Mark to Market for Dealers in Securities; Equity Interests in Related Parties and the Dealer-Customer Relationship

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[FI-32-95]

RIN 1545-AT94

Mark to Market for Dealers in Securities; Equity Interests in

Related Parties and the Dealer-Customer Relationship

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations that make mark-to-

market accounting inapplicable to most equity interests in related

entities. The regulations also relate to the definition of a dealer in

securities for certain federal income tax purposes. To qualify as a

dealer in securities, a taxpayer must engage in transactions with

customers. The proposed regulations concern the existence of dealer-

customer relationships. The Revenue Reconciliation Act of 1993 amended

the applicable tax law. These regulations provide guidance for

taxpayers that engage in securities transactions. This document also

provides notice of a public hearing on these proposed regulations.

DATES: Written comments and outlines of oral comments to be presented

at a public hearing scheduled for October 15, 1996, at 10 a.m., must be

received by September 18, 1996.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (FI-32-95), room 5228,

Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,

DC 20044. In the alternative, submissions may be hand delivered between

the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (FI-32-95), Courier's

Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,

Washington, DC 20224. The public hearing will be held in the

Commissioner's Conference Room, room 3313, Internal Revenue Building,

1111 Constitution Avenue NW., Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Jo Lynn L.

Ricks, (202) 622-3920, or Robert B. Williams, (202) 622-3960;

concerning submissions and the hearing, Michael Slaughter, (202) 622-

7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed

rulemaking has been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act of 1995 (44

U.S.C. 3507).

Comments on the collection of information should be sent to the

Office of Management and Budget, Attn: Desk Officer for the Department

of the Treasury, Office of Information and Regulatory Affairs,

Washington, DC 20503, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224.

Comments on the collection of information should be received by August

19, 1996.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

The collection of information is described in the Explanation of

Provisions section of the Preamble (rather than being included in the

text of the proposed regulations). The Preamble requests comments on

whether the final regulations should permit taxpayers to elect to

disregard certain inter-company transactions in determining status as a

dealer in securities. The preamble also indicates that, if the election

is allowed to be made, it is expected that taxpayers would make it by

attaching a statement to a tax return. If the final regulations allow

taxpayers to make this election in this manner, the information will be

required by the IRS to determine whether the election has been made,

and will be used for that purpose. The likely respondents will be

businesses that file consolidated tax returns. If taxpayers are allowed

to make the election, responses to this collection of information will

be required to obtain the benefit of having status as a dealer in

securities determined without regard to certain inter-company

transactions.

Books or records relating to a collection of information must be

retained as long as their contents may become material in the

administration of any internal revenue law. Generally, tax returns and

tax return information are confidential, as required by 26 U.S.C. 6103.

Estimated total annual reporting burden: 6,000 hours. The estimated

annual burden per respondent varies from .25 hour to 1 hour, depending

on individual circumstances, with an estimated average of .5 hours.

Estimated number of respondents: 12,000. Estimated annual frequency of

responses: once in the existence of each respondent.

Background

This document contains proposed regulations under section 475 of

the Internal Revenue Code, which requires mark-to- market accounting

for certain dealers in securities. Section 475 was added by section

13223 of the Revenue Reconciliation Act of 1993, Pubic Law 103-66, 107

Stat. 481, and is effective for all taxable years ending on or after

December 31, 1993.

Temporary and proposed regulations published on December 29, 1993,

(58 FR 68798) provide that stock in a 50-percent-controlled subsidiary

(and interests in 50-percent-controlled partnerships and trusts) are

deemed properly identified as held for investment and thus are excluded

from mark-to-market accounting. The IRS is reproposing this rule with

two changes. First, the IRS has concluded that the rationale for the

rule applies equally to equity interests in most related persons and

not just to persons controlled by the taxpayer. Second, after

considering various comments received, the IRS determined that this

rule prohibiting marking a security to market should not apply if two

requirements are met: (1) The security is actively traded on a national

securities exchange or through an interdealer quotation system; and (2)

the taxpayer who marks owns less than 5 percent of all shares or

interests of the same class. Comments are requested as

[[Page 31475]]

to whether it is appropriate to allow any equity interests in related

parties to be marked to market, and, if so, whether the proposed

limitations are the most appropriate ones. The provisions in this

document concerning these issues are referred to below in this preamble

as the reproposed regulations.

