[Federal Register Volume 60, Number 2 (Wednesday, January 4, 1995)]
[Proposed Rules]
[Pages 397-406]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-13]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[FI-42-94]
RIN 1545-AS85
Mark to Market for Dealers in Securities
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations relating to the
mark-to-market method of accounting for securities that is required to
be used by a dealer in securities. The proposed regulations address the
relationship between mark-to-market accounting and the accrual of
stated interest and discount and the amortization of premium and
between mark-to-market accounting and the tax treatment of bad debts.
They also provide rules relating to certain dispositions and
acquisitions of securities required to be marked to market, the
exemption from mark-to-market treatment of securities in certain
securitization transactions, and the identification requirements for
obtaining exemption from mark-to-market treatment. Finally, these
proposed regulations provide guidance relating to the exclusion of
REMIC residual interests from the definition of security and to the
relationship between the mark-to-market provisions and the integrated
transaction rules in the proposed regulations on debt instruments with
contingent payments. This document also provides notice of a public
hearing on these proposed regulations.
DATES: Written comments must be received by April 4, 1995. Outlines of
oral comments to be presented at a public hearing scheduled for May 3,
1995, at 10 a.m. must be received by April 4, 1995.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (FI-42-94), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (FI-42-94),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW,
Washington, DC.
The public hearing will be held in the Internal Revenue Auditorium,
7400 Corridor, Internal Revenue Building, 1111 Constitution Ave., NW,
Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Concerning Sec. 1.475(c)-2(a)(4),
Carol A. Schwartz, (202) 622-3920; concerning other sections of the
regulations, Robert B. Williams, (202) 622-3960, or JoLynn Ricks, (202)
622-3920; concerning submissions and the hearing, Michael Slaughter,
(202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act (44 U.S.C.
3504(h)). Comments on the collection of information should be sent to
the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC
20224.
The collection of information is in Sec. 1.475(b)-4. The
information required to be recorded under Sec. 1.475(b)-4 is required
by the IRS to determine whether exemption from mark-to-market treatment
is properly claimed. This information will be used to make that
determination upon audit of taxpayers' books and records. The likely
recordkeepers are businesses or other for-profit institutions.
Estimated total annual recordkeeping burden: 2,500 hours.
The estimated annual burden per recordkeeper varies from 15 minutes
to 3 hours, depending on individual circumstances, with an estimated
average of 1 hour.
Estimated number of recordkeepers: 2,500.
Background
Section 475 of the Internal Revenue Code requires mark-to-market
accounting for dealers in securities, broadly defined. Section 475 was
added by section 13223 of the Revenue Reconciliation Act of 1993 (Pub.
L. 103-66, 107 Stat. 481), and is effective for all taxable years
ending on or after December 31, 1993.
On December 29, 1993, temporary regulations (T.D. 8505, 58 FR
68747) and cross-reference proposed regulations (FI-72-93, 58 FR 68798)
were published to furnish guidance on several issues, including the
scope of exemptions from the mark-to-market requirements, certain
transitional issues relating to the scope of exemptions, and the
meaning of the statutory terms ``dealer in securities'' and ``held for
investment.'' This notice contains proposed regulations that
supplement, and in a few cases revise, the proposed regulations that
were published last December.
Explanation of Provisions
Stated Interest, Discount, and Premium
The proposed regulations contained in this notice provide rules for
taking into account interest (including original issue discount (OID)
and market discount), premium, and certain gains [[Page 398]] and
losses on securities that are debt instruments. In general, immediately
before a debt instrument is marked to market, Code provisions related
to calculating interest must be applied, and basis must be
correspondingly adjusted. The mark-to-market computations do not affect
either the amount treated as interest earned from a debt instrument or
the taxable years in which that interest is taken into account.
For example, immediately before a debt instrument is marked to
market, accruals of unpaid qualified stated interest (QSI) must be
taken into account, and basis must be correspondingly increased. This
is true regardless of the taxpayer's regular method of accounting.
Marking a debt instrument to market under section 475(a) precludes the
deferral that a cash-basis taxpayer might have experienced in the
absence of the statutory provision, and the current accrual under the
proposed regulations is needed in order to preserve the interest
character of the QSI.
For debt instruments acquired with original issue discount or
market discount, the proposed regulations require that, immediately
before the mark-to-market gain or loss is computed under section
475(a), any OID or market discount accrued through the date of
computation must be taken into account, and basis must be
correspondingly increased. The amount of discount attributable to a
particular period of time is computed under sections 1272 through 1275
(in the case of OID) and sections 1276 through 1278 (in the case of
market discount). Thus, for example, the computation of OID
attributable to a particular period takes into account any reduction
for acquisition premium under section 1272(a)(7).
As indicated in the preceding paragraph, the proposed regulations
provide that, in the case of a market discount bond to which section
475(a) applies, the holder must take market discount into account as it
accrues, regardless of whether the holder elected under section 1278(b)
to do so for all of its bonds. This rule is necessary to prevent market
discount from producing gain on the mark instead of interest income.
This provision, however, does not impose a section 1278(b) election on
the taxpayer, because it does not apply to bonds that are not marked to
market under section 475.
For taxable debt instruments acquired with amortizable bond
premium, the proposed regulations provide that, if a dealer has made an
election to amortize premium under section 171, any amortization for
the taxable year (or for the portion of the taxable year during which
the instrument is held by the dealer) must be taken into account (and
basis must be appropriately reduced) before the mark-to-market gain or
loss is computed under section 475. Because section 171 applies only to
instruments not held primarily for sale to customers in the ordinary
course of the taxpayer's trade or business, this proposed regulatory
provision is applicable only to premium instruments described in
section 475(b)(1) for which the taxpayer has not made the
identification described in section 475(b)(2).
In the case of tax-exempt bonds, the proposed regulations require
basis to be reduced as required by section 1016(a)(5) or (6) before
mark-to-market gain or loss is computed.
If a dealer acquires a bond with premium and a section 171 election
first applies to the bond in a taxable year after the year of
acquisition, the proposed regulations require the dealer to amortize
premium based on the original basis, without regard to any mark-to-
market adjustments that may have been taken into account before the
section 171 election became effective, but with regard to the
adjustments required under section 171(b)(1). Thus, for example, if a
dealer acquires in year 1 an instrument that is subject to section
475(a) and that has $10 of amortizable premium and if the dealer makes
an election to amortize premium that is first effective in year 4 (when
unamortized premium attributable to years 1 through 3 is $4), the
dealer takes into account the appropriate portion of the remaining $6
of amortizable bond premium (as required under section 171(b)(3)) each
taxable year before computing the mark-to-market adjustment on the
instrument. Any mark-to-market basis adjustments in taxable years 1
through 3 are ignored in determining the amount of amortizable bond
premium to which the election applies.
