Guidance under Section 851 Relating to Investments in Stock and Securities, 66576-66578 [2016-23408]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 81, Number 188 (Wednesday, September 28, 2016)]
[Proposed Rules]
[Pages 66576-66578]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-23408]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-123600-16]
RIN 1545-BN55


Guidance under Section 851 Relating to Investments in Stock and 
Securities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document provides guidance relating to the income test 
and the asset diversification requirements that are used to determine 
whether a corporation may qualify as a regulated investment company 
(RIC) for federal income tax purposes. These proposed regulations 
provide guidance to corporations that intend to qualify as RICs.

DATES: Written or electronic comments and requests for a public hearing 
must be received by December 27, 2016.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-123600-16), Room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
123600-16), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue NW., Washington, DC 20224, or sent electronically via the 
Federal eRulemaking Portal at www.regulations.gov (IRS REG-123600-16).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Matthew Howard of the Office of Associate Chief Counsel (Financial 
Institutions and Products) at (202) 317-7053; concerning submissions of 
comments and requests for a public hearing, Regina Johnson (202) 317-
6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1) relating to RICs. Section 851 of the Internal Revenue Code 
(Code) sets forth requirements for qualifying as a RIC.
    Section 851(a) provides that a RIC is any domestic corporation that 
(1) at all times during the taxable year is registered under the 
Investment Company Act of 1940, Public Law 76-768, 54 Stat. 789 
(codified as amended at 15 U.S.C. 80a-1--80a-64 (2016)) (the 1940 Act), 
as a management company or unit investment trust or has in effect an 
election under the 1940 Act to be treated as a business development 
company; or (2) is a common trust fund or other similar fund excluded 
by section 3(c)(3) of the 1940 Act from the definition of ``investment 
company'' and is not included in the definition of ``common trust 
fund'' by section 584(a).
    To be treated as a RIC for a taxable year, a corporation must 
satisfy the income test set forth in section 851(b). The income test 
under section 851(b)(2) requires that at least 90 percent of the 
corporation's gross income for the taxable year be derived from:

    (A) dividends, interest, payments with respect to securities 
loans (as defined in section 512(a)(5)), and gains from the sale or 
other disposition of stock or securities (as defined in section 
2(a)(36) of the [1940 Act]) or foreign currencies, or other income 
(including but not limited to gains from options, futures or forward 
contracts) derived with respect to its business of investing in such 
stock, securities, or currencies, and (B) net income derived from an 
interest in a qualified publicly traded partnership (as defined in 
[section 851(h)]).

    Section 851(b)(3) provides that to be treated as a RIC a 
corporation also must satisfy the following asset diversification 
requirements at the close of each quarter of the corporation's taxable 
year:

    (A) at least 50 percent of the value of its total assets is 
represented by--
    (i) cash and cash items (including receivables), Government 
securities and securities of other [RICs], and
    (ii) other securities for purposes of this calculation limited, 
except and to the extent provided in [section 851(e)], in respect of 
any one issuer to an amount not greater in value than 5 percent of 
the value of the total assets of the taxpayer and to not more than 
10 percent of the outstanding voting securities of such issuer, and
    (B) not more than 25 percent of the value of its total assets is 
invested in--
    (i) the securities (other than Government securities or the 
securities of other [RICs]) of any one issuer,
    (ii) the securities (other than the securities of other [RICs]) 
of two or more issuers which the taxpayer controls and which are 
determined, under regulations prescribed by the Secretary, to be 
engaged in the same or similar trades or businesses or related 
trades or businesses, or
    (iii) the securities of one or more qualified publicly traded 
partnerships (as defined in [section 851(h)]).

    These proposed regulations relate to the RIC income test and asset 
diversification requirements. Section A. of this preamble concerns the 
meaning of security. Section B. of this preamble addresses inclusions 
under sections 951(a)(1)(A)(i) and 1293(a). These proposed regulations 
also revise Sec.  1.851-2(b)(1) of the existing final regulations to 
merely incorporate changes to section 851(b)(2) since the existing 
final regulations were published in the Federal Register on November 
26, 1960, in TD 6500 (25 FR 11910).

