[Federal Register Volume 65, Number 16 (Tuesday, January 25, 2000)]
[Rules and Regulations]
[Pages 3817-3820]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1530]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 8867]
RIN 1545-AW69


Passive Foreign Investment Companies; Definition of Marketable 
Stock

AGENCY:  Internal Revenue Service (IRS), Treasury.

ACTION:  Final regulations.

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SUMMARY:  This document contains final regulations under section 1296 
relating to the new mark-to-market election for stock of a passive 
foreign investment company (PFIC). The final regulations interpret 
changes made by the Taxpayer Relief Act of 1997. The final 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).

DATES:  Effective Date: January 25, 2000.
    Applicability Dates: For dates of applicability see section 
1.1296(e)-1(g) of these regulations.

FOR FURTHER INFORMATION CONTACT:  Robert Laudeman, (202) 622-3840 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On February 2, 1999, the IRS published in the Federal Register 
proposed regulations (REG-113744-98, 64 FR 5014) regarding the taxation 
of U.S. holders of PFIC stock. Three written comments regarding the 
proposed regulations were received. Because no one requested to speak 
at a public hearing, no hearing was held. After consideration of all of 
the comments received, the proposed regulations under section 1296 are 
adopted as final regulations with some changes. The changes are 
discussed below.
    The preamble to the proposed regulations (64 FR 5014) provides a 
detailed discussion of the mark-to-market election for shareholders of 
PFIC stock and the proposed regulations.

Summary of Public Comments and Changes

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. 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 
marketable stock for purposes of section 1296. Specifically, the 
proposed regulations require that the exchange 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.
    The final regulations add a surveillance requirement and add the 
concept of perfecting a fair and orderly market to the requirements for 
exchanges. These changes are intended to clarify the characteristics 
that an exchange or other market must have in order to be a qualified 
exchange or market for purposes of section 1296 and to more closely 
represent common characteristics of foreign markets. See International 
Federation of Stock Exchanges (FIBV), 1998 Market Principles, available 
by request from [email protected], and International Organization of 
Securities Commissions (IOSCO), Supervisory Framework for Markets, 
Report by the Technical Committee, May 1999 (visited Oct. 5, 1999) 
http://www.iosco.org/iosco.html>.

Stock in Certain PFICs

    The proposed regulations provide that stock in certain PFICs is 
marketable stock if the PFIC both is a corporation described in section 
1296(e)(1)(B) (foreign corporations comparable to RICs) and offers for 
sale or has outstanding stock of which it is the

[[Page 3818]]

