* Partner, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, New York; Harvard College, A.B. 1978; Harvard Law School, J.D. 1983. The authors gratefully acknowledge the assistance of their colleague Nancy McGlamery, and the helpful comments of their colleagues Richard Bronstein and Peter Rothenberg. A prior version of this paper was presented to the Tax Forum in January, 2003.

**Associate, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, New York; Yale University, B.A. 1995; University of Chicago, J.D. 2001.

A great deal of uncertainty currently surrounds the determination of whether the activities of certain investment funds will give rise to income effectively connected with the conduct of a trade or business within the United States (ECI) for the fund itself (if a corporation) or for its non-U.S. investors (if a partnership). These uncertainties have multiplied as quickly as the range of activities in which these funds engage and the asset classes in which they invest. They have led to two types of inefficiencies. In the case of certain types of funds, such as issuers of collateralized debt obligations (CDOs), they have produced a series of byzantine, constantly shifting practitioner-developed rules that seek to achieve a "will" opinion level of certainty at the cost of artificially restricting the funds' activities, and, on the margin, the extent to which the funds add liquidity to U.S. capital markets. Other types of funds also adopt some byzantine structures, but otherwise settle for a lower level of certainty and as a result risk losing some foreign investors as a source of capital. Neither of the foregoing is entirely satisfactory in light of the fact that our system of inbound taxation was generally designed to attract passive foreign investment capital. While the authors believe that, at least in some respects, current law may provide somewhat greater comfort than is generally understood, that belief, of course, could benefit from confirmatory guidance from the Service (or, perhaps in some cases, legislation).

Part I of this paper outlines the general rules applicable to ECI. Part II presents the historical background of the taxation of inbound investment generally, including the use of the trade or business concept, and traces its development from 1913 to the present. Part III provides an overview of the limited statutory and regulatory guidance relating to "trade or business" specifically in the ECI context. Part IV explores relevant judicial and administrative development of the trade or business concept in specific areas that may be relevant to the investment funds that are the subject of this paper. Part V describes CDOs and their uses, and then applies relevant statutory, regulatory, judicial, and administrative authorities to analyze ECI issues raised by the activities of CDO issuers and distressed debt funds. Part VI considers selected ECI issues confronting foreign persons who invest in private equity funds.

Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center

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