[Congressional Record Volume 141, Number 146 (Tuesday, September 19, 1995)]
[Senate]
[Pages S13859-S13865]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. MOYNIHAN:
  S. 1261. A bill to amend the Internal Revenue Code of 1986 to prevent 
the avoidance of tax through the use of foreign trusts; to the 
Committee on Finance.


             the use of foreign trusts to avoid u.s. taxes

  Mr. MOYNIHAN. Mr. President, I rise today to introduce legislation 
designed to stem the use of foreign trusts for the avoidance of U.S. 
taxes. The administration's fiscal year 1996 budget, which contained a 
series of proposals for change in the taxation of income from foreign 
trusts, called attention to this problem earlier this year. Since then, 
I have been committed to developing practical rules to dramatically 
improve tax compliance when foreign trusts are used, without unduly 
burdening legitimate financial transactions. The bill I introduce today 
represents a serious attempt to achieve that balance.
  It is difficult to estimate precisely the magnitude of tax avoidance 
occurring through the use of foreign trusts. But we have some 
disturbing evidence. Under current law, U.S. taxpayers are required to 
report the assets held in foreign trusts that they have established. 
But the IRS reports that only $1.5 billion of foreign trust assets were 
reported in 1993. The estimates of total U.S. source funds held abroad 
in tax haven jurisdictions are staggering by comparison, in the 
hundreds of billions.
  In 1989, the New York Times reported that financial institutions in 
the Cayman Islands, Luxembourg, and the Bahamas had $240 billion, $200 
billion, and $180 billion, respectively, on deposit from the United 
States. (New York Times, October 29, 1989, pg. 10.) More recently, 
Barron's estimated that a total of $440 billion was on deposit in the 
Cayman Islands in 1993, with 60 percent of that amount--$264 billion--
coming from the United States. (Barron's, January 4, 1993, pg. 14.) To 
put this in some perspective, Barron's calculated that there was more 
American money on deposit in the Cayman Islands than in all of the 
commercial banks in California. Although only a portion of U.S. funds 
abroad are held in foreign trusts, the Treasury Department estimates 
that tens of billions of dollars are held in offshore asset protection 
trusts established by U.S. persons.
  Undoubtedly motivations behind establishing offshore accounts vary, 
and tax advantages may pale in comparison to the ability to protect 
assets from U.S. tort or other liabilities. Whatever the initial 
motivation for moving assets offshore, however, it seems clear that a 
very large portion of the assets soon disappear insofar as U.S. tax 
reporting is concerned. The result is rampant tax avoidance. Because 
tax haven jurisdictions typically have bank secrecy laws, the IRS is 
effectively precluded from uncovering the information necessary to 
enforce our tax laws. Tax enforcement is almost entirely dependent upon 
voluntary reporting by taxpayers, and the evidence is clear that 
voluntary compliance in this area is lacking.
  Something must be done, and the intent behind this bill is to end the 
ease with which taxpayers can reduce their tax bills by legally or 
illegally taking advantage of existing foreign trust rules.
  Over the past several months I have received extensive comments from 
practitioners and academics concerning the administration's original 
foreign trust proposals and possible alternatives. These comments have 
been very useful. I would like to thank in particular the tax section 
of the New York State Bar Association for their detailed analysis. A 
tremendous amount of work went into their submission, prepared on 
request and within a very short period of time.
  The bill I introduce today is substantially revised from the original 
administration bill--S. 453--to reflect many of the comments received. 
It has been developed over the last few months in cooperation with my 
counterpart on the Ways and Means Committee, Congressman Gibbons, who 
has been unwavering in his efforts to improve tax compliance in the 
foreign area. I have also worked with the Treasury Department to 
develop rules that adequately address the needs for effective tax 
administration.
  There are a number of aspects to this legislation. The provisions 
designed to enable the IRS to obtain better information on foreign 
trusts are perhaps the most significant. The bill would substantially 
strengthen the current information reporting rules on transfers to, and 
annual operations of, foreign trusts. Among other changes, the bill 
includes new rules designed to lead most foreign trusts established by 
U.S. persons to appoint a U.S. agent that can provide trust information 
to the IRS. In addition, the recipients of monies from foreign trusts 
would be required to report amounts received. Penalties for failure to 
comply with reporting requirements would be raised so that they have 
genuine deterrent effect--as contrasted to the nominal penalties of 
current law.

  The bill would also close a number of loopholes in the existing 
grantor trust tax rules, a series of rules that specify when the 
existence of a trust will be ignored for tax purposes because the 
creator of the trust retains sufficient control over the assets 
transferred to be appropriately treated as continuing to own the 
assets. For example, a foreign person--generally not taxable in the 
United States--transferring assets to a trust for the benefit of U.S. 
persons generally would not be treated as the tax owner of the assets 
in the trust unless the trust was fully revocable. Instead, the U.S. 
beneficiary receiving income from the trust would be taxed on receipt 
of that income.
  The ability to manipulate other foreign trust rules also would be 
curbed. A U.S. beneficiary's use of property of a foreign trust would 
be treated as the receipt of a distribution from the trust, taxable to 
the beneficiary. In addition, a U.S. beneficiary receiving a 
distribution from a foreign trust's accumulated income would be charged 
a market rate of interest on taxes due--on a prospective basis--rather 
than the currently prescribed 6 percent simple interest.
  Finally, the bill includes rules to provide greater certainty as to 
the classification of a trust as foreign or domestic. Under current 
law, there is considerable uncertainty on this issue because the 
determination is based on all relevant facts.
  A more comprehensive description of the bill, and of the major 
differences between the legislation that I introduce today and the 
original administration proposal, has been prepared. I ask unanimous 
consent that this summary, together with the bill, be placed in the 
Record at the conclusion of my remarks.
  Mr. President, I believe this legislation represents a balanced 
approach to the problem of tax avoidance through the use of foreign 
trusts, and a significant improvement over the administration's initial 
legislative proposal. There should be an opportunity to act this year 
to end the use of foreign trusts to avoid U.S. taxes. I look forward to 
continuing this effort.
  Mr. President, I ask unanimous consent that the text of the bill and 
additional material be printed in the Record.
  There being no objection, the bill was ordereed to be printed in the 
Record, as follows:

                                S. 1261

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Foreign Trust Tax Compliance 
     Act of 1995''.

     SEC. 2. IMPROVED INFORMATION REPORTING ON FOREIGN TRUSTS.

       (a) In General.--Section 6048 of the Internal Revenue Code 
     of 1986 (relating to returns as to certain foreign trusts) is 
     amended to read as follows:

     ``SEC. 6048. INFORMATION WITH RESPECT TO CERTAIN FOREIGN 
                   TRUSTS.

       ``(a) Notice of Certain Events.--
       ``(1) General rule.--On or before the 90th day (or such 
     later day as the Secretary may prescribe) after any 
     reportable event, the responsible party shall provide written 
     notice of such event to the Secretary in accordance with 
     paragraph (2).
       ``(2) Contents of notice.--The notice required by paragraph 
     (1) shall contain such information as the Secretary may 
     prescribe, including--
       ``(A) the amount of money or other property (if any) 
     transferred to the trust in connection with the reportable 
     event, and

[[Page S13860]]

       ``(B) the identity of the trust and of each trustee and 
     beneficiary (or class of beneficiaries) of the trust.
       ``(3) Reportable event.--For purposes of this subsection--
       ``(A) In general.--The term `reportable event' means--
       ``(i) the creation of any foreign trust by a United States 
     person,
       ``(ii) the transfer of any money or property (directly or 
     indirectly) to a foreign trust by a United States person, 
     including a transfer by reason of death, and
       ``(iii) the death of a citizen or resident of the United 
     States if--

       ``(I) the decedent was treated as the owner of any portion 
     of a foreign trust under the rules of subpart E of part I of 
     subchapter J of chapter 1, or
       ``(II) any portion of a foreign trust was included in the 
     gross estate of the decedent.

       ``(B) Exceptions.--
       ``(i) Fair market value sales.--Subparagraph (A)(ii) shall 
     not apply to any transfer of property to a trust in exchange 
     for consideration of at least the fair market value of the 
     transferred property. For purposes of the preceding sentence, 
     consideration other than cash shall be taken into account at 
     its fair market value and the rules of section 679(a)(3) 
     shall apply.
       ``(ii) Pension and charitable trusts.--Subparagraph (A) 
     shall not apply with respect to a trust which is--

       ``(I) described in section 404(a)(4) or 404A, or
       ``(II) determined by the Secretary to be described in 
     section 501(c)(3).

       ``(4) Responsible party.--For purposes of this subsection, 
     the term `responsible party' means--
       ``(A) the grantor in the case of the creation of an inter 
     vivos trust,
       ``(B) the transferor in the case of a reportable event 
     described in paragraph (3)(A)(ii) other than a transfer by 
     reason of death, and
       ``(C) the executor of the decedent's estate in any other 
     case.
       ``(b) United States Grantor of Foreign Trust.--
       ``(1) In general.--If, at any time during any taxable year 
     of a United States person, such person is treated as the 
     owner of any portion of a foreign trust under the rules of 
     subpart E of part I of subchapter J of chapter 1, such person 
     shall be responsible to ensure that--
       ``(A) such trust makes a return for such year which sets 
     forth a full and complete accounting of all trust activities 
     and operations for the year, the name of the United States 
     agent for such trust, and such other information as the 
     Secretary may prescribe, and
       ``(B) such trust furnishes such information as the 
     Secretary may prescribe to each United States person (i) who 
     is treated as the owner of any portion of such trust or (ii) 
     who receives (directly or indirectly) any distribution from 
     the trust.
       ``(2) Trusts not having united states agent.--
       ``(A) In general.--If the rules of this subsection apply to 
     any foreign trust, the determination of amounts required to 
     be taken into account with respect to such trust by a United 
     States person under the rules of subpart E of part I of 
     subchapter J of chapter 1 shall be determined by the 
     Secretary in the Secretary's sole discretion from the 
     Secretary's own knowledge or from such information as the 
     Secretary may obtain through testimony or otherwise.
       ``(B) United states agent required.--The rules of this 
     subsection shall apply to any foreign trust to which 
     paragraph (1) applies unless such trust agrees (in such 
     manner, subject to such conditions, and at such time as the 
     Secretary shall prescribe) to authorize a United States 
     person to act as such trust's limited agent solely for 
     purposes of applying sections 7602, 7603, and 7604 with 
     respect to--
       ``(i) any request by the Secretary to examine records or 
     produce testimony related to the proper treatment of amounts 
     required to be taken into account under the rules referred to 
     in subparagraph (A), or
       ``(ii) any summons by the Secretary for such records or 
     testimony.
     The appearance of persons or production of records by reason 
     of a United States person being such an agent shall not 
     subject such persons or records to legal process for any 
     purpose other than determining the correct treatment under 
     this title of the amounts required to be taken into account 
     under the rules referred to in subparagraph (A). A foreign 
     trust which appoints an agent described in this subparagraph 
     shall not be considered to have an office or a permanent 
     establishment in the United States, or to be engaged in a 
     trade or business in the United States, solely because of the 
     activities of such agent pursuant to this subsection.
       ``(C) Other rules to apply.--Rules similar to the rules of 
     paragraphs (2) and (4) of section 6038A(e) shall apply for 
     purposes of this paragraph.
       ``(c) Reporting by United States Beneficiaries of Foreign 
     Trusts.--
       ``(1) In general.--If any United States person receives 
     (directly or indirectly) during any taxable year of such 
     person any distribution from a foreign trust, such person 
     shall make a return with respect to such trust for such year 
     which includes--
       ``(A) the name of such trust,
       ``(B) the aggregate amount of the distributions so received 
     from such trust during such taxable year, and
       ``(C) such other information as the Secretary may 
     prescribe.
       ``(2) Inclusion in income if records not provided.--If 
     adequate records are not provided to the Secretary to 
     determine the proper treatment of any distribution from a 
     foreign trust, such distribution shall be treated as an 
     accumulation distribution includible in the gross income of 
     the distributee under chapter 1. To the extent provided in 
     regulations, the preceding sentence shall not apply if the 
     foreign trust elects to be subject to rules similar to the 
     rules of subsection (b)(2)(B).
       ``(d) Special Rules.--
       ``(1) Determination of whether united states person 
     receives distribution.--For purposes of this section, in 
     determining whether a United States person receives a 
     distribution from a foreign trust, the fact that a portion of 
     such trust is treated as owned by another person under the 
     rules of subpart E of part I of subchapter J of chapter 1 
     shall be disregarded.
       ``(2) Domestic trusts with foreign activities.--To the 
     extent provided in regulations, a trust which is a United 
     States person shall be treated as a foreign trust for 
     purposes of this section and section 6677 if such trust has 
     substantial activities, or holds substantial property, 
     outside the United States.
       ``(3) Time and manner of filing information.--Any notice or 
     return required under this section shall be made at such time 
     and in such manner as the Secretary shall prescribe.
       ``(4) Modification of return requirements.--The Secretary 
     is authorized to suspend or modify any requirement of this 
     section if the Secretary determines that the United States 
     has no significant tax interest in obtaining the required 
     information.''
       (b) Increased Penalties.--Section 6677 of such Code 
     (relating to failure to file information returns with respect 
     to certain foreign trusts) is amended to read as follows:

     ``SEC. 6677. FAILURE TO FILE INFORMATION WITH RESPECT TO 
                   CERTAIN FOREIGN TRUSTS.

       ``(a) Civil Penalty.--In addition to any criminal penalty 
     provided by law, if any notice or return required to be filed 
     by section 6048--
       ``(1) is not filed on or before the time provided in such 
     section, or
       ``(2) does not include all the information required 
     pursuant to such section or includes incorrect information,
     the person required to file such notice or return shall pay a 
     penalty equal to 35 percent of the gross reportable amount. 
     If any failure described in the preceding sentence continues 
     for more than 90 days after the day on which the Secretary 
     mails notice of such failure to the person required to pay 
     such penalty, such person shall pay a penalty (in addition to 
     the amount determined under the preceding sentence) of 
     $10,000 for each 30-day period (or fraction thereof) during 
     which such failure continues after the expiration of such 90-
     day period.
       ``(b) Special Rules for Returns Under section 6048(b).--In 
     the case of a return required under section 6048(b)--
       ``(1) the United States person referred to in such section 
     shall be liable for the penalty imposed by subsection (a), 
     and
       ``(2) subsection (a) shall be applied by substituting `5 
     percent' for `35 percent'.
       ``(c) Gross Reportable Amount.--For purposes of subsection 
     (a), the term `gross reportable amount' means--
       ``(1) the gross value of the property involved in the event 
     (determined as of the date of the event) in the case of a 
     failure relating to section 6048(a),
       ``(2) the gross value of the portion of the trust's assets 
     at the close of the year treated as owned by the United 
     States person in the case of a failure relating to section 
     6048(b)(1), and
       ``(3) the gross amount of the distributions in the case of 
     a failure relating to section 6048(c).
       ``(d) Reasonable Cause Exception.--No penalty shall be 
     imposed by this section on any failure which is shown to be 
     due to reasonable cause and not due to willful neglect. The 
     fact that a foreign jurisdiction would impose a civil or 
     criminal penalty on the taxpayer (or any other person) for 
     disclosing the required information is not reasonable cause.
       ``(e) Deficiency Procedures Not To Apply.--Subchapter B of 
     chapter 63 (relating to deficiency procedures for income, 
     estate, gift, and certain excise taxes) shall not apply in 
     respect of the assessment or collection of any penalty 
     imposed by subsection (a).''
       (c) Conforming Amendments.--
       (1) Paragraph (2) of section 6724(d) of such Code is 
     amended by striking ``or'' at the end of subparagraph (S), by 
     striking the period at the end of subparagraph (T) and 
     inserting ``, or'', and by inserting after subparagraph (T) 
     the following new subparagraph:
       ``(U) section 6048(b)(1)(B) (relating to foreign trust 
     reporting requirements).''
       (2) The table of sections for subpart B of part III of 
     subchapter A of chapter 61 is of such Code amended by 
     striking the item relating to section 6048 and inserting the 
     following new item:
``Sec. 6048. Information with respect to certain foreign trusts.''
       (3) The table of sections for part I of subchapter B of 
     chapter 68 of such Code is amended by striking the item 
     relating to section 6677 and inserting the following new 
     item:
``Sec. 6677. Failure to file information with respect to certain 
              foreign trusts.''

[[Page S13861]]

       (d) Effective Dates.--
       (1) Reportable events.--To the extent related to subsection 
     (a) of section 6048 of the Internal Revenue Code of 1986, as 
     amended by this section, the amendments made by this section 
     shall apply to reportable events (as defined in such section 
     6048) occurring after the date of the enactment of this Act.
       (2) Grantor trust reporting.--To the extent related to 
     subsection (b) of such section 6048, the amendments made by 
     this section shall apply to taxable years of United States 
     persons beginning after the date of the enactment of this 
     Act.
       (3) Reporting by united states beneficiaries.--To the 
     extent related to subsection (c) of such section 6048, the 
     amendments made by this section shall apply to distributions 
     received after the date of the enactment of this Act.

     SEC. 3. MODIFICATIONS OF RULES RELATING TO FOREIGN TRUSTS 
                   HAVING ONE OR MORE UNITED STATES BENEFICIARIES.

       (a) Treatment of Trust Obligations, Etc.--
       (1) Paragraph (2) of section 679(a) of the Internal Revenue 
     Code of 1986 is amended by striking subparagraph (B) and 
     inserting the following:
       ``(B) Transfers at fair market value.--To any transfer of 
     property to a trust in exchange for consideration of at least 
     the fair market value of the transferred property. For 
     purposes of the preceding sentence, consideration other than 
     cash shall be taken into account at its fair market value.''
       (2) Subsection (a) of section 679 of such Code (relating to 
     foreign trusts having one or more United States 
     beneficiaries) is amended by adding at the end the following 
     new paragraph:
       ``(3) Certain obligations not taken into account under fair 
     market value exception.--
       ``(A) In general.--In determining whether paragraph (2)(B) 
     applies to any transfer by a person described in clause (ii) 
     or (iii) of subparagraph (C), there shall not be taken into 
     account--
       ``(i) any obligation of a person described in subparagraph 
     (C), and
       ``(ii) to the extent provided in regulations, any 
     obligation which is guaranteed by a person described in 
     subparagraph (C).
       ``(B) Treatment of principal payments on obligation.--
     Principal payments by the trust on any obligation referred to 
     in subparagraph (A) shall be taken into account on and after 
     the date of the payment in determining the portion of the 
     trust attributable to the property transferred.
       ``(C) Persons described.--The persons described in this 
     subparagraph are--
       ``(i) the trust,
       ``(ii) any grantor or beneficiary of the trust, and
       ``(iii) any person who is related (within the meaning of 
     section 643(i)(3)) to any grantor or beneficiary of the 
     trust.''
       (b) Exemption of Transfers to Charitable Trusts.--
     Subsection (a) of section 679 of such Code is amended by 
     striking ``section 404(a)(4) or 404A'' and inserting 
     ``section 6048(a)(3)(B)(ii)''.
       (c) Other Modifications.--Subsection (a) of section 679 of 
     such Code is amended by adding at the end the following new 
     paragraphs:
       ``(4) Special rules applicable to foreign grantor who later 
     becomes a united states person.--
       ``(A) In general.--If a nonresident alien individual has a 
     residency starting date within 5 years after directly or 
     indirectly transferring property to a foreign trust, this 
     section and section 6048 shall be applied as if such 
     individual transferred to such trust on the residency 
     starting date an amount equal to the portion of such trust 
     attributable to the property transferred by such individual 
     to such trust in such transfer.
       ``(B) Treatment of undistributed income.--For purposes of 
     this section, undistributed net income for periods before 
     such individual's residency starting date shall be taken into 
     account in determining the portion of the trust which is 
     attributable to property transferred by such individual to 
     such trust but shall not otherwise be taken into account.
       ``(C) Residency starting date.--For purposes of this 
     paragraph, an individual's residency starting date is the 
     residency starting date determined under section 
     7701(b)(2)(A).
       ``(5) Outbound trust migrations.--If--
       ``(A) an individual who is a citizen or resident of the 
     United States transferred property to a trust which was not a 
     foreign trust, and
       ``(B) such trust becomes a foreign trust while such 
     individual is alive,
     then this section and section 6048 shall be applied as if 
     such individual transferred to such trust on the date such 
     trust becomes a foreign trust an amount equal to the portion 
     of such trust attributable to the property previously 
     transferred by such individual to such trust. A rule similar 
     to the rule of paragraph (4)(B) shall apply for purposes of 
     this paragraph.''
       (d) Modifications Relating to Whether Trust Has United 
     States Beneficiaries.--Subsection (c) of section 679 of such 
     Code is amended by adding at the end the following new 
     paragraphs:
       ``(3) Certain united states beneficiaries disregarded.--A 
     beneficiary shall not be treated as a United States person in 
     applying this section with respect to any transfer of 
     property to foreign trust if such beneficiary first became a 
     United States person more than 5 years after the date of such 
     transfer.
       ``(4) Treatment of former united states persons.--To the 
     extent provided by the Secretary, for purposes of this 
     subsection, the term `United States person' includes any 
     person who was a United States person at any time during the 
     existence of the trust.''
       (e) Technical Amendment.--Subparagraph (A) of section 
     679(c)(2) is amended to read as follows:
       ``(A) in the case of a foreign corporation, such 
     corporation is a controlled foreign corporation (as defined 
     in section 957(a)),''.
       (f) Regulations.--Section 679 is amended by adding at the 
     end the following new subsection:
       ``(d) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary or appropriate to carry out 
     the purposes of this section.''
       (g) Effective Date.--The amendments made by this section 
     shall apply to transfers of property after February 6, 1995.

     SEC. 4. FOREIGN PERSONS NOT TO BE TREATED AS OWNERS UNDER 
                   GRANTOR TRUST RULES.

       (a) General Rule.--
       (1) Subsection (f) of section 672 of the Internal Revenue 
     Code of 1986 (relating to special rule where grantor is 
     foreign person) is amended to read as follows:
       ``(f) Subpart Not To Result in Foreign Ownership.--
       ``(1) In general.--Notwithstanding any other provision of 
     this subpart, this subpart shall apply only to the extent 
     such application results in an amount being currently taken 
     into account (directly or through 1 or more entities) under 
     this chapter in computing the income of a citizen or resident 
     of the United States or a domestic corporation.
       ``(2) Exceptions.--
       ``(A) Certain revocable and irrecovable trusts.--
       ``(i) In general.--Except as provided in clause (ii), 
     paragraph (1) shall not apply to any trust if--

       ``(I) the power to revest absolutely in the grantor title 
     to the trust property is exercisable solely by the grantor 
     without the approval or consent of any other person or with 
     the consent of a related or subordinate party who is 
     subservient to the grantor, or
       ``(II) the only amounts distributable from such trust 
     (whether income or corpus) during the lifetime of the grantor 
     are amounts distributable to the grantor or the spouse of the 
     grantor.

       ``(ii) Exception.--Clause (i) shall not apply to any trust 
     which has a beneficiary who is a United States person to the 
     extent such beneficiary has made transfers of property by 
     gift (directly or indirectly) to a foreign person who is the 
     grantor of such trust. For purposes of the preceding 
     sentence, any gift shall not be taken into account to the 
     extent such gift is excluded from taxable gifts under section 
     2503(b).
       ``(B) Compensatory trusts.--Except as provided in 
     regulations, paragraph (1) shall not apply to any portion of 
     a trust distributions from which are taxable as compensation 
     for services rendered.
       ``(3) Special rules.--Except as otherwise provided in 
     regulations prescribed by the Secretary--
       ``(A) a controlled foreign corporation (as defined in 
     section 957) shall be treated as a domestic corporation for 
     purposes of paragraph (1), and
       ``(B) paragraph (1) shall not apply for purposes of 
     applying part III of subchapter G (relating to foreign 
     personal holding companies) and part VI of subchapter P 
     (relating to treatment of certain passive foreign investment 
     companies).
       ``(4) Recharacterization of purported gifts.--In the case 
     of any transfer directly or indirectly from a partnership or 
     foreign corporation which the transferee treats as a gift or 
     bequest, the Secretary may recharacterize such transfer in 
     such circumstances as the Secretary determines to be 
     appropriate to prevent the avoidance of the purposes of this 
     subsection.
       ``(5) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary or appropriate to carry out 
     the purposes of this subsection, including regulations 
     providing that paragraph (1) shall not apply in appropriate 
     cases.''
       (2) The last sentence of subsection (c) of section 672 of 
     such Code is amended by inserting ``subsection (f) and'' 
     before ``sections 674''.
       (b) Credit for Certain Taxes.--Paragraph (2) of section 
     665(d) of such Code is amended by adding at the end the 
     following new sentence: ``Under rules or regulations 
     prescribed by the Secretary, in the case of any foreign trust 
     of which the settlor or another person would be treated as 
     owner of any portion of the trust under subpart E but for 
     section 672(f), the term `taxes imposed on the trust' 
     includes the allocable amount of any income, war profits, and 
     excess profits taxes imposed by any foreign country or 
     possession of the United States on the settlor or such other 
     person in respect of trust gross income.''
       (c) Distributions by Certain Foreign Trusts Through 
     Nominees.--
       (1) Section 643 of such Code is amended by adding at the 
     end the following new subsection:
       ``(h) Distributions by Certain Foreign Trusts Through 
     Nominees.--For purposes of this part, any amount paid to a 
     United States person which is derived directly or indirectly 
     from a foreign trust of which the payor is not the grantor 
     shall be deemed in the year of payment to have been directly 

[[Page S13862]]
     paid by the foreign trust to such United States person.''
       (2) Section 665 of such Code is amended by striking 
     subsection (c).
       (d) Effective Date.--
       (1) In general.--Except as provided by paragraph (2), the 
     amendments made by this section shall take effect on the date 
     of the enactment of this Act.
       (2) Exception for certain trusts.--The amendments made by 
     this section shall not apply to any trust--
       (A) which is treated as owned by the grantor or another 
     person under section 676 or 677 (other than subsection (a)(3) 
     thereof) of the Internal Revenue Code of 1986, and
       (B) which is in existence on September 19, 1995.
     The preceding sentence shall not apply to the portion of any 
     such trust attributable to any transfer to such trust after 
     September 19, 1995.
       (e) Transitional Rule.--If--
       (1) by reason of the amendments made by this section, any 
     person other than a United States person ceases to be treated 
     as the owner of a portion of a domestic trust, and
       (2) before January 1, 1997, such trust becomes a foreign 
     trust, or the assets of such trust are transferred to a 
     foreign trust,
     no tax shall be imposed by section 1491 of the Internal 
     Revenue Code of 1986 by reason of such trust becoming a 
     foreign trust or the assets of such trust being transferred 
     to a foreign trust.

     SEC. 5. INFORMATION REPORTING REGARDING FOREIGN GIFTS.

       (a) In General.--Subpart A of part III of subchapter A of 
     chapter 61 of the Internal Revenue Code of 1986 is amended by 
     inserting after section 6039E the following new section:

     ``SEC. 6039F. NOTICE OF GIFTS RECEIVED FROM FOREIGN PERSONS.

       ``(a) In General.--If the value of the aggregate foreign 
     gifts received by a United States person (other than an 
     organization described in section 501(c) and exempt from tax 
     under section 501(a)) during any taxable year exceeds 
     $10,000, such United States person shall furnish (at such 
     time and in such manner as the Secretary shall prescribe) 
     such information as the Secretary may prescribe regarding 
     each foreign gift received during such year.
       ``(b) Foreign Gift.--For purposes of this section, the term 
     `foreign gift' means any amount received from a person other 
     than a United States person which the recipient treats as a 
     gift or bequest. Such term shall not include any qualified 
     transfer (within the meaning of section 2503(e)(2)).
       ``(c) Penalty For Failure To File Information.--
       ``(1) In general.--If a United States person fails to 
     furnish the information required by subsection (a) with 
     respect to any foreign gift within the time prescribed 
     therefor (including extensions)--
       ``(A) the tax consequences of the receipt of such gift 
     shall be determined by the Secretary in the Secretary's sole 
     discretion from the Secretary's own knowledge or from such 
     information as the Secretary may obtain through testimony or 
     otherwise, and
       ``(B) such United States person shall pay (upon notice and 
     demand by the Secretary and in the same manner as tax) an 
     amount equal to 5 percent of the amount of such foreign gift 
     for each month for which the failure continues (not to exceed 
     25 percent of such amount in the aggregate).
       ``(2) Reasonable cause exception.-- Paragraph (1) shall not 
     apply to any failure to report a foreign gift if the United 
     States person shows that the failure is due to reasonable 
     cause and not due to willful neglect.
       ``(d) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary or appropriate to carry out 
     the purposes of this section.''.
       (b) Clerical Amendment.--The table of sections for such 
     subpart is amended by inserting after the item relating to 
     section 6039E the following new item:
``Sec. 6039F. Notice of large gifts received from foreign persons.''
       (c) Effective Date.--The amendments made by this section 
     shall apply to amounts received after the date of the 
     enactment of this Act in taxable years ending after such 
     date.

     SEC. 6. MODIFICATION OF RULES RELATING TO FOREIGN TRUSTS 
                   WHICH ARE NOT GRANTOR TRUSTS.

       (a) Modification of Interest Charge on Accumulation 
     Distributions.--Subsection (a) of section 668 of the Internal 
     Revenue Code of 1986 (relating to interest charge on 
     accumulation distributions from foreign trusts) is amended to 
     read as follows:
       ``(a) General Rule.--For purposes of the tax determined 
     under section 667(a)--
       ``(1) Interest determined using underpayment rates.--The 
     interest charge determined under this section with respect to 
     any distribution is the amount of interest which would be 
     determined on the partial tax computed under section 667(b) 
     for the period described in paragraph (2) using the rates and 
     the method under section 6621 applicable to underpayments of 
     tax.
       ``(2) Period.--For purposes of paragraph (1), the period 
     described in this paragraph is the period which begins on the 
     date which is the applicable number of years before the date 
     of the distribution and which ends on the date of the 
     distribution.
       ``(3) Applicable number of years.--For purposes of 
     paragraph (2)--
       ``(A) In general.--The applicable number of years with 
     respect to a distribution is the number determined by 
     dividing--
       ``(i) the sum of the products described in subparagraph (B) 
     with respect to each undistributed income year, by
       ``(ii) the aggregate undistributed net income.
     The quotient determined under the preceding sentence shall be 
     rounded under procedures prescribed by the Secretary.
       ``(B) Product described.--For purposes of subparagraph (A), 
     the product described in this subparagraph with respect to 
     any undistributed income year is the product of--
       ``(i) the undistributed net income for such year, and
       ``(ii) the sum of the number of taxable years between such 
     year and the taxable year of the distribution (counting in 
     each case the undistributed income year but not counting the 
     taxable year of the distribution).
       ``(4) Undistributed income year.--For purposes of this 
     subsection, the term `undistributed income year' means any 
     prior taxable year of the trust for which there is 
     undistributed net income, other than a taxable year during 
     all of which the beneficiary receiving the distribution was 
     not a citizen or resident of the United States.
       ``(5) Determination of undistributed net income.--
     Notwithstanding section 666, for purposes of this subsection, 
     an accumulation distribution from the trust shall be treated 
     as reducing proportionately the undistributed net income for 
     prior taxable years.
       ``(6) Periods before 1996.--Interest for the portion of the 
     period described in paragraph (2) which occurs before January 
     1, 1996, shall be determined--
       ``(A) by using an interest rate of 6 percent, and
       ``(B) without compounding until January 1, 1996.''
       (b) Abusive Transactions.--Section 643(a) of such Code is 
     amended by inserting after paragraph (6) the following new 
     paragraph:
       ``(7) Abusive transactions.--The Secretary shall prescribe 
     such regulations as may be necessary or appropriate to carry 
     out the purposes of this part, including regulations to 
     prevent avoidance of such purposes.''
       (c) Treatment of Use of Trust Property.--
       (1) In general.--Section 643 of such Code (relating to 
     definitions applicable to subparts A, B, C, and D) is amended 
     by adding at the end the following new subsection:
       ``(i) Use of Foreign Trust Property.--For purposes of 
     subparts B, C, and D--
       ``(1) General rule.--If a foreign trust makes a loan of 
     cash or marketable securities directly or indirectly to--
       ``(A) any grantor or beneficiary of such trust who is a 
     United States person, or
       ``(B) any United States person not described in 
     subparagraph (A) who is related to such grantor or 
     beneficiary,
     the amount of such loan shall be treated as a distribution by 
     such trust to such grantor or beneficiary (as the case may 
     be).
       ``(2) Use of other property.--Except as provided in 
     regulations prescribed by the Secretary, any direct or 
     indirect use of trust property (other than cash or marketable 
     securities) by a person referred to in subparagraph (A) or 
     (B) of paragraph (1) shall be treated as a distribution to 
     the grantor or beneficiary (as the case may be) equal to the 
     fair market value of the use of such property. The Secretary 
     may prescribe regulations treating a loan guarantee by the 
     trust as a use of trust property equal to the value of the 
     guarantee.
       ``(3) Definitions and special rules.--For purposes of this 
     subsection--
       ``(A) Cash.--The term `cash' includes foreign currencies 
     and cash equivalents.
       ``(B) Related person.--
       ``(i) In general.--A person is related to another person if 
     the relationship between such persons would result in a 
     disallowance of losses under section 267 or 707(b). In 
     applying section 267 for purposes of the preceding sentence, 
     section 267(c)(4) shall be applied as if the family of an 
     individual includes the spouses of the members of the family.
       ``(ii) Allocation of use.--If any person described in 
     paragraph (1)(B) is related to more than one person, the 
     grantor or beneficiary to whom the treatment under this 
     subsection applies shall be determined under regulations 
     prescribed by the Secretary.
       ``(C) Exclusion of tax-exempts.--The term `United States 
     person' does not include any entity exempt from tax under 
     this chapter.
       ``(D) Trust not treated as simple trust.--Any trust which 
     is treated under this subsection as making a distribution 
     shall be treated as not described in section 651.
       ``(4) Subsequent transactions regarding loan principal.--If 
     any loan is taken into account under paragraph (1), any 
     subsequent transaction between the trust and the original 
     borrower regarding the principal of the loan (by way of 
     complete or partial repayment, satisfaction, cancellation, 
     discharge, or otherwise) shall be disregarded for purposes of 
     this title.''
       (2) Technical amendment.--Paragraph (8) of section 7872(f) 
     is amended by inserting ``, 643(i),'' before ``or 1274'' each 
     place it appears.
       (d) Effective Dates.--
       (1) Interest charge.--The amendment made by subsection (a) 
     shall apply to distributions after the date of the enactment 
     of this Act.

[[Page S13863]]

       (2) Abusive transactions.--The amendment made by subsection 
     (b) shall take effect on the date of the enactment of this 
     Act.
       (3) Use of trust property.--The amendment made by 
     subsection (c) shall apply to--
       (A) loans of cash or marketable securities after September 
     19, 1995, and
       (B) uses of other trust property after December 31, 1995.

     SEC. 7. RESIDENCE OF ESTATES AND TRUSTS, ETC.

       (a) Treatment as United States Person.--
       (1) In general.--Paragraph (30) of section 7701(a) of the 
     Internal Revenue Code of 1986 is amended by striking 
     subparagraph (D) and by inserting after subparagraph (C) the 
     following:
       ``(D) any estate or trust if--
       ``(i) a court within the United States is able to exercise 
     primary supervision over the administration of the estate or 
     trust, and
       ``(ii) in the case of a trust, one or more United States 
     fiduciaries have the authority to control all substantial 
     decisions of the trust.''
       (2) Conforming amendment.--Paragraph (31) of section 
     7701(a) of such Code is amended to read as follows:
       ``(31) Foreign estate or trust.--The term `foreign estate' 
     or `foreign trust' means any estate or trust other than an 
     estate or trust described in section 7701(a)(30)(D).''
       (3) Effective date.--The amendments made by this subsection 
     shall apply--
       (A) to taxable years beginning after December 31, 1996, or
       (B) at the election of the trustee of a trust, to taxable 
     years ending after the date of the enactment of this Act.
     Such an election, once made, shall be irrevocable.
       (b) Domestic Trusts Which Become Foreign Trusts.--
       (1) In general.--Section 1491 of such Code (relating to 
     imposition of tax on transfers to avoid income tax) is 
     amended by adding at the end the following new flush 
     sentence:
     ``If a trust which is not a foreign trust becomes a foreign 
     trust, such trust shall be treated for purposes of this 
     section as having transferred, immediately before becoming a 
     foreign trust, all of its assets to a foreign trust.''
       (2) Penalty.--Section 1494 of the Internal Revenue Code of 
     1986 is amended by adding at the end the following new 
     subsection:
       ``(c) Penalty.--In the case of any failure to file a return 
     required by the Secretary with respect to any transfer 
     described in section 1491, the person required to file such 
     return shall be liable for the penalties provided in section 
     6677 in the same manner as if such failure were a failure to 
     file a return under section 6048(a).''
       (3) Effective date.--The amendments made by this subsection 
     shall take effect on the date of the enactment of this Act.
                                                                    ____


                   Summary of Foreign Trust Proposals


                        I. INFORMATION REPORTING

                    A. Transferors to Foreign Trusts

       Current Law. U.S. persons are required to report transfers 
     of money or property to a foreign trust. Any person who fails 
     to file the required information is subject to a penalty of 5 
     percent of the amount transferred to the foreign trust, up to 
     a maximum of $1,000. A reasonable cause exception is 
     available.
       Reasons for Change. Existing penalties have not proven 
     adequate to encourage some U.S. taxpayers to report transfers 
     to foreign trusts. Information reporting of transfers to such 
     trusts is necessary to identify transactions subject to 
     existing excise taxes and to identify foreign trusts that 
     must be monitored in the future.
       Proposal. The proposal would increase the penalty for 
     failure to report a transfer to a foreign trust. The new 
     penalty would be 35 percent of the gross value of the 
     property transferred. In addition, monetary penalties could 
     be imposed for continuing noncompliance with IRS requests for 
     information. The reasonable cause exception is retained. The 
     proposal would be effective for transfers occurring after the 
     date of enactment.
       Differences from the Administration Proposal. The current 
     proposal is similar to the Administration proposal.

                   B. U.S. Grantors of Foreign Trusts

       Current Law. A U.S. grantor of a foreign trust is required 
     to provide an annual accounting of trust activities to the 
     IRS. Any person who fails to file the required information is 
     subject to a penalty of 5 percent of the value of the corpus 
     of the trust, up to a maximum of $1,000. A reasonable cause 
     exception is available.
       Reasons for Change. Existing information reporting rules 
     predate the significant expansion of the foreign grantor 
     trust rules in 1976. In general, penalties for noncompliance 
     with reporting requirements are minimal. As a result, U.S. 
     grantors of foreign trusts often do not report the income 
     earned by foreign trusts. Because these foreign trusts are 
     frequently established in tax haven jurisdictions with 
     stringent secrecy rules, IRS attempts to verify income earned 
     by foreign trusts are often unsuccessful. A regime which 
     allows the IRS access to information held by the foreign 
     trust is necessary to enforce existing law.
       Proposal. The proposal would require a U.S. grantor of a 
     foreign trust to cause the trust to (1) appoint a U.S. agent 
     that can provide relevant information to the IRS; and (2) 
     provide an annual accounting of trust activities, including 
     separate schedules (K-1s) for income attributable to the U.S. 
     grantor. If the foreign trust does not appoint a U.S. 
     agent, the IRS would be authorized to determine, in its 
     discretion, the tax consequences of any trust 
     transactions. The proposal would retain the existing 
     penalty for failure to file of 5 percent of the value of 
     the trust corpus, except that the penalty would no longer 
     be limited to $1,000. In addition, monetary penalties 
     could be imposed for continuing noncompliance with IRS 
     requests for information. The reasonable cause exception 
     is retained. The proposal would be effective for taxable 
     years of the U.S. grantor beginning after the date of 
     enactment.
       Differences from the Administration Proposal. The 
     Administration proposal would have allowed the IRS to 
     redetermine tax consequences if the trust did not appoint a 
     U.S. agent or if the trust did not file the required 
     information. The current proposal modifies the Administration 
     proposal by limiting the special IRS redetermination rule to 
     instances where the trust does not appoint a U.S. agent. The 
     Administration proposal would have imposed a monetary penalty 
     of 35 percent of trust income if either the agent were not 
     appointed or the information were not provided. The current 
     proposal modifies this penalty to 5 percent of trust assets, 
     and only imposes the penalty if the required information is 
     not reported.

                   C. Beneficiaries of Foreign Trusts

       Current Law. U.S. persons receiving distributions from 
     foreign nongrantor trusts are required to report them on 
     their U.S. income tax return. If distributions are not 
     reported, the U.S. person could be subject to general tax 
     penalties for failure to report taxable income. A reasonable 
     cause exception is available. U.S. persons receiving 
     distributions from a foreign grantor trust are not required 
     to report them to the IRS.
       Reasons for Change. Existing penalties have not proven 
     adequate to encourage some U.S. taxpayers to report 
     distributions from foreign nongrantor trusts. In addition, 
     requiring reporting of distributions from foreign grantor 
     trusts will allow the IRS to verify that the foreign trust is 
     a grantor trust.
       Proposal. The proposal would require a U.S. person 
     receiving money or property from a foreign trust, whether a 
     grantor trust or a nongrantor trust, to disclose the 
     distribution on the individual's Federal income tax return. 
     If a beneficiary does not disclose distributions or does not 
     have sufficient records to substantiate the tax treatment of 
     the distributions, then the distributions will be considered 
     distributions of accumulated income from the trust's average 
     year (the years the trust has been in existence divided by 
     two). If the beneficiary does not disclose distributions or 
     provides inaccurate information, a penalty equal to 35 
     percent of the trust distributions would be imposed upon the 
     beneficiary. In addition, monetary penalties could be imposed 
     for continuing noncompliance with IRS requests for 
     information. The reasonable cause exception is retained. It 
     is intended that the IRS respect the privacy of foreign 
     taxpayers to the extent consistent with the interests of tax 
     administration. This proposal would be effective with 
     respect to distributions received after the date of 
     enactment.
       Differences from the Administration Proposal. The 
     Administration proposal placed the responsibility of 
     reporting trust distributions on the trust. The current 
     proposal places that responsibility on the beneficiary.


                  ii. outbound foreign grantor trusts

       Under current law, a special rule applicable to foreign 
     trusts established by a U.S. person for the benefit of U.S. 
     persons provides that such trusts are generally ``grantor 
     trusts'', and the U.S. transferor is treated as the owner of 
     property transferred to the trust. The proposal revises 
     certain exceptions to this foreign grantor trust rule.

                       A. Sales to Foreign Trusts

       Current Law. Sales of property to a foreign trust at fair 
     market value are not transfers that are subject to the 
     foreign grantor trust rule.
       Reasons for Change. U.S. persons who transfer property to 
     foreign trusts sometimes attempt to inappropriately avoid the 
     foreign grantor trust rule by selling property to a foreign 
     trust in exchange for a note from the trust which the U.S. 
     transferor may not intend to collect. (If there is no bona 
     fide debt, these transactions are subject to challenge under 
     current law, because the exchange would not be at fair market 
     value.)
       Proposal. The proposal disregards any obligation issued or 
     guaranteed by the trust to any related person in determining 
     whether a sale to a foreign trust is for fair market value. 
     This proposal would be effective for assets transferred to 
     foreign trusts after February 6, 1995.
       Differences from the Administration Proposal. The 
     Administration proposal would have disregarded any trust 
     obligation issued or guaranteed by the trust to any U.S. 
     person. The current proposal only applies this rule to trust 
     obligations issued to related persons.

                        B. Pre-immigration Trust

       Current Law. The foreign grantor trust rule does not apply 
     to a foreign settlor who transfers property to a foreign 
     trust for the benefit of U.S. persons even if the settlor 
     later becomes a U.S. person.
       Reasons for Change. Prior to becoming residents of the 
     United States, foreign persons often put their assets into 
     irrevocable trusts in tax haven jurisdictions for the benefit 
     of U.S. persons. As a result, the future trust income escapes 
     U.S. tax until distribution. Thus, under current law, U.S. 
     persons 

[[Page S13864]]
     who have immigrated to the United States are able to avoid current 
     taxation of trust income in ways that are not available to 
     other U.S. persons.
       Proposal. If a foreign person transfers property to a 
     foreign trust with U.S. beneficiaries and the foreign person 
     then becomes a U.S. person within five years of the transfer, 
     the transferor would be treated as the owner of the trust 
     assets when he becomes a U.S. person. This proposal would be 
     effective for assets transferred to foreign trusts after 
     February 6, 1995.
       Differences from the Administration Proposal. The current 
     proposal is similar to the Administration proposal.

                      C. Outbound Trust Migrations

       Current Law. Although Revenue Ruling 91-6, 1991-1 C.B. 89, 
     describes the rules that must be applied when a foreign trust 
     becomes a domestic trust, current rules do not clearly 
     describe the tax consequences of a domestic trust becoming a 
     foreign trust.
       Reasons for Change. Outbound trust migrations are becoming 
     more common as tax haven jurisdictions enact legislation to 
     enable U.S. trusts to move to those jurisdictions. Rules 
     should be clarified to ensure that taxpayers will not be able 
     to achieve tax results through the outbound migration of a 
     domestic trust that they could not achieve directly by the 
     creation of a foreign trust.
       Proposal. If a domestic trust becomes a foreign trust 
     during the life of a U.S. person who transferred assets to 
     the domestic trust, the U.S. transferor will be considered 
     the grantor of the foreign trust. This proposal would 
     generally be effective for trust migrations after February 6, 
     1995.
       Differences from the Administration Proposal. Under the 
     Administration proposal, unless outbound trust migrations 
     were part of a prearranged plan, beneficiaries of the 
     migrating trust would be considered the grantors of the 
     trust. Under the current proposal, if a U.S. person who 
     transferred assets to a migrating trust is alive, that person 
     is considered the grantor of the trust. If the transferor is 
     not alive, a migrating trust is subject to the section 1491 
     excise tax (described below).

                          D. Other Provisions

       Transfers at Death. The Administration proposal would have 
     treated U.S. beneficiaries as grantors of foreign trusts 
     which were funded at the death of a U.S. person. The current 
     proposal does not include these provisions.
       Discretionary Beneficiaries. Because of changes to the 
     treatment of transfers at death and trust migrations, the 
     provisions in the Administration proposal relating to the 
     determination of a beneficiary's proportionate interests in 
     trusts are no longer necessary. The current proposal does not 
     include these provisions.


                  III. INBOUND FOREIGN GRANTOR TRUSTS

       Current Law. A person with certain powers over the trust 
     assets (the ``grantor'') is taxed as if he owned the trust 
     assets directly. This treatment is designed to prevent 
     attempts to shift income from U.S. grantors to U.S. 
     beneficiaries who are likely to be paying taxes at lower 
     rates than the grantor of the trust. Consequently, under 
     existing anti-abuse grantor trust rules, the grantor of such 
     a trust is taxed as if he owned the trust assets directly, 
     even if he retains only minimal economic connections with the 
     trust assets.
       Revenue Ruling 69-70, 1969-1 C.B. 182, provides that if a 
     foreign person is treated as the owner of a trust, a U.S. 
     beneficiary of that trust is not taxable on trust income 
     distributed to him.
       However, special rules in the Code modify the general 
     grantor trust rules where a U.S. beneficiary has made prior 
     gifts to a foreign grantor. In such a case, the U.S. 
     beneficiary is treated as the owner of the foreign trust 
     assets to the extent of the U.S. beneficiary's prior gifts to 
     the foreign grantor. The rule is designed to prevent wealthy 
     U.S. persons who have immigrated to the United States from 
     avoiding U.S. tax on their worldwide income. Prior to the 
     enactment of this rule, before moving to the United States 
     some immigrants transferred their assets to a foreign 
     relative, who then retransferred those assets to a foreign 
     trust for the benefit of the immigrant. Because the foreign 
     relative retained limited powers over the trust, the 
     immigrant treated the foreign relative as the owner of the 
     trust assets, and did not pay U.S. tax on trust 
     distributions.
       Reasons for Change. Existing law inappropriately permits 
     foreign taxpayers to affirmatively use the domestic anti-
     abuse grantor trust rules. Existing restrictions on the 
     ability of foreign taxpayers to use these rules are not 
     adequate to prevent U.S. beneficiaries, who enjoy the 
     benefits of United States citizenship or residency, from 
     avoiding U.S. tax on their income from trusts.
       Proposal. The grantor trust rules generally will only apply 
     to a trust if those rules would result in an amount being 
     included (directly or indirectly) in the gross income of a 
     U.S. citizen, domestic corporation, or a controlled foreign 
     corporation. The grantor trust rules would continue to apply 
     to trusts revocable by the grantor of the trust, to certain 
     compensatory trusts, and for purposes of applying the foreign 
     personal holding company rules and the passive foreign 
     investment company rules. It is intended that no inference 
     regarding the interpretation of present law be drawn from the 
     exclusion of certain trusts, including compensatory trusts, 
     from the application of the special rules of the proposal. 
     These rules are not intended to apply to normal security 
     arrangements involving a trustee (including the use of 
     indenture trustees and similar arrangements). The proposal 
     retains current rules regarding the treatment of U.S. 
     immigrants who made prior gifts to a foreign grantor.
       New rules would harmonize the treatment of purported gifts 
     by corporations and partnerships with the new foreign grantor 
     trust rules. In addition, U.S. persons would be required to 
     report the receipt of what they claim to be large gifts from 
     foreign persons in order to allow the IRS to verify that such 
     purported gifts are not in fact, disguised income to the U.S. 
     recipients.
       If a foreign trust that is a grantor trust under current 
     law becomes a nongrantor trust pursuant to this rule, the 
     trust would be treated as if it were resettled on the date 
     the trust becomes a nongrantor trust. Neither the grantor nor 
     the trust would recognize gain or loss. The section 1491 
     excise tax would not be applied to such a trust if the trust 
     migrates before December 31, 1996. Under special transition 
     rules, these rules would not apply to certain foreign trusts 
     where the foreign grantor retains substantial powers over the 
     trust assets, if those trusts were funded prior to September 
     19, 1995. Otherwise, this proposal would be effective on the 
     date of enactment.
       Differences from the Administration Proposal. The current 
     proposal modifies the Administration proposal by providing 
     exceptions for revocable trusts, controlled foreign 
     corporations, and compensatory trusts. The Administration 
     proposal did not contain the special transition rules 
     described above.


                     iv. foreign nongrantor trusts

                     A. Accumulation Distributions

       Current law. U.S. beneficiaries of foreign trusts are 
     subject to a nondeductible interest charge on distributions 
     of accumulated income earned by the trust in earlier taxable 
     years. The charge is based on the length of time during which 
     the tax was deferred because the accumulated income was not 
     distributed. Under existing law, the interest charge is equal 
     to 6 percent simple interest per year multiplied by the tax 
     imposed on the distribution. Accumulated income is deemed to 
     be distributed on a first-in, first-out basis. If adequate 
     records are not available to determine the portion of a 
     distribution that is accumulated income, the distribution is 
     deemed to be an accumulation distribution from the year that 
     the trust was organized.
       Reasons for Change. Current rules need to be revised to 
     eliminate U.S. tax incentives for accumulating income in 
     foreign trusts. Practitioners sometimes advise U.S. persons 
     to accumulate income trust because U.S. tax rules impose 
     interest at such a low rate (6 percent simple interest). 
     Thus, interest paid by U.S. beneficiaries of foreign 
     trusts should be modified to reflect market rates of 
     interest.
       However, current rules also need to be liberalized to tax 
     more appropriately distributions of accumulated income from 
     foreign trusts. Currently, a U.S. beneficiary pays an 
     interest charge on any distribution of accumulated trust 
     income as if the oldest trust earnings were distributed 
     first. The interest charge on such a distribution may be so 
     high as to discourage the U.S. beneficiary from receiving any 
     distributions from the trust. In addition, current rules 
     effectively require U.S. beneficiaries to obtain extensive 
     information about the foreign trust or, if information is not 
     obtained, pay a substantial interest charge based on the 
     assumption that all trust distributions were made from the 
     year that the trust was organized.
       Proposal. For periods of accumulation after December 31, 
     1995, the rate of interest charged on accumulation 
     distributions would correspond with the interest rate that 
     taxpayers pay on underpayments of tax.
       Distributions of accumulated trust income would be deemed 
     to come from a weighted average of the trust's accumulated 
     income. This calculation should be simpler than current law 
     because existing provisions require the taxpayer to maintain 
     separate pools of accumulated income for each year of the 
     trust. Under this weighted average method, the taxpayer would 
     only need to maintain a single pool of undistributed income.
       If information is not available regarding trust 
     distributions, distributions would generally be deemed to be 
     from income accumulated in the average year of the trust (the 
     years the trust has been in existence divided by two). If a 
     taxpayer is not able to demonstrate when the trust was 
     created, the IRS may use an approximation based on available 
     evidence.
       Taxpayers have used a variety of methods (e.g., tiered 
     trusts, divisions of trusts, mergers of trusts, and similar 
     transactions with corporations) to convert a distribution of 
     accumulated income into a distribution of current income or 
     corpus. The proposal would authorize the IRS to 
     recharacterize such transactions. Transactions that may be 
     entered into to avoid the interest charge on accumulation 
     distributions (e.g., excessive ``compensation'' paid to trust 
     beneficiaries who are directors of corporations owned by the 
     foreign trust) may be subject to recharacterization.
       The proposal also clarifies existing law by providing that 
     if an alien beneficiary of a foreign trust becomes a U.S. 
     resident and thereafter receives an accumulation 
     distribution, no interest would be charged during periods of 
     accumulation that predate U.S. residency. The proposal would 
     generally 

[[Page S13865]]
     be effective for distributions after the date of enactment.
       Differences from the Administration Proposal. The current 
     proposal is similar to the Administration proposal 
     liberalizes current law by imposing the interest charge based 
     on the weighted average life of the trust's accumulated 
     income instead of the trust's oldest undistributed income. 
     The current proposal also makes a corresponding change to the 
     treatment of trust distributions when information about the 
     trust is not available.

                     B. Constructive Distributions

       Current law. The tax consequences of the use of trust 
     assets by beneficiaries is ambiguous under present law. 
     Taxpayers may assert that a benefidiary's use of assets owned 
     by a trust does not constitute a distribution to the 
     beneficiary.
       Reasons for Change. If a corporation makes corporate assets 
     available for a shareholder's personal use (e.g., a corporate 
     apartment made available rent-free to a shareholder), the 
     fair market value of the use of that property is treated as a 
     constructive distribution. Further, if a controlled foreign 
     corporation makes a loan to a U.S. person, the loan is 
     treated as a deemed distribution by the foreign corporation 
     to its U.S. shareholders. The use of nongrantor foreign trust 
     assets by trust beneficiaries should give rise to tax 
     consequences that are similar to those associated with the 
     use of corporate assets by corporate shareholders.
       Proposal. If a U.S. beneficiary (or a U.S. related person) 
     uses assets of a nongrantor foreign trust, the value of that 
     use would be treated as income to the foreign trust which is 
     deemed distributed to the U.S. beneficiary. Thus, if a 
     nongrantor foreign trust made a residence available for use 
     by a U.S. beneficiary, the difference between the fair rental 
     value of the residence and any rent actually paid would be 
     treated as a constructive distribution to that beneficiary. 
     If a nongrantor foreign trust purported to loan cash or 
     marketable securities to a U.S. beneficiary, the loan 
     proceeds would be treated as a constructive distribution by 
     the foreign trust to the U.S. beneficiary. For this purpose, 
     an organization exempt from U.S. tax would not be considered 
     a U.S. person. It is intended that no inference be drawn from 
     the proposal as to the treatment under present law of the use 
     of trust assetss by beneficiaries and others. The provisions 
     would be effective for loans of cash or marketable securities 
     after September 19, 1995, and uses of other trust property 
     after December 31, 1995.
       Difference from the Administration Proposal. The current 
     proposal is similar to the Administration proposal.


                         V. RESIDENCE OF TRUSTS

                             A. Definition

       Current Law. Under current law, a ``foreign estate or 
     trust'' is an estate or trust the ``income of which, from 
     sources without the United States which is not 
     effectively connected with the conduct of a trade or 
     business within the United States, is not includible in 
     gross income under subtitle A'' of the Internal Revenue 
     Code. Section 7701(a)(31). This definition does not 
     provide criteria for determining when an estate or trust 
     is foreign.
       Court cases and rulings indicate that the residence of an 
     estate or trust depends on various factors, such as the 
     location of the assets, the country under whose laws the 
     estate or trust is created, the residence of the trustee, the 
     nationality of the decedent or settlor, the nationality of 
     the beneficiaries, and the location of the administration of 
     the trust. See e.g., B.W. Jones Trust v. Comm'r, 46 B.T.A. 
     531 (1942), aff'd, 132 F.2d 914 (4th Cir. 19543).
       Reasons for Change. Present rules provide insufficient 
     guidance for determining the residence of estates and trusts. 
     In addition, the increasing mobility of people and capital 
     make certain factors (e.g., nationality of the settlor or 
     beneficiaries, situs of assets) less relevant. Because the 
     tax treatment of an estate, trust, settlor or beneficiary may 
     depend on whether the estate or trust is foreign or domestic, 
     it is important to have an objective definition of the 
     residence of an estate or trust. Fewer factors for 
     determining the residence of estates or trusts would increase 
     the flexibility of grantors and trust administrators to 
     decide where to locate the trust and in what assets to 
     invest. For example, if the location of the administration of 
     the trust were no longer a relevant criterion, grantors of 
     foreign trusts would be able to choose whether to administer 
     the trusts in the United States or abroad based on nontax 
     considerations.
       Proposal. An estate or trust would be considered to be a 
     domestic estate or trust if two factors are present: (1) a 
     court within the United States is able to exercise primary 
     supervision over the administration of the estate or trust; 
     and (2) a U.S. fiduciary (alone or in concert with other U.S. 
     fiduciaries) has the authority to control decisions of the 
     estate or trust.
       The first factor is intended to refer to the court with 
     authority over the entire estate or trust, and not merely 
     jurisdiction over certain assets or a particular beneficiary. 
     Normally, the first factor would be satisfied if the trust 
     instrument is governed by the laws of a U.S. State. One way 
     to satisfy this factor is to register the estate or trust in 
     a State pursuant to a State law which is substantially 
     similar to Article VII of the Uniform Probate Code as 
     published by the American Law Institute. The second factor 
     would normally be satisfied if a majority of the fiduciaries 
     are U.S. persons and a foreign fiduciary (including a 
     ``protector'' or similar trust advisor) may not veto 
     important decisions of the U.S. fiduciaries. In applying this 
     factor, the IRS would allow an estate or trust a reasonable 
     period of time to adjust for inadvertent changes in 
     fiduciaries (e.g., a U.S. trustee dies or abruptly resigns 
     where a trust has two U.S. fiduciaries and one foreign 
     fiduciary).
       The new rules defining domestic estates and trusts would be 
     effective for taxable years of an estate or trust that begin 
     after December 31, 1996. The delayed effective date is 
     intended to allow an estate or trust a period of time to 
     conform its governing instrument or to change fiduciaries so 
     that the estate or trust may effectively elect to be treated 
     as domestic or foreign. However, trustees will be allowed to 
     elect to apply these rules for taxable years ending after the 
     date of enactment.
       Differences from the Administration Proposal. The current 
     proposal is similar to the Administration proposal.

                      B. Outbound Trust Migration

       Current Law. Under current law, a 35 percent excise tax is 
     imposed upon any appreciation in property that is transferred 
     by a U.S. person to a nongrantor foreign trust. A taxpayer 
     can avoid the excise tax by electing to pay income tax on any 
     appreciation in the transferred property. No excise tax is 
     imposed on transfers to foreign grantor trusts. Current law 
     is not clear as to whether the excise tax applies when a 
     nongrantor domestic trust changes its residence to become a 
     nongrantor foreign trust.
       Reasons for Change. The excise tax is designed to prevent 
     U.S. persons from transferring assets to a nongrantor foreign 
     trust without paying U.S. tax on the appreciation in those 
     assets. Taxpayers should not be able to achieve tax results 
     through migration of a domestic trust that they could not 
     achieve directly by the creation of a foreign trust.
       Proposal. The proposal would treat a nongrantor domestic 
     trust that becomes a nongrantor foreign trust as having 
     transferred, immediately before becoming a nongrantor foreign 
     trust, all of its assets to a foreign trust. The section 1491 
     excise tax would apply to this transfer. Penalties would be 
     imposed for failure to report any transaction subject to the 
     excise tax. The provisions would be effective on the date of 
     enactment.
       Differences from the Administration Proposal. Under the 
     Administration proposal, outbound migrations of trust with 
     U.S. beneficiaries would generally have been subject to the 
     foreign grantor trust rule, and the migrations would 
     therefore not have been subject to the excise tax. Because 
     the current proposal limits the application of the foreign 
     grantor trust rule to certain outbound trust migrations, the 
     current proposal applies the excise tax to outbound trust 
     migrations that result in a nongrantor foreign trust.

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