[Federal Register Volume 81, Number 249 (Wednesday, December 28, 2016)]
[Rules and Regulations]
[Pages 95419-95425]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-31291]


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SMALL BUSINESS ADMINISTRATION

13 CFR Part 107

RIN 3245-AG67


Small Business Investment Companies: Passive Business Expansion 
and Technical Clarifications

AGENCY: U.S. Small Business Administration.

ACTION: Final rule.

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SUMMARY: The U.S. Small Business Administration (SBA) is revising the 
regulations for the Small Business Investment Company (SBIC) program to 
expand permitted investments in passive businesses and provide further 
clarification with regard to investments in such businesses. SBICs are 
generally prohibited from investing in passive businesses under the 
Small Business Investment Act of 1958, as amended (Act). SBIC program 
regulations provide for two exceptions that allow an SBIC to structure 
an investment utilizing a passive small business as a pass-through. The 
first exception provides conditions under which an SBIC may structure 
an investment through up to two levels of passive entities to make an 
investment in a non-passive business that is a subsidiary of the 
passive business directly financed by the SBIC. The second exception, 
prior to this final rule, enabled a partnership SBIC, with SBA's prior 
approval, to provide financing to a small business through a passive, 
wholly-owned C corporation (commonly known as a blocker corporation), 
but only if a direct financing would cause the SBIC's investors to 
incur Unrelated Business Taxable Income (UBTI). This final rule 
clarifies several aspects of the first exception and in the second 
exception eliminates the prior approval requirement and expands the 
purposes for which a blocker corporation may be formed. The final rule 
also adds new reporting and other requirements for passive investments 
to help protect SBA's financial interests and ensure adequate oversight 
and makes minor technical amendments. Finally, this rule makes a 
conforming change to the regulations regarding the amount of leverage 
available to SBICs under common control. This change is necessary for 
consistency with the Consolidated Appropriations Act, 2016, which 
increased the maximum amount of such leverage to $350 million.

DATES: This rule is effective January 27, 2017.

FOR FURTHER INFORMATION CONTACT: Theresa Jamerson, Office of Investment 
and Innovation, (202) 205-7563 or [email protected].

SUPPLEMENTARY INFORMATION: 

I. Background Information

    The SBIC Program is an SBA financing program authorized under Title 
III of the Small Business Investment Act of 1958, 15 U.S.C. 681 et seq. 
Congress created the Small Business Investment Company (SBIC) program 
to ``stimulate and supplement the flow of private equity capital and 
long-term loan funds, which small-business concerns need for the sound 
financing of their business operations and for their growth, expansion, 
and modernization, and which are not available in adequate supply . . . 
.'' 15 U.S.C. 661. Congress intended that the program ``be carried out 
in such manner as to insure the maximum participation of private 
financing sources.'' Id. In accordance with that policy, SBA does not 
invest directly in small businesses. Rather, through the SBIC Program, 
SBA licenses and provides debenture leverage (Leverage) to SBICs. SBICs 
are privately-owned and professionally managed for-profit investment 
funds that make loans to, and investments in, qualified small 
businesses using a combination of privately raised capital and Leverage 
guaranteed by SBA. SBA will guarantee the repayment of debentures 
issued by an SBIC based on the amount of qualifying private capital 
raised by an SBIC up to a maximum amount of $150 million in Leverage.
    SBICs are generally prohibited from investing in passive businesses 
under the Small Business Investment Act of 1958. Prior to this final 
rule, the SBIC program regulations provided for the following two 
exceptions that allowed an SBIC to structure an investment utilizing a 
passive small business as a pass-through:
    A. ``Holding company exception''--Sec.  107.720(b)(2): This 
exception provides

[[Page 95420]]

conditions under which an SBIC may structure an investment through up 
to two levels of passive entities to make an investment in a non-
passive business that is a subsidiary of the passive business directly 
financed by the SBIC. The regulation defines a subsidiary company as 
one in which the financed passive business directly or indirectly owns 
at least 50% of the outstanding voting securities. As an example, this 
exception allows an SBIC to finance ABC Holdings 1, a passive small 
business, with the proceeds flowing through ABC Holdings 2, another 
passive small business, and then to ABC Manufacturing, a non-passive 
small business in which ABC Holdings 1 owns directly or indirectly at 
least 50% of the outstanding voting securities.
    B. ``Blocker corporation exception''--Sec.  107.720(b)(3): This 
exception enables a partnership SBIC, with SBA's prior approval, to 
provide financing to a small business through a passive, wholly-owned C 
corporation, but only if a direct financing would cause one or more of 
the SBIC's investors to incur Unrelated Business Taxable Income (UBTI). 
A passive C corporation formed under the second exception is commonly 
known as a blocker corporation.
    On October 5, 2015, SBA published a proposed rule (80 FR 60077) to 
further expand the permitted use of passive businesses, provide 
clarification with regard to investments in such businesses, and make 
minor technical clarifications. SBA received three comments on the 
proposed rule, not including one comment that generally questioned the 
fairness of the Act as a whole and did not provide any specific 
comments on the rule. The three comments pertinent to the rule are 
addressed in Section II.
    Section II also discusses a conforming regulatory change to 
implement Section 521 of the Consolidated Appropriations Act, 2016 
which increased the maximum leverage available to two or more SBICs 
under common control from $225 million to $350 million.