issuer and which is redeemable at its net asset value. The proposed 
regulations further provide that a PFIC is a corporation described in 
section 1296(e)(1)(B) only if the PFIC satisfies eight conditions 
listed in the proposed regulations with respect to the class of shares 
held by the electing taxpayer. The conditions are intended to describe 
PFICs that are comparable to 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.
    Two commentators asserted that the statute and legislative history 
indicate that Congress was only concerned that PFICs redeem stock at 
net asset values and that such values represent sound and legitimate 
fair market values and, therefore, it is not necessary that the PFIC 
resemble a RIC. The commentators suggest that the regulations be 
modified to include PFICs that redeem their stock at its net asset 
value but do not otherwise resemble RICs. Because the plain language of 
the statute clearly requires that the stock in any foreign corporation 
be comparable to a RIC, the final regulations retain the approach of 
requiring PFICs to be comparable to RICs in order for their stock to be 
marketable stock for purposes of section 1296(e)(1)(B).
    The proposed regulations provide that a foreign corporation must 
have one hundred or more unrelated shareholders. One commentator 
recommended that the number be reduced to ten unrelated shareholders, 
arguing that a corporation with ten unrelated shareholders as opposed 
to one hundred unrelated shareholders has the same susceptibility to 
legal liabilities if valuations are inaccurate. Requiring that a PFIC 
have one hundred or more unrelated shareholders is comparable to the 
requirement imposed on RICs by section 851(a). In addition, the IRS and 
the Treasury Department believe that there will be less likelihood of 
share price manipulation with corporations that have one hundred or 
more unrelated shareholders. Consequently, the above described rule in 
the proposed regulations is not changed except that ``one hundred or 
more'' is corrected to read ``more than one hundred'' unrelated 
shareholders.
    The proposed regulations require that the class of shares of the 
foreign corporation be 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.). One commentator recommended that this 
condition not be included in the final regulations because an 
investment ceiling will not make the valuation easier or less likely to 
be manipulated.
    The condition in the proposed regulations regarding initial 
investments is not an investment ceiling. Rather, the condition 
specifies that the foreign corporation not require a minimum initial 
investment of greater than $10,000 (U.S.) and that shares of the 
foreign corporation be readily available for purchase by the general 
public at net asset values. For example, a foreign corporation that 
requires new investors to purchase shares for a minimum initial 
investment of $5,000 (U.S.) satisfies the condition. However, a foreign 
corporation that requires new investors to purchase shares for a 
minimum initial investment of $20,000 (U.S.) does not satisfy the 
condition. There is not any limit, however, on the total amount that a 
shareholder can invest. The final regulations clarify that this 
condition is not an investment ceiling.
    Two additional requirements in the proposed regulations are that 
shares be available for purchase by the general public and that, no 
less frequently than annually, financial statements prepared by 
independent auditors be available to the public. One commentator 
asserted that availability to the general public of the shares of the 
foreign corporation and of the financial statements is not necessary 
and should not be required because it will not necessarily ensure a 
legitimate and sound fair market value for the foreign corporation's 
stock.
    Availability of shares for purchase by the general public is 
comparable to the requirement of availability of shares of RICs for 
purchase by the general public. In addition, availability of shares for 
purchase by the the general public for net asset value (in addition to 
current investors being able to redeem shares for the same net asset 
value), will ensure that the net asset values are legitimate and sound. 
However, shares will not be considered available for purchase by the 
general public if the shares are only available to individuals with 
high annual incomes or high net worth. For example, limiting investors 
to individuals with annual incomes in excess of $200,000 or net worth 
in excess of $1 million will not be considered available for purchase 
by the general public.
    Similarly, availability to the general public of audited financial 
statements is comparable to conditions imposed on RICs and will help to 
ensure that the foreign corporation's financial information is readily 
available to potential and current investors, which, in turn, will help 
ensure that the net asset values are legitimate and sound. Availability 
of financial statements to the general public requires no more than 
that the statements be available upon request to potential and current 
investors.
    The proposed regulations require that quotations for the 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. 
One commentator asserted that the condition is not necessary because 
the mark-to-market election is made on an annual basis at the close of 
the taxpayer's taxable year. The commentator recommended that the 
condition be changed to require that values be communicated to 
shareholders, on at least an annual basis, in written form that serves 
as support for such valuation.
    The final regulations do not adopt the commentator's 
recommendation. The publication of quotations for the shares is not 
intended to serve solely as a means for a current shareholder of the 
PFIC to determine the value of the PFIC on the mark date. The 
publication of quotations for the shares is comparable to the practice 
of RICs and helps to ensure that asset valuations are legitimate and 
sound by allowing potential investors as well as current shareholders 
to have ready access to price information.
    Because quotations for the shares of some PFICs may not be 
published on a daily basis, the daily publication requirement in the 
proposed regulations is changed to require that quotations for the 
shares of the foreign corporation be determined and published no less 
frequently than weekly. In addition, the publication requirement is 
changed to clarify that the quotations must be published in a permanent 
medium not controlled by the issuer of the shares, such as an 
independent trade publication. The requirement that the medium be 
permanent does not require the medium to be saved in a printed form; 
archived electronic data not susceptible to subsequent alteration are 
permanent. This change is intended to assist shareholders and the IRS 
in verifying valuations.
    The proposed regulations require that the foreign corporation be 
supervised or regulated as an investment company by a foreign 
government or instrumentality thereof. One commentator suggested that 
the condition be clarified with respect to the meaning of governmental 
supervision. In particular, the commentator asks whether a foreign 
jurisdiction that requires a local corporation to file information upon 
incorporation with the local government

[[Page 3819]]

