Regs on Mark-to-Market Accounting for Securities Dealers

 [4830-01-u]

 ACTION: Temporary regulations.

 SUMMARY: This document contains temporary regulations providing guidance to enable taxpayers to comply with the mark-to-market requirements of section 475. The temporary regulations provide guidance concerning the meaning of the statutory terms "dealer in securities," "held for investment," and "security." The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in the Proposed Rules section of this issue of the Federal Register.

 DATES: These temporary regulations are effective December 29, 1993.

 For dates of applicability, see section 1.475(e)-1T.

 FOR FURTHER INFORMATION CONTACT: Robert B. Williams at (202) 622-3960 or Jo Lynn Ricks at (202) 622-3920 (not toll-free calls).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545-1422. The estimated annual burden per recordkeeper varies from .25 to 3 hours, depending on individual circumstances, with an estimated average of 1 hour.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the IRS. Individual recordkeepers may require greater or less time, depending on their particular circumstances.

 For further information concerning this collection of information and where to submit comments on this collection of information, the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

BACKGROUND

This document contains temporary regulations under section 475 (relating to mark-to-market accounting for dealers in securities). Section 475 was added by section 13223 of the Revenue Reconciliation Act of 1993, Pub. L. 103-66, 107 Stat. 481, and is effective for all taxable years ending on or after December 31, 1993.

 On October 25, 1993, the IRS issued a revenue ruling that began the process of providing substantive guidance under the mark-to- market rules. The ruling was published as Rev. Rul. 93-76, 1993-35 I.R.B. 11 (November 8, 1993). These temporary regulations clarify several issues that were addressed in that ruling, including the meaning of the statutory terms "dealer in securities" and "held for investment."

EXPLANATION OF PROVISIONS

 Section 475(b) exempts certain securities from mark-to-market accounting under section 475(a). Among the exempted securities are those held for investment and debt securities not held for sale. The regulations clarify that held for investment, within the meaning of section 475(b)(1)(A), and not held for sale, within the meaning of section 475(b)(1)(B), have the same meaning. The regulations provide that both terms refer to a security that is not held by a taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.

 By providing that a security is held for investment if it is not held primarily for sale to customers in the ordinary course of a trade or business, the regulations adopt the concept of held for investment in section 1236(a). Thus, under these regulations, a dealer in securities may identify as held for investment a security that it holds primarily for sale to non-customers (e.g., a trading security). The IRS believes that providing a single standard for purposes of sections 475 and 1236 is consistent with the purpose of section 475. Comments are requested regarding other ways to simplify the task of identification.

 Holding 5 of Rev. Rul. 93-76 suggested that some securities properly identified as held for investment under section 1236(a) may not be identified as held for investment under section 475(b). Accordingly, Holding 5 of Rev. Rul. 93-76 is modified.

 The regulations identify certain assets that are inherently investments and, thus, may not be marked to market under section 475. Under the regulations, the following assets held by a dealer in securities are deemed to be properly identified as held for investment: (1) stock in a corporation that the taxpayer controls; (2) a partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust that the taxpayer controls; and (3) an annuity, endowment, or life insurance contract. The regulations define control for these purposes. Comments are requested as to other per se investments that should be deemed identified as held for investment.

 Under the authority of section 475(b)(4), the regulations provide that certain notional principal contracts and derivative securities (described in section 475(c)(2)(D) or (E)) that are held by a dealer in those securities are generally not eligible to be exempted from mark-to-market treatment as held for investment. This rule does not apply, however, if the taxpayer establishes unambiguously that the security was acquired other than in the taxpayer's capacity as a dealer in such securities. It is anticipated that this exception will apply only in rare instances.

