[Federal Register Volume 63, Number 113 (Friday, June 12, 1998)]
[Proposed Rules]
[Pages 32164-32166]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-15452]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-106031-98]
RIN 1545-AW13
Trading Safe Harbors
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 rules for the treatment of
foreign taxpayers trading in derivative financial instruments for their
own account. These proposed rules provide that foreign taxpayers who
effect transactions in derivative financial instruments for their own
accounts are not thereby engaged in a trade or business in the United
States if they are not dealers in stocks, securities, commodities or
derivatives. These proposed rules affect foreign persons that conduct
such trading for their own account either directly through U.S. offices
or indirectly through partnerships or other agents. This document also
provides notice of a public hearing on these proposed regulations.
DATES: Written comments must be received by September 10, 1998.
Outlines of oral comments to be discussed at the public hearing
scheduled for September 9, 1998, must be received by August 19, 1998.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-106031-98), 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-106031-98), 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 2615, Internal
Revenue Building, 1111 Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Milton Cahn of the Office of Associate
Chief Counsel (International), (202) 622-3870; concerning submissions
and the hearing, LaNita Van Dyke, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 864(b) of the Code provides that the phrase ``trade or
business within the United States'' generally includes the performance
of personal services within the United States at any time during the
taxable year but, under certain circumstances, does not include trading
in stocks, securities, or commodities through an independent agent or
for a taxpayer's own account (the ``trading safe harbors'').
Regulations regarding certain aspects of the trading safe harbors
were promulgated in 1972. Since the promulgation of these regulations,
the use of derivative financial instruments has increased
significantly. This is due in large measure to the overall expansion
and growing sophistication of global capital markets. Although guidance
concerning the tax treatment of derivatives and notional principal
contracts has been issued under other provisions of the Code (see,
e.g., Secs. 1.446-3, 1.863-7(b)), the section 864(b) regulations have
not been modernized to take into account the manner in which taxpayers
customarily use derivative transactions.
Explanation of Provisions
1. In General
These proposed regulations provide that foreign taxpayers who are
not dealers with respect to any derivative transactions, who are not
otherwise dealers in stocks, securities, or commodities, and who enter
into derivative transactions for their own
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accounts are not engaged in trade or business within the United States
solely by reason of those transactions. The term ``derivative'' is
defined as an interest rate, currency, equity or commodity notional
principal contract or an evidence of an interest in, or derivative
financial instrument in, any commodity, currency, or any of the items
described in Code section 475(c)(2)(A)-(D).
For purposes of these proposed regulations, the term ``currency''
is limited to those currencies that are of a kind customarily dealt in
on an organized commodity exchange. No inference is intended, however,
as to whether currencies that are not traded on an organized commodity
exchange are ``of a kind'' customarily dealt in on an organized
commodity exchange. Comments are solicited on this issue.
Under the statutory safe harbors, taxpayers who are dealers in
stocks and securities but not commodities may avail themselves of the
commodities trading safe harbor of section 864(b)(2)(B)(ii), and
likewise, dealers in commodities but not stocks and securities may
avail themselves of the stocks and securities trading safe harbor of
section 864(b)(2)(A)(ii). The proposed regulations, however, do not
specify into which statutory safe harbor any particular derivative
transaction falls. Accordingly, dealers in stocks, securities,
commodities, or derivatives may not avail themselves of the benefits of
these proposed regulations.
Treasury and the IRS are considering the appropriate application of
both the stocks and securities safe harbor of section 864(b)(2)(A)(ii)
and the commodities safe harbor of section 864(b)(2)(B)(ii) with
respect to a dealer in a derivative which arguably might be classified
as both a security and a commodity. Treasury and the IRS are also
considering the appropriate application of the section 864(b)(2)(A)(ii)
and (B)(ii) safe harbors to dealers in either stocks and securities or
commodities who enter into a derivative transaction which arguably
might be classified within both sections. Comments are solicited on
these points including the classification of specific derivatives for
purposes of the safe harbors.
Comments are also solicited regarding whether the final regulations
should include derivative transactions in either the stocks and
securities, or commodities trading safe harbors under sections
864(b)(2)(A)(i) and (B)(i). In particular, the IRS solicits comments as
to whether certain dealers could inappropriately avoid the limitations
of section 864(b)(2)(C) with respect to derivative transactions
effected through independent agents in the United States.
