Expiring Foreign Withholding Tax Provision Should Be Extended in 2007

Washington, DC, December 7, 2007 - ICI urged House and Senate leaders to approve legislation that extends soon-to-be expiring provisions which exempt foreign investors in U.S. funds from withholding tax on interest income and short-term capital gain distributions.

Background
Most types of income received by funds (for example, dividends, interest, and short-term capital gains) historically have been treated for tax purposes as dividends upon distribution to shareholders. Such dividend treatment arises because mutual funds are corporations for tax purposes, and corporate distributions of earnings are treated as dividends (absent a special rule).

The American Jobs Creation Act of 2004 (AJCA) provided a special provision in the Internal Revenue Code concerning fund distributions attributable to interest and short-term gains. Under AJCA, a fund may elect to "flow through" to its foreign shareholders the character of these two types of income. Flow-through treatment is beneficial because interest and short-term gains received by foreign shareholders generally are exempt from U.S. withholding tax, while dividends are taxable. Absent a legislative extension, Internal Revenue Code section 871(k) will expire after 2007.

The House of Representatives approved in November H.R. 3996, the "Temporary Tax Relief Act of 2007." This legislation extends the expiring provisions exempting foreign investors in U.S. funds from withholding tax on interest income and short-term capital gain distributions.

ICI Position
"Significant irreparable harm will occur if `flow-through' provisions are not enacted during 2007,' said ICI President Paul Schott Stevens, in letters to House and Senate leaders. Stevens states that the harm cannot be remedied fully by enacting legislation in 2008, noting that foreign investors already in U.S. funds will have a significant U.S.-tax-law incentive to leave them before 2008 for one of many alternative investments (including foreign funds investing in U.S. debt instruments), where they would not incur U.S. tax.

In a September 2007 letter, Stevens called on Congress to make permanent the flow-through provision, noting that it will provide tax certainty, promote tax fairness for investors, and enhance the global competitiveness of U.S. funds.

Related Links
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