FIN 48 Disclosure Requirements Updated For Alternative Investment Funds

Dec 7 2009 | 10:04am ET

By Lawrence S. Zeff -- In 2006, the Financial Accounting Systems Board (“FASB”) released Interpretation 48 (“FIN 48”), Accounting for Uncertainty in Income Taxes, as an interpretation of FAS Statement 109. The purpose of FIN 48 is to provide consistent guidance on the recognition in financial statements of “uncertain income tax positions.” It provides specific guidelines on recognition, measurement, and other aspects of reporting and disclosing these positions. Recognition is permitted on the financial statements for each position if, based on its technical merits, it is “more likely than not” that the position will be upheld under audit. Measurement requires an evaluation of the potential outcomes that could occur upon an eventual settlement with the taxing authorities and an application of the probabilities. The company is required to identify and evaluate all material tax positions taken in all tax returns filed in the past and still open for inspection, as well as tax returns filed currently and in the foreseeable future. Since FIN 48 applies to any entity which maintains its books and records in accordance with Generally Accepted Accounting Principles (“GAAP”), it has applicability to alternative investment vehicles and their portfolio investments even though they may operate as flow-through entities for tax purposes.

In order to prevent confusion, it should be noted that on July 1, 2009, the FASB initiated the FASB Accounting Standards Codification (“ASC”), which overhauled GAAP and changed from a standards to a topically based model. Approximately ninety topics are arranged by ASC numbers (ASC 740 is the income tax topic number). Each ASC topic is updated with an Accounting Standards Update (“ASU”).

On September 2, 2009, the FASB issued ASU 2009-06, which amends the disclosure requirements for nonpublic entities and provides additional guidance for pass-through and tax-exempt nonprofit entities.

Significant Highlights of ASU 2009-06

  • Effective Date for Compliance— For entities currently applying GAAP for uncertain tax positions, ASU 2009-06 is effective for interim and annual periods ending after September 15, 2009. For entities that have deferred the application of GAAP for uncertain tax positions, ASU 2009-06 is effective upon adoption of GAAP for uncertain tax positions.
  • Applicability to all entities— The guidance relating to accounting for uncertain tax positions is applicable to all entities, including tax-exempt entities, pass-through entities, and entities that are taxed in a manner similar to pass-through entities such as real estate investment trusts and registered investment companies.

The guidance:

— Eliminates the requirement for non-public entities to provide a tabular reconciliation of beginning and ending unrecognized tax benefits, as well as adjustments in the amount of unrecognized tax benefit caused by possible rate changes.

— Clarifies the definition of “tax positions” with the following examples:

a – The determination that the entity’s status is a pass-through entity or tax-exempt entity. Therefore, it requires assurance that the designation was properly and timely made.

b – The decision not to file a tax return. This frequently arises in connection with state and local nexus tax issues.

c – The characterization of income or a decision to exclude reporting taxable income in a tax return. Relevant issues include characterization as a trader or investor, the exclusion of what may be classified as effectively connected income (loan origination, service activities, etc.), and classification of a distribution as a return of capital rather than as a dividend.

d – The decision to classify a transaction, entity or other position in a tax return as tax-exempt. This issue may arise where a fund establishes an office in a foreign jurisdiction and mistakenly assumes it is not subject to tax in that jurisdiction. 

— Clarifies the attribution of income taxes. In a situation where the fund pays a tax on behalf of its investors, there has been confusion whether that tax is attributable to the fund for the purpose of applying FIN 48 procedures. ASU 2009-06 clarifies that it is the law of the assessing jurisdiction that will govern. For example, if the jurisdiction’s laws and regulations attribute the income tax to the owners, amounts due to or from the taxing jurisdiction should be treated as a transaction with the owners. Attribution will not be based on agreements between the entity and its owners.

Financial statements of a group of related entities will include taxable portfolio company FIN 48 information whether or not the fund itself is a pass-through entity.

For example, if the fund owns a 100% interest in a taxable entity, and the fund is required to issue consolidated financial statements, all unrecognized tax positions and related liabilities for unrecognized tax benefits will be required to be included in the consolidated financial information of the pass-through fund.


Alternative Investment Funds should immediately begin to plan for the implementation of FIN 48. Particular attention may be directed to the following areas of exposure:

a - Taxation in foreign jurisdictions--issues such as whether a branch office is subject to tax in the foreign jurisdiction, whether a pass-through entity may have filed a faulty “check the box” election, whether there is exposure under transfer pricing rules, and whether withholding tax has been properly withheld.

b - U.S. taxation of foreign investors--whether activities of the fund are deemed to create “effectively connected income” for foreign investors, which are subject to U.S. tax. For example, this may arise in the context of loan origination, or in the management of real estate.

c - In the area of state and local tax exposure where, for example, questionable decisions may have been made whether a state had proper nexus to tax income of the fund. Additionally, attention must be paid to exposure to specific taxes such as the New York City Unincorporated Business Tax, which is imposed directly on pass-through entities.

It should be noted that in a recent case, United States v. Textron et al., No. 07-2631 (1st Cir. Aug. 13, 2009), the U.S. Court of Appeals for the First Circuit denied Textron’s claim that its tax accrual workpapers were subject to the work product privilege and held that they could be requisitioned by the Internal Revenue Service. Great care should be taken in preparing these workpapers.

Lawrence Zeff, CPA, J.D., LL.M., is a tax partner at Eisner LLP, with significant expertise in the tax aspects of hedge funds, private equity funds, and registered broker-dealers. He regularly advises on such issues as the proper tax structure of new investments, taxation of proposed securities transactions, year-end trading strategies, and investment disposition strategies.

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