PLR 1026023: IRS approved fee allocations for RIC share classes under the dividends-paid deduction rules

Plain-English summary

The IRS ruled for two groups of registered investment company funds that issued multiple share classes with different fees and service arrangements. The funds allocated certain transfer-agency and sub-transfer-agency expenses differently among the classes, including special treatment for an institutional class that did not receive sub-transfer-agency services. The IRS concluded that variations in distributions caused solely by the described fee allocations, expense payments, and waivers or reimbursements did not make the funds' dividends preferential under IRC § 562. The ruling did not decide whether the funds otherwise qualified as RICs taxable under subchapter M or address other federal tax consequences of the expense arrangements.

Ruling snapshot

• Question: Would specified fee and expense allocations among multiple share classes prevent distributions by the funds from qualifying for the dividends-paid deduction?
• Outcome: approved
• Key authorities: IRC §§ 67(c)(2)(B), 561, 562, 851, and 852; Rev. Proc. 99-40; IRC § 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201026023
Release Date: 7/2/2010 Person To Contact:
-------------------------, ID No. -------------
Index Number: 562.00-00, 851.00-00 Telephone Number:
---------------------
Refer Reply To:

                                                            CC:FIP:B02

                                                            PLR-146327-09

-------------------------------------------- Date:
---------------------------- March 05, 2010

Legend:

Portfolio A = ---------------------------------------
Fund A = ---------------------------------------------

Fund B = ------------------------------------------

Fund C = ----------------------------------------------------------

Fund D = ---------------------------------------------

Portfolio B = -----------------------------------------
Fund E = -----------------------------------------------

Fund F = --------------------------------------------

Fund G = ------------------------------------------------

Fund H = ----------------------------------------------

Fund I = ----------------------------------------------

Fund J = -----------------------------------------------

Fund K = ------------------------------------------------------

Fund L = -----------------------------

Advisor = ---------------------------------------------------
Transfer Agent = --------------------------------------------------
PLR-146327-09 2

Distributor = ------------------------------------------------------
Date = ------------------

Dear --------------:

   This is in reply to a letter dated October 13, 2009, requesting rulings on behalf of

Portfolio A and its series funds, Funds A-D (collectively, the Portfolio A Funds), and
Portfolio B and its series funds, Funds E-L (collectively, the Portfolio B Funds). Portfolio
A and Portfolio B request a ruling that distributions made by Funds A-L (the Funds) will
be eligible for the dividends paid deduction under sections 561 and 852 of the Internal
Revenue Code.

Facts:

    Portfolio A and Portfolio B are each registered as an open-end investment

company under the Investment Company Act iof 1940, 15 U.S.C. 80a-1, et seq., as
amended (the “1940 Act”). The Portfolios are each a “series company” under Rule 18f-
2 of the 1940 Act with multiple portfolio series outstanding, including the Funds. The
Portfolios represent that each Fund has been and will continue to be operated in a
manner intended to qualify it as a regulated investment company (RIC) under section

851. Each Fund is treated as a separate corporation under section 851(g).

     Advisor serves as investment advisor and administrator for the Funds. There is
     

     currently no sub-advisor for the Funds. Transfer Agent, an affiliate of Advisor, is the
     transfer agent for the Funds. Distributor, an affiliate of Advisor, serves as the distributor
     for the Funds.

     The Portfolios have adopted a system of multiple classes of shares for each of
     

     the Funds (the “multiple class system”) pursuant to Rule 18f-3 under the 1940 Act.
     Each of the Portfolio A Funds may issue one or more of the following classes of shares:
     “Class A”, “Class B”, “Class C”, “Class R”, “Class Y” and “Class Z”. Portfolio B Funds
     may issue one or more of the following classes of shares: “Class A”, “Class B”, “Class
     C”, “Class E”, “Class F”, “Class R”, “Class T”, “Class Y” and “Class Z”. The multiple
     class system enables the Portfolios to offer investors the option of purchasing Fund
     shares subject to various fees and sales charges. For example, Class A, Class E and
     Class T shares are subject to a front-end sales charge with lower ongoing distribution
     fees payable from the assets of the class at an annual rate as a percentage of average
     daily net assets and generally no contingent deferred sales charge (“CDSC”). Class B,
     Class C, Class F, and Class R have no front-end sales charges but are subject to
     relatively higher annual ongoing distribution fees payable as a percentage of average
     daily net assets and a CDSC if the shares are redeemed within a specified number of
     years after purchase. Class Y and Class Z shares offer no front-end sales charges and
     no distribution and shareholder servicing fees of CDSC.
     PLR-146327-09 3

     The Class Y shares are known as the “Institutional Class” and all other classes of
     shares are known as the “Retail Classes”. Like Class Z, Class Y shares are not subject
     to any front-end sales charge, CDSC, or distribution or shareholder servicing fees.
     However, Class Y shares have significantly higher minimum investment amounts than
     Class Z and other retail class shares. Also, unlike the retail class shares, which are
     subject to fund-wide allocation of transfer agency fees and expenses, Class Y shares
     are subject to a separate, class-specific allocation of transfer agency fees and
     expenses. Class Y shares do not receive any sub-transfer agency services and
     therefore, are not assessed and do not incur any sub-transfer agency fees or expenses,
     unlike the retail classes.