II. Section-By-Section Analysis

A. Passive Business Rules

Section 107.720--Small Businesses That May Be Ineligible for Financing
    1. Changes to Holding Company Exception Sec.  107.720(b)(2): SBA 
proposed revisions to Sec.  107.720(b)(2) to explicitly permit an SBIC 
to form and finance a passive business that will either pass the 
proceeds through to or use the proceeds to acquire all or part of a 
non-passive business. These changes were intended to codify SBA's 
existing interpretation of the regulations.
    SBA received 2 comments on Sec.  107.720(b)(2) indicating that the 
proposed changes would be more effective if the passive business 
directly financed was not required to own at least 50 percent of the 
underlying active business. Commenters suggested that SBICs be allowed 
to structure investments using passive investment vehicles 
``irrespective of the number of parent entities involved so long as the 
parent entities in question directly or indirectly own or control at 
least 50 percent of the voting or economic interests of the active 
business.'' SBA received similar comments as part of the rulemaking 
process when it last proposed expanding the permitted use of passive 
businesses. SBA reconsidered these previous suggestions in developing 
this current rule; however, in light of the additional protections 
added in this final rule (see the discussion of Sec.  107.720(b)(4) in 
paragraph II.A.3 of this preamble), neither set of comments was 
adopted. Although the new Sec.  107.720(b)(4) should help address some 
of SBA's credit concerns, SBA believes that controlling ownership 
provisions are needed to facilitate access to information and records 
needed to effectively monitor these transactions and to aid in the 
recovery of assets in the event of a default. SBA also continues to 
maintain its position that effective monitoring of transactions with 
unlimited levels of passive companies would require resources well 
beyond those available to the Agency. Proposed Sec.  107.720(b)(2) is 
adopted without change.
    2. Changes to Blocker Corporation Exception--Sec.  107.720(b)(3): 
The proposed rule also included the following changes to Sec.  
107.720(b)(3):
    a. Removing the requirement to obtain SBA's prior approval to form 
a blocker corporation;
    b. Permitting an SBIC to form a blocker corporation to enable any 
foreign investors to avoid effectively connected income (ECI) under the 
Internal Revenue Code;
    c. Permitting a blocker corporation to provide financing to a 
second passive small business that passes the proceeds through to a 
non-passive small business in which it owns at least 50 percent of the 
outstanding voting securities (effectively permitting an investment 
structured with two levels of passive companies, one of which is the 
blocker corporation); and
    d. Removing outdated language indicating that an SBIC's ownership 
of a blocker corporation formed under Sec.  107.720(b)(3) will not 
constitute a violation of Sec.  107.865(a). This provision was rendered 
unnecessary by a rule change in 2002 (67 FR 64789) that revised Sec.  
107.865(a) to permit an SBIC to exercise control over a small business 
for up to seven years without SBA approval.
    SBA received comments on proposed Sec.  107.720(b)(3) as discussed 
below:
    a. Regulated Investment Company (RIC) Exception. All 3 commenters 
asked that the regulations provide an additional exception for SBICs 
that are wholly owned subsidiaries of Business Development Companies 
(BDCs). A BDC typically elects to be taxed as a RIC pursuant to 
Subchapter M of the Internal Revenue Code of 1986. In general, a RIC is 
not subject to U.S. federal income taxes on income and gains that it 
distributes to stockholders, provided that it satisfies certain minimum 
distribution requirements. To qualify as a RIC, a BDC must satisfy 
certain source of income and asset-diversification tests; among other 
things, a RIC must generally derive at least 90% of its gross income 
for each taxable year from certain types of investment. In particular, 
the commenters explained that equity interests in pass-through tax 
entities generate operating income that, if received or deemed received 
directly by a BDC, could disqualify the BDC from maintaining RIC 
status, and therefore, such interests must often be held through a 
blocker corporation. The commenters requested that Sec.  107.720(b)(3) 
be revised to permit an SBIC to form a blocker corporation to avoid 
adverse tax consequences to an investor that has elected to be taxed as 
a RIC. This final rule adopts the suggestion.
    b. Blocker Entity Form of Organization. SBA also received two 
comments suggesting that non-corporate forms of organization should be 
permitted for blocker entities. The commenters explained that these 
structures are often ``more streamlined in terms of corporate 
formalities than a C corporation'' and suggested the regulations allow 
``any entity that elects to be taxed as a corporation for Federal 
income tax purposes.'' SBA considered this suggestion to be overly 
broad, but partially adopted this suggestion in the final rule by 
allowing a blocker entity to be structured as an LLC that elects to be 
taxed as a corporation.
    c. Two Level Holding Company Financing. Two commenters indicated 
that Sec.  107.720(b)(3) should allow SBICs to structure a financing 
with a blocker entity and then two levels of passive holding companies 
as defined in Sec.  107.720(b)(2). The commenters stated

