The Treasury Department and the IRS recently issued proposed
REG-123600-16) that provide guidance on the requirements a
corporation must satisfy to qualify as a regulated investment
Two of the requirements that a corporation must satisfy to be
treated as an RIC are a gross income test under Section 851(b)(2)
(the RIC Income Test) and an asset diversification test under
Section 851(b)(3) (the RIC Asset Test). The RIC Income Test
provides that at least 90% of a RIC’s income must be derived
from a source list that includes dividends, interest, sale of stock
or securities, and other income derived with respect to its
business of investing in stock, securities or currencies. The RIC
Asset Test provides that at least 50% of the value of a RIC’s
assets must be made up of cash, securities and other similar
For purposes of both the RIC Income Test and the RIC Asset Test,
Section 851 defines securities by reference to the Investment Act
of 1940 (the 1940 Act). In 2006, the IRS issued Rev. Rul. 2006-1,
which ruled that a derivative with respect to a commodity was not a
security for RIC qualification purposes. That same year, the IRS
issued Rev. Rul. 2006-31, which clarified that not all instruments
that provided commodities exposure were foreclosed from being
treated as securities for RIC qualification purposes.
The preamble to the proposed regulations emphasizes that any
future guidance regarding whether particular financial instruments
are securities for purposes of the 1940 Act is within the
jurisdiction of the SEC rather than the IRS. Concurrently with the
issuance of the proposed regulations, the IRS stated in Revenue
Procedure 2016-50 that it will not ordinarily issue letter
rulings or determination letters that require a determination of
whether a financial instrument or position is a security as defined
in the 1940 Act.
Section 851 provides that a RIC may treat income of a foreign
corporation included in the RIC’s income under Section
951(a)(1)(A)(i) or Section 1293(a) as a dividend for purposes of
the RIC Income Test, as long as there is a distribution from the
foreign corporation’s earnings and profits that’s
attributable to the amount included. In the past, the IRS has
issued private letter rulings allowing RICs to count those
inclusions toward the 90% threshold of the RIC Income Test, even
without corresponding distributions, by treating the inclusions as
other income derived with respect to the business of investing in
stocks, securities or currencies. The proposed regulations provide
that an inclusion under Section 951(a)(1)(A)(i) or Section 1293(a)
cannot be treated as falling within that other income category.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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