2. Eligible Nondealer
Until Treasury and the IRS determine whether particular derivative
transactions should be classified under the stocks and securities or
commodities safe harbors, the proposed regulations provide that
derivative transactions (including hedging transactions) do not
constitute a U.S. trade or business if the taxpayer meets the newly
proposed definition of an ``eligible nondealer.''
An eligible nondealer is defined as a foreign resident taxpayer who
is not a dealer in stocks, securities, commodities or derivatives at
any time during the taxable year. Dealer status is determined on a
worldwide basis and disqualifies a taxpayer from the safe harbor of the
proposed regulations even if no dealing activities are conducted in the
United States. For example, if a taxpayer is a dealer in commodities
through its home country office and conducts no dealing activities
through its U.S. office, but enters into derivative transactions for
its own account through the U.S. office, the taxpayer fails to be an
eligible nondealer.
Under the proposed regulations, the definition of dealer in stocks
or securities refers to Sec. 1.864-2(c)(2)(iv) and the definition of
dealer in commodities refers to the use of that term in Sec. 1.864-
2(d). The definition of eligible nondealer contains language based on
the definition of dealer in securities in 475(c)(1)(B), including
regularly holding oneself out, in the ordinary course of one's trade or
business, as being willing and able to enter into either side of a
derivative transaction. See Sec. 1.475(c)-1(a)(2).
Treasury and the IRS are considering issuing additional guidance
with respect to the definition of a dealer for purposes of applying the
trading safe harbors generally. Comments are solicited regarding the
definition of a dealer, including the adequacy of the present rules in
Sec. 1.864-2(c)(2)(iv) and Sec. 1.864-2(d), possible rules for
identifying derivative transactions entered into with customers in the
``ordinary course,'' and the appropriateness of adopting a definition
similar to that provided in section 475(c)(1).
3. Swaps on U.S. Equities
Treasury and the IRS are aware that in order to avoid the tax
imposed on U.S. source dividends under sections 871 and 881 and Chapter
3 of the Code, some foreign investors use notional principal contract
transactions based on U.S. equities (``U.S. based equity swaps'').
Accordingly, Treasury and the IRS are considering whether rules should
be developed to preserve the withholding tax with respect to such
transactions. Specifically, Treasury and the IRS are evaluating whether
conduit (e.g., section 7701(l)) or other principles should be invoked
in regulations, to characterize payments made with respect to U.S.
based equity swaps as subject to U.S. withholding tax.
Treasury and the IRS are considering whether or not finalization of
the proposed regulations as they relate to U.S. based equity swaps
should await guidance concerning the application of the withholding
rules to such transactions. Broadening the section 864(b)(2)(A)(ii) and
(B)(ii) safe harbors to include derivatives could impair the ability of
the United States to tax U.S. source dividend payments.
Congress enacted the stocks and securities trading safe harbor in
1936 to provide certainty that foreign persons who merely trade stocks
and securities would not be subject to the net income tax regime.
Section 211(b), Revenue Act of 1936, Pub. L. 74-740, 49 Stat. 1648,
1714-15 (1936); S. Rep. No. 2156, 74th Cong., 2d Sess. 21 (1936).
Congress' decision to include the safe harbor was premised on the
fundamental assumption that ordinary income from U.S. stocks and
securities would be appropriately subject to U.S. taxation through the
withholding tax on fixed and determinable or annual and periodic income
(``FDAP''), and that activities beyond the scope of the safe harbor
would remain subject to net tax if the taxpayer was engaged in a trade
or business or had an office in the United States. Id. The Foreign
Investors Tax Act of 1966, which expanded the trading safe harbors to
include trading activities conducted by or on behalf of a non-U.S.
resident taxpayer through a U.S. office for the foreign taxpayer's own
account, built upon the same principles reflected in the Revenue Act of
1936. See Section 102(d), Foreign Investors Tax Act of 1966, Pub. L.
89-809, 80 Stat. 1539, 1544 (1966); S. Rep. No. 1701, 99th Cong., 2d
Sess. 16-17, 22-23, 32-33 (1966).