[[Page 95421]]

that the proposed rule puts an SBIC that requires a blocker entity to 
accommodate its investors at a disadvantage compared to other SBICs 
that do not require a blocker entity, since the blocker entity can only 
finance a single passive business entity that in turn makes an 
investment into an active business. For example, an SBIC with a foreign 
investor would not be able to participate in a financing that is 
structured as a two-level passive business financing under 
107.720(b)(2), if they also needed a separate passive business to serve 
as a blocker entity in order to avoid effectively connected income. 
However, SBA believes that one of the other passive businesses 
permitted under Sec.  107.720(b)(2) could possibly be used as a 
blocker. The commenters' suggestion would effectively permit up to 
three levels of passive businesses between the SBIC and the operating 
business. SBA did not adopt this suggestion because additional levels 
of passive businesses impose a burden on SBA as regulator and increase 
the Agency's credit risk. SBA believes that two levels of passive 
businesses under either exception should provide SBICs with sufficient 
flexibility to operate successfully.
    d. SBA did not receive any comments on the proposed change to Sec.  
107.720(b)(3) regarding the removal of outdated language. This rule 
adopts the change as proposed.
    3. Additional Passive Business Guidance--Sec.  107.720(b)(4): The 
proposed rule identified SBA's concerns with regard to passive 
investments, including making sure the financing dollars go to the 
eligible non-passive small business, fees being charged at each passive 
business level, and SBA's ability to access passive business financial 
records, especially in the case of a defaulting SBIC. To address these 
concerns, SBA proposed making the the following changes in new Sec.  
107.720(b)(4), which would apply to any eligible passive investment 
made under Sec.  107.720(b)(2) or (b)(3):
    a. ``Substantially All'' Definition. Clarifying the meaning of 
``substantially all'' in Sec.  107.720(b)(2) and (b)(3) to mean 99 
percent of the financing proceeds after deduction of actual application 
fees, closing fees, and expense reimbursements, which may not exceed 
those permitted under Sec.  107.860.
    b. Fee Requirements. Requiring fees charged by an SBIC or its 
Associate under Sec. Sec.  107.860 and 107.900 to not exceed those 
permitted if the SBIC had directly financed the eligible Small Business 
and requiring any such fees received by an SBIC's Associate to be paid 
to the SBIC in cash within 30 days of receipt.
    c. ``Portfolio Concern'' Clarification. Clarifying that both 
passive and non-passive businesses included in a financing are 
``Portfolio Concerns'' and therefore subject to record keeping and 
reporting obligations with respect to any ``Portfolio Concern,'' 
defined in Sec.  107.50 as ``a Small Business Assisted by a Licensee.''
    SBA received 3 comments on proposed Sec.  107.720(b)(4) as 
discussed below:
    a. ``Substantially All'' Definition. Commenters suggested that the 
definition of ``substantially all'' be lowered to 95 percent of the 
proceeds instead of 99% of the proceeds because they were concerned 
that the 99 percent threshold ``may be too limiting and pose issues in 
deal structuring.'' SBA did not adopt this comment. The definition 
already excludes allowable fees and expense reimbursements permitted 
under Sec. Sec.  107.860 and 107.900, and SBA believes that a 95 
percent threshold could result in excessive expenses being charged in 
the passive businesses that is diverted from the intended operating 
business. Although this percentage may seem inconsequential, 4% of a 
$20 million financing represents $800,000 that could be diverted from 
the operating business.
    b. Fee Requirements. Two commenters suggested removing the 
requirement that fees received by an Associate must be paid over in 
cash to the SBIC. They noted that SBIC program policy guidance known as 
TechNote 7a, which provides guidelines concerning allowable management 
expenses for leveraged SBICs (see www.sba.gov/sbicpolicy), already 
requires that 100% of fees collected under Sec.  107.860 or Sec.  
107.900 must benefit the SBIC, either by being paid directly to the 
SBIC or (if paid to an Associate) through a corresponding reduction in 
the management fee paid by the SBIC, typically called a ``management 
fee offset.'' Commenters also indicated that management fee offsets 
have tax advantages relative to other approaches. Although SBA 
recognizes that management fee offsets can provide tax advantages, SBA 
did not adopt this suggestion because of the difficulty in monitoring 
investments utilizing passive businesses and identifying fees 
associated with each passive business in addition to those paid by the 
operating business.
    c. ``Portfolio Concern'' Clarification. Two commenters indicated 
that the clarification of Portfolio Concern should be revised to apply 
only ``for the purposes of this part 107.720'' to avoid any unintended 
effects arising from the use of the term ``Portfolio Concern'' in other 
sections of the regulations. The commenters indicated that this 
adjustment would still allow SBA to retain the necessary information 
rights contemplated by the proposed rule. A search for the term 
``Portfolio Concern'' within the regulations identified the following 
instances.
     Sec.  107.50 defines ``Portfolio Concern'' as ``a Small 
Business Assisted by a Licensee.''
     Sec. Sec.  107.600-107.660 describe record keeping and 
information requirements, including those for a Portfolio Concern.
     Sec.  107.730 discusses conflicts of interest with regards 
to Portfolio Concerns.
     Sec.  107.760 discusses how a change in size or activity 
affect the Licensee with regards to a Portfolio Concern.
     Sec.  107.850 discusses restrictions on redemption of 
Equity Securities of a Portfolio Concern.
    SBA believes that all of the requirements in these sections are 
applicable to passive business financings. Therefore, this suggestion 
was not adopted.
    4. Section 107.610 Required certifications for Loans and 
Investments. The proposed rule also added a certification requirement 
to Sec.  107.610 to require an SBIC that finances a business under 
Sec.  107.720(b)(3) to certify as to the qualifying basis for such 
financing. The certification replaces the requirement for SBA prior 
approval of the formation and financing of a blocker corporation.
    Although SBA received no comments on proposed Sec.  107.610, 
because SBA adopted the suggestion to allow SBICs that are BDC 
subsidiaries to form blocker entities in order to maintain the BDC's 
RIC status under Sec.  107.720 (b)(3), the language in the final rule 
adds compliance with this tax election as a permissible basis for a 
passive business formed under Sec.  107.720(b)(3).

