PLR 1042015: Subpart F income from a commodity subsidiary counted as RIC qualifying income

Plain-English summary

The IRS considered whether a regulated investment company could treat subpart F income from a controlled foreign corporation subsidiary as qualifying income under IRC § 851(b)(2). The fund planned to invest in a subsidiary that would invest in commodities and commodity-linked instruments, and the fund would include its share of the subsidiary's subpart F income. 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. The ruling was based on the represented facts and did not express an opinion on whether the fund otherwise qualified as a RIC under subchapter M.

Ruling snapshot

• Question: Is the fund's allocable subpart F income from a controlled foreign subsidiary qualifying income for the RIC gross-income test?
• 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: 201042015
Release Date: 10/22/2010
Index Number: 851.02-00
Person To Contact:
---------------------------- ----------------------, ID No. -------------
--------------------------------------------------- Telephone Number:
-------------------- ---------------------
------------------------------ Refer Reply To:
CC:FIP:B02
PLR-111969-10
Date:
July 13, 2010

Fund = ----------------------------------------------------------------------------------------
--------------------

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

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

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

Type X = --------------------------------------------------
Company
Date 1 = ---------------

a = -----

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

    This responds to your letter dated March 16, 2010, submitted by your authorized

representative on behalf of the Fund. The Fund requests that the Internal Revenue
Service rule that subpart F income of a controlled foreign corporation subsidiary
attributable to the Fund is income derived with respect to the Fund’s business of
investing in the stock of such subsidiary and thus constitutes qualifying income to the
Fund under § 851(b)(2) of the Internal Revenue Code of 1986, as amended (the Code).

Facts:
PLR-111969-10 2

   The Fund is a series of Trust, which is a statutory trust organized under the laws

of State. Trust is an open-end management investment company registered under the
Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq., as amended (the 1940 Act).
The Fund uses an accrual method of accounting and intends to adopt an annual
accounting period based on its fiscal year ending Date 1. The Fund will file an election
to be a regulated investment company (RIC) under § 851 of the Code and intends each
year to meet the diversification requirements set forth in § 851(b)(3) and the distribution
requirements set forth in § 852(a).

   The Fund has a subsidiary (the “Subsidiary”) organized as a Type X Company

under the laws of Country. Under the laws of Country, a Type X Company provides
limited liability for all of its shareholders. The Subsidiary will file an election on Form
8832, Entity Classification Election, to ensure that it is treated as a corporation for
federal income tax purposes.

   The Fund represents that, although the Subsidiary will not 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 transactions in commodity futures
and other transactions in derivatives.

    The Fund intends to invest a portion of its assets in the Subsidiary, subject to the

limitations set forth in § 851(b)(3) of the Code. The Subsidiary expects to invest in
various investments linked to the performance of commodities or commodities indexes,
which may include commodity and financial futures and option contracts, deliverable
forward contracts and cash-settled non-deliverable forward contracts, commodity-linked
notes, and swaps on commodities or commodities indexes. The Subsidiary also may
invest in commodities directly and in various other leveraged and non-leveraged
commodity-related investments. The Subsidiary may also hold from time to time other
stock, securities, debt and cash (as collateral for leveraged commodity related
investments or as independent investments).

   The Fund owns a percent of the shares of the Subsidiary and no transaction is

currently contemplated that would result in the Fund owning less than a percent of the
shares of the Subsidiary. In all events the Fund expects that, at all relevant times, (i) it
will own at least 10 percent of the total combined voting power of all classes of stock of
the Subsidiary entitled to vote, and (ii) “United States Shareholders” within the meaning
of § 951(b) will own more than 50 percent of the combined voting power of all classes of
the Subsidiary’s shares entitled to vote and/or of the total value of the Subsidiary’s
shares.

Law and Analysis:
PLR-111969-10 3

   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
percent of its gross income must be derived from certain enumerated sources. Under
§ 851(b)(2), a corporation’s 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 . . . .

   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 combined voting power of all classes of voting stock of a
foreign corporation. The Fund is a United States person. The Fund represents that it
owns a percent of the voting power and the value of the stock of the Subsidiary. The
PLR-111969-10 4

Fund represents that the Subsidiary therefore qualifies 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 the corporation and who owns stock in the 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.

    The Subsidiary’s income from its investments in commodities and commodity-

linked instruments may generate subpart F income. The Fund will therefore be required
to include in its income its pro rata share of the Subsidiary’s subpart F income for each
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 the Fund’s
business of investing in the stock of the Subsidiary and thus constitutes qualifying
income under § 851(b)(2) of the Code.

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, no opinion is expressed with regard to whether
the Fund qualifies as a RIC under subchapter M 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) of the Code provides that this
letter may not be used or cited as precedent.
PLR-111969-10 5

     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,


                                   David B. Silber
                                   David B. Silber
                                   Chief, Branch 2
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)