Manager's Trade or Business Activities Attributed to Fund Fail Safe Harbor

Third Party Communication: None

LEGEND:

Fund, a State A limited partnership, was formed on Date A. In Year 2, Fund converted from a State A limited partnership to a Country X exempted limited partnership. During Year 1 and Year 2, Fund was treated as a partnership for federal tax purposes. During Year 1 and Year 2, Foreign Feeder, a Country X entity taxable as a corporation for federal tax purposes, was a limited partner in Fund. Country X does not have a bilateral income tax treaty with the United States. During the years at issue, Fund's taxable year was the calendar year.

II. Management of Fund

During Year 1 and Year 2, Fund had no employees. The management of Fund was vested exclusively in Fund Manager. Fund and Fund Manager entered into a management agreement pursuant to which Fund appointed Fund Manager as Fund's agent and irrevocable attorney-in-fact with full power to buy, sell, and otherwise deal in securities and related contracts for Fund's account. Fund further granted Fund Manager the full power and authority to do and perform every act necessary and proper to be done as fully as Fund might or could do personally. Pursuant to that grant of authority, Fund Manager conducted an extensive lending and stock distribution business on behalf of Fund. Fund Manager conducted these business activities and otherwise managed Fund primarily through an office in the United States. Fund Manager provided similar services for other investment entities, and no employees of Fund Manager worked exclusively for Fund.

Fund Manager held Fund out to the markets as a lender and underwriter, generating business for Fund in a variety of ways. Fund Manager had over Amount 1 investment professionals who used their extensive business and personal relationships to generate lending and stock distribution deals for Fund. As a result of the efforts of these investment professionals, accounting firms, securities attorneys, and third-party investment bankers referred potential borrowers and stock issuers to Fund. In marketing materials, Fund touted its "* * *." Fund Manager also sponsored and attended industry conferences relating to deal origination to generate lending and stock distribution opportunities for Fund.

III. Fund's Lending

Fund Manager, acting on Fund's behalf pursuant to the management agreement, committed extensive time and resources to Fund's lending activities. Over the course of Year 1 and Year 2, Fund held at least Amount 2 convertible debt instruments and Amount 3 promissory notes. Fund made many of the loans associated with those convertible debt instruments and promissory notes during Year 1 and Year 2. In Year 1, Fund determined that the value of its loan portfolio was over Amount 4. In Year 2, the value of Fund's loan portfolio exceeded Amount 5.

On behalf of Fund, Fund Manager negotiated directly with borrowers concerning all key terms of the loans. Before agreeing to make a loan, Fund conducted extensive due diligence on a potential borrower. Often, Fund lent borrowers money in return for debt instruments that were convertible into the borrowers' stock at a future date. Typically, the conversion prices were discounted from the trading prices of the borrowers' stock, determined at the time of conversion. After converting a debt instrument into stock at a discount, Fund sought to earn a spread by quickly disposing of the stock. Fund often received other property in connection with its lending agreements, including warrants to purchase additional shares of borrowers' stock. Borrowers also paid Fund various fees. Aside from Fund Manager, no other entity participated in Fund's lending activities.

IV. Fund's Stock Distribution Activity

Fund Manager, acting on Fund's behalf pursuant to the management agreement, also committed extensive time and resources to conducting Fund's stock distribution, or underwriting, activities.¹ Fund entered into Amount 6 Distribution Agreements with unrelated issuers in Year 1 and Amount 7 Distribution Agreements with unrelated issuers in Year 2. On behalf of Fund, Fund Manager negotiated the terms of each Distribution Agreement directly with the issuers.

A typical Distribution Agreement entitled an issuer to periodically issue and sell to Fund shares of stock in an amount equal to a total specified purchase price (often referred to as Fund's commitment amount). However, an issuer could typically only request a portion of the commitment amount (referred to as an advance) at any given time. The issuer was prohibited from requesting an advance until the issuer had filed with the Securities and Exchange Commission a registration statement registering the issuer's stock for resale by the Fund, and the registration statement had become effective. An issuer requested an advance by providing Fund with a written notice. After the issuer provided notice, Fund was irrevocably bound to purchase stock from the issuer after a specified number of business days (the "* * * Period"). During the * * * Period, Fund endeavored to pre-sell an amount of the issuer's stock that would generate enough cash to fund the advance requested by the issuer. Typically, Fund succeeded. Fund's sales of stock included sales to U.S. purchasers.

