Quick tax reference guide Ernst & Young LLP 1

Regulated investment companiesQuick tax reference guide Ernst & Young LLP

Quick tax reference guide Ernst & Young LLP 3Regulated investment companies2

This reference guide provides a summary of:• RIC qualification tests

• Spillback distributions

• Tax return filing requirements

• Capital gain tax rates

• Securities taxation

• Foreign securities

• Excise tax rules

• Post-October and qualified late-year ordinary loss deferrals

• Dividend payments

• Capital loss carryforwards

• Notification and reporting requirements to shareholders

Quick tax reference guide for regulated investment companiesThis guide describes the basic tax issues affecting regulated investment companies (RICs). It is intended only as a general guide and describes basic tax rules. It is not intended, and should not be regarded, as advice of any kind. As tax law is more complex than presented herein and changes frequently, we recommend consulting with your local Ernst & Young LLP office.

This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer’s facts and circumstances.

Quick tax reference guide Ernst & Young LLP 5Regulated investment companies4

Capital loss carryforwards• Net capital losses for taxable years

beginning after 22 December 2010 can be carried forward indefinitely. Such losses retain their character as short-term/long-term and must be utilized before capital losses that are subject to expiration can be used. Capital losses for taxable years beginning on or before 22 December 2010 may be carried forward for eight years as short-term.

• Net operating losses may not be carried forward or back; however, such losses may be used to offset the excess of net short-term gain over net long-term loss.

• A capital loss carryforward may be limited when a RIC merges with another RIC in a tax-free reorganization or otherwise has an equity structure shift.

Securities taxation• §1256 contracts: Regulated futures

contracts (RFCs), certain foreign currency contracts and non-equity options are marked to market at year-end, and any gain (loss) is treated as 60% LT, 40% ST.

• Straddles: In general, realized losses are deferred from any position to the extent of unrealized gains from offsetting positions where risk of loss is substantially diminished.

• Constructive sales: Short sales against the box (or similar hedging techniques that involve notional principal contracts, futures contracts or forward contracts) may result in recognition of any appreciation on the underlying asset, and the holding period is reset.

• Wash sales: A loss is deferred if a substantially identical security is acquired within 30 days prior to, or subsequent to, the disposition (special consideration should be given to in-kind transactions).

• Swaps: For interest-rate swaps, daily accruals are treated as ordinary income. For swaps with contingent payments (e.g., credit defaults swaps) and swaps with non-periodic payments (e.g., certain types of total return swaps), under proposed regulations, unrealized gain (loss) is projected and accrued or marked to market as ordinary income at year-end, and all periodic payments are picked up as ordinary income. Realized gain (loss) on the early termination of swaps (other than currency swaps) is treated as capital. Bullet (single payment) swaps generate capital gain/loss.

• Pay-down gains (losses): Generally, tax treatment is capital if purchased after 8 June 1997. However, market discount and premium rules should be considered.

• Original issue discount (OID): OID is amortized daily using the yield-to-maturity (YTM) method as interest (or tax-exempt interest).

• Market discount: Recognize at disposition as taxable interest (even on tax-exempt bonds) using the straight-line method. Interest is limited to the extent of gain realized; may elect that all bonds be amortized daily and may elect the YTM method.

• Bond premium: This involves use of the YTM method; for taxable bonds, amortization is not required, but if elected, premium is treated as interest offset; for tax-exempt bonds, mandatory amortization of premium as a non-deductible expense.

• Option premiums: Writer: premiums received liability, expire short-term capital gain, exercise call-add to proceeds and exercise put-reduce cost. For the purchaser, premiums paid-cost, expire-loss, exercise call-add to cost and exercise put-reduce proceeds.

RIC qualification tests These tests are based on tax year-end.

Annual• At least 90% of gross income must

be from dividends, interest, gross realized gains, payments with respect to securities loans, foreign currencies, net income derived from an interest in a qualifying publicly traded partnership and other income related to stock, securities or currencies. Cure, with imposition of tax, is available for inadvertent failures.

• At least 90% of tax-exempt and investment company taxable income must be distributed.

Quarterly• At least 50% of total assets must

be invested in cash, cash items, US government securities, other RICs and other securities (each issuer ≤5% of the RIC’s total assets and ≤10% of the outstanding voting stock of issuer; in most instances, 30-day cure period available; in certain instances, six-month cure also available).

• No more than 25% of total assets may be in one issuer, in two or more issuers that the RIC controls (20% voting) that are in a similar business, or in the securities of one or more qualified publicly traded partnerships (same cure period as 50% test).

• If a RIC is an investment option for a variable insurance contract (e.g., annuity and life), at the end of each calendar quarter: • The largest investment must be ≤55%

of total assets. • The largest two investments must be

≤70% of total assets. • The largest three investments must

be ≤80% of total assets. • The largest four investments must be

≤90% of total assets.

Spillback distributions • A RIC may elect to treat certain dividends

that it pays after the close of a tax year as having been paid during that tax year for purposes of the RIC distribution requirements and determining the RIC’s taxable income. These so-called spillback dividends are taxable to RIC shareholders in the year they are actually received. A spillover dividend must be declared before the later of:

• The 15th day of the 9th month following the close of the taxor

• If the time for filing the RIC’s return for the tax year is extended, the due date for filing such return, taking the extension into account

Tax return filing requirements• Effective for taxable years starting after

31 December 2015 (2016 tax returns): 1. Income tax returns for calendar-year

RICs will be due on 15 April, and extended returns will be due on 15 October.

2. RICs (other than 31 December and 30 June) will be due on the 15th day of the 4th month after year-end, and extended returns will be due on the 15th day of the 10th month after year-end.

