Menu
Tax Notes logo

Ernst & Young Asks IRS to Address Securities Lending in PTP Regs

APR. 14, 1998

Ernst & Young Asks IRS to Address Securities Lending in PTP Regs

DATED APR. 14, 1998
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Ernst & Young LLP
  • Cross-Reference
    For a summary of REG-105163-97, see Tax Notes, Dec. 22, 1997, p.

    1321; for the full text, see Doc 97-33836 (10 pages) or H&D, Dec. 19,

    1997, p. 3327.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    partnerships, publicly traded
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 98-12867 (2 pages)
  • Tax Analysts Electronic Citation
    98 TNT 78-41
====== SUMMARY ======

Ernst & Young LLP has asked the IRS to address in proposed regs under section 7704 whether income from securities lending activities meets the qualifying income test for publicly traded partnerships. Income from such activities should qualify, the accounting firm says, unless the activities are "conducted by one functioning as a broker, market maker or a dealer not in the capacity of a trade or investor." E&Y also asks that the regs clarify whether the qualifying income item "capital gain from the sale of stock" means gross gains without any capital losses, or net of capital losses.

====== FULL TEXT ======

April 9, 1998

Express Mail

 

CC:DOM:CORP:R (REG-105163-97)

 

Room 5228

 

Internal Revenue Service

 

P.O. Box 7604

 

Benjamin Franklin Station

 

Washington, DC 20044

COMMENTS ON PROPOSED REGULATION SECTION 1.7704-3 (REG-105163-97)

 

TREATMENT OF CERTAIN INVESTMENT INCOME UNDER QUALIFYING INCOME

 

PROVISIONS OF IRC SECTION 7704(d)

Ladies and Gentlemen:

[1] These comments are in response to the notice of Proposed Rulemaking (REG-105163-97) published in the Federal Register for December 17, 1997 containing Prop. Reg. section 1.7704-3 (the "Proposed Regulation"). The Proposed Regulation relates, in part, to the treatment of certain investment income under the qualifying income provisions of IRC section 7704(d).

[2] IRC section 7704 provides that a publicly traded partnership is generally treated as a corporation for Federal income tax purposes unless 90% or more of the gross income of the partnership consists of "qualifying income." IRC section 7704(d) defines qualifying income to include certain types of passive income, such as interest, dividends, real property rents and income that would qualify under the regulated investment company (RIC) provisions in IRC section 851(b)(2) or the real estate investment trust (REIT) provisions in IRC section 856(c)(2).

[3] The Preamble to the Proposed Regulation notes that since IRC section 7704 was enacted, several new types of financial investments have been developed that generate passive type investment income similar to interest and dividends. The Proposed Regulation broadens qualifying income to certain notional principal contracts and "other substantially similar income from ordinary and routine investments to the extent determined by the Commissioner."

[4] The Proposed Regulation makes it clear that qualifying income does not include income derived in the ordinary course of a trade or business. Income derived from an asset with respect to which the partnership functions as a broker, market maker, or dealer is treated as income derived in the ordinary course of a trade or business. However, the Proposed Regulation further states that income derived from an asset with respect to which the taxpayer is a trader or investor is not treated as income derived in the ordinary course of a trade or business.

[5] While we commend the Internal Revenue Service in its efforts to clarify and update the qualifying income test, the failure of the Proposed Regulation to specifically address the treatment of securities lending transactions has created great uncertainty for many securities partnerships and their partners concerned with classification under IRC section 7704. Securities lending is a common activity of securities partnerships. We therefore respectfully request that the tax treatment of securities lending be explicitly addressed in finalizing Reg. section 1.7704-3.

[6] Income from securities lending activities, except where conducted by one functioning as a broker, market maker or a dealer not in the capacity of a trader or investor, should be qualifying income for purposes of IRC section 7704(d). We note that the IRC section 512(b) exclusions from unrelated business taxable income include "payments with respect to securities loans" as one of the enumerated types of passive income. Also, IRC section 7704(d) provides, in part, that qualifying income includes income that would qualify under section 851(b)(2). IRC section 851(b)(2) includes, in part, income from "payments with respect to securities loans (as defined in Section 512(a)(5)) . . . derived with respect to its business of investing in stock, securities or currencies." Since IRC section 851(b)(2) is worded in terms of "investing" rather than "trading," clarification is necessary.

[7] In addition, we request that you clarify whether the qualifying income item "capital gain from the sale of stock" set forth in the Proposed Regulation means "gross" capital gain without any reduction for capital losses, or, alternatively, is net of capital losses. As noted above, IRC section 7704(d) defines qualifying income to include, in part, income that would qualify under the RIC provisions in IRC section 851(b)(2) or the REIT provisions in IRC section 856(c)(2). The regulations under those sections (Reg. section 1.851-2(b)(1) and Reg. section 1.856-2(c)(1)) explicitly provide that losses from the sale of stock or securities do not enter into the applicable gross income computation.

* * * * *

[8] Ernst & Young LLP appreciates the opportunity to comment on Prop. Reg. section 1.7704-3 and hopes that these comments will assist you in drafting the final regulation. Should you care at any time to discuss these comments, please contact Richard J. Shapiro at 212-773-2740.

Sincerely,

Ernst & Young LLP

 

New York, New York
DOCUMENT ATTRIBUTES
  • Institutional Authors
    Ernst & Young LLP
  • Cross-Reference
    For a summary of REG-105163-97, see Tax Notes, Dec. 22, 1997, p.

    1321; for the full text, see Doc 97-33836 (10 pages) or H&D, Dec. 19,

    1997, p. 3327.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    partnerships, publicly traded
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 98-12867 (2 pages)
  • Tax Analysts Electronic Citation
    98 TNT 78-41
Copy RID