[Federal Register Volume 61, Number 248 (Tuesday, December 24, 1996)]
[Proposed Rules]
[Pages 67752-67760]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32247]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-209040-88]
RIN 1545-AM41


Qualified Electing Fund Elections

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations permitting certain 
shareholders to make a special election under section 1295, in lieu of 
the election currently provided for under that section, with respect to 
certain preferred shares of a passive foreign investment company 
(PFIC). A shareholder that makes a special election must account for 
dividend income on the shares subject to the special election under 
special income inclusion rules, rather than under the general income 
inclusion rules of section 1293. This document also provides notice of 
a public hearing on these proposed regulations.

DATES: Written comments must be received by March 24, 1997. Requests to 
speak and outlines of oral comments to be discussed at the public 
hearing scheduled for May 8, 1997, at 10:00 a.m. must be received by 
April 17, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-209040-88), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-209040-88), Courier's 
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington, DC. Alternatively, taxpayers may submit comments 
electronically via the Internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The public hearing will be held in room 3313, Internal 
Revenue Building, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Judith 
Cavell Cohen, (202) 622-3880; concerning submissions and the hearing, 
Evangelista Lee, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of

[[Page 67753]]

Information and Regulatory Affairs, Washington, DC 20503, with copies 
to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, 
T:FP, Washington, DC 20224. Comments on the collection of information 
should be received by February 24, 1997. Comments are specifically 
requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The collection of information in this proposed regulation is in 
proposed regulation Sec. 1.1295-2(c)(3) and proposed regulation 
Sec. 1.1295-2(e) and (f). This information will notify the Commissioner 
that certain shareholders have made the special election. In addition, 
this information will enable the IRS to determine if a shareholder 
qualifies for the special election and is satisfying the income 
inclusion requirements of proposed regulation Sec. 1.1293-2. The 
collection of information is mandatory. The likely respondents are 
individuals, businesses, and other for-profit organizations.
    Estimated total annual reporting/recordkeeping burden: 600 hours. 
The estimated annual burden per respondent varies from 21 minutes to 
8.3 hours, depending on individual circumstances, with an estimated 
average of 35 minutes.
    Estimated number of respondents: 1030.
    Estimated annual frequency of responses: On occasion.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains proposed Income Tax Regulations (26 CFR part 
1) under sections 1293 and 1295 of the Internal Revenue Code. Sections 
1293 and 1295 were added by the Tax Reform Act of 1986 (the Act) and 
were amended by the Technical and Miscellaneous Revenue Act of 1988 
(TAMRA). The sections, as amended, were effective for taxable years of 
foreign corporations beginning after December 31, 1986. Section 1293 
also was amended by the Omnibus Reconciliation Act of 1993 (OBRA). 
Guidance for making the section 1295 election was provided in proposed 
regulation Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535. Guidance 
regarding the annual income inclusion rule for shareholders making a 
section 1295 election was provided in proposed regulation Sec. 1.1293-
1.

Explanation of Provisions

Special Preferred Section 1295 Election

1. Introduction
    The passive foreign investment company (PFIC) rules of the Code are 
designed to eliminate potential tax deferral opportunities associated 
with equity investments by United States persons in foreign 
corporations that have substantial levels of passive income or assets. 
The PFIC rules eliminate tax deferral opportunities by applying the 
section 1291 interest charge regime to PFIC shareholders that fail to 
make a section 1295 annual income inclusion election (section 1295 
election). In general, the section 1291 interest charge regime applies 
to the ``extraordinary'' portion of any distribution received by the 
shareholder, and any gain recognized on a disposition of shares.
    The PFIC rules apply to investments in both common and preferred 
shares of a PFIC. Preferred shares, unlike common shares, generally 
provide for limited dividend and liquidation or redemption rights, and 
thus do not participate significantly in corporate growth. Accordingly, 
preferred shares of a PFIC generally do not afford U.S. investors with 
the same potential for U.S. tax deferral as common shares of a PFIC.
    Preferred shareholders, like common shareholders, may make the 
section 1295 election to avoid the interest charge regime of section 
1291. Shareholders that make the section 1295 election are required 
under section 1293 to include in income annually, as ordinary income, 
their pro rata share of the PFIC's ordinary earnings and, as long-term 
capital gain, their pro rata share of the PFIC's net capital gain for 
the year. In order to determine their pro rata share of ordinary 
earnings and net capital gain, shareholders that have made a section 
1295 election must obtain certain U.S. tax accounting information from 
the PFIC regarding the PFIC's earnings. If this information is not 
available, the shareholders cannot make the section 1295 election. If 
the requisite information is available, the annual information 
reporting and collection requirements associated with the section 1295 
election may render the election impractical for smaller investors. 
Because preferred shares often do not afford investors with significant 
tax-deferral opportunity, commenters have suggested that the current 
section 1295 election regime should be simplified for certain types of 
preferred shares.
    The proposed regulations adopt a special section 1295 election 
regime that would require holders of certain preferred shares of a PFIC 
that elect to be subject to the regime to accrue annually ordinary 
dividend income with respect to the preferred shares regardless of the 
holder's pro rata share of ordinary earnings or net capital gain of the 
PFIC for the year. Because shareholders would accrue income regardless 
of the earnings and net capital gain of the PFIC, shareholders that 
elect to be subject to the regime would not have to report and collect 
any U.S. tax accounting information regarding the PFIC in order to make 
the special section 1295 election.
    The proposed regulations are issued under two sections of the Code. 
Section 1.1295-2 of the proposed regulations provides rules for making 
a QEF election under the special proposed section 1295 election regime 
(special preferred QEF election). Section 1.1293-2 describes the annual 
income inclusion rules for shareholders that have made the special 
preferred QEF election.
    The proposed regulations would apply only with respect to 
qualifying preferred shares issued after the date the proposed 
regulations are finalized.
2. Rules for Making the Special Preferred QEF Election
    Under proposed regulation Sec. 1.1295-2(a), the special preferred 
QEF election may be made in lieu of the section 1295 election described 
in proposed regulation Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535 
(regular section 1295 election), with respect to certain types of 
preferred shares (qualified

