Regulated Investment Company (RIC): Definition, Examples, Taxes

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What Is a Regulated Investment Company (RIC)

A regulated investment company (RIC) can be any one of several investment entities. For example, it may take the form of a mutual fund or exchange-traded fund (ETF), a real estate investment trust (REIT), or a unit investment trust (UIT). Whichever form the RIC assumes, the structure must be deemed eligible by the Internal Revenue Service (IRS) to pass through taxes for capital gains, dividends, or interest earned to the individual investors.

A regulated investment company is qualified to pass-through income under Regulation M of the IRS, with the specific regulations for qualifying as an RIC delineated in U.S. code, title 26, sections 851 through 855, 860, and 4982.

Regulated Investment Company (RIC) Basics

The purpose of utilizing pass-through or flow-through income is to avoid a double-taxation scenario as would be the case if both the investment company and its investors paid tax on company generated income and profits. The concept of pass-through income is also referred to as the conduit theory, as the investment company is functioning as a conduit for passing on capital gains, dividends and interest to individual shareholders.

Regulated investment companies do not pay taxes on their earnings.

Without the regulated investment company allowance, both the investment company and its investors would have to pay taxes on the company's capital gains or earnings. With pass-through income, the company is not required to pay corporate income taxes on profits passed through to the shareholders. The only income tax imposed is on individual shareholders.

Requirements to Qualify as an RIC

To qualify as a regulated investment company the business has to meet specific perimeters.

1. Exist as a corporation, or other entity, which would ordinarily have taxes assessed as a corporation.
2. Be registered as an investment company with the Securities and Exchange Commission (SEC).
3. Elect to be deemed as an RIC by the Investment Company Act of 1940 as long as its income source and diversification of assets meets specified requirements.

Additionally, an RIC must derive a minimum of 90% of its income from capital gains, interest or dividends earned on investments. Further, an RIC must distribute a minimum of 90% of its net investment income in the form of interest, dividends or capital gains to its shareholders.

Should the RIC not distribute this share of income, it may be subject to an excise tax by the IRS. The RIC would also have to issue an IRS Form 2439 to shareholders stating that the capital gains are being retained.

Finally, to qualify as a regulated investment company, at least 50% of a company's total assets must be in the form of cash, cash equivalents or securities. No more than 25% of the company’s total assets may be invested in securities of a single issuer unless the investments are government securities or the securities of other RICs.

Key Takeaways

• A regulated investment company can be any type of investment entity including mutual funds, ETFs, and REITS.
• An RIC must derive a minimum of 90% of its income from capital gains, interest, or dividends earned on investments.
• To qualify, at least 50% of a company's total assets must be in the form of cash, cash equivalents, or securities.
• President Obama signed the Regulated Investment Company Modernization Act of 2010 into law Dec. 22, 2010.

Real World Example

President Obama signed the Regulated Investment Company Modernization Act of 2010 into law Dec. 22, 2010. It made changes to the rules governing the tax treatment of regulated investment companies (RICs), including open-end mutual funds, closed-end funds, and most exchange-traded funds. The last update to the rules governing RICs was the Tax Reform Act of 1986.

The primary reason for the 2010 RIC Modernization Act was due to vast changes in the mutual fund industry in the 25 years between 1986 and 2010. Further, many of the tax rules applicable to RICs became obsolete, created administrative burdens or caused uncertainty.

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