PLR 1128022: IRS treats a fund's subpart F income as qualifying RIC income

Plain-English summary

The IRS ruled that subpart F income earned by a regulated investment company through its wholly owned foreign subsidiary would be qualifying income under IRC § 851(b)(2). The fund intended to invest in the subsidiary, which would be treated as a corporation for federal tax purposes and would invest in pooled investment vehicles, swaps, structured notes, and related assets. Because the fund owned all of the subsidiary and the subsidiary would qualify as a controlled foreign corporation, the fund would include its share of the subsidiary's subpart F income under IRC § 951. The IRS concluded that this income was derived with respect to the fund's business of investing in the subsidiary's stock and therefore counted toward the RIC gross-income test.

Ruling snapshot

• Question: Did the fund's inclusion of subpart F income from its wholly owned foreign subsidiary qualify as income under IRC § 851(b)(2)?
• Outcome: approved
• Key authorities: IRC §§ 851(b)(2), 851(b)(3), 951, 952(a)(2), 954(a)(1) and (c)(1)(A), 957, 959(a)(1), 1293(a) and (c), and 6110(k)(3)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201128022
Release Date: 7/15/2011 Person To Contact:
------------------ ID------------------
Index Number: 851.02-00 Telephone Number:
---------------------
Refer Reply To:

                                                              CC:FIP:B02

                                                              PLR-151128-10

-------------------------------- Date:
------------------------------- April 01, 2011

Legend:

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

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

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

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

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

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

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

    This is in response to a letter dated November 16, 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, which is organized under the law 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”).
PLR-151128-10 2

   Fund intends to qualify as a regulated investment company (“RIC”) under section

851 of the Code.

  Fund has formed a wholly owned subsidiary, Sub, under the laws of Country.

Under Country’s law, Sub is a Company. A Company provides limited liability for its
shareholders.

  Fund represents that Sub will qualify as an association taxable as a corporation

under sections 301.7701-3(b)(2)(B) and 301.7701-2(b)(2) of the Procedure and
Administration Regulations for federal income tax purposes. Sub will file an election (on
Form 8832) to be taxed as a corporation pursuant to §301.7701-3 of the regulations.

   Fund represents that although Sub will not be registered as an investment

company under the 1940 Act, Sub 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 primarily in securities of limited partnerships, corporations,

limited liability companies, and other types of pooled investment vehicles (collectively,
“underlying funds”), as well as swap contracts and structured notes. Each underlying
fund invests in options, futures, forwards or spot contracts, each of which may be tied to
commodities, financial indices and instruments, foreign currencies, or equity indices.

    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 will invest in underlying funds,
swap contracts, structured notes, and other investments intended to serve as margin or
collateral for swap positions.

   It is expected that Sub will generate subpart F income.

                              LAW AND ANALYSIS

    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 . . . .

PLR-151128-10 3

   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. Fund has represented that it owns 100 percent of
the stock of Sub. Fund is a United States person. Based upon Fund’s’ representations,
Sub 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 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.

  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.

                                  CONCLUSION

     Based on the facts as represented, we rule that the 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.
PLR-151128-10 4

     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
                                       Senior Technician Reviewer, Branch 2
                                       Office of Associate Chief Counsel
                                       (Financial Institutions and Products)