REIMBURSEMENT RECEIVED BY RIC FROM INVESTMENT ADVISER IS QUALIFYING INCOME.

Rev. Rul. 92-56

ISSUE

A regulated investment company (RIC) receives a reimbursement from its investment advisor in a transaction that is in the normal course of the RIC's business. The reimbursement is includible in the RIC's gross income. Is the reimbursement qualifying income under section 851(b)(2) of the Internal Revenue Code?

FACTS

R is a management company under the Investment Company Act of 1940, 15 U.S.C. section 80a-1 et seq., as amended. For each of its taxable years, R has qualified as a RIC within the meaning of section 851 of the Code and has been taxable under subchapter M, part I, of the Code. R files its income tax return on a calendar year basis.

T is R's investment advisor. In 1990, R paid T for investment advisory services that T provided to R. In 1991, T reimbursed part of this advisory fee. The reimbursement was includible in R's gross income in 1991 under section 61 of the Code. The reimbursement was made in the normal course of R's business and was not the result of a transaction entered into to artificially inflate R's qualifying gross income under section 851(b)(2).

LAW AND ANALYSIS

Section 851(b)(2) of the Code provides that a corporation is not a RIC for any taxable year unless at least 90 percent of its gross income is derived from certain enumerated sources including "other income (including but not limited to gains from options, futures, or forward contracts) derived with respect to [the RIC's] business of investing in . . . stock, securities, or [foreign] currencies."

The amount paid to R by T was a reimbursement of advisory fees paid to T by R in 1990. The reimbursement was made in the normal course of R's business and was not the result of a transaction entered into to artificially inflate R's qualifying gross income under section 851(b)(2) of the Code. The reimbursement was, therefore, derived with respect to R's business of investing in stock, securities, or foreign currencies.

HOLDING

If, in the normal course of its business, a RIC receives a reimbursement from its investment advisor and the reimbursement is includible in the RIC's gross income, the reimbursement is qualifying income under section 851(b)(2) of the Code.

EFFECT ON OTHER REVENUE RULINGS

In Rev. Rul. 64-247, 1964-2 C.B. 179, a company recovered excess management fees from its investment manager. The recovery was made as a result of legal action brought against the company's former officers and directors who had owned the investment manager. In Rev. Rul. 74-248, 1974-1 C.B. 167, a company's former investment advisor paid the company an amount the advisor had improperly received for assigning its advisory contract. The payment was made pursuant to a settlement agreement that was reached after the company's shareholders filed a derivative action against the investment advisor. In both rulings, the payments were includible in the company's gross income. The rulings held that the payments did not cause the companies to fail to meet the definition of RIC contained in section 851 of the Code, provided the companies in all other respects qualified for RIC status for the taxable year in question. The rulings also held that, for purposes of section 854, relating to limitations applicable to dividends received from RICs, the payments should be allocated between interest and dividends in proportion to the interest and dividends derived by the company during the taxable year in which the payments were includible in gross income.

Rev. Ruls. 64-247 and 74-248 predate the 1986 amendment of section 851(b)(2) of the Code, which specifies that qualifying income includes other income derived by a RIC with respect to its business of investing in stock, securities, or foreign currencies. See section 653(b) and (d), Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. 215. Accordingly, Rev. Ruls. 64-247 and 74-248 are obsolete to the extent they imply that the payments therein would not be qualifying income under section 851(b)(2). Rev. Ruls. 64-247 and 74-248 are also obsolete to the extent they would treat the payments, in part, as dividend income under section 854.

DRAFTING INFORMATION

The principal author of this revenue ruling is Nellie Howard of the Office of Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue ruling, contact Nellie Howard on (202) 566-3297 (not a toll-free call).