Safe-Harbor Lookthrough Treatment for RIC Investments in PPIPs

By Alan Munro, J.D., Washington, DC

Editor: David J. Kautter, CPA

In Rev. Proc. 2009-42, the IRS has outlined a safe harbor for regulated investment companies (RICs) for purposes of the Sec. 851(b)(3) asset diversification tests that treats a RIC as if it directly invested in the assets held by a public-private investment partnership (PPIP) in which it invests.

As part of the Troubled Asset Relief Program (TARP), Treasury partners with private investors to form PPIPs. The PPIPs acquire “legacy securities,” which are certain commercial mortgage-backed securities and nonagency (i.e., not securitized by Fannie Mae, Freddie Mac, or Ginnie Mae) residential mortgage securities issued before 2009 and rated AAA at origination.

For a domestic corporation to be taxed as a RIC, it must meet certain requirements, including asset diversification, at the close of each quarter (Sec. 851(b)). Under Sec. 851(b)(3)(A), at least 50% of the total RIC assets must be represented by cash and cash items, U.S. government securities, securities of other RICs, and certain other securities. The value of those other securities must not exceed 5% of the RIC assets per issuer and consist of no more than 10% of the outstanding voting securities of the issuer. Under Sec. 851(b)(3)(B), no more than 25% of the RIC’s total assets may be invested in the securities of any one issuer. The IRS will in some situations treat a RIC that invests in certain partnerships as if it had directly invested in the assets held by the partnership for purposes of the asset diversification tests.

Rev. Proc. 2009-42 applies to a RIC that invests at least 70% of its original assets (including seed capital and net proceeds from an initial public offering) as a partner in one or more PPIPs holding legacy securities; the PPIPs are treated as partnerships for federal income tax purposes. Partnership allocations generally must be in proportion to capital interests, with limited exceptions under Sec. 704 (presumably Sec. 704(c)) or as “agreed to by the Treasury Department” under the PPIP program. Under the revenue procedure, the RIC’s interest in the PPIP assets is determined in accordance with its percentage of ownership of the capital interests in the PPIP.


Rev. Proc. 2009-42 is welcome guidance to certain RICs included in the original group of nine PPIP investors. The 70% requirement (based on original assets) may not bear any relation to current assets for existing RICs, although a discussion with the drafters of the revenue procedure uncovered their belief that of the nine investors, the two that might be formed as RICs are new entities that will meet this requirement. The allowable allocation limit is actually a slight relaxation of prior private letter ruling standards. It is not clear, however, that other RICs can come within the safe harbor. Those that do not may need comfort on lookthrough treatment for PPIP investments through a private letter ruling, opinion of counsel, or other means.


David Kautter retired from Ernst & Young LLP in Washington, DC, in December 2009.

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.

For additional information about these items, contact Mike Dell at (202) 327-8788 or

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