SECTION 5. EFFECTIVE DATE

This revenue procedure is effective for repos held by a RIC on or after August 15, 2001.

.05 Section 851(b)(3)(B) provides that not more than 25 percent of the RIC’s total assets may be invested in the securities (other than Government securities and the securities of other RICs) of any one issuer, or of two or more issuers that the RIC controls and that are determined, under regulations, to be engaged in the same or similar trades or businesses or related trades or businesses.

.06 Section 5(b)(1) of the Investment Company Act of 1940, 15 U.S.C. 80a–1 et seq . (1940 Act) defines a “diversified company” as a management company that has at least 75 percent of its assets invested in cash and cash items (including receivables), Government securities, securities of other investment companies, and other securities that, for the purpose of this calculation, are limited in respect of any one issuer to an amount not greater in value than 5 percent of the value of the total assets of the management company and to not more than 10 percent of the outstanding voting securities of the issuer. The remaining 25 percent of the management company’s assets may be invested in any manner.

.07 Effective August 15, 2001, the SEC adopted Rule 5b–3, which is intended to adapt the 1940 Act to the economic realities of repos and to reflect recent developments in bankruptcy law protecting parties to repos. SEC Release No. IC–25058. Subject to certain conditions, Rule 5b–3 permits a fund to “look through” the counterparty to the collateral in determining whether the fund is in compliance with the investment criteria for diversified funds set forth in section 5(b)(1) of the 1940 Act and with certain other securities laws.

.08 The following definition is set forth in Rule 5b–3:

(1) Collateralized Fully in the case of a repurchase agreement means that:

(i) The value of the securities collateralizing the repurchase agreement (reduced by the transaction costs (including loss of interest) that the investment company reasonably could expect to incur if the seller defaults) is, and during the entire term of the repurchase agreement remains, at least equal to the Resale Price provided for in the agreement;

(ii) The investment company has perfected its security interest in the collateral;

(iii) The collateral is maintained in an account of the investment company with its custodian or a third party that qualifies as a custodian under the [1940] Act;

(iv) The collateral consists entirely of:

(A) Cash items; (B) Government securities;

(C) Securities that at the time the repurchase agreement is entered into are rated in the highest rating category by the requisite nationally recognized statistical rating organizations

[as defined in Rule 5b–3(c)(5)]; or

(D) Unrated Securities that are of comparable quality to securities that are rated in the highest rating category by the requisite nationally recognized statistical rating organizations, as determined by the investment company’s board of directors or its delegate; and

(v) Upon an Event of Insolvency with respect to the seller, the repurchase agreement would qualify under a provision of applicable insolvency law providing an exclusion from any automatic stay of creditors’ rights against the seller. Rule 5b–3(c)(1).

.09 The “Collateralized Fully” definition plays a critical role in the application of the 1940 Act diversification rules to repos:

(a) Repurchase Agreements . For purposes of [the 1940 Act investment criteria for diversified investment companies and prohibition on registered investment companies from acquiring an interest in a broker-dealer, underwriter, or investment advisor], the acquisition of a repurchase agreement may be deemed to be an acquisition of the underlying securities, provided the obligation of the seller to repurchase the securities from the investment company is Collateralized Fully. Rule 5b–3(a). The effect of this rule is that, for purposes of the definition of a diversified investment company in section 5 of the1940 Act, if a repo is Collateralized Fully, a fund may (but need not) treat an investment in the repo as an investment in the underlying security or securities.

2004-22 I.R.B. 985 June 1, 2004

affected the taxpayer’s Federal income tax liability as reported on any tax return filed on or before February 28, 2000. Section 1.6011–4T(b)(2) as published in T.D. 8877, 2000–1 C.B. 747, in 65 Fed. Reg. 11205. See also § 1.6011–4(h). .04 Sections 446(e) and 1.446–1(e) provide that, except as otherwise provided, a taxpayer must secure the consent of the Commissioner before changing a method of accounting for federal income tax purposes. Section 1.446–1(e)(3)(i) provides that, to obtain the Commissioner’s consent to an accounting method change, a taxpayer must file a Form 3115, Application for Change in Accounting Method, during the taxable year in which the taxpayer desires to make the proposed change. Section 1.446–1(e)(3)(ii) authorizes the Commissioner to prescribe administrative procedures setting forth the limitations, terms, and conditions deemed necessary to permit a taxpayer to obtain consent to change a method of accounting in accordance with § 446(e).

.05 Rev. Proc. 97–27, 1997–1 C.B. 680, (as modified and amplified by Rev. Proc. 2002–19, 2002–1 C.B. 696, as amplified and clarified by Rev. Proc. 2002–54, 2002–2 C.B. 432), provides procedures for obtaining the consent of the Commissioner to change a method of accounting for federal income tax purposes. In general, under these procedures a taxpayer must file a Form 3115 during the year of change and may not request or make a retroactive change in method of accounting unless specifically authorized by the Commissioner. Rev. Proc. 97–27, sections 5.01, 2.04. In addition, under these procedures a taxpayer generally takes into account a positive § 481(a) adjustment resulting from the change in method of accounting ratably over four taxable years and receives audit protection for taxable years prior to the year of change. Rev. Proc. 97–27, sections 5.02(3)(a), 9.01. However, section 8.01 of Rev. Proc. 97–27 states that the Service reserves the right to decline to process a Form 3115 “in situations in which it would not be in the best interest of sound tax administration to permit the requested change. In this regard, the Service will consider whether the change in method of accounting would clearly and directly frustrate compliance efforts of the Service in administering the income tax laws.”

DRAFTING INFORMATION

The principal author of this revenue procedure is Susan Thompson Baker of the Office of Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue procedure, contact her at (202) 622–3940 (not a toll-free call).

26 CFR 601.204: Changes in accounting periods and methods of accounting. (Also Part I, §§ 461, 481; 1.461–2.)

Rev. Proc. 2004–31