While most of the recent "Comments on Proposed Rule: Money Market Fund Reform; Amendments to Form PF posted on the SEC's website have been related to the SEC's recent posting of 4 "mini" studies, the latest related to tax issues and floating NAVs and comes from George C. Howell, III, Hunton & Williams LLP, on behalf of Federated Investors, Inc.. Howell writes, "We are writing on behalf of our client, Federated Investors, Inc., and its subsidiaries ("Federated"), to provide comments in response to the Securities and Exchange Commission's (the "Commission's") proposed rule on Money Market Fund Reform; Amendments to Form PF (the "Release"). Our comments in this letter will address the tax compliance issues that would result from the proposed rule's requirement that money market mutual funds ("MMFs") adopt a floating net asset value ("NAV"), unless specifically exempted."

The Federated letter continues, "As the Release acknowledges, if modifications to current federal income tax law are not made, "the tax reporting effects of a floating NAV could be quite burdensome for money market investors that typically engage in frequent transactions." These effects would be particularly burdensome for institutional investors, as such investors generally must make their own tax calculations rather than receiving reporting from the fund. As discussed in further detail below, significant changes would be needed to the existing federal income tax rules regarding gain and loss recognition to eliminate the substantial tax compliance burdens associated with applying the floating NAV requirement to MMFs. Furthermore, it is not clear that the Treasury Department and the Internal Revenue Service (the "IRS") currently have the regulatory authority necessary to implement the required tax law changes. To the extent that the Treasury Department and the IRS view themselves as not having the necessary regulatory authority or are unwilling to exercise it, a legislative fix would be required. Regardless of whether an administrative or legislative approach is taken, the tax compliance issues, which are described below, must be completely resolved and final legislation or administrative guidance in place prior to applying a floating NAV concept to institutional MMFs to avoid a potentially disastrous exodus of capital from the affected MMFs."

It tells us, "It is a fundamental tenet of the federal income tax law that, when an investor sells or redeems a security for more or less than the seller's cost, the investor recognizes the resulting gain or loss and must report it on the investor's tax return for the year of the sale. To calculate this gain or loss, the taxpayer must track both its cost or tax basis for the security and the price at which it sold or redeemed the security. Certain taxpayers, such as individuals, receive annual reporting of such information and the amount of the resulting gains or losses from the issuer of the security or the broker through which the sale was made. For taxpayers that are "exempt recipients," including corporations and most other institutional investors, the taxpayer must track this information and calculate the resulting gains and losses on its own."

Howell explains, "The Commission's floating NAV concept is proposed to apply only to institutional MMFs. Investors in institutional MMFs generally are corporations and other large institutional investors who use MMFs as a short-term investment vehicle and cash management tool. The amount of their investment in an MMF will vary from day to day as their cash balances go up or down. With stable NAV MMFs, there is no need for an investor to calculate or report gain or loss because the MMF maintains a stable $1 NAV per share and the redemption price of fund shares therefore always equals their cost. Thus, "money market fund shareholders therefore generally need not track the timing and price of purchase and sale transactions for capital gains or losses.""

He says, "Under the floating NAV proposal, the price of institutional MMF shares would change daily, albeit by a small amount. As a result, taxable investors would be required to track the cost or tax basis and redemption price of all shares that they purchase and redeem. In addition, such investors would be required to track the timing of individual purchase and redemption transactions to determine whether the "wash sale" rules applicable under federal income tax law disallow any of the losses. The existence and nature of this tax compliance burden is described in the IRS's recent proposed guidance regarding the application of the wash sale rules to floating NAV MMF shares. The examples in that guidance clearly indicate the need for investors to track the small gains and losses that would be associated with redemptions of floating NAV MMF shares. Furthermore, because the investors in institutional MMFs generally are "exempt recipients," the tax compliance burden would fall squarely on the investors, rather than on the funds. For institutional investors that themselves hold accounts for non-retail customers, this could require calculating small gains and losses on hundreds or thousands of accounts."