B. Technical Changes

    SBA also proposed the following technical changes to the 
regulations.
    1. Section 107.50 Definition of terms. Changing ``Associates's'' to 
``Associate's''.
    2. Section 107.210 Minimum capital requirements for Licensees. 
Modifying paragraph (a) of Sec.  107.210 to allow both Leverageable 
Capital and Regulatory Capital to fall below the stated minimums if the 
reductions are performed in accordance with an SBA-approved wind-up 
plan per Sec.  107.590(c), to conform with SBA's current oversight 
practices.
    3. Section 107.503 Licensee's adoption of an approved valuation

[[Page 95422]]

policy. Changing the last sentence of Sec.  107.503(a) to indicate that 
valuation guidelines for SBICs may be obtained from the SBIC program's 
public Web site, www.sba.gov/inv.
    4. Section 107.630 Requirement for Licensees to file financial 
statements with SBA (Form 468). Removing current Sec.  107.630(d), 
which provides a mailing address for submission of SBA Form 468, and 
re-designating paragraph (e) as paragraph (d). These instructions are 
no longer necessary because SBICs submit this information 
electronically using the SBA's web-based application.
    5. Section 107.1100 Types of Leverage and application procedures. 
Correcting the misspelling of ``Yu'' to ``You'' and removing paragraph 
(c) which identifies where to send Leverage applications. This 
paragraph is unnecessary because the application forms provide these 
instructions.
    None of the comments SBA received in response to the proposed rule 
were related to these technical changes. The final rule incorporates 
these changes as proposed.

