[Federal Register Volume 61, Number 120 (Thursday, June 20, 1996)]
[Proposed Rules]
[Pages 31474-31479]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-15666]
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DEPARTMENT OF THE TREASURY
26 CFR Part 1
[FI-32-95]
RIN 1545-AT94
Mark to Market for Dealers in Securities; Equity Interests in
Related Parties and the Dealer-Customer Relationship
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 that make mark-to-
market accounting inapplicable to most equity interests in related
entities. The regulations also relate to the definition of a dealer in
securities for certain federal income tax purposes. To qualify as a
dealer in securities, a taxpayer must engage in transactions with
customers. The proposed regulations concern the existence of dealer-
customer relationships. The Revenue Reconciliation Act of 1993 amended
the applicable tax law. These regulations provide guidance for
taxpayers that engage in securities transactions. This document also
provides notice of a public hearing on these proposed regulations.
DATES: Written comments and outlines of oral comments to be presented
at a public hearing scheduled for October 15, 1996, at 10 a.m., must be
received by September 18, 1996.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (FI-32-95), 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:R (FI-32-95), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC 20224. The public hearing will be held in the
Commissioner's Conference Room, room 3313, Internal Revenue Building,
1111 Constitution Avenue NW., Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jo Lynn L.
Ricks, (202) 622-3920, or Robert B. Williams, (202) 622-3960;
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 of 1995 (44
U.S.C. 3507).
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, T:FP, Washington, DC 20224.
Comments on the collection of information should be received by August
19, 1996.
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.
The collection of information is described in the Explanation of
Provisions section of the Preamble (rather than being included in the
text of the proposed regulations). The Preamble requests comments on
whether the final regulations should permit taxpayers to elect to
disregard certain inter-company transactions in determining status as a
dealer in securities. The preamble also indicates that, if the election
is allowed to be made, it is expected that taxpayers would make it by
attaching a statement to a tax return. If the final regulations allow
taxpayers to make this election in this manner, the information will be
required by the IRS to determine whether the election has been made,
and will be used for that purpose. The likely respondents will be
businesses that file consolidated tax returns. If taxpayers are allowed
to make the election, responses to this collection of information will
be required to obtain the benefit of having status as a dealer in
securities determined without regard to certain inter-company
transactions.
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.
Estimated total annual reporting burden: 6,000 hours. The estimated
annual burden per respondent varies from .25 hour to 1 hour, depending
on individual circumstances, with an estimated average of .5 hours.
Estimated number of respondents: 12,000. Estimated annual frequency of
responses: once in the existence of each respondent.
Background
This document contains proposed regulations under section 475 of
the Internal Revenue Code, which requires mark-to- market accounting
for certain dealers in securities. Section 475 was added by section
13223 of the Revenue Reconciliation Act of 1993, Pubic Law 103-66, 107
Stat. 481, and is effective for all taxable years ending on or after
December 31, 1993.
Temporary and proposed regulations published on December 29, 1993,
(58 FR 68798) provide that stock in a 50-percent-controlled subsidiary
(and interests in 50-percent-controlled partnerships and trusts) are
deemed properly identified as held for investment and thus are excluded
from mark-to-market accounting. The IRS is reproposing this rule with
two changes. First, the IRS has concluded that the rationale for the
rule applies equally to equity interests in most related persons and
not just to persons controlled by the taxpayer. Second, after
considering various comments received, the IRS determined that this
rule prohibiting marking a security to market should not apply if two
requirements are met: (1) The security is actively traded on a national
securities exchange or through an interdealer quotation system; and (2)
the taxpayer who marks owns less than 5 percent of all shares or
interests of the same class. Comments are requested as
[[Page 31475]]
to whether it is appropriate to allow any equity interests in related
parties to be marked to market, and, if so, whether the proposed
limitations are the most appropriate ones. The provisions in this
document concerning these issues are referred to below in this preamble
as the reproposed regulations.
