[Federal Register Volume 64, Number 21 (Tuesday, February 2, 1999)]
[Proposed Rules]
[Pages 5012-5015]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-1666]


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 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
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  Federal Register / Vol. 64, No. 21 / Tuesday, February 2, 1999 / 
Proposed Rules  

[[Page 5012]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-113744-98]
RIN 1545-AW69


Passive Foreign Investment Companies; Definition of Marketable 
Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
new mark to market election for stock of a passive foreign investment 
company (PFIC). The proposed regulations interpret changes made by the 
Taxpayer Relief Act of 1997. The proposed regulations affect persons 
holding PFIC stock that is regularly traded on certain U.S. or foreign 
exchanges or markets or holding stock in certain PFICs comparable to 
U.S. regulated investment companies (RICs). The proposed regulations 
also reserve treatment of and request comments on making the mark to 
market election for options on marketable stock.

DATES: Written comments or requests for a public hearing must be 
received by May 3, 1999.

ADDRESSES: Send submissions to CC:DOM:CORP:R (REG-113744-98), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered Monday through Friday between the hours of 8 a.m. and 5 p.m. 
to: CC:DOM:CORP:R (REG-110524-98), 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.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Robert Laudeman, (202) 622-3840; concerning submissions, LaNita 
VanDyke, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    This notice contains proposed amendments to the Income Tax 
Regulations (26 CFR Part 1) regarding the taxation of U.S. holders of 
PFIC stock.
    Since the enactment of the Tax Reform Act of 1986, U.S. holders of 
PFIC stock have been subject to two alternative sets of inclusion 
rules: the interest charge rules under section 1291 of the Internal 
Revenue Code and the qualified electing fund (QEF) rules under section 
1293.
    The interest charge rules apply to shareholders of PFICs that are 
not QEFs or for which a QEF election is unavailable. Under the interest 
charge rules, the PFIC shareholders pay tax and an interest charge that 
is attributable to the value of deferral on receipt of certain 
distributions and on disposition of the PFIC stock. By contrast, PFIC 
shareholders who make a QEF election include currently in gross income 
their respective shares of the PFIC's total earnings, with a separate 
election to defer payment of tax, subject to an interest charge, on 
income not currently received.
    Congress recognized that the interest charge rules are a 
substantial source of complexity for PFIC shareholders and that some 
shareholders would prefer the current inclusion method afforded by the 
QEF election, but are unable to make the election because they cannot 
obtain the necessary information from the PFIC. Congress accordingly 
enacted new section 1296 in the Tax Reform Act of 1997 to provide PFIC 
shareholders with an alternative method to include income currently 
with respect to their interests in a PFIC by allowing PFIC shareholders 
to elect to mark to market PFIC stock that qualifies as marketable 
stock.
    In general, a PFIC shareholder who elects under section 1296 to 
mark to market the marketable stock of a PFIC includes in income each 
year an amount equal to the excess, if any, of the fair market value of 
the PFIC stock as of the close of the taxable year over the 
shareholder's adjusted basis in such stock.
    A shareholder is also generally allowed a deduction for the excess, 
if any, of the adjusted basis of the PFIC stock over the fair market 
value as of the close of the taxable year. Deductions under this rule, 
however, are allowable only to the extent of any net mark to market 
gains with respect to the stock included by the shareholder for prior 
taxable years.
    Section 1296(e)(1) defines marketable stock as including several 
categories of stock. First, section 1296(e)(1)(A) states that 
marketable stock includes any stock which is regularly traded on (i) a 
national securities exchange which is registered with the Securities 
and Exchange Commission (SEC) or the national market system established 
pursuant to section 11A of the Securities Exchange Act of 1934, or (ii) 
any exchange or other market which the Secretary determines has rules 
adequate to carry out the purposes of the PFIC provisions. With respect 
to (ii) above, the conference report specifies that ``PFIC stock is 
considered marketable if it is regularly traded on any exchange or 
market that the Secretary of the Treasury determines has rules 
sufficient to ensure that the market price represents a legitimate and 
sound fair market value.'' H.R. Conf. Rep. No. 2014, 105th Cong., 1st 
Sess. 625 (1997). Second, section 1296(e)(1)(B) states that, to the 
extent provided in regulations, stock in any foreign corporation which 
is comparable to a RIC and which offers for sale or has outstanding any 
stock of which it is the issuer and which is redeemable at its net 
asset value will be marketable stock. Third, section 1296(e)(1)(C) 
states that, to the extent provided in regulations, any option on stock 
described in section 1296(e)(1)(A) or (B) will constitute marketable 
stock.
    Section 1296(e)(2) provides that in the case of any RIC which is 
offering for sale or has outstanding any stock of which it is the 
issuer and which is redeemable at net asset value, all stock in a PFIC 
which it owns directly or indirectly shall be treated as marketable 
stock for purposes of section 1296. Section 1296(e)(2) further provides 
that except as provided in regulations, similar treatment as marketable 
stock shall apply in the case of any other RIC which

