Although sovereign wealth funds (SWFs) are an important source of capital for PE funds, preservation of their preferential tax treatment under Section 892 of the Internal Revenue Code of 1986 can prove quite tedious for sponsors. Unless blockers and other intermediate vehicles are properly wielded, income from certain commercial investments can improperly flow through to SWFs. There is a catch, however, as those same intermediate vehicles can also inadvertently cause worse tax treatment for SWFs. Thus, sponsors need to walk a narrow and fraught line to optimize their funds for SWF investors. In a two-part guest series, Troutman Pepper attorneys Steven D. Bortnick and Morgan L. Klinzing outline material tax factors for PE sponsors to weigh when structuring their funds for SWF investors. This second article analyzes risks that a fund’s commercial activities pose to the tax-exempt status of SWFs and certain structuring approaches that can be taken. The first article
described the tax benefits, limitations and exemptions available to SWFs in the U.S. tax code. See our two-part series: “Notable U.S. Tax Developments Affecting PE Sponsors, Including Potential Rebirth of Significant BBBA Provisions in 2022
” (Jan. 25, 2022); and “Employment‑Related Tax Issues and Significant U.K. Tax Developments for PE Sponsors to Monitor
” (Feb. 1, 2022).