[[Page 67754]]

preferred shares) by certain holders satisfying prescribed ownership 
requirements.
    The special preferred QEF election may only be made with respect to 
qualified preferred shares as defined in proposed regulation 
Sec. 1.1295-2(b). To ensure that the special preferred QEF election 
cannot be used for tax avoidance purposes and to reduce complexity, the 
proposed regulations define qualified preferred shares narrowly to 
include only a limited class of preferred shares likely to be marketed 
to U.S. retail investors. Although the definition of qualified 
preferred shares includes both cumulative and non-cumulative preferred 
shares, the definition excludes various types of preferred shares, 
including preferred shares denominated in a foreign currency and 
preferred shares issued at a significant discount to their liquidation 
or redemption amounts. The PFIC issuing the preferred shares must 
represent that it intends to pay dividends currently. Proposed 
regulation Sec. 1.1295-2(b) provides additional restrictions with 
respect to preferred shares acquired in secondary market transactions.
    Proposed regulation Sec. 1.1295-2(c) describes shareholders who may 
make the election. Under proposed regulation Sec. 1.1295-2(c)(1), any 
United States person that acquires qualified preferred shares for cash 
or in certain nonrecognition transactions and that holds such shares 
directly may make the election. United States persons that are pass-
through entities, including partnerships, S corporations, trusts and 
estates, may qualify as shareholders.
    The special preferred QEF election regime is narrowly targeted to 
eliminate certain of the information reporting and collection 
requirements associated with the existing section 1295 election and 
annual inclusion rules for U.S. retail investors in preferred shares of 
PFICs. Treasury and the Service believe that the special preferred QEF 
election regime should only apply with respect to foreign corporations 
that are not expected to be in a position to provide U.S. tax 
accounting information to shareholders. Accordingly, proposed 
regulation Sec. 1.1295-2(c)(2) provides that the special preferred QEF 
election does not apply to holders of preferred shares in a PFIC that 
is a controlled foreign corporation. Further, proposed regulation 
Sec. 1.1295-2(c)(3) provides that the special preferred QEF election 
does not apply to holders that own 5 percent or more of the vote or 
value of any class of shares of the PFIC. Holders of five percent or 
more of the vote or value of any class of shares generally are not the 
type of retail investor that the proposed regulations are designed to 
assist. Such holders may only make the section 1295 election provided 
under current rules.
    Proposed regulation Sec. 1.1295-2(c)(3) requires the corporation to 
provide to electing shareholders a statement, directly or in a 
disclosure document generally available to all U.S. shareholders, 
either that it is or that it reasonably believes that it is a PFIC and 
that it is not a controlled foreign corporation. Shareholders that fail 
to receive such a statement are not permitted to make a special 
preferred QEF election.
    Proposed regulation Sec. 1.1295-2(d) describes the effect of the 
special preferred QEF election. Proposed regulation Sec. 1.1295-2(d)(1) 
provides that shares subject to a special preferred QEF election will 
be treated as shares of a pedigreed QEF (as defined in proposed 
regulation Sec. 1.1291-1(b)(2)(ii)) for all taxable years of the 
foreign corporation that are included wholly or partly in the 
shareholder's holding period of the shares. Under the proposed 
regulations, the election will apply to all qualified preferred shares 
of a foreign corporation owned directly by the shareholder that are 
acquired in the taxable year with respect to which the election is 
made. Although a special preferred QEF election will not apply 
automatically to qualified preferred shares acquired in subsequent 
taxable years of a shareholder, the proposed regulations permit the 
shareholder to make separate special preferred QEF elections with 
respect to qualified preferred shares acquired in later years.
    Proposed regulation Sec. 1.1295-2(d)(2) provides that the special 
preferred QEF election regime applies whether or not the foreign 
corporation is a PFIC in any year subsequent to the year of the 
election. Accordingly, shareholders that make the special preferred QEF 
election must make annual Sec. 1.1293-2 income inclusions, as provided 
in proposed regulation Sec. 1.1295-2(d)(3), even if the foreign 
corporation does not qualify as a PFIC for a particular year.
    Proposed regulation Sec. 1.1295-2(e) specifies the time and manner 
of making the special preferred QEF election. In order to make the 
special preferred QEF election, a shareholder files Form 8621 (Return 
by a Shareholder of a Passive Foreign Investment Company or Qualified 
Electing Fund), for the taxable year of the election, checking the 
appropriate box in Form 8621, Part I, for making the section 1295 
election, and indicating in the margin of Part I that the shareholder 
is making a special preferred QEF election with respect to certain 
specified shares. In addition, the shareholder must attach to Form 8621 
a brief statement containing the information and representations 
contained in proposed regulation Sec. 1.1295-2(e)(2)(ii). Under 
proposed regulation Sec. 1.1295-2(f), in subsequent years, the 
shareholder must file Form 8621 with respect to the foreign corporation 
but need not attach any statement to the form. For all taxable years 
covered by the election, the shareholder must report on Line 6a of Part 
II of Form 8621 the amount includible under proposed regulation 
Sec. 1.1293-2 with respect to qualified preferred shares subject to a 
special preferred QEF election.
    Proposed regulation Sec. 1.1293-2(g) states that a sale, exchange 
or other disposition of shares subject to a special preferred QEF 
election terminates the election with respect to those shares. Also, 
the Commissioner may terminate or invalidate an election if a 
shareholder fails to satisfy the initial or ongoing requirements of the 
election. For example, the Commissioner may terminate or invalidate a 
special preferred QEF election if the shareholder owns five percent or 
more of the vote or value of any class of shares of the PFIC at any 
time during the period that the shareholder owns qualified preferred 
shares subject to the election. A shareholder may not itself terminate 
a special preferred QEF election.
3. Annual Inclusion Rules for Electing Shareholders.
    Under proposed regulation Sec. 1.1293-2(a), a shareholder that has 
made a special preferred QEF election must make annual income 
inclusions with respect to qualified preferred shares subject to the 
election. Unlike the annual income inclusions provided under section 
1293 and proposed regulation Sec. 1.1293-1, the annual inclusions under 
the special preferred QEF election regime are determined without regard 
to the shareholder's pro rata share of the foreign corporation's 
ordinary earnings or net capital gains.
    Proposed regulation Sec. 1.1293-2(b) provides rules for determining 
the amount that a shareholder must include in income annually under the 
special preferred QEF election regime. Under the proposed regulations, 
this annual amount consists of two components. The first component is 
an annual inclusion amount based on a ratable daily portion of dividend 
income that accrues on the qualified preferred shares (annual dividend 
amount). This ratable inclusion rule for the annual dividend amount is 
analogous to the rule for inclusion of income with respect to

