Designing a Non-US Investor’s US Loan Investment Program

NOV 05, 2020 | PRACTUS LLP

Designing a Non-US Investor’s US Loan Investment Program

Non-US Investors Have Been Subject to Adverse Tax Consequences

Sophisticated Non-US investors frequently utilize intricate strategies when acquiring newly originated US loans in order to preserve their anonymity with the US Internal Revenue Service and avoid US federal income tax liability, among other business reasons. These strategies include: 

  • Season and Sell;
  • Leveraged Blocker Corporations; 
  • Business Development Companies and Registered Closed-End Funds; and
  • Treaty Structures (e.g., Ireland or Luxembourg).

Non-US investors may utilize these strategies in a number of scenarios. For example, the strategies may provide anon-US investor comfort when it acquires newly originated US loans from either an affiliate or a correspondent lender pursuant to a forward flow arrangement. non-US investor may also utilize these strategies when acquiring distressed loans with an intent towards working them out.

Non-US investors are not the only ones utilizing these strategies either; others may be utilizing them on their behalf, including:

  1. US loan originators;
  2. US direct lending funds;
  3. Sponsors of collateralized loan obligations (“CLOs”);
  4. Master limited partnerships (or publicly traded partnerships);
  5. Hedge funds;
  6. Private equity funds; and
  7. US mortgage UPREITs.


This blog post will focus on newly originated loan purchases by non-US investors for purposes of simplicity. The New York Times famously described Bain Capital’s use of Season and Sell to minimize the taxes borne by its non-US investors in it’s “Why Go Offshore?” article dated October 1, 2012.   This post examines this  commonly used strategy and its more streamlined version called Season & Sell 2.0SM. This author may address the other strategies in subsequent blog posts.

One business reason why non-US investors may utilize Season and Sell (and Season & Sell 2.0SM) is to avoid characterization of a loan purchase as a loan origination, which may trigger adverse tax consequences; and instead, to qualify a loan purchase as a more tax advantageous secondary market purchase. The US federal income tax consequences of each alternative characterization are described immediately below.

US Loan Origination Business

US Federal Income Tax Consequences Generally: On the one hand, non-US investors who originate US loans directly or indirectly through an agent generally must file US federal income tax returns (thereby losing their anonymity with the US Internal Revenue Service), and may incur US federal income tax liability at current rates up to 44.7% (absent tax treaty relief) on income earned from the loan origination business.

Secondary Market Purchases

US Federal Income Tax Consequences Generally:  On the other hand, US Congress blesses secondary market loan purchases pursuant to a safe harbor provision of the Internal Revenue Code of 1986, as amended (the “Code”). Section 864(b)(2) of the Code generally provides that non-US investors who are not dealers in stocks or securities and who trade loans for their own account are not engaged in a US trade or business. If a Non-US Investor is not engaged in a US trade or business, then the non-US investor may generally preserve its anonymity with the Internal Revenue Service and avoid US federal income tax liability on properly structured US loan acquisitions.

Distinguishing Secondary Market Purchases from Loan Originations

In very general terms, a secondary market refers to a market where securities are traded (as distinguished from a primary market where securities are created). It is often easy to identify a secondary market purchase. For example, the purchase of an “old and cold” loan (i.e., a loan that was originated a long time ago) on arm’s length market terms by one asset manager who is not a dealer in stocks or securities from an unrelated asset manager generally would qualify as a secondary market purchase (and not a loan origination) absent additional facts suggesting tax gamesmanship between the parties involved. 

There are instances, however, where the line of demarcation is less clear. For example, the line becomes less clear when a non-US investor purchases a loan in a private sale directly from its US affiliate immediately after the US affiliate originates it. In this situation, the Non-US Investor may need additional favorable facts to overcome a presumption of tax gamesmanship (and treatment as loan origination) because:

  1. The loan is sold in a private sale;
  2. The Non-US investor acquired the loan immediately after origination;
  3. Only related parties are involved in the private sale; and
  4. Characterization as a secondary market purchase is the most tax advantageous characterization of the transaction for the related parties.

This lack of clarity causes tax uncertainty, and US debt capital markets do not function efficiently with this type of uncertainty. To solve for this problem, non-US investors decades ago began challenging US tax practitioners to design objective investment guidelines that if followed by a non-US investor would assure the non-US investor that its acquisitions of US loans from either a related or unrelated US loan originator qualify as tax advantageous secondary market purchases.