[[Page 5013]]

publishes net asset valuations at least annually.
    The proposed regulations define marketable stock for purposes of 
section 1296. Specifically, the proposed regulations define regularly 
traded and list attributes that a foreign exchange or market must have 
in order for PFIC stock traded on such an exchange or market to be 
eligible for the mark to market election. The definition of regularly 
traded and the attributes required of foreign exchanges or markets are 
intended to ensure that the prices of PFIC shares listed on the 
exchange or market represent legitimate and sound fair market values. 
The proposed regulations also list the attributes that a foreign 
corporation must satisfy to be comparable to a RIC, and thus for its 
stock to be marketable stock. The attributes are intended to ensure 
that the foreign corporation is an investment vehicle similar in 
relevant respects to a U.S. mutual fund and that its representations of 
net asset value represent a legitimate fair market value.

Explanation of Provisions

Regularly Traded

    Under the proposed regulations, the class of PFIC stock held by the 
shareholder must be traded, other than in de minimis quantities, on at 
least 15 days during each calendar quarter. The proposed regulations 
also include an anti-abuse rule to prevent persons from manipulating 
the number of trades in order to meet this test.

Exchange or Other Market

    The proposed regulations require that a foreign exchange or market 
be regulated or supervised by a governmental authority of the country 
in which the market is located. This requirement will help to ensure 
that the prices of the stock listed by the exchange are legitimate and 
sound fair market values. Because the degree of governmental regulation 
or supervision for each foreign exchange or market may vary by exchange 
or market or country, the proposed regulations also list additional 
characteristics that the foreign exchange or market must have for stock 
that is regularly traded on the exchange or market to be considered 
marketable stock for purposes of section 1296.
    First, the exchange must have trading volume, listing, financial 
disclosure and other requirements, designed to prevent fraud, perfect 
the mechanism of a free and open market, and protect investors. See 
section 6 of the Securities Exchange Act of 1934, 15 U.S.C. 78f. There 
must be actual enforcement of these requirements by the exchange and 
government of the country in which the exchange is located.
    Second, the rules of the exchange must ensure active trading of 
listed stocks.
    Finally, the IRS and Treasury Department invite comments on whether 
PFIC stock that is regularly traded on any other type of exchange or 
market, such as an over-the-counter market, should be considered 
marketable stock. Additional comments are requested about what features 
those exchanges or markets should have to ensure that the stock prices 
quoted on such markets are legitimate and sound fair market values.