C. Increase to Maximum Leverage to SBICs Under Common Control

    Section 521 of the Consolidated Appropriations Act, 2016, Public 
Law 114-113, 129 Stat. 2242, (December 22, 2015) amended section 
303(b)(2) of the Small Business Investment Act of 1958 to increase the 
maximum amount of Leverage available to two or more SBICs under Common 
Control from $225 million to $350 million. SBA defines Common Control 
to mean a condition where two or more persons, either through 
ownership, management, contract, or otherwise, are under the control of 
one group or person. Under 13 CFR 107.50, SBA presumes that two or more 
SBICs are under Common Control if, among other things, they have common 
officers, directors, or general partners. Currently, 13 CFR 107.1150(b) 
limits two or more SBICs under Common Control to the maximum aggregate 
amount of outstanding Leverage of $225 million, which amount is subject 
to further limitations under SBA's credit policies. Solely as a 
conforming change, this rule increases the maximum amount set forth in 
the regulation from $225 million to $350 million. This statutory change 
was not addressed previously because it had not yet been enacted when 
the rule was proposed. Now that it has, the technical change is 
necessary to avoid public confusion and ensure consistency between the 
regulations and the current law.
Compliance With Executive Orders 12866, 12988, 13132, and 13563, the 
Paperwork Reduction Act (44 U.S.C. Ch. 35) and the Regulatory 
Flexibility Act (5 U.S.C. 601-612).
Executive Order 12866
    The Office of Management and Budget has determined that this rule 
is not a ``significant'' regulatory action under Executive Order 12866. 
This is also not a ``major'' rule under the Congressional Review Act, 5 
U.S.C. 801, et seq.
Executive Order 12988
    This action meets applicable standards set forth in section 3(a) 
and 3(b)(2) of Executive Order 12988, Civil Justice Reform, to minimize 
litigation, eliminate ambiguity, and reduce burden. The action does not 
have retroactive or presumptive effect.
Executive Order 13132
    The final rule would not have substantial direct effects on the 
States, or the distribution of power and responsibilities among the 
various levels of government. Therefore, for the purposes of Executive 
Order 13132, Federalism, SBA determines that this rule has no 
federalism implications warranting the preparation of a federalism 
assessment.
Executive Order 13563
    This final rule was developed in response to comments received on 
previously proposed amendments to these regulations on investments in 
passive businesses. See 78 FR 77377 (December 23, 2013). SBA received 
one set of comments on that rule that suggested changes to further 
liberalize permitted financings to passive businesses under Sec. 
107.720(b). In response to the comment, SBA indicated in the final rule 
(79 FR 62819) that it would further consider the suggested changes in a 
future rulemaking. As part of that reconsideration, SBA discussed the 
comments with industry representatives and solicited additional 
comments in the proposed rule published in October 2015 at 80 FR 60077. 
This final rule reflects the input received from those public outreach 
efforts.
Paperwork Reduction Act, 44 U.S.C. Ch. 35
    SBA has determined that this rule would impose additional reporting 
and recordkeeping requirements under the Paperwork Reduction Act. In 
particular, this rule implements changes to the Portfolio Financing 
Report, SBA Form 1031 (OMB Control Number 3245-0078), to clarify 
information to be reported in Parts A, B, and C of the form. The 
changes, described in detail below, also include designating current 
Part D as Part F and adding new Parts D and E.
    The title, description of respondents, description of the 
information collection and the changes to it are discussed below with 
an estimate of the revised annual burden. Included in the estimate is 
the time for reviewing instructions, searching existing data sources, 
gathering and maintaining the data needed, and completing and reviewing 
each collection of information.
    Title: Portfolio Financing Report, SBA Form 1031 (OMB Control 
Number 3245-0078).
    Summary: SBA Form 1031 is a currently approved information 
collection. SBA regulations, specifically Sec.  107.640, require all 
SBICs to submit a Portfolio Financing Report using SBA Form 1031 for 
each financing that an SBIC provides to a Small Business Concern within 
30 days after closing an investment. SBA uses the information provided 
on Form 1031 to evaluate SBIC compliance with regulatory requirements. 
The form is also SBA's primary source of information for compiling 
statistics on the SBIC program as a provider of capital to small 
businesses. The proposed rule (80 FR 60077) invited the public to 
provide comments on the following changes to SBA Form 1031:
    (1) Clarifying the SBIC should report the non-passive Small 
Business Concern information in the Form 1031. SBA has noted that SBICs 
sometimes report data on the passive Small Business Concern rather than 
the non-passive Small Business Concern when reporting financing 
information. SBA has clarified that the SBIC should report data on the 
non-passive Small Business Concern when reporting information on 
financings using passive businesses in the Form 1031 Part A--the Small 
Business Concern; Part B--the pre-financing data; and Part C--the 
financing information, with the exception of the financing dollars in 
Question 29. The amount of financing dollars provided by the SBIC 
should be the total amount of such financing, regardless of whether the 
dollars were provided directly or indirectly to the non-passive 
business concern. Example: The SBIC provides $5 million in equity to 
ABC Holding Corporation, which passes $4.98 million to the non-passive 
business, Acme Manufacturing LLC. In addition, the SBIC provides $5 
million in debt directly to Acme Manufacturing LLC. The SBIC would 
report information on Acme Manufacturing LLC in Parts A, B, and C. 
However, the

