The IRS and Treasury Department recently proposed regulations regarding the treatment of a regulated investment company’s (RIC) income inclusions with respect to controlled foreign corporations (CFCs) and private foreign investment companies (PFICs) and issued a new revenue procedure regarding determinations on whether or not a financial instrument or position is a security. These actions stem from the IRS’s historical guidance involving investment companies seeking to gain exposure to commodities.
According to the new revenue procedure, the IRS and Treasury Department will no longer issue letter rulings relating to the treatment of a corporation as a RIC if the matter would require a determination of whether a financial instrument or position is a security under the 1940 Act. The agencies stated that such determinations should be solely within the jurisdiction of the SEC. The revenue procedure and the proposed regulations are intended to resolve previous IRS guidance concerning the extent to which derivative investments in commodities would constitute securities that would produce qualifying income for purposes of an income test and asset diversification test, which must be satisfied in order for a corporation to qualify as a RIC under the Internal Revenue Code. The proposed regulations would effectively establish that income required to be included in the income of an investment company from a CFC or from a PFIC (which RICs typically utilize to gain exposure to commodities) will not be considered qualifying income unless the CFC or PFIC distributes such income in the current taxable year. Since 2006, the IRS had issued private letter rulings relating to what constituted qualifying income for RICs seeking exposure to commodities. In 2011, the IRS suspended issuing rulings on these issues. The proposed regulations do not prohibit RICs from investing in commodities through CFCs but may require them to ensure that their CFCs make timely distributions each year. The proposed regulations would be effective for taxable years beginning on or after the date 90 days after the date of publication of a Treasury decision adopting the proposed regulations as final. The IRS and Treasury have requested comments on the proposed regulations.