When commenting on the temporary and proposed regulations,
taxpayers asked the IRS to provide guidance on whether certain
transactions are entered into with customers for purposes of section
475. Whether transactions are entered into with customers can affect
both whether a taxpayer is a dealer in securities subject to mark-to-
market accounting (see section 475(c)(1)) and whether a dealer may
exempt a security from mark- to-market treatment (see section 475(b)(1)
(A) and (B) and Sec. 1.475(b)-1T(a)).
In response to these comments, on January 4, 1995, the IRS
published proposed regulations [(FI-42-94) (60 FR 397)] stating that
whether a taxpayer is transacting business with customers is determined
based on all of the facts and circumstances (see proposed
Sec. 1.475(c)-1(c), reproposed as Sec. 1.475(c)-1(a)). These proposed
regulations also provide that 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) (see
proposed Sec. 1.475(c)-1(c)(2), reproposed as Sec. 1.475(c)-1(a)(2)).
On March 4, 1996, the IRS published Notice 96-12 (1996-10 I.R.B.
29), stating that the IRS intended to publish additional proposed
regulations concerning when transactions with related parties may be
transactions with customers for purposes of section 475. Notice 96-12
also described the substance of rules that the proposed regulations
were expected to contain. The rules were expected to be proposed to be
effective for taxable years beginning on or after February 20, 1996.
The proposed regulations in this document generally reflect the
substance that was described in Notice 96-12.
Explanation of Provisions
Prohibition Against Marking Equity Interests in Related Persons
The reproposed regulations identify certain assets that are
inherently investments and, thus, may not be marked to market under
section 475. The new rules retain the provision in the temporary
regulations that prevents marking certain insurance products to market,
but they differ from the temporary regulations in the provisions that
prevent the marking of certain equity interests. Under the temporary
regulations, the prohibition against marking applies only if the dealer
in securities controls the issuer of an equity interest (whether it is
stock in a corporation or an interest in a widely held or publicly
traded partnership or trust). The reproposed regulations expand the
scope of this treatment so that mark-to-market accounting cannot be
used for equity interests in many related issuers. (For these purposes,
the reproposed regulations incorporate by reference the relevant
relations described in sections 267(b) and 707(b)(1).) The reproposed
regulations also narrow the scope of this prohibition against marking
so that mark-to-market accounting can be used for certain actively-
traded securities, regardless of the dealer's relation to the issuer of
the security, if the dealer owns less than five percent of the
securities. The IRS is particularly interested in receiving comments on
the scope of the reproposed rules' exception to the general prohibition
on marking to market equity interests in a related person.
These reproposed regulations also contain rules to cover situations
where a security begins, or ceases, to be subject to this deemed-
identification rule. First, if a security is being marked to market and
then, as a result of a change in facts, the regulations prohibit the
security from continuing to be marked to market, the regulations
require that the security be marked as of the close of business on the
last day before the day when the prohibition on marking first applies.
Second, the reproposed regulations also cover situations in which
the regulations have prohibited a security from being marked to market
and then the prohibition on marking ceases to apply. In these cases,
the deadline for the taxpayer to identify the security under section
475(b)(2) as exempt from mark-to-market treatment is generally extended
until the date the prohibition on marking ceases to apply. (If the
taxpayer had identified the security by the original deadline, the
extension, of course, is irrelevant.) If the identification is not made
on or before the deadline (as so extended), new changes in value are
taken into account under the mark-to-market method, but recognition of
appreciation and depreciation that occurred while the security was not
being marked is suspended. This is the approach adopted by section
475(b)(3) for securities that lose their exemption from mark-to-market
treatment. The reproposed rule is to apply both when the prohibition on
marking ceases because of a change in facts and when the prohibition on
marking ceases because the rule covering certain actively-traded
securities becomes effective.
