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DATE/ AUTHOR None	AUTHORS: Stephanie Strom

H Nonprofits Face Threat to a Tax Loophole

S1 Hedge funds have been very good to institutions like Yale.
S2 On its 2005 tax forms, the university reported annual income of $149 million from its hedge fund investments.

S3 And much of that income, which would have been taxable if derived from domestic hedge funds, was tax free because it was generated by offshore affiliates of such funds.

S4 That strategy of tax avoidance is one that many of the nation's wealthiest universities, as well as foundations and pension funds, have been using with great success.
S5 Now Congress is considering closing the loophole that allows it.

S6 The goal is to raise money for the Treasury.
S7 The Senate Permanent Subcommittee on Investigations, which has been looking into hedge fund practices, estimates that more than $100 billion in tax revenue a year is lost through the use of offshore tax havens and questionable tax shelters by investors of all types.

S8 ''A key concern is whether tax-exempt use of offshore corporations to invest in hedge funds is accelerating the shifting of U.S. assets offshore to avoid U.S. taxes,'' said Senator Carl Levin, the Michigan Democrat who heads the subcommittee and who is among the sponsors of legislation that would close a number of such loopholes.

S9 While nonprofit institutions are generally exempt from taxation, income produced by business activity that is deemed outside the scope of their mission may be subject to tax.
S10 Under the tax code, profits from any activities financed with borrowed money, like much of the income from hedge fund and private equity investments, are taxable.

S11 But if the nonprofit invests in an offshore company, there is no tax.
S12 So hedge funds and private equity funds have set up offshore subsidiaries for nonprofits and other tax-exempt groups like pension funds to invest in.

S13 For instance, Farallon Capital Institutional Partners L.P. of San Francisco, a hedge fund in which Yale, the University of Michigan and other universities have invested, has a management company in the British Virgin Islands.
S14 The offshore company was created in large part to help nonprofits avoid taxes, Thomas F. Steyer, Farallon's senior managing partner, wrote investors in a letter in 2000.

S15 A 2005 article in the newsletter Tax Notes said Duke University sought to keep 25 percent of its endowment, which now stands at $7.4 billion, invested in hedge funds.
S16 At the time, about 75 percent of Duke's hedge fund investments were in offshore funds, according to the article, written by Maximilian H. Haag, a Duke law student who had interviewed the university's investment managers.

S17 But universities do not generally disclose what portion of their endowment is invested in offshore hedge funds, and so it is impossible to estimate how much tax they are avoiding.
S18 And their officials are wary of discussing the issue.
S19 Spokesmen for 10 of the nation's wealthiest universities either did not respond to a reporter's messages or declined to make anyone from their investment management teams available.

S20 ''As a matter of policy, we do not comment on our portfolio,'' Cass Ciatt, a spokeswoman for Princeton, wrote in an e-mail message.

S21 David Jarmul, a spokesman for Duke, emphasized the university's support for research, its financial aid programs and the other benefits its endowment provides.

S22 The university invests ''in various ways to maximize returns,'' Mr. Jarmul said by e-mail.
S23 ''Like other universities, Duke uses legitimate tax-advantaged structures, always in accordance with applicable law.''

S24 With growing signs of displeasure from Congress, however, there are indications that some universities are reconsidering the use of offshore entities as a tax-avoidance method.

S25 ''This practice is legal and has been approved by the Internal Revenue Service in a number of rulings,'' said Patrick Dunkley, senior counsel at Stanford University, whose endowment stood at $14.1 billion in 2006.
S26 ''We are nonetheless currently reviewing the investment strategy.''

S27 Congress made a pass at closing the loophole in 1993.

S28 ''I can tell you why I proposed it in one word: revenue,'' said former Representative Dan Rostenkowski, Democrat of Illinois, who was chairman of the House Ways and Means Committee from 1981 to 1994.
S29 ''That's the same thing driving them now.''

S30 Mr. Rostenkowski said that under ''pay as you go'' budget rules, which Congress adopted anew in January, ''you have to raise the revenue to feed this appetite we have for spending money.''

S31 In some cases, hedge fund investors can realize returns as high as 40 percent or more.
S32 So while closing the loophole could mean additional taxes for nonprofits, it would be unlikely to reduce their investments in hedge funds and private equity funds significantly, said Leon M. Metzger, a former hedge fund executive who teaches hedge fund management at New York University.

S33 ''Because returns are so very attractive, unless Congress takes an extreme approach, I don't think this will have a major impact,'' Mr. Metzger said.

S34 In addition, two hedge fund partners who spoke only on condition of anonymity, for fear of alienating clients, said nonprofits could probably use other investment strategies to avoid taxes.

S35 Foundations also use the loophole, although the nation's largest, the Bill and Melinda Gates Foundation, had no hedge fund investments at the end of last year.

S36 Richard Tofel, the Rockefeller Foundation's general counsel, said 21 percent of its $3.7 billion endowment was invested in hedge funds and 12 percent in private equity funds.
S37 Mr. Tofel said he did not know what portion of those investments were offshore, but Rockefeller expects to pay $7 million in income taxes for 2006.

S38 He also said Rockefeller would be unlikely to end all its offshore investments if the law changed.

S39 ''Tax is part of what goes into the mix in making investment decisions,'' Mr. Tofel said, ''but on the other hand it's not the principal thing that drives investment decisions.
S40 You make judgments about underlying asset values, risk and reward, and taxes come in somewhere after that.''

