US Tax Court holds that non-US partnership was securities dealer engaged in US trade or business, liable for partnership withholding tax

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EY Global

22 Nov 2023
Subject Tax Alert
Categories Corporate Tax
Jurisdictions United States
  • A US-based asset manager's activities were attributed to a foreign partnership and were not within any safe harbors because the activities were not limited to managing investments or trading in stocks or securities.
  • The foreign partnership was found to be a "dealer in securities" and required to recognize gain under the "mark-to-market" rule of IRC Section 475(a)(2).
  • Gain or loss recognized by the foreign partnership with respect to securities was treated as effectively connected income under IRC Section 864(c)(3).
  • The period of limitation on the assessment of IRC Section 1446 withholding tax did not commence by filing IRS Form 1065 where no IRS Form 8804 was filed.

In YA Global Investments, LP v. Commissioner, 161 T.C. No. 11 (Nov. 15, 2023), the Tax Court (court) held that a foreign partnership providing funding to certain portfolio companies was considered to have a US office because its US-based asset manager acted as its agent. Consequently, the partnership was engaged in a US trade or business and is liable for withholding tax under IRC Section 1446 on the portion of its taxable income that was effectively connected with that trade or business and allocable to foreign partners. The court also found that the limitations period for the assessment never started because the partnership filed Form 1065, U.S. Return of Partnership Income, for the relevant years, but did not file Form 8804, Annual Return for Partnership Withholding Tax (Section 1446).


YA Global is a partnership registered in the Cayman Islands. Until 2007, Yorkville Advisors, which was located in New Jersey, was YA Global's sole general partner. From 2007 until 2011, Yorkville GP was YA Global's sole general partner.

YA Global and Yorkville Advisors had investment management agreements stating that (1) YA Global retained Yorkville Advisors to render investment management services and manage YA Global's securities investment account, and (2) YA Global constituted and appointed Yorkville Advisors as YA Global's agent and attorney-in-fact with full power and authority to buy, sell or otherwise deal with their account. One of the agreements also stated that the activities in which Yorkville Advisors engaged on behalf of YA Global were subject to the policies and control of YA Global's general partner. Yorkville Advisors was compensated for its services with a management fee of a specified percentage of YA Global's assets and a 20% incentive fee based on the profits.

YA Global provided funding to portfolio companies in the form of convertible debentures, standby equity distribution agreements (SEDAs) and other securities. YA Global invested primarily in microcap and low-priced public companies traded in the over-the-counter public markets.

Court analysis

The court broke down the case into the following seven issues and addressed each one separately.

1. Can the activities of Yorkville Advisors be attributed to YA Global?

The court found that Yorkville Advisors' activities could be attributed to YA Global, determining that Yorkville Advisors, which was YA Global's asset manager, acted on YA Global's behalf. In its analysis, the court said the "distinction between an agency relationship and one of service provider and recipient turns not on the ability to provide direction but instead on when that direction may be provided" (emphasis in original). In a relationship between service provider and recipient, the court explained, any instructions limiting the provider's discretion must be given at the outset and cannot be varied midstream. On the other hand, the principal in an agency relationship can give interim instructions.

The court found that YA Global could give interim instructions that would restrict Yorkville Advisors' discretion in managing YA Global's assets and retained a degree of control over Yorkville Advisors. Also, in the agreements, YA Global manifested its assent to Yorkville Advisors' acting on YA Global's behalf and being subject to YA Global's control in managing its assets, and Yorkville Advisors consented to act in that capacity. The court also found that Yorkville Advisors "devoted most of its activities to YA Global during the years at issue." "It follows that the relationship between the parties was one of 'agency,' as defined by section 1.01 of the Third Restatement and that, consequently, the activities Yorkville Advisors conducted pursuant to the 2005 Agreement and the 2007 Agreement can be attributed to the partnership for the purpose of determining whether the partnership was engaged in a U.S. trade or business during the years in issue," the court said.

2. Was YA Global engaged, through Yorkville Advisors, in the conduct of a US trade or business during 2006, 2007, and 2008?

The court found that YA Global's conduct (through Yorkville Advisors) rose to the level of a US trade or business during the relevant years.