3. 30 June fiscal year RICs income tax returns will be due on 15 October, and extended returns will be due on 15 April.

• Excise tax returns (Form 8613) are due on 15 March (additional six months available with an extension). An excise tax return is required to be filed only if an excise tax is due, although filing a return even when no tax is due should be considered for purposes of the statute of limitations.

Quick tax reference guide Ernst & Young LLP 7Regulated investment companies6

Foreign securities• Passive foreign investment company

(PFIC): A PFIC is a foreign corporation that meets certain criteria. A RIC may choose to: (1) elect to mark-to-market the PFIC at year-end (losses allowed to the extent of previous gains), (2) make a "qualified electing fund" election or (3) pay tax and interest charges on "excess distributions" (including gain on disposition).

• Forward foreign exchange (FX) contracts: Gain (loss) is recognized on the settlement date. An FX contract is a §1256 contract if it is in a currency traded through RFCs, is entered in the interbank market and is at arm’s length. Countries whose currencies meet these requirements are (as of January 2017): Australia, Brazil, Canada, Colombia, Chile, China, Czech Republic, EU, Hungary, India, Israel, Japan, Korea, Mexico, New Zealand, Norway, Poland, Russia, South Africa, Sweden, Switzerland, Turkey and the UK.

The treatment of FX contracts is as follows:

Note: A RIC may elect Section 988(a)(1)(B) treatment. The election, which is available only if the transaction is not part of a straddle, must be made before the close of the day on which the transaction is entered.

• §988 bond bifurcation rules: The foreign currency portion of the realized gain (loss) on the sale of a foreign bond should be treated as ordinary income (loss). If the capital and currency portions are not both a gain or both a loss, the character of net gain (loss) is determined by the dominant bucket.

For example:

Excise tax rules• To avoid a 4% non-deductible federal

excise tax on undistributed taxable income, a RIC must distribute the sum of: 1. 98% of its net investment income for

the calendar year 2. 98.2% of the net capital gains (short

and long) for the annual period ending 31 October (or a fund with a 30 November or 31 December year-end may elect to use its year-end)

3. 100% of prior year under-distributions

Note: The measurement period for foreign currency, PFIC income and other specified gains and losses is 31 October.

• Elective deferral of certain losses for non-calendar-year funds is available for excise tax purposes. This deferral includes ordinary losses and net specific losses from the beginning of the fiscal year through 31 December and 31 October, respectively.

• If an entity involved in the organization of a RIC underlying a variable contract has US$250,000 or less invested in the RIC, the RIC is not subject to the excise tax rules.

Qualified late-year loss deferrals• Post-October capital loss — A RIC may

elect to defer to the next tax year all or a portion of its net capital loss, net short-term capital loss or net long-term capital loss attributable to transactions occurring after 31 October.

• Late-year ordinary loss — A RIC may also elect to defer to the next year all or a portion of its post-October specified losses (such as currency and PFIC losses) incurred after 31 October and post-December ordinary loss incurred after 31 December.

Dividend payments • Ordinary — For RICs, ordinary income

includes net short-term capital gains, PFIC mark-to-market gains and foreign currency gains (losses) in addition to net investment income.

• Capital gain — This is the excess of net long-term capital gain over net short-term capital loss.

• Return of capital — The distribution in excess of the earnings and profits of the RIC is non-taxable return of capital, which reduces the basis of shareholders’ shares.

• Dividends declared in October, November and December, payable to shareholders of record in the same month and paid before 1 February, are generally treated as having been paid in the year declared.

• If at least 50% of the value of a fund’s total assets is invested in tax-exempt obligations (e.g., municipal securities) at each quarter-end (by tax year-end), the fund can distribute tax-exempt interest dividends.

• A fund of funds that, at the close of each quarter, has at least 50% of its total assets invested in other RICs can pass through to its shareholders any tax-exempt dividends from underlying investments.

• Foreign taxes paid — If a RIC has more than 50% of its year-end total assets invested in foreign securities, it may elect to permit its shareholders to take a credit or deduction for eligible foreign taxes paid.

Notification and reporting requirements to shareholders• Shareholders must be notified, after the

RIC’s fiscal year-end, of the following amounts paid, if applicable (and elected): capital gain dividends, the allocable foreign taxes paid and related foreign source gross income, and dividends qualifying for the corporate dividends received deduction. They must also be notified of dividends qualifying for the reduced maximum rate of 20% (qualified dividend income (QDI), interest-related dividends (QII), qualified short-term capital gains and exempt interest dividends.

• Form 1099-DIV: This includes the amount of ordinary income, QDI, capital gains and foreign tax credits, as well as non-taxable distributions by 31 January (may be extended until 28 February).

• Form 1099-INT: This includes the amount of tax-exempt income, as well as tax-exempt income that is subject to the alternative minimum tax, by 31 January.

• Form 2439: This includes the amount of long-term capital gains retained and taxes paid by the RIC on behalf of the shareholders by the 60th day after the end of the fund’s tax year.

• Form 1099-B: This includes shareholder proceeds from the sale of mutual fund shares by 31 January.

• Form 8937: This includes certain capital changes that impact the cost basis of fund shares, effective on the earlier of the 45th day following the organizational action or 15 January of the next calendar year.

Type of contract Timing Character Character with

§988(a)(1)(B)

1256 Mark-to-market Ordinary 60 LT/40 ST

Non-1256 Disposition Ordinary Capital

Capital Currency Net Tax treatment

100 70 170 100 capital70 ordinary

(100) (70) (170) (100) capital(70) ordinary

(100) 70 (30) (30) capital

(100) 120 20 20 ordinary

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