June 11, 2010
The Honorable Michael Mundaca
Assistant Secretary for Tax
Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220
The Honorable William J. Wilkins
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue NW
Washington, DC 20224
RE: Guidance Priority List
Recommendations
Dear Mr. Mundaca and Mr. Wilkins:
The Investment Company
Institute n1 recommends the
following issues affecting regulated investment companies ("RICs")
and their shareholders for inclusion on the 2010-2011 Guidance Priority
List. n2 As requested in Notice
2010-43, these recommendations have been listed in order of priority. The
Institute notes, however, that all of the issues described below are important
to the industry and their shareholders; most of these items have been included
in prior requests for guidance from the Internal Revenue Service
("IRS") and the Treasury Department, including prior suggestions for
the Guidance Priority List.
I. 2009-2010 Guidance Priority
List Items
The Institute requests that the
IRS and Treasury Department issue guidance as soon as possible on the following
items currently on the 2009-2010 Guidance Priority List.
A. Final Regulations on Cost Basis Reporting
First, the Institute urges the
IRS and Treasury Department to issue final regulations, implementing the
mandatory cost basis reporting requirements enacted in 2008, that adopt our
recommendations. As discussed in our comment letters, n3 the proposed regulations raise many issues that must be
resolved before mutual funds and brokers can begin the necessary programming
and systems changes. We believe that our proposed solutions would make
implementation of this new reporting regime more workable, easing the burdens
to brokers, shareholders, and the government while preserving the goals of the
statute. As the IRS and Treasury Department are aware, guidance is needed as
soon as possible so the industry can comply fully with the January 1, 2012 effective
date.
B. Distressed Debt
Second, the Institute requests
guidance addressing the accrual of interest on distressed debt. Investors have
long faced uncertainty regarding how the existing original issue discount and
market discount rules should apply to severely distressed, and speculative,
debt. In other cases, application of these rules creates what many believe to
be inappropriate results. n4 These
issues have been exacerbated by recent market events. n5
C. Notional Principal Contracts
Third, the Institute remains very
interested in guidance providing simplicity and certainty regarding the
taxation of notional principal contracts. In our letter on the regulations
proposed in 2004, n6 we expressed
reservations about the proposed regulations' complexity and recommended
significant modifications. We recommended that marks under the elective
mark-to-market method, as well as value payments under the noncontingent swap
method, be treated as resulting in capital gain or loss. We also suggested that
credit default swaps and certain short-term swaps be excluded from the modified
noncontingent swap method and the mark-to-market election. We requested
additional guidance on determining whether a payment is
"significant." We also commented on several technical issues.
Finally, we suggested that the guidance should be made entirely prospective
upon promulgation of final regulations.
D. Prepaid Forward Contracts
Finally, we urge guidance on
prepaid forward contracts. n7
Specifically, the Institute strongly supports prompt and comprehensive guidance
regarding the tax treatment of exchange-traded notes ("ETNs"). While
ETNs can provide important investment opportunities, they also take advantage
of gaps in the tax law to provide investors with tax deferral (of up to 30
years) and character conversion that is inappropriate. This treatment is far
more favorable than the treatment obtained by investors in comparable financial
instruments and provides a tax incentive to take on issuer credit risk (rather
than invest in products that do not entail this risk). In the absence of
legislation, regulations should be issued under Treasury's existing authority
under section 1260 and should provide a mark-to-market election. If a
comprehensive regulatory approach is not developed under section 1260,
guidance should be issued under section 446 to address any ETNs that
remain outside the scope of the section 1260 constructive ownership
solution.
