PLR 201108008: CFC subpart F income qualifies for RIC income test

Plain-English summary

Six regulated investment company funds planned to invest in wholly owned foreign subsidiaries that would trade in commodity-linked investments. The funds asked whether their shares of the subsidiaries' subpart F income would count as qualifying income under the RIC income test. The IRS ruled that the subsidiaries would be controlled foreign corporations under the represented ownership structure and that the attributable subpart F income would qualify under section 851(b)(2). The ruling was limited to the taxpayers' representations and did not address other RIC requirements.

Ruling snapshot

• Question: Does subpart F income from the funds' wholly owned commodity subsidiaries qualify as RIC qualifying income?
• Outcome: Approved
• Key authorities: IRC §§ 851(b)(2), 951, 952, 954, and 957

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 201108008
Release Date: 2/25/2011
Index Number: 851.02-00
Person To Contact:
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------------------ ID------------------
------------------------------------------------ Telephone Number:
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Refer Reply To:
CC:FIP:B02
PLR-124557-10
Date:
November 3, 2010

Legend:

Fund A = --------------------------------------------------
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Fund B = ------------------------------------------------------------
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Fund C = -------------------------------------------------------------
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Fund D = ------------------------------------------------------------------
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Fund E = ----------------------------------------------------------------
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Fund F = --------------------------------------------------
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New Name = -------------------------------------------------

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

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

Country = ----------------------
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Dear --------------:

This is in response to a letter dated June 10, 2010, requesting a ruling that income earned by each Fund from an investment in its respective 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

Each of Funds A, B, C, D, E and F (“Funds”) is a business trust organized under the laws of State. Fund F will change its name this calendar year to New Name. Each Fund is 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”).

Each Fund has filed or will file an election to be treated as a regulated investment company (“RIC”) under section 851 of the Code.

Each Fund intends to form a subsidiary (“Sub”) under the laws of Country, a non- United States jurisdiction. Under Country’s laws, each Sub will be formed as a Company. A Company provides limited liability for its shareholders.

Each Company will file an election (on Form 8832) to be taxed as a corporation pursuant to §301.7701-3 of the Procedure and Administration Regulations.

The Funds represent that although each Company will not be registered as an investment company under the 1940 Act, each Company 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.

Each Fund will own 100% of the outstanding shares of any Sub in which it invests at the time of the Sub’s formation. There is currently no contemplated transaction that would result in a Fund owning less than 100% of the shares of any Sub, and in all events each Fund expects at all relevant times to own at least 10% of the total combined voting power of all classes of stock of that Sub entitled to vote, and expects that “United States shareholders” within the meaning of section 951(b) of the Code will at all times own more than 50% of the combined voting power of all classes of that Sub’s shares entitled to vote, or 50% of the total value of that Sub’s shares, or own both such 50% thresholds.

Each Fund intends to invest a portion of its assets in its respective Sub subject to the asset diversification limitations set forth in section 851(b)(3) of the Code. Each Sub is expected to invest in various investments that are linked to the performance of one or more commodities or of one or more commodities indices, which may include
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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 indices. Subs may also invest in commodities directly and in various other leveraged and non-leveraged commodity-related investments. Although Funds expect that Subs will invest primarily in commodities and commodity- related investments, and that Subs’ incomes will be primarily derived from those investments, Subs may also hold from time to time other stock, securities, debt and cash (as collateral for leveraged commodity-related investments or as independent investments).

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
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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 sum of 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)(A) defines foreign personal holding company income to include dividends, interest, royalties, rents, and annuities.

Subs’ investments may generate foreign personal holding company income under section 954(c), which is subpart F income. Funds would therefore include in income their respective Sub’s subpart F income for the taxable year in accordance with section 951.

ANALYSIS AND CONCLUSION

Each Fund has represented that it will own 100 percent of the voting power of the stock of its respective subsidiary Sub. The Funds are United States persons. Based upon the Funds’ representations, each of the respective Subs will qualify as a CFC under these provisions.

Based on the facts as represented, we rule that subpart F income of the Subs that is attributable to the Funds is income derived with respect to the Funds’ business of investing in the stock of Subs, and thus constitutes qualifying income under section 851(b)(2).

This ruling is directed only to the taxpayers who requested it, and is limited to the facts as represented by the taxpayers. Section 6110(k)(3) provides that this letter may not be used or cited as precedent.
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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,

Thomas M. Preston
Thomas M. Preston
Senior Counsel, Branch 2
Office of Associate Chief Counsel
(Financial Institutions and Products)