[Federal Register Volume 60, Number 154 (Thursday, August 10, 1995)]
[Proposed Rules]
[Pages 40796-40797]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-19448]



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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[PS-29-92]
RIN 1545-AQ64


Diversification of Common Trust Funds

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of Proposed Rulemaking.

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SUMMARY: This document proposes regulations relating to the 
diversification of common trust funds at the time of a combination or 
division. The proposed regulations will affect common trust funds and 
their participants.

DATES: Written comments and requests for a public hearing must be 
received by November 8, 1995.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (PS-29-92), 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 (PS-29-92), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW., 
Washington, DC.

FOR FURTHER INFORMATION CONTACT: Brian J. O'Connor, (202) 622-3060 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document proposes amendments to the Income Tax Regulations (26 
CFR part 1) under section 584 of the Internal Revenue Code of 1986 
relating to common trust funds.
    A common trust fund is an investment vehicle set up by a bank in 
the form of a state-law trust. The investors in a common trust fund, 
referred to as participants, are trusts and certain other accounts for 
which the bank acts as a fiduciary.
    Section 584(b) provides that a common trust fund is not subject to 
taxation. Instead, each participant that invests in the common trust 
fund includes its proportionate share of the common trust fund's income 
or loss on its own return.
    Under section 584(e), the contribution of property to a common 
trust fund is a taxable event to the contributing participant. This 
provision was added to section 584(e) by the Tax Reform Act of 1976 and 
was intended to prevent participants from using a common trust fund to 
diversify their portfolios tax-free. Accordingly, the legislative 
history to the 1976 amendment indicates that mergers or divisions of 
common trust funds will continue to be tax-free as long as the 
combining or dividing funds have portfolios that are diversified within 
the meaning of the corporate merger rules. S. Rep. No. 938, pt. 2, 94th 
Cong., 2d Sess. 48 (1976), 1976-3 (Vol. 3) C.B. 643, 690. The 
diversification test for corporate mergers, section 368(a)(2)(F)(ii), 
was enacted in 1976 as part of the same legislation.
    Section 1.584-4(a), promulgated in 1984 and based on the 1976 
amendment, provides that the transfer of a participating interest as a 
result of the combination of two or more common trust funds, or the 
division of a single common trust fund, is not considered an admission 
or a withdrawal if the combining, dividing, and resulting funds have 
diversified portfolios within the meaning of section 368(a)(2)(F)(ii).
    Under section 368(a)(2)(F)(ii), a corporation has a diversified 
portfolio if not more than 25 percent of the value of its total assets 
is invested in the stock and securities of any one issuer and not more 
than 50 percent of the value of its total assets is invested in the 
stock and securities of five or fewer issuers. For purposes of the 
section 368(a)(2)(F)(ii) test, all members of a controlled group of 
corporations (within the meaning of section 1563(a)) shall be treated 
as one issuer. Also, a person holding stock in a regulated investment 
company, real estate investment trust, or other investment company (as 
defined by section 368(a)(2)(F)(iii)) that meets the requirements of 
section 368(a)(2)(F)(ii) shall be treated as holding its proportionate 
share of the assets held by the company. Section 368(a)(2)(F)(iv) 
provides that in determining total assets, certain assets shall be 
excluded, including cash and cash items (including receivables), 
Government securities, and assets acquired to meet section 
368(a)(2)(F)(ii) or to cease to be an investment company. Section 
368(a)(2)(F)(v) provides that section 368(a)(2)(F) shall not apply if 
the stock of each investment company is owned substantially by the same 
persons in the same proportions. Section 368(a)(2)(F)(vii) defines 
securities for purposes of clauses (ii) and (iii) of section 
368(a)(2)(F).
Reasons for Change

    Excluding Government securities from a common trust fund's total 
assets pursuant to section 368(a)(2)(F)(iv) could inappropriately cause 
a fund with investments in Government securities to fail to be 
diversified under section 368(a)(2)(F)(ii). For example, if 95 percent 
of a common trust fund's assets are invested in Government securities 
and five percent are invested in the stock of corporation X, only five 
percent of the fund's total assets (that is, only the X stock) would be 
included in total assets in applying section 368(a)(2)(F)(ii). As a 
result, the X stock would be treated as constituting 100 percent of the 
common trust fund's assets and the fund would not satisfy the 25 and 50 
percent test of section 368(a)(2)(F)(ii). Because excluding Government 
securities from a common trust fund's total assets could cause a fund 
with investments in Government securities to fail to be diversified 
under section 368(a)(2)(F)(ii), common trust funds might be discouraged 
from investing in Government securities.

