Jan.Senate PSI Hearing Discusses Mutual Fund Commodity Investments
AT TODAY’S SENATE SUBCOMMITTEE HEARING, members discussed the issuance of private-letter rulings by the Internal Revenue Service (IRS) that allows mutual funds to make indirect investments in commodities through controlled foreign corporations (CFCs).
Subcommittee Chairman Carl Levin (D-Mich.) in his opening statement said that mutual funds in 2005 began petitioning for and receiving private-letter rulings that would allow them to invest in commodities and that the IRS essentially opened the flood gates.
“The IRS letter rulings enable U.S. firms to use offshore shell corporations and financially engineered notes to make commodity investments, despite longstanding tax code restrictions,” he said.
In response to requests from individual mutual funds, “from 2006 to 2010, the IRS issued 72 private letter rulings allowing the mutual funds to whom the letters were addressed to use either wholly owned offshore corporations or financial instruments called ‘commodity linked notes’ to make unrestricted commodity investments, notwithstanding the 10 percent limit in Section 851” of the IRC, Levin said.
Under current law, mutual funds do not pay corporate income tax so long as certain types of investment, such as commodities, represent no more than 10 percent of income.
“In the past, under the 90 percent rule, mutual funds spent the lion’s share of their money on stocks, bonds, and other securities – providing needed capital for economic growth and jobs,” Levin said. “But as the commodity spigot opens, every dollar spent on commodity speculation diverts money from their securities investments. So instead of investing in U.S. businesses, mutual funds will spend increasing sums making bets on commodity price movements.”
The IRS in June 2011 halted the issuance of new private-letter rulings and IRS Commissioner Doug Shulman said the IRS is examining underlying policy issues. Levin again called for that decision to be made permanent.
Ranking Member Tom Coburn (R-Okla.) said that while he does not believe there is excessive speculation in the commodities markets, he does believe that mutual funds’ seeking IRS private-letter rulings is an attempt to go around what Congress intended.
“Tax avoidance is not illegal … tax evasion is,” Coburn said.
IRS Commissioner Shulman said the IRS’s decision last summer to stop issuing private-letter rulings gives the IRS the opportunity “to take a fresh look at this issue.”
Shulman said the IRS was involved in the issue in the first place because it is charged with providing guidance to taxpayers as to whether investments regulated investment companies (RICs) choose to make will produce qualifying RIC income, as defined in the tax law.
As required by law, the IRS cross referenced the definition of “securities” with the Investment Company Act of 1940 to determine what fits into the requirement that an RIC derive 90 percent of its income from investments that meet the qualifications of section 851, which generally requires that investments be related to stock, securities, or foreign currencies.
Shulman said the scope of that definition – and its application to investments providing indirect exposure to commodities – had been the focus of the private-letter rulings.
Shulman said the IRS arrived at the position reflected in the private-letter rulings because the IRS was unable to find any authoritative guidance on the proper scope of the definition of “security” from either the Securities and Exchange Commission (SEC) or the Commodities Futures Trading Commission (CFTC).
Acting Assistant Secretary for Tax Policy at Treasury Emily McMahon also noted that a security, as defined under the 1940 Act, is not explicitly excluded from qualifying income simply because it reflects exposure to commodity prices.
By 2010, Shulman said, the volume of private-letter ruling requests was becoming a concern, and consideration was given to issuing some form of broader published guidance.
Shulman said he is “confident that our staff did its best to interpret” a difficult set of tax laws.
“The IRS does not like being in a position where the law is unclear and it has to go and make interpretations,” Shulman said. “We think there needs to be either law, preferably, but in the absence of law, guidance of general applicability that can be relied on across the industry.”
McMahon laid out Treasury’s role in the issue, which she noted as policy, Treasury does not participate in the consideration of private-letter rulings.
She said that following the IRS’ decision to no longer issue new private-letter rulings, the Investment Company Institute (ICI) requested to meet with IRS and Treasury personnel to discuss proposals for published guidance that would permit commodity-related investments by RICs.
“The Treasury Department and IRS are considering the possibility of issuing published guidance on the subject of commodity-related investments by RICs,” she said.
During a heated question-and-answer session, Levin repeatedly asked Shulman why the IRS did not conclude that mutual funds were simply using offshore “sham” or “shell” companies in the Cayman Islands to avoid paying corporate taxes.
Shulman would not criticize CFCs and added that if he made “blanket generalizations about our views” on them “and when we’ll attack them and when we won’t has other implications beyond the issue at hand.”
“As Commissioner of the IRS, an agency that has been very aggressive attacking a lot of corporations around issues of economic substance, I want to be very clear for the record that the private-letter ruling that we issued that only pertained to and can only be relied on by the one company that we issue to, not broad applicability, are not precedent and in no way speak about the other attacks that we have around the economic substance doctrine,” Shulman said.
Shulman said there is a legitimate debate to be had of whether mutual funds should be allowed to invest more in commodities.
McMahon said that the CFTC and the SEC have the responsibility to determine whether that should be the case.
