Offshore hedge funds, whether structured as corporations or partnerships, are subject to the provisions of the U.S. Internal Revenue Code (IRC) that govern taxation of nonresident aliens and foreign entities.  Generally, a foreign person is subject to U.S. taxation on its U.S.-source income.  Taxable U.S.-source income generally falls into two categories: (1) effectively connected income (ECI), which is income earned in connection with a U.S. trade or business, and (2) “fixed or determinable annual or periodic gains, profits, or income” (FDAPI).  ECI is subject to U.S. taxation in the same manner as income earned by U.S. citizens and residents: recipients are required to file U.S. tax returns.  In contrast, IRC Sections 1441, 1442 and 1443 provide for taxation of FDAPI that is not ECI, and that is payable to foreign individuals, corporations and tax-exempt entities, at the flat rate of 30% of the gross amount payable (or lower treaty rate, if applicable).  The 30% tax must be withheld at the source (i.e., by the payer).  This second installment in our series covering the 15th Annual Effective Hedge Fund Tax Practices seminar, sponsored by Financial Research Associates and the Hedge Fund Business Operations Association, summarizes key lessons learned from a session entitled “Handling Issues Relative to Inbound Tax Matters.”  That session outlined the basics of withholding with respect to FDAPI; the portfolio interest exemption from FDAPI withholding; the pitfalls of ECI for offshore hedge funds; and the sources of ECI.  The speakers included Jill E. Darrow, Partner and head of the New York tax practice of Katten Muchin Rosenman LLP.  The first installment covered three sessions addressing the contribution and distribution of property to fund investors, the allocation of investment gains and losses to fund investors and the preparation of Forms K-1.  See “Hedge Fund Tax Experts Discuss Allocations of Gains and Losses, Contributions to and Distributions of Property from a Fund, Expense Pass-Throughs and K-1 Preparation at FRA/HFBOA Seminar (Part One of Four),” Hedge Fund Law Report, Vol. 7, No. 2 (Jan. 16, 2014).