[Federal Register Volume 60, Number 82 (Friday, April 28, 1995)]
[Proposed Rules]
[Pages 20922-20930]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-10174]



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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[INTL-0065-93]
RIN 1545-AS46


Exceptions to Passive Income Characterization for Certain Foreign 
Banks and Securities Dealers

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document provides guidance concerning the application of 
the exceptions to passive income contained in section 1296(b) for 
foreign banks, securities dealers and brokers. This document affects 
persons who own direct or indirect interests in certain foreign 
corporations. This document also provides notice of a public hearing on 
these proposed regulations.

DATES: Written comments must be received by August 10, 1995. Outlines 
of oral comments to be presented at the public hearing scheduled for 
August 31, 1995 at 10 a.m. must be received by August 10, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (INTL-0065-93), room 
5228, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R 
(INTL-0065-93), Courier's Desk, Internal Revenue Building, 1111 
Constitution Avenue NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Ramon 
Camacho at (202) 622-3870; concerning submissions and the hearing, Ms. 
Christina Vasquez, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    A passive foreign investment company (PFIC) is any foreign 
corporation that satisfies either the income test or asset test in 
section 1296(a) of the Internal Revenue Code (Code). Under the income 
test, a foreign corporation is a PFIC if 75 percent or more of its 
gross income for the year is passive income. Sec. 1296(a)(1). 
Alternatively, a foreign corporation is a PFIC if 50 percent or more of 
the average value of its assets for the taxable year produce passive 
income or are held for the production of passive income. Sec. 
1296(a)(2). Under section 1296(b)(1), passive income is foreign 
personal holding company income as defined in section 954(c) of the 
Code, and includes dividends, interest, certain rents and royalties, 
and gain from certain property transactions, including gain from the 
sale of assets that produce passive income.
    Under section 1296(b)(2)(A), income earned in the active conduct of 
a banking business by a foreign corporation licensed to do business as 
a bank in the United States and, to the extent provided in regulations, 
by other corporations engaged in the banking business is not passive. 
Notice 89-81, 1989-2 CB 399, (Notice) described rules to be 
incorporated into subsequent regulations that would expand this 
exception to certain foreign banks not licensed to do a banking 
business in the United States. The rules contained in Sec. 1.1296-4 of 
the proposed regulations would implement section 1296(b)(2)(A) for 
banking activities conducted by foreign corporations.
    In 1993, Congress added section 1296(b)(3)(A) to the Code, 
effective for taxable years beginning after September 30, 1993. See 
Omnibus Budget Reconciliation Act of 1993 (1993 Act), Pub. L. 103-66, 
section 13231(d), 107 Stat. 312, 499. The provision treats as 
nonpassive any income derived in the active conduct of a securities 
business by a controlled foreign corporation (CFC) if the CFC is a U.S. 
registered dealer or broker and, to the extent provided in regulations, 
a CFC not so registered. The rules contained in Sec. 1.1296-6 would 
implement section 1296(b)(3)(A).
    Section 956A, added by the 1993 Act, requires each U.S. shareholder 
of a CFC to include in income its pro rata share of the CFC's excess 
passive assets. Under section 956A(c)(2), a passive asset is any asset 
that produces passive income as defined in section 1296(b). An asset 
that generates nonpassive income under Sec. 1.1296-4 or Sec. 1.1296-6 
of the proposed regulations will be nonpassive for purposes of section 
956A.