For more information on this hearing, please click here.
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AT TODAY’S SENATE SUBCOMMITTEE HEARING, members discussed the issuance of private-letter rulings by the Internal Revenue Service (IRS) that allows mutual funds to make indirect investments in commodities through controlled foreign corporations (CFCs).
Subcommittee Chairman Carl Levin (D-Mich.) in his opening statement said that mutual funds in 2005 began petitioning for and receiving private-letter rulings that would allow them to invest in commodities and that the IRS essentially opened the flood gates.
“The IRS letter rulings enable U.S. firms to use offshore shell corporations and financially engineered notes to make commodity investments, despite longstanding tax code restrictions,” he said.
In response to requests from individual mutual funds, “from 2006 to 2010, the IRS issued 72 private letter rulings allowing the mutual funds to whom the letters were addressed to use either wholly owned offshore corporations or financial instruments called ‘commodity linked notes’ to make unrestricted commodity investments, notwithstanding the 10 percent limit in Section 851” of the IRC, Levin said.
Under current law, mutual funds do not pay corporate income tax so long as certain types of investment, such as commodities, represent no more than 10 percent of income.
“In the past, under the 90 percent rule, mutual funds spent the lion’s share of their money on stocks, bonds, and other securities – providing needed capital for economic growth and jobs,” Levin said. “But as the commodity spigot opens, every dollar spent on commodity speculation diverts money from their securities investments. So instead of investing in U.S. businesses, mutual funds will spend increasing sums making bets on commodity price movements.”
The IRS in June 2011 halted the issuance of new private-letter rulings and IRS Commissioner Doug Shulman said the IRS is examining underlying policy issues. Levin again called for that decision to be made permanent.
Ranking Member Tom Coburn (R-Okla.) said that while he does not believe there is excessive speculation in the commodities markets, he does believe that mutual funds’ seeking IRS private-letter rulings is an attempt to go around what Congress intended.
“Tax avoidance is not illegal … tax evasion is,” Coburn said.
IRS Commissioner Shulman said the IRS’s decision last summer to stop issuing private-letter rulings gives the IRS the opportunity “to take a fresh look at this issue.”
Shulman said the IRS was involved in the issue in the first place because it is charged with providing guidance to taxpayers as to whether investments regulated investment companies (RICs) choose to make will produce qualifying RIC income, as defined in the tax law.
As required by law, the IRS cross referenced the definition of “securities” with the Investment Company Act of 1940 to determine what fits into the requirement that an RIC derive 90 percent of its income from investments that meet the qualifications of section 851, which generally requires that investments be related to stock, securities, or foreign currencies.
Shulman said the scope of that definition – and its application to investments providing indirect exposure to commodities – had been the focus of the private-letter rulings.
Shulman said the IRS arrived at the position reflected in the private-letter rulings because the IRS was unable to find any authoritative guidance on the proper scope of the definition of “security” from either the Securities and Exchange Commission (SEC) or the Commodities Futures Trading Commission (CFTC).
Acting Assistant Secretary for Tax Policy at Treasury Emily McMahon also noted that a security, as defined under the 1940 Act, is not explicitly excluded from qualifying income simply because it reflects exposure to commodity prices.
By 2010, Shulman said, the volume of private-letter ruling requests was becoming a concern, and consideration was given to issuing some form of broader published guidance.
Shulman said he is “confident that our staff did its best to interpret” a difficult set of tax laws.
“The IRS does not like being in a position where the law is unclear and it has to go and make interpretations,” Shulman said. “We think there needs to be either law, preferably, but in the absence of law, guidance of general applicability that can be relied on across the industry.”
McMahon laid out Treasury’s role in the issue, which she noted as policy, Treasury does not participate in the consideration of private-letter rulings.
She said that following the IRS’ decision to no longer issue new private-letter rulings, the Investment Company Institute (ICI) requested to meet with IRS and Treasury personnel to discuss proposals for published guidance that would permit commodity-related investments by RICs.
“The Treasury Department and IRS are considering the possibility of issuing published guidance on the subject of commodity-related investments by RICs,” she said.
During a heated question-and-answer session, Levin repeatedly asked Shulman why the IRS did not conclude that mutual funds were simply using offshore “sham” or “shell” companies in the Cayman Islands to avoid paying corporate taxes.
Shulman would not criticize CFCs and added that if he made “blanket generalizations about our views” on them “and when we’ll attack them and when we won’t has other implications beyond the issue at hand.”
“As Commissioner of the IRS, an agency that has been very aggressive attacking a lot of corporations around issues of economic substance, I want to be very clear for the record that the private-letter ruling that we issued that only pertained to and can only be relied on by the one company that we issue to, not broad applicability, are not precedent and in no way speak about the other attacks that we have around the economic substance doctrine,” Shulman said.
Shulman said there is a legitimate debate to be had of whether mutual funds should be allowed to invest more in commodities.
McMahon said that the CFTC and the SEC have the responsibility to determine whether that should be the case.
For more information on this hearing, please click here.