TAX NEWS - June 2010

A Call to Update Tax Code

WASHINGTON — A senior official with Fidelity Investments called on U.S. lawmakers to update the tax code, arguing at a congressional hearing that tax treatment hasn't kept up with evolution in the mutual-fund industry.

Stephen Fisher, Fidelity's senior vice president and deputy general counsel, said Tuesday that outdated tax treatment leaves mutual-fund investors at a disadvantage compared with investors who buy stocks, bonds and other assets directly. He also declared "strong support" for a bill that seeks to modernize tax rules for mutual funds.

"The evolution of mutual-fund products and structures has resulted in unintended and unfavorable tax treatment for fund investors," Mr. Fisher told the House Ways and Means Subcommittee on Select Revenue Measures in written testimony.

Providing some examples of discrepancies for the tax-writing panel, he highlighted "fund-of-funds" structures, which refer to mutual funds that invest in other mutual funds. The problem, he said, is investors in funds of funds are treated differently than investors who purchase stocks, bonds and conventional mutual funds. As a result, investors in funds of funds are unable to receive the tax benefits of tax-exempt interest and foreign tax credits when the funds invest in municipal bonds and foreign securities, Mr. Fisher said.

Mr. Fisher, one of three witnesses at the congressional hearing, said a pending bill introduced last year would update the applicable tax rules so that investors aren't disadvantaged if they invest in funds of funds.

"With more than 50 million families, or almost half of all households, investing in mutual funds, we should make sure the tax code does not create obstacles for regulated investment companies," said Rep. Richard Neal (D., Mass.), one of the sponsors of the bill.

The bill would address many of the issues Mr. Fisher highlighted Tuesday. It would change rules that prevent mutual funds from earning income from commodities, rules that relate to preferential dividends, and rules that require mutual funds to send separate annual dividend designation notices to shareholders.

Still, as lawmakers focus on new energy and financial regulations, it appears unlikely that Congress also will rework tax laws for mutual funds this year.

Meanwhile, in his testimony, Mr. Fisher said mutual funds have increased issues of multiple classes of shares over the past two decades. But these multiple-class arrangements increase the risk that a mutual fund will inadvertently distribute a preferential dividend, which would subject the mutual fund to corporate-level tax, he said.

He also pointed out that a shareholder who invests in stocks or bonds directly can carry losses forward indefinitely. In contrast, mutual funds can carry losses forward only for eight years, after which time the losses expire if they aren't used.

Mr. Fisher also argued that it isn't appropriate for mutual funds to be subject to many of the corporate-tax rules applicable to conventional "C" corporations.

The pending bill "would rationalize situations where the C corporation rules create unintended effects" for mutual funds, he said. "This good-government legislation will benefit both mutual funds and their investors."