Part Cash, Part Stock, 100% Taxable – New IRS Guidance on RIC and REIT Distributions

by Dechert LLP
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The U.S. Internal Revenue Service (“IRS”), on August 11, 2017, issued Revenue Procedure 2017-45 (the “New Revenue Procedure”).1 Pursuant to the New Revenue Procedure, the IRS will treat part cash and part stock distributions of regulated investment companies (“RICs”) and real estate investment trusts (“REITs”) as being taxable dividends for all U.S. federal income tax purposes, including for purposes of the RIC and REIT distribution requirements, if the distribution satisfies the requirements of the New Revenue Procedure.

The New Revenue Procedure supplements temporary guidance issued by the IRS in 2008 and 2009 which has since expired (the “Prior Guidance”),2 and should obviate the need to obtain a private letter ruling (“PLR”) for distributions made in accordance with these guidelines.

Generally, in order to avoid liability for corporate level tax and qualify as a conduit of certain types of income and gain under subchapter M of the Internal Revenue Code of 1986, as amended (the “Code”), RICs and REITs must satisfy numerous requirements, including the requirement that the RIC or REIT’s deduction for dividends paid equal at least of 90% of the RIC or REIT’s net income with respect to each taxable year. A RIC or REIT’s distribution of its own shares of stock generally does not give rise to a deduction for dividends paid unless special circumstances apply, such as where a shareholder may elect to receive cash or other property in lieu of stock. In light of these rules, the New Revenue Procedure sets forth requirements whereby a distribution by a publicly offered RIC or REIT that is made partially in cash and partially in stock, at the election of the shareholder, will be included as a component of a RIC or REIT’s dividends paid deduction. Qualifying distributions also will be treated as taxable dividends by the RIC or REIT’s shareholders.

A distribution of shares of stock of a publicly offered RIC or REIT will qualify for the dividends paid deduction as well as taxable dividend treatment in the hands of shareholders under the New Revenue Procedure if the distribution satisfies the following requirements:

  • The publicly offered RIC or publicly offered REIT makes a distribution to its shareholders with respect to its stock;

  • Each shareholder may elect to receive part or all of the distribution in either cash or stock;3

  • The aggregate amount of cash to be distributed as limited by the declaration of distribution (the “cash limitation amount”) as a fraction of the aggregate total value of all stock and cash to be distributed (such fraction the “cash limitation percentage”) must not be less than 20%;

  • A shareholder electing to receive an equal or lower percentage of cash than the cash limitation percentage receives the full amount of cash elected to be received by such shareholder;

  • If the aggregate amount of cash elected to be received by all shareholders does not exceed the cash limitation amount, then shareholders receive the amount of cash elected to be received by them;

  • If the aggregate amount of cash elected to be received by all shareholders exceeds the cash limitation amount, then each shareholder electing to receive a percentage of cash which exceeds the cash limitation percentage receives cash in excess of the cash limitation percentage on a pro rata basis, in proportion to the amount by which the percentage of cash elected to be received by such shareholder exceeds the cash limitation percentage; and

  • The number of shares of stock to be received by each shareholder as part of this distribution is computed in accordance with a pre-determined timing and valuation guidelines. 

The New Revenue Procedure differs from the Prior Guidance in several respects, including the applicable cash limitation percentage required. Whereas the New Revenue Procedure requires the cash limitation percentage to be not less than 20%, which is in-line with numerous PLRs issued by the IRS both before and after the expiration of the Prior Guidance, the Prior Guidance had permitted a lower cash limitation percentage (i.e., no less than 10%). Furthermore, the New Revenue Procedure now applies to publicly offered RICs (which generally includes registered investment company structures, such as continuously-offered funds and publicly traded funds) and publicly offered REITs (i.e. REITs that are required to file annual and periodic reports with the Securities and Exchange Commission), versus only publicly traded RICs and REITs under the Prior Guidance. The New Revenue Procedure is effective with respect to distributions declared on or after August 11, 2017.

Footnotes

1) 2017 WL 3449210 (August 11, 2017).

2) Rev. Proc. 2010-12, 2010-3 I.R.B. 302; Rev. Proc. 2009-15, 2009-4 I.R.B. 356; Rev. Proc. 2008–68, 2008-52 I.R.B. 1373.

3) The New Revenue Procedure does not affect the tax treatment of the portion of the distribution, if any, that is not subject to the election.

 

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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