PLR 201103017: Subpart F income from a controlled foreign subsidiary will count as qualifying income for a RIC

Plain-English summary

A regulated investment company proposed to invest in a wholly owned foreign subsidiary that would invest in commodities and related instruments. The IRS concluded that the subsidiary would qualify as a controlled foreign corporation and that the fund's share of the subsidiary's Subpart F income would be income derived from the fund's business of investing in the subsidiary's stock. That income therefore would count as qualifying income under section 851(b)(2). The ruling was based on the fund's representations and did not address other federal tax consequences.

Ruling snapshot

• Question: Will the fund's Subpart F income from its wholly owned controlled foreign subsidiary count as qualifying income under IRC § 851(b)(2)?
• Outcome: Approved
• Key authorities: IRC §§ 851, 951, 952, 954, and 957

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201103017
Release Date: 1/21/2011
Index Number: 851.02-00
Person To Contact:
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Telephone Number:
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Refer Reply To:
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CC:FIP:B02
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PLR-120290-10
Date:
October 6, 2010

Legend:

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

Fund = ---------------------------------------
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Company = ------------------------------------

Sub = ----------------------------------------------------------

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

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

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

This is in response to a letter dated May 10, 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.

FACTS

Fund is a series of Trust, a business trust organized under the laws of State.
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Trust is registered with the Securities and Exchange Commission 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 will file an election to be treated as a regulated investment company (“RIC”) under section 851 of the Code.

Fund will form a wholly owned subsidiary (“Sub”) under the laws of Country, a non-United States jurisdiction. Under Country’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 pursuant to §301.7701-3 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 asset diversification limitations set forth in section 851(b)(3) of the Code. Sub is expected to invest in commodities and commodity-related instruments but may also invest in other securities, debt or cash.

It is expected that all of Sub’s income will be “subpart F” income, as described below. Fund may, however, also receive income from Sub that is not 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 -
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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 section 851(b) of the Code provides that, for purposes of section 851(b)(2), there shall be treated as dividends 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) (as the case may be), 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 sum of 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 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 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.
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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 it will own 100 percent of the voting power of the stock of Sub. Fund is a United States person. Based upon Fund’s representations, Sub will qualify as a CFC under section 857.

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 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,

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