[[Page 67755]]

periodic payments on notional principal contracts under Sec. 1.446-3. 
The second component of the preferred QEF amount arises only in respect 
of fixed term preferred shares, as described proposed regulation 
Sec. 1.1295-2(b)(vii), acquired in a secondary market transaction, and 
is calculated based on the ratable inclusion of the excess, if any, of 
the redemption price of the shares over the acquisition cost of the 
shares (preferred discount amount). This ratable inclusion rule for the 
preferred discount amount is analogous to the rule for the ratable 
inclusion of market discount on certain debt under section 1276(b)(1). 
The Service and Treasury solicit comments regarding the income 
inclusion rules of the proposed regulations, including comments as to 
whether foreign corporations and their agents could effectively assist 
holders in complying with the income inclusion rules applicable to 
preferred discount.
    Proposed regulation Sec. 1.1293-2(c) provides certain special rules 
regarding the annual income inclusion required under proposed 
regulation Sec. 1.1293-2(a). Under Sec. 1.1293-2(c)(1), annual amounts 
are included in income by shareholders irrespective of the PFIC's 
earnings and profits. In this regard, the special preferred QEF 
election differs from the regular section 1295 election in that 
shareholders making the special preferred QEF election must accrue the 
annual amount as ordinary income even if the amount exceeds the 
shareholder's pro rata share of the foreign corporation's earnings and 
profits. Proposed regulation Sec. 1.1293-2(c)(3) requires the 
shareholder to include the annual dividend amount as ordinary income 
regardless of whether any portion of the PFIC's earnings for the year 
represents net capital gain. Proposed regulation Sec. 1.1293-2(c)(4) 
provides rules for the tax-free distribution of previously taxed 
amounts. Proposed regulation Sec. 1.1293-2(c)(5) provides certain basis 
adjustment rules similar to the basis adjustment rule of section 
1293(d). Finally, proposed regulation Sec. 1.1293-2(c)(6) provides 
rules intended to limit the effect of a special preferred QEF election 
to the shareholder making the election. Accordingly, a special 
preferred QEF election will not affect the foreign corporation's 
calculation of its earnings and profits, and will have no consequences 
for shareholders that have not made a special preferred QEF election.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It is hereby 
certified that these regulations do not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that these regulations represent a wholly elective 
simpler alternative to the section 1295 election described in 
Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535, and impose a lighter 
collection of information burden. Further, the requirement that 
electing shareholders indicate their special election on Form 8621 
annually and attach a statement, providing certain information in the 
first year of the election only, is minimal and will not impose a 
significant economic impact on electing shareholders. Therefore, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the 
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 May 8, 1997, at 10:00 a.m. 
in room 3313, Internal Revenue Building, 1111 Constitution Avenue, NW., 
Washington DC. Because of access restrictions, visitors will not be 
admitted beyond the Internal Revenue Building lobby more than 15 
minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments by March 24, 1997, and submit an outline of the 
topics to be discussed and the time to be devoted to each topic (signed 
original and eight (8) copies) by April 17, 1997.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the schedule of 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 Judith Cavell Cohen of 
the Office of Associate Chief Counsel (International).
    However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
an entry in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.1293-2 also issued under 26 U.S.C. 1297(f).
    Section 1.1295-2 also issued under 26 U.S.C. 1297(f). * * *

    Par. 2. Section 1.1293-2 is added to read as follows:


Sec. 1.1293-2  Special Inclusion Rules for Special Preferred QEF 
Election.

    (a) In general. A shareholder (including a shareholder that is a 
pass-through entity, as described in Sec. 1.1295-2(c)(1)) that makes a 
special preferred QEF election under Sec. 1.1295-2 must, regardless of 
the shareholder's method of accounting, include in income in respect of 
each share subject to the election, an annual amount (preferred QEF 
amount) determined according to the rules of paragraph (b) of this 
section. A shareholder that makes a special preferred QEF election must 
include the preferred QEF amount in income under this section for each 
year in which the taxpayer continues to hold a share that is subject to 
the election. The rules of this section apply in lieu of the general 
rules of section 1293 and Sec. 1.1293-1.\1\
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    \1\ This proposed regulation was published on April 1, 1992, at 
57 FR 11024.
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    (b) Preferred QEF amount--(1) In general. The preferred QEF amount 
for any share subject to a special preferred QEF election is the sum of 
the ratable daily portion of each periodic dividend amount (as 
described in paragraph (b)(2) of this section) on the share for the 
taxable year of the shareholder to which that portion relates, plus the 
preferred discount amount (as defined below), if any, for the taxable 
year. For purposes of this section, the preferred discount amount for a 
taxable year is the amount that bears the same ratio to the total 
amount of preferred discount (as described in Sec. 1.1295-2(b)(2)(i)) 
on the share as the number of days that the taxpayer held the share in 
the taxable

