March 13, 2014

 

I.  INTRODUCTION

 

You have requested a letter ruling on behalf of your clients ***********, LLC and its four corporate members, ***********, ***********, ***********, and ***********, which are all S corporations.   You ask whether the S corporation members of the LLC qualify as mutual fund service corporations within the meaning of G.L. c. 63, § 38(m) based on the activities of the LLC.  To date, the S corporations have not filed using the special apportionment rules for mutual fund service corporations.  Below are the factual representations upon which this ruling is based.
 

II.  FACTS

***********, LLC (“the LLC”) is a limited liability company organized and based in Massachusetts.  The LLC is treated as a partnership for federal and Massachusetts income tax purposes.   The LLC was formed in **** by four principals.  It is currently owned equally by four S corporations formed under the laws of Massachusetts.   Each of the four founding principals of the LLC separately owns one of the four S corporations.     One of the S corporations was formed in **** and the remaining three were formed in ****.  The S corporations do not have any activities other than the flow through activities of the LLC.

The LLC is an investment management firm focused on long term international equity investing.  It provides management services to a fund advisor who is, in turn,  directly responsible for providing the management services to a regulated investment company (“RIC”) as defined in section 851 of the Internal Revenue Code (IRC).  Pursuant to an agreement between the fund advisor and the LLC, the LLC provides advice concerning the investment management of the RIC’s assets.  Specifically, the services provided by the LLC to the fund advisor (and on behalf of the RIC) consist of the following:
 

  • determining which securities shall be purchased by the RIC;
  • determining which securities of the RIC shall be held or sold;
  • determining what portion of RIC assets shall be uninvested (i.e. held as cash); and
  • arranging for the placing of all orders for the purchase and sale of portfolio securities with brokers and dealers selected by the LLC.


All services provided by the LLC are required to be in accordance with the investment objectives and policies of the RIC.  The LLC receives a fee from the fund advisor based on the portion of the RIC’s average daily net asset value that is managed by the LLC.  When the LLC makes a management decision, the LLC places the trade with a broker who executes the trade on behalf of the RIC.  

The LLC has approximately $37 billion of assets under management.  Approximately 89% of the LLC’s income is derived from rendering indirect management services to the RIC.  Revenue from the LLC’s other services represents approximately 11% of the LLC’s total annual revenue. 
 

The LLC does not precisely track the amount of expenses and deductions associated with performing investment management services as compared to other non-qualifying services.  The LLC estimates that the percentages of total expenses that relate to investment management services and other services  are the same as the percentages  of total revenue that relate to investment management  services and other services, i.e., 89% and 11%, respectively. 
 

III.  QUESTIONS PRESENTED
 

1.  Do the activities of the LLC qualify as mutual fund services?
2.  Do the S corporation members of the LLC qualify as mutual fund service corporations within the meaning of G.L. c. 63, § 38(m) based on the activities of the LLC? 
 

IV.  DISCUSSION

A.  Do the activities of the LLC qualify as mutual fund services?
 

Under the Massachusetts statute, mutual fund services are defined as management, distribution or administration services to a regulated investment company.  G.L. c.  63, § 38(m).  Management services are defined to include the following:
 

the rendering of investment advice directly or indirectly to a regulated investment company, making determinations as to when sales and purchases of securities are to be made on behalf of the regulated investment company, or the selling or purchasing of securities constituting assets of a regulated investment company, and related activities, but only where such activity or activities are performed: (i) pursuant to a contract with the regulated investment  company entered into pursuant to 15 USC section a—15(a), as from time to time amended; (ii) for a person that has entered into such contract with the regulated investment company; or (iii) for a person that is affiliated with a person that has entered into such contract with a regulated investment company.

G.L. c. 63, § 38(m).  We conclude that pursuant to the facts presented, the activities of the LLC qualify as mutual fund services.
 

B.  Do the S corporation members of the LLC qualify as mutual fund service corporations within the meaning of G.L. c. 63, § 38(m) based on the activities of the LLC?  
 

General Laws chapter 63, section 38(m)(1) defines “a mutual fund service corporation” as “any corporation doing business in the commonwealth which derives more than fifty percent of its gross income from the provision directly or indirectly of management, distribution or administration services to or on behalf of a regulated investment company.”  An S corporation subject to the net income measure of the corporate excise may be considered a mutual fund service corporation.  Thus, an S corporation that is subject to the corporate excise that derives more than 50% of its gross income from mutual fund service sales qualifies as a mutual fund service corporation.

A corporation with an interest in either a partnership or an LLC that elects to be treated as a partnership is required to include its distributive share of the partnership or LLC income in calculating its income for purposes of the corporate excise.  830 CMR 63.38.1(12); see G.L. c. 62, § 17.  Under the apportionment regulation, 830 CMR 63.38.1, the character of any item included in the distributive share of a corporate partner is determined as if it were realized or incurred directly by the corporation, suggesting  that the trade or business of the partnership is treated as the trade or business of the corporation.  830 CMR 63.38.1(12). The regulation further provides that for purposes of determining whether a corporation is a mutual fund service corporation, the corporation’s pro rata share of all of the partnership’s items, factors, and activities shall be taken into account to the extent relevant to the determination.  Id

The “pass through” concept is further supported by DOR Directive (“DD”) 00-4 which provides that the attributes and activities of the partnership or LLC treated as a partnership pass through to the corporate partner or member with respect to the partner’s or member’s distributive share of income in determining whether the corporation is eligible for special apportionment rules.[1]

As stated above, the taxpayer is a limited liability company that is treated as a partnership for federal and state tax purposes. Based on the discussion above, the activities of the LLC pass through to the S corporations for purposes of determining whether or not the S corporations qualify as mutual fund service corporations.  Having concluded that the LLC’s activities are mutual fund services, it follows that the S corporations qualify as mutual fund service corporations, because they have no activity other than the activity of the LLC and the revenue from such activities constitutes more than fifty percent of the S corporations’ gross income.
 

V.  RULINGS

1.  Pursuant to the facts presented, the activities of the LLC qualify as mutual fund service sales.
2.  Having concluded that the activities of the LLC are mutual fund service sales and the income from such activities represents more than fifty percent of the S corporations’ gross income, the S corporation members of the LLC qualify as mutual fund service corporations within the meaning of G.L. c. 63, § 38(m) based on the activities of the LLC.

 

Very truly yours,

/s/Amy Pitter

Amy Pitter
Commissioner of Revenue


AP:MTF:lbr

LR 14-2



[1] DD 00-4 concluded that in determining whether a corporation is a manufacturing corporation, the corporation may take into account its pro rata share of the manufacturing activities of the partnership in which it is a partner or the LLC in which it is a member.