A. Defining Securities

    The income test and asset diversification requirements both use the 
term ``securities.'' For purposes of the income test, a security is 
defined by reference to section 2(a)(36) of the 1940 Act, while section 
851(c) provides rules and definitions that apply for purposes of the 
asset diversification requirements of section 851(b)(3) but does not 
specifically define ``security.'' Section 851(c)(6), however, provides 
that the terms used in section 851(b)(3) and (c) have the same meaning 
as when used in the 1940 Act. An asset is therefore a security for 
purposes of the income test and the asset diversification requirements 
if it is a security under the 1940 Act.
    The Treasury Department and the IRS have in the past addressed 
whether certain instruments or positions are securities for purposes of 
section 851. In particular, Rev. Rul. 2006-1 (2006-1 CB 261) concludes 
that a derivative contract with respect to a commodity index is not a 
security for purposes of section 851(b)(2). The ruling also holds that 
income from such a contract is not qualifying other income for purposes 
of section 851(b)(2) because that income is not derived with respect to 
the RIC's business of investing in stocks, securities, or currencies. 
Rev. Rul. 2006-1 was modified and clarified by Rev. Rul. 2006-31 (2006-
1 CB 1133), which states that Rev. Rul. 2006-1 was not intended to 
preclude a conclusion that income from certain instruments (such as 
certain structured notes) that create commodity exposure for the holder 
is qualifying income under section 851(b)(2).
    After the issuance of Rev. Rul. 2006-31, the IRS received a number 
of private

[[Page 66577]]

letter ruling requests concerning whether certain instruments that 
provide RICs with commodity exposure were securities for purposes of 
the income test and the asset diversification requirements. By 2010, 
the IRS was devoting substantial resources to these private letter 
ruling requests. Moreover, it is not clear whether Congress intended to 
allow RICs to invest in securities that provided commodity exposure. 
Consequently, in July 2011, the IRS notified taxpayers that the IRS 
would not issue further private letter rulings addressing specific 
proposed RIC commodity-related investments while the IRS reviewed the 
issues and considered guidance of broader applicability.
    Finally, determining whether certain investments that provide RICs 
with commodity exposure are securities for purposes of the income test 
and the asset diversification requirements requires the IRS implicitly 
to determine what is a security within the meaning of section 2(a)(36) 
of the 1940 Act. Section 38 of the 1940 Act, however, grants exclusive 
rulemaking authority under the 1940 Act to the Securities and Exchange 
Commission (SEC), including ``defining accounting, technical, and trade 
terms'' used in the 1940 Act. Any future guidance regarding whether 
particular financial instruments, including investments that provide 
RICs with commodity exposure, are securities for purposes of the 1940 
Act is therefore within the jurisdiction of the SEC.
    Section 2.01 of Rev. Proc. 2016-3 (2016-1 IRB 126) provides that 
the IRS may decline to issue a letter ruling or a determination letter 
when appropriate in the interest of sound tax administration (including 
due to resource constraints) or on other grounds whenever warranted by 
the facts or circumstances of a particular case. If the IRS determines 
that it is not in the interest of sound tax administration to issue a 
letter ruling or determination letter due to resource constraints, the 
IRS will adopt a consistent approach with respect to taxpayers that 
request a ruling on the same issue. The IRS will also consider adding 
the issue to the no rule list at the first opportunity.
    The Treasury Department and the IRS have reviewed the issues, 
considered the concerns expressed, considered resource constraints, and 
determined that the IRS should no longer issue letter rulings on 
questions relating to the treatment of a corporation as a RIC that 
require a determination of whether a financial instrument or position 
is a security under the 1940 Act. Contemporaneously with the 
publication of these proposed regulations, the Treasury Department and 
the IRS are issuing Rev. Proc. 2016-50 (2016-43 IRB __), which provides 
that the IRS ordinarily will not issue rulings or determination letters 
on any issue relating to the treatment of a corporation as a RIC that 
requires a determination of whether a financial instrument or position 
is a security under the 1940 Act. Thus, for example, the IRS ordinarily 
will not issue a ruling on whether income is of a type described in the 
income test of section 851(b)(2) if that ruling depends on whether an 
instrument is a security under the 1940 Act.
    The Treasury Department and the IRS request comments as to whether 
Rev. Rul. 2006-1, Rev. Rul. 2006-31, and other previously issued 
guidance that involves determinations of whether a financial instrument 
or position held by a RIC is a security under the 1940 Act should be 
withdrawn effective as of the date of publication in the Federal 
Register of a Treasury decision adopting these proposed regulations as 
final regulations.

