ICI Requests Guidance from IRS Regarding Contributions to NAV Funds
In its letter to the IRS, the Investment Company Institute ("ICI") requested guidance regarding the tax treatment of contributions from a stable net asset value ("NAV") fund to a floating NAV fund.
The ICI stated that in order to comply with the SEC's money market fund rules, investment advisers may decide to make cash contributions to existing money market funds to bring the shadow NAV of a fund up to $1.0000. The ICI explained that while, for book purposes, the contribution would not result in gain or income to the fund, and largely would be treated as paid-in capital, the tax treatment of the contribution remains uncertain.
The ICI acknowledged that existing authorities suggest two possible "approaches" for analyzing the contributions; however, it also noted that neither fully resolves the issue. In the first approach, the contributions are treated as short-term capital gain. If the gain were treated as net capital gain (because the fund's losses were insufficient to offset the gain), the fund could either be required to distribute some or all of the net capital gain to its shareholders, or be subject to a corporate-level tax. The ICI explained that the distribution to shareholders or the tax would reduce the NAV to below the $1.0000 level, thereby negating the purpose of the contribution.
The second approach involves treating the contribution as a non-shareholder contribution, which would result in a basis reduction in any assets held by the fund 12 months after the contribution was received. The ICI explained that the fund would have capital gain equal to the amount of the contribution when those assets were sold. Similar to the first approach, the second would result in a net gain and would require the fund to make a distribution or pay a tax that would also reduce the NAV to below $1.0000, negating the original purpose of the contribution.
The ICI pointed out that since both approaches could negate the intended purpose of complying with the SEC's money market reform rules, it is requesting that the IRS issue a revenue procedure that provides a safe harbor for the treatment of adviser contributions. Under the requested safe harbor, the IRS would agree not to challenge a registered investment company's treatment of an adviser contribution as generating (i) no income or gain to the fund and (ii) no reduction in the basis of the fund's assets. The ICI also suggested that the scope of the IRS guidance be limited to money market funds that comply with ICA Rule 2a-7, and to contributions that are made prior to the October 16, 2016 compliance date for the floating NAV SEC Rule.
See: ICI Comment letter.Related news: SEC Issues Final Money Market Fund Reform Rules (Fed. Reg.) (with Lofchie Comment) (August 14, 2014); SEC Proposes to Grant an Exemptive Order Regarding Confirmation Requirements for Certain Money Market Funds (Fed. Reg.) (July 30, 2014); SEC Adopts Money Market Fund Reform Rules (with Lofchie Comment and Delta Strategy Group Summary) (July 23, 2014); SEC Proposes in the Federal Register Money Market Fund Reform and Amendments to Form PF; Comments Due September 17th (with Lofchie Comment) (June 19, 2013); SEC Proposes Money Market Fund Reforms (June 6, 2013); SEC Open Meeting: Money Market Fund Reform (with link to Delta Strategy Description of SEC Meeting) (June 5, 2013).