[[Page 67756]]

year bears to the number of days after the date the taxpayer acquired 
the share and up to (and including) the share's redemption date as 
established under the principles of Sec. 1.305-5(b). Notwithstanding 
the preceding sentence, the preferred discount amount for a taxable 
year is zero if the preferred discount on the share at the time of its 
acquisition by the shareholder was less than an amount equal to \1/4\ 
of 1 percent of the redemption price of the stock, multiplied by the 
number of complete years from the date of acquisition of the stock to 
the redemption date of the stock.
    (2) Periodic dividend amount. A periodic dividend amount is the 
amount payable with respect to a share, whether on a cumulative or 
noncumulative basis, for a period (wholly or partly within the 
shareholder's taxable year) for which dividends on the share are 
calculated based upon the redemption or liquidation price of the share 
multiplied by a fixed percentage rate.
    (c) Special rules of application--(1) Earnings and profits 
disregarded. The amounts to be included in income pursuant to this 
section are determined without regard to the earnings and profits of 
the foreign corporation with respect to which the special preferred QEF 
election applies.
    (2) Year of inclusion. The shareholder includes the preferred QEF 
amount in its taxable year without regard to the taxable year of the 
foreign corporation with respect to which the special preferred QEF 
election applies.
    (3) Character of inclusions. The shareholder includes all preferred 
QEF amounts in income as ordinary earnings.
    (4) Treatment of distributions. Distributions received by a 
shareholder on shares subject to a special preferred QEF election that 
are paid out of earnings and profits of the foreign corporation are not 
included in gross income of the shareholder to the extent the 
distributions do not exceed the preferred QEF amounts (other than any 
portion of preferred QEF amounts consisting of preferred discount 
amounts) previously includible in income pursuant to this section. 
These distributions will, however, be treated as dividends for all 
other purposes of the Code and regulations. Amounts distributed to a 
shareholder with respect to shares subject to a special preferred QEF 
election that exceed amounts previously included in income under this 
section with respect to such shares are treated for all purposes of the 
Code and regulations as a distribution of property subject to the rules 
of section 301.
    (5) Basis adjustment rules. The adjusted basis of a shareholder in 
shares that are subject to a special preferred QEF election shall be--
    (i) Increased by any amount that is included in the gross income of 
the shareholder under paragraph (a) of this section; and
    (ii) Decreased by any dividends (not to exceed the amount included 
in gross income under paragraph (a) of this section) actually paid to 
the shareholder in respect of such shares.
    (6) Effect limited to electing shareholder. This section does not 
apply to the foreign corporation with respect to which a special 
preferred QEF election applies. Accordingly, the provisions of this 
section will not affect the foreign corporation's calculation of its 
earnings and profits for any purpose of the Code or regulations. In 
addition, the rules of this section apply only for purposes of 
determining the tax consequences for holders of shares subject to the 
election. Thus, the election shall have no effect on the application of 
the Code or regulations with respect to the tax consequences of the 
ownership of shares that are not subject to the election, including for 
purposes of determining whether any distributions from the foreign 
corporation with respect to such shares should be treated as having 
been included in the income of any United States person pursuant to 
section 1293(c) or section 959.
    (d) Examples. The following examples illustrate the rules of 
paragraphs (a), (b) and (c) of this section. Although these examples 
assume a 30-day month, 360-day year, any reasonable counting method may 
be used to compute the length of accrual periods. For purposes of 
simplicity, the relevant amounts as stated are rounded to two decimal 
places. However, the computations do not reflect any such rounding 
convention. The examples are as follows:

    Example 1. Preferred QEF amount--(i) Facts. (A) On May 1, 1998, 
A, an individual who files his returns on a calendar year basis, 
purchased for $10,000 in a single secondary market transaction 100 
shares of nonconvertible Class A $100 par value preferred stock (the 
Class A Stock) of FC, a foreign corporation with a taxable year 
ending on March 31.
    (B) The terms of the Class A Stock provide for a mandatory 
redemption of the Class A Stock by the issuer at par on June 1, 
2012. The Class A Stock is not redeemable pursuant to an issuer call 
or holder put on any other date. Each share of Class A Stock 
provides for a semi-annual cumulative distribution payable in 
dollars on June 1 and December 1 equal to one-half the product of 
the par value of the Class A Stock and the applicable annual dollar 
LIBOR in effect on the distribution date immediately prior to the 
relevant distribution date. The shares of the Class A stock are 
qualified preferred shares in the hands of A. A purchases no other 
qualified preferred shares of FC during its 1998 or 1999 taxable 
years.
    (C) A made a special preferred QEF election for A's taxable year 
ended December 31, 1998, which applies to the Class A Stock acquired 
by A on May 1, 1998. FC is a PFIC under section 1296 for its taxable 
year ending March 31, 1999, but FC is not a PFIC for its taxable 
year ending March 31, 2000. FC paid no current dividends on June 1, 
1998, and December 1, 1998, paid the June 1, 1999, dividend 
currently on June 1, 1999, together with accumulated distributions 
from June 1, 1998, and December 1, 1998, and paid the December 1, 
1999, dividend currently on December 1, 1999. The applicable annual 
LIBOR is 8 percent on December 1, 1997, 7 percent on June 1, 1998, 9 
percent on December 1, 1998, 10 percent on June 1, 1999, and 9 
percent on December 1, 1999. FC had sufficient earnings and profits, 
within the meaning of section 312, for its taxable year ending on 
March 31, 2000, so that actual distributions to all shareholders of 
Class A Stock in that year were treated as paid out of earnings and 
profits of FC.
    (ii) Tax consequences to A for A's taxable year ending December 
31, 1998. As required under paragraph (a) of this section, A must 
include in gross income for its 1998 taxable year the 1998 preferred 
QEF amount. The preferred QEF amount, as determined under paragraph 
(b) of this section, for A's 1998 taxable year is the ratable 
portion of each periodic dividend amount for that year. For 1998, 
there are three periodic dividend amounts: The periodic dividend 
amount for the period from December 1, 1997, to June 1, 1998 
(periodic dividend amount 1), the periodic dividend amount for the 
period from June 1, 1998, to December 1, 1998 (periodic dividend 
amount 2), and the periodic dividend amount for the period from 
December 1, 1998, to June 1, 1999 (periodic dividend amount 3). 
Periodic dividend amount 1 in respect of each share owned by A is $4 
(1/2 multiplied by the applicable annual LIBOR of 8 percent set on 
December 1, 1997, multiplied by the $100 amount payable on 
redemption). Because A acquired the shares on May 1, 1998, A's 
ratable portion of periodic dividend amount 1 for 1998 is 
approximately $.67 (30/180 multiplied by $4) per share. Periodic 
dividend amount 2 in respect of each share owned by A is $3.50 (1/2 
multiplied by the applicable annual LIBOR of 7 percent set on June 
1, 1998, multiplied by $100). Because A owned the shares for the 
entire period associated with periodic dividend amount 2, A's 
ratable portion of periodic dividend amount 2 for 1998 is the full 
$3.50 per share. Periodic dividend amount 3 in respect of each share 
owned by A is $4.50 (1/2 multiplied by the applicable annual LIBOR 
of 9 percent set on December 1, 1998, multiplied by $100). Because 
the portion of 1998 associated with periodic dividend amount 3 is 
only the month of December, 1998, A's ratable portion of periodic 
dividend amount 3 for 1998 is approximately