At the end of the * * * Period, the issuer sold stock to Fund at a discounted price (generally * * * percent below the stock's lowest daily trading price during the * * * Period). Because Fund sold the stock at the current market price, but received stock from the issuer at a discount, Fund earned a spread on each share sold. Usually, an issuer also paid fees to Fund, including commitment, structuring, and due diligence fees.

A foreign corporation that engages in a trade or business within the United States is taxable on a net basis on its taxable income that is effectively connected with the conduct of a trade or business within the United States. § 882(a)(1).² A foreign corporation is considered to be engaged in a trade or business within the United States if that foreign corporation is a member of a partnership that is engaged in a trade or business within the United States. § 875(1).

II. Determining Whether Activities Constitute a "Trade or Business within the United States"

Mere managerial attention to investments is also insufficient to cause a foreign person to be engaged in a trade or business within the United States. Higgins v. Comm'r, 312 U.S. 212 (1941); Wilson v. United States, 376 F.2d 280, 293 (Ct. Cl. 1967) ("managing one's own investments in securities is not the carrying on of a trade or business"). An investor is "primarily interested in the long term growth potential of [the investor's] stocks." Estate of Yaeger v. Comm'r, 889 F.2d 29, 33 (2d Cir. 1989). By contrast, a foreign bank was "engaged in business" when the bank engaged in multiple financial transactions through U.S. brokers, including the purchase and sale of securities, taking deposits, participating in underwriting syndicates, and other monetary transactions. Berliner Handels-Gesellschaft v. United States, 30 F. Supp. 490 (Ct. Cl. 1939), cert. denied, 309 U. S. 670 (1940).

Whether an income-producing activity rises to the level of a trade or business within the United States is based on the nature and the extent of the activity required to conduct that activity. For example, in Pinchot, the Second Circuit held that a nonresident alien's management of real estate constituted a trade or business within the United States rather than "investment and re-investment of funds in real estate" based on the nature and degree of activity necessary to manage real estate. Pinchot, 113 F.2d at 719. The Second Circuit noted that the taxpayer's management activity "required regular and continuous activity of the kind which is commonly concerned with the employment of labor; the purchase of materials; the making of contracts; and many other things which come within the definition of business . . . and within the commonly accepted meaning of that word." Id. at 719 (citations omitted); cf. Snell v. Comm'r, 97 F.2d 891, 892-93 (5th Cir. 1938) ("[t]he word [business], notwithstanding disguise in spelling and pronunciation, means busyness; it implies that one is kept more or less busy, that the activity is an occupation."). Isolated or occasional activities, on the other hand, generally do not give rise to a trade or business. Pasquel v. Comm'r, 12 T.C.M. 1431 (1953) (holding that a nonresident alien was not engaged in a trade or business within the United States on account of the nonresident alien's limited involvement in a single, isolated loan transaction); Linen Thread Co. v. Comm'r, 14 T.C. 725 (1950) (holding that two small, isolated transactions did not give rise to a trade or business within the United States).

Cases addressing when lending activity gives rise to a trade or business for purposes of other Code provisions are also informative. For example, courts have frequently addressed whether lending constitutes a "business" for purposes of the bad debt deduction permitted by section 166. In those cases, courts have considered a number of factors, including the total number of loans made, the amount of time and effort expended, whether the taxpayer made loans to unrelated borrowers, and whether the taxpayer actively sought out lending business and solicited borrowers. E.g., Fuller v. Comm'r, 21 T.C. 407, 412-413 (1953); McCrackin v. Comm'r, 48 T.C.M. 248 (1984); Ruppel v. Comm'r, T.C.M. 1987-248.