Under section 475(a)(2), a dealer in securities recognizes mark-to-
market gain or loss on a security, other than inventory, as if the
security were sold on the last business day of the taxable year.
Although there may be circumstances under which marking a security to
market produces results similar to the actual sale of the security, the
statutory reference to the deemed sale prescribes the amount of gain or
loss to be taken into account and does not trigger all of the
consequences of a sale and reacquisition under the Code. For example,
when a dealer in securities marks a bond (or other security) to market
and takes recognized gain or loss into account, the dealer has not
actually sold and reacquired the bond. Thus, under the proposed
regulations, marking a debt instrument does not create, increase, or
reduce market discount, acquisition premium, or bond premium.
The proposed regulations also contain a special rule to provide the
proper character for mark-to-market gains or losses on a market
discount instrument that was originally identified as held for
investment by the dealer. This rule is necessary to ensure that all
market discount is ultimately characterized as interest income and not
as gain from the sale of a security.
Worthless Debts
The proposed regulations provide rules for marking a partially or
wholly worthless debt to market. These rules coordinate the mark-to-
market rules with the bad debt rules under the Code. The amount of gain
or loss recognized under section 475(a)(2) when a debt instrument is
marked to market generally is the difference between the adjusted basis
and the fair market value of the debt. Under the proposed regulations,
if a debt becomes partially or wholly worthless during a taxable year,
the amount of any gain or loss required to be taken into account under
section 475(a) is determined using a basis that reflects the
worthlessness. The basis of the mark-to-market debt is treated as
having been reduced by the amount of any book or regulatory charge-off
(including the establishment of a specific allowance for a loan loss)
for which a deduction could have been taken, without regard to whether
any portion of the charge-off is, in fact, deducted or charged to a tax
reserve for bad debts. The difference between this adjusted basis and
the fair market value of the debt is the amount of gain or loss to be
taken into account under section 475(a)(2). Thus, if the debt is wholly
worthless, its basis would be reduced to zero and no gain or loss would
be taken into account under section 475(a)(2).
This proposed treatment preserves the longstanding distinctions
between losses due to the worthlessness of debts and other losses on
debt instruments held by a taxpayer. See Sec. 1.166-1(a), which
requires bad debts to be taken into account either as a specific
deduction in respect of debts or as a deduction for a reasonable
addition to a reserve for bad debts. See also Secs. 1.585-3 and 1.593-
7(c), which require a reserve-method taxpayer to charge bad debts to
the reserve for bad debts. In addition, computing the mark-to-market
adjustment as if the debt's basis had been adjusted to reflect
worthlessness [[Page 399]] preserves a taxpayer's ability to postpone
claiming a deduction for partial worthlessness until the debt becomes
wholly worthless. To the extent that a debt has been previously charged
off, mark-to-market gain is treated as a recovery.
The rules that are provided for bad debts in the proposed
regulations do not apply to debts accounted for by a dealer as
inventory under section 475(a)(1). Although it is possible for a debt
that is in inventory to become partially worthless prior to sale, the
likelihood or frequency of such an occurrence is difficult to ascertain
given the speed with which inventory is sold. Comments are requested,
however, concerning whether similar rules are necessary for partially
worthless debt that is accounted for as inventory of the dealer.
Dispositions
Section 475(a) states that regulations may provide for securities
held by a dealer to be marked to market at times other than the end of
the dealer's taxable year. In general, the proposed regulations provide
that, if a dealer in securities ceases to be the owner of a security
for tax purposes, and if the security would have been marked to market
under section 475(a) if the dealer's taxable year had ended immediately
before the dealer ceases to own it, then (whether or not the security
is inventory in the hands of the dealer) the dealer must recognize gain
or loss as if the security had been sold for its fair market value
immediately before the dealer ceases to own it. Any gain or loss so
recognized is taken into account at that time.
In the absence of a mark upon disposition, a gain on a security
held by a dealer could be deferred by transferring the security before
the end of the taxable year to a related non-dealer in an intercompany
transaction or in a non-recognition, carry-over-basis transaction. This
potential for abuse is avoided if marking to market is required in
every case in which a dealer ceases to be the owner of a security for
tax purposes. The proposed requirement is analogous to the requirement
that applies to dispositions of securities that are required to be
marked to market under section 1256.
Transfers to which the proposed rule applies include the following:
(a) Transfers to a controlled corporation under section 351; (b)
Transfers to a trust (other than a grantor trust); (c) Transfers by
gift to a charitable or non-charitable donee; (d) Transfers to other
members of the same controlled group; (e) Transfers to a partnership
under section 721; and (f) Transfers of mortgages to a REMIC under
section 860F(b).
In the case of a transfer by a dealer to a partnership, the basis
of a security transferred is generally its fair market value, because
the security is marked to market immediately before the transfer. Thus,
no special allocation issues arise. If there is any difference between
a transferred security's basis after the mark and its fair market value
(because, for example, the security transferred had been properly
identified as held for investment but ceased to be so held at some time
prior to the date of transfer), any special allocation of built-in gain
or loss with respect to that security in the hands of the partnership
will be made under section 704 and the regulations thereunder.
The mark to market immediately before disposition is separate and
distinct from the disposition transaction. Thus, for example, the gain
or loss from the mark is not gain or loss from a deferred intercompany
transaction under Sec. 1.1502-13.
Securities Acquired With Substituted Basis
The proposed regulations provide rules for situations where a
dealer in securities receives a security with a basis in its hands that
is determined, in whole or in part, either by reference to the basis of
the security in the hands of the transferor or by reference to other
property held at any time by the dealer. In these cases, section 475(a)
applies only to post-acquisition gain and loss with respect to the
security. That is, section 475(a) applies only to changes in value of
the security occurring after its acquisition. See section 475(b)(3).
The character of the mark-to-market gain or loss is determined as
provided under section 475(d)(3). The character of pre-acquisition gain
or loss (that is, the built-in gain or loss at the date the dealer
acquires the security) and the time for taking that gain or loss into
account are determined without regard to section 475. The fact that a
security has a substituted basis in the dealer's hands does not affect
the security's date of acquisition for purposes of determining the
timeliness of an identification under section 475(b).
The proposed regulations provide rules for the identification of
securities contributed and received in securitization transactions.
Under the proposed regulations, a taxpayer that expects to contribute
securities to a trust or other entity in exchange for interests therein
may identify the contributed securities as held for investment (within
the meaning of section 475(b)(1)(A)) or not held for sale (within the
meaning of section 475(b)(1)(B)) only if it expects each of the
interests received (whether or not a security within the meaning of
section 475(c)(2)) to be either held for investment or not held for
sale to customers in the ordinary course of the taxpayer's business.
