PLR 1037014: IRS treated CFC subpart F income as qualifying RIC income

Plain-English summary

The IRS ruled that subpart F income from two wholly owned controlled foreign corporations would be qualifying income for their parent regulated investment companies under IRC § 851(b)(2). Each fund planned to invest in a subsidiary that would hold commodities, commodity-linked derivatives, and other investments. The funds represented that they would include the subsidiaries’ subpart F income in their own income under IRC § 951. The ruling treats that income as derived from each fund’s business of investing in the stock of its subsidiary, subject to the facts and representations in the letter.

Ruling snapshot

• Question: Could subpart F income from each fund’s wholly owned CFC subsidiary qualify as RIC income?
• Outcome: Approved
• Key authorities: IRC §§ 851(b)(2), 951, 952, 954, and 957

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201037014 Third Party Communication: None
Release Date: 9/17/2010 Date of Communication: Not Applicable
Index Number: 851.00-00
Person To Contact:
----------------------------------------------- ---------------------------, ID No. ------------
------------------------------------------ Telephone Number:
---------------------------------------------------------- ---------------------
----------------------- Refer Reply To:
------------------------------------ CC:FIP:B02
PLR-110290-10
Date:
June 04, 2010

Legend:

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

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

     Trust                      =        --------------------------------

     Type A Company             =        ------------------------------------

     State                      =        --------------------

     Country                    =        ----------------------

     Date 1                     =        -------------------

     Date 2                     =        -------------

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

  This responds to your letter dated March 3, 2010, submitted by your authorized

representative on behalf of Fund A and Fund B (each a “Fund” and, together, the
“Funds”). Funds request that the Internal Revenue Service rule 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) of the Internal
Revenue Code of 1986, as amended (the Code).
PLR-110290-10 2

Facts:

   Each Fund is a series of Trust, which is a business trust organized under the

laws of State. Trust 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 an accrual method taxpayer, classified as a corporation for federal income tax
purposes. Fund A uses a fiscal year ending Date 1, and Fund B uses a fiscal year
ending Date 2, as their taxable years. 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 set forth in § 851(b)(3) of the Code. 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. They may also invest in fixed income or equity investments and other
securities and derivatives.

   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.

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. Under this test, at least 90
PLR-110290-10 3

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, the flush language of § 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 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 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. Each Fund
represents that it will own 100 percent 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.
PLR-110290-10 4

    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 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).
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.

Conclusion:

    Based on the facts as represented, we rule that subpart F income of Subsidiary A

attributable to Fund A is income derived with respect to Fund A’s business of investing
in the stock of Subsidiary A and thus constitutes qualifying income under § 851(b)(2) of
the Code. We also rule that subpart F income of Subsidiary B attributable to Fund B is
income derived with respect to Fund B’s business of investing in the stock of Subsidiary
B and thus constitutes qualifying income under § 851(b)(2) of the Code.

   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,

                                                      Thomas M. Preston___________
                                                      Thomas M. Preston
                                                      Senior Counsel, Branch 2
                                                      Office of Associate Chief Counsel
                                                      (Financial Institutions & Products)