These comments to IRS provide a proposal to amend Reg. Sections 1.853-2, 1.853-3 and 1.853-4 and modify Form 1116, regarding separate country reporting of foreign tax credit by mutual funds. Included in the submission is the December 11, 1998, AICPA comments to the IRS recommending the regulations under IRS section 853 be amended to conform the regulations to Code changes made more than twenty years ago in order to simplify reporting requirements for mutual fund shareholders. Additionally, the AICPA suggests changing the due date for certain shareholder notices to 60 days to conform to 1986 statutory changes.

February 26, 2003

Carol A. Dunahoo
Director, International
IRS/LM:IN
950 L'Enfant Plaza South, SW—Suite 4401
Washington, D.C. 20024
(fax 202-874-1782)

Re: Proposal to Amend Reg. Sections 1.853-2, 1.853-3 and 1.853-4 and Form 1116

Dear Ms. Dunahoo:

As discussed briefly at the October 29, 2002, meeting of the AICPA International Tax Technical Resource Panel, we recommend amending the regulations under Internal Revenue Code section 853 to conform the regulations to Code changes made more than twenty years ago. A "clean-up" amendment would simplify reporting requirements for mutual fund shareholders by eliminating unnecessary information, and thus, enhance shareholder compliance.

A significant number of mutual funds invest assets abroad and are entitled to pass through a foreign tax credit to their shareholders. The typical international mutual fund has investments in 15 to 35 different countries, but pays only an insignificant amount of foreign taxes per share. (See Appendix A attached.) Our proposal would reduce the time and expense—which is often passed on to shareholders—that fund administrators spend providing superfluous tax information.

We have attached proposed amendments to the section 853 regulations. (See Appendix B.) We also recommend modifying Form 1116, Foreign Tax Credit (Individual, Estate, or Trust), to indicate that distributions from regulated investment companies (RICs) are exempt from per-country reporting. The attached mark-up also changes the due date for certain shareholder notices to 60 days to conform to 1986 statutory changes.

This proposal provides a no-cost opportunity to improve shareholder tax compliance, enhance investor relations, and reduce fund expenses. No revenue will be lost because these changes do not impact the computation of taxes, directly or indirectly. Rather, they simply eliminate reporting voluminous, unused information; thereby reducing fund expenses for compiling the information, drafting, printing and mailing it, and answering phone calls from perplexed shareholders. Finally, the confusion caused by the extensive table required to report per-country information will be eliminated. 

We would be pleased to discuss these matters with you or others within the IRS and Treasury. Please contact us if you have any questions or if we can be of assistance to you. I can be reached at (202) 414-0705; or you may contact Andrew Mattson, Chair, AICPA International Tax Technical Resource Panel, at (408) 369-2566; or Eileen Sherr, AICPA Technical Manager, at (202) 434-9256.

Sincerely,

Robert A. Zarzar
Chair, AICPA Tax Executive Committee

cc:

Pamela Olson, Assistant Secretary for Tax Policy, Treasury - MT 1330 (fax 202-622-0605)

Barbara Angus, International Tax Counsel, Treasury - MT 1000 (fax 202-622-0646)

Michael S. Novey, Treasury, Associate Tax Legislative Counsel, Room 1022 MT (fax 202-622-9260)

Sharon Galm, IRS (CC:FIP:B01), Acting Branch Chief, Branch 1, Room 4311 IR (fax 202-622-4425)

William E. Coppersmith (CC:FIP:B02), Branch Chief, Branch 2, Room 4312 IR (fax 202-622-4425)

Alice M. Bennett (CC:FIP:B03), Branch Chief, Branch 3, Room 4116 IR (fax 202-622-5699)

December 11, 1998

Donald C. Lubick
Assistant Secretary (Tax Policy)
U.S. Department of the Treasury
1500 Pennsylvania Ave., NW, Room 1000
Washington, DC 20220

Re: Proposal for Amendment to Income Tax Regulations §§1.853-2, 1.853-3 and 1.853-4 and to IRS Form 1116

Dear Mr. Lubick:

We are writing to recommend an amendment to Treasury Regulations under §853 of the Internal Revenue Code of 1986, as amended, ("the Code") to conform those regulations to changes in the Code that were made more than twenty years ago. This "clean-up" amendment would provide simplification for shareholders of mutual funds by eliminating the need for them to be burdened by unnecessary information, and thus, by simplifying reporting, would serve to enhance shareholder compliance. A significant number of mutual funds invest their assets abroad and are entitled to pass through a foreign tax credit to their shareholders. On average, although the amount of foreign taxes paid on a per share basis is generally insignificant, the typical international mutual fund might have its assets invested in fifteen to thirty-five different countries. (See Appendix A attached.) The proposal would reduce the time consuming effort expended by fund administrators required to provide superfluous information, the cost of which effort is often passed on to shareholders in the form of increased fund expenses.