 The regulations provide rules regarding a security held by a taxpayer as of the close of the last taxable year ending before December 31, 1993. If the security was identified under section 1236 as a security held for investment, the security is treated as being identified as held for investment for purposes of section 475(b). If the security was not identified under section 1236, the regulations provide that the security is treated as having been properly identified under section 475(b)(2) if the information in the dealer's records as of the close of that year supports the identification. If there is any ambiguity in those records, the taxpayer must, no later than January 31, 1994, place in its records a statement unambiguously indicating which securities are to be treated as properly identified. Any information that supports treating a security as having been properly identified under section 475(b)(2) must be applied consistently from one security to another. For purposes of identifying the position under section 475(c)(2)(F)(iii), these rules also apply to a position that is a security by virtue of section 475(c)(2)(F).

 Holding 9 of Rev. Rul. 93-76 established certain standards that a dealer in securities must apply in determining which of its securities must be marked to market at the beginning of its first taxable year that ends on or after December 31, 1993. This determination also controls the amount of the taxpayer's net section 481(a) adjustment. The regulations provide rules that are slightly different from the standards set forth in Holding 9. Consistent with the regulatory interpretation of "held for investment" (discussed above), the regulations clarify whether certain securities are treated as having been properly identified for purposes of being exempted from mark to market. Accordingly, Holding 9 of Rev. Rul. 93-76 is modified.

 Because the regulations provide new rules concerning the permissibility of certain identifications, a taxpayer has until January 31, 1994, to add or remove these identifications. For example, the regulations provide rules for adding identifications so that securities that were held for sale but were not held for sale to customers may be identified as being described in section 475(b)(1)(A) or (B). This identification may be added only if, prior to December 28, 1993, the taxpayer identified none of these securities as being described in section 475(b)(1)(A) or (B) and only if the retroactive identification is added for all of these securities. A security is not subject to the consistency provision in the preceding sentence if it may be timely identified after the date on which the retroactive identification is added. Thus, a taxpayer gains additional flexibility by making the retroactive identification early. In addition, any taxpayer that is a dealer in notional principal contracts or derivatives described in section 475(c)(2)(D) or (E) that had identified any such securities as held for investment may remove the identification.

 If a taxpayer adds or removes an identification discussed above, the regulations provide that the addition is timely for purposes of section 475(b)(2) and that the removal does not subject the taxpayer to the provisions of section 475(d)(2), regarding improper identifications. Similar relief is provided to a taxpayer that corrects identifications of securities held as of the close of the taxpayer's last taxable year ending before December 31, 1993.

 In general, the regulations provide that a taxpayer that sells nonfinancial goods or provides nonfinancial services (e.g., a consumer products retailer or an accountant) does not become a dealer in securities within the meaning of section 475(c)(1) by virtue of extending credit for the purchase of its goods or services, even if the taxpayer subsequently sells the evidences of indebtedness so acquired.

 The regulations provide that a taxpayer that regularly purchases securities from customers in the ordinary course of a trade or business (including regularly making loans to customers in the ordinary course of a trade or business of making loans) is not thereby a dealer in securities provided that the taxpayer does not sell more than a negligible portion of the securities so acquired. Whether the portion sold is negligible is generally determined without regard to certain extraordinary sales and certain sales of loans that declined in quality after the taxpayer acquired them. The regulations provide examples to illustrate the meaning of the term "negligible portion."

 Under the regulations, certain items are not securities within the meaning of section 475(c)(2). These items include: stock of the taxpayer or options to buy or sell the taxpayer's stock; liabilities of the taxpayer; REMIC residual interests that economically represent a liability at the time their basis is determined; and other REMIC residual interests or arrangements that the Commissioner determines have substantially the same economic effect (e.g., a widely held partnership that holds noneconomic REMIC residual interests). Marking these items to market would not carry out the purposes of section 475 and certain other Code sections (e.g., sections 1032 and 860E). Comments are requested as to other items that should similarly be excluded from the definition of a security.

 Comments are requested regarding whether additional rules are needed to carry out the purposes of section 475 for taxpayers that hold economic REMIC residual interests or interests in other passthrough entities (including subchapter S corporations or widely held partnerships).

