When investing in foreign (non-U.S.) companies, it’s important to ensure proper tax documentation is in place. One of the key documents in this context is the tax representation side letter.
What is a tax representation side letter?
A tax representation side letter is a document signed by the portfolio company to confirm its tax status and structure, particularly for foreign companies. It serves two main purposes:
- The company confirms that it is not majority owned by U.S. persons, and that it does not earn a majority of its income from passive sources such as rent or interest. This ensures that the company is not subject to U.S. tax obligations that arise from being classified as a Passive Foreign Investment Company (PFIC).
- The company agrees to notify AngelList if it ever becomes a PFIC or if its tax status changes in any way that would impact U.S. investors' tax reporting obligations.
These confirmations are essential for ensuring compliance with U.S. tax law and preventing unexpected tax liabilities for U.S. investors.
When do we need a tax representation side letter?
If you make an investment into a company that is not incorporated in the United States, we require the company to sign a tax representation side letter. Every US fund that invests in foreign incorporated companies will require the same or similar representations.
Why do we need a tax representation side letter?
The tax representation side letter serves several key purposes:
- Compliance with U.S. Tax Law: It ensures that the portfolio company adheres to certain criteria that are crucial for U.S. tax reporting. For example, the letter confirms that the company is not a Controlled Foreign Corporation (CFC) or a Passive Foreign Investment Company (PFIC)—both of which have complex tax obligations under U.S. law.
- Prevention of Adverse Tax Consequences: By confirming the company’s structure and income sources, the letter helps ensure that U.S. investors avoid unwanted tax complications, like PFIC rules, which can result in unfavorable tax treatment of foreign investments.
- Ongoing Monitoring: The portfolio company agrees to notify AngelList if any of the representations in the letter change. This ongoing monitoring ensures that any future changes to the company’s tax status are identified early, giving U.S. investors the chance to address any tax implications.