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<PAGE> PAGE 2
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<PAGE> PAGE 3
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SIGNATURE TANYA LODEN
TITLE CONTROLLER
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[DESCRIPTION] Report of Independent Auditors'
<PAGE> 1
[ERNST & YOUNG LLP LETTERHEAD]
REPORT OF INDEPENDENT AUDITORS
ON INTERNAL CONTROL STRUCTURE
Board of Directors
of American Capital Income Trust
In planning and performing our audit of the financial statements of American
Capital Income Trust for the year ended December 31, 1994, we considered its
internal control structure, including procedures for safeguarding securities,
in order to determine our auditing procedures for the purpose of expressing
our opinion on the financial statements and to comply with the requirements of
Form N-SAR, not to provide assurance on the internal control structure.
The management of American Capital Income Trust is responsible for
establishing and maintaining an internal control structure. In fulfilling
this responsibility, estimates and judgments by management are required to
assess the expected benefits and related costs of internal control
structure policies and procedures. Two of the objectives of an internal
control structure are to provide management with reasonable, but not absolute,
assurance that assets are safeguarded against loss from unauthorized use or
disposition and that transactions are executed in accordance with management's
authorization and recorded properly to permit preparation of financial
statements in conformity with generally accepted accounting principles.
Because of inherent limitations in any internal control structure, errors or
irregularities may occur and not be detected. Also, projection of any
evaluation of the structure to future periods is subject to the risk that it
may become inadequate because of changes in conditions or that the
effectiveness of the design and operation may deteriorate.
Our consideration of the internal control structure would not necessarily
disclose all matters in the internal control structure that might be material
weaknesses under standards established by the American Institute of Certified
Public Accountants. A material weakness is a condition in which the design or
operation of the specific internal control structure elements does not reduce
to a relatively low level the risk that errors or irregularities in amounts
that would be material in relation to the financial statements being audited
may occur and not be detected within a timely period by employees in the normal
course of performing their assigned functions. However, we noted no matters
involving the internal control structure, including procedures for safeguarding
securities, that we consider to be material weaknesses as defined above as of
December 31, 1994.
This report is intended solely for the information and use of management and
the Securities and Exchange Commission.
/s/ ERNST & YOUNG LLP
-----------------------
ERNST & YOUNG LLP
January 27, 1995
[DESCRIPTION] N-SAR Item 77C
<PAGE> 1
N-SAR ITEM 77C
a) The Annual Meeting of Shareholders was held on December 16, 1994.
b) The election of Directors included:
R. Richard Pettit
Steven Muller
Allen B. Shepard
Benjamin N. Woodson
Other Directors now in office include:
Donald M. Carlton, Ph.D.
A. Benton Cocanougher, Ph.D.
Stephen R. Gross
Norman Hackerman, Ph.D.
Robert D. Harvey
Jeffrey B. Lane
Alan G. Merten, Ph.D.
F. Robert Paulsen, Ph.D.
Don G. Powell
Miller Upton
c) The following were additional items voted on at the meeting:
1) Approval of a new investment advisory agreement between the
Registrant and American Capital Asset Management, Inc. to take effect upon the
closing of the proposed acquisition of American Capital Management & Research,
Inc. by the Van Kampen Merritt Companies, Inc.:
For 10,536,149.530 Against 188,501.036
2) Ratification of the selection of Ernst & Young as Independent
accountants for the Fund's current fiscal year:
For 10,788,417.090 Against 90,948.361
d) Inapplicable
[DESCRIPTION] Investment Advisory Agreement
<PAGE> 1
INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this 20th day of December, 1994 by and between AMERICAN CAPITAL
INCOME TRUST, a Massachusetts business trust, hereinafter referred to as the
"FUND," and AMERICAN CAPITAL ASSET MANAGEMENT, INC., a Delaware corporation,
hereinafter referred to as the "ADVISER."
The FUND and the ADVISER agree as follows:
(1) Services Rendered and Expenses Paid by ADVISER
The ADVISER, subject to the control, direction and supervision of the FUND's
Trustees and in conformity with applicable laws, the FUND's Agreement and
Declaration of Trust, Bylaws, registration statements and amendments thereto,
prospectus and stated investment objectives, policies and restrictions, shall:
a. manage the investment and reinvestment of the FUND's assets including, by
way of illustration, the evaluation of pertinent economic, statistical,
financial and other data, determination of the industries and companies to be
represented in the FUND's portfolio, and formulation and implementation of
investment programs;
b. maintain a trading desk and place all orders for the purchase and sale of
portfolio investments for the FUND's account with brokers or dealers selected
by the ADVISER;
c. furnish to the FUND office space, facilities, equipment and personnel
adequate to provide the services described in paragraphs a. and b. above and
pay the compensation of each FUND Trustee and FUND officer who is an affiliated
person of the ADVISER, except the compensation of the FUND's Treasurer and
related expenses as provided below.