In sum, under the reproposed regulations, the following assets held
by a dealer in securities are deemed to be properly identified as held
for investment: (1) Stock in a corporation (or a partnership or
beneficial ownership interest in a widely held or publicly traded
partnership or trust) to which the taxpayer is related (other than
certain actively-traded stock or interests); and (2) an annuity,
endowment, or life insurance contract. The provision concerning the
second category of assets continues to be proposed to apply to all
taxable years ending on or after December 31, 1993. The rules
concerning the first category of assets, however, are proposed to
prohibit only those marks to market that would have occurred on or
after June 19, 1996. If the prohibition against marking begins to apply
to a security solely because of this effective date rule, then (unlike
the situation when the onset of the prohibition is caused by a change
in facts) the security is not marked to market immediately before the
prohibition begins.
In general, the provision allowing certain actively-traded
securities to be marked to market even when the issuer of the security
is related is proposed to be effective for marks to market on or after
June 19, 1996. Thus, this effective date is the same as the effective
date in the reproposed regulations for the general prohibition on
marking to market securities issued by a related person. Until the
reproposed regulations are finalized, however, all equity interests
issued by controlled entities continue to be subject to the temporary
regulations' prohibition against being marked to market, even if the
dealer owns less than 5 percent of interests of that class and even if
the interests are actively traded.
Some commenters suggested there should be no per se rule treating
certain securities as held for investment, but instead there should be
a rebuttable presumption to this effect for these items. Other
commenters proposed to add, or delete, a variety of items to or from
those deemed to be per se held for investment. The reproposed
regulations do not adopt these suggestions.
Consolidated Returns
Under both the temporary and the reproposed regulations, there are
situations in which the mark-to-market method may apply to a
consolidated
[[Page 31476]]
group member's stock held by another member of the group. This may
result in the recognition of duplicate gain or loss. For instance, if a
common parent marks to market stock in a subsidiary to reflect
increases in the value of the subsidiary stock owned by the parent
resulting from appreciation in the value of the subsidiary's assets,
the parent will recognize gain on that stock under the mark-to-market
method. The subsidiary's subsequent sale of the assets will replicate
that gain at the subsidiary level. The gains will generate duplicate
stock basis increases under section 475 and Sec. 1.1502-32(b), creating
the potential for an offsetting loss when the stock is subsequently
marked down to fair market value under section 475. Section 1.1502-20,
however, may disallow any such offsetting loss. Comments are invited
regarding how to address the anomalies these rules may produce.
The Dealer-Customer Relationship
These proposed regulations clarify that a taxpayer's transactions
with members of its consolidated group or other related persons may be
transactions with customers for purposes of section 475. Thus, a
taxpayer may be a dealer in securities for purposes of section 475 even
if its only customer transactions are transactions with members of its
consolidated group. In enacting section 475, Congress adopted a
taxpayer-by- taxpayer approach to determining dealer status, rather
than the single-entity approach embodied in Sec. 1.1502-13.
An example in the proposed regulations clarifies that, for purposes
of section 475, transactions do not fail to be transactions with
customers solely because the parties enter into them with other than
arms-length pricing terms. Under section 482 and the regulations
thereunder, however, the district director may make allocations between
or among the members of the group if he or she determines that a member
has not reported its true taxable income.
These proposed regulations generally reflect the substance of the
rules set forth in Notice 96-12 (1996-10 I.R.B. 29). In response to
taxpayer comments, however, certain language in Notice 96-12 has been
clarified. Because of these changes, although the rules described in
Notice 96-12 were expected to be proposed to be effective for taxable
years beginning on or after February 20, 1996, these proposed
regulations are to be effective for taxable years beginning on or after
June 20, 1996. If there are any situations in which the proposed rules
lead to a different result from that which would be reached under the
rules described in the notice, a taxpayer may reasonably and
consistently apply the rules described in the notice for any taxable
year beginning on or after February 20, 1996, and before June 20, 1996.