When commenting on the temporary and proposed regulations,

taxpayers asked the IRS to provide guidance on whether certain

transactions are entered into with customers for purposes of section

475. Whether transactions are entered into with customers can affect

both whether a taxpayer is a dealer in securities subject to mark-to-

market accounting (see section 475(c)(1)) and whether a dealer may

exempt a security from mark- to-market treatment (see section 475(b)(1)

(A) and (B) and Sec. 1.475(b)-1T(a)).

In response to these comments, on January 4, 1995, the IRS

published proposed regulations [(FI-42-94) (60 FR 397)] stating that

whether a taxpayer is transacting business with customers is determined

based on all of the facts and circumstances (see proposed

Sec. 1.475(c)-1(c), reproposed as Sec. 1.475(c)-1(a)). These proposed

regulations also provide that the term dealer in securities includes a

taxpayer that, in the ordinary course of its trade or business,

regularly holds itself out as being willing and able to enter into

either side of a transaction enumerated in section 475(c)(1)(B) (see

proposed Sec. 1.475(c)-1(c)(2), reproposed as Sec. 1.475(c)-1(a)(2)).

On March 4, 1996, the IRS published Notice 96-12 (1996-10 I.R.B.

29), stating that the IRS intended to publish additional proposed

regulations concerning when transactions with related parties may be

transactions with customers for purposes of section 475. Notice 96-12

also described the substance of rules that the proposed regulations

were expected to contain. The rules were expected to be proposed to be

effective for taxable years beginning on or after February 20, 1996.

The proposed regulations in this document generally reflect the

substance that was described in Notice 96-12.

Explanation of Provisions

Prohibition Against Marking Equity Interests in Related Persons

The reproposed regulations identify certain assets that are

inherently investments and, thus, may not be marked to market under

section 475. The new rules retain the provision in the temporary

regulations that prevents marking certain insurance products to market,

but they differ from the temporary regulations in the provisions that

prevent the marking of certain equity interests. Under the temporary

regulations, the prohibition against marking applies only if the dealer

in securities controls the issuer of an equity interest (whether it is

stock in a corporation or an interest in a widely held or publicly

traded partnership or trust). The reproposed regulations expand the

scope of this treatment so that mark-to-market accounting cannot be

used for equity interests in many related issuers. (For these purposes,

the reproposed regulations incorporate by reference the relevant

relations described in sections 267(b) and 707(b)(1).) The reproposed

regulations also narrow the scope of this prohibition against marking

so that mark-to-market accounting can be used for certain actively-

traded securities, regardless of the dealer's relation to the issuer of

the security, if the dealer owns less than five percent of the

securities. The IRS is particularly interested in receiving comments on

the scope of the reproposed rules' exception to the general prohibition

on marking to market equity interests in a related person.

These reproposed regulations also contain rules to cover situations

where a security begins, or ceases, to be subject to this deemed-

identification rule. First, if a security is being marked to market and

then, as a result of a change in facts, the regulations prohibit the

security from continuing to be marked to market, the regulations

require that the security be marked as of the close of business on the

last day before the day when the prohibition on marking first applies.

Second, the reproposed regulations also cover situations in which

the regulations have prohibited a security from being marked to market

and then the prohibition on marking ceases to apply. In these cases,

the deadline for the taxpayer to identify the security under section

475(b)(2) as exempt from mark-to-market treatment is generally extended

until the date the prohibition on marking ceases to apply. (If the

taxpayer had identified the security by the original deadline, the

extension, of course, is irrelevant.) If the identification is not made

on or before the deadline (as so extended), new changes in value are

taken into account under the mark-to-market method, but recognition of

appreciation and depreciation that occurred while the security was not

being marked is suspended. This is the approach adopted by section

475(b)(3) for securities that lose their exemption from mark-to-market

treatment. The reproposed rule is to apply both when the prohibition on

marking ceases because of a change in facts and when the prohibition on

marking ceases because the rule covering certain actively-traded

securities becomes effective.