[[Page 95423]]

total financing dollars would be reported as $5 million in equity and 
$5 million in debt for a total of $10 million in total financing 
dollars.
    (2) Identifying financings using one or more passive businesses. 
SBA has added a question on whether the financing utilizes one or more 
passive businesses as part of the financing, to help SBA identify these 
financings.
    (3) Adding information on passive business financings to aid in 
regulatory compliance monitoring. SBA has also added a requirement for 
SBICs to upload a file in Portable Document Format (PDF) that contains 
the following information, which SBA will use to help assess whether 
the financing meets regulatory compliance:
    (a) Qualifying exception: Identification of the passive business 
exception under which the financing is made (i.e., Sec.  107.720(b)(2) 
Exception for pass-through of proceeds to subsidiary, or Sec.  
107.720(b)(3) Exception for certain Partnership Licensees). If the SBIC 
indicates that the financing is made under Sec.  107.720(b)(3), it 
would also indicate the qualifying basis for the financing (i.e., 
financing would cause an investor in the fund to incur unrelated 
business taxable income or effectively connected income or to receive 
non-qualifying income for a regulated investment company).
    (b) Passive Business Entities: Identification of the name and 
employer ID number for each passive business entity used within the 
financing. This is needed so that SBA can identify all Portfolio 
Concerns involved in the financing.
    (c) Financing Structure Description: A description of the financing 
structure, including the flow of the money between the SBIC and the 
non-passive Small Business Concern that receives the proceeds 
(including amounts and types of securities between each entity), and 
the ownership from the SBIC through each entity to the non-passive 
Small Business Concern. This information will help SBA assess that the 
Small Business Concern receives ``substantially all'' the financing 
dollars and the ownership percentages are in compliance with the 
regulations. This will also help SBA with SBICs transferred to the 
Office of Liquidation to identify the structure of the financing and 
aid in recovery of SBA leverage.
    (4) Impact Fund Policy Initiative: Finally, a new Part D, 
consisting of two questions concerning whether the investment is a 
fund-identified impact investment or SBA-identified impact investment 
has been added to the Form. This change provides a vehicle for SBICs 
licensed to participate in SBA's Impact Investment Fund (Impact SBICs 
to more clearly report whether they are reporting on an SBA-identified 
impact investment or a Fund-identified impact investment. The Impact 
Investment Fund was launched in April 2011 as part of President Obama's 
Start-Up America Initiative. See, [https://www.sba.gov/about-sba/sba-initiatives/startup-america/about-startup-america.] The initiative was 
amended in September 2014 to allow Impact SBICs to invest in self-
identified impact investments. [https://www.sba.gov/sites/default/files/articles/SBA%20Impact%20Investment%20Fund%20Policy%20-%20September%202014_1.pdf or https://www.sba.gov/content/new-2014-expanding-sbas-impact-fund] While Impact SBICs, like all SBICS use Form 
1031 to report on their financings, SBA has determined that it would be 
beneficial to Impact SBICs if SBA Form 1031 were to include questions 
specifically targeted towards impact investments.
    SBA did not receive any comments on the changes; therefore, they 
are adopted as proposed.
    Description of Respondents and Burden: There are approximately 299 
licensed SBICs. All of these SBICs are required to submit SBA Form 1031 
for each financing. The current estimated number of responses (i.e., 
number of financings) is 2,021 based on a recent three year period (FY 
2012 through 2014). The current estimate indicates that it takes 
approximately 12 minutes to complete the form, for a total annual 
burden of 404 hours.
    Neither the number of respondents nor the number of responses per 
year is expected to be affected by this rule. However, SBA estimates a 
slight increase in the burden hour as a result of the additional 
reporting in new Parts D (Impact Investments) and Part E (Passive 
Business).
    Impact Fund Reporting. This reporting is expected to have minimal 
impact. The estimated eight SBICs making impact investments would 
complete new Part D an estimated total 56 times annually. At an 
estimated 2 minutes per response, this additional reporting would add 2 
hours to the annual burden for Form 1031.
    Passive Business Reporting. SBA believes that the SBIC should be 
able to provide the passive business information since it should be 
readily available as part of the financing. SBA estimates that 
providing the information will take on average an additional 30 minutes 
for those financings utilizing passive businesses, with no incremental 
burden for those financings that do not use a passive business. SBA 
estimates that about 12% of the annual responses relate to passive 
businesses financings (based on financing data in 2014). Based on the 
number of SBICs reporting such financings the total estimated annual 
hour burden resulting from new Part E reporting would be 122.
    Therefore the total estimated annual hour burden for all SBICs 
submitting SBA Form 1031s in a year would be 528 hours.
    The current cost estimate for completing SBA Form 1031 uses a rate 
of $35 per hour for an accounting manager to fill out the form. Using 
that same rate, the cost per form would change from $7 per form to 
$9.14 per form. However, SBA has increased its estimate of an hourly 
rate for an accounting manager to $43 per hour (estimated using 
www1.salary.com/Accounting-Manager-hourly-wages.html in July 2015), 
which rate results in a new cost per form of $11.23 for an aggregate 
cost of $22,704 for the 2,021 estimated responses.
    This final rule also identifies information that an SBIC must 
maintain in its files to support the required changes. SBA believes 
that the SBICs should already be maintaining this information since a 
passive business by definition is a Portfolio Concern and the SBIC 
should be maintaining all documents needed to support each financing. 
The rule makes this expectation explicit. Furthermore, currently, an 
SBIC must maintain this information for it to effectively monitor and 
evaluate an investment that uses a passive business to finance a non-
passive business. Therefore, SBA does not believe this recordkeeping 
requirement increases the burden.
    The rule also requires a certification under Sec.  107.610 when the 
SBIC makes a financing using the exemption in Sec.  107.720(b)(3). This 
includes maintaining records supporting the certification. Since this 
regulation effectively replaces the requirement for SBICs to seek prior 
SBA approval and maintain these records, SBA does not believe this 
change will increase the burden.
Regulatory Flexibility Act, 5 U.S.C. 601-612
    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601, requires 
administrative agencies to consider the effect of their actions on 
small entities, small non-profit businesses, and small local 
governments. Pursuant to the RFA, when an agency issues a rule, the 
agency must prepare an Initial Regulatory Flexibility Act (IRFA) 
analysis which describes whether the impact of the rule will have a 
significant

