Tax Provisions In Clinton Administration's FY 2000 Budget Proposal

Washington, DC, February 3, 1999 - The Clinton Administration's budget proposal for the fiscal year beginning October 1, 1999 includes several provisions of interest to regulated investment companies (RICs) and their shareholders. Many of the provisions discussed below have been previously proposed by the Administration. More information about these and other provisions can be found in the Treasury Department's "General Explanations of the Administration's Revenue Proposals." (Ed. Note: links to a .pdf file of size 593k.)

Withholding Tax Exemption for Certain Bond Fund Distributions

The Administration again has proposed to exempt from U.S. withholding tax all distributions made to foreign investors in certain bond funds. The proposal would apply to mutual fund taxable years beginning after the date of enactment.

Specifically, the Treasury explanation provides that all income received by a U.S. mutual fund "that invests substantially all of its assets in U.S. debt securities or cash" would be treated as interest exempt from U.S. withholding tax when distributed to the fund's foreign investors. A fund would be treated as meeting this "substantially all" test "if it also invests some of its assets in foreign debt instruments that are free from foreign tax pursuant to the domestic laws of the relevant foreign countries." The Treasury explanation does not indicate what portion of a fund's assets could be invested in foreign bonds without violating the "some" standard.

The Institute has previously supported this Administration proposal as an important first step toward eliminating all U.S. tax incentives for foreign investors to prefer foreign funds over U.S. funds.

Mandatory Accrual of Market Discount

The Administration would modify significantly the taxation of market discount by eliminating the option taxpayers now have to defer the inclusion of any market discount into income until the debt instrument acquired with market discount is sold. Under the Administration's proposal, accrual basis taxpayers would be required to include market discount in income currently, i.e., as it accrues. The holder's yield for market discount accrual purposes would be limited to the greater of (1) the original yield-to-maturity of the debt instrument plus five percentage points or (2) the applicable Federal rate (at the time the holder acquired the debt instrument) plus five percentage points. The proposal would apply to debt instruments acquired on or after the date of enactment.

Increased Penalties for Failure to File Correct Information Returns

The Administration again has proposed to increase the maximum penalty for failure to file correct information returns-currently set at $50 per return-to the greater of $50 per return or five percent of the aggregate amount required to be reported correctly (subject, in general, to a $250,000 cap). An exception to the increased penalty would apply, however, if the aggregate amount actually reported by the taxpayer on all returns filed for that calendar year was at least 97 percent of the amount required to be reported. The proposal would be effective for returns the due date for which (without regard to extensions) is more than 90 days after the date of enactment.

The Institute previously has opposed this proposal because the current penalty structure provides powerful incentives for RICs to correct promptly any error made.