Tax technology for investment partnerships
Article originally published in Bloomberg Tax on Feb. 19, 2021
The world of the partnership in business has evolved over many years. Industries from real estate to business professional organizations to asset management firms look to partnerships to help streamline their operations, allocate their gains and offer flow through tax treatment to their partners, among other benefits.
It’s especially the case with private equity funds. As the industry has matured, private equity funds have used partnerships to help with a range of issues, including the location of investments—domestic or offshore—partner allocation models and partner preferences. To achieve this, private equity funds have added co-investment fund entities, blocker corps and various other types of investment vehicle funds.
The result has been an increasingly complex business landscape that fund managers and chief financial officers (CFOs) have contended with as they attempt to attract and satisfy investors.
In addition, as the complexity has grown, so has the challenge of tax compliance. Put simply, the innovation in tax preparation has not kept pace with the sophisticated structure of investment funds such as private equity and hedge funds.
There is a way to meet this challenge.
The solution lies in partnership tax technology, which has revolutionized the way investment partnerships provide tax reporting. Partnership tax technology has allowed for efficiencies and transparency for funds. The tax reporting to partners of a fund now has a way to provide information in real time to their investors.
There are any number of benefits to this tax compliance automation and technology solution.
Perhaps one private equity fund partnership sits on top of other fund partnerships along with separate arms to each entity—how can those structures, commonly referred to as tiered structures, be efficiently managed for tax purposes? Attorneys, along with transaction advisory and tax professionals, have suggested tiered entity fund structures to solve common tax-sensitive partner concerns and offshore investment tax issues.
Then there is a firm’s need to manage the sheer volume and number of pass-through investments. After all, keeping track of the various investments or allowing fund partners to have tax transparency into all the various investments is difficult.
It all goes back to the use of the partnership as the preferred tax entity of choice, how best to manage that.
Partnerships in their myriad forms offer flexibility and ability to do special allocations, which at various times during the life of the fund can be complex. Partnerships offer asset management funds the needed flexibility for various partner allocations that are called for and required according to limited partnership agreements (LPA). These are commonly referenced as waterfall, carried interest and claw-back allocations. There are layering and aggregate methods used for partner allocations as well.
Looking to automation
But when it comes to tax compliance, the process has traditionally been labor intensive and cumbersome.
Automation of tax compliance for partnerships has been missing for some time, and its evolution has been welcomed by many CFOs and general partners at funds.
Technology in the tax compliance area will solve many roadblocks and obstacles caused by the current slow information sharing of tax compliance.
Partnership tax compliance technology has opened the door for much more data analysis, addressing partner K-1 questions in a timely fashion and allowing funds to release K-1s more quickly.
Partners in a fund structure who are invested across many private equity funds can now be provided information much more efficiently with a few clicks of the computer.
Tax technology has been missing for a long time for many partnerships, most notably investment partnerships. There has been an increasing demand from fund CFOs for much more timely tax reporting, and the need to report and respond to investors much more quickly with speed and accuracy. Partnership tax technology allows funds to meet these demands.
The automation of tax compliance using a technology platform will offer advantages such as providing transparency for investors, simplifying complex allocations and allowing a deep enough simplification to fund entity tiering.
In the end, it’s about meeting the expectations of the fund founders and their partner investors. In an increasingly digital world, where everything from watching movies to buying pet food is on demand, they expect nothing less—so why not meet those expectations in tax reporting?
Reproduced with permission from Copyright 2021 The Bureau of National Affairs, Inc. (800-372-1033) www.bloombergindustry.com.