[Federal Register Volume 77, Number 34 (Tuesday, February 21, 2012)]
[Rules and Regulations]
[Pages 9846-9847]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-3909]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9579]
RIN 1545-BJ78


Source of Income From Qualified Fails Charges

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that prescribe the 
source of income received on a qualified fails charge under section 863 
of the Internal Revenue Code (Code). The regulations finalize proposed 
regulations and withdraw temporary regulations published on December 8, 
2010, and affect persons that pay or are entitled to receive qualified 
fails charges, including withholding agents.

DATES: Effective Date. These regulations are effective on February 21, 
2012.
    Applicability Date. For the date of applicability, see Sec.  1.863-
10(g).

FOR FURTHER INFORMATION CONTACT: Karen Walny, Office of Associate Chief 
Counsel (International) (202) 622-3870 (not a toll free call).

SUPPLEMENTARY INFORMATION:

Background

    In response to persistent delivery failures in delivery-versus-
payment transactions involving U.S. Treasury securities (Treasuries), 
the Treasury Market Practices Group (TMPG) and the Securities Industry 
and Financial Markets Association published a trading practice 
governing failed deliveries of Treasuries in 2008. In July, 2009, the 
Treasury Department and the Internal Revenue Service (IRS) issued 
Notice 2009-61 (2009-2 CB 181), which provided that the IRS will not 
challenge the position taken by a taxpayer or a withholding agent that 
a fails charge paid with respect to a Treasury on or before December 
31, 2010 is not subject to U.S. gross basis taxation. On December 8, 
2010, the Treasury Department and the IRS issued temporary and proposed 
regulations that establish source rules for a fails charge paid with 
respect to a Treasury, with a correction to the temporary regulations 
on December 28, 2010. 75 FR 76262, 75 FR 76321, and 75 FR 81457, 
respectively.
    The temporary and proposed regulations provide that the source of 
income from a qualified fails charge is generally determined by 
reference to the residence of the taxpayer that is the recipient of the 
qualified fails charge income, with two exceptions. Qualified fails 
charge income earned by a qualified business unit (QBU) of a taxpayer 
is sourced to the country in which the QBU is engaged in a trade or 
business, and qualified fails charge income that arises from a 
transaction the income from which is effectively connected to a United 
States trade or business is sourced in the United States and treated as 
effectively connected to the conduct of a United States trade or 
business.
    No comments were received on the proposed regulations, and no 
hearing was requested or held. This Treasury decision adopts the 
proposed regulations with the changes discussed in this preamble.

Explanation of Provisions

    These final regulations adopt, with one substantive change, the 
proposed regulations on the source of a qualified fails charge. The 
final regulations also make a number of clarifying changes to the 
language of the regulations.
    The preamble to the temporary regulations noted that no trading 
practice existed at that time for fails charges on securities other 
than Treasuries, but that if a fails charge trading practice pertaining 
to other securities was endorsed by the TMPG or an agency of the United 
States government, the Treasury Department and the IRS would consider 
whether the source rule in the regulations should be extended to those 
fails charges. The TMPG has subsequently endorsed a trading practice 
for debentures issued by the Federal National Mortgage Association 
(Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac), 
and the Federal Home Loan Banks and agency pass-through mortgage-backed 
securities issued or guaranteed by the Government National Mortgage 
Association (Ginnie Mae), Fannie Mae, and Freddie Mac (Agency Debt and 
Agency MBS, respectively) beginning in February, 2012.
    The Treasury Department and the IRS have determined that the same 
source rule should apply to fails charges incurred with respect to 
Agency Debt and Agency MBS as to fails charges on Treasuries. 
Accordingly, these final regulations expand the scope of a qualified 
fails charge to fails charges paid with respect to Agency Debt. The 
sourcing rule in the final regulations also applies to a fails charge 
on Agency MBS guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae 
(for tax purposes, Fannie Mae, Freddie Mac, and Ginnie Mae do not issue 
Agency MBS). The final regulations do not address the source of any 
other payment, including a fails charge that is not a qualified fails 
charge.
    The Treasury Department and the IRS are considering whether 
separate guidance is needed on the source of income attributable to 
certain payments, other than qualified fails charges, that arise in 
securities lending transactions or repurchase transactions and request 
comments regarding this issue.