[[Page 67757]]

$.75 (30/180 multiplied by $4.50). Accordingly, A s preferred QEF 
amount for 1998 is approximately $4.92 ($.67 + $3.5 + $.75) per 
share. A must include approximately $492 (approximately $4.92 per 
share, multiplied by 100 shares) in income as ordinary earnings for 
its 1998 tax year even though FC paid no actual dividend to 
shareholders of Class A Stock for the period in 1998 during which A 
held the Class A Stock.
    (iii) Tax consequences to A for A's taxable year ending December 
31, 1999. As required under paragraph (a) of this section, A 
includes in gross income for its 1999 taxable year its preferred QEF 
amount for 1999. The preferred QEF amount, as determined under 
paragraph (b) of this section, for A's 1999 taxable year is the 
ratable portion of each periodic dividend amount for that year. For 
1999, there are three periodic dividend amounts: The periodic 
dividend amount for the period from December 1, 1998, to June 1, 
1999 (periodic dividend amount 1), the periodic dividend amount for 
the period from June 1, 1999, to December 1, 1999 (periodic dividend 
amount 2), and the periodic dividend amount for the period from 
December 1, 1999, to June 1, 2000 (periodic dividend amount 3). 
Periodic dividend amount 1 in respect of each share owned by A is 
$4.50 (1/2 multiplied by the applicable annual LIBOR of 9 percent 
set on December 1, 1998, multiplied by $100). Because A held each 
share of Class A Stock for five months in 1999 for the period 
associated with periodic dividend amount 1, A's ratable portion of 
periodic dividend amount 1 for 1999 is approximately $3.75 (150/180 
multiplied by $4.50). Periodic dividend amount 2 in respect of each 
share owned by A is $5 (1/2 multiplied by the applicable annual 
LIBOR of 10 percent set on June 1, 1999, multiplied by $100). 
Because A owned the share for the entire period associated with 
periodic dividend amount 2, A's ratable portion of periodic dividend 
amount 2 for 1999 is the full $5. Periodic dividend amount 3 in 
respect of each share owned by A is $4.50 (1/2 multiplied by the 
applicable annual LIBOR of 9 percent set on December 1, 1999, 
multiplied by $100). Because A held each share of Class A Stock for 
one month in 1999 for the period associated with periodic dividend 
amount 3, A's ratable portion of periodic dividend amount 3 for 1999 
is approximately $.75 (30/180 multiplied by $4.50). Accordingly, A's 
preferred QEF amount for 1998 is approximately $9.50 ($3.75 + $5 + 
$.75). A must include approximately $950 ($9.50 per share, 
multiplied by 100 shares) in income as ordinary income for its 1999 
taxable year even though FC was not a PFIC for FC's taxable year 
ending in 2000. The current distributions and arrearages actually 
paid to A with respect to the Class A Stock are not includible in 
income by A under paragraph (c)(4) of this section because they 
constitute amounts previously included in income.
    Example 2. Preferred Discount--(i) Facts. The facts are the same 
as in Example 1 except that A acquired the 100 shares of Class A 
Stock for $9000.
    (ii) Tax Consequences to A for A s taxable year ending December 
31, 1998. (A) Because the Class A Stock is fixed term preferred 
stock (as described in Sec. 1.1295-2(b)(1)(vii)) and A acquired each 
share of the Class A stock with $10 of preferred discount, as 
described in Sec. 1.1295-2(b)(2), A's preferred QEF amount to be 
included by A for the taxable year consists of the sum of the 
ratable daily portion of each periodic dividend amount, as 
calculated in paragraph (d)(ii) of Example 1 of this section, plus 
the preferred discount amount described in paragraph (b)(1) of this 
section.
    (B) The preferred discount amount with respect to each share is 
approximately $.47 ($10 multiplied by 240 days/5070 days to 
maturity). A must include approximately $47 ($.47 per share, 
multiplied by 100 shares), together with the amount calculated in 
paragraph (d)(ii) of Example 1 of this section, in income as 
ordinary earnings for its 1998 tax year even though FC paid no 
actual dividend to shareholders of Class A Shares for the period in 
1998 during which A held the Class A Stock.
    (iii) Tax consequences to A for A's taxable year ending December 
31, 1999. The portion of the preferred discount on each share 
includible under paragraph (a) of this section is approximately $.71 
($10 multiplied by 360 days/5070 days to maturity). A must include 
this amount, together with the amount calculated in paragraph 
(d)(iii) of Example 1 of this section, in income as ordinary 
earnings for its 1999 tax year even though FC was not a PFIC for 
FC's taxable year ending in 2000. The current distributions and 
arrearages actually paid to A in 1999 with respect to the Class A 
Stock are not includible in income by A under paragraph (c)(4) of 
this section, because they constitute amounts previously included in 
income.

