December 22, 2006 Letter to ICI re: Implementation of FASB Interpretation No. 48
December 22, 2006
Mr. Paul Schott Stevens
Dear Mr. Stevens:
Chairman Cox has shared your December 11, 2006 letter concerning the application of FASB Interpretation No. 48 (Interpretation 48) to the fund industry with the Commissionís Office of the Chief Accountant and the Division of Investment Management. We understand that the implementation of Interpretation 48 presents challenges to the fund industry. Specifically, you have indicated that the general tax rules applicable to funds or their investments are at times unclear and the guidance that exists cannot always be applied confidently to specific fact patterns. As there are limited rules and regulations addressing the specific requirements a fund must meet in order to maintain its tax free status, you have indicated that funds often rely upon less formal Internal Revenue Service (IRS) guidance and practices when determining the technical merits of their tax positions. You also indicated that the IRS is aware both that funds face these uncertainties and that fund shareholders ultimately bear the burden of any fund-level tax. Thus, you represented that the IRS at times addresses fund industry issues by providing guidance that is prospective only such that no taxes are due for prior periods. You expressed concern that these types of informal guidance and practices of the taxing authority cannot be considered in applying Interpretation 48. These concerns have previously been expressed to the staff of the Office of the Chief Accountant and the Division of Investment Management by representatives of the Investment Company Institute and others.
We agree that informal guidance of the taxing authority is often an important form of evidence that one looks to when assessing the technical merits of a tax position. However, we believe that the provisions of Interpretation 48 do permit, and indeed necessitate, the consideration of such informal guidance. Specifically, we do not believe Interpretation 48 places any limits on the type of evidence that an enterprise can look to in making its determination of the technical merits of a tax position. While paragraph 7 of Interpretation 48 lists certain forms of evidence that may be available when making such a determination, this list should not be viewed as the totality of evidence that may be considered. Less formal forms of guidance from the taxing authority should be considered as well. A fundís management should weigh all available forms of evidence based on their persuasiveness.
Pursuant to paragraph 7(b) of Interpretation 48, we also believe that the administrative practices and precedents of the taxing authority should be considered in a fundís analysis. Specifically, you have asserted that, in the event that the IRS objects to a tax position taken by a fund, the IRS at times grants prospective transition to cure the underlying deficiency such that no additional taxes are due for prior periods. If this is in fact the case, we believe that funds can, and should, consider the taxing authorityís practice of addressing fund industry issues on a prospective basis as part of the administrative practices and precedents of the taxing authority. We would expect a fundís management to analyze the technical merits of a particular tax position, any known views of the taxing authority with respect to the position, the history of the taxing authority with respect to resolving fund tax issues with similar levels of technical support, and any other relevant information. Of course, when performing this analysis, pursuant to paragraph 7(a) of Interpretation 48, a fund must presume that the tax position will be examined by a taxing authority that has knowledge of all relevant information.
Staff in the Commissionís Office of the Chief Accountant and the Division of Investment Management have previously engaged in discussions with representatives of the Investment Company Institute and with staff of the FASB to discuss the challenges and issues raised in your letter. We believe these issues were adequately considered by the FASB prior to the completion and issuance of Interpretation 48. We also believe that our staffís discussions with representatives of the fund industry should help to clarify our views regarding the importance of considering all available evidence. These discussions have given us the opportunity to note, as is summarized again in this letter, that Interpretation 48 should not be read to limit the types or forms of evidence that may be considered. We hope this alleviates its concerns about reliance upon less formal guidance and administrative practices and precedents to support their tax positions.
In your letter you also requested either the FASB or the Commission delay the required implementation date of Interpretation 48 for the fund industry. We understand that the fund industryís implementation issues differ significantly from the issues faced by operating companies because funds calculate net asset values per share (NAV). The calculation of NAV and the transactions based upon NAV are a significant component of a fundís financial statements provided to shareholders and filed with the Commission. Funds must calculate their NAV, however, much more frequently than they prepare financial statements for periodic reports. Open-end funds generally calculate NAVs daily in order to effect transactions in their shares, i.e., purchases and redemptions of shares. Closed-end funds calculate NAVs to facilitate trading of their shares, to make periodic repurchases, to offer shares through dividend reinvestment plans, to make new offerings, and for other purposes.
Because Interpretation 48 is effective for fiscal years beginning after December 15, 2006, calendar year open-end funds, for example, would have to comply with Interpretation 48 beginning as early as January 2, 2007--the first date of the fiscal year that these funds will calculate NAVs. Calendar year operating companies, however, do not calculate daily NAVs and generally have until after the end of their first quarter to assess tax positions and determine the impact on their financial statements. Thus, operating companies may have significantly more time than funds to comply with Interpretation 48.
In light of the unique issues and challenges that the application of Interpretation 48 present for funds (particularly with respect to the calculation of NAV), we would not object if a fund implements Interpretation 48 in its NAV calculation as late as its last NAV calculation in the first required financial statement reporting period for its fiscal year beginning after December 15, 2006. Thus, like an operating company, Interpretation 48 would be incorporated into a fundís first periodic report containing financial statements prepared in accordance with U.S. generally accepted accounting principles for fiscal years beginning after December 15, 2006. Calendar year end funds are the first funds that would have a fiscal year end that begins after December 15, 2006. A calendar year open-end or closed-end fund would implement Interpretation 48 no later than its June 29, 2007 (the last business day of the semi-annual reporting period) NAV and the effects of Interpretation 48 would be reflected in the fundís semi-annual financial statements contained in its Form N-CSR filing. Similarly, a open-end or closed-end fund that has a fiscal year ending at the end of February would implement Interpretation 48 no later than its August 31, 2007 financial statements and calculation of NAV. Business development companies (BDCs) also would implement Interpretation 48 no later than the last day of the first reporting period beginning after December 15, 2006, which for a calendar year end BDC would be the Form 10-Q for the period ending March 31, 2007. Lastly, a unit investment trust would implement Interpretation 48 no later than December 31, 2007, which is the date of the information contained in its next report on Form N-SAR for fiscal years beginning after December 15, 2006.
We expect that funds will make good use of this additional time to carefully assess all issues related to the implementation of Interpretation 48.
Based upon the facts and representations in your December 11, 2006 letter, we would not recommend enforcement action to the Commission under sections 11(a), 16(c), 22(a), 23(b) and (c), 30, 61(a) and 63(2) and (3) of the 1940 Act and rule 22c-1 thereunder against any fund based solely on the fundís implementation of Interpretation 48 as of the dates set forth above. This response expresses our views on enforcement action only and does not express any legal conclusions on the issues presented. Because our position is based on the facts and representations in your letter, you should note that any different facts or representations may require a different conclusion. The views expressed herein should not be extended by analogy or relied upon in any other circumstances.
Thank you again for your recent correspondence. We hope this response is helpful to you and others in the fund industry. If you have any further questions related to this matter, please contact Richard Sennett in the Division of Investment Management at 202-551-6918 or Joe Ucuzoglu in the Office of the Chief Accountant at 202-551-5301.
Barry D. Miller