Treasury and the IRS request comments regarding the U.S. taxation
of non-U.S. persons investing in derivatives generally in addition to
the treatment of derivatives under the trading safe harbors. Comments
are also solicited concerning the appropriate source of payments made
pursuant to U.S. based equity swaps and whether conduit or other
principles should be invoked for purposes of sections 871, 881 and
Chapter 3 of the Code, including the circumstances under which such
payments between non-U.S.
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resident counterparties (i.e., foreign-to-foreign payments) may be
included in such regulations. In addition, comments are also solicited
concerning the appropriate treatment of swaps or other derivative
transactions on property (other than stocks and securities) that
produce FDAP income, e.g., rents and royalties.
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 impact analysis is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations, and because the
regulation does not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. 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 Code, this notice of proposed
rulemaking will be submitted to the Chief Counsel for Advocacy of the
Small Business Administration for comment on their 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 that are submitted
timely to the IRS (a signed original and eight (8) copies). All
comments will be available for public inspection and copying.
A public hearing has been scheduled for September 9, 1998, at 10:00
A.M., in room 2615, 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 September 10, 1998, and submit an outline of the topics to
be discussed and the time to be devoted to each topic by August 19,
1998.
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.
Proposed Effective Date
These regulations are proposed to be effective for taxable years
beginning 30 days after the date final regulations are published in the
Federal Register. Taxpayers may elect to apply the provisions of the
final regulations to taxable years beginning before the date which is
30 days after these regulations are published as final in the Federal
Register. No inference is intended regarding the treatment of
derivative transactions under sections 864(b)(2)(A)(ii) and (B)(ii) and
the current regulations. For periods prior to the effective date,
taxpayers engaged in derivative transactions may take any reasonable
position with regard to the section 864(b)(2)(A)(ii) and (B)(ii) safe
harbors. Positions consistent with these proposed regulations will be
considered reasonable.
Drafting Information
The principal author of these regulations is Milton Cahn 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 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.864(b)-1 is added to read as follows:
Sec. 1.864(b)-1 Trading in derivatives.
(a) Trading for taxpayer's own account. As used in part I (section
861 and following) and part II (section 871 and following), subchapter
N, chapter 1 of the Internal Revenue Code (Code), and chapter 3
(section 1441 and following) of the Code, and the regulations
thereunder, if a taxpayer is an eligible nondealer, the term engaged in
trade or business within the United States does not include effecting
transactions in derivatives for the taxpayer's own account, including
hedging transactions within the meaning of Sec. 1.1221-2.
(b) Definitions--(1) Eligible nondealer. For purposes of this
section, an eligible nondealer is a person that is not a resident of
the United States and is not, at any place (domestic or foreign), nor
at any time during that person's taxable year, any of the following--
(i) A dealer in stocks or securities as defined in Sec. 1.864-
2(c)(2)(iv)(a);
(ii) A dealer in commodities as that term is used in Sec. 1.864-
2(d); or
(iii) A person that regularly offers to enter into, assume, offset,
assign or otherwise terminate positions in derivatives with customers
in the ordinary course of a trade or business, including regularly
holding oneself out, in the ordinary course of one's trade or business,
as being willing and able to enter into either side of a derivative
transaction.
(2) Derivative. For purposes of this section, the term derivative
includes--
(i) An interest rate, currency (as defined in paragraph (b)(3) of
this section), equity, or commodity (as the term is used in section
864(b)(2)(B) and Sec. 1.864-2(d)) notional principal contract (as the
term is used in section 475(c)(2)); or
(ii) An evidence of an interest, or a derivative financial
instrument (including any option, forward contract, short position and
any similar financial instrument), in any--
(A) Commodity (as the term is used in section 864(b)(2)(B) and
Sec. 1.864-2(d));
(B) Currency (as defined in paragraph (b)(3) of this section);
(C) Share of stock (as the term is used in Sec. 1.864-2(c)(2));
(D) Partnership or beneficial ownership interest in a widely held
or publicly traded partnership or trust;
(E) Note, bond, debenture, or other evidence of indebtedness; or
(F) Notional principal contract described in paragraph (b)(2)(i) of
this section.
(3) Limitation. For purposes of this section, the term currency is
limited to currencies of a kind customarily dealt in on an organized
commodity exchange.
Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
[FR Doc. 98-15452 Filed 6-11-98; 8:45 am]
BILLING CODE 4830-01-P