    (e) Effective date. The rules under this section apply with respect 
to qualified preferred stock subject to a special preferred QEF 
election made after the date that is 30 days after the date of 
publication of this document as a final regulation.
    Par. 3. Section 1.1295-2 is added to read as follows:


Sec. 1.1295-2  Special Preferred QEF Election.

    (a) In general. This section provides rules permitting certain 
shareholders to make a special election under section 1295 (special 
preferred QEF election) in lieu of the election described in 
Sec. 1.1295-1 \2\ and Notice 88-125, 1988-2 C.B. 535 (see 
Sec. 601.601(d)(2)(ii)(b) of this chapter), with respect to certain 
preferred shares (qualified preferred shares) of a foreign corporation 
that certifies either that it is a PFIC (as defined in Sec. 1.1291-
1(b)(1)(i)) \3\ or that it reasonably believes that it is a PFIC. In 
order to make a special preferred QEF election, a shareholder must 
satisfy the stock ownership requirement of paragraph (c)(2) of this 
section. A special preferred QEF election of a shareholder applies only 
to those qualified preferred shares acquired and held directly by the 
shareholder in the taxable year of the shareholder for which the 
election is made. A shareholder making a special preferred QEF election 
must account for dividend income on shares subject to the election 
under the special income inclusion rules described in Sec. 1.1293-2, 
rather than under the general income inclusion rules of section 1293 
and Sec. 1.1293-1. In addition, for purposes of determining the tax 
consequences of owning shares subject to the special preferred QEF 
election, an electing shareholder must treat the foreign corporation as 
a PFIC for the entire period during which the shareholder continues to 
hold any of such shares. Paragraph (b) of this section defines 
qualified preferred share. Paragraph (c) of this section provides rules 
for determining who may make the special preferred QEF election. 
Paragraph (d) of this section provides rules concerning the effect of 
the election. Paragraph (e) of this section provides rules for the time 
and manner of making the election. Paragraph (f) of this section sets 
forth the annual reporting requirement for the election. Paragraph (g) 
of this section provides rules concerning the possible termination or 
invalidation of the election. For the applicability date of this 
section, see paragraph (h) of this section.
---------------------------------------------------------------------------

    \2\ This proposed regulation was published on April 1, 1992, at 
57 FR 11024.
    \3\ This proposed regulation was published on April 1, 1992, at 
57 FR 11024.
---------------------------------------------------------------------------

    (b) Qualified preferred share defined--(1) In general. For purposes 
of this section, a share of a foreign corporation is a qualified 
preferred share only if--
    (i) The share was originally issued for cash or in exchange for 
qualified preferred shares of the foreign corporation in a transaction 
to which section 354(a)(1) applied;
    (ii) If the share were to constitute a debt obligation, the share 
would be in registered form within the meaning of Sec. 5f.103-1(c) of 
this chapter;
    (iii) All amounts payable with respect to the share are denominated 
in U.S. dollars and are not determined by reference to the value of a 
currency other than the U.S. dollar;
    (iv) The share is limited and preferred as to dividends and does 
not participate in corporate growth to any significant extent within 
the meaning of section 1504(a)(4)(B);
    (v) The share has a fixed redemption or liquidation price;
    (vi) The share provides for cumulative or noncumulative dividend 
rights that are limited to an annual (or shorter period) amount 
computed by

[[Page 67758]]

multiplying either the redemption or liquidation price of the share by 
a specified index described in Sec. 1.446-3(c)(2)(i), (iii), or (iv) 
(specified index), or by a specified index periodically re-established 
pursuant to an auction reset mechanism, set in advance of the period 
with respect to which the specified index applies;
    (vii) If the share may be redeemed under circumstances described in 
Sec. 1.305-5(b) such that redemption premium (as described in 
Sec. 1.305-5(b)) could be treated under section 305(c) as a 
constructive distribution (fixed term preferred stock), the share was 
not issued with redemption premium exceeding the de minimis amount 
described in section 305(c)(1) and Sec. 1.305-5(b)(1);
    (viii) If the share may not be redeemed under circumstances 
described in Sec. 1.305-5(b) such that redemption premium would not be 
treated under section 305 as a constructive distribution (perpetual 
preferred stock), the share does not provide shareholders with the 
right to receive an amount upon liquidation or redemption that exceeds 
the issue price of the share (as determined under the principles of 
section 1273(b)) by an amount in excess of 5 percent of such 
liquidation or redemption amount;
    (ix) If redeemable, the share is redeemable only in whole and not 
in part and is not subject to mandatory redemption within five years of 
the issue date of the share. Further, the share is not subject to a 
holder put or issuer call that, based on all the facts and 
circumstances as of the issue date of the share, is more likely than 
not to be exercised at a time within five years of the issue date;
    (x) If convertible, the share is not convertible into a share other 
than a share meeting all the conditions set forth in paragraphs 
(b)(1)(i) through (b)(1)(ix) of this section; and
    (xi) The issuer of the share has indicated in an offering document 
relating to the original issuance of the share or in a written 
statement available to U.S. holders that the issuer has no current 
intention or belief that it will not pay dividends on the share on a 
current basis and that the share meets the conditions set forth in 
paragraphs (b)(1)(i) through (b)(1)(x) of this section and this 
paragraph (b)(1)(xi).
    (2) Special rules for shares acquired in secondary market 
transactions--(i) Fixed term preferred stock. A share of fixed term 
preferred stock (as described in paragraph (b)(1)(vii) of this section) 
that satisfies the conditions set forth in paragraph (b)(1) of this 
section and that is acquired in a transaction other than in connection 
with the initial issuance of the share (a secondary market 
transaction), shall constitute a qualified preferred share with respect 
to a shareholder, but only if the shareholder acquires the share for 
cash and the share has preferred discount (as defined below) that is 
less than or equal to an amount equal to 1 percent of the redemption 
price, multiplied by the number of complete years from the date of 
acquisition of the share to the redemption date as established under 
the principles of Sec. 1.305-5(b). Sales of shares to bond houses, 
brokers, or similar persons or organizations acting in the capacity as 
underwriters, placement agents, or wholesalers are ignored for purposes 
of determining whether a share is acquired in connection with the 
initial issuance of the share. For purposes of this section, the 
preferred discount for a share is the excess of the redemption price of 
the share payable on the redemption date over the shareholder's 
acquisition cost for the share.
    (ii) Perpetual preferred stock. A share of perpetual preferred 
stock, within the meaning of paragraph (b)(1)(viii) of this section, 
that satisfies the conditions set forth in paragraph (b)(1) of this 
section and that is acquired in a secondary market transaction, shall 
constitute a qualified preferred share with respect to the shareholder, 
but only if the shareholder acquires the share for cash and the amount 
payable upon liquidation of the share exceeds the shareholder's 
acquisition cost for the share by an amount less than or equal to 10 
percent of such liquidation amount.
    (iii) Examples. The following examples illustrate the rules of this 
paragraph (b)(2).

