IRS Issues Proposed Regulations Relating to the Treatment by Regulated Investment Companies of Income from Subsidiaries Investing in Commodities

November 04, 2016

The U.S. Internal Revenue Service ("IRS") has recently issued Proposed Regulations under Section 851(b) of the Internal Revenue Code (the “Proposed Regulations”), and a Revenue Procedure that address the treatment to regulated investment companies (“RICs”) with respect to income from certain commodities-linked notes (“CLNs”) and income from subsidiaries investing in commodities and commodities derivatives.

The preamble to the Proposed Regulations provides that the IRS will no longer issue private letter rulings (“PLRs”) on whether income from a financial instrument or position (such as CLNs) is income from a “security” under §2(a)(36) of the Investment Company Act of 1940, that would therefore be qualifying income for purposes of the income test applicable to RICs. Simultaneously with the release of the Proposed Regulations, the IRS issued a revenue procedure to this effect (the “Revenue Procedure”).

The Proposed Regulations also provide that amounts included in income by a RIC in respect of a foreign corporation that is a controlled foreign corporation (“CFC”), or is a passive foreign investment company (“PFIC”), subject to a qualified electing fund (“QEF”) election, will be treated as dividends (and thus as qualifying RIC income) only to the extent that the earnings attributable to such income are timely distributed by the foreign corporation to the RIC. Unlike the approach taken in PLRs previously issued by the IRS, the Proposed Regulations also provide that an income inclusion under the CFC or PFIC QEF rules is not qualifying RIC income as other income derived from a RIC's business of investing in stock, securities, or currencies.

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