In performing the services described in paragraph b. above, the ADVISER shall
use its best efforts to obtain for the FUND the most favorable price and
execution available and shall maintain records adequate to demonstrate
compliance with this requirement. Subject to prior authorization by the FUND's
Trustees of appropriate policies and procedures, the ADVISER may, to the extent
authorized by law, cause the FUND to pay a broker or dealer that provides
brokerage and research services to the ADVISER an amount of commission for
effecting a portfolio investment transaction in excess of the amount of
commission another broker or dealer would have charged for effecting that
transaction. To the extent authorized by law the ADVISER shall not be deemed to
have acted unlawfully or to have breached any duty created by this Agreement or
otherwise solely by reason of such action.
<PAGE> 2
Except as otherwise agreed, or as otherwise provided herein, the FUND shall
pay, or arrange for others to pay, all its expenses other than those expressly
stated to be payable by the ADVISER hereunder or by the Manager pursuant to the
Administrative Agreement, which expenses payable by the FUND shall include (i)
interest and taxes; (ii) brokerage commissions and other costs in connection
with the purchase and sale of portfolio investments; (iii) compensation of its
Trustees and officers other than those who are affiliated persons of the
ADVISER or the Manager; (iv) compensation of its Treasurer, compensation of
personnel working under the Treasurer's direction, and expenses of office
space, facilities, and equipment used by the Treasurer and such personnel in
the performance of their normal duties for the Fund which consist of
maintenance of the accounts, books, and other documents which constitute the
record forming the basis for the FUND's financial statements, preparation of
such financial statements, and other FUND documents and reports of a financial
nature required by federal and state laws, and participation in the production
of the FUND's registration statement and amendments thereto, prospectuses,
proxy solicitation materials and reports (including accounting and tax
information) to shareholders; (v) fees of outside counsel to and of independent
accountants of the FUND selected by the Trustees; (vi) custodian, registrar,
transfer agent, depository, dividend disbursing agent, and dividend
reinvestment agent fees and expenses; (vii) expenses related to the repurchase
or redemption of its shares including expenses related to a program of periodic
repurchases and redemptions; (viii) expenses related to the issuance of its
shares against payment therefor by or on behalf of the subscribers thereto;
(ix) fees and related expenses of registering and qualifying the FUND and its
shares for distribution under state and federal securities laws; (x) expense of
printing and mailing of registration statements, prospectuses, reports, notices
and proxy solicitation materials of the FUND; (xi) all other expenses
incidental to holding meetings of the FUND's shareholders including proxy
solicitations therefor; (xii) expenses for servicing accounts (including the
provision of accounting and tax information to shareholders); (xiii) insurance
premiums for fidelity coverage and errors and omissions insurance; (xiv) dues
for the FUND's membership in trade associations approved by the Trustees; and
(xv) such non-recurring expenses as may arise, including those associated with
actions, suits, or proceedings to which the FUND is a party and arising from
any legal obligation which the FUND may have to indemnify its officers and
Trustees with respect thereto. To the extent that any of the foregoing expenses
are allocated between the FUND and any other party, such allocations shall be
pursuant to methods approved by the Trustees.
2
<PAGE> 3
(2) Role of ADVISER
The ADVISER, any person controlled by or under common control with the ADVISER,
shall be free to render similar services to others and engage in other
activities, so long as the services rendered to the FUND are not impaired.
Except as otherwise required by the Investment Company Act of 1940 any of the
shareholders, Trustees, officers and employees of the FUND may be a
shareholder, director, officer or employee of, or be otherwise interested in,
the ADVISER, and in any person controlled by or under common control with the
ADVISER, and the ADVISER, and any person controlled by or under common control
with the ADVISER, may have an interest in the FUND.
Except as otherwise agreed, in the absence of willful misfeasance, bad faith,
negligence, or reckless disregard of obligations or duties hereunder on the
part of the ADVISER, the ADVISER shall not be subject to liability to the FUND,
or to any shareholder of the FUND, for any act or omission in the course of, or
connected with, rendering services hereunder or for any losses that may be
sustained in the purchase, holding or sale of any security.
(3) Compensation Payable to ADVISER
The FUND shall pay to the ADVISER, as compensation for the services rendered,
facilities furnished and expenses paid by the ADVISER, a monthly fee computed
at the annual rate of 0.65% of the FUND's average weekly net assets. Such
average weekly net assets shall be determined by taking the average of the net
assets for each week ending during a calendar month. Such fee shall be payable
for each calendar month as soon as practicable after the end of that month.