Effective Date

    These regulations are effective on February 21, 2012.

Applicability Date

    These regulations apply to a qualified fails charge paid or accrued 
on or after December 8, 2010.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. It has also been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to

[[Page 9847]]

these regulations, and because these regulations do not impose a 
collection of information on small entities, the provisions of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply. Pursuant 
to section 7805(f) of the Code, the proposed regulations preceding 
these regulations were 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 Karen Walny, Office of 
the Associate Chief Counsel (International). However, other persons 
from the Office of Associate Chief Counsel (International) and the 
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

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 863(a) and 7805 * * *


0
Par. 2. Section 1.863-10 is added to read as follows:


Sec.  1.863-10  Source of income from a qualified fails charge.

    (a) In general. Except as provided in paragraphs (b) and (c) of 
this section, the source of income from a qualified fails charge shall 
be determined by reference to the residence of the taxpayer as 
determined under section 988(a)(3)(B)(i).
    (b) Qualified business unit exception. The source of income from a 
qualified fails charge shall be determined by reference to the 
residence of a qualified business unit (as defined in section 989) of a 
taxpayer if--
    (1) The taxpayer's residence, determined under section 
988(a)(3)(B)(i), is the United States;
    (2) The qualified business unit's residence, determined under 
section 988(a)(3)(B)(ii), is outside the United States;
    (3) The qualified business unit is engaged in the conduct of a 
trade or business in the country where it is a resident; and
    (4) The transaction to which the qualified fails charge relates is 
attributable to the qualified business unit. A transaction will be 
treated as attributable to a qualified business unit if it satisfies 
the principles of Sec.  1.864-4(c)(5)(iii) (substituting ``qualified 
business unit'' for ``U.S. office'').
    (c) Effectively connected income exception. Qualified fails charge 
income that arises from a transaction any income from which is (or 
would be if the transaction produced income) effectively connected with 
a United States trade or business pursuant to Sec.  1.864-4(c) is 
treated as from sources within the United States, and the income from 
the qualified fails charge is treated as effectively connected to the 
conduct of a United States trade or business.
    (d) Qualified fails charge. For purposes of this section, a 
qualified fails charge is a payment that--
    (1) Compensates a party to a transaction that provides for delivery 
of a designated security (as defined in paragraph (e) of this section) 
in exchange for the payment of cash (delivery-versus-payment 
settlement) for another party's failure to deliver the specified 
designated security on the settlement date specified in the relevant 
agreement; and
    (2) Is made pursuant to--
    (i) A trading practice or similar guidance approved or adopted by 
either an agency of the United States government or the Treasury Market 
Practices Group, or
    (ii) Any trading practice, program, policy or procedure approved by 
the Commissioner in guidance published in the Internal Revenue 
Bulletin.
    (e) Designated security. For purposes of this section, a designated 
security means any--
    (i) Debt instrument (as defined in Sec.  1.1275-1(d)) issued by the 
United States Treasury Department, the Federal National Mortgage 
Association, the Federal Home Loan Mortgage Corporation, or any Federal 
Home Loan Bank; or
    (ii) Pass-through mortgage-backed security guaranteed by the 
Federal National Mortgage Association, the Federal Home Loan Mortgage 
Corporation, or the Government National Mortgage Association.
    (g) Effective/applicability date. This section is effective on 
February 21, 2012. This section applies to a qualified fails charge 
paid or accrued on or after December 8, 2010.


Sec.  1.863-10T  [Removed]

0
Par. 3. Section 1.863-10T is removed.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: February 14, 2012.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury, Tax Policy.
[FR Doc. 2012-3909 Filed 2-17-12; 8:45 am]
BILLING CODE 4830-01-P