1 The capital gain provisions in the Contract were first introduced in this Congress as part of H.R. 9, the "Job Creation
and Wage Enhancement Act of 1995." See Institute Memorandum to Tax Committee No. 6-95, Accounting/Treasurers
Committee No. 8-95, Operations Committee No. 6-95, Transfer Agent Advisory Committee No. 11-95 and Closed-End
Fund Committee No. 5-95, dated February 3, 1995.
2 Under a partnership look-through rule suggested by the Institute, a RIC would be treated as owning its proportionate
share of the assets of any partnership in which it invests.
March 17, 1995
TO: TAX MEMBERS No. 16-95
ACCOUNTING/TREASURERS MEMBERS No. 15-95
OPERATIONS MEMBERS No. 14-95
TRANSFER AGENT ADVISORY COMMITTEE No. 20-95
CLOSED-END FUND COMMITTEE No. 10-95
RE: HOUSE WAYS AND MEANS COMMITTEE APPROVES CAPITAL GAINS/
INDEXING LEGISLATION
______________________________________________________________________________
The House Ways and Means Committee has approved tax legislation (H.R. 1215) that
incorporates the two capital gains provisions (attached) from the “Contract With America” advanced last
fall by Republican candidates for the U.S. House of Representatives.1 Under the first provision, certain
taxpayers would be permitted to deduct from income 50 percent of their net long-term capital gains
arising from dispositions on or after January 1, 1995. Second, certain taxpayers would be permitted to
increase or “index” for inflation the cost basis of certain capital assets. For example, if an asset was
purchased for $100 and held for 10 years, during which time inflation totalled 40 percent, the indexed
basis of the asset would be $140.
One important difference between H.R. 1215 and the Contract is that both the 50 percent
deduction and the indexing provision would be limited to taxpayers other than corporations. These
capital gains benefits would flow through a regulated investment company (“RIC”), however, to its non-
corporate shareholders.
Under H.R. 1215, RICs would be permitted to index the cost basis of their indexing-eligible
assets, i.e., domestic common stock (but neither debt nor, in general, foreign securities). Eligible RIC
shareholders would index the cost basis of their RIC shares to the extent that the underlying RIC
portfolio consisted of indexing-eligible assets.2 Specifically, RIC shares would be treated as an "indexed
asset" eligible for indexing for any calendar quarter in the same ratio as the average value of the RIC's
indexed assets at the close of each month in the quarter bears to the average value of all of the RIC's
assets at the close of such months (the "indexed asset calculation"). Adopting an Institute suggestion, a
"safe harbor" would treat RIC shares as eligible for (a) 100 percent of any indexing adjustment for a
particular quarter if at least 80 percent of the RIC's assets (on average) were invested in indexed assets
on the last day of each month in the quarter and (b) no inflation adjustment for that quarter if 20 percent
3 Thus, for example, if a ecurity purchased for $100, that was eligible for a 40 percent indexing adjustment to $140, were
sold for $125, indexing would eliminate the $25 of nominal gain, but could not be used to create a $15 loss.2
4 Mark-to-market losses, however, could never be used to reduce a taxpayerGs tax liability.
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or less of the RIC's assets (on average) were invested in indexed assets on the last day of each month in
the quarter.
Among the other changes made by H.R. 1215 to the indexing provisions included in the
Contract are the following. First, indexing would apply only for purposes of calculating gain; indexing
adjustments could not be used to generate or increase the amount of a loss.3 Second, indexing would
apply only to assets held for more than three years, rather than more than one year. Third, an asset
would not be treated as an "indexed asset" eligible for indexing for any period during which a taxpayer's
risk of loss on the asset had been substantially reduced by reason of any transaction entered into by the
taxpayer. Fourth, indexing would apply only to assets acquired after December 31, 1994. Taxpayers
who acquired assets before 1995 would be permitted by H.R. 1215 to index them if they marked them to
market using January 1, 1995 values and included in income any resulting mark-to-market gain.4 This
election would be made on an asset-by-asset basis. As drafted, however, this mark-to-market election
could be made by a RIC's individual shareholders with respect to their RIC shares, but not by the RIC
with respect to its portfolio securities.
One significant effect of H.R. 1215's limitation of indexing benefits to non-corporate
shareholders would be to cause RICs with both corporate and non-corporate shareholders to report
different amounts of taxable income to each group, even though they would receive the same
distributions. Under the bill, RICs would be required to distribute to shareholders only the amount of
gain that was taxable to non-corporate shareholders after application of the indexing adjustment. For
example, if a RIC realized a $100 gain, $40 of which was attributable to inflation, the RIC would be
required to distribute only $60 to shareholders. However, because corporate shareholders would not be
entitled to the benefits of indexing, RICs would have to report as dividends to these shareholders their
allocable share of both the amount distributed ($60) and the amount retained ($40), all of which would
be taxable to these corporate shareholders.
Action on H.R. 1215 by the House of Representatives could come within the next few weeks.
We will keep you informed of developments.
Keith D. Lawson
Associate Counsel - Tax
Attachment