Business Development Company - Regulation and Tax Structure

Regulation and Tax Structure

Election means the BDC must subject itself to all relevant provisions of the Investment Company Act, which (a) limits how much debt a BDC may incur, (b) prohibits certain types of affiliated transactions, (c) requires a code of ethics and a comprehensive compliance program, and (d) requires regulation by the Securities and Exchange Commission (SEC) and subject to regular examination, like all mutual funds and closed-end funds. BDCs are also required to file quarterly reports, annual reports, and proxy statements with the SEC.

BDCs are usually taxed as regulated investment companies (RIC) under the Internal Revenue Code. Like real estate investment trusts (REITs), as long as the RIC meets certain income, diversity, and distribution requirements, the company pays little or no corporate income tax. As a pass-through tax structure, RICs must distribute at least 90 percent of taxable income as dividends to investors. Most BDCs distribute 98 percent of their taxable income to avoid all corporate taxation. (RICs fall under section 851 of the Internal Revenue Code; REITS fall under section 856.)

Because income is not taxed at the corporate level, distributions to investors are generally taxable for investors based on the type of income earned by the BDC. For example, ordinary income to the BDC is taxable for investors at ordinary income rates, while capital gains income to the BDC is generally taxable for investors at capital gains rates.

Historically, BDCs are listed on a national stock exchange like the NYSE or NASDAQ. Recently, as is common for REITs, some BDCs have declined listing on an exchange. Unlisted BDCs are required to follow the same regulatory structure as listed BDCs, but they must also follow certain distribution requirements as set forth by the Financial Industry Regulatory Authority (FINRA). FINRA.