New US Tax Reform Regulations: Sovereign Wealth Funds Face New Investment Taxation Obligations

【BlockBeats】On January 16, a piece of news that all global investors should be concerned about was announced—U.S. authorities are pushing forward with a major tax reform, directly targeting the tax exemption issues for sovereign wealth funds investing in the U.S. This move is expected to put significant pressure on the largest segment of private capital.

The IRS released a draft proposal in December last year, intending to revise the tax exemption provisions for sovereign wealth funds and certain public pension funds under the Internal Revenue Code. This is the latest in a series of policy adjustments recently introduced by the Trump administration, which are already prompting global sovereign wealth funds to reconsider their investment strategies in the U.S.

The core change is coming— the IRS plans to significantly broaden the definition of “business activities,” including many activities previously classified as investment behaviors into the scope of business activities. In simple terms, more actions will be reclassified. This has the greatest impact on several types of operations by sovereign wealth funds: providing direct loans to companies, participating in private equity investments, and intervening in bond default restructurings, all of which could incur new tax obligations.

It is especially important to note that this new regulation will also affect a commonly used industry tool—the so-called “blockers” mechanism. Sovereign wealth funds and pension funds often invest directly in certain enterprises through special purpose vehicles (SPVs) in partnership with private equity firms. The adjustments in the new regulation could cause this previously smooth investment structure to face new tax considerations. These series of changes are essentially redefining what kinds of investment activities require taxation and how they should be taxed.