[Federal Register Volume 61, Number 248 (Tuesday, December 24, 1996)]
[Proposed Rules]
[Pages 67752-67760]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32247]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-209040-88]
RIN 1545-AM41
Qualified Electing Fund Elections
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 permitting certain
shareholders to make a special election under section 1295, in lieu of
the election currently provided for under that section, with respect to
certain preferred shares of a passive foreign investment company
(PFIC). A shareholder that makes a special election must account for
dividend income on the shares subject to the special election under
special income inclusion rules, rather than under the general income
inclusion rules of section 1293. This document also provides notice of
a public hearing on these proposed regulations.
DATES: Written comments must be received by March 24, 1997. Requests to
speak and outlines of oral comments to be discussed at the public
hearing scheduled for May 8, 1997, at 10:00 a.m. must be received by
April 17, 1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209040-88), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209040-88), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 3313, Internal
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Judith
Cavell Cohen, (202) 622-3880; concerning submissions and the hearing,
Evangelista Lee, (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 of 1995 (44
U.S.C. 3507(d)). 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
[[Page 67753]]
Information and Regulatory Affairs, Washington, DC 20503, with copies
to the Internal Revenue Service, Attn: IRS Reports Clearance Officer,
T:FP, Washington, DC 20224. Comments on the collection of information
should be received by February 24, 1997. Comments are specifically
requested concerning:
Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collection of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collection of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and
Estimates of capital or start-up costs and costs of operation,
maintenance, and purchase of services to provide information.
The collection of information in this proposed regulation is in
proposed regulation Sec. 1.1295-2(c)(3) and proposed regulation
Sec. 1.1295-2(e) and (f). This information will notify the Commissioner
that certain shareholders have made the special election. In addition,
this information will enable the IRS to determine if a shareholder
qualifies for the special election and is satisfying the income
inclusion requirements of proposed regulation Sec. 1.1293-2. The
collection of information is mandatory. The likely respondents are
individuals, businesses, and other for-profit organizations.
Estimated total annual reporting/recordkeeping burden: 600 hours.
The estimated annual burden per respondent varies from 21 minutes to
8.3 hours, depending on individual circumstances, with an estimated
average of 35 minutes.
Estimated number of respondents: 1030.
Estimated annual frequency of responses: On occasion.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office of
Management and Budget.
Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
This document contains proposed Income Tax Regulations (26 CFR part
1) under sections 1293 and 1295 of the Internal Revenue Code. Sections
1293 and 1295 were added by the Tax Reform Act of 1986 (the Act) and
were amended by the Technical and Miscellaneous Revenue Act of 1988
(TAMRA). The sections, as amended, were effective for taxable years of
foreign corporations beginning after December 31, 1986. Section 1293
also was amended by the Omnibus Reconciliation Act of 1993 (OBRA).
Guidance for making the section 1295 election was provided in proposed
regulation Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535. Guidance
regarding the annual income inclusion rule for shareholders making a
section 1295 election was provided in proposed regulation Sec. 1.1293-
1.
Explanation of Provisions
Special Preferred Section 1295 Election
1. Introduction
The passive foreign investment company (PFIC) rules of the Code are
designed to eliminate potential tax deferral opportunities associated
with equity investments by United States persons in foreign
corporations that have substantial levels of passive income or assets.
The PFIC rules eliminate tax deferral opportunities by applying the
section 1291 interest charge regime to PFIC shareholders that fail to
make a section 1295 annual income inclusion election (section 1295
election). In general, the section 1291 interest charge regime applies
to the ``extraordinary'' portion of any distribution received by the
shareholder, and any gain recognized on a disposition of shares.
The PFIC rules apply to investments in both common and preferred
shares of a PFIC. Preferred shares, unlike common shares, generally
provide for limited dividend and liquidation or redemption rights, and
thus do not participate significantly in corporate growth. Accordingly,
preferred shares of a PFIC generally do not afford U.S. investors with
the same potential for U.S. tax deferral as common shares of a PFIC.
Preferred shareholders, like common shareholders, may make the
section 1295 election to avoid the interest charge regime of section
1291. Shareholders that make the section 1295 election are required
under section 1293 to include in income annually, as ordinary income,
their pro rata share of the PFIC's ordinary earnings and, as long-term
capital gain, their pro rata share of the PFIC's net capital gain for
the year. In order to determine their pro rata share of ordinary
earnings and net capital gain, shareholders that have made a section
1295 election must obtain certain U.S. tax accounting information from
the PFIC regarding the PFIC's earnings. If this information is not
available, the shareholders cannot make the section 1295 election. If
the requisite information is available, the annual information
reporting and collection requirements associated with the section 1295
election may render the election impractical for smaller investors.
Because preferred shares often do not afford investors with significant
tax-deferral opportunity, commenters have suggested that the current
section 1295 election regime should be simplified for certain types of
preferred shares.
The proposed regulations adopt a special section 1295 election
regime that would require holders of certain preferred shares of a PFIC
that elect to be subject to the regime to accrue annually ordinary
dividend income with respect to the preferred shares regardless of the
holder's pro rata share of ordinary earnings or net capital gain of the
PFIC for the year. Because shareholders would accrue income regardless
of the earnings and net capital gain of the PFIC, shareholders that
elect to be subject to the regime would not have to report and collect
any U.S. tax accounting information regarding the PFIC in order to make
the special section 1295 election.
The proposed regulations are issued under two sections of the Code.
Section 1.1295-2 of the proposed regulations provides rules for making
a QEF election under the special proposed section 1295 election regime
(special preferred QEF election). Section 1.1293-2 describes the annual
income inclusion rules for shareholders that have made the special
preferred QEF election.