IRC Section 1446(a) requires a partnership to pay a withholding tax on the portion of any "effectively connected taxable income" allocable to a foreign partner. This term generally refers to the taxable income of the partnership that is effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States (ECI). Neither the Internal Revenue Code nor regulations, however, contain a comprehensive definition of what it means to be engaged in a US trade or business, the court said. IRC Section 864(b) provides that the term "trade or business within the United States" includes the performance of personal services within the United States at any time during the tax year. IRC Section 864(b)(2) lists activities that are not within scope, including trading in stocks, securities or commodities through a resident broker, commission agent, custodian or other independent agent. In addition, courts (see, e.g., Commissioner v. Groetzinger, 480 U.S. 23 (1987) and Higgins v. Commissioner, 312 U.S. 212 (1941)) have generally recognized that a taxpayer whose activities are limited to investment is not engaged in a US trade or business.

The court said that whether YA Global engaged in a US trade or business through Yorkville Advisors turned on three questions. First, "were the activities Yorkville Advisors conducted on behalf of YA Global continuous, regular, and engaged in for the primary purpose of income or profit? Second, were those activities limited to the management of investments? And third, were they covered by the safe harbor provided in [IRC S]ection 864(b)(2)(A) for trading in stocks or securities?"

After reviewing the transactions in question, the court said first, there was no question that Yorkville Advisors' activities were regular, continuous and directed at profit. Second, the activities went beyond the management of investments because the payment of fees by the portfolio companies indicated that the portfolio companies received something of value from Yorkville Advisors above and beyond the capital they received from YA Global. In this connection, the court noted that Yorkville Advisors at times remitted to YA Global fees that Yorkville Advisors had received from portfolio companies to the extent that those fees exceeded what Yorkville Advisers needed to offset its expenses and overhead costs. Third, just as the activities were not covered by the judicially-created safe harbor for the management of investments, the activities were not within the scope of the statutory safe harbor for trading in securities under IRC Section 864(b)(2)(A). Specifically, YA Global did not fall under the trading safe harbor because the portfolio companies compensated Yorkville Advisors and YA Global for benefits that went beyond the use of invested capital.

3. Was YA Global required to recognize gain under the "mark-to-market" rule of IRC Section 475(a)(2) for 2006, 2007 and 2008?

The court found that YA Global was required to recognize gain under the IRC Section 475(a)(2) "mark-to-market" rule for the 2006, 2007 and 2008 tax years. Under IRC Section 475(a)(2), in "the case of any security which is not inventory in the hands of the dealer and which is held at the close of any taxable year — (A) the dealer shall recognize gain or loss as if such security were sold for its fair market value on the last business day of such [tax] year, and (B) any gain or loss shall be taken into account for such [tax] year."

The threshold issue for whether YA Global was subject to the IRC Section 475 mark-to-market rules is whether YA Global was a "dealer in securities" for each of the years at issue. IRC Section 475(c)(1) defines "dealer in securities" as "a taxpayer who — (A) regularly purchases securities from or sells securities to customers in the ordinary course of a trade or business; or (B) regularly offers to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business."

The court found that YA Global held itself out as being willing and able to provide capital to portfolio companies, so the portfolio companies from which it made those purchases were its "customers" within the meaning of IRC Section 475(c)(1)(A). Because YA Global regularly purchased securities from customers in the ordinary course of a trade or business, it was a dealer in securities and subject to the mark-to-market rule.

IRC Section 475(b)(1) lists "any security held for investment" as an example of a security to which the mark-to-market rules of IRC Section 475(a) do not apply. The court found that the securities held by YA Global were not covered by the investment exception because YA Global did not properly identify them as such. "[T]o meet the requirement of [IRC S]ection 475(b)(2)," the court explained, "the description of a security in the dealer's books and records must 'state whether the security is described in — (1) Either of the first two subparagraphs of section 475(b)(1) (identifying a security as held for investment or not held for sale); or (2) [t]he third subparagraph thereof (identifying the security as a hedge).' Treas. Reg. [Section] 1.475(b)-2(a) (emphasis added)." Thus, the court held, that proper identification "does require writing the words 'section 475.'"

4. How much of YA Global's taxable income for each year was ECI?

IRC Section 1446(c) generally defines "effectively connected taxable income" as the taxable income of the partnership, which is ECI. The rules for determining whether income is ECI depend on the income's nature and source. YA Global's income at issue in the case included gains on sales of securities, dividends and interest.