Stock in Certain PFICs

    The proposed regulations provide that stock in certain PFICs will 
be marketable stock if the PFIC is a corporation described in section 
1296(e)(1)(B) (foreign corporations comparable to RICs) and if the PFIC 
offers for sale or has outstanding stock of which it is the issuer and 
which is redeemable at its net asset value. A PFIC will be a 
corporation described in section 1296(e)(1)(B) if the PFIC satisfies 
the conditions listed in the proposed regulations and described below, 
with respect to the class of shares held by the electing taxpayer. 
These conditions are intended to describe PFICs that are comparable to 
U.S. RICs in relevant respects and to implement the intent of the 
statute by ensuring that the net asset valuations of such companies 
represent legitimate and sound fair market values for the companies' 
stock.
    First, the class of stock held by an electing shareholder must be 
held by one hundred or more unrelated shareholders. The relationships 
set forth in section 267(b) are used to define related shareholders 
that are excluded from satisfying this test. This condition is 
consistent with the requirements for RICs under section 851(a) and 
Sec. 1.851-1 of the income tax regulations.
    Second, the applicable class of shares of the foreign corporation 
must be regularly available for purchase by the general public at its 
net asset value in initial amounts not greater than $10,000 (U.S.). The 
IRS and Treasury Department invite comments on whether $10,000 is the 
appropriate ceiling to ensure that the shares of the company will be 
widely available to the general public. The IRS and Treasury Department 
also invite comments on whether and under what conditions the 
regulations should allow shares of a foreign corporation to be 
purchased at amounts different from their net asset value, such as for 
a price that includes a sales load. Additional comments are requested 
about whether the regulations should cover foreign corporations that 
otherwise qualify but are closed to new investors.
    Third, the proposed regulations require that quotations for the 
class of shares of the foreign corporation be determined and published 
on a daily basis in a widely-available medium, such as a newspaper of 
general circulation. This requirement approximates the practice of U.S. 
RICs and is intended to ensure that shareholders and prospective 
purchasers have regular access to publicly available price information.
    Fourth, financial statements of the foreign corporation prepared by 
independent auditors that include balance sheets (statements of assets, 
liabilities, and net assets) and statements of income and expenses, 
must be prepared and made available to the public no less frequently 
than annually. This requirement approximates the requirements imposed 
on U.S. mutual funds by the SEC and is intended to ensure that 
shareholders and prospective purchasers have regular access to 
financial information for the foreign corporation.
    Fifth, the foreign corporation must be supervised or regulated as 
an investment company by a foreign government or an agency or 
instrumentality thereof. This condition is intended to approximate the 
SEC's regulation of U.S. RICs while taking into account the variety of 
regulatory regimes used by different governments.
    Sixth, the foreign corporation may not have any senior securities 
authorized or outstanding, including any debt other than de minimis 
amounts. This requirement is similar to the requirement imposed on U.S. 
RICs by the SEC.
    Finally, the foreign corporation must meet the PFIC income and 
asset tests in sections 1297(a)(1) and (2) with the requisite 
percentages increased from 75 percent to 90 percent and from 50 percent 
to 90 percent respectively. This condition is intended to approximate 
the characteristic of U.S. RICs as passive investment vehicles.
    The proposed regulations also include an anti-abuse rule to prevent 
a foreign corporation from improperly manipulating its net asset 
valuations to reduce the U.S. tax under section 1296 of one or more 
shareholders of the corporation.

Options on Marketable Stock

    The proposed regulations reserve the paragraph for defining how and 
when options on marketable stock, as defined

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by these regulations, will be eligible for mark to market treatment. 
The IRS and Treasury Department invite comments regarding the 
conditions under which the regulations should define options on 
marketable stock to be marketable stock.

Special Rules for RICs

    The proposed regulations clarify that shares in a PFIC that are 
owned directly or indirectly by a U.S. RIC, which is offering for sale 
or has outstanding any stock of which it is the issuer and which is 
redeemable at net asset value, shall be treated as marketable stock for 
purposes of section 1296. The IRS and Treasury Department invite 
comments regarding situations where PFIC stock held by other U.S. RICs 
that publish asset valuations at least annually should not be treated 
as marketable stock for purposes of section 1296.

Proposed Effective Date

    The regulations are proposed to be applicable for shareholders 
whose taxable years end on or after the date these regulations are 
published as final regulations in the Federal Register. In addition, it 
is proposed that shareholders may elect to apply these regulations to 
taxable years beginning after December 31, 1997.

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) does not apply to these regulations, and, because the 
regulations do not impose a requirement for the collection of 
information on small entities, the Regulatory Flexibility Act (5 U.S.C. 
chapter 6) does not apply. 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. The IRS and 
Treasury Department request comments on the clarity of the proposed 
rules and how they can be made easier to understand. All comments will 
be available for public inspection and copying. A public hearing may be 
scheduled if requested by any person that timely submits 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 Robert Laudeman, 
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 adding 
an entry in numerical order to read as follows:

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

    Section 1.1296(e)-1 also issued under 26 U.S.C. 1296(e). * * *
    Par. 2. Section 1.1296(e)-1 is added to read as follows:


Sec. 1.1296(e)-1  Definition of marketable stock.

    (a) General rule. For purposes of section 1296, the term marketable 
stock means--
    (1) Passive foreign investment company (PFIC) stock that is 
regularly traded, as defined in paragraph (b) of this section, on a 
qualified exchange or other market, as defined in paragraph (c) of this 
section;
    (2) Stock in certain PFICs, as described in paragraph (d) of this 
section; and
    (3) Options on stock that is described in paragraph (a)(1) or (2) 
of this section, to the extent provided in paragraph (e) of this 
section.
    (b) Regularly traded--(1) General rule. For purposes of paragraph 
(a)(1) of this section, a class of stock that is traded on one or more 
qualified exchanges or other markets, as defined in paragraph (c) of 
this section, is considered to be regularly traded on such exchanges or 
markets for any calendar year during which such class of stock is 
traded, other than in de minimis quantities, on at least 15 days during 
each calendar quarter.
    (2) Anti-abuse rule. Trades that have as one of their principal 
purposes the meeting of the trading requirement of paragraph (b)(1) of 
this section shall be disregarded. Further, a class of stock shall not 
be treated as meeting the trading requirement of paragraph (b)(1) of 
this section if there is a pattern of trades conducted to meet the 
requirement of that paragraph.
    (c) Qualified exchange or other market--(1) General rule. For 
purposes of paragraph (a)(1) of this section, the term qualified 
exchange or other market means, for any taxable year--
    (i) A national securities exchange which is registered with the 
Securities and Exchange Commission or the national market system 
established pursuant to section 11A of the Securities Exchange Act of 
1934 (15 U.S.C. 78f); or
    (ii) A foreign securities exchange that is regulated or supervised 
by a governmental authority of the country in which the market is 
located and which has the following characteristics--
    (A) The exchange has trading volume, listing, financial disclosure, 
and other requirements designed to prevent fraudulent and manipulative 
acts and practices, to remove impediments to and perfect the mechanism 
of a free and open market, and to protect investors; and the laws of 
the country in which the exchange is located and the rules of the 
exchange ensure that such requirements are actually enforced; and
    (B) The rules of the exchange ensure active trading of listed 
stocks.
    (2) Exchange with multiple tiers. If an exchange in a foreign 
country has more than one tier or market level on which stock may be 
separately listed or traded, each such tier shall be treated as a 
separate exchange.
    (d) Stock in certain PFICs--(1) General rule. Except as provided in 
paragraph (d)(2) of this section, a foreign corporation will be a 
corporation described in section 1296(e)(1)(B), and paragraph (a)(2) of 
this section, if the foreign corporation offers for sale or has 
outstanding stock of which it is the issuer and which is redeemable at 
its net asset value and if the foreign corporation satisfies the 
following conditions with respect to the class of shares held by the 
electing taxpayer--
    (i) The foreign corporation has one hundred or more shareholders 
with respect to the class, other than shareholders who are related 
under section 267(b);
    (ii) The class of shares of the foreign corporation is readily 
available for purchase by the general public at its net asset value by 
new investors in initial amounts not greater than $10,000 (U.S.);
    (iii) Quotations for the class of shares of the foreign corporation 
are

[[Page 5015]]

determined and published on a daily basis in a widely-available medium, 
such as a newspaper of general circulation;
    (iv) No less frequently than annually, independent auditors must 
prepare financial statements of the foreign corporation that include 
balance sheets (statements of assets, liabilities, and net assets) and 
statements of income and expenses, and those statements must be made 
available to the public;
    (v) The foreign corporation is supervised or regulated as an 
investment company by a foreign government or an agency or 
instrumentality thereof;
    (vi) The foreign corporation has no senior securities authorized or 
outstanding, including any debt other than in de minimis amounts;
    (vii) Ninety percent or more of the gross income of the foreign 
corporation for its taxable year is passive income, as defined in 
section 1297(a)(1) and the regulations thereunder; and
    (viii) The average percentage of assets held by the foreign 
corporation during its taxable year which produce passive income or 
which are held for the production of passive income, as defined in 
section 1297(a)(2) and the regulations thereunder, is at least 90 
percent.
    (2) Anti-abuse rule. If a foreign corporation undertakes any action 
with a principal purpose of manipulating the net asset value of a class 
of its shares in order to reduce the United States tax under section 
1296 of one or more of its shareholders, the class of shares will not 
qualify as marketable stock for purposes of paragraph (d)(1) of this 
section.
    (e) [Reserved]
    (f) Special rules for regulated investment companies (RICs)--(1) 
General rule. In the case of any RIC which is offering for sale or has 
outstanding any stock of which it is the issuer and which is redeemable 
at net asset value, its stock in any passive foreign investment company 
which it owns directly or indirectly, as defined in sections 958(a) (1) 
and (2), shall be treated as marketable stock owned by that RIC for 
purposes of section 1296.
    (2) [Reserved]
    (g) Effective date. This section applies to shareholders whose 
taxable year ends on or after the date these regulations are published 
as final regulations in the Federal Register for stock in a foreign 
corporation whose taxable year ends with or within the shareholder's 
taxable year. In addition, shareholders may elect to apply these 
regulations to any taxable year beginning after December 31, 1997, for 
stock in a foreign corporation whose taxable year ends with or within 
the shareholder's taxable year.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 99-1666 Filed 2-1-99; 8:45 am]
BILLING CODE 4830-01-U