The proposed regulations would apply only with respect to
qualifying preferred shares issued after the date the proposed
regulations are finalized.
2. Rules for Making the Special Preferred QEF Election
Under proposed regulation Sec. 1.1295-2(a), the special preferred
QEF election may be made in lieu of the section 1295 election described
in proposed regulation Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535
(regular section 1295 election), with respect to certain types of
preferred shares (qualified
[[Page 67754]]
preferred shares) by certain holders satisfying prescribed ownership
requirements.
The special preferred QEF election may only be made with respect to
qualified preferred shares as defined in proposed regulation
Sec. 1.1295-2(b). To ensure that the special preferred QEF election
cannot be used for tax avoidance purposes and to reduce complexity, the
proposed regulations define qualified preferred shares narrowly to
include only a limited class of preferred shares likely to be marketed
to U.S. retail investors. Although the definition of qualified
preferred shares includes both cumulative and non-cumulative preferred
shares, the definition excludes various types of preferred shares,
including preferred shares denominated in a foreign currency and
preferred shares issued at a significant discount to their liquidation
or redemption amounts. The PFIC issuing the preferred shares must
represent that it intends to pay dividends currently. Proposed
regulation Sec. 1.1295-2(b) provides additional restrictions with
respect to preferred shares acquired in secondary market transactions.
Proposed regulation Sec. 1.1295-2(c) describes shareholders who may
make the election. Under proposed regulation Sec. 1.1295-2(c)(1), any
United States person that acquires qualified preferred shares for cash
or in certain nonrecognition transactions and that holds such shares
directly may make the election. United States persons that are pass-
through entities, including partnerships, S corporations, trusts and
estates, may qualify as shareholders.
The special preferred QEF election regime is narrowly targeted to
eliminate certain of the information reporting and collection
requirements associated with the existing section 1295 election and
annual inclusion rules for U.S. retail investors in preferred shares of
PFICs. Treasury and the Service believe that the special preferred QEF
election regime should only apply with respect to foreign corporations
that are not expected to be in a position to provide U.S. tax
accounting information to shareholders. Accordingly, proposed
regulation Sec. 1.1295-2(c)(2) provides that the special preferred QEF
election does not apply to holders of preferred shares in a PFIC that
is a controlled foreign corporation. Further, proposed regulation
Sec. 1.1295-2(c)(3) provides that the special preferred QEF election
does not apply to holders that own 5 percent or more of the vote or
value of any class of shares of the PFIC. Holders of five percent or
more of the vote or value of any class of shares generally are not the
type of retail investor that the proposed regulations are designed to
assist. Such holders may only make the section 1295 election provided
under current rules.
Proposed regulation Sec. 1.1295-2(c)(3) requires the corporation to
provide to electing shareholders a statement, directly or in a
disclosure document generally available to all U.S. shareholders,
either that it is or that it reasonably believes that it is a PFIC and
that it is not a controlled foreign corporation. Shareholders that fail
to receive such a statement are not permitted to make a special
preferred QEF election.
Proposed regulation Sec. 1.1295-2(d) describes the effect of the
special preferred QEF election. Proposed regulation Sec. 1.1295-2(d)(1)
provides that shares subject to a special preferred QEF election will
be treated as shares of a pedigreed QEF (as defined in proposed
regulation Sec. 1.1291-1(b)(2)(ii)) for all taxable years of the
foreign corporation that are included wholly or partly in the
shareholder's holding period of the shares. Under the proposed
regulations, the election will apply to all qualified preferred shares
of a foreign corporation owned directly by the shareholder that are
acquired in the taxable year with respect to which the election is
made. Although a special preferred QEF election will not apply
automatically to qualified preferred shares acquired in subsequent
taxable years of a shareholder, the proposed regulations permit the
shareholder to make separate special preferred QEF elections with
respect to qualified preferred shares acquired in later years.
Proposed regulation Sec. 1.1295-2(d)(2) provides that the special
preferred QEF election regime applies whether or not the foreign
corporation is a PFIC in any year subsequent to the year of the
election. Accordingly, shareholders that make the special preferred QEF
election must make annual Sec. 1.1293-2 income inclusions, as provided
in proposed regulation Sec. 1.1295-2(d)(3), even if the foreign
corporation does not qualify as a PFIC for a particular year.
Proposed regulation Sec. 1.1295-2(e) specifies the time and manner
of making the special preferred QEF election. In order to make the
special preferred QEF election, a shareholder files Form 8621 (Return
by a Shareholder of a Passive Foreign Investment Company or Qualified
Electing Fund), for the taxable year of the election, checking the
appropriate box in Form 8621, Part I, for making the section 1295
election, and indicating in the margin of Part I that the shareholder
is making a special preferred QEF election with respect to certain
specified shares. In addition, the shareholder must attach to Form 8621
a brief statement containing the information and representations
contained in proposed regulation Sec. 1.1295-2(e)(2)(ii). Under
proposed regulation Sec. 1.1295-2(f), in subsequent years, the
shareholder must file Form 8621 with respect to the foreign corporation
but need not attach any statement to the form. For all taxable years
covered by the election, the shareholder must report on Line 6a of Part
II of Form 8621 the amount includible under proposed regulation
Sec. 1.1293-2 with respect to qualified preferred shares subject to a
special preferred QEF election.
Proposed regulation Sec. 1.1293-2(g) states that a sale, exchange
or other disposition of shares subject to a special preferred QEF
election terminates the election with respect to those shares. Also,
the Commissioner may terminate or invalidate an election if a
shareholder fails to satisfy the initial or ongoing requirements of the
election. For example, the Commissioner may terminate or invalidate a
special preferred QEF election if the shareholder owns five percent or
more of the vote or value of any class of shares of the PFIC at any
time during the period that the shareholder owns qualified preferred
shares subject to the election. A shareholder may not itself terminate
a special preferred QEF election.