 The regulations clarify that marking to market a security that is not held in connection with a taxpayer's activities as a dealer in securities does not affect the character of gain or loss from that security.

 These temporary regulations generally apply to taxable years ending on or after December 31, 1993.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal authors of these regulations are Robert B. Williams and Jo Lynn Ricks, Office of Assistant Chief Counsel (Financial Institutions and Products), Internal Revenue Service. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR part 1

 Income taxes, Reporting and recordkeeping requirements.

26 CFR part 602

 Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

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

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

Section 1.475(b)-1T also issued under 26 U.S.C. 475(b)(4) and 26 U.S.C. 475(e).

Section 1.475(b)-2T also issued under 26 U.S.C. 475(b)(2), 26 U.S.C. 475(e), and 26 U.S.C. 6001.

Section 1.475(c)-1T also issued under 26 U.S.C. 475(e).

Section 1.475(c)-2T also issued under 26 U.S.C. 475(e) and 26 U.S.C. 860G(e).

Section 1.475(d)-1T also issued under 26 U.S.C. 475(e).

Section 1.475(e)-1T also issued under 26 U.S.C. 475(e). * * *

Par. 2. Sections 1.475(b)-1T, 1.475(b)-2T, 1.475(c)-1T, 1.475(c)-2T, 1.475(d)-1T, and 1.475(e)-1T are added to read as follows:

SECTION 1.475(b)-1T SCOPE OF EXEMPTIONS FROM MARK-TO-MARKET REQUIREMENT (TEMPORARY).

(a) SECURITIES HELD FOR INVESTMENT OR NOT HELD FOR SALE. Except as provided by paragraph (c) of this section, a security is held for investment (within the meaning of section 475(b)(1)(A)) or not held for sale (within the meaning of section 475(b)(1)(B)) if it is not held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business.

(b) SECURITIES DEEMED IDENTIFIED AS HELD FOR INVESTMENT -- (1) IN GENERAL. The following items held by a dealer in securities are per se held for investment within the meaning of section 475(b)(1)(A) and are deemed to be properly identified as such for purposes of section 475(b)(2) --

(i) Stock in a corporation that the taxpayer controls (within the meaning of paragraph (b)(2)(i) of this section);

(ii) A partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust that the taxpayer controls (within the meaning of paragraph (b)(2)(ii) of this section); or

(iii) A contract that is treated for Federal income tax purposes as an annuity, endowment, or life insurance contract (see sections 817 and 7702).

(2) CONTROL DEFINED. Control means the ownership, directly or indirectly through persons described in section 267(b) (taking into account section 267(c)), of --

(i) 50 percent or more of the total combined voting power of all classes of stock entitled to vote; or

(ii) 50 percent or more of the capital interest, the profits interest, or the beneficial ownership interest in the widely held or publicly traded partnership or trust.

(c) SECURITIES DEEMED NOT HELD FOR INVESTMENT -- (1) GENERAL RULE FOR DEALERS IN NOTIONAL PRINCIPAL CONTRACTS AND DERIVATIVES. Section 475(b)(1)(A) (exempting certain securities from mark-to- market accounting) does not apply to a security if --

(i) The security is described in subparagraph (D) or (E) of section 475(c)(2) (describing certain notional principal contracts and derivative securities); and

(ii) The taxpayer is a dealer in such securities.

(2) EXCEPTION FOR SECURITIES NOT ACQUIRED IN DEALER CAPACITY. Paragraph (c)(1) of this section does not apply if the taxpayer establishes unambiguously that the security was not acquired in the taxpayer's capacity as a dealer in such securities.

SECTION 1.475(B)-2T EXEMPTIONS -- TRANSITIONAL ISSUES (TEMPORARY).

(a) TRANSITIONAL IDENTIFICATION -- (1) CERTAIN SECURITIES PREVIOUSLY IDENTIFIED UNDER SECTION 1236. If, as of the close of the last taxable year ending before December 31, 1993, a security was identified under section 1236 as a security held for investment, the security is treated as being identified as held for investment for purposes of section 475(b).

(2) CONSISTENCY REQUIREMENT FOR OTHER SECURITIES. In the case of a security (including a security described in section 475(c)(2)(F)) that is not described in paragraph (a)(1) of this section and that was held by the taxpayer as of the close of the last taxable year ending before December 31, 1993, the security is treated as having been properly identified under section 475(b)(2) or section 475(c)(2)(F)(iii) if the information contained in the dealer's books and records as of the close of that year supports the identification. If there is any ambiguity in those records, the taxpayer must, no later than January 31, 1994, place in its records a statement resolving this ambiguity and indicating unambiguously which securities are to be treated as properly identified. Any information that supports treating a security as having been properly identified under section 475(b)(2) or section 475(c)(2)(F)(iii) must be applied consistently from one security to another.

(b) CORRECTIONS ON OR BEFORE JANUARY 31, 1994 -- (1) PURPOSE. This paragraph (b) allows a taxpayer to add or remove certain identifications covered by section 1.475(b)-1T.

(2) TO CONFORM TO SECTION 1.475(b)-1T(a) -- (i) ADDED IDENTIFICATIONS. To the extent permitted by paragraph (b)(2)(ii) of this section, a taxpayer may identify as being described in section 475(b)(1)(A) or (B) --

(A) A security that was held for immediate sale but was not held primarily for sale to customers in the ordinary course of the taxpayer's trade or business (e.g., a trading security); or

(B) An evidence of indebtedness that was not held for sale to customers in the ordinary course of the taxpayer's trade or business and that the taxpayer intended to hold for less than one year.

(ii) Limitations. An identification described in paragraph (b)(2)(i) of this section is permitted only if--

(A) Prior to December 38, 1993, the taxpayer did not identify as being described in section 475(b)(1)(A) or (B) any of the securities described in paragraph (b)(2)(i) of this section;

(B) The taxpayer identifies every security described in paragraph (b)(2)(i) for which a timely identification of the security under section 475(b)(2) cannot be made after the date on which the taxpayer makes these added identifications; and

(C) The identification is made on or before January 31, 1994.

(3) TO CONFORM TO SECTION 1.475(b)-1T(c). On or before January 31, 1994, a taxpayer described in section 1.475(b)-1T(c)(1)(ii) may remove an identification under section 475(b)(1)(A) of a security described in section 1.475(b)-1T(c)(1)(i).

(c) EFFECT OF CORRECTIONS. An identification added under paragraph (a)(2) or (b)(2) of this section is timely for purposes of section 475(b)(2) or section 475(c)(2)(F)(iii). An identification removed under paragraph (a)(2) or (b)(3) of this section does not subject the taxpayer to the provisions of section 475(d)(2).

SECTION 1.475(c)-1T DEFINITIONS -- DEALERS IN SECURITIES (TEMPORARY).

(a) SELLERS OF NONFINANCIAL GOODS AND SERVICES. If the principal activity of a taxpayer is selling nonfinancial goods or providing nonfinancial services, the fact that the taxpayer extends credit to the purchasers of its nonfinancial goods or services does not make the taxpayer a dealer in securities within the meaning of section 475(c)(1), even if the taxpayer sells the evidences of indebtedness so acquired. The preceding sentence does not apply if, for purposes of section 471, the taxpayer claims to be a dealer in those evidences of indebtedness.

(b) TAXPAYERS THAT PURCHASE SECURITIES BUT DO NOT SELL MORE THAN A NEGLIGIBLE PORTION OF THE SECURITIES -- (1) EXEMPTION FROM DEALER STATUS. A taxpayer that regularly purchases securities from customers in the ordinary course of a trade or business (including regularly making loans to customers in the ordinary course of a trade or business of making loans) is not thereby a dealer in securities for purposes of section 475(c)(1) if the taxpayer does not sell more than a negligible portion of the securities so acquired. The preceding sentence does not apply if, for purposes of section 471, the taxpayer claims to be a dealer in those securities.

