PLR 201103009: Income from a wholly owned foreign subsidiary qualifies for a RIC's gross income test

Plain-English summary

An investment fund asked whether income from investing in a wholly owned foreign subsidiary would count toward the income test for regulated investment company status. The fund represented that the subsidiary would be a controlled foreign corporation and that the fund would include the subsidiary's subpart F income in its own income. The IRS ruled that the fund's income from its investment in the subsidiary would be income derived from investing in the subsidiary's stock and would qualify under section 851(b)(2). The ruling matters because qualifying income is part of the requirements for maintaining regulated investment company treatment.

Ruling snapshot

• Question: Does income from a fund's investment in its wholly owned controlled foreign corporation qualify under the regulated investment company gross income test?
• Outcome: approved
• Key authorities: IRC § 851(b)(2); IRC §§ 951, 952, 954, and 957

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201103009
Release Date: 1/21/2011
Index Number: 851.02-00
Person To Contact:
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CC:FIP:B02
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PLR-116694-10
Date:
October 8, 2010

Legend:

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

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

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

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

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

This is in response to a letter dated April 14, 2010, 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
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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 a series of an open-end management company registered under the Investment Company Act of 1940, 15 U.S.C. 80a-1 et seq. (“the 1940 Act”). Fund is a United States person.

Fund will elect to be treated as and 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 will be formed as a Company. A Company provides limited liability for its shareholders. Sub will file an election on Form 8832 to be taxed as a corporation under section 310.7701 of the Procedure and Administration Regulations.

Fund represents that although Sub 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.

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 all of Sub’s income will be “subpart F” income. Fund may also receive income from Sub that is not properly characterized as subpart F income.

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 . . . .

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.

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.
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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 the income of Fund that is derived from its investment in Sub is income derived with respect to Fund’s business of investing in the stock of Sub, and will constitute qualifying income under section 851(b)(2).

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,

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