December 6, 2021

Volume XI, Number 340

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December 03, 2021

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Proposed Tax Legislation Could Impact Exchange-Traded Funds

On September 10, 2021, Senator Ron Wyden (D-Oregon), Chairman of the U.S. Senate Committee on Finance, proposed draft legislation aimed at eliminating certain perceived loopholes and ambiguities in the tax rules applicable to partnerships and other pass-through entities. Notably, the proposed legislation would repeal a tax code provision, Section 852(b)(6), that allows regulated investment companies (RICs), including mutual funds and ETFs, to avoid recognizing gain on appreciated securities when they satisfy shareholder redemptions in kind (i.e., providing portfolio securities rather than cash in exchange for fund shares).

Although the repeal of Section 852(b)(6) would impact redemptions in kind made by both mutual funds and ETFs, the tax preference afforded to in-kind distributions provided by Section 852(b)(6) is at present a key advantage of the ETF structure. Unlike mutual funds, which typically satisfy shareholder redemptions in cash, most ETFs rely on the ability to effect in-kind creations and redemptions of shares with authorized participants in the normal course of their operations and thereby avoid realizing taxable gains on appreciated securities. A repeal of Section 852(b)(6) would require ETFs to recognize gains on any appreciated securities distributed to authorized participants in routine in-kind redemptions. As a result, because RICs are required under the tax code to distribute substantially all of their income and gains each year to avoid U.S. federal income tax at the fund level, ETFs would need to distribute to shareholders gains recognized on in-kind redemptions, which generally would be taxable to shareholders unless their shares are held in a tax-advantaged account. In addition, ETFs may need to sell securities in order to raise cash to satisfy this annual distribution requirement, potentially incurring transaction costs and generating additional gains. This change would therefore eliminate a key advantage ETFs currently enjoy vis-à-vis traditional mutual funds.

If the proposed legislation is enacted, the repeal of Section 852(b)(6) would apply to taxable years beginning after December 31, 2022.

A copy of the proposed legislation is available here, and a section-by-section summary is available here.

© 2021 Vedder PriceNational Law Review, Volume XI, Number 288
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About this Author

John Marten Investment Attorney Vedder Price Law FIrm
Shareholder

John S. Marten, a Shareholder in the Chicago office of Vedder Price, has substantial experience representing clients in the investment management industry.

As a member of the firm’s Investment Services group, Mr. Marten counsels clients on a wide variety of matters involving the application of the federal securities laws to investment companies, investment advisers and broker-dealers. He has significant experience counseling investment company clients with respect to new products and was recently involved in the creation of two mutual funds...

(312) 609 7753
Jacob Tiedt,Vedder Price law firm investment services attorney
Shareholder

Jacob C. Tiedt is a Shareholder at Vedder Price and a member of the Investment Services group.

Mr. Tiedt’s practice includes the representation of registered mutual funds, closed-end funds and exchange-traded funds; private funds; investment advisers; and other financial institutions on a broad range of regulatory, governance and compliance matters. Mr. Tiedt regularly counsels clients on matters relating to SEC registration, disclosure and compliance; shareholder solicitation; NYSE, Nasdaq and FINRA regulation; corporate governance; and board administration. Mr....

312-609-7697
Nathaniel Segal Investment Attorney Vedder Price Law Firm
Counsel

Nathaniel Segal is counsel at Vedder Price and a member of the Investment Services group. He focuses his practice on investment companies and investment advisers in connection with the organization and operation of investment products and services, including traditional mutual funds, closed-end investment companies (including interval funds and listed closed-end funds), variable insurance products and registered hedge funds, as well as mutual funds utilizing complex hedging and absolute return strategies. Mr. Segal has experience in conducting transactional due diligence...

(312) 609 7747
Jake Wiesen Investment Attorney Vedder Price
Associate

Jake W. Wiesen is an Associate in the Chicago office of Vedder Price and a member of the firm’s Investment Services practice group.

While in law school, Mr. Wiesen served as Associate Editor of the University of Illinois Law Review, a student attorney for the Civil Litigation Clinic and a teaching assistant for Introduction to Advocacy. He was also the recipient of the CALI Excellence for the Future Award in Administrative Law and Employee Benefits.

Prior to joining Vedder Price, Mr. Wiesen worked as a legal intern for the Chicago Transit Authority and served as a...

312 609 7838
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