Tax regulations

IRS issues final tax regulations on registered investment companies on imputed income of foreign affiliates and certain other foreign companies


On March 18, 2019, the US Department of the Treasury and the Internal Revenue Service released final tax regulations for registered investment funds that are taxed as regulated investment companies (“RICs”) and that invest in 100% foreign subsidiaries (or other foreign companies and certain passive foreign investment companies or “PFICs”). The new regulations provide that the imputed income of such a foreign affiliate or PFIC, if it is derived from the activity of the RIC of investing in stocks, securities or currencies, constitutes qualifying income for the purposes of the subchapter M income tax. The final rule eliminates a previously proposed requirement that such imputed income must in all cases be paid annually as a dividend by the subsidiary to the RIC. Additionally, the IRS reconfirmed its previously announced policy that the IRS will no longer provide private letter rulings on matters that require the IRS to determine for the purposes of the RIC qualifying income test whether a financial instrument or position is a title under the Investment Company Act of 1940.

All registered investment companies, including mutual funds, exchange-traded funds, and closed-end funds, that have elected for U.S. income tax purposes to be RICs must meet various annual requirements for eligible income, asset diversification and minimum distribution under subchapter M of internal regulations. Income code. Under the qualifying income requirement, a CIP must derive at least 90% of its gross income from dividends, interest, securities lending payments, gains from the sale of stocks, securities or foreign currency, allocations from certain publicly traded partnerships, or other income (including, but not limited to, gains from options, futures or contracts) derived from the activity of the RIC consisting in investing in these stocks, securities or currencies. Certain other provisions of the Code require RICs and other U.S. corporations, among other taxpayers, to recognize as imputed income each year certain types of net profits recognized by lower-level controlled foreign corporations or PFICs.

Many RICs have established foreign wholly owned subsidiaries to invest in commodity related investments. Certain commodity-related investments, such as many futures contracts and commodity index swaps, are not considered to generate qualifying income for the purposes of the RIC and therefore are not held directly by the RICs. As a result, many RICs seeking exposure related to commodities have over time formed foreign wholly owned subsidiaries to hold such investments. Many of these RICs have obtained decisions from private letters from the IRS approving such subsidiary commodity structures. In 2006, however, the IRS suspended issuance of such decisions to RICs pending administrative review of the matters at issue. In 2016, the IRS proposed a tax regulation that, under certain conditions, would have considered imputed income of these foreign affiliates and certain other foreign companies as eligible income for the purposes of subchapter M only if such imputed income had been paid in the same tax year as a dividend from the foreign affiliate to the parent company. The proposed regulations would also have applied the dividend payment requirement to certain imputed income from an investment in a PFIC, such as the equity investment of certain CLOs. Thus, under the proposed regulation, such imputed income would only have been considered qualifying income to the extent that it was paid as a dividend by the PFIC in the same taxation year to the fund. investment. This proposed dividend payment requirement has been strongly criticized by the investment fund industry as being unnecessary and impractical in certain situations.

The final tax regulations removed the dividend payment requirement but otherwise broadly adopted the proposed tax regulations without significant change. Thus, the final tax regulations published this week provide that imputed income of the RIC from the activity of the RIC of investing in stocks, securities or currencies and from a foreign affiliate, such as a controlled foreign company or a PFIC, is treated as Income eligible for the RIC in the “other income” category even if it is not distributed in the form of a dividend by the subsidiary. If the imputed income is actually distributed during the same tax year by the foreign affiliate or the SPEP, the final regulation treats this income as income eligible for the RIC in the category of “dividend” income.

Under the final rule, “low tax intangible global income” or “GILTI”, in relation to the investment of a foreign company investing in stocks, securities or currencies.

As mentioned above, the IRS has made permanent its current policy that it will no longer issue private letter rulings as to whether particular financial instruments are considered “securities” for the purposes of the qualifying income test. RIC. In 2006, the IRS examined whether certain commodity-related instruments and positions were considered “securities” for the purposes of section 851. Tax rulings 2006-1 and 2006-31 provided that certain derivative contracts on indexes of commodities were not “securities” for the purposes of the Section 851 (b) (2) Code, and that, therefore, income from such contracts would not meet the qualifying income requirement if they were held directly by an RIC. The IRS subsequently issued rulings by private letter confirming that certain other types of commodity index derivative contracts were “securities” for Section 851 purposes and would produce qualifying RIC income. But, after some time, the IRS stopped making such rulings on commodity index derivative contracts pending further consideration of the matter. As a result of the review, the IRS ended its policy of providing positive indications as to whether certain commodity index derivative contracts constitute securities for RIC purposes and also revoked its rulings. previously issued in so far as these decisions concerned derivative contracts on commodity indices. The preamble to the final rule released this week reconfirms and makes permanent the IRS policy that no more private decisions will be made in this area, but also confirms that Tax Rulings 2006-1 and 2006-31 will not be revoked.

Final settlements apply to tax years beginning after June 17, 2019, but can be voluntarily claimed for tax years beginning after September 28, 2016.


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