IRC Sections 861 through 865 determine the source of various types of income. The source of interest and dividend income is generally determined by the residence of the payor. Gains on sales of personal property are generally sourced by reference to the seller's residence. If a nonresident maintains an office or other fixed place of business in the United States (US office), IRC Section 865(e)(2)(A) treats income from any sale of personal property attributable to that US office as US source. IRC Section 864(c)(5)(A) requires an agent's office or other fixed place of business to be disregarded in determining whether a nonresident has US office unless the agent "(i) has the authority to negotiate and conclude contracts in the name of the nonresident alien individual or foreign corporation and regularly exercises that authority or has a stock of merchandise from which he regularly fills orders on behalf of such individual or foreign corporation, and (ii) is not a general commission agent, broker, or other agent of independent status acting in the ordinary course of his business."

The determination of whether US-source fixed or determinable annual or periodical income and gain or loss from the sale or exchange of capital assets is ECI is governed by the asset use and business activities tests in IRC Section 864(c)(2). Under IRC Section 864(c)(3), any US-source income, gain or loss not covered by IRC Section 864(c)(2) is treated as ECI regardless of the factual connection between the specific item and the taxpayer's business.

The court determined that any gain or loss recognized by YA Global from securities is US-source income treated as ECI under IRC Section 864(c)(3). The court first rejected YA Global's argument that Yorkville Advisors was an independent agent and held that Yorkville Advisors' US office is attributed to YA Global. As a result, the court concluded that YA Global is considered to have had a US office, within the meaning of IRC Section 864(c)(5), during the relevant period. The court then noted, "solely for purposes of determining the 1446 tax, [IRC] Section 865(e)(2)(A) treats income from sales of personal property as U.S.-source income if that income is attributable to a U.S. office or other fixed place of business maintained (or attributable to) the partnership." The court went on to say that YA Global's income from sales of securities was attributable to YA Global's US office because the US office was a "material factor" in the production of that income and activities of the type from which the income was derived "were regularly carrie[d] on" at that office.

Based on the court's earlier conclusion that YA Global's securities were required to be marked to market under IRC Section 475, the court further concluded that, for purposes of determining YA Global's withholding tax liability, YA Global's securities were treated as assets other than capital assets. Based on this, the court concluded that the partnership's income from sales of securities was US-source income under IRC Section 865(e)(2)(A) and treated as ECI under IRC Section 864(c)(3).

It appears that the court concluded that the taxpayer's burden was not met with respect to dividends and interest because the court did not have sufficient evidence to determine the source of that income. Thus, the court held that YA Global did not meet its burden of establishing that any portion of its taxable income was not ECI.

5. If YA Offshore Global Investments, Ltd. (YA Offshore) was allocated effectively connected taxable income for 2007 and 2008, can YA Global's liability for IRC Section 1446 withholding tax for each year be adjusted under IRC Section 1464 to reflect stipulated expenses of YA Offshore beyond its distributive share of partnership deductions?

YA Global's Forms 1065 for 2006, 2007 and 2008 included at least one Schedule K-1 issued to a partner identified as foreign (YA Offshore). YA Global argued that the determination of YA Global's IRC Section 1446 withholding tax without regard to YA Offshore's nonpartnership deductions would result in an overpayment of withholding tax.

For purposes of IRC Section 1446, the court noted, the regulations allow partnerships to rely on certifications provided by foreign partners of the nonpartnership deductions they expect to be available to offset the taxable income attributable to their US businesses. The court noted that YA Global did not follow the certification procedures specified in the regulations by which nonpartnership deductions can be taken into account to reduce the partnership's withholding tax liability under IRC Section 1446. According to the court, YA Global instead relied on IRC Section 1464 "as a back-door means of giving effect to YA Offshore's nonpartnership deductions despite YA Offshore's failure to have certified those deductions."

The court explained that IRC Section 1464 allows a credit or refund for an overpayment of tax under Chapter 3 of the Code while IRC Section 882 (i.e., the provision imposing income tax liability on YA Offshore) appears in Chapter 1. Accordingly, the court noted that the determination of any overpayment in withholding tax under Chapter 3 should compare the amount of withholding tax paid to the amount of the withholding tax due under IRC Section 1446, and not YA Offshore's liability for income tax under IRC Section 882. According to the court, "[t]he tax imposed on a withholding agent and the tax imposed on the recipient of the income are not one and the same."

