CFC subpart F income treated as qualifying RIC income

Plain-English summary

The IRS ruled that subpart F income from a regulated investment company's wholly owned controlled foreign corporation is income derived from the fund's business of investing in the subsidiary's stock. That income therefore constitutes qualifying income under IRC § 851(b)(2). The subsidiary is expected to invest in commodities and commodity-linked instruments, and the fund will include its share of the subsidiary's subpart F income in its own income. The ruling does not decide whether the fund qualifies as a regulated investment company under all of the requirements of subchapter M.

Ruling snapshot

• Question: Is the fund's share of the subsidiary's subpart F income qualifying income under § 851(b)(2)?
• Outcome: Approved
• Key authorities: IRC §§ 851, 951, 952, 954, 957, 959, 1293, and 6110

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201043017
Release Date: 10/29/2010
Index Number: 851.02-00
Person To Contact:
-------------------- ----------------------, ID No. -------------
------------------------------------------------------ Telephone Number:
--------------------------------------- ---------------------
-------------------------------------- Refer Reply To:
-------------------------------------------- CC:FIP:02
PLR-113640-10
Date:
July 13, 2010

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

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

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

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

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

   This responds to your letter dated March 2, 2010, submitted by your authorized

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

Facts:

   The Fund is a corporation organized under the laws of State. The 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). The Fund
intends to qualify as a regulated investment company (RIC) under § 851 of the Code.
The Fund uses an accrual method of accounting and has an annual accounting period
ending Date 1.

PLR-113640-10 2

   The Fund has a wholly owned 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 holders of its shares. The Fund represents that
Subsidiary will be treated as a corporation under the default entity classification rules
and intends to ensure such classification by filing a protective election on Form 8832,
Entity Classification Election.

   The Fund represents that, although the Subsidiary will not be registered as an

investment company under the 1940 Act, the 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 index swap agreements 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 will invest primarily in
one or more of the following types of instruments that are linked to the performance of
one or multiple commodities (including a commodity index): commodity and financial
futures and options contracts (and fixed income securities that serve as collateral for
these contracts), deliverable forward contracts, and cash-settled nondeliverable forward
contracts. The Subsidiary may also invest in swaps on commodities or commodities
indices or in commodity-linked notes. In addition, the Subsidiary may invest directly in
commodities.

   Because the Subsidiary will be wholly owned by the Fund, the Fund represents

that the Subsidiary will be a controlled foreign corporation. The Subsidiary is expected
to generate subpart F income and the Fund represents that it will include in its income
the Subsidiary’s subpart F income under the provisions of subpart F of 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. 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 –

PLR-113640-10 3

   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
will wholly own the Subsidiary and that the Subsidiary therefore 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 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 (among
other things): dividends, interest, royalties, rents, and annuities; gains in excess of

PLR-113640-10 4

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 is expected to 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.

     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,


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