On Jan. 15, the IRS released Notice 2016-10, which announced the
government’s intention to amend regulations under Sections
853 and 905(c) to provide guidance on regulated investment
companies (RICs) obtaining administrative relief when a RIC
received a foreign tax refund during a period in which it made a
Section 853 election. The guidance provides two methods a RIC may
use to account for foreign tax determination events (e.g., a refund
of foreign taxes) under Section 905(c).
A RIC is an association taxable as a corporation for federal income
tax purposes. Many mutual funds are organized as RICs for tax
purposes. Certain eligible RICs may make an election under Section
853 to not claim a deduction or credit for its foreign taxes, but
instead to pass the amounts of taxes paid and corresponding
gross-ups through to shareholders, who may be eligible to credit or
deduct such taxes. For a RIC to be eligible for this election, more
than 50% of the value (as defined in Section 851(c)(4)) of its
total assets at the close of the taxable year must consist of stock
or securities in foreign corporations, and it must satisfy other
requirements under Section 852(a).
The notice states that, generally speaking, RICs do not have
changes to their foreign tax liabilities, as described in Section
905(c), both because foreign withholding taxes, which RICs
generally pay, are usually determinable at the time the income from
which the tax is withheld is paid or accrued, and because RICs must
adhere to specific functional currency rules. However, after the
European Union Court of Justice recently held that member states
couldn't impose withholding taxes on foreign investors if
similar domestic investors weren't subject to tax, many RICs
sought and have received refunds of foreign taxes paid to EU member
states. As RICs are often widely held, the IRS said Section 905(c)
could lead to significant administrative costs and uncertainty for
the U.S. government, and also for RICs and their shareholders,
without guidance providing alternative procedures.
To alleviate this administrative burden, the notice provided two
alternative procedures to the general procedures under Section
905(c). The two methods the netting method and a closing
agreement.
The netting method provides that a RIC may reduce the amount of
foreign taxes reported by the RIC to its shareholders for the
refund year by the amount of the foreign tax adjustment as
determined under the notice. This adjustment includes foreign tax
refunds and an interest adjustment. The notice also contains
specific requirements, which a RIC must satisfy to qualify for the
netting method.
The closing agreement method provides that a RIC may request a
closing agreement addressing the treatment of the refund. The
notice states that a request for a closing agreement will be
granted when “such an agreement is determined by the IRS to
be in the interest of sound tax administration.” The notice
includes examples of when a request will be in the interest of
sound tax administration (as when a RIC is either precluded from
applying, or it is not reasonably practical for it to apply, the
general rules under Section 905(c)).
This new guidance should be carefully reviewed by taxpayers that
may be qualifying RICs as the guidance contains rules that
significantly reduce the administrative burden when applying
Section 905(c) to any refunds sought from EU member states. Except
as otherwise provided in the notice, the notice is expected to
apply to any refund year ending on or after Feb. 8, 2016.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.