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Mutual Fund Industry Strongly Supports Legislation Modernizing Federal Tax Code Treatment of Funds

By Jim Hamilton

The mutual fund industry strongly supports the legislation passed by Congress modernizing the tax treatment of mutual funds and other investment companies regulated by the SEC. In a statement, the Investment Company Institute said that the Regulated Investment Company Modernization Act (HR 4337) will make funds more efficient and reduce the need for investors to file amended tax returns related to their investments. The legislation streamlines and updates technical tax rules, allowing fund companies to focus on innovating and serving shareholders, said the Institute. HR 4337 has passed the Senate and House and now goes to the White House for the President?s signature into law.

The Regulated Investment Company Modernization Act modifies and updates federal tax code provisions pertaining to SEC-regulated investment companies in order to make them better conform to, and interact with, other aspects of the tax code and applicable federal securities laws. The Regulated Investment Company Modernization Act will reduce the burden arising from amended year-end tax information statements, improve a mutual fund's ability to meet its distribution requirements, create remedies for inadvertent mutual find qualification failures, improve the tax treatment of investing in a fund-of-funds structure, and update the tax treatment of fund capital losses.

Specifically, the legislation:

Sets forth a special rule allowing unlimited carryovers of the net capital losses of regulated investment companies
Exempts regulated investment companies from loss of tax-preferred status and additional tax for failure to satisfy the gross income and assets tests if such failure is due to reasonable cause and not due to willful neglect and is de minimis.
Revises the definitions of "capital gain dividend" and "exempt-interest dividend" for purposes of the taxation of funds and their shareholders to require such dividends to be reported to shareholders in written statements
Excludes net capital losses of funds from earnings and profits. Prohibits earnings and profits from being reduced by any amount which is not allowable as a deduction in computing taxable income, except with respect to such a net capital loss.
Allows a regulated investment company, in the case of a qualified fund of funds, to pay exempt-interest dividends and allow its shareholders the foreign tax credit without regard to certain investment requirements in state and local bonds and foreign securities.
Modifies rules for dividends paid by funds after the close of a taxable year, so called, spillover dividends.
Revises the method for allocating fund earnings and profits to require such earnings and profits to be allocated first to distributions made prior to December 31 of a calendar year
Allows funds with shares that are redeemable upon demand to treat distributions in redemption of stock as an exchange for income tax purposes.
Repeals preferential dividend rules for funds that are publicly offered.
Allows funds to elect to treat a post-October capital loss and any late-year ordinary loss as arising on the first day of the following taxable year.
Exempts from holding period requirements applicable to fund stock regular dividends paid by a fund which declares exempt-interest dividends on a daily basis in an amount equal to at least 90% of its net tax-exempt interest and distributes such dividends on a monthly or more frequent basis

Extends the exemption from excise tax for failure to distribute taxable income of a fund to other tax-exempt entities with an ownership interest in a fund.
Allows specified gain and loss of a fund derived after October 31 of a calendar year to be deferred, for excise tax purposes, until January 1 of the following calendar year.
Sets forth a special rule for estimated excise tax payments of funds.
Increases from 98% to 98.2% the amount of capital gain net income funds are required to distribute.
Repeals the additional penalty on funds for tax deficiencies for which a deficiency dividend has been distributed

Full post as published by Jim Hamilton's World of Securities Regulation on December 16, 2010 (boomark / email).