- Fund Regulation
- Retirement Security
- Trading & Markets
- Fund Governance
- ICI Comment Letters
Statement of the
Investment Company Institute
on the Tax Technical Corrections Act of 2003
Submitted to the
Committee on Ways and Means
United States House of Representatives
January 23, 2004
Table of Contents
- The Tax Technical Corrections Act of 2003 Should Be Enacted Promptly The Investment Company Institute strongly supports the Tax Technical Corrections Act of 2003 (“TTCA”) and urges its prompt enactment. In particular, we support the technical corrections to the Jobs and Growth Tax Relief and Reconciliation Act of 2003 (“JGTRRA”) that clarify rules relating to qualified dividend income (“QDI”) taxable at the new 15 percent maximum tax rate. These technical corrections would provide the approximately 25 million mutual fund shareholders who invest through taxable accounts in funds holding equities with the tax benefits intended by Congress when JGTRRA was enacted.
- Effect of Technical Corrections on Mutual Fund Shareholders
- Transition Relief from 60-day Designation RequirementThe TTCA includes transition relief from the statutory requirements for timely designating the character of dividends paid. QDI designations for distributions made by funds for taxable years ending during 2003 are being made, taking this transition relief into account, by January 31, 2004 (the date by which the fund must provide IRS Form 1099 information to shareholders for payments made in 2003).
- Flow through of QDI from Qualified Foreign Corporations and REITsThe TTCA clarifies that dividends received by a fund from qualified foreign corporations and REITs that are eligible for QDI treatment do not inadvertently lose that eligibility when they flow through a fund to its shareholders.
- Effective Date for Partnerships in Master Feeder StructuresThe TTCA clarifies that JGTRRA provides investors in partnerships with the same effective date for QDI benefits that JGTRRA expressly provides to shareholders in mutual funds. Among other things, the clarification will permit fund shareholders who invest in a feeder fund that holds an interest in a master fund partnership (where the portfolio management is performed) to receive the same benefits as other fund shareholders.
- Mutual Fund Distribution of Subchapter C Earnings and ProfitsThe TTCA clarifies that a fund shareholder will receive QDI treatment for dividends attributable to amounts previously taxed to a fund’s predecessor.
- Holding Period Requirement for Qualified Dividend IncomeThe TTCA clarifies that the period during which common stock must be held for 61 days to receive QDI treatment is 121, rather than 120, days (i.e., 60 days both before and after the ex-dividend date). This clarification will permit an investor who acquires stock the day before it goes ex-dividend to meet the holding-period requirement.
The Investment Company Institute (the "Institute")1 strongly supports the Tax Technical Corrections Act of 2003 (“TTCA”)2 and urges its prompt enactment. In particular, we support the technical corrections to the Jobs and Growth Tax Relief and Reconciliation Act of 2003 (“JGTRRA”) that clarify rules relating to qualified dividend income (“QDI”) taxable at the new 15 percent maximum tax rate. The approximately 25 million mutual fund shareholders who invest through taxable accounts in funds holding equities would benefit from these changes to Internal Revenue Code section 8543 (which provides the rules pursuant to which QDI received by a mutual fund beginning January 1, 2003 retains its character when paid by the fund to its shareholders).
Transition Relief from 60-Day Designation Requirement
Section 854(b)(2), as amended by JGTRRA, provides that the amount of any distribution by a fund that may be treated as QDI shall not exceed the amount designated by the fund “in a written notice to its shareholders mailed not later than 60 days after the close of its taxable year.” For funds with taxable years that ended more than 60 days before JGTRRA was enacted (i.e., funds with January and February year-ends), there was no opportunity to make this 60-day designation for distributions made during the taxable year. Even for funds with later taxable year-ends, the ability to make prompt designations has been hampered by delays in the issuance of comprehensive Treasury guidance (particularly before the recent release of guidance regarding dividends from foreign corporations) and by the funds’ need to review 2003 transaction histories.
The TTCA would provide transition relief for 2003 from the 60-day designation requirement. Specifically, the TTCA would provide that, with respect to the taxable year of a fund ending on or before November 30, 2003, the period for providing notice of the qualified dividend amount, as required under section 854(b)(2), does not expire prior to the date by which the fund must provide IRS Form 1099 information to shareholders in accordance with section 6042(c) (i.e., January 31, 2004).
Flow Through of QDI from Qualified Foreign Corporations and REITs
Under section 854(b)(1)(B), as enacted in JGTRRA, if the aggregate dividends received by a fund are less than 95 percent of its gross income for the year, then shareholders can treat as QDI only the portion of the fund’s dividends designated by the fund as such. Section 854(b)(1)(C) limits the amount of dividends that a fund may designate as QDI to the amount of aggregate dividends received by the fund for the taxable year.
The definition of aggregate dividends provided by section 854(b)(3) prior to enactment of JGTRRA excluded certain dividends that generally are treated as QDI and also included other dividends that generally are not treated as QDI. To address the under-inclusiveness of section 854(b)(3), JGTRRA added new clauses (iii) and (iv) of section 854(b)(1)(B) to expand the definition of aggregate dividends for purposes of clause (i) of section 854(b)(1)(B) to include dividends received from qualified foreign corporations and certain dividends received from a real estate investment trust (“REIT”). To address the over-inclusiveness of the term “aggregate dividends,” JGTRRA added new section 854(b)(5) to limit the amount that a fund can include in aggregate dividends, for purposes of section 854(b)(1)(B), to the QDI of the fund.