Thus, for example, if a mortgage banker securitizes its loans and does
not intend to hold for investment (or for other than sale to customers)
all of the interests received in the securitization transaction, the
mortgage banker will be required to account for its inventory of
mortgages at fair market value under section 475(a)(1), regardless of
whether the mortgages are to be sold to a trust or contributed to a
REMIC.
Under the proposed regulations, if a dealer engages in a
securitization transaction that results in dispositions of only partial
interests in the contributed securities, the dealer is not permitted to
identify the contributed securities as exempt under section
475(b)(1)(A) or (B). As a result, all of the contributed securities
must be accounted for under section 475(a). Moreover, under the mark-
on-disposition rule of these proposed regulations, the dealer is
required to mark the securities to market immediately before the
securitization transaction. The Service invites comments on whether
there are other administrable approaches that reflect the fact that
only a partial disposition of the securities has occurred.
In other securitization transactions, a taxpayer transfers
securities to a trust (or other entity) in a transaction that is not a
disposition of the securities for tax purposes. The trust issues
certificates (or other forms of interest) that represent secured debt
of the taxpayer rather than debt of the trust or ownership of the
underlying securities. In these cases, if the taxpayer retains the full
ownership of the contributed securities for tax purposes and if the
contributed securities otherwise qualify to be identified as held for
investment or not held for sale, then the taxpayer may identify the
securities as held for investment or not held for sale notwithstanding
the transfer.
Further, if a transfer of securities is a disposition, a taxpayer
may identify the interests received in a securitization transaction as
exempt from mark-to-market if the interests are described in section
475(b)(1) and are not treated for tax purposes as continuing ownership
of the securities transferred. This identification is permitted even if
the securitized assets were marked to market under section 475. For
example, a taxpayer may identify some of the [[Page 400]] REMIC regular
interests received on the transfer of mortgage securities to a REMIC,
even if the mortgages were subject to section 475(a). Conversely, a
taxpayer that has marked mortgages to market but subsequently
contributes those mortgages to a grantor trust and receives beneficial
interests therein may not identify the beneficial interests as exempt
from mark-to-market treatment, because the beneficial interests
represent continued ownership of the contributed securities, whose
eligibility for exemption was determined when they were acquired.
The proposed regulations clarify that an identification of a
security as exempt must specify the subparagraph of section 475(b)(1)
under which the exemption is claimed and that the time by which a
dealer must identify a security as exempt is not affected by whether
the dealer has a substituted basis in the security. The proposed
regulations also provide rules for determining whether an
identification of a security as exempt is timely where a dealer engages
in certain integrated transactions described in Sec. 1.1275-6 as
proposed on December 16, 1994 (FI-59-91, 59 FR 64884, 64905).
Definition of Dealer in Securities
Section 475(c)(1) defines a dealer in securities as a taxpayer who
regularly purchases securities from, or sells securities to, customers
in the ordinary course of a trade or business or who regularly offers
to enter into, assume, offset, assign or otherwise terminate positions
in securities with customers in the ordinary course of a trade or
business.
The proposed regulations provide that whether a taxpayer is
transacting business with customers is determined based on all of the
facts and circumstances.
Under section 475(c)(1)(B) and the proposed regulations, the term
dealer in securities includes a taxpayer that, in the ordinary course
of its trade or business, regularly holds itself out as being willing
and able to enter into either side of a transaction enumerated in
section 475(c)(1)(B). For instance, if a taxpayer regularly holds
itself out as being willing to enter a swap in which it is either the
fixed or the floating payor, the taxpayer is a swaps dealer.
The proposed regulations clarify that a life insurance company does
not become a dealer in securities solely by selling annuity, endowment,
or life insurance policies to its customers. Under the temporary
regulations published on December 29, 1993 (T.D. 8505), a contract that
is treated for federal income tax purposes as an annuity, endowment, or
life insurance contract is deemed to have been identified as held for
investment, and is therefore not marked to market by the policy holder.
This was necessary because variable life and annuity products fall
within the literal language of section 475(c)(2)(E). Because many life
insurance companies sell these insurance contracts to their customers,
some commentators asked whether these life insurance companies were
dealers in securities. There is no indication that Congress intended
for a life insurance company that was not otherwise a dealer in
securities to be characterized as a dealer merely because it sells life
insurance policies to its customers. These proposed regulations provide
the appropriate clarification.
Definition of Security
The temporary regulations that were published on December 29, 1993
(T.D. 8505), exclude certain items from the definition of security.
Among the excluded items are liabilities of the taxpayer and negative
value residual interests (NVRIs) in a REMIC and other arrangements that
are determined to have substantially the same economic effect as NVRIs
(for example, a widely held partnership that holds noneconomic REMIC
residual interests). Those rules are needed to carry out the purposes
of section 475 and other Code provisions, including section 860E.
These proposed regulations clarify that a liability of the taxpayer
means a debt issued by the taxpayer. Also, for the reasons given below,
these proposed regulations exclude all REMIC residual interests from
the definition of security.
A typical REMIC holds a pool of long-term, real estate mortgages
originated at a ``blended'' interest rate. These mortgages are used to
support the issuance of regular interests, which are treated as debt,
with varied maturities and interest rates. The REMIC takes cash flows
on the mortgages and redirects them to holders of the regular
interests. As a result, there is generally a mismatch in the
recognition of interest income from the mortgages and the interest
expense attributable to the regular interests. This mismatch of
interest income and interest deductions results in taxable income or
loss that does not represent economic gain or loss. Some commentators
refer to this as ``phantom'' income or loss.
Phantom income or loss is allocated to the holders of the residual
interests in a REMIC even though that income or loss does not represent
any economic benefit or detriment to those holders. Further, sections
860C and 860E require a residual interest holder to pay taxes on a
portion of phantom income (called ``excess inclusion'') and to increase
the basis of the residual interest by the amount of phantom income.
Because this basis increase does not represent economic value, a
subsequent mark to market is likely to result in a loss. Permitting
taxpayers to take this loss into account currently under the mark-to-
market provisions effectively undermines the Congressional mandate
embodied in section 860E to require current taxation of phantom income.
