Taxpayers-mutual funds or RICs filed ruling request seeking favorable determination from the National Office of the Internal Revenue Service that income derived from each Fund's investments in a wholly-owned subsidiary that is a controlled foreign corporation (CFC) constitutes qualifying income under §851(b)(2).
Each Fund, a corporation using the accrual method of accounting, is a series of a business trust and is registered as an investment company under the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq., as amended (the 1940 Act). Each Fund is a regulated investment company (RIC) under § 851(a) of the Code.
Fund A intends to form a wholly-owned subsidiary (Subsidiary A) incorporated as a Type A Company under the laws of Country . Fund B also intends to form a wholly- owned subsidiary (Subsidiary B) incorporated as a Type A Company under the laws of Country. Under the laws of Country, a Type A Company provides limited liability for all holders of shares. A shareholder's liability is limited to the amount, if any, unpaid with respect to the shares acquired by the shareholder. Subsidiary A and Subsidiary B intend to file elections on Form 8832, Entity Classification Election, to ensure that they will be treated as corporations for federal income tax purposes.
Each Fund represents that, although neither Subsidiary A nor Subsidiary B will be registered as an investment company under the 1940 Act, each Subsidiary will comply with the requirements of section 18(f) of the 1940 Act, Investment Company Act Release No. 10666, and related SEC guidance pertaining to asset coverage with respect to transactions in commodity swaps, commodity futures and other transactions in derivatives.
Each Fund will invest a portion of its assets in its Subsidiary, subject to the limitations contained in §851(b)(3). Each subsidiary is expected to invest primarily in commodities, commodity-linked swaps, commodity-linked futures, and other commodity-linked derivatives, including total return swaps and commodity-linked securities. Subsidiary A will be wholly-owned by Fund A, and Subsidiary B will be wholly- owned by Fund B, and both are thus expected to be classified as CFCs, as defined in § 957 of the Code. Each Fund will include its "subpart F" income attributable to its Subsidiary under the rules in the Code applicable to CFCs.
RIC Qualifying Income Requirement
Section 851(b)(2) states a corporation fails to be treated as a RIC for any taxable year unless it meets an income test whereby 90% or more of its gross income is derived from certain sources. Section 851(b)(2) defines qualifying income as dividends, interest, payments with respect to securities loans (per §512(a)(5)), and gains from the sale or other disposition of stock or securities (per §2(a)(36) of the 1940 Investment Act) or foreign currencies, or other income (including but not limited to gains from options, futures or forward contracts) derived with respect to [the RIC's] business of investing in such stock, securities, or currencies which are defined in accordance therein. .
Under the flush language of § 851(b), for purposes of § 851(b)(2), dividends include amounts included in gross income under the controlled foreign corporation rule in §§ 951(a)(1)(A)(i) or 1293(a) for the taxable year to the extent that, under §§ 959(a)(1) or 1293(c) (as the case may be), there are distributions out of the earnings and profits of the taxable year which are attributable to the amounts so included.
Section 957 of the Code defines a controlled foreign corporation (CFC) as any foreign corporation in which more than 50 percent of (1) the total combined voting power of all classes of stock entitled to vote, or (2) the total value of the stock is owned by US shareholders on any day during the corporation's taxable year. A US shareholder is defined in § 951(b) as a US person who owns 10% or more of the total voting power of a foreign corporation. Each Fund represents that it will own 100% of the voting power of the stock of its Subsidiary. Each Fund is a United States person. Each Fund therefore represents that its Subsidiary will qualify as a CFC under these provisions as well as the other requirements under §951(a)(1).
Under § 954(a)(1), foreign base company income constitutes Subpart F income and includes foreign personal holding company income determined under § 954(c). Section 954(c)(1) defines foreign personal holding company income to include dividends, interest, royalties, rents, and annuities; gains in excess of losses from transactions in commodities (including futures, forward, and similar transactions but excluding certain hedging transactions and certain active business gains and losses); and, subject to certain exceptions, net income from notional principal contracts. Each Subsidiary's income from its investments in commodities and commodity- linked instruments may generate subpart F income. Each Fund therefore represents that it will include in income its Subsidiary's subpart F income for the taxable year in accordance with § 951.
Service Issues Favorable Ruling
Based on the facts set forth in the ruling, the Service ruled that the income derived from each Fund’s investing in stock of a CFC would constitute qualifying income under § 851(b)(2).