      Except as noted below, all shares of each Fund are continually offered pursuant
     

     to a public offering. The various classes of shares have different investment and
     eligibility requirements. It is represented that by offering distinct classes of shares, the
     Portfolios are able to provide investors with a broad range of distribution and service
     arrangements and are able to apportion distribution expenses more equitably among
     different types of investors.

     Each of a Fund’s share classes represents interests in the same portfolio of
     securities and has identical voting, dividend, liquidation, and other rights and the same
     terms and conditions, except (i) as noted above, certain classes are subject to some
     combination of fees and/or sales charges; (ii) Class B shares will convert automatically
     into Class A shares of the same Fund after eight years, subject to certain conditions; (iii)
     Class F shares will convert automatically to Class E shares after eight years, subject to
     certain conditions; (iv) Class E shares convert to Class A shares of the same Fund if the
     irrevocable trust in which they are held terminates and Class F shares convert to Class
     B shares of the same Fund if the trust in which it is held terminates; (v) each class has
     exclusive voting rights on any matter dealing with that class’s distribution or shareholder
     servicing arrangements; and (vi) there are differences relating to eligible investors as
     may be set forth in the prospectuses and statements of additional information of the
     Portfolios. Shareholders of any of the Funds may exchange their shares for available
     shares of the same class in any of the other Funds at any time, with the exception of
     Class E and Class F shares, which are only offered by Fund E. The Funds have
     represented that each of a Fund’s share classes separately meet the requirements of
     section 67(c)(2)(B) and that the rights and obligations of the shareholders of each class
     are set forth in the organizing documents of each Fund.

     Prior to Date, all “Class Expenses” were allocated pro rata to each class of a
     Fund on the basis of the relative net assets of the respective classes. “Class Expenses”
     include all expenses (other than distribution fees and shareholder servicing fees) that
     are properly allocable to a separate class under Rule 18f-3 of the 1940 Act. Distribution
     and shareholder servicing fees incurred by a specific class were specially allocated and
     paid by that class. A Fund’s total transfer agency fees were based on the aggregate
     PLR-146327-09 4

number of open accounts across all of the Fund’s share classes and then allocated to
each share class based on each class’s relative net assets. Also, all identifiable out-of-
pocket transfer agency expenses were allocated to a Fund based on evenly weighted
factors, including the total number of shareholder accounts, number of transactions, and
average assets. Sub-transfer agency fees and expenses were allocated to a Fund
based on actual services provided and invoiced to the particular Fund and, in turn, were
allocated to each class based on the class’s share of the Fund’s net assets.

     The services provided and fees assessed under the Class Y transfer agency

agreements are substantially similar to those currently to those currently provided under
the Retail Class transfer agency agreements between the Funds and Transfer Agent for
all of the other classes. However, unlike the Retail Classes, the transfer agency fees
and expenses incurred for Class Y shares are specially allocated to Class Y
shareholders and the Class Y shareholders do not receive any sub-transfer agency
services. Therefore, the Class Y shareholders are not assessed any sub-transfer
agency fees or expenses.

   Beginning on Date, each Fund has specially allocated transfer agency fees to

Class Y shares based on a per account fee for each Class Y open account. The similar
per-account transfer agency fees under Retail Class transfer agency agreements are
determined without reference to the number of Class Y open accounts or Class Y
shares’ assets. While the benefit of any waiver or reimbursement of all of part of Class
Y class expenses is specially allocated to the Class Y shares, any waiver or
reimbursement of the Retail Classes’ class expenses is allocated based on each Retail
Class’s share of net assets relative to the net assets of all Retail Class shares, in effect
treating all of the Retail Classes like a single class of shares. All identifiable out-of-
pocket transfer agency expenses for both the Class Y shares and the Retail Classes’
shares are allocated to each Fund based on actual services performed and invoiced.
The transfer agency expenses are allocated based on each Retail Class’s share of the
net assets relative to the net assets of all Retail Class shares. This allocation method is
also applicable to any sub-transfer agency fees or expenses attributable to the Retail
Classes of shares.

