FIN 48 + Implementation & DisclosuresA growing chorus of hedge fund and private equity groups has asked FASB for an exemption from FIN 48, a FASB interpretation of a standard on accounting for income taxes. In a letter to FASB, the Managed Funds Association said that the sophisticated investors that invest in hedge funds do not need the enhanced disclosures that FIN 48 was designed to provide. In its letter, the Private Company Financial Reporting Committee stated that private company financial statement users find the accounting matters and disclosures encompassed by FIN 48 to be largely irrelevant to their decision making. The committee’s also noted that FASB and the IASB are working on a convergence project on accounting for income taxes and that this may significantly affect FIN 48. Thus, if FASB is unwilling to grant hedge funds an exemption from FIN 48, the private fund groups ask that the Board at least postpone the effective date of FIN 48 pending completion of the convergence project.
FIN 48 was adopted to provide for increased relevance and comparability in financial reporting of income taxes and to provide enhanced disclosures of information about the uncertainty in income tax assets and liabilities. The genesis of FIN 48 is FASB Statement No. 109, which established financial accountants and reporting standards for the effects of income taxes that result from an enterprise’s activities during the current and preceding years. It requires an asset and liability approach to financial accounting and reporting for income taxes
While acknowledging the need for FIN 48-type disclosures in the case of companies offering securities to the investing public, the MFA pointed out that the institutions and individuals that invest in private investment funds do not fall within this category. Hedge fund investors typically conduct extensive due diligence assisted by their own lawyers, accountants and other advisers, noted the MFA, and they often request, and receive, additional information, including tax information, if they believe that such information is material to their investment decision.
Moreover, private investment funds with U.S. investors are treated as partnerships for Federal income tax purposes. As a result, a private investment fund is not itself a taxpayer. It files an annual information return with the IRS, said the MFA, and each investor in the fund pays tax on its pro-rata share of the income of the fund. Thus, while fund personnel have historically focused substantive attention on issues surrounding the proper allocation of taxable items in a partnership environment, explained the MFA, it has been unnecessary for them to devote substantial time to traditional FAS 109 accruals.
For this reason, private investment funds are incurring significant costs in preparing to comply with, and complying with, FIN 48. Even more, many private investment funds make investments outside the United States, said the MFA, and FIN 48 will require them to make an additional layer of judgments concerning uncertainties in the tax laws of other countries.
Finally, the MFA noted that hedge funds need to determine NAV with reasonable frequency, both to establish a price for investments and redemptions, and also for other purposes. As a result of the fiduciary nature of the NAV calculation, and economic fairness to investors that subscribe and redeem at that amount, the MFA believes there are substantial questions whether FIN 48 analyses should be reflected in the NAV of a private investment fund.
The MFA is aware that SEC has concluded that FIN 48 analyses should be reflected in NAV in order to give investors more disclosure. Significantly, however, the SEC said its guidance was limited to assessing tax positions reflected in NAV calculations subject to the Investment Company Act and should not be applied by analogy in other cases.
The MFA believes that there are differences between public and private investment companies that warrant a different conclusion with respect to private investment funds. The MFA stands ready to make a more comprehensive submission on this point if the FASB believes that it would be of assistance.
Guest post by Jim Hamilton
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