* Section 368(a)(2)(F)(ii) effectively requires greater diversification of investment than does section
851(b)(4), which provides the diversification requirement for RIC qualification.
January 18, 1995
TO: ACCOUNTING/TREASURERS COMMITTEE No. 4-95
TAX COMMITTEE No. 3-95
RE: IRS RULINGS ON FORMATION OF MASTER/FEEDER STRUCTURES
______________________________________________________________________________
It is common practice for mutual funds adopting a master/feeder structure to obtain a
letter ruling from the IRS to the effect that adopting the structure will not cause adverse tax
consequences for the fund or its shareholders. One issue frequently addressed in such a
request for a ruling is whether a contribution of assets by existing mutual funds to a master
fund partnership will cause recognition of gain or loss under Internal Revenue Code 721.
Section 721(a) provides that, generally, that no gain or loss is recognized by a partnership or
any of its partners as a result of a contribution of property, including money, to the partnership
for an interest in the partnership. Section 721(b) provides an exception to the general
nonrecognition rule if the transfer results in diversification of the transferor's investment and
more than 80 percent of the transferee's assets (excluding cash and non-convertible bonds) are
readily marketable stocks and securities held for investment. See section 351(e)(1) and Treas.
Reg 1.351-1(c)(1).
If two or more RICs contributing assets to a master fund seek a ruling on the tax
consequences of the contribution, the IRS currently requires the funds to make three
representations concerning the nature of the assets to be contributed and the operation of the
master fund following the contribution. The representations, which are designed to
demonstrate that no meaningful diversification occurs as a result of the contribution, are:
(a) The assets transferred to the transferee will satisfy the diversification test of
section 368(a)(2)(F)(ii).* For purposes of applying this test, "government
securities" are not included within the meaning of "securities" in section
368(a)(2)(ii), but are included within the meaning of "total assets" in section
368(a)(2)(F)(iv).
(b) The quality and level of risks of the assets transferred by the transferor will be
substantially identical to the quality and level of risks of assets that will be held
by the transferee after the transfer. For purposes of this representation, the
quality and level of risk is determined by taking into account, among other
things, the assets’ relative values, nature, and mix. Further, if the transferee
promptly acquires assets with transferred cash, the acquired assets are deemed
transferred, and that transferred cash is not taken into account as a transferred
asset.
(c) The transferee has no plan or intention to depart in any way from the investment
strategy or practice of the transferor. For purposes of this representation, the
transferee’s investment practice is determined by taking into account, among
other things, the relative values, nature, and mix of assets in its asset portfolio
historically and immediately before the proposed transfer.
Some members have expressed concerns about the meaning of the representations and their
ability to provide them.
Recently, the Institute met with representatives of the IRS to discuss member concerns
regarding the representations and possible replacements for them. During the meeting, the IRS
requested the Institute’s reaction to two possible replacements for the existing representations.
The IRS is considering a rule that would treat all contributions by regulated investment
companies ("RICs") to partnerships as tax-free under section 721(a) on the grounds that a RIC’s
assets are already so well diversified that their contribution to a partnership cannot result in
meaningful diversification. Section 368(a)(2)(F)(i) provides a similar rule that allows RICs to
participate in tax-free corporate reorganizations on the same basis as other corporations. The
IRS indicated that if it adopts this standard, persons seeking a ruling may be required to make
representations concerning the transaction’s business purpose or its compliance with other
conditions that typically must be satisfied for corporate reorganizations to be accorded
nonrecognition status.
In the alternative, the IRS is considering requiring a new representation in place of the
second and third representations quoted above. The new representation would be similar to
the following: "The transferee’s investment objectives and policies will be substantially similar
to the transferor’s investment objectives and policies. The transferee has no present plan or
intention to change its investment objectives and policies."
Through this memorandum the Institute seeks comments on the IRS suggestions. We
are tentatively planning a conference call with interested members on February 6, 1995 at 2:00
p.m. to discuss the IRS proposals. Please contact the undersigned by February 1, 1995 if you
would like to participate in the conference call or to express your views on this issue (Phone
202-326-5827; Fax 202-326-5841).
Peter J. Cinquegrani
Assistant Counsel - Tax