April 15, 1991
TO: TAX COMMITTEE NO. 10-91
MEMBERS - ONE PER COMPLEX NO. 16-91
RE: IRS PAPER REGARDING TREATMENT OF EXPENSES OF ORGANIZING
FUNDS
__________________________________________________________
Currently the Internal Revenue Service is auditing the tax
returns of several mutual fund investment advisers. As a result
of these audits, the IRS has proposed making the tax treatment of
costs incurred by investment advisers in creating new mutual
funds a "coordinated issue". Attached is a copy of the proposed
coordinated issue paper.
A "coordinated issue" is one in which the Service develops
a uniform position on a matter which potentially affects an en-
tire industry. Taxpayers in that industry may then be targeted
with respect to the coordinated issue, and the Service generally
applies the conclusions of the coordinated issue paper to all
such taxpayers. In an audit, an IRS agent cannot settle a
coordinated issue on terms which differ from the coordinated is-
sue paper without express permission from the IRS industry spe-
cialist responsible for the issue.
The proposed coordinated issue is whether expenses incurred
by investment advisers in forming new mutual funds and obtaining
the investment management contracts for those funds can be
deducted in the year paid as an expense under Internal Revenue
Code section 162(a), or whether these amounts should be
capitalized under Code section 263 and amortized over a period of
years. Generally, expenditures are capitalized if they serve to
create or enhance a separate and distinct asset with a useful
life extending beyond one year.
As you know, the expenses incurred by the investment
adviser in forming a new fund typically are treated as ordinary
and necessary business expenses to the extent not allocated to
the fund. The IRS claims that the management contract is an
asset and that the expenses of organizing the fund and obtaining
the management contract must be amortized over the useful life of
the asset. However, because the IRS is contending that
management contracts have an indefinite life, the paper concludes
that the expenses of obtaining this asset are nonamortizable.
Because the Internal Revenue Service National Office must
approve any coordinated issue proposal, this paper has been
submitted to the National Office. In addition, the affected
industry is generally given the opportunity to respond to the
proposed coordinated issue paper. The Institute is currently
developing a response.
We will keep you informed of developments.
Catherine L. Heron
Vice President - Tax and
Pension
Attachment