II. Items Deleted from the
2009-2010 Guidance Priority List
A number of items affecting RICs
and their shareholders were deleted from the 2009-2010 Priority Guidance List
without guidance being issued. Legislation introduced in the House of
Representatives in 2009 (H.R. 4337, the Regulated Investment Company Modernization
Act of 2009) effectively would resolve two concerns that would have been
addressed by items on prior Guidance Priority Lists:
[#186] the application of section 1 (h) to RIC
capital gain
dividends
n8 and similar bifurcation-related issues
arising under section 871(k)(2), which
permits flow-through
of short-term capital gain dividends; and
[#186] minor errors made by RICs, such as mathematical,
computer and processing errors that may create
preferential
dividends.
n9
We urge the Treasury Department's
support for this important legislation
n10 and the issuance of any post-enactment guidance that might be
necessary. Should additional issues arise relating to capital gain dividends or
minor errors, we will request guidance addressing them.
The ICI also urges the IRS and
Treasury to address issues regarding section 529 qualified tuition
programs ("section 529 plans"). A project to address these
issues, which was included on prior Guidance Priority Lists, similarly was
deleted from the 2009-2010 list without guidance being issued. Guidance
regarding section 529 plans remains necessary to implement fully the
Advance Notice of Proposed Rulemaking ("Advance Notice") regarding section
529 plans that the IRS released in 2008. We are pleased that the Advance
Notice reflects several comments previously submitted jointly by the Institute
and the Securities Industry and Financial Markets Association
("SIFMA"). n11 It
remains important, for those saving for education through section 529 plans,
that the tax treatment of investments in such plans be clear. We urge the IRS
to continue its work on this guidance project to address outstanding
issues. n12
III. Other Issues Directly
Affecting RICs and Their Shareholders'
n13
A. The Application of General Corporate Tax Rules
to RICs
The Institute requests that the
IRS and Treasury address issues arising from the application of the general
corporate tax rules to RICs. These rules can be unnecessarily difficult to
apply and can result in unintended consequences.
1. Business Continuity Requirement for
Tax-Free Mergers
First, the Institute requests
guidance clarifying the application of the "business continuity" requirement
to RICs under section 368 and Treas. Reg. section 1.368-1(d)(2). n14 This clarification is necessary
because it is difficult to discern the intended scope of the business
continuity test as applied to RIC reorganizations. As a result, many RICs engaging
in merger transactions are compelled to rely on the "asset
continuity" test; n15 this
test, to the detriment of the RICs shareholders, can place artificial limits on
the ability of a portfolio manager to dispose of portfolio securities acquired
from a target RIC and imposes significant compliance burdens on funds. This
issue has become increasingly important given recent financial conditions,
under which more and more RICs are being merged. The Institute requested
guidance on this issue in 2004, at which point the IRS informed us that they
wished to gather more information on RIC mergers through the private letter
ruling process. The Institute hopes that the IRS and Treasury now have
sufficient information to open a project on this issue and requests that they
do so.
2. Ownership Tracking Requirements
Second, the Institute asks that a
project be opened to amend the regulations under sections 382 and 383
with respect to ownership tracking requirements that apply to
participant-directed retirement accounts holding RIC shares and to variable
insurance products. Specifically, the regulations should permit a RIC to look
through participant-directed retirement accounts and variable insurance product
account owners and treat each participant/investor who holds less than five
percent of the RIC's shares as part of the RIC's direct public group. The
concerns against which sections 382 and 383 are directed are not
implicated when a RIC's new shareholders are retirement accounts or variable
insurance product accounts that cannot benefit from such tax attributes.
This change effectively would
prevent a large collection of small investors making independent investment
decisions from being treated as a single entity for ownership change purposes.
Absent this change, a retirement plan administrator's decision as to what RICs
to offer in a plan could significantly affect whether other shareholders in the
RIC can benefit from the RIC's capital losses even though the retirement plan
administrator is neither a beneficial owner of RIC shares nor responsible for
allocating investment assets among RICs. Likewise, absent this change, an
ownership change could occur if another company buys the insurance company
holding the variable insurance product shares.
B. RIC Portfolio Investments
The Institute requests guidance
on several issues arising from RICs' portfolio investments.
1. PFICs
First, we ask the IRS and
Treasury to issue additional guidance regarding passive foreign investment
companies ("PFICs"). The preamble to the final PFIC mark-to-market
regulations (TD 9123) published on April 29, 2004, notes in three places that
comments received relating to the impact of the PFIC rules on RICs were beyond
the scope of that regulations project.
n16 We request that a regulations project be opened to address these and
other PFIC-related issues faced by the industry.
Specifically, the Institute
requests guidance providing (i) that gains from dispositions of former PFIC
stock are capital while losses are ordinary to the extent of prior unreversed
inclusions; (ii) RICs with automatic consent to terminate a section 1296
election during a non-PFIC year; (iii) that RICs may recognize any change in
PFIC status of a foreign corporation for the RIC's taxable year within which
the taxable year of the foreign corporation ends; (iv) that the consequences to
RICs of applying former Prop. Treas. Reg. section 1.1291-8 will be respected,
where relevant, for purposes of section 1296; and (v) that RICs may
determine qualified electing fund ("QEF") inclusions using audited
financial statements that were prepared using U.S. Generally Accepted
Accounting Principles or International Financial Reporting standards, and that
all QEF inclusions subject to this election will be treated as ordinary, but
retain the capital character of disposition gains and losses.
2. RIC Investments in Partnerships with
Different
Taxable Year-Ends
Second, we request guidance
regarding RIC investments in a partnership in which the RICs and the
partnership have different tax years; this guidance should allow RICs to take
partnership items into income at the end of each month, rather than at
year-end. In general, partners must take partnership items into account at the
end of the partnership's tax year. If a RIC invests in a partnership with a
different tax year, however, this can cause mismatches between the RIC's
distributions and the amount of earnings and profits associated with the
partnership's income.
3. Taxable Mortgage Pools
Third, we request regulatory
guidance to clarify issues relating to excess inclusion income of a REIT that
is a taxable mortgage pool ("TMP") or that has a qualified REIT
subsidiary that is a TMP. While Notice 2006-97 n17 addressed a few issues, and responded to some of the
Institute's concerns with the lack of guidance in this area, n18 many critically important issues
remain unresolved. At a minimum, and as requested by the Institute in 2006,
guidance should be issued stating that Notice 2006-97 will not be
applied until some reasonable period after a practical reporting regime is
implemented and the many uncertainties arising from the Notice are
resolved. n19
C. Information Reporting
The Institute also asks the IRS
and Treasury Department to issue guidance on several important reporting issues
affecting RICs and their shareholders.
1. Uncertain Tax Positions
The Institute urges the IRS to
exempt from Schedule UTP reporting those tax positions for which a FIN 48
liability is not recorded because of administrative practice.
2. TIN Masking
Second, the Institute asks the
IRS and Treasury Department to make permanent its pilot program permitting
information return filers to "mask" (or obscure) the full Social
Security number on Forms 1099 and 5498 mailed to investors, with the changes
suggested by the Institute. n20
Masking or obscuring the full taxpayer identification number is the most
effective way to combat identity theft, and many RICs already do so on non-tax
documents sent to shareholders. We believe the pilot program is an important
step towards minimizing situations in which taxpayers' personal information may
be misappropriated from tax forms and, therefore, should be continued.
IV. Foreign Bank and Financial
Account Reporting
Finally, we urge the IRS to make
permanent its recent guidance regarding Form TD F 90-22.1, the Foreign Bank and
Financial Accounts Report ("FBAR"). Specifically, Notice 2010-23
provides that a taxpayer with signature authority over, but no financial interest
in, a foreign financial account, and who has no other reportable foreign
financial accounts, should check the "no" box in response to
FBAR-related questions on federal tax forms for 2009 and earlier years that ask
about the existence of a financial interest in, or signature authority over, a
foreign financial account. Requiring taxpayers with no financial interest in a
foreign financial account to report such information is of no value to the IRS.
Therefore, this guidance should be made permanent.