3. Annual Inclusion Rules for Electing Shareholders.
Under proposed regulation Sec. 1.1293-2(a), a shareholder that has
made a special preferred QEF election must make annual income
inclusions with respect to qualified preferred shares subject to the
election. Unlike the annual income inclusions provided under section
1293 and proposed regulation Sec. 1.1293-1, the annual inclusions under
the special preferred QEF election regime are determined without regard
to the shareholder's pro rata share of the foreign corporation's
ordinary earnings or net capital gains.
Proposed regulation Sec. 1.1293-2(b) provides rules for determining
the amount that a shareholder must include in income annually under the
special preferred QEF election regime. Under the proposed regulations,
this annual amount consists of two components. The first component is
an annual inclusion amount based on a ratable daily portion of dividend
income that accrues on the qualified preferred shares (annual dividend
amount). This ratable inclusion rule for the annual dividend amount is
analogous to the rule for inclusion of income with respect to
[[Page 67755]]
periodic payments on notional principal contracts under Sec. 1.446-3.
The second component of the preferred QEF amount arises only in respect
of fixed term preferred shares, as described proposed regulation
Sec. 1.1295-2(b)(vii), acquired in a secondary market transaction, and
is calculated based on the ratable inclusion of the excess, if any, of
the redemption price of the shares over the acquisition cost of the
shares (preferred discount amount). This ratable inclusion rule for the
preferred discount amount is analogous to the rule for the ratable
inclusion of market discount on certain debt under section 1276(b)(1).
The Service and Treasury solicit comments regarding the income
inclusion rules of the proposed regulations, including comments as to
whether foreign corporations and their agents could effectively assist
holders in complying with the income inclusion rules applicable to
preferred discount.
Proposed regulation Sec. 1.1293-2(c) provides certain special rules
regarding the annual income inclusion required under proposed
regulation Sec. 1.1293-2(a). Under Sec. 1.1293-2(c)(1), annual amounts
are included in income by shareholders irrespective of the PFIC's
earnings and profits. In this regard, the special preferred QEF
election differs from the regular section 1295 election in that
shareholders making the special preferred QEF election must accrue the
annual amount as ordinary income even if the amount exceeds the
shareholder's pro rata share of the foreign corporation's earnings and
profits. Proposed regulation Sec. 1.1293-2(c)(3) requires the
shareholder to include the annual dividend amount as ordinary income
regardless of whether any portion of the PFIC's earnings for the year
represents net capital gain. Proposed regulation Sec. 1.1293-2(c)(4)
provides rules for the tax-free distribution of previously taxed
amounts. Proposed regulation Sec. 1.1293-2(c)(5) provides certain basis
adjustment rules similar to the basis adjustment rule of section
1293(d). Finally, proposed regulation Sec. 1.1293-2(c)(6) provides
rules intended to limit the effect of a special preferred QEF election
to the shareholder making the election. Accordingly, a special
preferred QEF election will not affect the foreign corporation's
calculation of its earnings and profits, and will have no consequences
for shareholders that have not made a special preferred QEF election.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It is hereby
certified that these regulations do not have a significant economic
impact on a substantial number of small entities. This certification is
based on the fact that these regulations represent a wholly elective
simpler alternative to the section 1295 election described in
Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535, and impose a lighter
collection of information burden. Further, the requirement that
electing shareholders indicate their special election on Form 8621
annually and attach a statement, providing certain information in the
first year of the election only, is minimal and will not impose a
significant economic impact on electing shareholders. Therefore, a
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the
Internal Revenue 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 May 8, 1997, at 10:00 a.m.
in room 3313, Internal Revenue Building, 1111 Constitution Avenue, NW.,
Washington DC. 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 March 24, 1997, 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 17, 1997.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the schedule of 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 author of these regulations is Judith Cavell Cohen of
the Office of Associate Chief Counsel (International).
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
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1293-2 also issued under 26 U.S.C. 1297(f).
Section 1.1295-2 also issued under 26 U.S.C. 1297(f). * * *
Par. 2. Section 1.1293-2 is added to read as follows:
Sec. 1.1293-2 Special Inclusion Rules for Special Preferred QEF
Election.
(a) In general. A shareholder (including a shareholder that is a
pass-through entity, as described in Sec. 1.1295-2(c)(1)) that makes a
special preferred QEF election under Sec. 1.1295-2 must, regardless of
the shareholder's method of accounting, include in income in respect of
each share subject to the election, an annual amount (preferred QEF
amount) determined according to the rules of paragraph (b) of this
section. A shareholder that makes a special preferred QEF election must
include the preferred QEF amount in income under this section for each
year in which the taxpayer continues to hold a share that is subject to
the election. The rules of this section apply in lieu of the general
rules of section 1293 and Sec. 1.1293-1.\1\
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\1\ This proposed regulation was published on April 1, 1992, at
57 FR 11024.
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(b) Preferred QEF amount--(1) In general. The preferred QEF amount
for any share subject to a special preferred QEF election is the sum of
the ratable daily portion of each periodic dividend amount (as
described in paragraph (b)(2) of this section) on the share for the
taxable year of the shareholder to which that portion relates, plus the
preferred discount amount (as defined below), if any, for the taxable
year. For purposes of this section, the preferred discount amount for a
taxable year is the amount that bears the same ratio to the total
amount of preferred discount (as described in Sec. 1.1295-2(b)(2)(i))
on the share as the number of days that the taxpayer held the share in
the taxable
[[Page 67756]]
year bears to the number of days after the date the taxpayer acquired
the share and up to (and including) the share's redemption date as
established under the principles of Sec. 1.305-5(b). Notwithstanding
the preceding sentence, the preferred discount amount for a taxable
year is zero if the preferred discount on the share at the time of its
acquisition by the shareholder was less than an amount equal to \1/4\
of 1 percent of the redemption price of the stock, multiplied by the
number of complete years from the date of acquisition of the stock to
the redemption date of the stock.
