by onshore funds that are classified as partnerships, while U.S. tax-exempt and non-U.S. investors prefer to invest in offshore funds classified as corporations. The reasons for these investor preferences are set out in further detail below.

A. U.S. Taxable Investors - Preference for Onshore Funds Classified as Partnerships

U.S. taxable investors typically prefer to invest in onshore funds classified as partnerships for U.S. federal income tax purposes (including limited partnerships and limited liability companies that are taxed as partnerships). Note that the legal form of an entity for state law purposes does not necessarily establish its classification for U.S. federal income tax purposes. For example, while entities that are corporations for state law purposes will also be classified as corporations for U.S. federal income tax purposes, other types of entities, such as limited liability companies and business trusts, may elect to be treated as partnerships for U.S. federal income tax purposes even though they are not partnerships as a matter of state law.

Partnerships are not subject to an entity-level tax at the federal level. Instead, the income, losses, deductions and credits generated by the partnership are allocated to the partners under the terms of the partnership agreement. These partners can also take advantage of favorable tax rates on long-term capital gains and qualified dividend income, and can offset losses generated by the partnership against income from other sources (subject to some limitations).

While entity structure dictates certain tax filing requirements, specific investments may also increase tax requirements. For example, investments in publicly traded partnerships may increase state filing requirements and larger holdings in foreign entities will increase foreign tax reporting.

Non-U.S. investors can participate in onshore funds. However, withholdings on U.S. source investment income, such as dividends, are required. These withholdings may be due as soon as three business days from the end of the period.

PFIC Considerations. U.S. taxable investors rarely prefer to invest in an offshore corporation due to U.S. tax laws regarding Passive Foreign Investment Companies (PFIC). An investment by a U.S. taxable investor in an offshore corporate fund that constitutes a PFIC likely will entail adverse federal income tax consequences. In fact, most offshore funds in corporate form are considered PFICs When a U.S. taxable investor invests in a PFIC, capital gains arising from the PFIC are taxed at ordinary income rates, and the investor is subject to an "interest charge" on PFIC income that is not picked up on a current basis but deferred until it is distributed by the PFIC. It is possible to avoid some, but not all, of the negative PFIC tax consequences by making certain shareholder-level elections, such as a "qualified electing fund" election, but many offshore funds do not provide the information necessary for U.S. taxable investors to make such an election. For these reasons, U.S. taxable investors tend to avoid offshore funds that are PFICs and prefer instead to invest in domestic funds that are taxed as partnerships.

B. U.S. Tax-Exempt Investors - Preference for Offshore Funds Classified as Corporations

U.S. tax-exempt investors typically prefer to invest in offshore funds that are taxed as corporations, rather than onshore or offshore funds taxed as partnerships, if the funds are likely to generate "unrelated business taxable income" (UBTI) or U.S. "effectively connected taxable income" (ECI). U.S. tax-exempt investors generally are not subject to U.S. federal income tax on dividends, interest, capital gains and similar portfolio income realized from securities investments or trading activity. U.S. tax-exempt investors may realize UBTI, however, if the fund in which they invest (1) incurs debt for any purpose or (2) invests in underlying funds that are classified as partnerships for U.S. federal income tax purposes and such underlying funds incur debt for any purpose. For example, if a U.S. tax-exempt investor holds an interest in a U.S. fund that is taxed as a partnership and the fund borrows money to leverage its investment portfolio, the U.S. tax-exempt investor is deemed to have incurred debt equal to a pro rata share of the fund's borrowings in order to purchase a pro rata share of the fund's investments. The U.S. tax-exempt investor would thus be considered to own debt-financed property, and would be required to pay tax on UBTI. Similarly, if the fund were to generate ECI, a tax-exempt investor would be subject to tax on the ECI at federal corporate tax rates. Instead of the above results, an offshore fund that is taxed as a corporation serves as a "blocker" that can prevent UBTI or ECI from being allocated to a tax-exempt investor.

C. Non-U.S. Investors - Preference for Offshore Funds Classified as Corporations

Non-U.S. investors typically prefer to invest in offshore funds that are taxed as corporations (e.g., Cayman Islands corporations) rather than offshore or onshore funds that are taxed as partnerships. Similar to as described above with respect to U.S. tax-exempt investors, the offshore corporation serves as a "blocker" of ECI and insulates the offshore investor from U.S. taxation.

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