The court, therefore, concluded that YA Offshore's nonpartnership deductions had no bearing on YA Global's IRC Section 1446 withholding tax liability.

6. Did YA Global's filing of Form 1065 for 2006, 2007 and 2008 commence the period of limitation on the assessment of IRC Section 1446 withholding tax?

YA Global filed Form 1065, U.S. Return of Partnership Income for 2006, 2007 and 2008, but did not file Form 8804, Annual Return for Partnership Withholding Tax, for any of those years.

Citing Commissioner v. Lane-Wells Co., 321 U.S. 219 (1944), the court said that a taxpayer's filing of one return cannot start the period of limitation on the assessment of a tax required to be shown on an unfiled return unless the return filed shows the facts on which liability would be based. The court noted that the Forms 1065 that YA Global filed were "insufficient to advise the Commissioner of the partnership's liability for [IRC] Section 1446 withholding tax that it should have disclosed on Forms 8804." For example, the returns filed did not disclose the "key fact" relevant to the calculation of the withholding tax liability — namely, the partnership's conduct of a US trade or business.

Because YA Global did not file a Form 8804 for either year, the court concluded that the applicable period of limitation never began to run. Even if the filing of a Form 1065 for each year commenced the running of the period of limitation, the court explained, the consents executed on Forms 872-P, Consent to Extend the Time to Assess Tax Attributable to Partnership Items, extended that period under IRC Section 6229. The court noted that "[s]pecific reference to [IRC S]ection 1446 withholding tax on the extension forms was unnecessary. The forms' preprinted language covered the assessment of that tax (an income tax) against YA Global (considered, for that purpose, a partner)."

7. Is YA Global liable for additions to tax under IRC Section 6651(a)(1) and (2) for its failure to file Forms 8804 and pay IRC Section 1446 withholding tax?

The court found that, in addition to being required to file Form 1065, YA Global had to file a Form 8804 each year because YA Global had at least one foreign partner for 2006, 2007 and 2008; if YA Global had effectively connected taxable income for 2006, 2007 and 2008, the court continued, at least some of that income for each of those years was allocable to a foreign partner.

The court said that YA Global's filing of Forms 1065 did not satisfy the requirement to file Forms 8804. YA Global is thus subject to the failure-to-file and failure-to-pay additions to tax unless its failure to have filed the required returns and pay IRC Section 1446 withholding tax was due to reasonable cause and not willful neglect. The court found YA Global did not establish that this was the case.


The court's finding that the taxpayer was engaged in a trade or business beyond the trading safe harbor was focused on the fact that the taxpayer earned fees that were compensation for services, rather than simply earning a return on invested capital. Many alternative asset managers have sought to limit the receipt of fees by an investment fund for precisely this reason, and this case may cause funds and management companies to be even more cautious regarding the receipt of these fees. IRC Section 892 investors should be aware that certain portfolio fees earned by asset managers and paid to limited partners may cause the IRC Section 892 partner to potentially be engaged in a commercial activity.

The court's conclusions on the IRC Section 475 dealer issue would, if not reversed on appeal, appear to reflect a substantial broadening of the definition of the term "dealer" for purposes of IRC Section 475. Before the decision's release, many advisors would have advised their clients that being a dealer required offering to enter into trades to meet the needs of a counterparty. The court, however, seems to have adopted an interpretation of the term that would arguably require only that the taxpayer manifest a publicly-disseminated willingness to enter into trades, rather than offering to enter into trades as a service to a counterparty. Under this broadened definition, traders may become dealers if they let it be known publicly that they are willing and able to enter into trades. Regarding the identification issue, the case highlights the importance of drafting identification statements precisely if securities are to be successfully identified out of being marked-to-market.


Contact Information

For additional information concerning this Alert, please contact:

International Tax and Transaction Services
  • Arlene Fitzpatrick
  • Leo Naughton
  • Anna Moss
FSO – Private Equity Tax
  • Gerald Whelan
International Tax and Transactions Services – Capital Markets
  • Matthew A. Stevens
  • Huvie Weinreich

Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.