The Internal Revenue Service has ruled that mutual funds may treat "refunded bonds" in their portfolios as government securities for purposes of qualifying for investment company tax treatment under Section 851 of the code, according to BW sister publication Fund Action. The section is intended to keep funds out of illiquid assets. The Service put out this guidance in Revenue Ruling 203-84.
The primary beneficiaries of the ruling will be bond funds, said Theodore Press, partner at Kirkpatrick & Lockhart.
Bonds bought by such a fund--"refunded bonds"--would be refunded through a transaction in which government securities would be placed in escrow to cove r the principal and interest on the refunded bonds. In general, not much guidance has been issued by the IRS on what may be defined as a government security for Section 851 purposes, and the statute itself is silent. "Revenue Ruling 2003-18 is a niche," says Kirkpatrick & Lockhart's Press, "but an important niche."