III. Statutory Safe Harbors for Certain Trading Activities

The regulations provide two exceptions to the definition of the term "dealer in stocks or securities." A foreign person that otherwise may be considered a "dealer in stocks or securities" is not considered a dealer:

We conclude that during Year 1 and Year 2: (1) the nature and extent of Fund's lending and underwriting, which were conducted by Fund Manager acting as Fund's agent, caused Fund to be engaged in a trade or business within the United States; (2) Fund's lending and underwriting did not constitute "trading in stocks or securities" for purposes of the Trading Safe Harbors; and (3) even if Fund's lending and underwriting had constituted "trading in stocks or securities" for purposes of the Trading Safe Harbors, Fund would not have qualified for the Trading Safe Harbors.

I. During Year 1 and Year 2, Fund's Lending and Stock Distribution Activities Caused Fund to Be Engaged in a Trade or Business within the United States.

Fund's lending and underwriting activities were profit-oriented activities that Fund conducted on a considerable, continuous, and regular basis in the United States during Year 1 and Year 2. Based on the facts and circumstances, Fund's lending and underwriting activities rose to the level of a trade or business within the United States.⁸

Fund Manager, acting as Fund's agent, conducted all aspects of Fund's business. Those activities were performed by Fund Manager on behalf of Fund, and were attributable to Fund for purposes of sections 864(b) and 882. See, e.g., De Amodio v. Commissioner, 34 T.C. 894 (1960).

Unlike a passive investor, Fund conducted an active business in the United States. Contrast Higgins v. Comm'r, 312 U.S. 212 (1941); Estate of Yaeger v. Comm'r, 889 F.2d 29 (2d Cir. 1989). Nor were Fund's activities sporadic and occasional. Contrast Pasquel v. Comm'r, 12 T.C.M. 1431 (1953); Linen Thread Co. v. Comm'r, 14 T.C. 725(1950). During the years at issue, Fund made numerous loans to borrowers and entered into dozens of Distribution Agreements with issuers. Fund dedicated significant time, resources, and effort to these activities. Fund negotiated with its counterparties and conducted extensive due diligence on potential borrowers and issuers. Fund actively solicited potential borrowers and issuers. Acting as an agent of Fund, Fund Manager dedicated over Amount 1 of its investment banking personnel and other professionals to the process of sourcing and originating potential deals.

The nature and extent of Fund's lending and underwriting activities demonstrate that Fund engaged in a lending and underwriting business on a considerable, continuous, and regular basis. As a result, Fund was engaged in a trade or business within the United States during the years at issue.

II. Fund's Lending and Stock Distribution Activities during Year 1 and Year 2 Did Not Constitute "Trading in Stocks or Securities" within the Meaning of the Trading Safe Harbors.

Fund's lending and underwriting activities also did not constitute "trading in stocks or securities" for purposes of the Trading Safe Harbors. The regulations under section 864, as well as relevant authorities in other contexts, establish that lending and underwriting are distinctive activities that go beyond the "effecting of transactions in stocks and securities" and are therefore not treated as trading for purposes of the Trading Safe Harbors.

III. Even if Fund's Lending and Stock Distribution Activities Were Treated as "Trading in Stocks or Securities" for Purposes of the Trading Safe Harbors, Fund Would Have Been Ineligible for the Trading Safe Harbors during Year 1 and Year 2.

The conclusion that Fund's lending and underwriting activities were not "trading in stocks or securities" is sufficient to exclude these activities from the Trading Safe Harbors. However, even if Fund's lending and underwriting activities had constituted trading in stocks or securities, Fund was ineligible for the (A)(i) Safe Harbor because Fund granted discretionary authority to Fund Manager. Further, Fund did not qualify for the (A)(ii) Safe Harbor because Fund acted as a dealer during Year 1 and Year 2.

The 1939 Code provided that a "nonresident alien individual engaged in trade or business in the United States or having an office or place of business therein" was subject to U.S. tax on a net basis. See § 211(b) of the 1939 Code. The 1939 Code also included a safe harbor that was similar to the current (A)(i) Safe Harbor. Specifically, section 211(b) of the 1939 Code provided that the phrase "engaged in trade or business within the United States" did not include "the effecting of transactions in the United States in stocks, securities, or commodities through a resident broker, commission agent, or custodian." Id. In 1966, Congress amended that safe harbor by adding "or other independent agent" so that it permitted trading through "a resident broker, commission agent, custodian, or other independent agent."