It is important to note that active, open and robust decentralized secondary loan trading marketplace platforms didn’t exist back then, so tax practitioners invented Season and Sell investment guidelines based on traits that they would expect to find in marketplace loan trades even though the US loan originators were selling many of those newly originated loans privately to related non-US investors. Season and Sell began evolving in US debt capital markets against this backdrop.

Season and Sell

Today’s Season and Sell investment guidelines typically require that a US loan originator:

  • maintain tax ownership of the loan for an appropriate period of time after loan origination before selling the loan to the non-US investor (i.e., loan seasoning); and
  • sell the loan in a manner that would reasonably be expected in a secondary market trade.

Tax practitioners vary on what constitutes an appropriate period of time of loan seasoning, although they generally agree that 24 to 48 hours of loan seasoning is appropriate for loan sales between unrelated parties (as an aside, this is one reason why non-US investors utilize unrelated correspondent loan originators), and that 30 to 90 days is appropriate for loan sales between related parties (e.g., loan sales between commonly controlled companies). Some tax practitioners do not require any loan seasoning if the facts and circumstances clearly demonstrate that the loan seller was not acting on behalf of the non-US investor when originating the loan.

There is also no universally accepted standard set of Season and Sell investment guidelines in US debt capital markets. Some reasons for this include:

  1. Lending programs vary from non-US investor to non-US investor, and investment guidelines must be tailored to the facts and circumstances of each unique lending program;
  2. Tax practitioners vary in their approaches to Season and Sell; and
  3. Non-US investors frequently vary in their degree of tax risk tolerance.

CLO sponsors, for example, tend to follow the most stringent set of investment guidelines and operate at a “will level” of tax opinion comfort, while US direct lending fund sponsors tend to follow more relaxed investment guidelines and operate at a “should level” of tax opinion comfort, and some hedge funds follow no investment guidelines and receive no tax opinion comfort at all.

That being said, each sponsor utilizing Season and Sell investment guidelines likely has some version of one or more of the following three requirements (among others) set forth in their investment guidelines: 

  • Valuation Comfort – each loan sale requires some form of valuation comfort (e.g., an independent valuation).
  • Market Sale Comfort – the loan seller must sell some percentage (e.g., 15%-50%) of its loan production to unrelated third parties with loan terms and conditions substantially identical to those for a related-party sale.
  • Independent Approval Comfort – the loan purchaser receives independent authorization to purchase the loan from a related loan originator/seller. 

Season & Sell 2.0SM

Season & Sell 2.0SM provides non-US investors with an alternative or supplemental strategy to invest in newly originated loans if they consider the historic Season and Sell program to be unattractive due to cost or another reason.

Season & Sell 2.0SM utilizes modern financial technology to streamline the historic Season and Sell approach described above by: (i) reducing the loan seasoning period to precisely 20 days in all instances; (ii) eliminating the three requirements (valuation comfort, market sale comfort and independent approval comfort) set forth in the bullet list immediately above; and (iii) eliminating most other constraints historically required by the Season and Sell program.

Those requirements and constraints are no longer necessary because, unlike the historic Season and Sell approach, Season & Sell 2.0SM ensures that:

  1. Each loan trades through an active, open and robust decentralized secondary loan trading marketplace platform (which didn’t exist until relatively recently).
  2. There is zero tax gamesmanship by any party in the marketplace.
  3. Other benefits include it’s inexpensive to use, administratively simple, and uniform in its application.   

In general, a loan originator who utilizes Season & Sell 2.0SM would originate loans for its own account and sell them to the highest bidder in the marketplace. The purchaser may be a related party or an unrelated third party, each of whom has had sufficient time to diligence, bid, and purchase the loans. More technically, the program works as follows:

  • The loan seller registers with an online loan marketplace that qualifies for the program (registration is free for loan sellers and loan buyers). 
  • The loan seller lists its loan(s) in the online loan marketplace (listing is free).
  • Simultaneously:
    • The loan seller sells its loan(s) to the highest bidder on the 20th calendar day (a reserve price must be set at a price that yields the loan seller a profit typical of loan sellers).
    • The loan seller pays the online loan marketplace its fee as the loan sale closes.
    • The loan seller, the loan buyer and the the online loan marketplace execute a very carefully designed set of proprietary boilerplate US tax representations that they pre-approved at the time of loan listing (to ensure that there is zero tax gamesmanship by any party involved with the loan sale). 
    • Loan buyer receives a US federal income tax opinion with the highest level of tax opinion comfort.

Practus, LLP provides this information as a service to clients and others for educational purposes only. It should not be construed or relied on as legal advice or to create an attorney-client relationship. Readers should not act upon this information without seeking advice from professional advisers.

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