Rev. Rul. 73-463

The purpose of this Revenue Ruling is to clarify and restate Rev. Rul. 72-13, 1972-1 C.B. 42, relating to the question of whether an open-end investment company as defined in the Investment Company Act of 1940, as amended (54 Stat. 789; 15 U.S.C. 80a-1 to 80b-2) can deduct the stock issuance expenses described below as ordinary and necessary business expenses.

There are two general types of open-end investment companies. The first is one that imposes a sales charge on the shares sold. It sells its shares to an underwriter who sells the shares to a broker-dealer who in turn sells them to the ultimate public investor. The second type of open-end investment company is one that sells its shares directly to the public investor without imposing a sales charge. Both types normally continuously offer their shares for sale.

An open-end investment company is generally restricted to issuing stock that at all times is subject to the demand by the shareholder that it be redeemed upon tender.

There are certain expenses connected with the issuance and redemption of the stock of an open-end investment company. These include fees and costs directly incurred in the registration, issuance, and redemption of such stock. Specific examples of stock issuance costs are: legal and accounting fees incurred in preparation of a registration statement, an S.E.C. filing fee, "Blue-Sky" filing and registration fees, distributing and printing prospectuses, printing stock certificates, printing and processing periodic investment and dividend reinvestment plans, processing applications for redemption, processing stock certificates, maintaining stockholder share accounts, and costs of issuing checks for the proceeds of redeemed shares.

Stock issuance expenses may be paid by the open-end investment company, the underwriter of its shares, its registrar, transfer agent, custodian of the open-end investment company's assets, or its shareholders. For example, in the first type of open-end investment company described in the second paragraph of this Revenue Ruling the underwriter contractually agrees with the open-end investment company to pay out of its (the underwriter's) fee the cost of the prospectuses, literature and advertising, registration and filing fees, and general operating expenses of the open-end investment company. In other cases a fee per transaction might be imposed on the shareholder for such services as processing periodic investments, dividend reinvestments, and partial withdrawals. These fees are commonly paid to a bank acting as the open-end investment company's dividend disbursing agent, transfer agent, and custodian. Frequently, a redemption fee (usually a percentage of the value of the share tendered) is imposed upon the shareholder by the open-end investment company where shares are redeemed.

Section 162(a) of the Internal Revenue Code of 1954 provides that there shall be allowed as a deduction all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

The capital needs of the open-end investment company are subordinate to the wishes of its shareholders for a return of their capital without approval of directors or the majority of all shareholders. It is this constant possibility of withdrawal of part or all of capital by means of the redemption of stock, independent of all the usual business risks, that clearly distinguishes stock of open-end investment companies from the stock of other corporations. However, an open-end investment company is similar to an ordinary corporation in the sense that by its initial stock offering to the public it acquires the minimum capital necessary to engage in business. The initial stock offering period for an open-end investment company ends ninety days after the day its registration statement under the Securities Act of 1933 is first declared effective. The ninety day period was determined by reference to section 14 of the Investment Company Act of 1940, 54 Stat. 811; 15 U.S.C. 80a-14, which permits an investment company a maximum period of ninety days after a registration statement of its securities, offered for public sale under the Securities Act of 1933, becomes effective to raise its statutory minimum capital.

Although an open-end investment company normally continuously offers its shares for sale to the public, there is no requirement under the Securities Act of 1933 that it must register all of its authorized shares for sale at the time of its initial registration of shares under that Act. After the original registration statement has been declared effective, a post-effective amendment to the original registration statement must be filed to register for sale additional shares in excess of the number originally registered and for other purposes such as updating financial data. The purpose of the post-effective amendment is to permit an open-end investment company to continue its normal operations and not to embark on a major new capital-raising effort. For that reason, the ninety day period after a post-effective amendment has been declared effective is neither a new stock offering period nor an extension of the initial stock offering period.

In general, stock issuance expenses are nondeductible capital expenditures. For example, see General Bancshares Corporation v. Commissioner, 326 F. 2d 712 (8th Cir. 1964), cert. denied, 379 U.S. 832 (1964). However, the unique circumstances which permit shareholders of an open-end investment company to withdraw their capital from the company on demand leads to the conclusion that continuous capital raising efforts by the company after the initial stock offering period is an essential part of its day to day business operations.

Accordingly, stock issuance expenses, except those incurred during the initial stock offering period, are deductible as ordinary and necessary business expenses under section 162(a) of the Code to the extent they are in fact paid or incurred by the open-end investment company.

Rev. Rul. 72-13 is superseded, since the position set forth therein is restated in this Revenue Ruling.