The amendment was prompted by a 1948 Tax Court decision interpreting the 1939 Code's trading safe harbor. In Adda, the Tax Court concluded that the section 211(b) safe harbor in the 1939 Code was inapplicable to a nonresident alien who granted discretionary authority to a U.S.-resident agent (the taxpayer's brother) to deal in commodity futures for the nonresident alien's account. 10 T.C. at 277-78. The Tax Court reasoned:

Soon afterwards, the Internal Revenue Service reached a similar conclusion, ruling that a Canadian investment company was engaged in trade or business in the United States when the company had an agent in the United States with discretionary power to purchase and sell securities. See Rev. Rul. 55-282, 1955-1 C.B. 634.

Congress enacted section 864(b)(2) as part of the Foreign Investors Tax Act of 1966 (P.L. 89-809) ("FITA"). FITA amended the 1939 Code's statutory trading safe harbor in two relevant ways. First, whereas the 1939 Code permitted trading in the United States "through a resident broker, commission agent, or custodian," Congress amended that safe harbor to permit trading through a resident broker, commission agent, custodian, "or other independent agent." Second, in the newly-enacted (A)(ii) Safe Harbor, Congress expressly permitted foreign persons that are not dealers in stocks or securities to trade in stocks, securities, and commodities in the United States through resident agents vested with discretionary authority.

The term "independent agent" is not explicitly defined for purposes of section 864(b). However, the term should be understood in the context of FITA's overhaul of the pre-1966 statutory trading safe harbor. Congress expressly permitted taxpayers invoking the (A)(ii) Safe Harbor to grant discretionary authority to U.S.-resident agents, but did not extend the same right to taxpayers invoking the (A)(i) Safe Harbor. Concurrently, Congress limited the scope of trading permitted under the (A)(i) Safe Harbor to trading "through a resident broker, commission agent, custodian, or other independent agent." By specifically permitting trading through resident agents granted discretionary authority solely in the (A)(ii) Safe Harbor, while simultaneously limiting the scope of the (A)(i) Safe Harbor to trading "through a resident broker, commission agent, custodian, or other independent agent," Congress implicitly defined an "independent agent" as an agent lacking discretionary authority.

Permitting dealers to trade in the United States through resident agents vested with discretionary authority would have undermined Congress's decision to exclude dealers from the (A)(ii) Safe Harbor. Unlike the (A)(i) Safe Harbor, the (A)(ii) Safe Harbor permits trading through employees or an office located in the United States.¹⁰ By preventing dealers from qualifying for the Trading Safe Harbors when trading through an employee or office in the United States, Congress sought to block foreign dealers from actively competing with U.S. dealers while also qualifying for the Trading Safe Harbors. See CC:LR-1185, 1987 WL 1363873 at p.7-8 ("A second question arose with respect to the exclusion of dealers from section 864(b)(2)(A)(ii) (trading for taxpayer's own account). The reason for this is that dealers are in the business of trading in stocks or securities for their own account. If they were artificially to be considered not engaged in trade or business in the United States by virtue of their United States trading they would have a distinct competitive advantage vis-à-vis their United States counterparts."). If the (A)(i) Safe Harbor permitted trading through resident agents vested with discretionary authority, then dealers could use that safe harbor to do exactly what Congress was trying to prevent: that is, those dealers could trade through U.S.-resident agents granted discretionary authority and exempt their trading gains from U.S. taxation while their domestic competitors were subject to full U.S. taxation on their trading gains. This would eviscerate Congress's purpose in banning dealers from the (A)(ii) Safe Harbor.

