One of Jason’s favorite restaurants is Queen’s English in the Columbia Heights neighborhood of Washington, DC. He patronizes it often enough that the servers don’t need to give him a menu; he is committed to consume whatever dishes chef Henji Cheung and his wife Sarah Thompson, who commands the front of the house, send his way.

The dining room accommodates fewer than 40 guests at a time, and Henji often orders ingredients with his regulars in mind. When he knows Jason is coming in for dinner, Henji tries to get a hold of a few sugar toads — small pufferfish native to the Chesapeake Bay — which he powders with spiced rice flower and lightly fries.

Even though Henji customizes his inventory for Jason and a pattern of past conduct establishes Jason’s commitment to buying from Henji within a very short time frame, it would strain logic to suggest that Jason is engaged in the restaurant business. Henji (not Jason) selects the suppliers, solicits the ingredients, and negotiates the prices, and the price Jason pays includes a markup that reflects Henji’s work.

But if Jason were a credit fund with foreign investors and Queen’s English was selling him newly issued loans instead of sugar toads, Jason’s U.S. tax advisers likely would fret that Jason is engaged in a U.S. lending business that subjects him or his foreign investors to U.S. net income tax.

That concern is reasonable in light of the IRS’s historical saber rattling. In 2009 and in 2015 the IRS issued informal memoranda concluding that credit funds were engaged in a U.S. trade or business when their agents regularly loaned money on their behalf.1 More recently, in 2019 and in 2020, the IRS is rumored to have sent information document requests asking asset managers about the season-and-sell strategies their credit funds use to avoid a U.S. trade or business.2 Thus, like other tax practitioners in this space, we advise our non-U.S. clients that they risk being engaged in a U.S. trade or business if they buy loans at initial issuance, even if they don’t hold themselves out as lenders to borrowers (that is, they don’t “solicit” borrowers) or negotiate with the borrowers. However, as discussed below, this industry-wide concern may be rooted more in lore than in law.

This article examines the authorities on lending as a U.S. trade or business. We argue that the code and Treasury regulations appear to protect purchases of loans at initial issuance unless the purchaser or someone acting in the name of the purchaser solicits or negotiates with the borrowers, and we contend that the IRS’s informal guidance can be read consistently with this conclusion. We then provide several examples of tax guidelines that credit funds follow when purchasing loans to avoid a U.S. trade or business under a conservative interpretation of IRS guidance. The examples illustrate how the IRS’s failure to clarify our reading inappropriately limits the availability of credit to prospective borrowers.


Domestic corporations are subject to a 21 percent net income tax,3 so most credit funds are structured as either partnerships or foreign corporations. If the fund is a partnership, non-U.S. investors typically invest through a foreign “feeder” corporation. If the fund is a foreign corporation, non-U.S. investors typically invest directly.

Under section 882(a), foreign corporations that are engaged in a U.S. trade or business are subject to U.S. federal income tax on any income that is “effectively connected” with the conduct of that trade or business. Under section 1446, partnerships (both domestic and foreign) that are engaged in a U.S. trade or business must withhold tax at the highest rate (now 21 percent for corporations and 37 percent for individuals)4 on their foreign partners’ distributive share of any income that is effectively connected with that U.S. trade or business.5

The rules for calculating effectively connected income are convoluted and difficult to apply. In the absence of clear guidance, asset managers generally assume the worst: If they are engaged in a U.S. trade or business, all their income and gain will be effectively connected and subject to U.S. tax. In light of the acute downside, they and their tax advisers often err on the side of caution in assessing whether lending activities constitute a U.S. trade or business.


Under the securities trading safe harbor of section 864(b)(2)(A)(ii), trading in stocks or securities for one’s own account, either directly or through a resident agent, isn’t a U.S. trade or business unless one is a dealer in stocks or securities.

This section contends that “securities” include loans, “trading” includes buying at initial issuance, and “dealing” doesn’t include buying at initial issuance.

A. Loans Are Securities

The IRS seems to accept that loans are securities under section 864(b)(2)(A)(ii). If they weren’t, every U.S.-managed credit fund that trades loans would be engaged in a U.S. trade or business — that of trading property not described in the securities safe harbor — and either the credit fund or its foreign investors would be subject to U.S. tax. Here we briefly explain why loans are securities.

Reg. section 1.864-2(c)(2) defines securities to include “any note, bond, debenture, or other evidence of indebtedness.”6 A loan is evidence of indebtedness.

The regulatory definition of securities mimics statutory language from section 22(b)(9) of the Revenue Act of 1939 (the predecessor to section 108). That language was understood to include loans,7 just as today’s section 108 is understood to include loans.8 Had the IRS wanted to exclude loans from the definition of securities under section 864(b)(2)(A)(ii), it could instead have modeled the definition on section 117(f) of the Revenue Act of 1934.9

An example in the section 864 regulations also explicitly refers to loans as securities,10 and, in analogous contexts, the IRS has interpreted the phrase “other evidence of indebtedness” to include loans.11

B. Trading Includes Buying

Reg. section 1.864-2(c)(2) defines trading to mean “the effecting of transactions,” which includes buying, selling, and any other activity closely related thereto, without any carveout for buying at initial issuance. The same regulation defines securities to include the right to subscribe to or purchase a security, which appears to protect commitments to buy a security when issued. Buying stocks and bonds at initial issuance is widely understood to be a protected activity under section 864(b)(2)(A)(ii), and the IRS has never asserted otherwise. There is no indication in the regulations that a different rule might apply to loans.