Although the adverse effect of section 475 on section 860E is most
apparent when the residual interests being considered are NVRIs,
residual interests with positive value present the same issue. Many
residual interests with positive value, in spite of being entitled to
REMIC distributions, have substantially the same economic effect as
NVRIs and thus are already excluded by the temporary regulations from
the definition of ``security.'' The IRS is concerned, however, that
residual interests may be structured in a way that avoids embodying
substantially the same economic effects as an NVRI but that still
undermines the purposes of section 860E. The proposed regulations,
therefore, contain a rule that would remove from the category of
securities subject to section 475 all residual interests that are
acquired after January 4, 1995. Also removed are arrangements that are
acquired after that date and are determined to have substantially the
same economic effect as a REMIC residual interest (for instance, an
interest in a widely held partnership holding residual interests). The
temporary regulations continue to apply to all residual interests
described therein for all taxable years ending on or after December 31,
1993.
In addition, the Commissioner has determined that, if a residual
interest, or an interest or arrangement that has substantially the same
economic effect, is not a security within the meaning of section 475,
it should not be treated as inventory under other provisions.
Additional guidance on this matter will be issued.
Comments are requested concerning whether there are any residual
interests that do not undermine section 860E upon being marked to
market. If comments are received that describe any such interests,
subsequent guidance may provide that they are included in the mark-to-
market regime. In this regard, it is important that any mechanism for
identifying these interests not impose an undue burden on either
taxpayers or the IRS. [[Page 401]]
Additional Comments Requested
The provisions of section 475 generally apply in determining the
taxable income of a dealer that may also be subject to various
international provisions of the Code. The Service is considering the
possibility of using the definitions contained in section 475 and the
regulations thereunder for purposes of various international
provisions, except where a modification of the provisions is necessary
to carry out the purposes of those international provisions. Comments
on this issue also are welcome.
Finally, the Service is considering whether there are additional
situations in which securities should not be accounted for under
section 475(a). (The temporary and proposed regulations that were
published on December 29, 1993, listed some such situations.) For
example, a dealer in securities may acquire at original issue and in
exchange for property certain non-interest-bearing debt instruments
that are not subject to the interest imputation provisions of section
1274 or 483. Because these instruments will seldom appreciate in value,
it may be inappropriate to subject them to the mark-to-market regime.
Dates of Applicability
The proposed regulations will apply to identifications made,
securities acquired, or events occurring, on or after January 4, 1995,
or to taxable years beginning on or after January 1, 1995, as
appropriate.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Code, this notice of proposed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for Wednesday, May 3, 1995 at
10 a.m. The public hearing will be held in the Internal Revenue
Auditorium, 7400 corridor, Internal Revenue Building, 1111 Constitution
Avenue NW, Washington, DC 20224. Because of access restrictions,
visitors will not be admitted beyond the Internal Revenue Building
lobby more than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments by April 4, 1995 and submit an outline of the
topics to be discussed and the time to be devoted to each topic (signed
original and eight (8) copies) by April 4, 1995.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are Robert B. Williams
and JoLynn Ricks, Office of Assistant Chief Counsel (Financial
Institutions & Products). However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.475(a)-1 also issued under 26 U.S.C. 475(e).
Section 1.475(a)-2 also issued under 26 U.S.C. 475(a) and 26
U.S.C. 475(e).
Section 1.475(a)-3 also issued under 26 U.S.C. 475(e).
* * * * *
Section 1.475(b)-3 also issued under 26 U.S.C. 475(e).
Section 1.475(b)-4 also issued under 26 U.S.C. 475(b)(2) and 26
U.S.C. 475(e).
Section 1.475(c)-1 also issued under 26 U.S.C. 475(e).
* * * * *
Section 1.475(c)-2 also issued under 26 U.S.C. 475(e) and 26
U.S.C. 860G(e).
* * * * *
Section 1.475(e)-1 also issued under 26 U.S.C. 475(e).
* * * * *
Par. 2. Section 1.475-0 is added to read as follows:
Sec. 1.475-0 Table of contents.
This section lists headings contained in Secs. 1.475-0, 1.475(a)-1,
1.475(a)-2, 1.475(a)-3, 1.475(b)-1, 1.475(b)-2, 1.475(b)-3, 1.475(b)-4,
1.475(c)-1, 1.475(c)-2, 1.475(d)-1, and 1.475(e)-1.
Sec. 1.475-0 Table of contents.
Sec. 1.475(a)-1 Mark to market of debt instruments.
(a) Overview.
(b) No effect on amount of market discount, acquisition premium, or
bond premium.
(c) Accrual of interest, discount, and premium.
(1) Qualified stated interest.
(2) General rule regarding accrual of discount.
(3) Bond premium.
(d) Mandatory current inclusion of market discount.
(1) General rule.
(2) Interaction with section 1278(b).
(e) Recognition of market discount that accrued before section
475(a) applies to a market discount bond.
(1) General rule.
(2) Examples.
(f) Worthless debts
(1) Computation of mark-to-market gain or loss.
(2) Treatment of mark-to-market gain or loss.
(g) Additional rules applicable to reserve-method taxpayers.
(h) Example.
Sec. 1.475(a)-2 Mark to market upon disposition of security by a
dealer.
(a) General rule.
(b) Example.
Sec. 1.475(a)-3 Acquisition by a dealer of a security with a
substituted basis.
(a) Scope.
(b) Rules.
Sec. 1.475(b)-1 Scope of exemptions from mark-to-market
requirement.
(a) Securities held for investment or not held for sale.
(b) Securities deemed identified as held for investment.
(1) In general.
(2) Control defined.
(c) Securities deemed not held for investment.
(1) General rule for dealers in notional principal contracts and
derivatives.
(2) Exception for securities not acquired in dealer capacity.
Sec. 1.475(b)-2 Exemptions--Transitional issues.
(a) Transitional identification. [[Page 402]]
(1) Certain securities previously identified under section 1236.
(2) Consistency requirement for other securities.
(b) Corrections on or before January 31, 1994.
(1) Purpose.
(2) To conform to Sec. 1.475(b)-1(a)
(i) Added identifications.
(ii) Limitations.
(3) To conform to Sec. 1.475(b)-1(c).
(c) Effect of corrections.
Sec. 1.475(b)-3 Exemption of securities in certain securitization
transactions.
(a) Exemption of contributed assets.
(b) Exemption of resulting interests.
(1) General rule.
(2) Examples.
Sec. 1.475(b)-4 Exemptions--Identification requirements.
(a) Identification of the basis for exemption.
(b) Time for identifying a security with a substituted basis.
(c) Securities involved in integrated transactions under
Sec. 1.1275-6.
(1) Definitions.
(2) Synthetic debt held by a taxpayer as a result of legging in.
(3) Securities held after legging out.
Sec. 1.475(c)-1 Definitions--Dealer in securities.
(a) Sellers of nonfinancial goods and services.
(b) Taxpayers that purchase securities but do not sell more than a
negligible portion of the securities.