Furthermore, the legislative history to FITA demonstrates that Congress sought to overturn the result in Adda for non-dealers (by enacting the (A)(ii) Safe Harbor) while preserving the Adda result for dealers (by clarifying that if an agent were granted discretionary authority, then the (A)(i) Safe Harbor would not apply):

Numerous commentators have concurred with the conclusion that the (A)(i) Safe Harbor is inapplicable when a foreign person grants discretionary authority to a U.S.-resident agent. See, e.g., Sidney I. Roberts, U.S. Taxation of Foreign Taxpayers' Stock or Security Transactions: An Analysis, Tax'n of Int'l Trade 66, 72 (August 1970) ("a dealer can qualify for exclusion only under the general rule of Section 864(b)(2)(A)(i) . . . [t]hus, a foreign dealer in stocks or securities who regularly effects transactions in the United States, is within the statutory exclusion only if he effects such transactions through an independent nondiscretionary agent."); Leslie B. Samuels & Patricia A. Brown, Observations on the Taxation of Global Securities Trading, 45 Tax L. Rev. 527, 547-48 (1990) (arguing that the (A)(i) Safe Harbor does not apply to a foreign person who grants discretionary authority to a U.S.-resident agent); Yaron Z. Reich, Taxing Foreign Investors' Portfolio Investments: Developments and Discontinuities, 16 Tax Notes Int'l (TA) 1975, 1980 n.22 (Jun. 22, 1998) (noting that the (A)(i) Safe Harbor, "which is available to dealers . . . is intended to facilitate the execution of transactions through U.S. brokers that do not exercise discretionary authority on behalf of the taxpayer."); David R. Sicular & Emma O. Sobol, Selected Current Effectively Connected Income issues for Investment Funds , 56 Tax Law. 719, 762 (Summer 2003) (noting that pre-FITA case law suggests that an independent agent cannot, for section 864 purposes, be granted discretionary investment authority); New York City Bar, Report Offering Proposed Guidance Regarding U.S. Federal Income Tax Treatment of Certain Lending Activities Conducted Within the U.S., at 4 (May 3, 2007) (noting that legislative history to FITA suggests that an agent with discretionary authority may not be considered "independent" for purposes of the (A)(i) Safe Harbor).

This conclusion is unaffected by the fact that, in other contexts, an independent agent may exercise discretionary authority on behalf of its principal. See, e.g., Taisei Fire and Marine Insurance Co. Ltd. , 104 T.C. 535, 552 (May 2, 1995) (reasoning that "[i]t is freedom in the manner by which the agent performs [specified] duties that distinguishes him as independent" in determining whether a Japanese resident would be deemed to have a U.S. permanent establishment under article 9 of the Convention Between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Mar. 9, 1971, 23 U.S.T. (Part 1) 969).¹¹

This narrow exception to the dealer definition allows a foreign dealer to qualify for the (A)(ii) Safe Harbor when the foreign dealer effects transactions of a customer through an agent with discretionary authority. If a dealer could grant discretionary authority to a U.S.-resident agent to transact on the dealer's behalf and still qualify for the (A)(i) Safe Harbor, then there would be no need to provide (or illustrate) this exception to the dealer definition. Hence, the regulations demonstrate that foreign persons that grant discretionary authority to U.S.-resident agents to transact on the foreign person's behalf can only use the (A)(ii) Safe Harbor. See also CC:LR-1185, 1987 WL 1363873 at p.4 (indicating, in the transmittal letter for the final section 1.864-2 regulations, that an example in section 1.864 -2(c)(2)(i) was intended to demonstrate that Adda had been reversed for non-dealers by the addition of section 864(b)(2)(A)(ii) (the (A)(ii) Safe Harbor) to the Code).

Fund acted as a merchant of stocks by purchasing stocks from issuers with a view to distributing or selling that stock to the public. See Seeley v. Helvering, 77 F.2d 323, 324 (2d Cir. 1935) ("a merchant, ordinarily at least, does not resell to the same class of persons from whom he buys; he is a middleman in distributing the goods."). Fund held itself out to the public as providing issuers with access to public markets through Distribution Agreements. Pursuant to the Distribution Agreements, Fund was irrevocably bound to purchase stock from the issuers. During the Period, Fund typically sold an issuer's stock in an amount that would generate enough cash to fund the advance requested by the issuer. The terms of the Distribution Agreements and the Fund's conduct show that it purchased and sold issuers' stock in the course of its underwriting business. Moreover, the number of transactions that occurred over the course of several years shows that Fund regularly engaged in this underwriting activity. Fund entered into Amount 6 Distribution Agreements with unrelated issuers in Year 1 and Amount 7 Distribution Agreements with unrelated issuers in Year 2.