(2) Periodic dividend amount. A periodic dividend amount is the
amount payable with respect to a share, whether on a cumulative or
noncumulative basis, for a period (wholly or partly within the
shareholder's taxable year) for which dividends on the share are
calculated based upon the redemption or liquidation price of the share
multiplied by a fixed percentage rate.
(c) Special rules of application--(1) Earnings and profits
disregarded. The amounts to be included in income pursuant to this
section are determined without regard to the earnings and profits of
the foreign corporation with respect to which the special preferred QEF
election applies.
(2) Year of inclusion. The shareholder includes the preferred QEF
amount in its taxable year without regard to the taxable year of the
foreign corporation with respect to which the special preferred QEF
election applies.
(3) Character of inclusions. The shareholder includes all preferred
QEF amounts in income as ordinary earnings.
(4) Treatment of distributions. Distributions received by a
shareholder on shares subject to a special preferred QEF election that
are paid out of earnings and profits of the foreign corporation are not
included in gross income of the shareholder to the extent the
distributions do not exceed the preferred QEF amounts (other than any
portion of preferred QEF amounts consisting of preferred discount
amounts) previously includible in income pursuant to this section.
These distributions will, however, be treated as dividends for all
other purposes of the Code and regulations. Amounts distributed to a
shareholder with respect to shares subject to a special preferred QEF
election that exceed amounts previously included in income under this
section with respect to such shares are treated for all purposes of the
Code and regulations as a distribution of property subject to the rules
of section 301.
(5) Basis adjustment rules. The adjusted basis of a shareholder in
shares that are subject to a special preferred QEF election shall be--
(i) Increased by any amount that is included in the gross income of
the shareholder under paragraph (a) of this section; and
(ii) Decreased by any dividends (not to exceed the amount included
in gross income under paragraph (a) of this section) actually paid to
the shareholder in respect of such shares.
(6) Effect limited to electing shareholder. This section does not
apply to the foreign corporation with respect to which a special
preferred QEF election applies. Accordingly, the provisions of this
section will not affect the foreign corporation's calculation of its
earnings and profits for any purpose of the Code or regulations. In
addition, the rules of this section apply only for purposes of
determining the tax consequences for holders of shares subject to the
election. Thus, the election shall have no effect on the application of
the Code or regulations with respect to the tax consequences of the
ownership of shares that are not subject to the election, including for
purposes of determining whether any distributions from the foreign
corporation with respect to such shares should be treated as having
been included in the income of any United States person pursuant to
section 1293(c) or section 959.
(d) Examples. The following examples illustrate the rules of
paragraphs (a), (b) and (c) of this section. Although these examples
assume a 30-day month, 360-day year, any reasonable counting method may
be used to compute the length of accrual periods. For purposes of
simplicity, the relevant amounts as stated are rounded to two decimal
places. However, the computations do not reflect any such rounding
convention. The examples are as follows:
Example 1. Preferred QEF amount--(i) Facts. (A) On May 1, 1998,
A, an individual who files his returns on a calendar year basis,
purchased for $10,000 in a single secondary market transaction 100
shares of nonconvertible Class A $100 par value preferred stock (the
Class A Stock) of FC, a foreign corporation with a taxable year
ending on March 31.
(B) The terms of the Class A Stock provide for a mandatory
redemption of the Class A Stock by the issuer at par on June 1,
2012. The Class A Stock is not redeemable pursuant to an issuer call
or holder put on any other date. Each share of Class A Stock
provides for a semi-annual cumulative distribution payable in
dollars on June 1 and December 1 equal to one-half the product of
the par value of the Class A Stock and the applicable annual dollar
LIBOR in effect on the distribution date immediately prior to the
relevant distribution date. The shares of the Class A stock are
qualified preferred shares in the hands of A. A purchases no other
qualified preferred shares of FC during its 1998 or 1999 taxable
years.
(C) A made a special preferred QEF election for A's taxable year
ended December 31, 1998, which applies to the Class A Stock acquired
by A on May 1, 1998. FC is a PFIC under section 1296 for its taxable
year ending March 31, 1999, but FC is not a PFIC for its taxable
year ending March 31, 2000. FC paid no current dividends on June 1,
1998, and December 1, 1998, paid the June 1, 1999, dividend
currently on June 1, 1999, together with accumulated distributions
from June 1, 1998, and December 1, 1998, and paid the December 1,
1999, dividend currently on December 1, 1999. The applicable annual
LIBOR is 8 percent on December 1, 1997, 7 percent on June 1, 1998, 9
percent on December 1, 1998, 10 percent on June 1, 1999, and 9
percent on December 1, 1999. FC had sufficient earnings and profits,
within the meaning of section 312, for its taxable year ending on
March 31, 2000, so that actual distributions to all shareholders of
Class A Stock in that year were treated as paid out of earnings and
profits of FC.
(ii) Tax consequences to A for A's taxable year ending December
31, 1998. As required under paragraph (a) of this section, A must
include in gross income for its 1998 taxable year the 1998 preferred
QEF amount. The preferred QEF amount, as determined under paragraph
(b) of this section, for A's 1998 taxable year is the ratable
portion of each periodic dividend amount for that year. For 1998,
there are three periodic dividend amounts: The periodic dividend
amount for the period from December 1, 1997, to June 1, 1998
(periodic dividend amount 1), the periodic dividend amount for the
period from June 1, 1998, to December 1, 1998 (periodic dividend
amount 2), and the periodic dividend amount for the period from
December 1, 1998, to June 1, 1999 (periodic dividend amount 3).