* * *
We will contact your offices
shortly to request a meeting to discuss further these issues and their
importance to the industry. In the meantime, if we can provide you with any
additional information regarding these issues, please do not hesitate to
contact me at (202) 326-5832 or lawson@ici.org.
Sincerely,
Keith Lawson
Senior Counsel --
Tax Law
Investment Company
Institute
Washington, DC
cc:
CC:PA:LPD:PR (Notice 2010-43)
Notice.Comments@irscounsel.treas.gov
Manal Corwin
Jeffrey Van Hove
Karl Walli
John J. Cross III
Michael S. Novey
Catherine V. Hughes
Jeanne F. Ross
Mark S. Smith
John Harrell
William D. Alexander
Stephen R. Larson
Steven A. Musher
Curtis G. Wilson
Phoebe Mix
Alice M. Bennett
Rebecca Harrigal
Susan T. Baker
Walter Harris
Richard LaFalce
Stephen J. Schaeffer
Roger E. Wade
FOOTNOTES:
n1
The Investment Company Institute is the national association
of U.S. investment companies, including mutual funds, closed-end funds,
exchange-craded funds (ETFs), and unit investment trusts (UITs). ICI seeks to
encourage adherence to high echical standards, promote public understanding,
and otherwise advance the interests of funds, their shareholders, directors,
and advisers. Members of ICI manage total assets of $ 11.97 trillion and serve
almost 90 million shareholders.
n2
A separate submission describes our Guidance Priority List
recommendations for retirement security issues.
n3
See Institute letters to William J. Wilkins dated
February 8, 2010, and May 25, 2010.
n4
See, e.g., Letter of May 15, 1991, from Jere D.
McGaffey to Fred T. Goldberg, Jr. (transmitting comments prepared by members of
the ABA's Section of Taxation on the application of market discount rules to
speculative bonds).
n5
See, e.g., Institute letter to Eric Solomon and Donald
Korb, dated July 28, 2008.
n6
See Institute letter to Greg F. Jenner and Donald L.
Korb, dated July 21, 2004.
n7
See Institute letter to Eric Solomon and Donald L.
Korb, dated May 13, 2008. See also, Testimony of William M. Paul on behalf of
the Institute, presented on March 5, 2008 before the House Ways and Means
Subcommittee on Select Revenue Measures,
http://waysandmeans.house.gov/hearings.asp?formmode=view&id=6824.
n8
See e.g., Institute letter to Alice Bennett, dated May
24, 2006.
n9
See Institute letter to Eric Solomon and Donald L.
Korb, dated September 12, 2008.
n10
The RIC Modernization Act legislation also would address
several other issues that have been included in prior ICI letters requesting
items for the Guidance Priority List. These items include: (1) treating all
redemptions of mutual fund shares as not being essentially equivalent to a
dividend; (2) addressing certain "flow-through" issues for funds of
funds; and (3) providing automatic extensions to file IRS Forms 1120-RIC.
n11
See Institute and SIFMA letter to Michael Desmond,
dated June 12, 2007.
n12
See Institute letter to Richard Hurst, Mary Berman and
Monice Rosenbaum, dated May 12, 2008, for comments regarding the Advance
Notice.
n13
At this time, we are not requesting a further extension of
Notice 2008-55 (relating to auction rate preferred stock). Should the
market conditions persist that necessitated the extension of Notice 2008-55
(provided by Notice 2010-3), we will make a separate request.
n14
See Institute letter to William D. Alexander and Lon
B. Smith, dated January 15, 2003. See also Institute letter to William
D. Alexander, dated April 30, 2004.
n15
See Treas. Reg.section 1.368-1(d)(3).
n16
See Institute letter, dated November 22, 2002, and
Institute letter to Dale S. Collinson, dated April 24, 2003.
n17
2006-2 C.B. 904.
n18
See Institute letter to Eric Solomon and Donald L.
Korb, dated May 12, 2006.
n19
See Institute letter to Lon B. Smith, dated December
29, 2006.
n20
See Institute letter regarding Notice 2009-93, dated April 30, 2010.
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