[[Page 95424]]

economic impact on a substantial number of small entities. However, 
Section 605 of the RFA allows an agency to certify a rule, in lieu of 
preparing an IRFA, if the rulemaking is not expected to have a 
significant economic impact on a substantial number of small entities. 
This rule would affect all SBICs, of which there are currently close to 
300. SBA estimates that approximately 75 percent of these SBICs are 
small entities. Therefore, SBA has determined that this rule would have 
an impact on a substantial number of small entities. However, SBA has 
determined that the economic impact on entities affected by the rule 
would not be significant. As discussed under the Paperwork Reduction 
Act section, SBICs would need to provide descriptions of the 
transactions in the Form 1031, which based on the estimate would cost 
each SBIC approximately $28 per year. The changes in the passive 
business regulation provide SBICs with additional flexibility to employ 
transaction structures commonly used by private equity or venture 
capital funds that are not SBICs.
    SBA asserts that the economic impact of the rule, if any, would be 
minimal and beneficial to small SBICs. Accordingly, the Administrator 
of the SBA certifies that this rule would not have a significant 
economic impact on a substantial number of small entities.

List of Subjects in 13 CFR Part 107

    Investment companies, Loan programs-business, Reporting and 
recordkeeping requirements, Small businesses.

    For the reasons stated in the preamble, the Small Business 
Administration amends 13 CFR part 107 as follows:

PART 107--SMALL BUSINESS INVESTMENT COMPANIES

0
1. The authority citation for part 107 is revised to read as follows:

    Authority: 15 U.S.C. 681, 683, 687(c), 687b, 687d, 687g, 687m.


Sec.  107.50  [Amended]

0
2. Amend Sec.  107.50 by removing from the definition of ``Lending 
Institution'' the term ``Associates's'' and adding in its place the 
term ``Associate's''.

0
3. Amend Sec.  107.210 by revising paragraph (a) introductory text to 
read as follows:


Sec.  107.210  Minimum capital requirements for Licensees.

    (a) Companies licensed on or after October 1, 1996. A company 
licensed on or after October 1, 1996, must have Leverageable Capital of 
at least $2,500,000 and must meet the applicable minimum Regulatory 
Capital requirement in this paragraph (a), unless lower Leverageable 
Capital and Regulatory Capital amounts are approved by SBA as part of a 
Wind-Up Plan in accordance with Sec.  107.590(c):
* * * * *

0
4. Amend Sec.  107.503 by revising the last sentence of paragraph (a) 
to read as follows:


Sec.  107.503  Licensee's adoption of an approved valuation policy.

    (a) * * * These guidelines may be obtained from SBA's SBIC Web site 
at www.sba.gov/inv.
* * * * *

0
5. Amend Sec.  107.610 by adding paragraph (g) to read as follows:


Sec.  107.610  Required certifications for Loans and Investments.

* * * * *
    (g) For each passive business financed under Sec.  107.720(b)(3), a 
certification by you, dated as of the closing date of the Financing, as 
to the basis for the qualification of the Financing under Sec.  
107.720(b)(3) and identifying one or more limited partners for which a 
direct Financing would cause those investors:
    (1) To incur ``unrelated business taxable income'' under section 
511 of the Internal Revenue Code (26 U.S.C. 511);
    (2) To incur ``effectively connected income'' to foreign investors 
under sections 871 and 882 of the Internal Revenue Code (26 U.S.C. 871 
and 882); or
    (3) For an investor that has elected to be taxed as a regulated 
investment company, to receive or be deemed to receive gross income 
that does not qualify under Section 851(b)(2) of the Internal Revenue 
Code (26 U.S.C. 851(b)(2)).


