New Massachusetts Withholding Rules for Pass-Throughs May Apply to Many Investment Funds

Massachusetts recently promulgated rules, effective January 1, 2009, that may require certain investment funds and other pass-through entities that maintain an office or do business in Massachusetts to withhold on certain members’ distributive shares of Massachusetts-source income. Pass-through entities include general partnerships, limited partnerships, LLPs, S corporations, and certain LLCs, trusts and estates. Special rules apply to publicly traded partnerships. Accordingly, many different types of investment funds (e.g., private equity funds, venture capital funds, real estate funds and hedge funds) that are pass-through entities and have a connection with Massachusetts may be subject to the new withholding regime. Exemptions from the withholding requirements (e.g., the exemption for "investment partnerships," as discussed below) may apply to a pass-through entity or with respect to certain members of a pass-through entity that comply with applicable certification procedures.

Exemptions from Withholding for the Pass-Through Entity. In general, an investment fund treated as a partnership in Massachusetts may be exempt from withholding if it qualifies as an "investment partnership" or invests in a lower-tier entity that has previously satisfied any applicable withholding requirements. The term "investment partnership" generally refers to a partnership, substantially all of the assets of which consist of investment securities, deposits, or office equipment and office space reasonably necessary to carry on its investment activities, and substantially all of the income of which consists of interest, dividends and capital gains, provided that the partnership is not engaged in a trade or business in Massachusetts. Although many investment funds will fit the initial terms of the definition of an investment partnership, if a fund’s activities cause it to be engaged in a Massachusetts trade or business, the fund generally would be subject to the withholding requirements with respect to its non-exempt members.

Exemption from Withholding for Members. A member of a pass-through entity may be exempt from withholding if it furnishes the pass-through entity with an exemption certificate (Form PTE-EX) claiming an exemption from withholding. The certification procedure is generally available to many (but not all) types of investors in investment funds. For example, tax-exempt investors and certain members of securities partnerships may be exempt from withholding if they comply with the certification procedure. Unless a member of a pass-through entity is eligible for an exemption and furnishes the pass-through entity with an exemption certificate by April 30, 2009, the pass-through entity may be required to withhold even if the member would not ultimately be subject to Massachusetts tax (e.g., because the pass-through entity is a limited partnership engaged exclusively in buying, selling, dealing in or holding securities on its own behalf and not as a broker that does not qualify as an "investment partnership").

Compliance with Massachusetts Withholding Regime. Pass-through entities should consult their tax advisors to discuss exemptions from and compliance with the Massachusetts withholding tax regime based upon their particular circumstances.