Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What defines a regulated investment company?

1. One that invests primarily in foreign securities

2. One that distributes at least 90% of its net investment income

3. One that is actively managed by a financial institution

4. One that is entirely tax-free

The correct answer is: One that distributes at least 90% of its net investment income

The definition of a regulated investment company (RIC) is rooted in its requirement to distribute a significant portion of its income to shareholders. To qualify as a RIC under the Internal Revenue Code, a company must distribute at least 90% of its net investment income to its shareholders. This distribution allows the RIC to avoid paying federal income taxes on the income that is passed through to shareholders, thus creating a favorable tax treatment that encourages investment in mutual funds and similar investment vehicles. Investing primarily in foreign securities does not inherently define a RIC, as it can invest in both domestic and international markets. While active management can be a characteristic of some investment companies, it is not a requirement for being classified as a RIC. Additionally, the classification of tax-free is misleading; while RICs do not pay taxes at the entity level on the income they distribute, they are not completely tax-free, as shareholders may still incur tax liability on any dividends received.