Explanation of Provisions

I. Description of Proposed Rules for Foreign Banks

A. General Rule
    Section 1.1296-4(a) of the proposed regulations provides generally 
that, for purposes of section 1296(a)(1), passive income does not 
include banking income earned by an active bank or by a qualified 
affiliate of such a bank. For this purpose, an active bank is either a 
corporation that possesses a license issued under federal or state law 
to do business as a bank in the United States, or a foreign corporation 
that meets the licensing, deposit-taking, and lending requirements of 
paragraphs (c), (d), and (e), respectively, of Sec. 1.1296-4.
    The proposed rules generally adopt the deposit, lending, and 
licensing standards contained in the Notice. These standards are 
consistent with the provisions of the Code that define a bank as an 
institution that accepts deposits from and makes loans to the public 
and is licensed under state or federal law to conduct banking 
activities. See e.g., sec. 581. The IRS and Treasury believe that 
Congress intended [[Page 20923]] to grant the banking exception only to 
corporations that conform to a traditional U.S. banking model.
    However, the proposed rules liberalize the approach taken in the 
Notice in several ways. Most significantly, the proposed rules adopt 
subjective tests to measure whether the corporation meets the deposit-
taking and lending requirements. The IRS and Treasury rejected reliance 
on objective tests such as those in the Notice after learning, through 
several ruling requests pursuant to the Notice, that objective 
standards may cause legitimate banks to be treated as nonbanks.
    Because of the rigidity of the objective tests, the Notice 
permitted the IRS to rule in rare and unusual circumstances that a 
foreign corporation was an active bank even though it failed to satisfy 
the requirements of the Notice. The proposed regulations do not adopt 
this procedure because the IRS and Treasury believe that the enhanced 
flexibility of the proposed rules should permit all foreign 
corporations actively conducting a licensed banking business (whether 
directly or through affiliates) to qualify for the bank exception.
B. Licensing Requirement
    A foreign corporation that is not licensed in the United States 
satisfies the licensing requirements of Sec. 1.1296-4(c) if it is 
licensed or authorized to accept deposits from residents of the country 
in which it is chartered or incorporated, and to conduct, in such 
country, any of the banking activities described in the proposed 
regulations. However, a corporation fails this licensing test if one of 
the principal purposes for its obtaining a license was compliance with 
the requirements of this section.
    The IRS and Treasury believe that being licensed as a bank by a 
bank regulatory authority is strong evidence that a corporation is a 
bank. The proposed regulations therefore adopt a licensing test to 
distinguish banks from investment funds.
C. Deposit-Taking Test
    A foreign corporation satisfies the deposit-taking test of 
Sec. 1.1296-4(d) if it regularly accepts deposits in the ordinary 
course of its trade or business from customers who are residents of the 
country in which it is licensed or authorized. In addition, the amount 
of deposits shown on the corporation's balance sheet must be 
substantial. Section 1.1296-4(d)(3) provides that whether the amount of 
deposits on a corporation's balance sheet is substantial depends on all 
the facts and circumstances, including whether the capital structure 
and funding of the bank as a whole are similar to that of comparable 
banking institutions engaged in the same types of activities and 
subject to regulation by the same banking authorities.
    The proposed regulations adopt this deposit-taking test in part to 
distinguish banks from finance companies, which do not accept deposits. 
This distinction between finance companies and banks is required by 
Congress. H.R. Conf. Rep. No. 213, 103d Cong., 1st Sess. 641 (1993) 
(noting that the banking, insurance, and securities exemptions ``do not 
apply to income derived in the conduct of financing and credit services 
businesses''). Although the IRS and Treasury believe that deposit-
taking is a key attribute of all active banks, they also recognize that 
subjective tests will better accommodate the various types of banks 
that have developed as a result of different banking systems and 
regulatory frameworks.
    The proposed regulations introduce flexibility to the deposit-
taking requirements in several ways. First, the requirement that the 
amount of deposits be substantial is more flexible than the Notice 
requirement that deposits constitute at least 50 percent of the total 
liabilities of the bank. The IRS and Treasury recognize that a bank's 
funding preferences may be affected by market conditions and regulatory 
requirements and believes that an institution may be properly treated 
as an active bank even if deposits do not constitute the institution's 
primary source of funding.
    Second, unlike the Notice, the proposed regulations do not include 
any special rules for interbank deposits but treat them like any other 
deposit, regardless of whether they are received from persons who are 
members of a related group as defined in Sec. 1.1296-4(i)(4). The IRS 
and Treasury believe this change is appropriate because the acceptance 
of interbank deposits from related or unrelated persons on an arm's 
length basis is a banking activity normally engaged in by banks. In 
addition, the impact of a rule that distinguishes between interbank 
deposits received from related persons and those received from 
unrelated persons is diminished where deposit-taking activity is not 
measured with a bright-line test.
    Finally, the proposed rules change the Notice requirement that a 
corporation must hold deposits from at least 1,000 persons who are bona 
fide residents of the country that issued the corporation's banking 
license because this requirement proved troublesome for certain private 
banks with clientele from several countries. The requirement was 
intended to address cases where a bank is licensed by a country but not 
allowed to accept deposits from its residents. In the IRS and 
Treasury's view, such an entity should not be treated as an active bank 
for purposes of section 1296 because it is not accorded full bank 
status by the bank authorities that issued its banking license. 
However, the IRS and Treasury believe that a bright-line deposit 
standard is not necessary to address this concern. Instead, the 
proposed regulations require that a corporation regularly accept 
deposits from residents of the country in which it is licensed.
D. Lending Test
    A foreign corporation satisfies the lending test of Sec. 1.1296-
4(e) if it regularly makes loans to customers in the ordinary course of 
its trade or business. This is a change from the Notice's requirement 
that loans to unrelated persons make up more than 50 percent of the 
corporation's loan portfolio. The lending test is necessary to 
distinguish banks, which extend credit to customers, from corporations 
that merely invest. However, such a distinction can be drawn without 
relying on a bright-line standard such as that contained in the Notice.
    In order to distinguish loans from investments for purposes of 
these rules, the proposed regulations provide that a note, bond, 
debenture or other evidence of indebtedness is a loan only if it is 
received by the corporation on an extension of credit made pursuant to 
a loan agreement entered into in the ordinary course of the 
corporation's banking business. Debt instruments treated as securities 
for purposes of the corporation's financial statements generally are 
not loans.
E. Banking Income and Activities
    Section 1.1296-4(f)(1) provides that banking income is gross income 
derived from the active conduct of any banking activity as defined in 
Sec. 1.1296-4(f)(2). These activities include all of the activities 
treated as banking activities in the Notice, with no material changes, 
except that finance leasing is included as a banking activity.
    The proposed regulations do not adopt the Notice's rule that all of 
the U.S. effectively connected income earned by a foreign corporation 
in the active conduct of a trade or business pursuant to a U.S. bank 
license automatically is nonpassive. One effect of this rule was that 
effectively connected income earned by a U.S.- licensed bank from 
transactions with related parties would have been banking income, while 
income earned by non- [[Page 20924]] U.S.-licensed banks from similar 
related-party transactions would not have been banking income. Because 
the proposed regulations generally do not differentiate between related 