Moreover, there was no secondary market in loans in 1967, when section 864(b)(2)(A)(ii) was enacted.12 So if a foreigner held a loan, they probably bought it at initial issuance. As explained above, loans are securities under section 864(b)(2)(A)(ii). It stands to reason that when section 864(b)(2)(A)(ii) was enacted, Congress expected it to prevent purchasing loans at initial issuance from being a U.S. trade or business.

Indeed, before Congress enacted the “portfolio interest exemption” in 1984, foreigners were subject to 30 percent withholding tax on U.S.-source interest income. Foreign lenders lobbied Congress to instead subject that income to net basis tax.13 Those lobbying efforts would have been unnecessary if Congress had believed that purchasing loans at initial issuance from within the United States already subjected foreigners to net income tax.

C. Buying Is Not Dealing

The securities trading safe harbor doesn’t extend to dealers,14 but buying a loan at initial issuance doesn’t, in itself, constitute dealing for this purpose.15 If the IRS had wanted dealing under section 864(b)(2)(A)(ii) to include buying loans at initial issuance, it could have issued regulations saying so, as it did under section 475.16 It didn’t, and the two sections have very different purposes.

There also is no suggestion that Congress intended buying loans at initial issuance to be treated as dealing under section 864(b)(2)(A)(ii). Congress’s evident policy rationale for excluding dealers from the securities trading safe harbor was to prevent foreigners from unfairly competing with U.S. commercial banks.17 Congress didn’t express a similar concern about non-bank foreign lenders.18

Nor has Congress expressed concern about buying loans at initial issuance in analogous contexts. U.S. tax-exempt entities aren’t subject to unrelated business income tax on interest they receive from loans they buy at initial issuance,19 but they are subject to tax on gains from dealer activities. Real estate investment trusts aren’t subject to the 100 percent prohibited transactions tax on interest they receive from loans they buy at initial issuance,20 but they are subject to tax on gains from dealer activities.

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1. AM 2009-010; ILM 201501013.

2. We discuss season-and-sell strategies infra in Section IV.C.

3. Section 11(b).

4. Section 1(j).

5. Section 875.

6. Reg. section 1.864-2(c)(2)(i) (emphasis added).

7. Stanley S. Surrey, “The Revenue Act of 1939 and the Income Tax Treatment of Cancellation of Indebtedness,” 49 Yale L.J. 1153 (1940).

8. See, e.g., LTR 201328023.

9. See Gerard v. Commissioner, 40 B.T.A. 64 (1939) (concluding that mortgage loans were not “other evidences of indebtedness . . . with interest coupons or in registered form” under section 117(f) of the Revenue Act of 1934 (emphasis added)). Section 22(b)(9) of the Revenue Act of 1939 doesn’t include the language “with interest coupons or in registered form.”

10. Reg. section 1.864-4(c)(5)(vii), Example 1 (referring to “loans, bonds, notes, and bills” collectively as “securities”).

11. See FSA 199935017 (concluding that loans are securities described in section 475(c)(2)(C), which mimics reg. section 1.864-2(c)(2)); reg. section 1.892-3T(a)(3) (“The term ‘other securities’ includes any note or other evidence of indebtedness. Thus, an annuity contract, a mortgage, a banker’s acceptance or a loan are securities for purposes of this section.”).

12. Blaise Gadanecz, “The Syndicated Loan Market: Structure, Development, and Implications,” Bank for Int’l Settlements Q. Rev. 75, 76 (Dec. 2004) (secondary market for corporate loans began in 1990s); S&P Global Ratings, “A Guide to the Loan Market” (Sept. 2011) (secondary market for loans began in the 1980s).

13. See “Foreign Investors Tax Act of 1966, Hearing on H.R. 13103 Before the S. Comm. on Finance, 89th Cong. 29,” at 173 (Banco de Ponce’s “net profit before taxes from all of its operations everywhere averages far less than 30 percent of its entire gross income.”).

14. Section 864(b)(2)(A)(ii).

15. Reg. section 1.864-2(c)(2)(iv) (a dealer is “a merchant of stocks or securities, with an established place of business, regularly engaged as a merchant in purchasing stocks or securities and selling them to customers with a view to the gains and profits that may be derived therefrom” (emphasis added)).

16. Reg. section 1.475(c)-1(c)(1).

17. See ILM 201501013, citing IRS TAM, “Treasury Decision — Definition of ‘Trade or Business Within the United States’ as Applied to Nonresident Aliens and Foreign Corporations” 8 (Nov. 5, 1987) (“Dealers are in the business of trading stocks or securities for their own account. If they were artificially to be considered not engaged in a trade or business in the United States by virtue of their U.S. trading they would have a distinct competitive advantage vis a vis their U.S. counterparts.”).

18. See, e.g., “Task Force on Promoting Increased Foreign Investment in U.S. Corporate Securities and Increased Foreign Financing for U.S. Corporations Operating Abroad” (Apr. 27, 1964) (“Revision of U.S. taxation of foreign investors is one of the most immediate and productive ways to increase the flow of foreign capital to this country.”); Hearing, supra note 13, at 117-118 (“As you know, European capital markets are poorly developed and very congested, and indigenous foreign banks are already unable to meet fully the needs of their own domestic customers.” (Alfred W. Barth, executive vice president, the Chase Manhattan Bank)).

19. Section 512(b)(1).

20. See Rev. Rul. 80-57, 1980-1 C.B. 157 (the REIT was “engaged primarily in originating, making, and servicing short-term construction and development loans”); and GCM 35803 (May 3, 1974) (the REIT “makes conventional residential mortgage loans (Joint Loans) in cooperation with a commercial bank”).