IRS Should End Commodity Mutual-Fund Runaround, Levin Says

IRS Should End Commodity Mutual-Fund Runaround, Levin Says
Seed corn in Sheffield, Illinois, on Sept. 22, 2011. Photographer: Daniel Acker/Bloomberg

U.S. tax authorities should stop a private rulemaking process that has encouraged speculation in oil and agricultural markets by letting mutual funds exceed limits on commodity investments, Senator Carl Levin said.

The Internal Revenue Service’s so-called private letter rulings, which let funds use foreign corporations and other strategies to escape the tax implications of boosting commodity holdings above 10 percent of income, are a “blatant end-run around the legal restrictions,” Levin said today at a hearing held by the Senate Permanent Subcommittee on Investigations.

The IRS has issued more than 70 such rulings since 2006, according to Levin, the Michigan Democrat who leads the panel, and Senator Tom Coburn of Oklahoma, the committee’s top Republican. Levin said the IRS should permanently ban the practice and revoke the existing rulings.

“The IRS letter rulings enable U.S. firms to use offshore shell corporations and financially engineered notes to make commodity investments, despite longstanding tax code restrictions,” he said.

The IRS in June temporarily suspended new private rulings pending a review of its policies. The IRS has an “open mind on this issue” and may publish new guidelines, IRS Commissioner Douglas H. Shulman told lawmakers at the hearing.

‘Law Is Unclear’

“The IRS does not like being in a position where the law is unclear and it has to go and make interpretations,” Shulman said. “We think there needs to be either law, preferably, but in the absence of law, guidance of general applicability that can be relied on across the industry.”

Under current tax code, mutual funds don’t pay corporate income tax so long as they comply with limits on investment type that say commodities can’t represent more than 10 percent of income. Private rule-making by the IRS can allow funds to invest more of their assets in commodities and exceed the 10 percent limit, according to Levin.

“This issue is another example that shows how our tax code is so convoluted that companies have to jump through hoops just to operate,” Coburn said in a statement yesterday. “We need to reform our rules so that everyone knows exactly what is expected of them.”

Position Limits

Levin has pushed for greater limits on speculation in commodities markets, including through so-called position limits that would be imposed by the Commodity Futures Trading Commission. The private letter process has “opened the floodgates” to speculation by allowing more money to flow into commodities markets, he said.

Forty mutual funds that use offshore units for commodity investments had a combined $50 billion in holdings, according to the committee. U.S. mutual funds held a total of $11.6 trillion in assets at the end of November, according to the Washington-based Investment Company Institute, which represents mutual-fund firms.

The fund industry defended the private-ruling process and said it has helped retail customers invest in commodities.

“There is a strong legal basis as well as administrative practice that supports the IRS position here,” ICI General Counsel Karrie McMillan said in a telephone interview yesterday. “What funds are really trying to do is give their investors the ability to invest to some degree in commodities.”

The IRS has received an additional 28 requests for private-letter rulings during the suspension, Shulman said at today’s hearing.

“We want to see the IRS continue to issue either the rulings or just issue generalized guidance the industry can follow,” McMillan said in the interview yesterday.

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