IRS Addresses RIC Asset Diversification Requirements

Katten Muchin Rosenman LLP

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.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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