Federated's letter states, "Based on the foregoing, it is clear that, if the tax compliance burden associated with a floating NAV cannot be eliminated, the application of that concept would be damaging to institutional MMFs and investors. It would also be counterproductive to the Commission's stated goals with respect to such funds, which include "preserv[ing] as much as possible the benefits of money market funds for investors and the short-term financing markets." The remainder of this letter addresses the difficulty of eliminating that tax compliance burden without resorting to a legislative fix, which, of course, presents its own set of political and procedural challenges."

It comments, "To date, the only guidance that has been issued by the IRS with respect to the floating NAV concept is a proposed revenue procedure that would make the wash sale rule inapplicable to purchases and sales of MMF shares if the losses are below a specified threshold. The Release indicates that the Treasury Department and the IRS are also considering guidance that would allow (i) mutual funds to report net information regarding gains and losses recognized on sales of their shares and (ii) shareholders to report summary information on their returns regarding sales of mutual fund shares. However, eliminating the tax compliance burden on institutional MMF shareholders associated with the floating NAV concept would require much more in the way of guidance. The proposed revenue procedure would not make the wash sale rule inapplicable to all sales of MMF shares, but would merely disengage it if the recognized losses are below a specified threshold. As a result, MMF shareholders would still be required to gather and retain information regarding the possible application of the wash sale rule for fear that losses might exceed the threshold. Similarly, simplifying the reporting of gains and losses from sales of MMF shares on a shareholder's tax return is helpful in a limited sense, but it does not obviate the need to track and retain the information necessary to calculate the gains and losses that would be recognized on individual share redemptions, which can occur on a daily basis."

Federated writes, "Eliminating the tax compliance burden on institutional MMF shareholders associated with the floating NAV concept would require the issuance of two types of guidance. First, it would be necessary to provide full relief from the wash sale rule to the extent that losses are recognized on MMF investments. Without this full relief, institutional MMF shareholders would still have significant tax compliance obligations relating to the wash sale rule. The second and more important type of guidance that would be required is a modification of the basic gain and loss recognition regime that would eliminate the need to track gains and losses from individual MMF share redemptions. One way to achieve this goal would be to use to a "mark-to-market" tax accounting method for floating NAV MMF investments.... A final option, which represents an even further departure from existing federal income tax law, would be to provide that gains and losses from MMF share redemptions are ignored and never recognized for tax purposes under the theory that such amounts are always de minimis. As indicated in the next section, it is unclear whether the Treasury Department and the IRS have the regulatory authority to implement any of the foregoing guidance."

Finally, the letter concludes, "As discussed above, converting to a floating NAV would cause fund shareholders to recognize small gains and losses with respect to redemptions of MMF shares. Because the floating NAV proposal applies only to institutional MMFs, it is expected that, in general, fund shareholders, rather than the funds themselves, will be required to track and calculate these gains and losses. Because institutional investors use MMFs as a cash management tool, they typically engage in share purchases and redemptions on a daily or weekly basis. Accumulating and maintaining the information necessary to calculate the numerous small gains and losses resulting from frequent share redemptions would require significant time and expense on the part of fund shareholders. If this tax compliance burden cannot be eliminated, it is likely that most taxable institutional investors would abandon MMFs for other short-term investment alternatives that have a stable NAV and therefore do not require tracking and calculating cost or tax basis and redemption price. This exodus of capital from institutional MMFs would be damaging to the funds and the issuers of securities that are purchased by such funds. At the same time, institutional investors would be damaged because they will be precluded from using their preferred cash management tool merely because of the unsupportable tax administrative burden that would be imposed by the floating NAV concept. Finally, it also would be counterproductive to the Commission's stated goals with respect to MMFs, including preserving the benefits of MMFs for investors. For these reasons, the Commission should not implement the floating NAV proposal unless and until the Treasury Department or the IRS has issued administrative guidance that in fact eliminates the tax compliance burden on institutional MMF shareholders."

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