Treas. Reg. § 1.864-2(c)(2)(iv)(a) establishes that dealers seek to derive "gains and profits" specifically from the activity of acting as merchants and buying stocks and securities and selling them to customers, meaning that dealers are distinguished from investors or traders by charging a mark-up as middlemen rather than seeking to derive profits solely from market appreciation. Whereas a dealer is one who acquires securities to hold for resale to customers, charging a mark -up on such securities for providing a service, a trader buys and sells securities with a view to profiting from changes in value in the securities. See Bielfeldt v. Commissioner, 231 F.3d 1035, 1037 (7th Cir. 2000) (explaining that "the dealer's income is based on the service he provides in the chain of distribution of the goods he buys and resells, rather than on fluctuations in the market value of those goods, while the trader's income is based not on any service he provides but rather on, precisely, fluctuations in the market value of the securities or other assets that he transacts in.").

In light of this distinction between the profits earned by a dealer and a trader, Fund earned profits as a dealer. Fund did not profit by speculating in an issuer's stock; instead, Fund acquired the issuer's stock at a discount and sold the stock at market price. Fund, as an underwriter, distributed stock or securities in exchange for fees, discounted securities, and other property. That compensation constitutes "income . . . based on the service [an underwriter] provides in the chain of distribution of the goods he buys and resells," rather than profits derived from market fluctuations. Id. These gains and profits are consistent with the gains and profits earned by a "dealer in stocks and securities" for purposes of Treas. Reg. § 1.864-2(c)(2)(iv)(a) and for other purposes of the Code.

As a result of its underwriting activity, Fund purchased stocks and sold them to customers within the meaning of Treas. Reg. § 1.864-2(c)(2)(iv)(a). The reference to "purchasing stocks or securities and selling them to customers" does not establish a conjunctive test pursuant to which a dealer must both (x) purchase stocks or securities from a specified class of persons identifiable as "customers" and (y) sell those stocks or securities to a class of persons also identifiable as "customers." Rather, the regulation articulates a standard pursuant to which a dealer is a person that acts as a middleman or market-maker with respect to stocks or securities. Further, the regulations do not require that the middleman establish any particular prescribed or pre-existing relationship with a given purchaser in order for that purchaser to qualify as a "customer" for purposes of the dealer definition. Rather, a middleman's vendees are customers per se whenever the middleman is seeking to earn a profit by reselling to such vendees. Cf. Kemon v. Comm'r, 16 T.C. 1026 (1951) ("[t]hose who sell 'to customers' a recomparable to a merchant in that they purchase their stock in trade, in this case securities, with the expectation of reselling at a profit, not because of a rise in value during the interval of time between purchase and resale, but merely because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost. This excess or mark-up represents remuneration for their labors as a middleman bringing together buyer and seller, and performing the usual services of retailer or wholesaler of goods. Such sellers are known as 'dealers.'"). This is true even when a middleman's vendees are, for example, other dealers, provided that the middleman is seeking to earn a mark-up through the transaction. Therefore, when Fund sold the stock acquired pursuant to the Distribution Agreements, Fund's vendees were "customers" simply by virtue of the fact that Fund was providing market access to issuers.

In addition, Fund performed its underwriting activities through the Fund Manager's office, which served as an "established place of business" within the meaning of Treas. Reg. § 1.864-2(c)(2)(iv)(a). Fund and Fund Manager entered into a management agreement pursuant to which Fund appointed Fund Manager as Fund's agent and irrevocable attorney-in-fact with full power to buy, sell, and otherwise deal in securities and related contracts for Fund's account. Pursuant to that grant of authority, Fund Manager conducted a stock distribution business on behalf of Fund through Fund Manager's office.

