Fund Directions - An Overview of Federal Income Tax Considerations for Fund Boards in Reviewing Proposed Fund Mergers

An Overview of Federal Income Tax Considerations for Fund Boards in Reviewing Proposed Fund Mergers

By Susan A. Johnston and Amy B. Snyder*

Susan A. Johnston

Amy B. Snyder The recent market downturn has led to increased fund merger activity as advisers seek to streamline their product lines by merging away small and poorly performing funds. Accordingly, boards have seen an increase in requests to approve mergers of funds in their complex. In order to approve a merger between affiliated funds, Rule 17a-8 under the 1940 Act requires the participating funds' boards to determine that the proposed merger is in the best interests of the funds and not dilutive of the interests of existing fund shareholders. In doing so, the boards must consider and give appropriate weight to all pertinent factors. Among these factors, the SEC has indicated that boards should consider any direct and indirect tax consequences of a merger to participating fund shareholders.1 This article will focus on the U.S. federal income tax consequences of fund mergers, although foreign, state, local and other tax consequences also can arise.

The tax considerations relating to fund mergers are highly complex and can give rise to a number of legal and business issues. Fund boards typically rely on information and advice provided by in-house and outside tax advisors. Directors should be in a position to understand, evaluate and distill the information and advice provided to them, and consider whether additional information may be needed in order for them to understand and weigh the tax consequences of a proposed merger.

Summary of Federal Income Tax Considerations of a Proposed Fund Merger

A board's federal income tax considerations fall into two categories: (1) the anticipated tax status of the proposed merger itself as taxable or tax-free and, even where tax-free, (2) the potential tax effects of the merger on the participating funds and their shareholders.

Understanding the tax status of a proposed merger--Not all tax-free merger opinions are created equal.

Fund mergers are implemented almost universally on a tax-free basis where no gains or losses are currently recognized by either the participating funds or their shareholders, and are typically effected in reliance on opinions of fund counsel that such mergers are tax-free.

Directors should understand the following in ...

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An Overview of Federal Income Tax Considerations for Fund Boards in Reviewing Proposed Fund Mergers