Under these regulations, a taxpayer may be a dealer in securities
based solely on transactions with other members of its consolidated
group. The IRS requests comments on whether certain consolidated groups
should be allowed to disregard inter-member transactions in determining
a member's status as a dealer in securities. For instance, a group
might be allowed to disregard inter-member transactions if the group,
considered as a single corporation, would not be a dealer in securities
for purposes of section 475. It is likely that the election, if
permitted by the final regulations, would be made by attaching an
appropriate statement to the taxpayer's return. (See the Paperwork
Reduction Act section of this preamble, which requests comments on the
burden that might be imposed by this requirement.) The IRS hereby
requests comments on the desirability and potential terms and
conditions of any such election. Comments could also address whether
such an election should apply in determining whether a taxpayer had
made more than negligible sales for purposes of reproposed
Sec. 1.475(c)-1(c). Further, the IRS requests comments on whether the
election should be available only to groups that have not made a
separate-entity election under Sec. 1.1221-2(d)(2).
Miscellaneous
Some of the 1993 and 1995 proposed regulations are reordered.
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 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 October 15, 1996, at 10
a.m. in the Commissioner's Conference Room, room 3313, 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 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 September 18, 1996.
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 Jo Lynn L. Ricks and
Robert B. Williams, 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, as proposed on
January 4, 1995, at 60 FR 401, is further amended by revising the
entries for ``Section 1.475(b)-1'', ``Section 1.475(b)-2'', and
``Section 1.475(b)-4'' to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.475(b)-1 also issued under 26 U.S.C. 475(a) and 26
U.S.C. 475(e).
Section 1.475(b)-2 also issued under 26 U.S.C. 475(b)(2) and 26
U.S.C. 475(e). * * *
Section 1.475(b)-4 also issued under 26 U.S.C. 475(b)(2), 26
U.S.C. 475(e), and 26 U.S.C. 6001. * * *
Par. 2. Section 1.475-0, as proposed on January 4, 1995 (60 FR
401), is amended by:
[[Page 31477]]
1. Revising the heading and entries for Secs. 1.475(b)-1, 1.475(b)-
2, and 1.475(b)-4.
2. Revising the entries under Secs. 1.475(c)-1 and 1.475(c)-2.
3. Removing the entries under Sec. 1.475(e)-1.
The revisions read as follows:
Sec. 1.475-0 Table of contents.
* * * * *
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) Relationships.
(i) General rule.
(ii) Attribution.
(iii) Trusts treated as partnerships.
(3) Securities traded on certain established financial markets.
(4) Changes in status.
(i) Onset of prohibition against marking.
(ii) Termination of prohibition against marking.
(iii) Examples.
(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.
(d) Special rules.
(1) Stock, partnership, and beneficial ownership interests in
certain controlled corporations, partnerships, and trusts.
(i) In general.
(ii) Control defined.
(iii) Applicability.
(2) [Reserved].
Sec. 1.475(b)-2 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(b)-4 Exemptions--Transitional issues.
(a) Transitional identification.
(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(c)-1 Definitions--Dealer in securities.
(a) Dealer-customer relationship.
(1) [Reserved].
(2) Transactions described in section 475(c)(1)(B).
(i) In general.
(ii) Examples.
(3) Related parties.
(i) In general.
(ii) Example.
(b) Sellers of nonfinancial goods and services.
(c) 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.
(d) Issuance of life insurance products.
Sec. 1.475(c)-2 Definitions--Security.
(a) In general.
(b) Synthetic debt held by a taxpayer as a result of an
integrated transaction under Sec. 1.1275-6.
(c) Negative value REMIC residuals.
(d) Special rules.
* * * * *
Sec. 1.475(e)-1 Effective dates.
Par. 3. Section 1.475(b)-1 as proposed on December 29, 1993 (58 FR
68798), is amended by revising paragraph (b) and adding paragraph (d)
to read as follows:
Sec. 1.475(b)-1 Scope of exemptions from mark-to-market requirement.
* * * * *
(b) Securities deemed identified as held for investment--(1) In
general. The following items held by a dealer in securities are per se
held for investment within the meaning of section 475(b)(1)(A) and are
deemed to be properly identified as such for purposes of section
475(b)(2)--
(i) Except as provided in paragraph (b)(3) of this section, stock
in a corporation, or a partnership or beneficial ownership interest in
a widely held or publicly traded partnership or trust, to which the
taxpayer has a relationship specified in paragraph (b)(2) of this
section; or
(ii) A contract that is treated for federal income tax purposes as
an annuity, endowment, or life insurance contract (see sections 817 and
7702).
(2) Relationships--(i) General rule. The relationships specified in
this paragraph (b)(2) are--
(A) those described in section 267(b)(2), (3), (10), (11), or (12);
or
(B) those described in section 707(b)(1) (A) or (B).
(ii) Attribution. The relationships described in paragraph
(b)(2)(i) of this section are determined taking into account sections
267(c) and 707(b)(3), as appropriate.
(iii) Trusts treated as partnerships. For purposes of this
paragraph (b)(2), the phrase partnership or trust is substituted for
the word partnership in sections 707(b)(1) and 707(b)(3), and a
reference to beneficial ownership interest is added to each reference
to capital interest or profits interest in those sections.
(3) Securities traded on certain established financial markets.
Paragraph (b)(1)(i) of this section does not apply to a security if--
(i) The security is actively traded within the meaning of
Sec. 1.1092(d)-1(a) taking into account only established financial
markets identified in Sec. 1.1092(d)-1(b)(1) (i) or (ii) (describing
national securities exchanges and interdealer quotation systems), and
(ii) The taxpayer owns less than 5 percent of all of the shares or
interests in the same class.
(4) Changes in status--(i) Onset of prohibition against marking--
(A) Once a security begins to be described in paragraph (b)(1) of this
section and for so long as it continues to be so described, section
475(a) does not apply to the security in the hands of the taxpayer.
(B) If a security has not been timely identified under section
475(b)(2) and, after the last day on which such an identification would
have been timely, the security begins to be described in paragraph
(b)(1) of this section, then the dealer must recognize gain or loss on
the security as if it were sold for its fair market value as of the
close of business of the last day before the security begins to be
described in paragraph (b)(1) of this section, and gain or loss is
taken into account at that time.
(ii) Termination of prohibition against marking. If a taxpayer did
not timely identify a security under section 475(b)(2) and paragraph
(b)(1) of this section applies to the security on the last day on which
such an identification would have been timely but it thereafter ceases
to apply--
(A) An identification of the security under section 475(b)(2) is
timely if made on or before the close of the day paragraph (b)(1) of
this section ceases to apply; and
(B) Unless the taxpayer timely identifies the security under
section 475(b)(2) (taking into account the additional time for
identification that is provided by paragraph (b)(4)(ii)(A) of this
section), section 475(a) applies to changes in value of the security
after the cessation in the same manner as under section 475(b)(3).
(iii) Examples. These examples illustrate this paragraph (b)(4):
[[Page 31478]]
Example 1. Onset of prohibition against marking--(A) Facts.
Corporation H owns 75 percent of the stock of corporation D, a
dealer in securities within the meaning of section 475(c)(1). On
December 1, 1995, D acquired less than half of the stock in
corporation X. D did not identify the stock for purposes of section
475(b)(2). On July 17, 1996, H acquired from other persons 70
percent of the stock of X. As a result, D and X became related
within the meaning of paragraph (b)(2)(i) of this section. The stock
of X is not described in paragraph (b)(3) of this section
(concerning securities traded on certain established financial
markets).
(B) Holding. Under paragraph (b)(4)(i) of this section, D
recognizes gain or loss on its X stock as if the stock were sold for
its fair market value at the close of business on July 16, 1996, and
the gain or loss is taken into account at that time. As with any
application of section 475(a), proper adjustment is made in the
amount of any gain or loss subsequently realized. After July 16,
1996, section 475(a) does not apply to D's X stock while D and X
continue to be related to each other.
Example 2. Termination of prohibition against marking; retained
securities identified as held for investment--(A) Facts. On July 1,
1996, corporation H owned 60 percent of the stock of corporation Y
and all of the stock of corporation D, a dealer in securities within
the meaning of section 475(c)(1). Thus, D and Y are related within
the meaning of paragraph (b)(2)(i) of this section. Also on July 1,
1996, D acquired, as an investment, 10 percent of the stock of Y.