(1) Exemption from dealer status.
(2) Negligible portion.
(3) Special rules.
(c) Dealer-customer relationship.
(1) [Reserved].
(2) Transactions described in section 475(c)(1)(B).
(d) Issuance of life insurance products.
Sec. 1.475(c)-2 Definitions--Security.
(a) In general.
(b) Negative value REMIC residuals.
(c) Special rules.
(d) Synthetic debt held by a taxpayer as a result of an integrated
transaction under Sec. 1.1275-6.
Sec. 1.475(d)-1 Character of gain or loss.
Sec. 1.475(e)-1 Effective dates.
(a) Taxable years ending on or after December 31, 1993.
(b) Taxable years beginning on or after January 1, 1995.
(c) Securities acquired on or after January 4, 1995.
(d) Events occurring on or after January 4, 1995
.Par. 3. Section 1.475(a)-1 is added to read as follows:
Sec. 1.475(a)-1 Mark to market of debt instruments.
(a) Overview. This section provides rules for taking into account
interest accruals and gain and loss on a debt instrument to which
section 475(a) applies. Paragraph (b) of this section clarifies that
the mark-to-market computation affects neither the amount treated as
interest earned from a debt instrument nor the taxable year in which
that interest is taken into account. Paragraph (c) of this section
prescribes general rules. Paragraph (d) of this section prescribes
additional rules for instruments acquired with market discount.
Paragraph (e) of this section provides rules for taking into account
market discount that accrued on a bond before the bond became subject
to the mark-to-market requirements. Paragraph (f) of this section
prescribes rules for computing the mark-to-market gain or loss on
partially or wholly worthless debts, and paragraph (g) provides rules
for dealers accounting for bad debts using a reserve method of
accounting.
(b) No effect on amount of market discount, acquisition premium, or
bond premium. Marking a debt instrument to market does not create,
increase, or reduce market discount, acquisition premium, or bond
premium, nor does it affect the adjusted issue price of, or accruals of
original issue discount (OID) on, a bond issued with OID.
(c) Accrual of interest, discount, and premium. In general, the
amount of gain or loss from marking a debt instrument to market is
computed after adjustments to basis for accruals of stated interest,
discount, and premium.
(1) Qualified stated interest. Immediately before a debt instrument
is marked to market under section 475(a), the holder of the instrument
must take any unpaid accrued qualified stated interest into account and
must correspondingly increase the basis of the instrument. The holder
must later decrease the basis of the instrument when accrued qualified
stated interest is actually received. (See Sec. 1.1273-1(c) for the
definition of qualified stated interest and Sec. 1.446-2(b) for the
rule governing its accrual.)
(2) General rule regarding accrual of discount. If a bond that was
acquired with OID or market discount is marked to market under section
475(a), then, immediately before the bond is marked to market, the
discount accrued through that date (determined under section 1272,
1275(d), or 1276, as applicable) is included in gross income, to the
extent not previously included, and the bond's basis is correspondingly
increased for amounts so included. (Because accrued OID is determined
under all of the rules of section 1272 and the regulations thereunder,
it is computed taking into account the reduction for acquisition
premium that is required by section 1272(a)(7).) See paragraph (d) of
this section, which requires the current inclusion in income of market
discount on bonds marked to market. See paragraph (e) of this section
for exceptions, and additional rules, for market discount bonds that
become subject to section 475(a) after acquisition.
(3) Bond premium. If a debt instrument that is subject to the basis
adjustment required by section 1016(a) (5) or (6) is marked to market
under section 475(a), then, immediately before the debt instrument is
marked to market, the required basis adjustment must be made.
Accordingly, the mark-to-market adjustment is computed after the basis
of the debt instrument has been adjusted under section 1016(a) (5) or
(6) for disallowed amortizable bond premium (in the case of tax-exempt
bonds) or deductible bond premium (in the case of taxable bonds). If an
election under section 171(c) is made after the first taxable year in
which section 475(a) applies to the bond, the amount of bond premium is
determined under section 171(b)(1) without regard to any basis
adjustments that may have been required as a result of the bond being
marked to market in prior taxable years. See paragraph (b) of this
section for the rule that marking a debt instrument to market does not
affect bond premium.
(d) Mandatory current inclusion of market discount--(1) General
rule. If section 475(a) applies to a bond during any portion of a
taxable year, gross income for that taxable year includes the market
discount attributable to the portion of the year to which section
475(a) applies (as determined under section 1276(b)). Section 1276 does
not apply to the bond except with respect to market discount, if any,
that accrued before the bond became subject to section 475(a).
Similarly, section 1277 does not apply to the bond except with respect
to any net direct interest expense (as defined in section 1277(c)) that
accrued before the bond became subject to section 475(a). See paragraph
(e) of this section for additional rules governing this situation. For
purposes of the Code other than the purposes described in the last
sentence of section 1278(b)(1), any amount included in gross income
under this paragraph (d)(1) is treated as interest. The bond's basis is
correspondingly increased for any amount so included in gross income.
(2) Interaction with section 1278(b). Paragraph (d)(1) of this
section applies to a dealer, even if the dealer has not elected under
section 1278(b) to include market discount currently. If the dealer has
not made that election, however, this paragraph (d) does not require
current inclusion of market discount on any bond to which section
475(a) does not apply.
[[Page 403]]
(e) Recognition of market discount that accrued before section
475(a) applies to a market discount bond--(1) General rule. In the case
of a debt instrument that is acquired with market discount, that is not
subject to an election under section 1278(b), and that first becomes
subject to section 475(a) in the taxpayer's hands on a date after its
acquisition, this paragraph (e) governs the recognition of market
discount that is attributable (as determined under section 1276(b)) to
any period before section 475(a) applies to the debt instrument. To the
extent that the market discount described in the preceding sentence is
greater than the excess, if any, of the fair market value of the debt
instrument at the time it became subject to section 475(a) over its
adjusted basis at that time, section 1276(a)(1) applies to any gain
recognized under section 475(a). To the extent of any remaining market
discount that had accrued before section 475(a) became applicable,
section 1276(a) applies no later than it would have applied if section
475(a) did not apply to the bond. For example, section 1276(a) applies
to the previously accrued market discount as partial principal payments
are made. Except as provided in the preceding sentences, gain
recognized under section 475(a) is not recharacterized as interest by
section 1276(a).
(2) Examples. The rules of paragraphs (d) and (e) of this section
are illustrated by the following examples:
Example 1.
(i) Facts. Bond X was issued on January 1, 1996, for $1,000.
