IRS revokes PLR on whether commodity-linked notes qualify as RIC securities

On Oct. 24, 2016, the Treasury Department and the IRS issued proposed regulations (REG-123600-16) that provided guidance on the requirements a corporation must satisfy to qualify as a regulated investment company (RIC).

To be treated as a RIC, a corporation must satisfy a gross income test under Section 851(b)(2) (the RIC Income Test) and an asset diversification test under Section 851(b)(3) (the RIC Asset Test). Under the RIC Income Test, at least 90% of a RIC’s income must be derived from dividends, interest, sale of stock or securities, and other income derived with respect to the RIC’s business of investing in stock, securities or currencies. Under the RIC Asset Test, at least 50% of the value of a RIC’s assets must be made up of cash, securities and other similar assets.

For purposes of both the RIC Income Test and the RIC Asset Test, Section 851 defines securities by reference to the Investment Act of 1940 (the 1940 Act).  The preamble to the proposed regulations emphasized that any future guidance regarding whether particular financial instruments are securities for purposes of the 1940 Act is within the jurisdiction of the SEC rather than the IRS. Concurrently with the issuance of the proposed regulations, the IRS issued Rev. Proc. 2016-50, which stated that the IRS will not ordinarily issue letter rulings that require a determination of whether an instrument is a security as defined in the 1940 Act.

Over the last decade, the IRS has issued about a dozen private letter rulings (PLRs) in which it determined that commodity-linked notes (CLNs) held by taxpayers met the definition of “security” in the 1940 Act. Recently, the IRS followed up on the proposed regulations and Rev. Proc. 2016-50 by revoking those PLRs. For taxpayers who requested prospective application of the revocations, the IRS ruled that the revocation applied only to CLNs acquired by those taxpayers after June 30, 2017.

Andy Cordonnier
Partner, Washington National Tax Office
T +1 202 521 1502

Jeff Borghino
Partner, Washington National Tax Office
T +1 202 521 1532

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