The JGTRRA provisions designed to address the under-inclusiveness of section 854(b)(3) -- by expanding the definition of aggregate dividends -- apparently do not apply for purposes of section 854(b)(1)(C), which limits the amount of QDI the fund can designate under section 854(b)(1)(B) to the amount of aggregate dividends received by the fund. Likewise, the JGTTRA provisions designed to address the over-inclusiveness of section 854(b)(3) -- by limiting the amount that a fund can include in aggregate dividends -- apparently do not apply for purposes of the section 854(b)(1)(C) limitation.
The effect of the JGTRRA changes not applying for purposes of section 854(b)(1)(C) would be to prevent funds that do not receive at least 95 percent of their gross income from qualifying dividends from treating any dividends received from qualified foreign corporations and REITs as part of the aggregate dividends that may be designated as QDI.
To ensure that section 854 operates as intended, the TTCA would modify the limitation on the designation of QDI and thereby clarify that dividends from qualified foreign corporations and eligible REIT dividends may flow through a fund to its shareholders.
Effective Date for Partnerships in Master Feeder Structures
The 15 percent maximum tax rate on QDI provided by JGTRRA applies to dividends received by individuals in taxable years beginning after December 31, 2002. In the case of dividends received by funds, JGTRRA applies to dividends received after December 31, 2002 (without regard to the fund’s taxable year).
A recently-issued IRS Announcement interpreting the JGTRRA effective date provisions (Announcement 2003-56) states that, in the case of partnerships with fiscal years beginning in 2002 and ending in 2003, no dividends received by the partnership during that fiscal year may be treated as qualified dividends, even if received during 2003. By its terms, this announcement would appear to apply to funds that invest in partnerships, including funds that are part of a master-feeder structure.
The master-feeder structure, which is common in the mutual fund industry,4 typically consists of one or more mutual funds, known as “feeder funds,” with substantially identical investment objectives that pool their assets in a single investment pool, or “master fund,” that is classified as a partnership for federal income tax purposes. The feeder funds and the master fund typically have the same taxable year. Feeder funds, as partners in a partnership, do not receive dividends directly; instead, they take into income their distributive shares of the dividend income received by the master fund partnership pursuant to section 702.
Under the effective date provision applicable to mutual funds, a mutual fund with a taxable year ending on June 30, 2003 would treat the new qualified dividend provisions as applying to dividends it received during the period from January 1, 2003 through June 30, 2003. We believe that this result was intended to apply without regard to whether the mutual fund received the dividends directly from the distributing corporation or through a master fund that held the stock of the distributing corporation.
The TTCA would modify JGTRRA by essentially providing partnerships with the same effective date that applies to funds. Under the TTCA, partnerships, like funds, would be permitted to treat as QDI the eligible dividends received after 2002, even if the partnership’s fiscal year began before January 2003.
Mutual Fund Distribution of Subchapter C Earnings and Profits
JGTRRA does not include any specific provision pursuant to which a fund may treat as QDI a distribution of subchapter C earnings and profits that it acquired in a tax-free acquisition of a C corporation’s assets or as a result of a C corporation converting to a mutual fund; these amounts must be distributed by the fund to maintain its status as a regulated investment company under subchapter M.
Subchapter C earnings and profits have been taxed at the entity level and hence may be distributed to the C corporation’s shareholders as QDI. Shareholders in a fund that distributes Subchapter C earnings and profits received in situations described above likewise should be permitted to treat the distributed amounts as QDI. Treatment as QDI should not be forfeited merely because the Subchapter C earnings and profits are distributed by the fund rather than by the C corporation.
The TTCA would modify section 854(b)(1)(C) to provide that the amount that may be designated by a fund as QDI under section 854(b)(1)(B) shall not exceed the sum of QDI and “the amount of any earnings and profits which were distributed by the company for such taxable year in order to comply with the requirements of section 852(a)(2)(B) and accumulated in a taxable year with respect to which this part did not apply.”
Holding Period Requirement for Qualified Dividend Income
In order for a dividend on common stock to be treated as QDI under JGTRRA, the taxpayer must hold the stock on which the dividend is paid for at least 61 days. Sections 1(h)(11)(B)(iii) and 246(c). For this purpose, only days during the 120-day period beginning on the date that is 60 days before the ex-dividend date are taken into account. Also for this purpose, the taxpayer’s holding period begins the day after the date on which the stock is acquired. Section 246(c)(3).
JGTRRA, as originally enacted, prevents a taxpayer who acquires common stock the day before the ex-dividend date from meeting the 61-day holding period requirement for that dividend. For example, if an individual acquires stock on July 30 that goes ex-dividend on July 31, the 120-day period begins on June 1 (60 days before the July 31 ex-dividend date) and ends on September 28 (59 days after the July 31 ex-dividend date). Because the taxpayer’s holding period begins on July 31 (the day after the purchase date) and only 59 days remain (after July 31) in the 120-day period, the taxpayer can never meet the 61-day holding period requirement for that first dividend. The 2003 Form 1040 Instructions, reflecting JGTRRA as enacted, contain a similar example and indicate that such a dividend is not QDI.5
The TTCA would allow an investor who acquires common stock the day before it goes ex-dividend to meet the 61-day holding-period requirement by extending the 120-day holding period to 121 days -- thereby providing a period that includes 60 days both before and after the ex-dividend date.6
1 The Investment Company Institute is the national association of the American investment company industry. Its membership includes 8,672 open-end investment companies ("mutual funds"), 605 closed-end investment companies, 108 exchange-traded funds and 6 sponsors of unit investment trusts. Its mutual fund members have assets of about $7.149 trillion. These assets account for more than 95% of assets of all U.S. mutual funds. Individual owners represented by ICI member firms number 86.6 million as of mid 2003, representing 50.6 million households.