PLR 201042001: Undistributed subpart F income counted as RIC qualifying income

Plain-English summary

The IRS considered whether a regulated investment company could treat undistributed subpart F income from a wholly owned controlled foreign corporation subsidiary as qualifying income under IRC § 851(b)(2). The subsidiary was expected to invest in commodities and commodity-related investments, and the fund would include its share of the subsidiary's subpart F income under § 951. The IRS ruled that the subpart F income attributable to the fund was derived from the fund's business of investing in the subsidiary's stock and therefore was qualifying income, regardless of whether the subsidiary distributed the income to the fund. The ruling was limited to the represented facts.

Ruling snapshot

• Question: Is undistributed subpart F income from the fund's wholly owned commodity subsidiary qualifying income under § 851(b)(2)?
• Outcome: Approved
• Key authorities: IRC §§ 851(b)(2), 951, 952, 954, and 957; Investment Company Act of 1940 § 2(a)(36)

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201042001
Release Date: 10/22/2010
Index Number: 851.02-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
CC:FIP:B02
PLR-100330-10
Date:
July 9, 2010

Legend:

Fund = --------------------------------------------------------
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Trust = ----------------------------------

Company = ------------------------------------

Sub = -----------------------------------------------------------------------
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State = --------------------

Offshore = ----------------------

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

This is in response to a letter dated December 23, 2009, requesting a ruling that income earned by Fund from an investment in its wholly-owned subsidiary that qualifies as a controlled foreign corporation (“CFC”) constitutes qualifying income under section 851(b)(2) of the Internal Revenue Code without regard to whether that income is distributed to Fund.

FACTS

Fund is a series of Trust and is classified as a corporation for federal income tax purposes. Trust is a business trust organized under the law of State. Fund is registered
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as an open-end management company under the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq. (“the 1940 Act”).

Fund intends to qualify each year as a regulated investment company (“RIC”) under section 851 of the Code.

Fund intends to invest in a wholly-owned subsidiary (“Sub”) formed under the laws of Offshore, a non-United States jurisdiction. Under Offshore’s laws, Sub has been formed as a Company. A Company provides limited liability for its shareholders. It is represented that Sub will be treated as a corporation for federal income tax purposes under default entity classification rules.

Fund represents that although Sub does not expect to be registered as an investment company under the 1940 Act, it 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 Sub were registered under the 1940 Act.

Fund will invest a portion of its assets in Sub, subject to the limitations set forth in section 851(b)(3) of the Code.

It is expected that Sub will invest in commodities and commodity-related investments, such as commodity futures and derivative contracts related to commodities and commodity indices. These investments may include trusts and other investment vehicles that invest primarily or exclusively in commodities, such as exchange-traded funds that invest in precious metals or other commodities.

Fund expects that all of Sub’s income will be “subpart F” income. Fund will include in its income its share of Sub’s subpart F income for the taxable year in accordance with section 951 of the Code.

LAW

Section 851(b)(2) of the Code provides that a corporation is not considered a RIC for any taxable year unless it meets an income test. Under this test, at least 90 percent of its gross income must be derived from certain sources. Under section 851(b)(2), qualifying income includes

. . . 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 its business of investing in such stock, securities, or currencies . . . .
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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.

Section 851(b) of the Code provides that, for purposes of section 851(b)(2), the term “dividends” includes amounts included in gross income under sections 951(a)(1)(A)(i) or 1293(a) for the taxable year to the extent that, under sections 959(a)(1) or 1293(c), 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 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 section 951(b) as a United States person who owns 10 percent or more of the total voting power of a foreign corporation.

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 the corporation and who owns stock in it 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(a)(2) defines subpart F income to include foreign base company income determined under section 954. Under section 954(a)(1), foreign base company income includes foreign personal holding company income determined under section 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 incommodities (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.
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Sub’s investments may generate foreign personal holding company income under section 954(c), which is subpart F income. Fund would therefore include in income Sub’s subpart F income for the taxable year in accordance with section 951.

ANALYSIS AND CONCLUSION

Fund has represented that Sub will be a wholly-owned subsidiary of Fund. Fund is a United States person. Based upon Fund’s representations, Sub will qualify as a CFC under these provisions.

Based on the facts as represented, we rule that subpart F income of Sub that is attributable to Fund is income derived with respect to Fund’s business of investing in the stock of Sub, and thus constitutes qualifying income under section 851(b)(2). This ruling applies without regard to whether Sub’s income is distributed to 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, copies of this letter are being sent to your authorized representatives.

Sincerely,

Susan Thompson Baker
Susan Thompson Baker
Assistant to the Branch Chief, Branch 2
Office of Associate Chief Counsel
Financial Institutions and Products