1 The relevant pension-related provisions in the bill are summarized in a separate Institute Memorandum.
2 See Institute Memorandum to Accounting/Treasurers Members No. 19-99, Closed-End Investment Company
Members No. 27-99, Operations Members No. 18-99, Tax Members No. 21-99, Transfer Agent Advisory
Committee No. 46-99 and Unit Investment Trust Members No. 16-99, dated July 27, 1999.
[11154]
August 3, 1999
TO: ACCOUNTING/TREASURERS MEMBERS No. 20-99
CLOSED-END INVESTMENT COMPANY MEMBERS No. 29-99
OPERATIONS MEMBERS No. 19-99
TAX MEMBERS No. 24-99
TRANSFER AGENT ADVISORY COMMITTEE No. 49-99
UNIT INVESTMENT TRUST MEMBERS No. 17-99
RE: SENATE APPROVES TAX LEGISLATION
______________________________________________________________________________
The Senate has approved S. 1429, the “Taxpayer Refund Act of 1999” (hereinafter “the bill”).
This memorandum discusses the following attached provisions of interest to regulated investment
companies (“RICs”) and their shareholders:1 (1) the treatment of distributions of accumulated earnings
and profits from a “non-RIC” year; (2) the treatment of gain from constructive ownership transactions,
including certain “synthetic” investments in RICs; and (3) proposed revisions affecting the taxation of
capital gains, including an annual $1,000 deduction for net capital gains of individuals.
Note, however, that the bill contains the attached “sunset” provision (Attachment D) designed
to comply with procedures under the Congressional Budget Act of 1974 by which Congress implements
spending and tax policies contained in a budget resolution. Specifically, the bill provides that all of its
provisions and amendments that are in effect on September 30, 2009 will cease to apply as of that date.
As with the House-passed tax legislation,2 President Clinton has indicated that he would veto the bill if it
were presented to him in its current form because of the magnitude of the bill’s tax cut provisions.
Distribution of Accumulated Earnings and Profits from a Non-RIC Year (Attachment A)
The bill would make three modifications to the provisions of Subchapter M that impact certain
RICs with accumulated earnings and profits from “non-RIC” years. A RIC may acquire such earnings
and profits through either a conversion from non-RIC to RIC status or a merger with a non-RIC.
First, the bill would amend section 852(c) to provide that any distribution made to satisfy the
requirement that the RIC have no non-RIC earnings and profits as of the end of the taxable year “shall
be treated . . . as made from the earliest earnings and profits accumulated in any taxable year to which
the provisions of this part did not apply.” This would represent a change from current law under which
distributions from earnings and profits essentially are treated as being made on a last in, first out basis.
Second, the bill would provide that a distribution treated as being made from accumulated earnings and
profits shall not be treated as a distribution for purposes of calculating the dividends paid deduction
under section 852(b)(2)(D) or the “spillover” dividend rules of section 855. This change expressly would
permit a RIC to use a spillover dividend to distribute its taxable income for a year in which it acquires
non-RIC earnings and profits that it must distribute. Third, the bill would expand the “deficiency
dividend” relief provided by section 852(e) where a failure to qualify under Subchapter M is attributable
solely to a failure to distribute non-RIC earnings and profits. Under the provision, a deficiency-type
distribution of non-RIC earnings and profits would permit the RIC to qualify in the initial year to which
a failed determination under Subchapter M applied, in addition to subsequent years (before the
deficiency-type distribution is made). These provisions would apply to distributions after December 31,
2000.
Treatment of Gain from Constructive Ownership Transactions (Attachment B)
The bill would prevent the conversion of ordinary income or short-term capital gain into income
eligible for long-term capital gain treatment with respect to certain “constructive ownership
transactions” involving, among other things, an equity interest in a pass-thru entity (that would be
defined to include a RIC). Under proposed new section 1260, a taxpayer generally would be treated as
having entered into a constructive ownership transaction with respect to a pass-thru entity if the
taxpayer: (1) holds a long position under a swap contract with respect to the entity; (2) enters into a
forward or futures contract to acquire the entity; (3) is the holder of a call option, and is the grantor of a
put option, with respect to the entity and the such options have substantially equal strike prices and
substantially contemporaneous maturity dates; or (4) enters into one or more other transactions (or
acquires one or more positions) that have substantially the same effect as a transaction described above.
More specifically, the bill would (1) limit the amount of long-term gain to the long-term gain, if
any, that the taxpayer would have received had an investment been made directly in the underlying pass-
thru entity (an amount termed the “net underlying long-term capital gain”) and (2) impose an interest
charge on any deferred short-term gain. An exception to this treatment would be provided if all of the
positions that are part of the transaction are marked to market.
Under the bill’s effective date, the constructive ownership provisions would apply to
transactions entered into after July 11, 1999. For this purpose, a contract, option or any other
arrangement that is entered into or exercised on or after July 12, 1999 which extends or otherwise
modifies the terms of a transaction entered into prior to such date is treated as a transaction entered into
on or after July 12, 1999.
Capital Gains Provisions (Attachment C)
A. Annual Deduction for the First $1,000 of Net Capital Gains Earned by
Individuals
In proposed new section 1202, the bill would allow an individual to deduct the first $1,000 of
net capital gain for each taxable year. For this purpose, net capital gain would not include gain from
related-party sales or exchanges. The deduction generally would not be available to (1) dependents
claimed as an exemption on another taxpayer’s return; (2) a married individual filing a separate return for
the taxable year; or (3) an estate or trust. In applying the provision to RICs and other pass-thru entities,
the determination of when a sale or exchange occurs would be made at the entity level. The deduction
for capital gains generally would apply to taxable years beginning after December 31, 2005.
B. Treatment of Collectibles Gain (or Loss) as Short-Term
The bill would treat any gain (or loss) from the sale of a collectible (such as gold bullion) as
short-term capital gain (or loss), without regard to the collectible’s actual holding period. Under the bill,
any gain from the sale or exchange of an interest in a partnership, S corporation or trust that is
attributable to unrealized appreciation in the value of collectibles held by such entity would be treated as
collectibles gain. This provision effectively would eliminate application of the 28 percent rate to
collectibles gain. The provision would apply to sales and exchanges of collectibles after December 31,
2005.
Deanna J. Flores
Assistant Counsel
Attachment
Note: Not all recipients receive the attachment. To obtain a copy of the attachment referred to in this Memo, please call the
ICI Library at (202) 326-8304, and ask for attachment number 11154. ICI Members may retrieve this Memo and its
attachment from ICINet (http://members.ici.org).