September 25, 1991
TO: TAX MEMBERS NO. 41-91
INTERNATIONAL MEMBERS NO. 5-91
ACCOUNTING/TREASURERS MEMBERS NO. 27-91
RE: BILL INTRODUCED TO ENHANCE INTERNATIONAL COMPETITIVENESS OF
U.S. MUTUAL FUNDS
__________________________________________________________
Yesterday, Senator Max Baucus, Chairman of the Senate
Finance Subcommittee on International Trade, introduced S. 1748,
the "International Competitiveness Act of 1991," legislation
designed to enhance the international competitiveness of U.S.
mutual funds. Attached is Senator Baucus' Record statement upon
introduction of the bill, which includes the bill's text and a
description of its provisions.
The bill would remove the competitive tax disadvantages
currently faced by U.S. funds selling abroad and put the U.S.
fund industry on a more equal footing with its foreign-based
competitors. These objectives would be achieved by modifying the
current withholding and distribution requirements applicable to
foreign investors in U.S. funds.
Withholding Requirements
Current U.S. withholding rules discourage foreign
investment in U.S. funds in two ways. First, while interest on
most U.S. obligations issued after July 18, 1984 is exempt from
U.S. withholding tax when paid to foreign investors, including
foreign investors in foreign funds, such interest is subject to
withholding when the investor purchases shares of a U.S. fund
holding these obligations. Second, short-term capital gains are
exempt from U.S. withholding tax when received directly by
foreign investors, including foreign investors in foreign funds,
but subject to withholding tax when distributed to foreign
investors by a U.S. fund. The bill would provide flow-through
treatment to foreign investors for each of these types of income.
Section 2 of the bill would amend section 852(b) of the
Internal Revenue Code ("Code") to provide a mechanism for
regulated investment companies ("RICs") to distribute to all
shareholders as taxable interest the taxable-interest income
earned by the RIC. Under proposed new Code section 852(b)(10), a
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RIC could designate taxable interest distributed to shareholders
as a "taxable-interest dividend" by mailing to shareholders a
written notice not later than 60 days after the close of its
taxable year. Under proposed new Code section 852(b)(11), the
RIC could designate as a "qualifying-interest dividend", which
would not be subject to U.S. withholding tax, that portion of the
taxable-interest dividend that would have been exempt from U.S.
withholding tax if the income had been paid directly to a foreign
investor. A related amendment would exclude from U.S. estate tax
the portion of a foreign investor's RIC stock that would have
been exempt had the RIC's assets been owned directly by the
foreign investor.
Section 3 of the bill would amend Code section 852(b) to
provide a mechanism for RICs to distribute to foreign investors
as a "short-term capital gain dividend" the short-term capital
gains realized by the RIC. Under proposed new Code section
852(b)(12), any distribution designated as a short-term capital
gain dividend would be exempt from U.S. withholding tax, just as
long-term capital gains realized by a RIC are currently exempt
when designated as capital gain dividends. Clerical amendments
would change the Code's references to "capital gain dividends" to
"long-term capital gain dividends," to distinguish short-term
from long-term gains.
Distribution Requirement
The current distribution requirements applicable to RICs
provide another incentive for foreign investors to purchase
foreign funds rather than U.S. funds. These distribution
requirements effectively result in foreign investors paying tax
in their own countries on the U.S. fund's income on a current
basis, while many foreign investors in foreign funds may pay tax
in their own countries on such gain, if at all, only when the
fund shares are sold.
Section 4 of the bill would correct this tax disincentive
by adding two new Code sections, Code section 1355, which defines
a new type of U.S. corporation, an International Regulated
Investment Company ("IRIC"), and Code section 1356, which
provides the manner of taxing IRICs and their shareholders.
Under proposed new Code section 1355, the IRIC would invest only
in the shares of a single RIC and could be owned only by foreign
investors. Under proposed new Code section 1356, the IRIC would
have no distribution requirement of its own, but would pay U.S.
tax on a current basis on any distributions from the RIC that
would have been subject to U.S. withholding tax had the foreign
investor held the RIC shares directly. If the IRIC's
shareholders were all eligible by treaty for U.S. withholding tax
at a rate of 15 percent or less, the IRIC could make a "treaty
countries election", which would reduce the otherwise applicable
tax rate from 30 percent to 15 percent on that portion of the
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IRIC's earnings subject to tax. To provide comparable tax
treatment for foreign investors in U.S. funds and foreign funds,
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IRIC stock would not be deemed to be property within the U.S. and
would, therefore, be exempt from the U.S. estate tax.
The bill is proposed to be effective for taxable years
beginning after date of enactment.
We will keep you informed of developments.
Keith D. Lawson
Associate Counsel - Tax
Attachments
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