Bond X matures on December 31, 2005, provides for a principal
payment of $1,000 on the maturity date, and provides for interest
payments at a rate of 8%, compounded annually, on December 31 of
each year. D is a dealer in securities within the meaning of section
475(c)(1). On January 1, 1997, D purchased bond X for $955. D had
not elected under section 1278(b) to include market discount in
gross income currently. Under section 475(b), section 475(a) did not
apply to bond X until January 1, 1999, at which time bond X had a
fair market value of $961. On December 31, 1999, bond X had a fair
market value of $980.
(ii) Holdings. In the absence of an election under section
1276(b)(2), market discount on bond X accrues under section
1276(b)(1) at the rate of $5 per year. On January 1, 1999, when bond
X became subject to section 475(a), $10 of market discount had
accrued, but the excess of the bond's fair market value on January
1, 1999, over its adjusted basis on that date (the built-in gain)
was only $6 ($961--$955). During 1999, D is required to include as
interest income the $5 of market discount that accrues during that
year, and D increases by that amount its basis in the bond and the
amount to be used in computing mark-to-market gain or loss. On
December 31, 1999, B must mark bond X to market and recognize a gain
of $14 ($980--[$961 + $5]). Under section 1276(a)(1) and (4) and
paragraph (e)(1) of this section, $4 of that $14 gain is treated as
interest income. The $4 is the amount by which the market discount
of $10 that had accrued on January 1, 1999, exceeded the $6 built-in
gain on that date.
Example 2.
(i) Facts. The facts are the same as in Example 1, except that,
in addition, D sells bond X for its fair market value of $1,000 on
June 30, 2000.
(ii) Holdings. Immediately before the sale, D is required to
include as interest income the $2.50 of market discount that accrued
during the portion of the year through June 30, and D increases by
that amount its basis in the bond and the amount to be used in
computing mark-to-market gain or loss. Also, under Sec. 1.475(a)-2,
immediately before the sale, D recognizes $17.50 of mark-to-market
gain (the increase in value since the preceding mark to market, less
the basis increase of $2.50 from the market discount accrual. See
Sec. 1.475(a)-2). On the sale, D also recognizes the $6 of built-in
gain, all of which is recharacterized as ordinary interest income
under section 1276(a)(4).
Example 3.
(i) Facts. The facts are the same as in Example 1, except that,
during 2001, the issuer of bond X made a partial principal payment
in the amount of $20.
(ii) Holdings. Under paragraph (e)(1) of this section and
section 1276(a)(4), $6 of the partial principal payment is included
in D's 2001 income as interest income. The $6 is the portion of the
$10 of market discount that had accrued at the time bond X became
subject to section 475(a) and that had not previously caused gain or
a partial principal payment to be treated as interest income.
(f) Worthless debts--(1) Computation of mark-to-market gain or
loss. This paragraph (f) applies to any dealer that, under section
475(a)(2), marks to market either a debt that was charged off during
the year because it became partially worthless or a debt that became
wholly worthless during the taxable year (without regard to whether the
debt was charged off). Any gain or loss attributable to marking a debt
to market is determined by deeming the debt's adjusted basis to be the
debt's adjusted basis under Sec. 1.1011-1, less the amount charged off
during the taxable year or during any prior taxable year, to the extent
that amount has not previously reduced tax basis. A debt that becomes
wholly worthless is deemed to have an adjusted basis of zero. The
deemed adjusted basis, however, is used solely for this paragraph (f).
Thus, any portion of a loss attributable to a bad debt continues to be
accounted for under the bad debt provisions of the Code, and the basis
of the debt continues to be adjusted as otherwise required under the
Code.
(2) Treatment of mark-to-market gain or loss. To the extent that a
debt has been previously charged off, mark-to-market gain is treated as
a recovery. Thus, for example, a dealer using the section 585 reserve
method of accounting for bad debts must credit to the reserve any
portion of mark-to-market gain that is treated as a recovery of a bad
debt previously charged to the reserve account, and the dealer must
include any excess in gross income as required by Sec. 1.585-3(a).
Similarly, if a dealer is a large bank that changed to the specific
charge-off method of accounting for bad debts using the elective cut-
off procedures described in Sec. 1.585-7, the dealer must charge to the
reserve for pre-disqualification loans all losses recognized as a
result of marking to market a debt that is a pre-disqualification loan
within the meaning of Sec. 1.585-7(b)(2). Marking a pre-
disqualification loan to market, however, is not a disposition of that
loan under Sec. 1.585-7(d).
(g) Additional rules applicable to reserve-method taxpayers. If a
dealer accounts for bad debts using the reserve method of accounting
under section 585 or 593, the following additional rules apply in
computing a reasonable addition to a reserve--
(1) To determine the amount of total loans outstanding, the
outstanding balance on a debt that is marked to market is increased or
decreased by the amount of any mark-to-market gain or loss recognized,
except that the outstanding balance of the debt may never exceed the
actual balance currently due; and
(2) If the reasonable addition to the reserve is computed based on
a percentage of taxable income, any gain or loss attributable to
marking a debt to market must be taken into account in computing
taxable income.
(h) Example. This example illustrates paragraphs (f) and (g) of
this section.
Example.
(i) B, a calendar year taxpayer, is a dealer that marks some of
its debts to market under section 475(a)(2). Additionally, B is a
bank that accounts for bad debts using the section 585 reserve
method of accounting. B has not made an election to use the
conformity method of accounting described in Sec. 1.166-2(d)(3).
(ii) On December 31, 1995, B has total loans outstanding of
$1,000,000 and a bad debt reserve balance of $1000. Among the loans
that B marks to market is loan X. On January 1, 1995, loan X had a
book and tax basis of $100. During the taxable year, loan taxable
became partially worthless, and B charged off the loan by $5. Thus,
loan X had a book basis of $95 and a tax basis of $100. The fair
market value of loan X was $94 on December 31, 1995.
(iii) B computes the amount of gain or loss to be taken into
account under section [[Page 404]] 475(a)(2) with respect to loan X
using the rules of paragraph (f) of this section. Under paragraph
(f)(1) of this section, B treats the adjusted tax basis of loan X as
having been reduced by the $5 charge-off. Thus, B determines that it
is required to take into account a $1 mark-to-market loss based on
the difference between B's adjusted basis in loan X of $95, as
determined under paragraph (f)(1) of this section, and loan X's fair
market value of $94.
(iv) Further, B decides to claim a bad debt deduction with
respect to loan X in 1995, rather than waiting until loan X becomes
totally worthless. Thus, B charges the $5 of partial worthlessness
to its reserve for bad debts. In computing a reasonable addition to
the reserve under section 585(b), B reduces the amount of its total
loans outstanding by $6 ($5 charged to the reserve for bad debts,
plus $1 mark-to-market loss).