The fees payable to the ADVISER by the FUND pursuant to this Section 3 shall be
reduced by any commissions, tender solicitation and other fees, brokerage or
similar payments received by the ADVISER, or any other direct or indirect
majority owned subsidiary of American Capital Management & Research, Inc., or
its successor, in connection with the purchase and sale of portfolio
investments of the FUND, less any direct expenses incurred by the ADVISER, or
any such person of the ADVISER, in connection with obtaining such commissions,
fees, brokerage or similar payments. The ADVISER shall use its best efforts to
recapture all available tender offer solicitation fees and exchange offer fees
in connection with the FUND's portfolio transactions and shall advise the
Trustees of any other commissions, fees, brokerage or similar payments which
may be possible for the ADVISER or any other direct or indirect majority owned
subsidiary of American Capital Management & Research, Inc., or its successor,
to receive in connection with the FUND's portfolio transactions or other
arrangements which may benefit the FUND.
3
<PAGE> 4
In the event that the ordinary business expenses of the Fund for any fiscal
year should exceed 2% of the Fund's average weekly net assets determined in the
manner described in this Section 3, the compensation due the ADVISER for such
fiscal year shall be reduced by the amount of such excess. The ADVISER's
compensation shall be so reduced by a reduction or a refund thereof, at the
time such compensation is payable after the end of each calendar month during
such fiscal year of the FUND, and if such amount should exceed such monthly
compensation, the ADVISER shall pay the FUND an amount sufficient to make up
the deficiency, subject to readjustment during the FUND's fiscal year. For
purposes of this paragraph, all ordinary business expenses of the FUND shall
exclude expenses incurred by the FUND (i) for interest and taxes; (ii) for
brokerage commissions; (iii) as a result of litigation in connection with a
suit involving a claim for recovery by the FUND; (iv) as a result of litigation
involving a defense against a liability asserted against the FUND, provided
that, if the ADVISER made the decision or took the actions which resulted in
such claim, it acted in good faith without negligence or misconduct; and (v)
for any indemnification paid by the FUND to its officers and Trustees and the
ADVISER in accordance with applicable state and federal laws as a result of
such litigation.
If the ADVISER shall serve for less than the whole of any month, the foregoing
compensation shall be prorated.
(4) Duration of Agreement
This Agreement shall have an initial term of two years from the date hereof and
shall continue in force from year to year thereafter, but only so long as such
continuance is approved at least annually by the vote of a majority of the
FUND's Trustees who are not parties to this Agreement or interested persons of
any such parties, cast in person at a meeting called for the purpose of voting
on such approval, and by a majority of the FUND's Trustees or the holders of a
majority of the FUND's outstanding voting securities.
This Agreement shall terminate automatically in the event of its assignment.
The Agreement may be terminated at any time by the FUND's Trustees, by vote of
the holders of a majority of FUND's outstanding voting securities, or by the
ADVISER, on not more than 60 days', nor less than 30 days' written notice, or
upon such shorter notice as may be mutually agreed upon. Such termination shall
be without payment of any penalty.
(5) Miscellaneous Provisions
For the purposes of this Agreement, the terms "affiliated person,"
"assignment," "interested person," and "majority of the outstanding voting
securities" shall have their respective meanings defined in the Investment
Company Act of 1940 and the Rules and Regulations
4
<PAGE> 5
thereunder, subject, however, to such exemptions as may be granted to either
the ADVISER or the FUND by the Securities and Exchange Commission, or such
interpretive positions as may be taken by the Commission or its staff, under
said Act, and the term "brokerage and research services" shall have the meaning
given in the Securities Exchange Act of 1934 and the Rules and Regulations
thereunder.
(6) Limitation of Liability of Trustees and Shareholders
A copy of the Agreement and Declaration of Trust of the FUND is on file with
the Secretary of The Commonwealth of Massachusetts, and notice is hereby given
that this written instrument is executed on behalf of the Trustees of the FUND
as Trustees and not individually and that the obligations of or arising out of
this instrument are not binding upon any of the Trustees or shareholders
individually but are binding only upon the assets and property of the FUND.
The parties hereto each have caused this Agreement to be signed in duplicate on
its behalf by its duly authorized officer on the above date.
AMERICAN CAPITAL INCOME TRUST
By: /s/ CURTIS W. MORELL
____________________________________
Name: Curtis W. Morell
____________________________________
Its: Vice President
____________________________________
AMERICAN CAPITAL ASSET MANAGEMENT, INC.
By: NORI L. GABERT
____________________________________
Name: Nori L. Gabert
____________________________________
Its: Vice President
____________________________________
Executed: as of
________________________________
5
