In a letter to the Internal Revenue Service, the hedge fund industry asked that proposed regulation 130507-11 on net investment income be implemented in a manner that avoids unintended consequences, such as limiting the ability of taxpayers to net against relevant income applicable expenses, losses, and deductions. The industry cautioned that limiting the ability of taxpayers to include these appropriate items when they calculate their net investment income will lead to taxpayers incurring tax liability on investment income beyond the taxpayer’s real net gains or losses on relevant categories of income.
Thus, and more specifically, the Managed Fund Association urged the IRS to amend the proposed regulation to better ensure that gains and losses derived from the trade or business of trading in securities or commodities can be netted against each other and ensure that capital gains and losses can be fully netted against each other. The proposed regulation should also permit net operating loss carryforwards with respect to eligible items, subject to appropriate tracking, permit taxpayers to deduct foreign taxes in calculating their net investment income and permit up to $3,000 in capital losses to be deducted from gross income from interest, dividends, annuities, royalties, and rents.
Moreover, the proposed regulation should permit the election with respect to the treatment of controlled foreign corporations and passive foreign investment corporations that are qualified electing funds to be made at the partnership level, or allow the election to be made on individual corporate level.
The proposed regulation currently requires that a taxpayer make an irrevocable election to treat earnings from foreign companies as current net investment income for purposes of the tax. This requirement presents a significant problem for investment funds as the election would be made at the individual investor level. As such, an investment fund would have to maintain two sets of records with respect to all of its investments in foreign corporations unless the investment fund can confirm that all of its direct and indirect investors have made the necessary election. In order to make the election more feasible for investment funds and other partnerships, the MFA urged the IRS to allow the election regarding the net investment income tax treatment of controlled foreign corporations and passive foreign investment corporations to be made at the partnership level on behalf of underlying investors.
Alternatively, the IRS was encouraged to permit taxpayers to make the election on an entity-by-entity basis. The MFA reasoned that this alternative approach would make it more likely that an investment fund or other partnership could require all of its investors to make the election as the election would only pertain to the investor’s indirect investments in controlled foreign corporations and passive foreign investment corporations through its investment in the fund.