The stock of Y is not described in paragraph (b)(3) of this section
(concerning securities traded on certain established financial
markets). When D acquired its shares of Y stock, it did not identify
them for purposes of section 475(b)(2). On December 27, 1996, D
identified its shares of Y stock as held for investment under
section 475(b)(2). On December 30, 1996, H sold all of its shares of
stock in Y to an unrelated party. As a result, D and Y cease to be
related within the meaning of paragraph (b)(2)(i) of this section.
(B) Holding. Under paragraph (b)(4)(ii)(A) of this section,
identification of the Y shares is timely if done on or before the
close of December 30, 1996. Because D timely identified its Y shares
under section 475(b)(2), it continues to refrain from marking to
market its Y stock after December 30, 1996.
Example 3. Termination of prohibition against marking; retained
securities not identified as held for investment--(A) Facts. The
facts are the same as in Example 2 above, except that D did not
identify its stock in Y for purposes of section 475(b)(2) on or
before December 30, 1996. Thus, D did not timely identify these
securities under section 475(b)(2) (taking into account the
additional time for identification provided in paragraph
(b)(4)(ii)(A) of this section).
(B) Holding. Under paragraph (b)(4)(ii)(B) of this section,
section 475(a) applies to changes in value of D's Y stock after
December 30, 1996, in the same manner as under section 475(b)(3).
Thus, any appreciation or depreciation that occurred while the
securities were prohibited from being marked to market is suspended.
Further, section 475(a) applies only to those changes occurring
after December 30, 1996.
* * * * *
(d) Special rules--(1) Stock, partnership, and beneficial ownership
interests in certain controlled corporations, partnerships, and
trusts--(i) In general. The following items held by a dealer in
securities are per se held for investment within the meaning of section
475(b)(1)(A) and are deemed to be properly identified as such for
purposes of section 475(b)(2)--
(A) Stock in a corporation that the taxpayer controls (within the
meaning of paragraph (d)(1)(ii) of this section); or
(B) A partnership or beneficial ownership interest in a widely held
or publicly traded partnership or trust that the taxpayer controls
(within the meaning of paragraph (d)(1)(ii) of this section).
(ii) Control defined. Control means the ownership, directly or
indirectly through persons described in section 267(b) (taking into
account section 267(c)), of--
(A) 50 percent or more of the total combined voting power of all
classes of stock entitled to vote; or
(B) 50 percent or more of the capital interest, the profits
interest, or the beneficial ownership interest in the widely held or
publicly traded partnership or trust.
(iii) Applicability. The rules of this paragraph (d)(1) apply only
before the date 30 days after final regulations on this subject are
published in the Federal Register.
(2) [Reserved].
Sec. 1.475 [Amended]
Par. 4. Section 1.475(b)-2, as proposed on December 29, 1993 (58 FR
68798), is redesignated as Sec. 1.475(b)-4.
Par. 5. Section 1.475(b)-4, as proposed on January 4, 1995 (60 FR
404), is redesignated as Sec. 1.475(b)-2.
Par. 6. Section 1.475(c)-1, as proposed on December 29, 1993 (58 FR
68798), and amended on January 4, 1995 (60 FR 405), is amended as
follows:
1. Paragraph (c) is removed.
2. Paragraphs (a) and (b) are redesignated as paragraphs (b) and
(c), respectively.
2. New paragraph (a) is added to read as follows:
Sec. 1.475(c)-1 Definitions--Dealer in securities.
(a) 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)--(i) In general.
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).
(ii) Examples. The following examples illustrate the rules of this
paragraph (a)(2). In the following examples, B is a bank:
Example 1. B regularly offers to enter into interest rate swaps
with other persons in the ordinary course of its trade or business.
B is willing to enter into interest rate swaps under which it either
pays a fixed interest rate and receives a floating rate or pays a
floating rate and receives a fixed rate. B is a dealer in securities
under section 475(c)(1)(B), and the counterparties are its
customers.
Example 2. B, in the ordinary course of its trade or business,
regularly holds itself out as being willing and able to enter into
either side of positions in a foreign currency with other banks in
the interbank market. B's activities in the foreign currency make it
a dealer in securities under section 475(c)(1)(B), and the other
banks in the interbank market are its customers.