Periodic dividend amount 1 in respect of each share owned by A is $4
(1/2 multiplied by the applicable annual LIBOR of 8 percent set on
December 1, 1997, multiplied by the $100 amount payable on
redemption). Because A acquired the shares on May 1, 1998, A's
ratable portion of periodic dividend amount 1 for 1998 is
approximately $.67 (30/180 multiplied by $4) per share. Periodic
dividend amount 2 in respect of each share owned by A is $3.50 (1/2
multiplied by the applicable annual LIBOR of 7 percent set on June
1, 1998, multiplied by $100). Because A owned the shares for the
entire period associated with periodic dividend amount 2, A's
ratable portion of periodic dividend amount 2 for 1998 is the full
$3.50 per share. Periodic dividend amount 3 in respect of each share
owned by A is $4.50 (1/2 multiplied by the applicable annual LIBOR
of 9 percent set on December 1, 1998, multiplied by $100). Because
the portion of 1998 associated with periodic dividend amount 3 is
only the month of December, 1998, A's ratable portion of periodic
dividend amount 3 for 1998 is approximately
[[Page 67757]]
$.75 (30/180 multiplied by $4.50). Accordingly, A s preferred QEF
amount for 1998 is approximately $4.92 ($.67 + $3.5 + $.75) per
share. A must include approximately $492 (approximately $4.92 per
share, multiplied by 100 shares) in income as ordinary earnings for
its 1998 tax year even though FC paid no actual dividend to
shareholders of Class A Stock for the period in 1998 during which A
held the Class A Stock.
(iii) Tax consequences to A for A's taxable year ending December
31, 1999. As required under paragraph (a) of this section, A
includes in gross income for its 1999 taxable year its preferred QEF
amount for 1999. The preferred QEF amount, as determined under
paragraph (b) of this section, for A's 1999 taxable year is the
ratable portion of each periodic dividend amount for that year. For
1999, there are three periodic dividend amounts: The periodic
dividend amount for the period from December 1, 1998, to June 1,
1999 (periodic dividend amount 1), the periodic dividend amount for
the period from June 1, 1999, to December 1, 1999 (periodic dividend
amount 2), and the periodic dividend amount for the period from
December 1, 1999, to June 1, 2000 (periodic dividend amount 3).
Periodic dividend amount 1 in respect of each share owned by A is
$4.50 (1/2 multiplied by the applicable annual LIBOR of 9 percent
set on December 1, 1998, multiplied by $100). Because A held each
share of Class A Stock for five months in 1999 for the period
associated with periodic dividend amount 1, A's ratable portion of
periodic dividend amount 1 for 1999 is approximately $3.75 (150/180
multiplied by $4.50). Periodic dividend amount 2 in respect of each
share owned by A is $5 (1/2 multiplied by the applicable annual
LIBOR of 10 percent set on June 1, 1999, multiplied by $100).
Because A owned the share for the entire period associated with
periodic dividend amount 2, A's ratable portion of periodic dividend
amount 2 for 1999 is the full $5. Periodic dividend amount 3 in
respect of each share owned by A is $4.50 (1/2 multiplied by the
applicable annual LIBOR of 9 percent set on December 1, 1999,
multiplied by $100). Because A held each share of Class A Stock for
one month in 1999 for the period associated with periodic dividend
amount 3, A's ratable portion of periodic dividend amount 3 for 1999
is approximately $.75 (30/180 multiplied by $4.50). Accordingly, A's
preferred QEF amount for 1998 is approximately $9.50 ($3.75 + $5 +
$.75). A must include approximately $950 ($9.50 per share,
multiplied by 100 shares) in income as ordinary income for its 1999
taxable year even though FC was not a PFIC for FC's taxable year
ending in 2000. The current distributions and arrearages actually
paid to A with respect to the Class A Stock are not includible in
income by A under paragraph (c)(4) of this section because they
constitute amounts previously included in income.
Example 2. Preferred Discount--(i) Facts. The facts are the same
as in Example 1 except that A acquired the 100 shares of Class A
Stock for $9000.
(ii) Tax Consequences to A for A s taxable year ending December
31, 1998. (A) Because the Class A Stock is fixed term preferred
stock (as described in Sec. 1.1295-2(b)(1)(vii)) and A acquired each
share of the Class A stock with $10 of preferred discount, as
described in Sec. 1.1295-2(b)(2), A's preferred QEF amount to be
included by A for the taxable year consists of the sum of the
ratable daily portion of each periodic dividend amount, as
calculated in paragraph (d)(ii) of Example 1 of this section, plus
the preferred discount amount described in paragraph (b)(1) of this
section.
(B) The preferred discount amount with respect to each share is
approximately $.47 ($10 multiplied by 240 days/5070 days to
maturity). A must include approximately $47 ($.47 per share,
multiplied by 100 shares), together with the amount calculated in
paragraph (d)(ii) of Example 1 of this section, in income as
ordinary earnings for its 1998 tax year even though FC paid no
actual dividend to shareholders of Class A Shares for the period in
1998 during which A held the Class A Stock.
(iii) Tax consequences to A for A's taxable year ending December
31, 1999. The portion of the preferred discount on each share
includible under paragraph (a) of this section is approximately $.71
($10 multiplied by 360 days/5070 days to maturity). A must include
this amount, together with the amount calculated in paragraph
(d)(iii) of Example 1 of this section, in income as ordinary
earnings for its 1999 tax year even though FC was not a PFIC for
FC's taxable year ending in 2000. The current distributions and
arrearages actually paid to A in 1999 with respect to the Class A
Stock are not includible in income by A under paragraph (c)(4) of
this section, because they constitute amounts previously included in
income.
