CFC's Subpart F income was qualifying income for RIC parent

PLR 201120017

IRS has privately ruled that the Subpart F income of a regulated investment company's (RIC's) wholly owned subsidiary, which was a controlled foreign corporation (CFC), from its investments in commodity-related investments and short-term, high quality securities to be used to support its commodity derivatives, was qualifying income under Code Sec. 851(b)(2) , without regard to whether that income was distributed by the subsidiary to the RIC.

Background. Under Code Sec. 851(b)(2) , to be a RIC for a tax year, a corporation must meet an income test (qualifying income requirement) under which at least 90% of its gross income is derived from certain enumerated sources, including dividends, interest, payments with respect to securities loans, and gains from the sale or other disposition of stock or securities (as defined in §2(a)(36) of the Investment Company Act of 1940 (the 1940 Act, 15 U.S.C. 80a-1 et seq.) 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 the stock, securities, or currencies.

For purposes of Code Sec. 851(b)(2) , amounts included in gross income under Code Sec. 951(a)(1)(A)(i) (relating to CFCs) are treated as dividends for the tax year to the extent that under Code Sec. 959(a)(1) , there is a distribution out of the earnings and profits of the tax year which are attributable to the amounts so included. ( Code Sec. 851(b) )

CFC. Under Code Sec. 957 , a CFC is defined as a foreign corporation with regard to which more than 50% of the total combined voting power of all classes of stock entitled to vote or the total value of the stock of the corporation is owned (directly, indirectly, or constructively) by U.S. shareholders. A U.S. shareholder for CFC purposes is defined as a U.S. person who owns (directly, indirectly, or constructively) 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. ( Code Sec. 951(b) )

Under Code Sec. 952 , Subpart F income includes foreign base company income, which in tern, under Code Sec. 954(a)(1) , includes foreign personal holding company income. Under Code Sec. 964(c)(1) , foreign personal holding company income includes (among other things): dividends, interest, royalties, rents and annuities; gains in excess of losses from transactions in commodities (including futures, forwards, and similar transactions but excluding certain hedging transaction and certain active business gains and losses), and, subject to certain exceptions, net income from notional principal contracts.

Facts. Fund intends to qualify each year as a regulated investment company (RIC). Fund, which is registered as an open-end management investment company under the 1940 Act, is a series of Trust, which is a State business trust under Subchapter M of the Code. Fund invests in Subsidiary, a wholly-owned subsidiary incorporated as a Type A Company under the laws of Country. Under Country's law, a Type A Company shareholder's liability is limited to the amount, if any, unpaid with respect to the shares acquired by the shareholder. Subsidiary will file an election on Form 8832, Entity Classification Election, to be taxed as a corporation for federal income tax purposes under Reg. § 301.7701-3 .

Fund represents that, although Subsidiary will not be registered as an investment company under the 1940 Act, it will comply with the requirements of §18(f) of the 1940 Act, Investment Company Act Release No. 10666, and related SEC guidance on asset coverage with respect to investments that would apply if the Subsidiary were registered.

Fund will invest a portion of its assets in Subsidiary, subject to the limitations set out in Code Sec. 851(b)(3) . Subsidiary invests in commodity-related investments. It also invests in short-term, high quality securities to be used to support its commodity derivative investments. Subsidiary will be wholly-owned by Fund, a U.S. person, and so is expected to be classified as a CFC. Fund will include its Subpart F income attributable to the Subsidiary under the rules applicable to CFCs under the Code.

PLR's conclusion. In the private letter ruling (PLR), IRS concluded that based on the facts represented, Subsidiary's Subpart F income attributable to the Fund was income derived with respect to Fund's business of investing in the Subsidiary stock. Accordingly, it was qualifying income under Code Sec. 851(b)(2) , without regard to whether that income was distributed by Subsidiary to the Fund.

References: For RICs, see FTC 2d/FIN ¶  E-6001 et seq.; United States Tax Reporter ¶  8514 et seq.; TG ¶  20525 et seq.

 
UIL No. 851.02-00

Regulated investment cos.—qualifying income.

Headnote:

Subpart F income of sub. attributable to funds is income derived with respect to funds' business of investing in sub. and therefore is qualifying income under Code Sec. 851(b)(2); .

Reference(s): Code Sec. 851;

Full Text:

Number: 201120017

Release Date: 5/20/2011

Index Number: 851.02-00

[Third Party Communication: [Redacted Text]

Date of Communication: Month DD, YYYY]

Person To Contact: [Redacted Text]

[Redacted Text], ID No.

