July 17, 1996
TO: BOARD OF GOVERNORS No. 40-96
RE: IRS MEMORANDUM ON ADIVSER FEE WAIVERS AND EXPENSE
REIMBURSEMENTS
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We are pleased to report that the IRS National Office has issued the attached technical
advice memorandum regarding the tax treatment by a fund adviser of certain fee waivers and
fund expense reimbursements. As you may recall, in recent months IRS agents were reported
to have questioned in a number of audits of advisers the treatment of voluntary reductions of a
fund’s management fee and the payment of certain fund expenses by an adviser. The IRS
agents asserted that an adviser should include in income the gross, unreduced amount of the
management fee and could not deduct the amount of any fund expenses paid by the adviser.
The Institute set up a special task force and worked closely with members audited on these
issues.
In the memorandum issued by the IRS National Office in connection with the audit of a
fund adviser, the IRS concluded that only the net, reduced amount of any management fee was
includible in the adviser’s income, because the fee reductions were established on a prospective
basis. The memorandum further concluded that in the situation where an adviser pays an
amount in excess of its management fee to a fund by virtue of the imposition of a ceiling on
fund expenses, the amount paid is a deductible expense of the adviser. In reaching the
determination that these amounts need not be capitalized, the IRS focused on the short-lived,
recurring nature of the fee ceilings.
We will keep you informed of further developments.
Catherine L. Heron
Vice President and Senior Counsel