- 1 -
April 12, 1990
TO: TAX MEMBERS NO. 15-90
ACCOUNTING/TREASURERS MEMBERS NO. 11-90
RE: IRS PRIVATE LETTER RULING ON MULTIPLE CLASS 12b-1
ARRANGEMENTS
__________________________________________________________
The attached IRS private letter ruling involves a regulated
investment company ("RIC") that will charge different 12b-1
expenses to its "Class A" and "Class B" shareholders and,
consequently, will pay different dividend distributions to each
"class." Two issues are presented. First, will these "Class A"
and "Class B" shares be treated as one or two classes for
purposes of the preferential dividend rules of Code section
562(c)? Second, if the "Class A" and "Class B" shares are
treated as being part of a single class, will the payment of
different dividend distributions to the "Class A" and "Class B"
shares cause the dividends paid to be treated as "preferential"
and therefore not eligible for the dividends paid deduction? The
ruling concludes that, although the two "classes" of shareholders
will be treated as one class for purposes of section 562(c), the
payment of different distributions with respect to the "Class A"
and "Class B" shareholders will not cause the distributions to be
treated as preferential dividends.
The RICs involved in the ruling will each have two
"classes" of shareholders. Each class will be sold without a
sales charge but subject to a 12b-1 fee. "Class A" shares will
pay a 12b-1 fee capped at x percent of the class' average net
asset value. "Class B" shares will pay a 12b-1 fee with a higher
cap (of x percent plus y percent) and the distributor will be
authorized to use the y portion of the 12b-1 fee to compensate
institutional shareholders for providing certain distribution-
related administrative services to accounts on whose behalf the
shareholders have purchased shares.
A "class" of shares is described in the ruling as "a group
of shareholders whose rights are so closely aligned and so
different from other shareholders' rights as to warrant a
conclusion that members of the group should all be treated the
- 2 -
same...." Applying this standard to the "Class A" and "Class B"
shares involved, the ruling concludes that only one class exists
because the different cash distributions to the separate
"classes" and the right of "Class B" shares to effectively vote
on both the "Class A" and the "Class B" 12b-1 plans are
insufficient differences.
The ruling then provides the following rationale for not
treating the different distributions to the "Class A" and "Class
B" shareholders as preferential dividends. The ruling first
states that, while a 12b-1 fee is a portfolio expense for
purposes of computing investment company taxable income, 12b-1
fees "are akin to front-end sales loads because both amounts are
primarily for distribution expenses." Treating these expenses as
"indirect" shareholder expenses, the ruling concludes that all
shareholders have the benefit of the same economic distributions
because all shareholders are entitled to the same distribution
before 12b-1 fees are taken into account. As each shareholder
has the benefit of the same economic distribution, no
preferential dividend arises. The ruling further concludes that
treating 12b-1 fees as indirect investor expenses for purposes of
section 562(c) does not cause a shareholder to treat his
allocable share of the 12b-1 fee as income for income recognition
purposes because of the exemption provided in Code section 67(c)
for publicly offered RICs.
We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachment