(Bloomberg News) 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 assets, are a "runaround" of the law that reflects a "tortured reading," Levin said at a news conference yesterday.
The IRS has issued more than 70 such rulings since 2006, according to Levin, a Michigan Democrat who leads the Senate's Permanent Subcommittee on Investigations, and Senator Tom Coburn of Oklahoma, the panel's top Republican. Levin, who briefed reporters ahead of a hearing today, said the IRS should permanently ban the practice and revoke the existing rulings.
"Those mutual funds in effect are allowed by the IRS to do indirectly what they cannot do directly," Levin said. The IRS in June temporarily suspended new private rulings pending a review of its policies, he said.
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 than 10 percent of their assets in commodities, 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. The IRS needs to review how it deals with mutual funds instead of creating a patchwork of private rulings."
Levin has pushed for greater limits on speculation in commodities markets, including through the use of so-called position limits at the Commodity Futures Trading Commission, the main U.S. derivatives regulator. The private letter process has allowed more money to flow into commodities markets and "opened the floodgates" to speculation, 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," Karrie McMillan, general counsel at the ICI, said in a telephone interview. "Under the tax code, what funds are really trying to do is give their investors the ability to invest to some degree in commodities."
"We want to see the IRS continue to issue either the rulings or just issue generalized guidance the industry can follow," McMillan said.
IRS Commissioner Douglas H. Shulman and Emily McMahon, acting assistant Treasury secretary for tax policy, are scheduled to testify at today's hearing.