    Example 1--(i) Facts. On May 1, 1998, A, an individual who files 
her return on a calendar year basis, purchases for $9000 cash in a 
single secondary market transaction (as defined in paragraph 
(b)(2)(i) of this section) 100 shares of nonconvertible Class A $100 
par value preferred stock (Class A Stock) of FC, a foreign 
corporation with a taxable year ending March 31. The terms of the 
Class A Stock satisfy all the conditions described in paragraph 
(b)(1) of this section and provide for a mandatory redemption of the 
Class A Stock by the issuer in U.S. dollars at par on June 1, 2012. 
The Class A Stock is not redeemable pursuant to an issuer call or 
holder put on any other date.
    (ii) Analysis. In order for A to make a special preferred QEF 
election with respect to the Class A Stock acquired by A, the Class 
A Stock acquired must constitute qualified preferred shares. 
Although the Class A Stock meets the requirements for qualified 
preferred shares set forth in paragraph (b)(1) of this section, the 
stock also must satisfy the requirements described in paragraph 
(b)(2) because A acquired the stock in a secondary market 
transaction. Because the terms of the Class A Stock provide that the 
stock will be redeemed by the issuer on June 1, 2012, the stock 
constitutes fixed term preferred stock within the meaning of 
paragraph (b)(1)(vii) of this section. A purchased the Class A Stock 
for $90 per share, representing a $10 discount ($100 June 1, 2012, 
per share redemption price less $90 acquisition cost). Because this 
$10 discount, which constitutes preferred discount within the 
meaning of paragraph (b)(2)(i) of this section, is less than $14 (1 
percent of the redemption price multiplied by 14 (the number of 
complete years until the mandatory redemption date)), the Class A 
Stock acquired by A satisfies the conditions of paragraph (b)(2)(i) 
of this section and therefore constitutes qualified preferred 
shares.
    Example 2--(i) Facts. The facts are the same as in Example 1, 
except that A acquires the 100 shares of Class A Stock for $8000.
    (ii) Analysis. In this case, A purchased the Class A Stock for 
$80 per share, representing a $20 discount ($100 June 1, 2012, 
redemption price less $80 acquisition cost). Because this $20 of 
preferred discount is greater than $14 (1 percent of the redemption 
price multiplied by 14 (the number of complete years until the 
mandatory redemption date)), the Class A Stock fails to satisfy the 
conditions of paragraph (b)(2)(i) of this section and therefore 
fails to qualify as qualified preferred shares.

    (c) Who may make the election--(1) In general. A U.S. person that 
acquires qualified preferred shares for cash or in a nonrecognition 
transaction described in Sec. 1.1291-6(a) \4\ (nonrecognition 
transaction) and that holds such shares directly may make a special 
preferred QEF election, provided that, in the case of shares acquired 
in a nonrecognition transaction, either the qualified preferred shares 
are treated as stock of a pedigreed QEF, as defined in Sec. 1.1291-
1(b)(2)(ii), immediately prior to the nonrecognition transaction, or 
the gain, if any, realized on the transaction would be recognized under 
Sec. 1.1291- 6(b) with respect to the nonrecognition transaction. A 
special preferred QEF election will not apply to any shares with 
respect to which the electing shareholder is an indirect shareholder, 
within the meaning of Sec. 1.1291-1(b)(8). Solely for purposes of this 
section, partnerships, S corporations, trusts and estates (pass-through 
entities) that directly own qualified preferred shares are treated as 
shareholders that may make a special preferred QEF election. A 
shareholder may not make a special preferred QEF election if at any 
time the shareholder made a section 1295 election (other than a special 
preferred QEF election) with respect to the foreign corporation. A 
shareholder may not

[[Page 67759]]

make a special preferred QEF election unless the shareholder satisfies 
the stock ownership requirements set forth in paragraph (c)(2) of this 
section, and the shareholder receives from the foreign corporation the 
statement described in paragraph (c)(3) of this section.
---------------------------------------------------------------------------

    \4\ This proposed regulation was published on April 1, 1992, at 
57 FR 11024.
---------------------------------------------------------------------------