(e) Effective date. The rules under this section apply with respect
to qualified preferred stock subject to a special preferred QEF
election made after the date that is 30 days after the date of
publication of this document as a final regulation.
Par. 3. Section 1.1295-2 is added to read as follows:
Sec. 1.1295-2 Special Preferred QEF Election.
(a) In general. This section provides rules permitting certain
shareholders to make a special election under section 1295 (special
preferred QEF election) in lieu of the election described in
Sec. 1.1295-1 \2\ and Notice 88-125, 1988-2 C.B. 535 (see
Sec. 601.601(d)(2)(ii)(b) of this chapter), with respect to certain
preferred shares (qualified preferred shares) of a foreign corporation
that certifies either that it is a PFIC (as defined in Sec. 1.1291-
1(b)(1)(i)) \3\ or that it reasonably believes that it is a PFIC. In
order to make a special preferred QEF election, a shareholder must
satisfy the stock ownership requirement of paragraph (c)(2) of this
section. A special preferred QEF election of a shareholder applies only
to those qualified preferred shares acquired and held directly by the
shareholder in the taxable year of the shareholder for which the
election is made. A shareholder making a special preferred QEF election
must account for dividend income on shares subject to the election
under the special income inclusion rules described in Sec. 1.1293-2,
rather than under the general income inclusion rules of section 1293
and Sec. 1.1293-1. In addition, for purposes of determining the tax
consequences of owning shares subject to the special preferred QEF
election, an electing shareholder must treat the foreign corporation as
a PFIC for the entire period during which the shareholder continues to
hold any of such shares. Paragraph (b) of this section defines
qualified preferred share. Paragraph (c) of this section provides rules
for determining who may make the special preferred QEF election.
Paragraph (d) of this section provides rules concerning the effect of
the election. Paragraph (e) of this section provides rules for the time
and manner of making the election. Paragraph (f) of this section sets
forth the annual reporting requirement for the election. Paragraph (g)
of this section provides rules concerning the possible termination or
invalidation of the election. For the applicability date of this
section, see paragraph (h) of this section.
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\2\ This proposed regulation was published on April 1, 1992, at
57 FR 11024.
\3\ This proposed regulation was published on April 1, 1992, at
57 FR 11024.
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(b) Qualified preferred share defined--(1) In general. For purposes
of this section, a share of a foreign corporation is a qualified
preferred share only if--
(i) The share was originally issued for cash or in exchange for
qualified preferred shares of the foreign corporation in a transaction
to which section 354(a)(1) applied;
(ii) If the share were to constitute a debt obligation, the share
would be in registered form within the meaning of Sec. 5f.103-1(c) of
this chapter;
(iii) All amounts payable with respect to the share are denominated
in U.S. dollars and are not determined by reference to the value of a
currency other than the U.S. dollar;
(iv) The share is limited and preferred as to dividends and does
not participate in corporate growth to any significant extent within
the meaning of section 1504(a)(4)(B);
(v) The share has a fixed redemption or liquidation price;
(vi) The share provides for cumulative or noncumulative dividend
rights that are limited to an annual (or shorter period) amount
computed by
[[Page 67758]]
multiplying either the redemption or liquidation price of the share by
a specified index described in Sec. 1.446-3(c)(2)(i), (iii), or (iv)
(specified index), or by a specified index periodically re-established
pursuant to an auction reset mechanism, set in advance of the period
with respect to which the specified index applies;
(vii) If the share may be redeemed under circumstances described in
Sec. 1.305-5(b) such that redemption premium (as described in
Sec. 1.305-5(b)) could be treated under section 305(c) as a
constructive distribution (fixed term preferred stock), the share was
not issued with redemption premium exceeding the de minimis amount
described in section 305(c)(1) and Sec. 1.305-5(b)(1);
(viii) If the share may not be redeemed under circumstances
described in Sec. 1.305-5(b) such that redemption premium would not be
treated under section 305 as a constructive distribution (perpetual
preferred stock), the share does not provide shareholders with the
right to receive an amount upon liquidation or redemption that exceeds
the issue price of the share (as determined under the principles of
section 1273(b)) by an amount in excess of 5 percent of such
liquidation or redemption amount;
(ix) If redeemable, the share is redeemable only in whole and not
in part and is not subject to mandatory redemption within five years of
the issue date of the share. Further, the share is not subject to a
holder put or issuer call that, based on all the facts and
circumstances as of the issue date of the share, is more likely than
not to be exercised at a time within five years of the issue date;
(x) If convertible, the share is not convertible into a share other
than a share meeting all the conditions set forth in paragraphs
(b)(1)(i) through (b)(1)(ix) of this section; and
(xi) The issuer of the share has indicated in an offering document
relating to the original issuance of the share or in a written
statement available to U.S. holders that the issuer has no current
intention or belief that it will not pay dividends on the share on a
current basis and that the share meets the conditions set forth in
paragraphs (b)(1)(i) through (b)(1)(x) of this section and this
paragraph (b)(1)(xi).
(2) Special rules for shares acquired in secondary market
transactions--(i) Fixed term preferred stock. A share of fixed term
preferred stock (as described in paragraph (b)(1)(vii) of this section)
that satisfies the conditions set forth in paragraph (b)(1) of this
section and that is acquired in a transaction other than in connection
with the initial issuance of the share (a secondary market
transaction), shall constitute a qualified preferred share with respect
to a shareholder, but only if the shareholder acquires the share for
cash and the share has preferred discount (as defined below) that is
less than or equal to an amount equal to 1 percent of the redemption
price, multiplied by the number of complete years from the date of
acquisition of the share to the redemption date as established under
the principles of Sec. 1.305-5(b). Sales of shares to bond houses,
brokers, or similar persons or organizations acting in the capacity as
underwriters, placement agents, or wholesalers are ignored for purposes
of determining whether a share is acquired in connection with the
initial issuance of the share. For purposes of this section, the
preferred discount for a share is the excess of the redemption price of
the share payable on the redemption date over the shareholder's
acquisition cost for the share.
