Blocker Structures
Blocker structures are corporations that effectively “block” taxable income at the corporate level for U.S. federal, state and local income tax purposes.
Most commonly they are U.S. corporations that absorb tax. Taxable income passed through on a Schedule K-1 by a portfolio company generally falls into the category of income “effectively connected with a U.S. trade or business” (ECI) for foreign investors and unrelated business taxable income (UBTI) for U.S. tax-exempt investors.
Foreign investors want to avoid being allocated effectively connected income because exposure to an allocation of that income subjects them to a U.S. income tax filing requirement and potentially to U.S. federal income and withholding taxes.
Tax-exempt investors want to avoid being allocated income that is UBTI because that income will subject the otherwise tax-exempt investor to U.S. excise taxes.
Neither foreign or tax-exempt investors want to hold directly an equity interest in a U.S. business taxed as a partnership. Hence, the use of a U.S C corporation as a “blocker corporation” to block the flow-through of income on a Schedule K-1 at the corporate level.
Must be held through entities taxed as corporations, which will “block” receipt of ECI by the investor. In addition, the terms of many investment fund agreements relieve the fund of its obligation to avoid investments resulting in ECI if non-U.S. investors are offered the opportunity to invest through a “blocker.” This blocker typically will be a U.S. corporation (or other U.S. entity that elects to be treated as a corporation), although a non-U.S. corporation (or a non-U.S. partnership that elects to be treated as a corporation) may be preferable where the potential ECI is attributable solely to an investment in a USRPHC. A blocker structure prevents the flow-through of ECI to the investor. However, the blocker corporation will be fully subject to U.S. taxation, and any dividends may be subject to U.S. withholding taxes. Thus, while the blocker avoids the requirement for the investor to file U.S. income tax returns, the U.S. taxation faced by the blocker may be substantially the same as, or greater than, the taxation that would be faced by the investor if no blocker were used.