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President Signs Legislation Modernizing Federal Tax Code Treatment of SEC-Regulated Investment Companies

By Jim Hamilton

President Obama signed today bi-partisan legislation modifying and updating 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, HR 4337, would 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. Click here for a detailed white paper on the legislation,

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

The House passed the legislation by a voice vote on September 28, 2010. The Senate passed the legislation by unanimous consent on December 8, 2010. Because the Senate passed the legislation with an amendment (the Bingaman Amendment stripping out Sec. 201 on fund commodities investments), HR 4337 returned to the House and, on December 15, 2010, the House agreed to the Senate Amendment and sent the legislation to the President.

The legislation would modernize federal tax code provisions governing mutual funds that have not been updated in any meaningful or comprehensive way since the adoption of the Internal Revenue Code of 1986, and some of the provisions date back more than 60 years. Numerous developments during the past two decades, including the development of new fund structures and distribution channels, have placed considerable stress on the current tax code sections.

In general, regulated investment companies under the Code are domestic corporations
that either meet or are excepted from SEC registration requirements under the Investment Company Act, that derive at least 90 percent of their ordinary income from passive investment income, and that have a portfolio of investments that meet certain diversification requirements. Regulated investment companies under the Code can be either open-end companies (mutual funds) or closed-end companies.

The incoming Chair of the House Ways and Means Committee, Rep. Dave Camp (R-Michigan) strongly supports the complete legislative overhaul of federal tax code provisions affecting investment companies. Specifically, Rep. Camp, who was a manager of the Regulated Investment Company Modernization Act, HR 4337, said that the legislation would modernize federal tax code provisions governing mutual funds that have not been updated in any meaningful or comprehensive way since the adoption of the Internal Revenue Code of 1986, and some of the provisions date back more than 60 years. Noting that he is not aware of any controversy or opposition to the legislation, Rep. Camp broadly emphasized that it is entirely appropriate for Ways and Means to periodically review the tax law to ensure that targeted provisions of importance to particular segments of the economy, including the mutual fund industry and their investors, are kept up to date. (Cong. Record, Sept. 28, 2010, H7069-7070).

Full post as published by Jim Hamilton's World of Securities Regulation on December 22, 2010 (boomark / email).