Explanation of Provisions

    Under the proposed amendment to Sec. 1.584-4(a), the 
diversification test applied to a common trust fund at the time of a 
merger or division will continue to be section 368(a)(2)(F)(ii). 
However, the test is modified so that Government securities are now 
counted in determining a fund's total assets, unless the Government 
securities are acquired to meet section 368(a)(2)(F)(ii).
    For purposes of Sec. 1.584-4(a), relevant provisions of section 
368(a)(2)(F) will apply to the section 368(a)(2)(F)(ii) test. Those 
provisions include the controlled group and look-through rules found in 
clause (ii) (members of a controlled group of corporations are 
considered as one issuer and persons holding stock in certain 
investment companies are treated as holding a proportionate share of 
the investment company's assets), the common ownership rule found in 
clause (v) (diversification will not be considered to occur if the 
interests in 

[[Page 40797]]
the common trust funds transferred are held substantially by the same 
persons in the same proportions), and the definition of securities 
found in clause (vii) (the term securities includes investments 
constituting a security within the meaning of the Investment Company 
Act of 1940 (15 U.S.C. 80a-2(36)). The definition of total assets in 
section 368(a)(2)(F)(iv) will apply, except that, as stated above, 
Government securities will be included in determining total assets, 
unless the Government securities are acquired to meet section 
368(a)(2)(F)(ii).
    The proposed regulations contain the same diversification test as 
that in the proposed regulations under section 351(e) dealing with 
transfers to investment companies. Thus, these proposed regulations 
would ensure that a uniform diversification test is applied to common 
trust funds and similar investment entities.
    The proposed regulations also update the regulations under section 
584 to conform to changes in the law.

Proposed Effective Date

    These regulations are proposed to apply to combinations and 
divisions of common trust funds consummated on or after the date of 
publication as final regulations in the Federal Register.

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 Requests for a 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 may be scheduled if requested in writing by a person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the hearing will be published 
in the Federal Register.

Drafting Information

    The principal author of these regulations is Brian J. O'Connor, 
Office of Assistant Chief Counsel (Passthroughs and Special 
Industries). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations
    Accordingly, 26 CFR part 1, is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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


Sec. 1.584-2  [Amended]

    Par. 2. Section 1.584-2 is amended by:
    1. Removing paragraph (b)(1).
    2. Redesignating paragraph (b)(2) as paragraph (b).
    Par. 3. Section 1.584-4 is amended by:
    1. Removing paragraphs (a)(1) and (a)(2).
    2. Revising the sixth sentence of paragraph (a).
    3. Adding two sentences after the sixth sentence of paragraph (a).
    The revision and additions read as follows:


Sec. 1.584-4  Admission and withdrawal of participants in the common 
trust fund.

    (a) * * * When a participating interest is transferred by a bank, 
or by two or more banks that are members of the same affiliated group 
(within the meaning of section 1504), as a result of the combination of 
two or more common trust funds or the division of a single common trust 
fund, the transfer to the surviving or divided fund is not considered 
to be an admission or a withdrawal if the combining, dividing, and 
resulting common trust funds have diversified portfolios. For purposes 
of this paragraph, a common trust fund has a diversified portfolio if 
it satisfies section 368(a)(2)(F)(ii), applying the relevant provisions 
of section 368(a)(2)(F), except that, in applying section 
368(a)(2)(F)(iv), Government securities are included in determining 
total assets, unless the Government securities are acquired to meet 
section 368(a)(2)(F)(ii). In addition, for a transfer of a 
participating interest in a division of a common trust fund not to be 
considered an admission or withdrawal, each participant's pro rata 
interest in each of the resulting common trust funds must be 
substantially the same as was the participant's pro rata interest in 
the dividing fund.
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 95-19448 Filed 8-9-95; 8:45 am]
BILLING CODE 4830-01-U