Background

Section 853 of the Code permits a regulated investment company (RIC) that holds, at the close of its taxable year, at least 50 percent of the value of its assets in the stock or securities of foreign corporations, to elect to flow through to its shareholders its foreign-source income and the taxes paid by the RIC during the taxable year to foreign countries and possessions of the United States. If the election is made, the RIC is not allowed a deduction under §164(a) or a credit under §901. Each shareholder of the RIC includes in gross income and treats as paid by him, his proportionate share of such taxes and treats as gross foreign source income the sum of his proportionate share of such taxes and the portion of any dividend paid by such RIC which represents income derived from sources within foreign countries and possessions of the United States.

Section 853(c) of the Code and Treasury Regulations §§1.853-3 and 1.853-4 provide certain requirements for a RIC to perfect an election to pass through its foreign taxes. First, the RIC must designate, in a written notice mailed to shareholders not later than 60 days after the close of the taxable year, the shareholder's portion of taxes paid to each country or possession and the portion of the dividend which represents income derived from sources within any foreign country or possession of the United States. In addition, the RIC must file with Forms 1099 and 1096 a statement setting forth certain detailed information on its foreign-source income and foreign taxes paid and include with its tax return a modified Form 1118.

Section 901 provides that a taxpayer may elect a credit against income tax for any income, war profits and excess profits taxes paid or accrued to a foreign country or U.S. possession, subject to the limitations of §904. Section 904 states that the ratio of a taxpayer's foreign tax credit to his U.S. tax liability cannot exceed the ratio that his foreign-source taxable income bears to his total taxable income for the year. This limitation is applied separately to different 'baskets" of income identified in §904(d)(1). However, §904(j), which was added by the Taxpayer Relief Act of 1997, provides an exception to the limitations in §904 for individuals whose only foreign source income is attributable to the passive basket and whose creditable foreign taxes do not exceed $300 ($600 in the case of a joint return).

Problem

Regulations §§1.853-2, 3 and 4 contain references to a requirement that information on foreign taxes paid and foreign-source gross income be provided to shareholders and the IRS on a per country basis. Moreover, this information must be provided to shareholders twice: on a fiscal year basis with the 60-day notice required by §853(c), and on a calendar year basis with Form 1099. In addition, Form 1116, which is required to be filed by individuals that do not qualify for simplified reporting under new §904(j), requires reporting of foreign-source taxable income and foreign taxes paid on a per country basis.

The regulations reflect law in effect prior to 1976 that required the allowable foreign tax credit to be computed on a separate country basis. The Tax Reform Act of 1976 amended §904 to provide an overall limitation instead of separate country limitations. This change was reflected in §904(a) and eliminated any previous reference to the computation of the limitation on a separate country basis. Because taxpayers are now required to compute their foreign tax credit limitation based on aggregate foreign income applied to a basket, and because §904(j) now provides a simplified method of reporting for taxpayers whose only foreign-source income is "passive", it should no longer be necessary for RICs to specify the amount of income from and the amount of tax paid to each separate country.

Proposed Amendment

The AICPA proposes that the Regulations under §853 be amended as reflected in the attached mark-up. (See Appendix B.) In addition, the AICPA proposes that Form 1116 be modified to indicate that distributions from RICs are exempt from per country reporting.

The attached mark-up also reflects proposed amendments to the regulations to change to 60 days the due date for certain notices to shareholders to conform with statutory changes made by the Tax Reform Act of 1986.

This proposal will not result in a loss of revenues because it does not directly or indirectly impact the computation of taxes. It is a request to eliminate the reporting of unused information. The request is important to mutual funds, however, because funds have taken a leadership role in educating their shareholders on how to properly report the tax consequences of owning mutual funds. The extensive table required for reporting per country information has a significant history of confusing shareholders, leading to lower levels of compliance and further dissatisfaction with the Internal Revenue Code as well as mutual fund ownership. Confusion results in a real increase in fund expenses through the costs incurred in compiling the information, drafting, printing and mailing it, and answering phone calls from perplexed shareholders. This proposal provides a no cost opportunity to improve shareholder tax compliance and investor relations and reduce funds' expenses.

The AICPA would like to schedule a meeting to discuss the aforementioned issues and will contact your office in the next week to arrange a meeting time convenient for you. If you have any questions or comments in the meantime, please contact me at (212) 572-5555; Arlene J. Sakatos, Chair of the Investment Companies Subgroup of the Financial Services Industry Taxation Committee at (212) 596-8358; or Marc A. Hyman, AICPA Technical Manager at (202) 434-9231.

