October 24, 1989
TO: TAX MEMBERS NO. 42-89
CLOSED-END FUND MEMBERS NO. 61-89
UNIT INVESTMENT TRUST MEMBERS NO. 58-89
ACCOUNTING/TREASURERS COMMITTEE NO. 46-89
OPERATIONS COMMITTEE NO. 21-89
TRANSFER AGENT SHAREHOLDER ADVISORY COMMITTEE NO. 27-89
RE: SENATE APPROVES TAX PROVISIONS IN OMNIBUS RECONCILIATION
ACT OF 1989 (ORA)
__________________________________________________________
The Senate recently approved certain revenue reconciliation
provisions in the Omnibus Reconciliation Act of 1989 (ORA).
Earlier, the House accepted the revenue reconciliation provisions
previously approved by the House Ways and Means Committee. (See
Institute Memorandum to Tax Members No. 32-89, Closed-End Fund
Members No. 43-89, Unit Investment Trust Members No. 49-89,
Accounting/Treasurers Committee No. 38-89, Operations Committee
No. 17-89, and Transfer Agent Shareholder Accounting Advisory
Committee No. 24-89, dated September 27, 1989.)
The following is a summary of the provisions of the bill
which affect regulated investment companies ("RICs") and their
shareholders. The relevant portions of the bill and the Senate
Finance Committee Report are attached.
I. PHANTOM INCOME
No provision regarding phantom income (section 67(c)) is
included in the bill. As we previously informed you, when
Congress enacted the Technical and Miscellaneous Revenue Act of
1988 (TAMRA) last year, it intended to postpone imposition of the
phantom income tax on publicly-offered RICs until 1990. However,
the enacted TAMRA language both delayed the application of
section 67(c) to publicly-offered RICs until 1990 and repealed
section 67(c) entirely for taxable years beginning after 1989.
(See Institute Memorandum to Tax Members No. 59-88, Closed-End
Fund Members No. 55-88, Unit Investment Trust Members No. 69-88
and Accounting/Treasurer Advisory Committee No. 41-88, dated
November 14, 1988.) This year, during its deliberation of the
tax bill, the Senate Finance Committee determined that section
67(c) should continue to apply to taxpayers other than publicly-
offered RICs but that publicly-offered RICs should be permanently
exempted from the application of section 67(c). However, it is
our understanding that language implementing the Committee's
discussion was inadvertently left out of the Finance Committee
bill and the accompanying Committee Report. Consequently, no
special provision regarding phantom income is included in the
bill.
II. RIC-SPECIFIC PROVISIONS
1. Section 4982 Ordinary Income Distribution Requirement
(Attachment 1).
The bill would increase the section 4982 minimum
distribution requirement for ordinary income from 97 percent to
98 percent. This amendment would apply to calendar years ending
after July 10, 1989.
2. Sales Load Basis Deferral (Attachment 2).
Section 852 would be amended by the bill to require any
shareholder who purchased shares in one RIC (RIC "A"), and
transferred all or part of that investment to a second RIC in the
same investment company complex (RIC "B"), to exclude from the
basis of any RIC "A" shares that were disposed of within six
months from the purchase date (30 days in the House bill) the
sales load incurred on those shares to the extent that the sales
load on the RIC "B" shares was reduced because a load had
previously been paid on the RIC "A" shares. Any sales charge not
included in the basis of RIC "A" shares would be treated as
incurred to acquire the RIC "B" shares. This amendment would
apply to sales loads incurred after October 3, 1989 in taxable
years ending after such date.
3. Dividend Accrual on Ex-dividend Date (Attachment 3).
The bill would amend section 852(b) to require a RIC to
treat any dividend it receives as received on the later of (i)
the date the stock owned by the RIC became ex-dividend with
respect to such dividend, or (ii) the date the RIC acquired such
stock.
III. RIC-RELATED PROVISIONS
4. Applicable High Yield Discount Obligations (Attachment 4).
The Senate bill would substantially modify the treatment
provided in the House bill for any "applicable high yield
discount obligation," i.e., any debt instrument (1) with a
maturity date of more than 5 years from the date of issue, (2)
with a yield to maturity that equalled or exceeded the sum of the
applicable Federal rate for the calendar month in which the
obligation was issued plus 5 percentage points, and (3) which had
"significant original issue discount."
Under the House bill, "disqualified discount obligations"
would be treated as preferred stock, both for purposes of the
issuer and the holder of such an instrument. Under the Senate
bill, a Subchapter C corporation would not be permitted to deduct
any portion of original issue discount on an "applicable high
yield discount obligation" until such portion was actually paid.
