Cross-border Tax Implications in the U.S. CLO Equity Investing by the Qualified Korean Investors
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On February 9, 2018, the U.S. Court of Appeals for the D.C. Circuit held that U.S. managers of collateralized loan obligations (CLOs) are not required to retain a financial interest in the CLOs under the U.S. risk retention rules. In its decision, the court noted that CLOs are not susceptible to the moral hazard inherent in the “Originate to Securitize” model that Dodd-Frank was intended to curtail. CLOs are actively managed and their fee structure aligns the interests of the collateral manager with those of the investors by providing for payment of the significant management fees only after the CLO has paid off its debt and has achieved a specified hurdle rate of return on its equity tranche. The capitalized manager vehicle (CMV) structure facilitates this alignment of interests as well as the additional risk retention requirements. Tax leakage on the cash flowing from the underlying borrowers of the CLO’s leveraged loans through the CLO issuer and into the hands of the noteholders can also occur at the level of payments by the CLO issuer, potentially decreasing their after-tax returns. We make comments about the Dodd-Frank risk retention issues in connection with the D.C. Circuit Court ruling and related impacts from the latest U.S. Tax Cuts and Jobs Act (“Tax Act”) of 2017 in terms of tax compliances. We also discuss some various cross-border tax issues between Korea and the U.S. relevant to qualified Korean individual and institutional investors. While retaining their anonymity, Korean investors would rather avoid paying foreign taxes or at least entitled to the tax treaty benefits. A typical solution to this issue is to make Korean investors put their contribution through an offshore blocker corporate entity established primarily for non-U.S. investors. This offshore blocker corporation will ensure that the Korean investor’s identity will not have to be disclosed to the U.S. tax authority, regardless of the outstanding FATCA rules.
Abstract
On February 9, 2018, the U.S. Court of Appeals for the D.C. Circuit held that U.S. managers of collateralized loan obligations (CLOs) are not required to retain a financial interest in the CLOs under the U.S. risk retention rules. In its decision, the court noted that CLOs are not susceptible to the moral hazard inherent in the “Originate to Securitize” model that Dodd-Frank was intended to curtail. CLOs are actively managed and their fee structure aligns the interests of the collateral manager with those of the investors by providing for payment of the significant management fees only after the CLO has paid off its debt and has achieved a specified hurdle rate of return on its equity tranche. The capitalized manager vehicle (CMV) structure facilitates this alignment of interests as well as the additional risk retention requirements. Tax leakage on the cash flowing from the underlying borrowers of the CLO’s leveraged loans through the CLO issuer and into the hands of the noteholders can also occur at the level of payments by the CLO issuer, potentially decreasing their after-tax returns. We make comments about the Dodd-Frank risk retention issues in connection with the D.C. Circuit Court ruling and related impacts from the latest U.S. Tax Cuts and Jobs Act (“Tax Act”) of 2017 in terms of tax compliances. We also discuss some various cross-border tax issues between Korea and the U.S. relevant to qualified Korean individual and institutional investors. While retaining their anonymity, Korean investors would rather avoid paying foreign taxes or at least entitled to the tax treaty benefits. A typical solution to this issue is to make Korean investors put their contribution through an offshore blocker corporate entity established primarily for non-U.S. investors. This offshore blocker corporation will ensure that the Korean investor’s identity will not have to be disclosed to the U.S. tax authority, regardless of the outstanding FATCA rules.
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