The Investment Company Institute sent a letter recently to William Wilkins, Chief Counsel for the Internal Revenue Service on "Money Market Fund Reform -- Adviser Contributions." The letter, penned by ICI's Karen Lau Gibian, Associate General Counsel – Tax Law, seeks additional guidance on the new rules for money market funds that could help prevent runs. She writes, "The requested guidance is necessary to, among other things, prevent redemptions from money market funds as they are required to transition from a stable net asset value ("NAV") fund to a floating NAV fund. As mentioned in our earlier submission and discussed below, we understand that some investment advisers may decide to make contributions of cash to existing money market funds to bring the shadow NAV of a fund up to $1.0000 before the compliance date for the SEC Rule. Although for book purposes this contribution would be treated as additional paid-in capital, with no resulting gain or income to the fund, the tax treatment by the fund is uncertain. Existing authorities suggest two possible approaches for analyzing these payments. As discussed below, however, neither approach fully resolves the issues raised by a contribution for this purpose." (Note: Welcome to those readers and subscribers attending Crane's Money Fund Symposium, which takes place Wednesday through Friday in Minneapolis. We hope you enjoy the show! Watch for highlights in coming days and in the July issue of our Money Fund Intelligence.)
ICI's Gibian writes, "The first possible approach would treat the contribution as short-term capital gain. If the fund does not have sufficient losses to offset the amount of the contribution, however, the fund would have net capital gain, some or all of which it must either distribute to its shareholders or retain and be subject to corporate-level tax. The amount of the distribution or tax paid would reduce the NAV to below the intended $1.0000 level. This result largely would negate the purpose of the contribution."
She adds, "The second possible approach would treat the payment as a non-shareholder contribution. Although the payment would not result in immediate gain or income to the fund under section 118, it would result in a basis reduction in any assets held by the fund twelve months after the contribution is received under section 362(c). The fund thus would have capital gain equal to the amount of the contribution when those assets are sold. Again, any resulting net gain recognized would require the fund to make a distribution or retain and pay tax on all or part of such gain, negating the purpose of the original contribution."
The letter explains, "As neither of these approaches would allow all of the contributed amount to remain in the fund, which is essential to ensure that the NAV is $1.0000 on the compliance date for the SEC Rule, guidance allowing a third alternative is necessary. Specifically, it is critical that such contributions remain in the fund's NAV, not creating income or gain to the fund or causing a reduction in the basis of the fund's assets."
It adds, "We thus ask the Internal Revenue Service ("IRS") to issue a revenue procedure, pursuant to which the IRS will not challenge a regulated investment company's ("RIC's") treatment of a contribution of cash from an investment adviser as resulting in (1) no capital gain or income to the fund, and (2) no reduction in the basis of the RIC's assets under section 362(c) of the Internal Revenue Code. To avoid any unintended consequences, we suggest that the requested revenue procedure be limited to (i) money market funds that comply with SEC Rule 2a-7, and (ii) contributions made prior to the compliance date for the floating NAV SEC Rule (October 16, 2016)."
Gibian continues, "Transitioning from a stable NAV to a floating NAV presents a number of non-tax challenges. One substantial concern is that shareholders will leave the fund prior to the transition date. As noted above, money market funds will be required to disclose the shadow NAV in early 2016, if they are not doing so already. Thus, shareholders will know the mark-to-market value of a fund's portfolio. If a fund has a shadow NAV of less than $1.0000, investors may be inclined to sell their shares before the transition to avoid experiencing a decline in share value once the NAV begins to float. In other words, if the shadow NAV of the fund is less than $1.0000, investors may choose to sell their shares at $1.00 while the NAV remains stable, rather than wait and experience a loss once the shares begin to trade at their four decimal place-NAV. This could cause a run on institutional money market funds, which is the very situation the floating NAV is intended to prevent. To prevent such behavior, we understand that some money market fund investment advisers may make cash contributions to their funds, to bring the shadow NAV up to $1.0000. This would allow the fund to begin with a floating NAV of $1.0000, rather than something less."
She says, "These contributions may be made for other reasons as well. As the date for compliance with the new SEC Rule approaches, we anticipate that more firms will consider adviser contributions. We note that the SEC already has recognized the need for such contributions. In its recently released Frequently Asked Questions, the SEC provides that an adviser contribution made as part of a one-time reorganization, intended to bring a fund into compliance with the SEC Rule, is not financial support that must be reported on Form NCR.”
She concludes, "The mutual fund industry is working diligently to prepare for compliance with the new SEC Rule. As such, it is considering all options to ensure that the transition goes as smoothly as possible for both shareholders and funds. This type of adviser contribution is one mechanism that can assist in accomplishing this result. We thus ask the IRS to issue a revenue procedure that provides a safe harbor for the treatment of adviser contributions. Under this guidance, the IRS would not challenge a RIC's treatment of an adviser contribution as resulting in (1) no income or gain to the fund, and (2) no reduction in basis of the fund assets under section 362(c). The guidance could be limited in scope to contributions made to funds that comply, or plan to comply, with Rule 2a-7, if such amounts are received prior to the compliance date for the SEC Rule (October 16, 2016). Given the short time-frame before funds must comply with the SEC Rule, we ask the IRS to issue such guidance expeditiously. We believe that such guidance would prevent runs on money market funds and help ease the transition to the new money market fund marketplace."