(2) NEGLIGIBLE PORTION. The meaning of negligible portion is illustrated by the following examples:

(i) EXAMPLE 1. A regularly acquires loans (both by making loans to customers and by otherwise purchasing loans) in the ordinary course of its business. A retains almost all of the loans that it acquires. In 1993, A sells fewer than 60 loans. Accordingly, in 1993 A does not sell more than a negligible portion of the securities it acquired.

(ii) EXAMPLE 2. B regularly acquires loans (both by making loans to customers and by otherwise purchasing loans) in the ordinary course of its business. In 1993, B sells more than 60 loans, but the total adjusted basis of the loans that B sells in 1993 is less than 5% of the total basis, immediately after acquisition, of the loans that it acquires in that year. Accordingly, in 1993 B does not sell more than a negligible portion of the securities it acquired.

(3) SPECIAL RULES. Whether the portion of securities sold is negligible is determined without regard to --

(i) Sales of evidences of indebtedness that decline in quality while in the taxpayer's hands and that are sold pursuant to an established policy of the taxpayer to dispose of evidences of indebtedness below a certain quality; or

(ii) Sales that are necessitated by exceptional circumstances and that are not undertaken as recurring business activities.

SECTION 1.475(c)-2T DEFINITIONS -- ITEMS THAT ARE NOT SECURITIES (TEMPORARY).

(a) IN GENERAL. The following items held by a dealer in securities are not securities within the meaning of section 475(c)(2) and, therefore, are not subject to section 475 --

(1) Stock (including treasury stock) of the taxpayer and any option to buy or sell its stock (including treasury stock);

(2) A liability of the taxpayer; or

(3) A REMIC residual interest that is described in paragraph (b) of this section or an interest or arrangement that is determined by the Commissioner to have substantially the same economic effect.

(b) NEGATIVE VALUE REMIC RESIDUALS. A residual interest in a REMIC is described in this paragraph (b) if, on the date the taxpayer acquires the residual interest, the present value of the anticipated tax liabilities associated with holding the interest exceeds the sum of --

(1) The present value of the expected future distributions on the interest; and

(2) The present value of the anticipated tax savings associated with holding the interest as the REMIC generates losses.

(c) SPECIAL RULES. Solely for purposes of paragraphs (a)(3) and (b) of this section --

(1) If a transferee taxpayer acquires a residual interest with a basis determined by reference to the transferor's basis, then the transferee is deemed to acquire the interest on the date the transferor acquired it (or is deemed to acquire it under this paragraph (c)(1)).

(2) Anticipated tax liabilities, expected future distributions, and anticipated tax savings are determined under the rules in section 1.860E-2(a)(3) and without regard to the operation of section 475.

(3) Present values are determined under the rules in section 1.860E-2(a)(4).

SECTION 1.475(d)-1T CHARACTER OF GAIN OR LOSS (TEMPORARY).

If a security is never held in connection with the taxpayer's activities as a dealer in securities, section 475(d)(3)(A) does not affect the character of gain or loss from the security, even if the taxpayer fails to identify the security under section 475(b)(2).

SECTION 1.475(e)-1T EFFECTIVE DATES (TEMPORARY).

Sections 1.475(b)-1T, 1.475(b)-2T, 1.475(c)-1T, 1.475(c)-2T, and 1.475(d)-1T generally apply to taxable years ending on or after December 31, 1993.

Par. 3. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 4. Section 602.101(c) is amended by adding an entry in numerical order to the table to read as follows:

SECTION 602.101 OMB CONTROL NUMBERS.

* * * * *

(c) * * *

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