(ii) Perpetual preferred stock. A share of perpetual preferred
stock, within the meaning of paragraph (b)(1)(viii) of this section,
that satisfies the conditions set forth in paragraph (b)(1) of this
section and that is acquired in a secondary market transaction, shall
constitute a qualified preferred share with respect to the shareholder,
but only if the shareholder acquires the share for cash and the amount
payable upon liquidation of the share exceeds the shareholder's
acquisition cost for the share by an amount less than or equal to 10
percent of such liquidation amount.
(iii) Examples. The following examples illustrate the rules of this
paragraph (b)(2).
Example 1--(i) Facts. On May 1, 1998, A, an individual who files
her return on a calendar year basis, purchases for $9000 cash in a
single secondary market transaction (as defined in paragraph
(b)(2)(i) of this section) 100 shares of nonconvertible Class A $100
par value preferred stock (Class A Stock) of FC, a foreign
corporation with a taxable year ending March 31. The terms of the
Class A Stock satisfy all the conditions described in paragraph
(b)(1) of this section and provide for a mandatory redemption of the
Class A Stock by the issuer in U.S. dollars at par on June 1, 2012.
The Class A Stock is not redeemable pursuant to an issuer call or
holder put on any other date.
(ii) Analysis. In order for A to make a special preferred QEF
election with respect to the Class A Stock acquired by A, the Class
A Stock acquired must constitute qualified preferred shares.
Although the Class A Stock meets the requirements for qualified
preferred shares set forth in paragraph (b)(1) of this section, the
stock also must satisfy the requirements described in paragraph
(b)(2) because A acquired the stock in a secondary market
transaction. Because the terms of the Class A Stock provide that the
stock will be redeemed by the issuer on June 1, 2012, the stock
constitutes fixed term preferred stock within the meaning of
paragraph (b)(1)(vii) of this section. A purchased the Class A Stock
for $90 per share, representing a $10 discount ($100 June 1, 2012,
per share redemption price less $90 acquisition cost). Because this
$10 discount, which constitutes preferred discount within the
meaning of paragraph (b)(2)(i) of this section, is less than $14 (1
percent of the redemption price multiplied by 14 (the number of
complete years until the mandatory redemption date)), the Class A
Stock acquired by A satisfies the conditions of paragraph (b)(2)(i)
of this section and therefore constitutes qualified preferred
shares.
Example 2--(i) Facts. The facts are the same as in Example 1,
except that A acquires the 100 shares of Class A Stock for $8000.
(ii) Analysis. In this case, A purchased the Class A Stock for
$80 per share, representing a $20 discount ($100 June 1, 2012,
redemption price less $80 acquisition cost). Because this $20 of
preferred discount is greater than $14 (1 percent of the redemption
price multiplied by 14 (the number of complete years until the
mandatory redemption date)), the Class A Stock fails to satisfy the
conditions of paragraph (b)(2)(i) of this section and therefore
fails to qualify as qualified preferred shares.
(c) Who may make the election--(1) In general. A U.S. person that
acquires qualified preferred shares for cash or in a nonrecognition
transaction described in Sec. 1.1291-6(a) \4\ (nonrecognition
transaction) and that holds such shares directly may make a special
preferred QEF election, provided that, in the case of shares acquired
in a nonrecognition transaction, either the qualified preferred shares
are treated as stock of a pedigreed QEF, as defined in Sec. 1.1291-
1(b)(2)(ii), immediately prior to the nonrecognition transaction, or
the gain, if any, realized on the transaction would be recognized under
Sec. 1.1291- 6(b) with respect to the nonrecognition transaction. A
special preferred QEF election will not apply to any shares with
respect to which the electing shareholder is an indirect shareholder,
within the meaning of Sec. 1.1291-1(b)(8). Solely for purposes of this
section, partnerships, S corporations, trusts and estates (pass-through
entities) that directly own qualified preferred shares are treated as
shareholders that may make a special preferred QEF election. A
shareholder may not make a special preferred QEF election if at any
time the shareholder made a section 1295 election (other than a special
preferred QEF election) with respect to the foreign corporation. A
shareholder may not
[[Page 67759]]
make a special preferred QEF election unless the shareholder satisfies
the stock ownership requirements set forth in paragraph (c)(2) of this
section, and the shareholder receives from the foreign corporation the
statement described in paragraph (c)(3) of this section.
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\4\ This proposed regulation was published on April 1, 1992, at
57 FR 11024.
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(2) Ownership requirement. A holder of qualified preferred shares
of a foreign corporation may make a special preferred QEF election only
if, at all times during the taxable year of the shareholder, the
shareholder does not own, directly, indirectly, or constructively,
within the meaning of section 958, five percent or more of the vote or
value of any class of stock of the foreign corporation. The five
percent vote or value limitation must be satisfied for each taxable
year of the shareholder during which the shareholder continues to hold
shares subject to the special preferred QEF election.
(3) Statement from corporation. A shareholder may make the special
preferred QEF election only if the foreign corporation has provided a
written statement relating to the taxable year of the corporation that
ends with or within the taxable year of the shareholder for which the
election is made certifying either that the foreign corporation is, or
that it reasonably believes that it is, a PFIC, and that it is not a
controlled foreign corporation within the meaning of section 957(a) for
such taxable year of the corporation. The statement must be provided
directly to the electing shareholder or in a disclosure or other
document generally available to all U.S. holders. Electing shareholders
must retain a copy of the statement for their records.