Sec.  107.630  [Amended]

0
6. Amend Sec.  107.630 by removing paragraph (d) and redesignating 
paragraph (e) as paragraph (d).

0
7. Amend Sec.  107.720 by revising paragraphs (b)(2) and (3) and adding 
paragraph (b)(4) to read as follows:


Sec.  107.720   Small Businesses that may be ineligible for financing.

* * * * *
    (b) * * *
    (2) Exception for pass-through of proceeds to subsidiary. You may 
provide Financing directly to a passive business, including a passive 
business that you have formed, if it is a Small Business and it passes 
substantially all the proceeds through to (or uses substantially all 
the proceeds to acquire) one or more subsidiary companies, each of 
which is an eligible Small Business that is not passive. For the 
purpose of this paragraph (b)(2), ``subsidiary company'' means a 
company in which the financed passive business either:
    (i) Directly owns, or will own as a result of the Financing, at 
least 50 percent of the outstanding voting securities; or
    (ii) Indirectly owns, or will own as a result of the Financing, at 
least 50 percent of the outstanding voting securities (by directly 
owning the outstanding voting securities of another passive Small 
Business that is the direct owner of the outstanding voting securities 
of the subsidiary company).
    (3) Exception for certain Partnership Licensees. If you are a 
Partnership Licensee, you may form one or more blocker entities in 
accordance with this paragraph (b)(3). For the purposes of this 
paragraph, a ``blocker entity'' means a corporation or a limited 
liability company that elects to be taxed as a corporation for Federal 
income tax purposes. The sole purpose of a blocker entity must be to 
provide Financing to one or more eligible, unincorporated Small 
Businesses. You may form such blocker entities only if a direct 
Financing to such Small Businesses would cause any of your investors to 
incur ``unrelated business taxable income'' under section 511 of the 
Internal Revenue Code (26 U.S.C. 511); incur ``effectively connected 
income'' to foreign investors under sections 871 and 882 of the 
Internal Revenue Code (26 U.S.C. 871 and 882); or (for an investor that 
has elected to be taxed as a regulated investment company) receive or 
be deemed to receive gross income that does not qualify under section 
851(b)(2) of the Internal Revenue Code (26 U.S.C. 851(b)(2)). Your 
ownership and investment of funds in such blocker entities will not 
constitute a violation of Sec.  107.730(a). For each passive business 
financed under this section 107.720(b)(3), you must provide a 
certification to SBA as required under Sec.  107.610(g). A blocker 
entity formed under this paragraph may provide Financing:
    (i) Directly to one or more eligible non-passive Small Businesses; 
or
    (ii) Directly to a passive Small Business that passes substantially 
all the proceeds directly to (or uses substantially all the proceeds to 
acquire) one or more eligible non-passive Small Businesses in which the 
passive Small Business directly owns, or will own as a result of the 
Financing, at least 50% of the outstanding voting securities.

[[Page 95425]]

    (4) Additional conditions for permitted passive business 
financings. Financings permitted under paragraphs (b)(2) or (b)(3) of 
this section must meet all of the following conditions:
    (i) For the purposes of this paragraph (b), ``substantially all'' 
means at least ninety-nine percent of the Financing proceeds after 
deduction of actual application fees, closing fees, and expense 
reimbursements, which may not exceed those permitted by Sec.  107.860.
    (ii) If you and/or your Associate charge fees permitted by Sec.  
107.860 and/or Sec.  107.900, the total amount of such fees charged to 
all passive and non-passive businesses that are part of the same 
Financing may not exceed the fees that would have been permitted if the 
Financing had been provided directly to a non-passive Small Business. 
Any such fees received by your Associate must be paid to you in cash 
within 30 days of the receipt of such fees.
    (iii) For the purposes of this part 107, each passive and non-
passive business included in the Financing is a Portfolio Concern. The 
terms of the financing must provide SBA with access to Portfolio 
Concern information in compliance with this part 107, including without 
limitation Sec. Sec.  107.600 and 107.620.
* * * * *


Sec.  107.1100  [Amended]

0
8. Amend Sec.  107.1100 by removing the term ``Yu'' in the second to 
the last sentence of paragraph (b) and adding in its place ``You'', and 
by removing paragraph (c).


Sec.  107.1150  [Amended]

0
9. Amend Sec.  107.1150 by removing the term ``$225 million'' in the 
first sentence of paragraph (b) and adding in its place ``$350 
million''.

    Dated: December 20, 2016.
Maria Contreras-Sweet,
Administrator.
[FR Doc. 2016-31291 Filed 12-27-16; 8:45 am]
BILLING CODE 8025-01-P