No change would be made to the requirement that the holder of
such an obligation (such as a RIC) include such interest in
income as it accrues.
This provision would be effective generally for instruments
issued after July 10, 1989. An assumption by a taxpayer of an
instrument issued by another taxpayer would be treated as a new
issuance for purposes of this rule. The effective date rule
would, however, be subject to exceptions, including one which
would exempt from the rule instruments issued pursuant to the
terms of a debt instrument that was issued before the effective
date, such as a payment-in-kind ("PIK") bond issued after July
10, 1989 as interest on a PIK bond issued before July 10, 1989.
5. Disqualified Preferred Stock (Attachment 5).
The bill would also amend section 1059 to treat as an
extraordinary dividend any dividend with respect to "disqualified
preferred stock," i.e., a stock which (1) when issued, had a
dividend rate which declined (or could reasonably be expected to
decline) in the future, (2) had an issue price that exceeded its
liquidation rights or its stated redemption price, or (3) was
otherwise structured to avoid the other provisions of section
1059 and to enable corporate shareholders to reduce tax through a
combination of dividend received deductions and loss on the
disposition of the stock.
The provision is not intended to apply to preferred stock
dividends where the declining dividend rate is due to an
unforeseen economic downturn in the issuer's business or to
dividends on floating rate or auction rate preferred stock whose
dividend rate declines solely in response to market changes.
Treatment of a dividend as extraordinary would result in a
reduction in a corporate shareholder's basis in its stock by the
portion of the dividend eligible for the dividends received
deduction. This amendment would apply generally to stock issued
after July 10, 1989.
6. Debt/Equity Regulatory Authority (Attachment 6).
The bill would clarify the Treasury Department's regulatory
authority under section 385 to treat an instrument as part stock
and part debt. This authority would apply prospectively only
with respect to instruments issued after public guidance was
released.
7. Dividends Paid by Members of Consolidated Group
(Attachment 7).
Section 246 would be amended by the bill to disallow the
dividends received deduction ("DRD") in certain circumstances for
distributions made (i) by a member of an affiliated group of
corporations filing a consolidated return to a nonmember
shareholder, such as a RIC, (ii) with respect to stock described
in section 1504(a)(4) (generally, nonvoting preferred stock that
does not participate in corporate growth to any significant
extent). The amount of dividends with respect to which the DRD
would be disallowed would be determined by applying a formula
that would compare the amount of certain losses and credits of
other members of the affiliated group with the separately
computed taxable income of the corporation paying the dividend.
The Committee Report indicates that this amendment is proposed
because, under present law, the consolidated group may in effect
sell the benefit of its consolidated net operating losses or
credits through the availability of the dividends received
deduction for distributions to minority shareholders.
The House bill took a different approach with regard to
dividends paid by members of a consolidated group. As we
previously informed you, the House bill would amend section 1503
to require that any distribution made by a member of an
affiliated group of corporations filing a consolidated return to
a nonmember shareholder, such as a RIC, be treated as a dividend
only to the extent that the consolidated group as a whole, and
not the corporation paying the dividend, had earnings and
profits.
The Senate bill provision would be generally effective for
distributions after October 2, 1989. Subject to certain
exceptions, however, the provision would not apply to dividends
with respect to subsidiary stock issued on or before that date.
8. Reduction in Built-In Loss Threshold (Attachment 8).
The bill would restrict the use of built-in losses for
purposes of the section 382 limitation on net operating loss
carryforwards and, by cross-reference, the section 383 limitation
on capital loss carryforwards. Under present law, these
limitations apply only if the net unrealized built-in loss
exceeds 25 percent of the fair market value of the corporation's
assets. Under the Senate bill, these limitations would apply if
the net unrealized built-in loss exceeded the lower of (1) 15
percent of the fair market value of the corporation's assets or
(2) $25 million ($10 million in the House bill). This Senate
bill provision would be generally effective for ownership changes
and acquisitions after October 2, l989 in taxable years ending
after such date.
IV. HOUSE BILL PROVISIONS EXCLUDED FROM SENATE BILL
Several provisions included in the House bill (such as
capital gains rate reductions/indexing, civil tax penalty reform
and technical corrections) are not included in the Senate bill.
Many of these provisions (or alternative proposals) were
originally included in the bill reported by the Senate Finance
Committee. The bill the Senate has sent to the Conference
Committee, however, is "stripped down" essentially to provisions
which raise the money needed to satisfy Gramm-Rudman-Hollings
requirements.
* * * * *
We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachments