January 7, 1993
TO: TAX COMMITTEE NO. 1-93
ACCOUNTING/TREASURERS COMMITTEE NO. 1-93
RE: INTERNAL REVENUE SERVICE ISSUES FINAL REGULATIONS ON REMICS
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The Internal Revenue Service has released the attached
final regulations related to real estate mortgage investment
conduits ("REMICS"). Of possible interest to regulated
investment companies ("RICs") are several provisions dealing with
the treatment of holders of REMIC regular and residual interests,
and in particular two provisions dealing with the tax on the
transfer of REMIC residual interests to "disqualified
organizations".
The Internal Revenue Code imposes a tax on transfers of
REMIC residual interests to "disqualified organizations". A
disqualified organization is any U.S. or foreign government and
any entity exempt from the federal income tax, other than a tax
exempt entity paying tax on unrelated business taxable income.
The tax is imposed at the highest corporate rate on the present
value of the total excess inclusions anticipated to accrue on the
residual interest after the transfer. Excess inclusions on a
REMIC residual interest are defined as the excess of the income
actually allocated by the REMIC to the REMIC residual interest
over the amount of income which would accrue if the purchase
price of the REMIC residual interest earned income at 120 percent
of the federal long-term rate. The regulations provide that a
transferor will not be liable for the tax if (1) the transferee
of the REMIC residual interest provided, under penalties of
perjury, the transferee's social security number and a statement
that it is not a disqualified organization and (2) the transferor
did not know that this information was false. See Treas. Reg.
section 1.860E-2(a)(7).
In addition, the Code provides that if a "pass-thru
entity", which includes a RIC, holds a REMIC residual interest
and has a disqualified organization as a shareholder, the pass-
thru entity is subject to tax annually. The tax is imposed at
the highest corporate rate on the total excess inclusions for the
year with respect to the REMIC residual interest. No tax will be
imposed with respect to a shareholder in a pass-thru entity if
the entity obtains an affidavit from the shareholder similar to
that described above, and has no actual knowledge that the
affidavit is false.
Where the tax is imposed, it is deductible against the
pass-thru entity's taxable income. The regulations clarify that
a RIC will not be considered to be paying preferential dividends
within the meaning of Code section 562(c) if the tax incurred by
the RIC with respect to a shareholder which is a disqualified
organization is allocated to that shareholder, thus reducing the
shareholder's distribution from the RIC. See Treas. Reg. section
1.860E-2(b).
We will keep you informed of further developments.
David J. Mangefrida Jr.
Assistant Counsel - Tax