Example 3. B engages in frequent transactions in a foreign
currency in the interbank market. Unlike the facts in Example 2,
however, B does not regularly hold itself out as being willing and
able to enter into either side of positions in the foreign currency,
and all of B's transactions are driven by its internal need to
adjust its position in the currency. No other circumstances are
present to suggest that B is a dealer in securities for purposes of
section 475(c)(1)(B). B's activity in the foreign currency does not
qualify it as a dealer in securities for purposes of section
475(c)(1)(B), and its transactions in the interbank market are not
transactions with customers.
(3) Related parties--(i) In general. A taxpayer's transactions with
members of its consolidated group or with other related persons may be
transactions with customers for purposes of section 475. For example,
transactions enumerated in section 475(c)(1)(B) between members of a
consolidated group are transactions with customers if, in the ordinary
course of its business, the taxpayer holds itself out as being willing
and able to engage in these transactions on a regular basis. A taxpayer
may be a dealer in securities within the meaning of section 475(c)(1)
even if its only customer transactions are transactions with other
members of its consolidated group.
(ii) Example. The following example illustrates this paragraph
(a)(3):
Example. Risk management transactions--(1) Facts. HC, a hedging
center, provides
[[Page 31479]]
interest rate hedges to all of the members of its consolidated
group. Because of the efficiencies created by having a centralized
risk manager, group policy prohibits members other than HC from
entering into derivative interest rate positions with outside
parties. HC regularly holds itself out as being willing and able to,
and in fact does, enter into either side of interest rate swaps with
its fellow members. HC periodically computes its aggregate position
and hedges the net risk with an unrelated party. HC does not
otherwise enter into interest rate positions with persons that are
not members of the consolidated group. Because HC attempts to
operate at cost and the terms of its swaps do not factor in any risk
of default by the affiliate, HC's affiliates receive somewhat more
favorable terms then they would receive from an unrelated swaps
dealer.
(2) Holding. Because HC regularly holds itself out as being
willing and able to enter into transactions enumerated in section
475(c)(1)(B), HC is a dealer in securities for purposes of section
475(c)(1)(B) and the other members are its customers.
* * * * *
Sec. 1.475 [Amended]
Par. 7. Section 1.475(c)-2, as proposed on December 29, 1993 (58 FR
68798), and amended on January 4, 1995 (60 FR 405), is amended as
follows:
1. Paragraphs (b), (c), and (d) are redesignated as paragraphs (c),
(d), and (b), respectively.
2. Paragraph (a) and newly designated paragraph (c) are revised by
removing the phrase ``paragraph (b)'' each place it appears and
replacing it with ``paragraph (c)'' each place it appeared.
3. Newly designated paragraph (d) is revised by removing the phrase
``paragraphs (a)(3) and (b)'' and replacing it with ``paragraphs (a)(3)
and (c)''. Newly designated paragraph (d) is further revised by
removing the phrase ``this paragraph (c)(1)).'' and replacing it with
the phrase ``this paragraph (d)(1)).''.
4. Newly designated paragraph (b) is revised by removing the words
``See Sec. 1.475(b)-4(c)'' and replacing them with the words ``See
Sec. 1.475(b)-2(c)''.
Par. 8. Section 1.475(e)-1, as proposed on December 29, 1993 (58 FR
68798), and amended on January 4, 1995 (60 FR 405), is revised to read
as follows:
Sec. 1.475(e)-1 Effective dates.
(a) Section 1.475(a)-1 (concerning mark-to-market for debt
instruments) applies to taxable years beginning on or after January 1,
1995.
(b) Section 1.475(a)-2 (concerning marking a security to market
upon disposition) applies to dispositions or terminations of ownership
occurring on or after January 4, 1995.
(c) Section 1.475(a)-3 (concerning acquisition by a dealer of a
security with a substituted basis) applies to securities acquired,
originated, or entered into on or after January 4, 1995.
