The IRS has taken the position that a foreigner whose U.S. agent regularly makes loans to the public on its behalf is engaged in a U.S. trade or business and subject to U.S. net income tax. As a result, most foreign CLOs (as well as credit funds with foreign investors) generally comply with tax guidelines that prohibit their U.S. managers from engaging in primary loan origination on their behalves.

An exception to the prohibition on primary loan origination may be available if (1) the CLO acquired a performing loan with no expectation that the loan would default, (2) the loan subsequently defaults or default becomes imminent, and (3) the manager reasonably believes that an additional advance to the borrower would protect the value of the CLO's investment. These types of workouts are typical byproducts of being an investor, and arguably do not give rise to a customer relationship reflective of a U.S. trade or business.

Historically, tax practitioners have not articulated this exception in their tax guidelines, preferring instead to address the permissibility of additional advances on a case-by-case basis. (All tax guidelines can be modified on a case-by-case basis pursuant to advice of counsel.) However, in light of the expected uptick in defaults as a result of the COVID-19 pandemic, a number of tax practitioners are considering whether tax guidelines ought to spell out this exception.

We will keep you abreast of any developments.