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IRS Addresses RIC Asset Diversification Requirements

On September 14, the Internal Revenue Service (IRS) issued final regulations under Internal Revenue Code Section 851 clarifying that control groups under the regulated investment company (RIC) rules may consist of two entities (i.e., the RIC and one subsidiary), rather than two levels of entities, settling a decades-long debate. The IRS also issued Rev. Proc. 2015-45, 2015-39 IRB 1, which provides a safe harbor for fund of funds structures.

RIC Control Groups. Changes have been made to examples 1 and 4 in Reg. Section 1.851-5 to clarify that a wholly owned subsidiary of a RIC is a member of the RIC’s control group whether or not the subsidiary controls another entity. New example 7 was also added to illustrate the application of the requirement under Section 851(b)(3)(B)(iii) that no more than 25 percent of a RIC’s assets may be in qualified publicly traded partnerships (QPTPs). The new example clarifies that RICs must look through a corporation to the corporation’s assets if the RIC owns more than 20 percent of the voting stock of the corporation in assessing compliance with the 25 percent limit on QPTP investment.

Fund of Fund Safe Harbor. The new safe harbor for a RIC of RICs is in the form of a per se determination, subject to anti-abuse rules, that a RIC will be treated as satisfying its asset diversification requirement if each subsidiary RIC that is within its control group meets the 25 percent asset diversification test (including by applying certain exceptions and cure periods at the subsidiary RIC level). Thus, the IRS has clarified that a fund of funds may look through its underlying funds to determine compliance with the requirements. Prior uncertainty under the RIC control group rules as to whether the fund of funds could satisfy its diversification requirements on a look- through basis, and whether it could determine some of the exceptions and cure periods based on the subsidiary RIC, would have led to unanticipated compliance burdens for a fund of funds.

©2020 Katten Muchin Rosenman LLPNational Law Review, Volume V, Number 269

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About this Author

Robert Loewy, Tax Legal Specialist, Katten Muchin Law firm
Special Counsel

Robert Loewy concentrates his practice in tax planning and litigation.

Robert advises domestic and foreign clients on a broad range of US and international tax issues. His practice is both transactional and advisory, focusing on the taxation of financial instruments and products, hedge funds and private clients. He also has extensive experience in advising clients as to the tax consequences of domestic and cross-border mergers, acquisitions and restructurings.

212-940-6303
Partner

Jill E. Darrow is head of Katten's New York Tax Planning practice. She concentrates her practice in tax planning and tax law with a focus on partnership transactions, financial services, hedge funds, commodities funds and real estate.

Jill advises clients on all aspects of tax with a concentration in the areas of financial services and real estate. Her practice covers the tax aspects of transactions involving partnerships, limited liability companies, carried interests, subchapter S corporations, regulated investment companies (mutual funds), recording and publishing ventures, real estate investment trusts (REITs), publicly traded partnerships, real estate limited partnerships, partnership tender offers, partnership roll-ups, securities and commodities funds (domestic and offshore), hedge funds and passive foreign investment companies.

212-940-7113