or agency would qualify as supervision or regulation.
    The condition in the proposed regulations is intended to require 
that the PFIC be supervised or regulated as an investment company in a 
manner comparable, but not identical, to RICs. Consequently, the final 
regulations clarify the type of supervision or regulation required. The 
final regulations provide that sufficient supervision or regulation 
requires that the government or agency have broad inspection and 
enforcement authority and effective oversight over investment companies 
to ensure that such companies provide complete and accurate disclosure 
of relevant financial information to shareholders and potential 
investors and to provide adequate sanctions for false or inadequate 
disclosure. The mere filing of information upon incorporation does not 
qualify as supervision or regulation.
    Finally, the proposed regulations require that the foreign 
corporation have no senior securities authorized or outstanding, 
including any debt other than de minimis amounts. In addition, the 
proposed regulations require that the foreign corporation 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. One commentator asserted that 
these conditions not be included in the final regulations because there 
is no basis for requiring a PFIC to have the same borrowing 
restrictions, asset composition, and characteristics of RICs in order 
for the PFIC's stock to be marketable stock under section 1296.
    Conditions regarding debt and asset composition are essential 
characteristics of RICs. The IRS and the Treasury Department believe 
that Congress intended to provide mark-to-market treatment to shares of 
PFICs that are, in fact, comparable to RICs.

Special Rules for RICs

    The proposed regulations provide that if shares in a PFIC are owned 
directly or indirectly by a RIC, that is offering for sale, or has 
outstanding any stock of which it is the issuer, and which is 
redeemable at net asset value, the PFIC shares 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 publishes net asset valuations at least annually. The IRS and 
Treasury Department invited comments regarding situations where PFIC 
stock held by other RICs that publish asset valuations at least 
annually should not be treated as marketable stock for purposes of 
section 1296.
    One commentator explained why PFIC stock held by any closed-end RIC 
that publishes net asset values at least annually should be treated as 
marketable stock. In particular, that commentator pointed out that 
closed-end RICs are subject to many of the same regulatory requirements 
as open-end RICs. In addition, that commentator explained that an 
industry practice has developed under which closed-end RICs typically 
determine and publish current share prices, together with net asset 
values, on a weekly basis in print and other media.
    At this time, the IRS and Treasury Department know of no reason not 
to treat PFIC stock held by closed-end funds that publish net asset 
values at least annually as marketable stock. Consequently, as provided 
by section 1296(e)(2), PFIC stock held by any closed-end RIC that 
publishes net asset values at least annually shall be treated as 
marketable stock. The final regulations, however, continue to reserve 
this issue in the event that it is determined that situations exist 
where PFIC stock held by closed-end RICs that publish net asset 
valuations at least annually should not be treated as marketable stock 
for purposes of section 1296. If such a situation is found to exist, 
the reservation will be replaced at that time by a new regulatory 
exception.

Special Analyses

    It has been determined that these regulations are not significant 
regulatory actions 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, the 
notice of proposed rulemaking preceeding these regulations was 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Robert Laudeman of the 
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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is 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 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 paragraph (b)(1) of this section.
    (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 calendar year--
    (i) A national securities exchange that is registered with the 
Securities and

[[Page 3820]]

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, 
surveillance, 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, fair and orderly, 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 effectively promote 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 is 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) At all times during the calendar year, the foreign corporation 
has more than one hundred shareholders with respect to the class, other 
than shareholders who are related under section 267(b);
    (ii) At all times during the calendar year, the class of shares of 
the foreign corporation is readily available for purchase by the 
general public at its net asset value and the foreign corporation does 
not require a minimum initial investment of greater than $10,000 
(U.S.);
    (iii) At all times during the calendar year, quotations for the 
class of shares of the foreign corporation are determined and published 
no less frequently than on a weekly basis in a widely-available 
permanent medium not controlled by the issuer of the shares, such as a 
newspaper of general circulation or a trade publication;
    (iv) No less frequently than annually, independent auditors 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 are 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 that has broad inspection and enforcement 
authority and effective oversight over investment companies;
    (vi) At all times during the calendar year, 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 
actions that have as one of their principal purposes the manipulation 
of the net asset value of a class of its shares, for the calendar year 
in which the manipulation occurs, the shares are not 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 that is offering for sale, or has 
outstanding, any stock of which it is the issuer and which is 
redeemable at net asset value, if the RIC owns directly or indirectly, 
as defined in sections 958(a)(1) and (2), stock in any passive foreign 
investment company, that stock will be treated as marketable stock 
owned by that RIC for purposes of section 1296. Except as provided in 
paragraph (f)(2) of this section, in the case of any other RIC that 
publishes net asset valuations at least annually, if the RIC owns 
directly or indirectly, as defined in sections 958(a)(1) and (2), stock 
in any passive foreign investment company, that stock will 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 January 25, 2000 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.
    Approved: January 12, 2000.
Jonathan Talisman,
Assistant Secretary of the Treasury.
[FR Doc. 00-1530 Filed 1-21-00; 8:45 am]
BILLING CODE 4830-01-P