B. Inclusions Under Section 951(a)(1)(A)(i) or 1293(a)

    In certain circumstances, a U.S. person may be required under 
section 951(a)(1)(A)(i) or 1293(a) to include in taxable income certain 
earnings of a foreign corporation in which the U.S. person holds an 
interest, without regard to whether the foreign corporation makes a 
corresponding distribution of cash or property to the U.S. person. 
Section 851(b) was amended by the Tax Reduction Act of 1975, Public Law 
94-12, section 602, 89 Stat. 26, 58 (the ``1975 Act'') (for inclusions 
under section 951(a)(1)(A)(i)), and by the Tax Reform Act of 1986, 
Public Law 99-514, section 1235, 100 Stat. 2085, 2575 (the ``1986 
Act'') (for inclusions under section 1293(a)), to specify how a RIC 
treats amounts included in income under section 951(a)(1)(A)(i) or 
1293(a) for purposes of the income test of section 851(b)(2). The 
language added in those amendments provides:

    For purposes of [section 851(b)(2)], there shall be treated as 
dividends amounts included in gross income under section 
951(a)(1)(A)(i) or 1293(a) for the taxable year to the extent that, 
under section 959(a)(1) or 1293(c) (as the case may be), there is a 
distribution out of the earnings and profits of the taxable year 
which are attributable to the amounts so included.

The significance of treating an inclusion as a dividend under section 
851 is that a dividend is qualifying income under section 851(b)(2). 
The amendments to section 851(b) made by the 1975 Act and the 1986 Act 
unambiguously condition dividend treatment of an inclusion under 
section 951(a)(1)(A)(i) or 1293(a) on a distribution from the foreign 
corporation's earnings and profits attributable to the amount included. 
Absent a distribution, there is no support in the Code for treating an 
inclusion under section 951(a)(1)(A)(i) or 1293(a) as a dividend under 
section 851.
    Notwithstanding the distribution required by section 851(b), in 
certain circumstances the IRS has previously issued letter rulings 
under section 851(b)(2) that permit an inclusion under section 
951(a)(1)(A)(i) or 1293(a) to qualify as ``other income'' derived with 
respect to a RIC's business of investing in currencies or 1940 Act 
stock or securities even in the absence of a distribution. Reading 
section 851(b)(2) in this manner ignores the requirement in section 
851(b) that amounts be distributed in order to treat these inclusions 
as dividends. This distribution requirement is a more specific 
provision than the other income clause. In addition, it cannot be 
suggested that the distribution requirement was superseded by the other 
income clause because the other income clause and the distribution 
requirement for inclusions under section 1293(a) were both added by the 
1986 Act. Therefore, these proposed regulations specify that an 
inclusion under section 951(a)(1)(A)(i) or 1293(a) is treated as a 
dividend for purposes of section 851(b)(2) only to the extent that the 
distribution requirement in section 851(b) is met. These proposed 
regulations further provide that, for purposes of section 851(b)(2), an 
inclusion under section 951(a)(1) or 1293(a) does not qualify as other 
income derived with respect to a RIC's business of investing in stock, 
securities, or currencies.