(d) Effect of election--(1) In general. Unless terminated or
invalidated pursuant to paragraph (g) of this section, shares subject
to a special preferred QEF election will be treated as shares of a
pedigreed QEF (as defined in Sec. 1.1291-1(b)(2)(ii)) for all taxable
years of the foreign corporation that are included wholly or partly in
the shareholder's holding period of the shares. A special preferred QEF
election applies to all qualified preferred shares owned directly by
the shareholder that are acquired in the taxable year of the election.
Separate special preferred QEF elections may be made for qualified
preferred shares acquired in other taxable years of the taxpayer. A
special preferred QEF election is personal to the shareholder that made
the election and does not apply to a transferee of the shares. A
shareholder that has made a special preferred QEF election may not
make, with respect to the foreign corporation, any other election
permitted under sections 1291 through 1297 and the regulations under
those sections, including a section 1295 election as described in
Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535 (see
Sec. 601.601(d)(2)(ii)(b) of this chapter), for any period during which
the special preferred QEF election remains in effect with respect to
any shares of the shareholder.
(2) Continued PFIC Characterization. By making the special
preferred QEF election, the shareholder agrees to treat the foreign
corporation as a PFIC with respect to qualified preferred shares
subject to the election at all times during its holding period for such
shares, without regard to whether the foreign corporation is a PFIC for
any taxable year of the foreign corporation during which the preferred
QEF election remains in effect.
(3) Section 1293 inclusions. For each taxable year of the
shareholder to which an election under this section applies, the
shareholder must include in income the preferred QEF amount, as defined
in Sec. 1.1293-2, in the manner and under the rules provided in that
section.
(e) Time for and manner of making the special preferred QEF
election--(1) Time for making the election. A special preferred QEF
election must be made on or before the due date, as extended, for
filing the shareholder's return for the taxable year during which the
shareholder acquired the qualified preferred shares for which the
election is being made. A special preferred QEF election may not be
made for those shares at any other time pursuant to any other provision
of the Code or regulations.
(2) Manner of making the election--(i) In general. A shareholder
makes the special preferred QEF election under this section for all
qualified preferred shares of a foreign corporation acquired during the
shareholder's taxable year by checking the appropriate box in Form 8621
(Return by a Shareholder of a Passive Foreign Investment Company or
Qualified Electing Fund), Part I, for making the section 1295 election,
and indicating in the margin of Part I that the shareholder is making a
special preferred QEF election with respect to certain specified
shares. The shareholder also must report the preferred QEF amount for
the taxable year of the election on Line 6a of Part II of Form 8621. In
addition, the shareholder must attach to Form 8621 the statement
(preferred QEF statement) described in paragraph (e)(2)(ii) of this
section, signed by the shareholder under penalties of perjury, stating
that the information and representations provided in the preferred QEF
statement are true, correct, and complete to the best of the
shareholder's knowledge and belief.
(ii) Preferred QEF statement contents. The preferred QEF statement
must include the following information and representations:
(A) The first taxable year of the shareholder for which the special
preferred QEF election is made;
(B) The number of shares subject to the election, their acquisition
date(s) and acquisition price(s), and the class designation(s) of the
shares;
(C) A representation by the shareholder that it did not at any time
during its taxable year own directly, indirectly, or constructively,
within the meaning of section 958, five percent or more of the vote or
value of any class of stock of the foreign corporation with respect to
which the election applies;
(D) A representation by the shareholder that it has obtained the
written statement described in paragraph (c)(3) of this section; and
(E) A representation by the shareholder that it has never made a
section 1295 election other than a special preferred QEF election with
respect to the foreign corporation.
(f) Annual reporting requirement. For each taxable year of a
shareholder during which the shareholder holds shares of a foreign
corporation subject to one or more special preferred QEF elections, the
shareholder must file Form 8621 with respect to the foreign corporation
regardless of whether the foreign corporation is or is not a PFIC under
section 1296 during any portion of the taxable year. The shareholder
must indicate in the margin of Part I of Form 8621 the number of
special preferred QEF elections of the shareholder that remain in
effect with respect to the foreign corporation. In addition, the
shareholder must report, on Line 6a of Part II of Form 8621, the
aggregate of the preferred QEF amounts for all relevant special
preferred QEF elections in effect for the taxable year.
(g) Termination or invalidation of election--(1) In general. A
sale, exchange or other disposition of a share that is subject to a
special preferred QEF election will terminate the special preferred QEF
election with respect to that share. In addition, the Commissioner may,
in the Commissioner's discretion, terminate or invalidate a special
preferred QEF election if a shareholder that made the election fails to
satisfy the initial or ongoing requirements of the election. Once made,
a special preferred QEF election may not be terminated or invalidated
by the shareholder.
[[Page 67760]]
(2) Effect of termination or invalidation. Termination of a special
preferred QEF election by the Commissioner will be effective on the
first day of the shareholder's first taxable year following the last
taxable year of the shareholder for which the requirements of the
election are satisfied. For purposes of sections 1291 through 1297 and
the regulations thereunder, the holding period of qualified preferred
shares subject to an election that has been terminated will be treated
as beginning on the effective date of the termination. A shareholder
that has made an election that is invalidated by the Commissioner will
be treated for purposes of sections 1291 through 1297 and the
regulations thereunder as if the shareholder never made the election.
(h) Effective date. An election under this section may only be made
with respect to qualified preferred shares that are issued after the
date that is 30 days after the date of publication of this document as
a final regulation.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-32247 Filed 12-23-96; 8:45 am]
BILLING CODE 4830-01-U
