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Abstract: 

With the finalization of changes to the Section 817 regulations,1 Treasury and the IRS have finally put their “Keyport ruling,” PLR 200244001, on firm regulatory ground.2 The Service’s primary concern, as expressed in the Keyport ruling, was that insurance companies could effectively invest along with public investors in a hedge fund. Because of the tax advantages provided to owners of insurance and annuity policies, investors would presumably prefer to make the hedge fund investment through the insurance medium rather than owning units of the hedge fund directly. The concern was expressed in the preamble to proposed regulations. Regulation 1.817-5(f)(3), referred to in the parenthetical, allows ownership of a beneficial interest by (1) the general account of a life insurance company, or (2) “the manager, or a corporation related in a manner specified in section 267(b) to the manager, of the investment company, partnership, or trust, but only if the holding of the interests is in connection with the creation or management of the investment company, partnership, or trust....”4 This provision elaborates the requirements of Section 817(h)(4)(A) and (B). The ownership arrangement permitted under Reg. 1.817-5(f)(3) is depicted in Figure 1. The problem comes from the wording of Reg. 1.817-5(f)(2)(ii) prior to TD 9185, which stated: (ii) Nonregistered partnerships. This paragraph (f) shall also apply to a partnership interest if the partnership interest is not registered under a Federal or State law regulating the offering or sale of securities. The provision did not explicitly condition use of the look-through rule for a hedge fund by limiting the ownership of interests in such a partnership to specified holders, unlike Reg. 1.817-5(f)(2)(i), referring to general insurance company accounts and managers of the investment companies, partnerships, and trusts. This left room for ownership by “qualified purchasers and accredited investors” referred to in the preamble to the final regulations. By eliminating Reg. 1.817-5(f)(2)(ii), the Service solves the problem.

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