party and non-related party transactions in the same way as the Notice, 
the only effect of the rule would have been to treat, in the case of 
U.S. licensed banks only, as banking income the income earned on 
transactions with related parties who are not customers and income 
earned from activities (such as securities activities) that are not 
banking activities described in Sec. 1.1296-4(f). The IRS and Treasury 
believe that the standards for determining whether income is derived in 
the active conduct of a banking business should be the same for all 
corporations that are either active banks or qualified bank affiliates.
    The IRS and Treasury are aware that many bank activities may also 
be considered securities activities. Under the proposed regulations, an 
entity that performs an activity that is both a banking activity and a 
securities activity must satisfy only the requirements of the bank 
rules to treat income from such activity as nonpassive. For example, an 
entity that derives income from dealing in foreign exchange may treat 
such income as nonpassive if it is an active bank (or a qualified bank 
affiliate) even though it is not a controlled foreign corporation.
    Dealing in securities, however, is not included as both a banking 
activity and a securities activity. The IRS and Treasury believe that 
Congress intended that income from dealing in securities should be 
nonpassive only if it is earned by a controlled foreign corporation 
that actively conducts a securities business and meets the other 
requirements of section 1296(b)(3)(A).
    The IRS and Treasury have become aware that certain developing 
country economies impose high deposit reserve requirements as a tool 
for implementing monetary policy. Because the central banks of these 
countries require the maintenance of such reserves as a prerequisite to 
conducting a banking business, the earnings on such assets, if any, 
should appropriately be excluded from passive income.
F. Customer Relationship
    Under the proposed regulations, a bank satisfies the deposit and 
lending tests only if it carries on such activities with customers. 
Moreover, only the income from its banking activities (and those of its 
qualified bank affiliates) conducted with, or for, customers will 
produce nonpassive income. This is a change from the Notice 
requirement, under which activities qualified only if they were 
conducted with unrelated parties. Under the proposed regulations, a 
customer may be any person, related or unrelated, if that person has a 
customer relationship with the bank. Whether such a relationship exists 
depends on all the facts and circumstances. However, persons who are 
related to, or who are shareholders, officers, directors, or other 
employees of, the corporation will not be treated as customers of the 
corporation if one of the principal purposes for the corporation's 
transacting business with such persons was to qualify the corporation 
as an active bank or qualified bank affiliate.
G. Affiliates of Active Banks
    The IRS and Treasury recognize that many active banks conduct one 
or more banking activities through separately incorporated affiliates 
that may not individually qualify as active banks. Accordingly, the 
proposed regulations provide rules under which income from banking 
activities may be treated as nonpassive if earned by a corporation that 
does not qualify as an active bank but is a member of a related group 
of which an active bank is also a member. However, such income is 
nonpassive only for purposes of determining whether any member of the 
related group is a passive foreign investment company or for purposes 
of applying the excess passive asset rules of section 956A(c)(2)(A). In 
addition, such income remains passive with respect to persons who own 
stock in the affiliate but who are not members of the related group of 
which the affiliate is a member.
    For purposes of these rules, a related group is any group of 
persons related within the meaning of section 954(d)(3), substituting 
person for controlled foreign corporation. This definition is a 
departure from the affiliated group definition of the Notice because it 
permits noncorporate entities (such as partnerships) to count as 
members of the group for purposes of satisfying the groupwide gross 
income test.
    Section 1.1296-4(i)(2) requires the bank affiliate to generate more 
than 60 percent of its income from banking, insurance and securities 
activities (but not other financial services). For purposes of this 
test, the look-through rules of sections 1296(c) and 1296(b)(2)(C) do 
not apply. This requirement ensures that a bank affiliate's eligibility 
for the bank exception depends upon the business activities conducted 
directly by the affiliate, and is not influenced by activities 
conducted by related persons. However, a bank affiliate may 
nevertheless apply sections 1296(c) and 1296(b)(2)(A) to determine 
whether it is a PFIC under the income or asset tests of section 
1296(a).
    In addition, the related group must meet two gross income tests for 
the exception to apply. First, under Sec. 1.1296-4(i)(3)(i), income 
from banking activities derived by active banks must constitute at 
least 30 percent of the financial services income earned by group 
members. Second, under Sec. 1.1296-4(i)(3)(ii), income earned by group 
members from banking activities, securities activities, and insurance 
activities must constitute at least 70 percent of the financial 
services income earned by group members that are financial services 
entities. The regulations adopt the definition of financial services 
income contained in Sec. 1.904-4(e), which includes only income earned 
by financial services entities.
    These affiliate rules are structurally similar to the affiliate 
rules contained in the Notice, but have been modified in several 
respects to respond to taxpayer comments. For example, the 80 percent 
stock ownership threshold of the Notice caused many corporations to be 
treated as PFICs solely because the gross income of subsidiaries in 
which the group owned less than an 80 percent interest was excluded for 
purposes of the Notice's gross income tests, even though the group had 
voting control of such subsidiaries. The adoption of a lower 50 percent 
ownership threshold for group membership in the proposed regulations 
recognizes that international groups are not organized to meet the 80 
percent threshold required for consolidation under U.S. tax law.
    In addition, the gross income tests were changed in several ways to 
deal with problems encountered by diversified affiliated groups. First, 
the denominators of the fractions now include only financial services 
income, which by its terms includes only income earned by financial 
services entities. This change prevents foreign corporations that are 
part of a banking group from being disqualified solely because the 
group is a subgroup of a larger group that does not perform solely 
financial services.
    Second, the numerator of the fraction for the groupwide gross 
income test now includes gross income from securities and insurance 
activities in addition to banking activities. This change prevents a 
foreign corporation engaged in banking activities that is part of a 
banking subgroup from being disqualified solely because it is part of a 
larger group that provides a broad range of financial services. 
[[Page 20925]] 
    Finally, the proposed rules drop the Notice requirement that an 
active bank be a group member for 5 years before its income may count 
towards satisfaction of the gross income tests. Since PFIC status is 
determined annually, the IRS and Treasury believe that whether a group 
is a banking group should depend only on its status during the current 
taxable year.
H. Income From Nonbanking Activities
    As in the Notice, Sec. 1.1296-4(j) of the proposed regulations 
provides that income derived from the conduct of activities other than 
banking activities described in Sec. 1.1296-4(f)(2) and income from 
assets held for the conduct of such activities are nonpassive only to 
the extent provided in section 1296.
J. Effective Date
    Section 1.1296-4 is proposed to be effective for all taxable years 
beginning after December 31, 1994. However, taxpayers may apply 
Sec. 1.1296-4 to a taxable year beginning after December 31, 1986, but 
must consistently apply Sec. 1.1296-4 to such taxable year and all 
subsequent years. While application of Sec. 1.1296-4 to a year 
beginning after December 31, 1986, cannot affect the tax liability of a 
taxpayer for any closed taxable year, a taxpayer may apply Sec. 1.1296-
4 to a closed taxable year for the purpose of determining whether a 
foreign corporation is a PFIC in calculating the taxpayer's liability 
for an open taxable year.

II. Exception for Income Earned in a Securities Business

A. General Rule
    Section 1.1296-6(a) of the proposed regulations provides generally 
that securities income earned by an active securities dealer, active 
securities broker or qualified securities affiliate is nonpassive. As 
required by section 1296(b)(3)(C), the rules apply only for purposes of 
determining whether a controlled foreign corporation (as defined in 
section 957(a)) is a PFIC with respect to its United States 
shareholders (as defined in section 951(b)), or for purposes of 
determining whether an asset is passive under section 956A(c)(2).
B. Active Securities Dealer and Active Securities Broker
    Under Sec. 1.1296-6(b)(1), an active dealer or broker is a dealer 
or broker that meets certain licensing requirements.
    Section 1.1296-6(c) defines a securities dealer as a dealer in 
securities within the meaning of section 475(c)(1). Under Sec. 1.1296-
6(d), a securities broker is a foreign corporation that stands ready to 
effect transactions in securities and other financial instruments for 
the account of customers in the ordinary course of its trade or 
business during the taxable year. A securities dealer or broker is 
licensed under Sec. 1.1296-6(b) if it possesses a U.S. license to do 
business as a securities dealer or broker in the United States or if it 
is licensed or authorized in the country in which it is chartered or 
incorporated to conduct one or more securities activities described in 
Sec. 1.1296-6(e)(2) with residents of that country. The conduct of such 
activities must be subject to bona fide regulation, including 
appropriate reporting, monitoring and prudential requirements, by a 
securities regulatory authority that regularly enforces compliance with 
such standards.
C. Securities Income & Securities Activities
    Section 1.1296-6(e)(1) provides generally that securities income 
means the gross income derived from the active conduct of any 
securities activity that constitutes a trade or business. The list of 
securities activities contained in Sec. 1.1296-6(e)(2) generally is 
consistent with the legislative history to section 1296(b)(3)(A). See 
H.R. Rep. No. 111, 103d Cong., 1st Sess. 704 (1993).
    Section 1.1296-6(e)(2)(iv) includes as an additional securities 
activity the maintenance of a capital deposit required under foreign 
law as a prerequisite to acting as a broker in that jurisdiction. 
Without this rule, a broker that is not also a dealer could be a PFIC 
under section 1296(a)(2) even though the majority of its income is 
commission income. This rule applies only if significant restrictions 
exist on the use of its capital. Thus, working capital will not qualify 
as a deposit for purposes of this rule.
    In general, only income from transactions entered into with, or on 
behalf of, persons with whom the corporation has a dealer-customer 
relationship may be treated as nonpassive. Section 1.1296-6(g) adopts 
without change the definition of dealer-customer relationship contained 
in the bank rules.
    Under Sec. 1.1296-6(h) of the proposed regulations, income and gain 
from a security identified as held for investment under section 
475(b)(1)(A) or which is not held for sale within the meaning of 
section 475(b)(1)(B) is passive. Because the identification rules of 
sections 475(b) and 1.475(b)-1T and 1.475(b)-2T apply, the rules 
governing identification of inventory securities in Notice 88-22, 1988-
1 CB 489 and Notice 89-81, 1989-2 CB 399 do not apply with respect to 
taxable years beginning after September 30, 1993. However, the 
inventory identification rules of Notice 89-81 and Notice 88-22 will 
continue to apply for taxable years beginning before October 1, 1993.
D. Matched Book Income
    Section 1.1296-6(i) of the proposed regulations provides special 
rules for determining a securities dealer's income from certain matched 
transactions. These rules are adopted in order to eliminate a potential 
opportunity for abuse that arises from the manner in which a matched 
book repo business is conducted by securities dealers.
    A matched transaction is defined as a sale and repurchase agreement 
with respect to the same security, entered into by the controlled 
foreign corporation in the active conduct of its trade or business and 
properly treated as offsetting agreements in a matched book. In a 
typical repurchase agreement a taxpayer sells a security and, at the 
same time, agrees to repurchase an identical security from the 
purchaser at a price in excess of the taxpayer's sales price. In a 
reverse repurchase agreement, a taxpayer purchases a security and 
concurrently agrees to sell an identical security to the seller at a 
price in excess of the taxpayer's purchase price. A taxpayer who keeps 
a matched book generally enters into offsetting repurchase and reverse 
repurchase agreements involving identical securities. Such taxpayers 
act as intermediaries by matching persons who need cash for a short 
period with those who need securities for the same period.
    Under the proposed regulations, securities income includes only the 
net (not gross) income from matched transactions. Without the proposed 
regulation's netting rule, related groups that are predominantly 
engaged in passive activities could easily meet the gross income tests 
contained in the qualified affiliate rules because a CFC conducting a 
matched book business will earn large amounts of gross income, even 
though net economic income from matched book activities is 
comparatively small.
E. Affiliates of Dealers or Brokers
    Like banks, securities dealers and brokers frequently operate 
through separately incorporated subsidiaries that may not qualify 
independently as active securities dealers or brokers but which form 
part of an integrated securities business conducted by an active dealer 
or broker. Accordingly, the proposed regulations contain rules that 
extend the [[Page 20926]] securities dealer/broker exception to certain 
qualified affiliates of active securities dealers or brokers. These 
rules generally mirror the qualified bank affiliate rules contained in 
Sec. 1.1296-4(i), except that they extend the securities dealer/broker 
exception only to qualified securities affiliates that are CFCs, as 
required by section 1296(b)(3)(A).
F. Income From Nonsecurities Activities
    Section 1.1296-6(k) of the proposed regulations provides that 
income derived from the conduct of activities other than securities 
activities described in Sec. 1.1296-6(e)(2) and income from assets held 
for the conduct of such activities are nonpassive only to the extent 
provided in section 1296.
G. Effective Date
    The rules contained in Sec. 1.1296-6 are proposed to be effective 
for taxable years beginning after September 30, 1993.

III. Look-Through Rules

    The proposed regulations do not contain guidance regarding the 
look-through rules of sections 1296(c) and 1296(b)(2)(C) or the 
grouping rules of section 956A(d). In general, the proposed regulations 
also do not address whether, and to what extent, look-through 
principles may apply to characterize income from a partnership as 
nonpassive and an interest in a partnership as a nonpassive asset, 
except to the extent that section 475 may treat a partnership as a 
securities dealer. Because these issues are not unique to financial 
institutions, the IRS and Treasury will address them in future 
regulations of more general application. The IRS and Treasury solicit 
comments on the proper scope and application of look-through and 
grouping concepts to banks, securities dealers and securities brokers.

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 August 31, 1995, at 10 
a.m., in the Internal Revenue Service Auditorium, 7400 corridor. 
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 an outline of the topics to be discussed 
and the time to be devoted to each topic (signed original and eight (8) 
copies) by August 10, 1995.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    The principal author of these regulations is Ramon Camacho, Office 
of the Associate Chief Counsel (International). However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for Sections 1.1291-10T, 1.1294-1T, 1.1295-1T, and 
1.1297-3T and adding entries in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *

Section 1.1291-10T also issued under 26 U.S.C. 1291(d)(2).
Section 1.1294-1T also issued under 26 U.S.C. 1294.
Section 1.1295-1T also issued under 26 U.S.C. 1295.
Section 1.1296-4 also issued under 26 U.S.C. 1296(b)(2)(A).
Section 1.1296-6 also issued under 26 U.S.C. 1296(b)(3)(A).
Section 1.1297-3T also issued under 26 U.S.C. 1297(b)(1). * * *


Sec. 1.1291-0T  [Redesignated as Sec. 1.1291-0]

    Par. 2. Section 1.1291-0T is redesignated as Sec. 1.1291-0.
    Par. 3. Newly designated Sec. 1.1291-0 is amended as follows:
    1. The section heading for newly designated Sec. 1.1291-0 is 
revised.
    2. The introductory language for newly designated Sec. 1.1291-0 is 
revised.
    3. Entries for Secs. 1.1296-4 and 1.1296-6 are added in numerical 
order.
    The revisions and additions read as follows:


Sec. 1.1291-0  Passive foreign investment companies--table of contents.

    This section lists headings under sections 1291, 1294, 1296 and 
1297 of the Internal Revenue Code.
* * * * *

Sec. 1.1296-4  Characterization of certain banking income of 
foreign banks as nonpassive.

(a) General rule.
(b) Active bank.
(1) U.S. licensed banks.
(2) Other foreign banks.
(c) Licensing requirements.
(d) Deposit-taking requirements.
(1) General rule.
(2) Deposit.
(3) Substantiality of deposits.
(e) Lending activities test.
(f) Banking income.
(1) General rule.
(2) Banking activities.
(g) Certain restricted reserves.
(h) Customer relationship.
(i) Income earned by qualified bank affiliates.
(1) General rule.
(2) Affiliate income requirement.
(3) Group income requirements.
(4) Related group.
(j) Income from nonbank activities.
(k) Effective date.

Sec. 1.1296-6  Characterization of certain securities income.

(a) General rule.
(b) Active dealer or broker.
(1) General rule.
(2) U.S. licensed dealers and brokers.
(3) Other dealers and brokers.
(i) General rule.
(ii) Licensing requirements.
(c) Securities dealer.
(d) Securities broker.
(e) Securities income.
(1) General rule.
(2) Securities activities.
(f) Certain deposits of capital.
(g) Dealer-customer relationship.
(h) Investment income. [[Page 20927]] 
(i) Calculation of gross income from a matched book.
(j) Income earned by qualified securities affiliates.
(1) General rule.
(2) Affiliate income requirement.
(3) Group income requirements.
(4) Related group.
(5) Example.
(k) Income from nonsecurities activities.
(l) Effective date.
* * * * *
    Par. 4. Section 1.1296-4 is added to read as follows:


Sec. 1.1296-4  Characterization of certain banking income of foreign 
banks as nonpassive.

    (a) General rule. For purposes of section 1296, banking income 
earned by an active bank, as defined in either paragraph (b) (1) or (2) 
of this section, or by a qualified bank affiliate, as defined in 
paragraph (i) of this section, is nonpassive income.
    (b) Active bank--(1) U.S. licensed banks. A corporation (whether 
domestic or foreign) is an active bank if it is licensed by federal or 
state bank regulatory authorities to do business as a bank in the 
United States. A foreign corporation will not satisfy the requirements 
of this paragraph (b)(1) if, under its federal or state license or 
licenses, the foreign corporation is permitted to maintain only an 
office, such as a representative office, that is prohibited by federal 
or state law from taking deposits or making loans.
    (2) Other foreign banks. A foreign corporation is an active bank if 
it meets the licensing requirement of paragraph (c) of this section and 
it actively conducts, within the meaning of Sec. 1.367(a)-2T(b)(3), a 
banking business that is a trade or business within the meaning of 
Sec. 1.367(a)-2T(b)(2). In order for the business conducted by a 
foreign corporation to be considered a banking business, the foreign 
corporation must also meet the deposit-taking requirements of paragraph 
(d) of this section and the lending requirements of paragraph (e) of 
this section.
    (c) Licensing requirements. To be an active bank under paragraph 
(b)(2) of this section, a foreign corporation must be licensed or 
authorized to accept deposits from residents of the country in which it 
is chartered or incorporated and to conduct, in that country, one or 
more of the banking activities described in paragraph (f)(2) of this 
section. However, in no case will a foreign corporation satisfy the 
requirements of this paragraph (c) if one of the principal purposes for 
its obtaining a license or authorization was to satisfy the 
requirements of this section.
    (d) Deposit-taking requirements--(1) General rule. To be an active 
bank under paragraph (b)(2) of this section--
    (i) A foreign corporation must, in the ordinary course of the 
corporation's trade or business, regularly accept deposits from 
customers who are residents of the country in which it is licensed or 
authorized; and
    (ii) The amount of deposits shown on the corporation's balance 
sheet must be substantial.
    (2) Deposit. Whether a liability constitutes a deposit for purposes 
of this paragraph (d) is determined by reference to the characteristics 
of the relevant instrument and does not depend solely on whether the 
instrument is designated as a deposit.
    (3) Substantiality of deposits. Whether the amount of deposits 
(including interbank deposits) shown on a corporation's balance sheet 
is substantial depends on all the facts and circumstances, including 
whether the corporation's capital structure and funding sources as a 
whole are similar to that of banking institutions engaged in the same 
types of activities and subject to the jurisdiction of the same bank 
regulatory authorities.
    (e) Lending activities test. To be an active bank under paragraph 
(b)(2) of this section, a corporation must regularly make loans to 
customers in the ordinary course of its trade or business. A note, 
bond, debenture or other evidence of indebtedness will be treated as a 
loan for purposes of this section only if the debt instrument is 
received by the corporation on an extension of credit made pursuant to 
a loan agreement entered into in the ordinary course of the 
corporation's banking business. Such debt instruments generally will 
not be considered loans for purposes of this section if the instruments 
are not treated as loans (but are classified as securities or other 
investment assets, for example) for purposes of the foreign 
corporation's financial statements.
    (f) Banking income--(1) General rule. Banking income is the gross 
income derived from the active conduct (within the meaning of 
Sec. 1.367(a)-2T(b)(3)) of any banking activity described in paragraph 
(f)(2) of this section.
    (2) Banking activities. For purposes of this section, the following 
are banking activities--
    (i) Lending activities described in paragraph (e) of this section;
    (ii) Factoring evidences of indebtedness for customers;
    (iii) Purchasing, selling, discounting, or negotiating for 
customers notes, drafts, checks, bills of exchange, acceptances, or 
other evidences of indebtedness;
    (iv) Issuing letters of credit and negotiating drafts drawn 
thereunder for customers;
    (v) Performing trust services, including activities as a fiduciary, 
agent or custodian, for customers, provided such trust activities are 
not performed in connection with services provided by a dealer in 
stock, securities or similar financial instruments;
    (vi) Arranging foreign exchange transactions (including any section 
988 transaction within the meaning of section 988(c)(1)) for, or 
engaging in foreign exchange transactions with, customers;
    (vii) Arranging interest rate or currency futures, forwards, 
options or notional principal contracts for, or entering into such 
transactions with, customers;
    (viii) Underwriting issues of stock, debt instruments or other 
securities under best efforts or firm commitment agreements for 
customers;
    (ix) Engaging in finance leases, as defined in Sec. 1.904-
4(e)(2)(i)(V);
    (x) Providing charge and credit card services for customers or 
factoring receivables obtained in the course of providing such 
services;
    (xi) Providing traveler's check and money order services for 
customers;
    (xii) Providing correspondent bank services for customers;
    (xiii) Providing paying agency and collection agency services for 
customers;
    (xiv) Maintaining restricted reserves (including money or 
securities) as described in paragraph (g) of this section; and
    (xv) Any other activity that the Commissioner determines, through a 
revenue ruling or other formal published guidance (see 
Sec. 601.601(d)(2) of this chapter), to be a banking activity generally 
conducted by active banks in the ordinary course of their banking 
business.
    (g) Certain restricted reserves. A deposit of assets in a reserve 
is, for purposes of this section, a banking activity if the deposit is 
maintained in a segregated account in order to satisfy a capital or 
reserve requirement under the laws of a jurisdiction in which the 
corporation actively conducts (within the meaning of Sec. 1.367(a)-
2T(b)(3)) a banking business that is a trade or business (within the 
meaning of Sec. 1.367(a)-2T(b)(2)). A deposit of assets into a reserve 
qualifies under this paragraph (g) if and only to the extent that the 
assets are not available for use in connection with the corporation's 
banking business because of significant [[Page 20928]] regulatory 
restrictions on the investment of such assets. This paragraph (g) does 
not apply to ordinary working capital, which is available for 
unrestricted use.
    (h) Customer relationship. Whether a customer relationship exists 
is determined by reference to all the facts and circumstances. Such a 
relationship does not exist with respect to transactions between 
members of a related group, as defined in paragraph (i)(4) of this 
section, or transactions with any shareholders, officers, directors or 
other employees of any person that would otherwise be treated as an 
active bank or qualified bank affiliate if one of the principal 
purposes for such transactions was to satisfy the requirements of this 
section.
    (i) Income earned by qualified bank affiliates--(1) General rule. A 
foreign corporation that is not an active bank but which derives 
banking income, as defined in paragraph (f)(1) of this section, is a 
qualified bank affiliate for purposes of this section if such 
corporation meets the requirements of paragraph (i)(2) of this section 
and the related group of which it is a member meets the requirements of 
paragraph (i)(3) of this section. Banking income earned by a qualified 
bank affiliate is nonpassive only for purposes of determining whether 
any member of the related group is a passive foreign investment company 
or holds stock in a passive foreign investment company or for purposes 
of applying section 956A(c)(2)(A). However, banking income of a 
qualified bank affiliate remains passive with respect to persons who 
own stock in that affiliate but who are not members of the related 
group of which the affiliate is a member.
    (2) Affiliate income requirement. To be a qualified bank affiliate, 
at least 60 percent of the foreign corporation's total gross income for 
the taxable year must be banking income, securities income, as defined 
in Sec. 1.1296-6(e)(1), or gross income described in section 
1296(b)(2)(B) (relating to insurance activities). For purposes of 
applying this paragraph (i)(2), the look-through rules of sections 
1296(b)(2)(C) and 1296(c) do not apply.
    (3) Group income requirements. The related group qualifies under 
this paragraph (i) if--
    (i) At least 30 percent of the aggregate gross financial services 
income, as defined in Sec. 1.904-4(e)(1), earned during the taxable 
year by members of the related group is banking income earned by active 
banks who are members of the related group during the current taxable 
year; and
    (ii) At least 70 percent of the aggregate gross financial services 
income earned during the taxable year by members of the related group 
is banking income, securities income, or gross income described in 
section 1296(b)(2)(B)(relating to insurance activities).
    (4) Related group. The related group is the group of persons 
consisting of the entity being tested under this paragraph (i) and all 
entities that are related within the meaning of section 954(d)(3) to 
such entity, substituting ``person'' for ``controlled foreign 
corporation'' each time the latter term appears.
    (j) Income from nonbank activities. Income derived from the conduct 
of activities other than banking activities described in paragraph 
(f)(2) of this section and income from assets held for the conduct of 
such other activities are nonpassive only to the extent otherwise 
provided in section 1296.
    (k) Effective date. This section is effective for taxable years 
beginning after December 31, 1994. However, taxpayers may apply this 
section to a taxable year beginning after December 31, 1986, but must 
consistently apply this section to such taxable year and all subsequent 
years.
    Par. 5. Section 1.1296-6 is added to read as follows:


Sec. 1.1296-6  Characterization of certain securities income.

    (a) General rule. For purposes of section 1296, securities income 
earned by an active dealer or active broker, as defined in paragraph 
(b) of this section, or a qualified securities affiliate, as defined in 
paragraph (j) of this section, is nonpassive income. This section 
applies only for purposes of determining whether a controlled foreign 
corporation, as defined in section 957(a), is a passive foreign 
investment company with respect to its United States shareholders as 
defined in section 951(b), or for the purpose of determining whether an 
asset is passive under section 956A(c)(2)(A).
    (b) Active dealer or broker--(1) General rule. A securities dealer, 
as defined in paragraph (c) of this section, or a securities broker, as 
defined in paragraph (d) of this section, is an active dealer or an 
active broker for purposes of this section if it meets the requirements 
of either paragraph (b) (2) or (3) of this section.
    (2) U.S. licensed dealers and brokers. A securities dealer or 
securities broker (whether foreign or domestic) is an active dealer or 
an active broker if it is registered as a securities dealer or broker 
under section 15(a) of the Securities Exchange Act of 1934 or is 
registered as a Government securities dealer or broker under section 
15C(a) of such Act.
    (3) Other dealers and brokers--(i) General rule. A securities 
dealer or a securities broker is an active dealer or an active broker 
if it meets the licensing requirements of paragraph (b)(3)(ii) of this 
section and actively conducts, within the meaning of Sec. 1.367(a)-
2T(b)(3), one or more securities activities, as defined in paragraph 
(e)(2) of this section, as a trade or business within the meaning of 
Sec. 1.367(a)-2T(b)(2).
    (ii) Licensing requirements. To be an active dealer or an active 
broker under paragraph (b)(3) of this section, a securities dealer or 
securities broker must be licensed or authorized in the country in 
which it is chartered, incorporated or organized to conduct one or more 
of the securities activities described in paragraph (e)(2) of this 
section with residents of that country. The conduct of such activities 
must be subject to bona fide regulation, including appropriate 
reporting, monitoring and prudential (including capital adequacy) 
requirements, by a securities regulatory authority in that country that 
regularly enforces compliance with such requirements and prudential 
standards.
    (c) Securities dealer. For purposes of this section, a securities 
dealer is a dealer (whether foreign or domestic) in securities within 
the meaning of section 475(c)(1).
    (d) Securities broker. For purposes of this section, a securities 
broker is a corporation (whether domestic or foreign) that, during its 
taxable year, stands ready, in the ordinary course of its trade or 
business, to effect transactions in securities and other financial 
instruments for the account of customers, including the arrangement of 
loans of securities owned by customers.
    (e) Securities income--(1) General rule. Securities income means 
the gross income (except as provided in paragraph (i) of this section) 
derived from the active conduct (within the meaning of Sec. 1.367(a)-
2T(b)(3)) of any securities activity described in paragraph (e)(2) of 
this section.
    (2) Securities activities. For purposes of this section, the 
following are securities activities--
    (i) Purchasing or selling stock, debt instruments, interest rate or 
currency futures or other securities or derivative financial products 
(including notional principal contracts) from or to customers and 
holding stock, debt instruments and other securities as inventory for 
sale to customers, unless the relevant securities or derivative 
financial products (including notional [[Page 20929]] principal 
contracts) are not held in a dealer capacity;
    (ii) Effecting transactions in securities for customers as a 
securities broker;
    (iii) Arranging futures, forwards, options, or notional principal 
contracts for, or entering into such transactions with, customers;
    (iv) Arranging foreign exchange transactions (including any section 
988 transaction within the meaning of section 988(c)(1)) for, or 
engaging in foreign exchange transactions with, customers;
    (v) Underwriting issues of stocks, debt instruments, or other 
securities under best efforts or firm commitment agreements with 
customers;
    (vi) Purchasing, selling, discounting, or negotiating for customers 
on a regular basis notes, drafts, checks, bills of exchange, 
acceptances or other evidences of indebtedness;
    (vii) Borrowing or lending stocks or securities for customers;
    (viii) Engaging in securities repurchase or reverse repurchase 
transactions with customers;
    (ix) Engaging in hedging activities directly related to another 
securities activity described in this paragraph (e)(2);
    (x) Repackaging mortgages and other financial assets into 
securities and servicing activities with respect to such financial 
assets (including the accrual of interest incidental to such 
activities);
    (xi) Engaging in financing activities typically provided by an 
investment bank, such as--
    (A) Project financing provided in connection with, for example, 
construction projects;
    (B) Structured finance, including the extension of a loan and the 
sale of participations or interests in the loan to other financial 
institutions or investors; and
    (C) Leasing activities to the extent incidental to financing 
activities described in this paragraph (e)(2)(xi) or to advisory 
services described in paragraph (e)(2)(xii) of this section;
    (xii) Providing financial or investment advisory services, 
investment management services, fiduciary services, trust services or 
custodial services;
    (xiii) Providing margin or any other financing for a customer 
secured by securities or money market instruments, including repurchase 
agreements, or providing financing in connection with any of the 
activities listed in paragraphs (e)(2)(i) through (e)(2)(xii) of this 
section;
    (xiv) Maintaining deposits of capital (including money or 
securities) described in paragraph (f) of this section; and
    (xv) Any other activity that the Commissioner determines, through a 
revenue ruling or other formal published guidance, to be a securities 
activity generally conducted by active dealers or active brokers in the 
ordinary course of their securities business.
    (f) Certain deposits of capital. A deposit of capital is, for 
purposes of this section, a securities activity if the deposit is 
maintained in a segregated account in order to satisfy a capital 
requirement for registration as a securities broker or dealer under the 
laws of a jurisdiction in which the broker or dealer actively conducts 
(within the meaning of Sec. 1.367(a)-2T(b)(3)) a trade or business 
(within the meaning of Sec. 1.367(a)-2T(b)(2)) as a securities broker 
or dealer. A deposit of capital qualifies under this paragraph (f) if 
and only to the extent that the assets are not available for use in 
connection with the controlled foreign corporation's activities as a 
securities broker or dealer because of significant regulatory 
restrictions on the investment of such assets. This paragraph (f) does 
not apply to ordinary working capital, which is available for 
unrestricted use.
    (g) Dealer-customer relationship. Whether a dealer-customer 
relationship exists is determined by reference to all the facts and 
circumstances. Such a relationship does not exist with respect to 
transactions between members of a related group, as defined in 
paragraph (j)(4) of this section, or transactions with any 
shareholders, officers, directors or other employees of any person that 
would otherwise be treated as an active dealer, active broker or 
qualified securities affiliate if one of the principal purposes for 
such transactions was to satisfy the requirements of this section.
    (h) Investment income. Income earned on any securities held for 
investment within the meaning of section 475(b)(1)(A) or not held for 
sale within the meaning of section 475(b)(1)(B), is passive for 
purposes of sections 1296(a)(1), 1296(a)(2) and 956A(c)(2)(A).
    (i) Calculation of gross income from a matched book. Securities 
income includes only the net (not gross) income from matched 
transactions. For purposes of this section, a matched transaction is a 
sale and repurchase agreement with respect to the same security 
properly treated as offsetting agreements in a matched book.
    (j) Income earned by qualified securities affiliates--(1) General 
rule. A foreign corporation that is not an active dealer or an active 
broker but which derives securities income described in paragraph 
(e)(1) of this section is a qualified securities affiliate for purposes 
of this section if such corporation meets the requirements of paragraph 
(j)(2) of this section and is a member of a related group that meets 
the requirements of paragraph (j)(3) of this section. Securities income 
earned by a qualified securities affiliate is nonpassive only for 
purposes of determining whether any member of the related group is a 
passive foreign investment company or holds stock in a passive foreign 
investment company or for purposes of applying section 956A(c)(2)(A). 
However, securities income of a qualified securities affiliate remains 
passive with respect to persons who own stock in that affiliate but who 
are not members of the related group of which the affiliate is a 
member.
    (2) Affiliate income requirement. To be a qualified securities 
affiliate, at least 60 percent of the foreign corporation's total gross 
income for the taxable year must be banking income, as defined in 
Sec. 1.1296-4(f)(1), securities income, as defined in paragraph (e)(1) 
of this section, or gross income described in section 1296(b)(2)(B) 
(relating to insurance activities). For purposes of this paragraph 
(j)(2), the look-through rules of sections 1296(b)(2)(C) and 1296(c) do 
not apply.
    (3) Group income requirements. The related group qualifies under 
this paragraph (j) if--
    (i) At least 30 percent of the aggregate gross financial services 
income, as defined in Sec. 1.904-4(e)(1), earned during the taxable 
year by members of the related group is securities income earned by 
active dealers or active brokers who are members of the related group 
during the current taxable year; and
    (ii) At least 70 percent of the aggregate gross financial services 
income earned during the taxable year by members of the related group 
is banking income, securities income, or gross income described in 
section 1296(b)(2)(B) (relating to insurance activities).
    (4) Related group. The related group is the group of persons 
consisting of the entity being tested under this paragraph (j) and all 
entities that are related within the meaning of section 954(d)(3) to 
such entity, substituting ``person'' for ``controlled foreign 
corporation'' each time the latter term appears.
    (5) Example. The following example illustrates the rules of this 
paragraph (j).

    Example. (i) Facts. SD is a country Y corporation that owns 85 
percent of the stock of M, a country Z corporation. A, a U.S. 
person, owns the remaining 15 percent of the stock of M. B, C, and 
D, all unrelated U.S. persons, own 5, 15, and 36 percent, 
respectively, of the stock of SD. The rest of SD's stock is publicly 
held. SD is a securities dealer within the meaning of section 
[[Page 20930]] 475(c)(1) and satisfies the licensing requirements of 
paragraph (b)(3)(ii) of this section. Because M's sole activity is 
conducting a matched book repo business, M is not a securities 
dealer within the meaning of section 475. For its taxable year 
ending December 31, 1994, SD earns $100 of gross income from trading 
profits and interest and dividends on inventory. For its taxable 
year ending December 31, 1994, M earns $50 of net interest income 
from its matched book repo business. SD and M earn no other income. 
All of SD and M's assets are held in connection with their 
securities businesses and none has been identified as having been 
held for investment.
    (ii) Securities income earned by SD. SD is an active dealer 
under paragraph (b) of this section because it is a securities 
dealer under section 475 and satisfies the licensing requirements of 
paragraph (b)(3)(ii) of this section. Therefore, because SD is a 
controlled foreign corporation, SD's securities income is nonpassive 
under paragraph (a) of this section.
    (iii) Securities income earned by M. (A) SD and M are financial 
services entities that are the only members of a related group as 
defined in paragraph (j)(4) of this section. The percentage of the 
SD-M related group's financial services income that is securities 
income earned by active dealers (SD), is 66.66 percent (($100/$150) 
X 100). The percentage of the SD-M related group's financial 
services income that is securities income, banking income (as 
defined in Sec. 1.1296-4(f)), or insurance income (as defined in 
section 1296(b)(2)(B)) is 100 percent (($150/$150) x 100). In 
addition, the percentage of M's income that is securities income is 
100 percent (($50/$50) x 100).
    (B) M is a qualified securities affiliate because the gross 
income tests of paragraphs (j)(2) and (3) of this section are 
satisfied. Accordingly, because M is a controlled foreign 
corporation, M's securities income is nonpassive for purposes of 
determining whether C or D own an interest in a PFIC (whether SD or 
M). M is thus not a PFIC with respect to C or D because it does not 
meet the income or asset tests of section 1296(a). SD also is not a 
PFIC with respect to C or D because it does not meet the income or 
assets tests of section 1296(a), after applying the look-through 
rule of section 1296(c).
    (C) However, because B owns less than 10 percent of the stock of 
SD, and is therefore not a United States shareholder with respect to 
SD under section 951(b), M's interest income is passive (even though 
it is securities income) for purposes of determining whether B's 
indirect interest in M is an interest in a PFIC. Moreover, M's 
interest income is passive for purposes of determining whether A 
owns an interest in a PFIC. As a result, M meets the income and 
asset tests of section 1296(a) and is therefore a PFIC with respect 
to A and B.

    (k) Income from nonsecurities activities. Income derived from the 
conduct of activities other than securities activities described in 
paragraph (e)(2) of this section and income from assets held for the 
conduct of such other activities are nonpassive only to the extent 
otherwise provided in section 1296.
    (l) Effective date. This section is effective for taxable years 
beginning after September 30, 1993.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-10174 Filed 4-27-95; 8:45 am]
BILLING CODE 4830-01-U