Current Events: New Proposed Regs. under 707: Partnership Allocations and Disguised Payments for Services

Treasury issued new proposed regulations that list factors for determining whether a partnership has made a disguised payment for services to a partner.

An issue that has existed in the hedge fund space for quite some time is whether interests allocated to general partners or management companies would be treated as allocations of partnership income or would be treated as service payments; the ultimate issue being the character of the income received by these “partners”.

It seems that the regulations adopt all of the factors addressed by the legislative history and adopt an additional factor not discussed in the legislative history.  Specifically, the new factor is present if “…the arrangement provides for different allocations or distributions with respect to different services received, where the services are provided either by a single person or by persons that are related under sections 707(b) or 267(b), and the terms of the differing allocations or distributions are subject to levels of entrepreneurial risk that vary significantly.”

The proposed regulations provide an example where the general partner is subject to a clawback on its interest but the management company is not.  As a result of this factor, the management company is more likely to be treated as having received a disguised payment for services.

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