(v) On December 31, 1997, loan X has a fair market value of $93
and an adjusted basis (and outstanding principal balance) of $90. No
additional worthlessness occurred with respect to loan X in 1996 or
1997. B determines that it is required to recognize a $3 mark-to-
market gain with respect to loan X. Because B previously charged $5
to the bad debt reserve with respect to loan X, the entire $3 is a
recovery item and must be credited to the bad debt reserve. See
paragraph (f)(2) of this section. In computing a reasonable addition
to the reserve for 1997, B does not increase the balance of its
total loans outstanding by the $3 mark-to-market gain, because that
adjustment would increase the balance to an amount in excess of the
actual outstanding principal balance of $90. See paragraph (g)(1) of
this section.
Par. 4. Section 1.475(a)-2 is added to read as follows:
Sec. 1.475(a)-2 Mark to market upon disposition of security by a
dealer.
(a) General rule. If a dealer in securities ceases to be the owner
of a security for federal income tax purposes and if the security would
have been marked to market under section 475(a) if the dealer's taxable
year had ended immediately before the dealer ceases to own it, then
(whether or not the security is inventory in the hands of the dealer)
the dealer must recognize gain or loss on the security as if it were
sold for its fair market value immediately before the dealer ceases to
own it, and gain or loss is taken into account at that time. The amount
of any gain or loss subsequently realized must be properly adjusted, in
the form of a basis adjustment or otherwise, for gain or loss taken
into account under this paragraph (a). See Sec. 1.475(b)-4(b) for the
rule governing when a security with substituted basis must be
identified if it is to be exempted from the application of section
475(a).
(b) Example. The rule of paragraph (a) of this section is
illustrated by the following example.
Example.
(i) Facts. D is a dealer in securities within the meaning of
section 475(c)(1) and is a member of a consolidated group that uses
the calendar year as its taxable year. On February 1, 1995, D
acquired for $100 a debt instrument issued by an unrelated party. On
June 1, 1995, D sold the debt instrument to another member of the
group, M1, for $110, which was the fair market value of the security
on that date. D would have been required to mark the debt instrument
to market under section 475(a) if its taxable year had ended
immediately before it sold the debt instrument to M1.
(ii) Holding. Under paragraph (a) of this section, D marks the
debt instrument to market immediately before the sale to M1 and
takes into account $10 of gain. The gain is not deferred
intercompany gain. As a result, D's basis in the debt instrument
increases to $110 immediately before the sale. Accordingly, there is
no gain or loss on the sale, and M1's basis in the debt instrument
is $110.
Par. 5. Section 1.475(a)-3 is added to read as follows:
Sec. 1.475(a)-3 Acquisition by a dealer of a security with a
substituted basis.
(a) Scope. This section applies if--
(1) A dealer in securities acquires a security that is subject to
section 475(a) and the dealer's basis in the security is determined, in
whole or in part, by reference to the basis of that security in the
hands of the person from whom the security was acquired; or
(2) A dealer in securities acquires a security that is subject to
section 475(a) and the dealer's basis in the security is determined, in
whole or in part, by reference to other property held at any time by
the dealer.
(b) Rules. If this section applies to a security--
(1) Section 475(a) applies only to changes in value of the security
occurring after the acquisition; and
(2) Any built-in gain or loss with respect to the security (based
on the difference between the fair market value of the security on the
date the dealer acquired it and its basis to the dealer on that date)
is taken into account at the time, and has the character, provided by
the sections of the Code that would apply to the built-in gain or loss
if section 475(a) did not apply to the security.
Par. 6. Section 1.475(b)-3 is added to read as follows:
Sec. 1.475(b)-3 Exemption of securities in certain securitization
transactions.
(a) Exemption of contributed assets. If a taxpayer expects to
contribute securities (for example, mortgages) to a trust or other
entity, including a REMIC, in exchange for interests therein (including
ownership interests or debt issued by the trust or other entity), the
contributed securities qualify as held for investment (within the
meaning of section 475(b)(1)(A)) or not held for sale (within the
meaning of section 475(b)(1)(B)) only if the taxpayer expects each of
the interests received (whether or not a security within the meaning of
section 475(c)(2)) to be either held for investment or not held for
sale to customers in the ordinary course of the taxpayer's trade or
business.
(b) Exemption of resulting interests--(1) General rule. If a
taxpayer contributes securities to a trust or other entity in exchange
for interests therein (including ownership interests or debt issued by
the trust or other entity) and if, for federal income tax purposes, the
ownership of the interests received is not treated as ownership of the
securities contributed, the interests received may be identified as
being described in section 475(b)(1), even if some or all of the
contributed securities were not so described and could not have been so
identified. For purposes of determining the timeliness of an
identification of an interest received, the interest is treated as
acquired on the day of its receipt.
(2) Examples. The following examples illustrate the principles of
paragraph (b)(1) of this section.
Example 1. Identification of REMIC regular interests. If a
taxpayer holds mortgages that are marked to market under section 475
and the taxpayer contributes the mortgages to a REMIC in exchange
for REMIC regular interests that are described in section 475(b)(1),
the taxpayer may identify the regular interests as exempt from mark-
to-market treatment. This is permissible because REMIC regular
interests are debt securities issued by the REMIC and do not
represent continued ownership of the contributed mortgages.
Example 2. Identification of interests in a grantor trust. If a
taxpayer contributes securities to a grantor trust and receives
beneficial interests therein and if the taxpayer marked the
contributed securities to market under section 475, the taxpayer
cannot identify the beneficial interests in the grantor trust as
exempt from mark-to-market treatment. Because ownership of a
beneficial interest in a grantor trust represents continued
ownership of an undivided interest in the contributed assets, no new
security has been acquired.
Par. 7. Section 1.475(b)1-4 is added to read as follows:
Sec. 1.475(b)-4 Exemptions--Identification requirements.
(a) Identification of the basis for exemption. An identification of
a security as exempt does not satisfy section 475(b)(2) if it fails to
identify the subparagraph of section 475(b)(1) in which the security is
described. [[Page 405]]
(b) Time for identifying a security with a substituted basis. For
purposes of determining the timeliness of an identification under
section 475(b)(2), the date that a dealer acquires a security is not
affected by whether the dealer's basis in the security is determined,
in whole or in part, either by reference to the basis of the security
in the hands of the person from whom the security was acquired or by
reference to other property held at any time by the dealer. See
Sec. 1.475(a)-3 for rules governing how the dealer accounts for such a
security if this identification is not made.