Telephone Number: [Redacted Text]

Refer Reply To: [Redacted Text]

CC:FIP:B01

PLR-150582-10

Date :

February 15, 2011

Legend:

Fund =

Trust =

Advisor =

Subsidiary =

Type A Company =

State =

Country =

Dear [Redacted Text]

This responds to your letter dated December 6, 2010, submitted by your authorized representative on behalf of Fund. Fund requests that the Internal Revenue Service rule that income derived from its investment in a wholly-owned subsidiary that is a controlled foreign corporation (“CFC”) constitutes qualifying income under  § 851(b)(2) of the Internal Revenue Code of 1986, as amended (the “Code”).

Facts:

Fund is registered as an open-end management investment company under the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq., as amended (the “1940 Act”). Fund is a series of Trust, which is a State business trust. Fund intends to qualify each year as a regulated investment company (“RIC”) under Subchapter M of the Code.

Fund invests in Subsidiary, a wholly-owned subsidiary 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 will file an election on Form 8832, Entity Classification Election, to be taxed as a corporation for federal income tax purposes pursuant to  § 301.7701-3 of the Procedure and Administration Regulations.

Fund represents that, although Subsidiary will not be registered as an investment company under the 1940 Act, 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 investments that would apply if the Subsidiary were registered under the 1940 Act.

Fund will invest a portion of its assets in Subsidiary, subject to the limitations set forth in  § 851(b)(3) of the Code. The Subsidiary invests in commodity-related investments. The Subsidiary also invests in short-term, high quality securities to be used to support its commodity derivative investments. It is expected that all of the Subsidiary's income will be subpart F income as defined in  § 952.

Subsidiary will be wholly-owned by Fund, and is thus expected to be classified as a CFC, as defined in  § 957. Fund will include its “subpart F income” attributable to the Subsidiary under the rules applicable to CFCs under the Code.

Law and Analysis:

 Section 851(b)(2) of the Code provides that a corporation shall not be considered a RIC for any taxable year unless it meets an income test (the “Qualifying Income Requirement”). Under this test, at least 90 percent of its gross income must be derived from certain enumerated sources.  Section 851(b)(2) defines qualifying income, in relevant part, as -

dividends, interest, payments with respect to securities loans (as defined in  section 512(a)(5)), and gains from the sale or other disposition of stock or securities (as defined in  section 2(a)(36) of the 1940 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...

 Section 2(a)(36) of the 1940 Act defines the term “security” as -

any note, stock, treasury stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, in general, any interest or instrument commonly known as a “security”, or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

In addition,  § 851(b) of the Code provides that, for purposes of  § 851(b)(2), there shall be treated as dividends amounts included in gross income under  §§ 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 is a distribution 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 United States shareholders on any day during the corporation's taxable year. A United States shareholder is defined in  § 951(b) as a United States person who owns 10 percent or more of the total voting power of a foreign corporation. Fund represents that it will own 100 percent of the voting power of the stock of Subsidiary. Fund is a United States person. Fund therefore represents that Subsidiary will qualify as a CFC under these provisions.

 Section 951(a)(1) of the Code provides that, if a foreign corporation is a CFC for an uninterrupted period of 30 days or more during any taxable year, every person who is a United States shareholder of this corporation and who owns stock in this corporation on the last day of the taxable year in which the corporation is a CFC shall include in gross income the sum of the shareholder's pro rata share of the CFC's subpart F income for the taxable year.

 Section 952 of the Code defines subpart F income to include foreign base company income determined under  § 954. Under  § 954(a)(1), foreign base company income includes foreign personal holding company income determined under  § 954(c).

Under  § 964(c)(1), foreign personal holding company income includes (among other things): dividends, interest, royalties, rents and annuities; gains in excess of losses from transactions in commodities (including futures, forwards, and similar transactions but excluding certain hedging transaction and certain active business gains and losses); and, subject to certain exceptions, net income from notional principal contracts.

Subsidiary's income from its investments in commodity-related investments and short-term, high quality securities to be used to support its commodity derivative investments may generate subpart F income. Fund therefore represents that it will include in income Subsidiary's subpart F income for the taxable year in accordance with  § 951.

Conclusion:

Based on the facts as represented, we rule that subpart F income of the Subsidiary attributable to the Fund is income derived with respect to Fund's business of investing in the stock of Subsidiary and thus constitutes qualifying income under  § 851(b)(2), without regard to whether that income is distributed by Subsidiary to the Fund.

This ruling is directed only to the taxpayer who requested it, and is limited to the facts as represented by the taxpayer.  Section 6110(k)(3) provides that this letter may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

Diana Imholtz

Diana Imholtz

Branch Chief, Branch 1

Office of Associate Chief Counsel

(Financial Institutions & Products)


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