    (2) Ownership requirement. A holder of qualified preferred shares 
of a foreign corporation may make a special preferred QEF election only 
if, at all times during the taxable year of the shareholder, the 
shareholder does not own, directly, indirectly, or constructively, 
within the meaning of section 958, five percent or more of the vote or 
value of any class of stock of the foreign corporation. The five 
percent vote or value limitation must be satisfied for each taxable 
year of the shareholder during which the shareholder continues to hold 
shares subject to the special preferred QEF election.
    (3) Statement from corporation. A shareholder may make the special 
preferred QEF election only if the foreign corporation has provided a 
written statement relating to the taxable year of the corporation that 
ends with or within the taxable year of the shareholder for which the 
election is made certifying either that the foreign corporation is, or 
that it reasonably believes that it is, a PFIC, and that it is not a 
controlled foreign corporation within the meaning of section 957(a) for 
such taxable year of the corporation. The statement must be provided 
directly to the electing shareholder or in a disclosure or other 
document generally available to all U.S. holders. Electing shareholders 
must retain a copy of the statement for their records.
    (d) Effect of election--(1) In general. Unless terminated or 
invalidated pursuant to paragraph (g) of this section, shares subject 
to a special preferred QEF election will be treated as shares of a 
pedigreed QEF (as defined in Sec. 1.1291-1(b)(2)(ii)) for all taxable 
years of the foreign corporation that are included wholly or partly in 
the shareholder's holding period of the shares. A special preferred QEF 
election applies to all qualified preferred shares owned directly by 
the shareholder that are acquired in the taxable year of the election. 
Separate special preferred QEF elections may be made for qualified 
preferred shares acquired in other taxable years of the taxpayer. A 
special preferred QEF election is personal to the shareholder that made 
the election and does not apply to a transferee of the shares. A 
shareholder that has made a special preferred QEF election may not 
make, with respect to the foreign corporation, any other election 
permitted under sections 1291 through 1297 and the regulations under 
those sections, including a section 1295 election as described in 
Sec. 1.1295-1 and Notice 88-125, 1988-2 C.B. 535 (see 
Sec. 601.601(d)(2)(ii)(b) of this chapter), for any period during which 
the special preferred QEF election remains in effect with respect to 
any shares of the shareholder.
    (2) Continued PFIC Characterization. By making the special 
preferred QEF election, the shareholder agrees to treat the foreign 
corporation as a PFIC with respect to qualified preferred shares 
subject to the election at all times during its holding period for such 
shares, without regard to whether the foreign corporation is a PFIC for 
any taxable year of the foreign corporation during which the preferred 
QEF election remains in effect.
    (3) Section 1293 inclusions. For each taxable year of the 
shareholder to which an election under this section applies, the 
shareholder must include in income the preferred QEF amount, as defined 
in Sec. 1.1293-2, in the manner and under the rules provided in that 
section.
    (e) Time for and manner of making the special preferred QEF 
election--(1) Time for making the election. A special preferred QEF 
election must be made on or before the due date, as extended, for 
filing the shareholder's return for the taxable year during which the 
shareholder acquired the qualified preferred shares for which the 
election is being made. A special preferred QEF election may not be 
made for those shares at any other time pursuant to any other provision 
of the Code or regulations.
    (2) Manner of making the election--(i) In general. A shareholder 
makes the special preferred QEF election under this section for all 
qualified preferred shares of a foreign corporation acquired during the 
shareholder's taxable year by checking the appropriate box in Form 8621 
(Return by a Shareholder of a Passive Foreign Investment Company or 
Qualified Electing Fund), Part I, for making the section 1295 election, 
and indicating in the margin of Part I that the shareholder is making a 
special preferred QEF election with respect to certain specified 
shares. The shareholder also must report the preferred QEF amount for 
the taxable year of the election on Line 6a of Part II of Form 8621. In 
addition, the shareholder must attach to Form 8621 the statement 
(preferred QEF statement) described in paragraph (e)(2)(ii) of this 
section, signed by the shareholder under penalties of perjury, stating 
that the information and representations provided in the preferred QEF 
statement are true, correct, and complete to the best of the 
shareholder's knowledge and belief.
    (ii) Preferred QEF statement contents. The preferred QEF statement 
must include the following information and representations:
    (A) The first taxable year of the shareholder for which the special 
preferred QEF election is made;
    (B) The number of shares subject to the election, their acquisition 
date(s) and acquisition price(s), and the class designation(s) of the 
shares;
    (C) A representation by the shareholder that it did not at any time 
during its taxable year own directly, indirectly, or constructively, 
within the meaning of section 958, five percent or more of the vote or 
value of any class of stock of the foreign corporation with respect to 
which the election applies;
    (D) A representation by the shareholder that it has obtained the 
written statement described in paragraph (c)(3) of this section; and
    (E) A representation by the shareholder that it has never made a 
section 1295 election other than a special preferred QEF election with 
respect to the foreign corporation.
    (f) Annual reporting requirement. For each taxable year of a 
shareholder during which the shareholder holds shares of a foreign 
corporation subject to one or more special preferred QEF elections, the 
shareholder must file Form 8621 with respect to the foreign corporation 
regardless of whether the foreign corporation is or is not a PFIC under 
section 1296 during any portion of the taxable year. The shareholder 
must indicate in the margin of Part I of Form 8621 the number of 
special preferred QEF elections of the shareholder that remain in 
effect with respect to the foreign corporation. In addition, the 
shareholder must report, on Line 6a of Part II of Form 8621, the 
aggregate of the preferred QEF amounts for all relevant special 
preferred QEF elections in effect for the taxable year.
    (g) Termination or invalidation of election--(1) In general. A 
sale, exchange or other disposition of a share that is subject to a 
special preferred QEF election will terminate the special preferred QEF 
election with respect to that share. In addition, the Commissioner may, 
in the Commissioner's discretion, terminate or invalidate a special 
preferred QEF election if a shareholder that made the election fails to 
satisfy the initial or ongoing requirements of the election. Once made, 
a special preferred QEF election may not be terminated or invalidated 
by the shareholder.

[[Page 67760]]

    (2) Effect of termination or invalidation. Termination of a special 
preferred QEF election by the Commissioner will be effective on the 
first day of the shareholder's first taxable year following the last 
taxable year of the shareholder for which the requirements of the 
election are satisfied. For purposes of sections 1291 through 1297 and 
the regulations thereunder, the holding period of qualified preferred 
shares subject to an election that has been terminated will be treated 
as beginning on the effective date of the termination. A shareholder 
that has made an election that is invalidated by the Commissioner will 
be treated for purposes of sections 1291 through 1297 and the 
regulations thereunder as if the shareholder never made the election.
    (h) Effective date. An election under this section may only be made 
with respect to qualified preferred shares that are issued after the 
date that is 30 days after the date of publication of this document as 
a final regulation.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 96-32247 Filed 12-23-96; 8:45 am]
BILLING CODE 4830-01-U