Proposed Effective/Applicability Date

    The rule in Sec.  1.851-2(b)(2)(iii) of the proposed regulations 
applies to taxable years that begin on or after the date that is 90 
days after the date of publication in the Federal Register of a 
Treasury decision adopting these proposed regulations as final 
regulations.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does

[[Page 66578]]

not apply to these regulations, and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, this notice of proposed 
rulemaking will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS as prescribed in this preamble under the ``Addresses'' 
heading. The Treasury Department and the IRS specifically request 
comments on the clarity of the proposed regulations and how they can be 
made easier to understand. All comments will be made available for 
public inspection at www.regulations.gov or upon request. A public 
hearing will be scheduled if requested in writing by any person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

Drafting Information

    The principal author of these proposed regulations is Matthew 
Howard, Office of Associate Chief Council (Financial Institutions and 
Products). However, other personnel from the Treasury Department and 
the IRS participated in their development.

Statement of Availability of IRS Documents

    The IRS revenue rulings and revenue procedure cited in this 
preamble are published in the Internal Revenue Bulletin (or Cumulative 
Bulletin) and are available from the Superintendent of Documents, U.S. 
Government Publishing Office, Washington, DC 20402, or by visiting the 
IRS Web site at www.irs.gov.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.851-2 is amended by:
0
1. Revising paragraphs (b)(1) and (b)(2)(i).
0
2. Adding paragraph (b)(2)(iii).
    The addition and revisions read as follows:


Sec.  1.851-2   Limitations.

* * * * *
    (b) Gross income requirement--(1) General rule. A corporation will 
not be a regulated investment company for a taxable year unless 90 
percent of its gross income for that year is income described in 
paragraph (b)(1)(i) of this section or in paragraph (b)(1)(ii) of this 
section. Any loss from the sale or other disposition of stock or 
securities is not taken into account in the gross income computation.
    (i) Gross income amounts. Income is described in this paragraph 
(b)(1)(i) if it is gross income derived from:
    (A) Dividends;
    (B) Interest;
    (C) Payments with respect to securities loans (as defined in 
section 512(a)(5));
    (D) Gains from the sale or other disposition of stocks or 
securities (as defined in section 2(a)(36) of the Investment Company 
Act of 1940, as amended);
    (E) Gains from the sale or other disposition of foreign currencies; 
or
    (F) Other income (including but not limited to gains from options, 
futures, or forward contracts) derived with respect to a regulated 
investment company's business of investing in such stock, securities, 
or currencies.
    (ii) Income from a publicly traded partnership. Income is described 
in this paragraph (b)(1)(ii) if it is net income derived from an 
interest in a qualified publicly traded partnership (as defined in 
section 851(h)).
    (2) Special rules--(i) For purposes of section 851(b)(2)(A) and 
paragraph (b)(1)(i)(A) of this section, amounts included in gross 
income for the taxable year under section 951(a)(1)(A)(i) or 1293(a) 
are treated as dividends only to the extent that, under section 
959(a)(1) or 1293(c) (as the case may be), there is a distribution out 
of the earnings and profits of the taxable year that are attributable 
to the amounts included in gross income for the taxable year under 
section 951(a)(1)(A)(i) or 1293(a). For allocation of distributions to 
earnings and profits of foreign corporations, see Sec.  1.959-3.
* * * * *
    (iii) For purposes of section 851(b)(2)(A) and paragraph 
(b)(1)(i)(F) of this section, amounts included in gross income under 
section 951(a)(1) or 1293(a) are not treated as other income derived 
with respect to a corporation's business of investing in stock, 
securities, or currencies. The rule in this paragraph (b)(2)(iii) 
applies to taxable years that begin on or after the date that is 90 
days after the date of publication in the Federal Register of a 
Treasury decision adopting these proposed regulations as final 
regulations.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2016-23408 Filed 9-27-16; 8:45 am]
 BILLING CODE 4830-01-P