   All other expenses of the Funds (except distribution and shareholder servicing

fees and expenses) continue to be aggregated and allocated to each class, including
Class Y, in proportion to the respective class’s share of the net assets of the Fund. The
benefit of any waiver or reimbursement of all or any part of distribution fees and/or
expenses or shareholder servicing fees is allocated to the share class on behalf of
which the fee or expense was incurred

Law, Analysis and Conclusion:

  Section 851(a) defines a RIC, in part, as a domestic corporation registered under

the 1940 Act as a management company.
PLR-146327-09 5

   Section 851(b) limits the definition of a RIC to a corporation meeting certain

election, gross income, and diversification requirements.

   Section 851(g) provides a special rule for a RIC having more than one fund. This

provision treats each fund as a separate corporation for all purposes of the Code, other
than the definitional requirement of section 851(a).

   Section 852 provides that a RIC is not taxable under subchapter M, part I, unless

its deduction for dividends paid (as that term is defined in section 561(a) with certain
modifications) for the taxable year equals or exceeds a specified portion of its taxable
income (with certain adjustments) and its net tax-exempt interest income.

   Section 561(a) defines the deduction for dividends paid, for purposes of section

852, to include dividends paid during the taxable year. Section 561(b) applies the rules
of section 562 to determine which dividends are eligible for the deduction for dividends
paid under section 561(a).

   Section 562(c) provides that the amount of any distribution by a RIC to its

shareholders shall not be considered a dividend for purposes of computing the
dividends paid deduction under section 561, unless such distribution is pro rata, with no
preference to any share of stock as compared with other shares of the same class, and
with no preference to one class of stock as compared with another class except to the
extent that the former is entitled (without reference to waivers of their rights by
shareholders) to such preference.

    Rev. Proc. 99-40, 1999-2 C.B. 565, describes certain conditions under which

distributions to RIC shareholders may vary and nevertheless be deductible under as
dividends under section 562. The revenue procedure applies to a RIC that issues
groups of shares that represent interests in the same portfolio of securities but have
different arrangements for shareholder services or the distribution of shares or both.
The revenue procedure provides that if variations in distributions to shareholders of
different Qualified Groups (as defined in section 3 of the Revenue Procedure) exist
solely as a result of the allocation and payment of fees and expenses and the allocation
of the benefit of waivers and reimbursements of fees and expenses (as provided in the
Revenue Procedure), the variations do not prevent the distributions from being
dividends under section 562.

    Based on the information submitted and representations made, we conclude that

each Fund in Portfolios A and B (Funds A–L) meets the requirements of Rev. Proc. 99-

40. Section 3.02 of this revenue procedure provides that certain expenses not related
    to the management of the RIC’s assets, a category which includes transfer agency fees,
    may be allocated to a particular Qualified Group if these expenses are actually incurred
    in a different amount by that Qualified Group or if the Qualified Group receives services
    PLR-146327-09 6

of a different kind or to a different degree than other Qualified Groups. The special
allocation of sub-transfer agency fees away from Class Y, which does not receive sub-
transfer agency services, and the allocation of transfer agency fees to the retail classes
as a whole in accordance with the net asset value of each retail class, is an allocation
method based on the standards enunciated in section 3.02 of Rev. Proc. 99-40.

    Further, section 4.02 of this revenue procedure provides that if, under section

3.02, a fee or expense is allocated on the basis of the amount incurred or services
received, as in the case of the transfer agency and sub-transfer agency fees described
in this letter, the benefit of any waiver or reimbursement of such a fee or expense is to
be allocated in like fashion. Funds have represented that the benefit of any waiver or
reimbursement of transfer agency fees is to be allocated to the share class on behalf of
which the expense was incurred, in accordance with the requirements of section 4.02 of
Rev. Proc. 99-40.

   Accordingly, we rule that variations in distributions to shareholders of Funds A-L

that exist solely as a result of the allocation and payment of fees and expenses and the
allocation of the benefit of waivers and reimbursement of fees and expenses as
described in this letter do not cause dividends paid by each Fund to be preferential
under section 562.

   No opinion is expressed concerning whether any Fund qualifies as a RIC that is

taxable under subchapter M of Chapter 1 of the Code. Also, assuming any Fund does
qualify as a RIC, no opinion is expressed as to the federal tax consequences of any
expense allocation, waiver, or reimbursement other than as provided in Rev. Proc. 99-
40.

  This ruling is directed only to the Funds who requested it. Section 6110(k)(3)

provides that it 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
representatives.

                                         Sincerely yours,

                                         Susan Thompson Baker
                                         Susan Thompson Baker
                                         Senior Technician Reviewer, Branch 2
                                         Office of Associate Chief Counsel
                                         (Financial Institutions & Products)