Although Treasury regulations permit a foreign person to engage in limited underwriting activities without being treated as a dealer, these exceptions are not available to Fund. Specifically, a foreign person is not considered a dealer solely because the foreign person acts as an underwriter, or as a selling group member, for the purpose of making a distribution of stocks or securities of a domestic issuer to foreign purchasers of such stocks or securities. Treas. Reg. § 1.864-2(c)(2)(iv)(b)(1) & (c)(2)(iv)(c), Example (1). However, Fund's activities were not within the scope of the exception because Fund's distribution of stock was not limited to foreign purchasers. Further, the narrow scope of this exception establishes that a foreign person purchasing stocks or securities from U.S. issuers with a view to distributing those stocks or securities to U.S. purchasers will typically be treated as a dealer for purposes of the (A)(ii) Safe Harbor.

Accordingly, Fund was a dealer in stocks or securities within the meaning of section 1.864-2(c)(iv)(a). As a dealer in stocks or securities within the meaning of section 1.864-2(c)(iv)(a), Fund was ineligible for the (A)(ii) Safe Harbor.¹²

This memorandum is limited to an analysis of whether Fund and Foreign Feeder were engaged in a trade or business within the United States. * * *

Please call Mark Erwin, Peter Merkel, or Raymond Stahl at (202) 317-6938 if you have any further questions.

² Except as noted, all section references are to the Code.

³ I.R.C. § 864(b):

⁵ Treas. Reg. § 1.864-2(c):

⁶ Treas. Reg. § 1.864-2(c)(2)(iv)(a):

⁸ Because Fund conducted a lending and underwriting business on a considerable, continuous, and regular basis, it is unnecessary to address, and this memorandum does not address, whether certain of the Fund's activities may constitute engaging in a U.S. trade or business without regard to the extent of those activities. See § 864(b).

⁹ Section 1221(a)(1) excludes from capital asset status "stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer . . . or property held by the taxpayer primarily for sale to customers and property held for sale to customers in the ordinary course of his trade or business." Courts have held that section 1221(a)(1) describes securities held by dealers, but not traders. See, e.g., Marrin v. Comm'r, 147 F.3d 147, 151 (2d Cir. 1998).

¹⁰ Prior to the Taxpayer Relief Act of 1997, P.L. 105-34, § 1162(a), a foreign corporation generally could qualify for the (A)(ii) Safe Harbor unless the foreign corporation's principal business was trading in stocks or securities and the corporation's principal office was in the United States. The Taxpayer Relief Act eliminated that restriction.

¹¹ Commentators have noted evolving uses of the term "independent agent" in the treaty context. See generally John F. Avery Jones & David A. Ward, Agents as Permanent Establishments under the OECD Model Tax Convention, 33 Eur. Tax'n 154 (1993); Sidney I. Roberts, The Agency Element of Permanent Establishment: The OECD Commentaries From the Civil Law View (Parts 1 &2), 9 Intertax 396 & 488(1993); Richard Crawford Pugh, Policy Issues Relating to the U.S. Taxation of Foreign Persons Engaged in Business in the United States through Agents: Some Proposals for Reform, 1 San Diego Int'l Law L. J.1 (2000).

¹² Fund purchased convertible debt instruments that were typically converted to discounted stock within a year. Fund sought to distribute that stock to the public market immediately following conversion. Notwithstanding the fact that Fund (i) sold stock rather than the notes that it acquired from borrowers and (ii) held its borrowers' notes for a brief period before converting the notes to stock and selling the stock to the public, the distribution activity associated with Fund's convertible loans constituted dealing in stocks or securities for the same reasons that Fund's activities related to its Distribution Agreements constituted dealing in stocks or securities.

Moreover, in other contexts, making loans to the public may be sufficient to cause a person to be treated as a dealer even when the lender holds the loans instead of selling them. See, e.g., Treas. Reg. § 1.475(c)-1(c)(i) (providing an exception from dealer status for a "taxpayer that regularly purchases securities from customers in the ordinary course of a trade or business (including regularly making loans to customers in the ordinary course of a trade or business of making loans)" that engages in no more than negligible sales of the securities is not a dealer, unless the taxpayer elects otherwise). (Emphasis added.) This memorandum expresses no opinion as to whether other types of lending activity (for example, lending but not selling the loans) would be sufficient to cause a foreign person to be treated as a dealer for purposes of the (A)(ii) Safe Harbor.