Very truly yours,

David A. Lifson, Chair
Tax Executive Committee

Cc:

Je Young Baik
Alice M. Bennett
Patrick J. Brown
Paul Crispino
Barbara A. Felker
Rebecca Rosenberg
Lon B. Smith
Philip R. West

Appendix B

§ 1.853 2 Effect of election.
(d)(4) The X Corporation meets the 50 percent requirement of section 851(b)(4) and the requirements of section 852(a). It notifies each shareholder by mail, within the time prescribed by section 853(c), that by reason of the election they are to treat as foreign taxes paid $0.30 per share of stock ($75,000 of foreign taxes paid, divided by the 250,000 shares of stock outstanding). The shareholders must report as income $2.88 per share ($2.58 of dividends actually received plus the $0.30 representing foreign taxes paid). Of the $2.88 per share, $1.80 per share ($450,000 (which represents such part of the net dividend income of $720,000 as the foreign dividend income of $500,000 bears to the total dividend income of $800,000) divided by 250,000 shares) is to be considered as received from foreign sources.

§ 1.853 3 Notice to shareholders.

(a) General rule. If a regulated investment company makes an election under section 853(a), inthe manner provided in §1.853 4, the investment company is required, under section 853(c), to furnish its shareholders with a written notice mailed not later than 60 days after the close of its taxable year. The notice must designate the hareholder's portion of foreign taxes paid to foreign countries or possessions of the United States and the portion of the dividend which represents income derived from sources within such countries or possessions. For purposes of section 853(b)(2) and paragraph (b) of §1.853 2, the amount that a shareholder may treat as his proportionate share of foreign taxes paid and the amount to be included as gross income derived from foreign countries or possessions of the United States shall not exceed the amounts so designated by the company in such written notice. If, however, the amount designated by the company in the notice exceeds the shareholder's proper proportionate share of foreign taxes or gross income from sources within such foreign countries or possessions, the shareholder is limited to the amount correctly ascertained.

(b) Shareholder of record custodian of certain unit investment trusts. In any case where a notice is mailed pursuant to paragraph (a) of this section by a regulated investment company with respect to a taxable year of the regulated investment company ending after December 8, 1970 to a shareholder of record who is a nominee acting as a custodian of a unit investment trust described in section 85l (f)(1) and paragraph (b) of § 1.851 7, the nominee shall furnish each holder of an interest in such trust with a written notice mailed on or before the 55th day following the close of the regulated investment company's taxable year. The notice shall designate the holder's roportionate share of the amounts of foreign taxes paid to foreign countries or possessions of the United States and the holder’s proportionate share of the dividend which represents income derived from sources within such countries or possessions shown on the notice received by the nominee identified as such. This paragraph shall not apply if the regulated investment company agrees with the nominee to satisfy the notice requirements of paragraph (a) of this section with respect to each holder of an interest in the unit investment trust whose shares are being held by the nominee as custodian and not later than 60 days following the close of the company's taxable year, files with the Internal Revenue Service office where such company's return for the taxable year is to be filed, a statement that the holders of the unit investment trust with whom the agreement was made have been directly notified by the regulated investment company. Such statement shall include the name, sponsor, and custodian of each unit investment trust whose holders have been directly notified. The nominee's requirements under this paragraph shall be deemed met if the regulated investment company transmits a copy of such statement to the nominee within such 60 day period; provided however, if the regulated investment company fails or is unable to satisfy the requirements of this paragraph with respect to the holders of interest in the unit investment trust, it shall so notify the Internal Revenue Service within 60 days following the close of its taxable year. The custodian shall, upon notice by the Internal Revenue Service that the regulated investment company has failed to comply with the agreement, satisfy the requirements of this paragraph within 30 days of such notice.

§ 1.853 4 Manner of making election.

(a) General rule. A regulated investment company, to make a valid election under section 853, must—

(1) File with Form 1099 and Form 1096 a statement as part of its return which sets forth the following information:

(i) The total amount of income received from sources within foreign countries and possessions of the United States;

(ii) The total amount of income, war profits, or excess profits taxes (described in section 901(b)(1)) paid, or deemed to have been paid under the provisions of any treaty to which the United States is a party, to such foreign countries or possessions;

(iii) The date, form, and contents of the notice to its shareholders;

(iv) The proportionate share of such taxes paid during the taxable year and foreign income received during such year attributable to one share of stock of the regulated investment company; and
(2) File as part of its return for the taxable year a Form 1118 modified so that it becomes a statement in support of the election made by a regulated investment company for taxes paid to foreign countries or possessions of the United States.

(c) Irrevocability of the election. The election is applicable only with respect to taxable years subject to the Code, shall be made with respect to all such foreign taxes, and must be made not later than the time prescribed for filing the return (including extensions thereof). Such election, if made, shall be irrevocable with respect to the dividend (or portion thereof), and the foreign taxes paid with respect thereto, to which the election applies.