(c) Securities involved in integrated transactions under
Sec. 1.1275-6--(1) Definitions. The following terms are used in this
paragraph (c) with the meanings that are given to them by Sec. 1.1275-
6: integrated transaction, legging into, legging out, qualifying debt
instrument, Sec. 1.1275-6 hedge, and synthetic debt instrument.
(2) Synthetic debt held by a taxpayer as a result of legging in. If
a taxpayer becomes the holder of a synthetic debt instrument as the
result of legging into an integrated transaction, then, for purposes of
the timeliness of an identification under section 475(b)(2), the
synthetic debt instrument is treated as having the same acquisition
date as the qualifying debt instrument. A pre-leg-in identification of
the qualifying debt instrument under section 475(b)(2) applies to the
synthetic debt instrument as well.
(3) Securities held after legging out. If a taxpayer legs out of an
integrated transaction, then, for purposes of the timeliness of an
identification under section 475(b)(2), the qualifying debt instrument,
or the Sec. 1.1275-6 hedge, that remains in the taxpayer's hands is
generally treated as having been acquired, originated, or entered into,
as the case may be, immediately after the leg-out. If any loss or
deduction determined under Sec. 1.1275-6(d)(2)(ii)(B) is disallowed by
Sec. 1.1275-6(d)(2)(ii)(D) (which disallows deductions when a taxpayer
legs out of an integrated transaction within 30 days of legging in),
then, for purposes of this section and section 475(b)(2), the
qualifying debt instrument that remains in the taxpayer's hands is
treated as having been acquired on the same date that the synthetic
debt instrument was treated as having been acquired.
Par. 8. Section 1.475(c)-1, as proposed on December 29, 1993 (58 FR
68798), is amended as follows:
1. The heading of the section is revised.
2. Paragraphs (c) and (d) are added.
3. The revision and additions read as follows:
Sec. 1.475(c)-1 Definitions--Dealer in securities.
* * * * *
(c) Dealer-customer relationship. Whether a taxpayer is transacting
business with customers is determined on the basis of all of the facts
and circumstances.
(1) [Reserved].
(2) Transactions described in section 475(c)(1)(B). For purposes of
section 475(c)(1)(B), the term dealer in securities includes, but is
not limited to, a taxpayer that, in the ordinary course of the
taxpayer's trade or business, regularly holds itself out as being
willing and able to enter into either side of a transaction enumerated
in section 475(c)(1)(B). An example of a taxpayer willing to enter into
either side of a transaction is a taxpayer willing to enter into an
interest rate swap and either pay a fixed interest rate and receive a
floating rate or pay a floating rate and receive a fixed rate.
(d) Issuance of life insurance products. A life insurance company
that is not otherwise a dealer in securities under section 475(c)(1)
does not become a dealer solely because it regularly issues life
insurance products to its customers in the ordinary course of a trade
or business. For purposes of the preceding sentence, the term life
insurance product means a contract that is treated for federal income
tax purposes as an annuity, endowment, or life insurance contract. See
sections 817 and 7702.
Par. 9. Section 1.475(c)-2, as proposed on December 29, 1993 (58 FR
68798), is amended as follows:
1. The heading of the section is revised.
2. Paragraph (a)(2) is revised.
3. Paragraph (a)(3) is amended by adding ``; or'' in lieu of the
period at the end of that paragraph.
4. Paragraph (a)(4) and paragraph (d) are added.
5. The revisions and additions read as follows:
Sec. 1.475(c)-2 Definitions--Security.
(a) * * *
(2) A debt issued by the taxpayer (including a synthetic debt
instrument, within the meaning of Sec. 1275-6(b), that the taxpayer is
treated as having issued as a result of an integrated transaction under
Sec. 1.1275-(6);
(3) * * * ; or
(4) A REMIC residual interest, or an interest or arrangement that
is determined by the Commissioner to have substantially the same
economic effect, if the residual interest or the interest or
arrangement is acquired on or after January 4, 1995.
* * * * *
(d) Synthetic debt held by a taxpayer as a result of an integrated
transaction under Sec. 1.1275-6. If, as the result of an integrated
transaction under Sec. 1.1275-6, a taxpayer is treated as the holder of
a synthetic debt instrument (within the meaning of Sec. 1.1275-6(b)),
the synthetic debt instrument is a security held by the taxpayer within
the meaning of section 475(c)(2)(C). See Sec. 1.475(b)-4(c) for rules
governing identification of such a synthetic debt instrument for
purposes of section 475(b).
Par. 10. Section 1.475(e)-1, as proposed on December 29, 1993 (58
FR 68798), is revised to read as follows:
Sec. 1.475(e)-1. Effective dates.
(a) Taxable years ending on or after December 31, 1993. The
following sections apply to taxable years ending on or after December
31, 1993: Secs. 1.475(b)-1 (concerning the scope of exemptions from
mark-to-market requirement), 1.475(b)-2 (concerning transitional issues
relating to exemptions), 1.475(c)-1(a) (concerning sellers of
nonfinancial goods and services) and (b) (concerning taxpayers that
purchase securities but do not sell more than a negligible portion of
the securities), 1.475(c)-2 (concerning the definition of security),
and 1.475(d)-1 (concerning the character of gain or loss). Note,
however, that, by its terms, Sec. 1.475(c)-2(a)(4) applies only to
interests or arrangements that are acquired on or after January 4,
1995, and the integrated transactions to which Sec. 1.475(c)-2(d)
applies will exist only after the effective date of Sec. 1.1275-6.
(b) Taxable years beginning on or after January 1, 1995. The
following sections apply to taxable years beginning on or after January
1, 1995: Secs. 1.475(a)-1 (concerning mark to market accounting for
debt instruments) and 1.475(c)-1(c) (concerning the dealer-customer
relationship) and (d) (concerning the issuance of life insurance
products).
(c) Securities acquired on or after January 4, 1995. The following
sections apply to securities acquired, originated, or entered into on
or after January 4, 1995: Secs. 1.475(a)-3 (concerning acquisition by a
dealer of a security with a substituted basis), 1.475(b)-3(a)
(concerning securities the taxpayer expects to contribute to a trust or
other entity in a securitization transaction), and 1.475(b)-3(b)
(concerning securities received in a securitization transaction).
(d) Events occurring on or after January 4, 1995. [[Page 406]]
(1) Section 1.475(a)-2 (concerning marking a security to market
upon disposition) applies to dispositions occurring on or after January
4, 1995.
(2) Section 1.475(b)-4 (concerning the identification requirements
for obtaining an exemption from mark-to-market treatment) applies to
identifications made on or after January 4, 1995.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-13 Filed 01-03-95; 8:45 am]
BILLING CODE 4830-01-U