(d) Section 1.475(b)-1 (concerning the scope of exemptions from the
mark-to-market requirement) applies as follows:
(1) Section 1.475(b)-1(a) (concerning securities held for
investment or not held for sale) applies to taxable years ending on or
after December 31, 1993.
(2) Except as provided elsewhere in this paragraph (d)(2),
Sec. 1.475(b)-1(b)(1) (concerning securities deemed identified as held
for investment) applies to taxable years ending on or after December
31, 1993.
(i) Section 1.475(b)-1(b)(1)(i) (concerning equity interests issued
by a related person) applies on or after June 19, 1996. If, on June 18,
1996, a security is subject to mark-to-market accounting and, on June
19, 1996, Sec. 1.475(b)-1(b)(1) begins to apply to the security solely
because of the effective dates in this paragraph (d)(2) (rather than
because of a change in facts), then the rules of Sec. 1.475(b)-
1(b)(4)(i)(A) (concerning the prohibition against marking) apply, but
Sec. 1.475(b)-1(b)(4)(i)(B) (imposing a mark to market on the day
before the onset of the prohibition) does not apply.
(ii) Section 1.475(b)-1(b)(2) (concerning relevant relationships
for purposes of determining whether equity interests in related persons
are prohibited from being marked to market) applies on or after June
19, 1996.
(iii) Section 1.475(b)-1(b)(3) (concerning certain activelytraded
securities) generally applies on or after June 19, 1996 to securities
held on or after that date. In the case, however, of securities
described in Sec. 1.475(b)-1(d)(1)(i) (concerning equity interests
issued by controlled entities), Sec. 1.475(b)-1(b)(3) applies on or
after the date thirty days after final regulations on this subject are
published in the Federal Register to securities held on or after that
date. If Sec. 1.475(b)-1(b)(1) ceases to apply to a security by virtue
of the operation of this paragraph (d)(2)(ii), the rules of
Sec. 1.475(b)-1(b)(4)(ii) apply to the cessation.
(iv) Except to the extent provided in paragraph (d)(2)(i) of this
section, Sec. 1.475(b)-1(b)(4) (concerning changes in status) applies
on or after June 19, 1996.
(e) Section 1.475(b)-2 (concerning the identification requirements
for obtaining an exemption from mark-to-market treatment) applies to
identifications made on or after January 4, 1995.
(f) Section 1.475(b)-3 (concerning exemption of securities in
certain securitization transactions) applies to securities acquired,
originated, or entered into on or after January 4, 1995.
(g) Section 1.475(b)-4 (concerning transitional issues relating to
exemptions) applies to taxable years ending on or after December 31,
1993.
(h) Section 1.475(c)-1(a) (concerning the dealer-customer
relationship), except for Sec. 1.475(c)-1(a)(1), (a)(2)(ii), and
(a)(3), applies to taxable years beginning on or after January 1, 1995.
Section 1.475(c)-1(a)(2)(ii) and (a)(3) (concerning certain aspects of
the dealer-customer relationship) apply to taxable years beginning on
or after June 20, 1996.
(i) Section 1.475(c)-1(b) (concerning sellers of nonfinancial goods
and services) and (c) (concerning taxpayers that purchase securities
but do not sell more than a negligible portion of the securities)
applies to taxable years ending on or after December 31, 1993.
(j) Section 1.475(c)-1(d) (concerning the issuance of life
insurance products) applies to taxable years beginning on or after
January 1, 1995.
(k) Section 1.475(c)-2 (concerning the definition of security)
applies to taxable years ending on or after December 31, 1993. Note,
however, that, by its terms, Sec. 1.475(c)-2(a)(3) applies only to
interests or arrangements that are acquired on or after January 4,
1995, and that the integrated transactions to which Sec. 1.475(c)-2(b)
applies will exist only after the effective date of Sec. 1.1275-6.
(l) Section 1.475(d)-1 (concerning the character of gain or loss)
applies to taxable years ending on or after December 31, 1993.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-15666 Filed 6-19-96; 8:45 am]
BILLING CODE 4830-01-P