In sum, under the reproposed 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 (or a partnership or

beneficial ownership interest in a widely held or publicly traded

partnership or trust) to which the taxpayer is related (other than

certain actively-traded stock or interests); and (2) an annuity,

endowment, or life insurance contract. The provision concerning the

second category of assets continues to be proposed to apply to all

taxable years ending on or after December 31, 1993. The rules

concerning the first category of assets, however, are proposed to

prohibit only those marks to market that would have occurred on or

after June 19, 1996. If the prohibition against marking begins to apply

to a security solely because of this effective date rule, then (unlike

the situation when the onset of the prohibition is caused by a change

in facts) the security is not marked to market immediately before the

prohibition begins.

In general, the provision allowing certain actively-traded

securities to be marked to market even when the issuer of the security

is related is proposed to be effective for marks to market on or after

June 19, 1996. Thus, this effective date is the same as the effective

date in the reproposed regulations for the general prohibition on

marking to market securities issued by a related person. Until the

reproposed regulations are finalized, however, all equity interests

issued by controlled entities continue to be subject to the temporary

regulations' prohibition against being marked to market, even if the

dealer owns less than 5 percent of interests of that class and even if

the interests are actively traded.

Some commenters suggested there should be no per se rule treating

certain securities as held for investment, but instead there should be

a rebuttable presumption to this effect for these items. Other

commenters proposed to add, or delete, a variety of items to or from

those deemed to be per se held for investment. The reproposed

regulations do not adopt these suggestions.

Consolidated Returns

Under both the temporary and the reproposed regulations, there are

situations in which the mark-to-market method may apply to a

consolidated

[[Page 31476]]

group member's stock held by another member of the group. This may

result in the recognition of duplicate gain or loss. For instance, if a

common parent marks to market stock in a subsidiary to reflect

increases in the value of the subsidiary stock owned by the parent

resulting from appreciation in the value of the subsidiary's assets,

the parent will recognize gain on that stock under the mark-to-market

method. The subsidiary's subsequent sale of the assets will replicate

that gain at the subsidiary level. The gains will generate duplicate

stock basis increases under section 475 and Sec. 1.1502-32(b), creating

the potential for an offsetting loss when the stock is subsequently

marked down to fair market value under section 475. Section 1.1502-20,

however, may disallow any such offsetting loss. Comments are invited

regarding how to address the anomalies these rules may produce.

The Dealer-Customer Relationship

These proposed regulations clarify that a taxpayer's transactions

with members of its consolidated group or other related persons may be

transactions with customers for purposes of section 475. Thus, a

taxpayer may be a dealer in securities for purposes of section 475 even

if its only customer transactions are transactions with members of its

consolidated group. In enacting section 475, Congress adopted a

taxpayer-by- taxpayer approach to determining dealer status, rather

than the single-entity approach embodied in Sec. 1.1502-13.

An example in the proposed regulations clarifies that, for purposes

of section 475, transactions do not fail to be transactions with

customers solely because the parties enter into them with other than

arms-length pricing terms. Under section 482 and the regulations

thereunder, however, the district director may make allocations between

or among the members of the group if he or she determines that a member

has not reported its true taxable income.

These proposed regulations generally reflect the substance of the

rules set forth in Notice 96-12 (1996-10 I.R.B. 29). In response to

taxpayer comments, however, certain language in Notice 96-12 has been

clarified. Because of these changes, although the rules described in

Notice 96-12 were expected to be proposed to be effective for taxable

years beginning on or after February 20, 1996, these proposed

regulations are to be effective for taxable years beginning on or after

June 20, 1996. If there are any situations in which the proposed rules

lead to a different result from that which would be reached under the

rules described in the notice, a taxpayer may reasonably and

consistently apply the rules described in the notice for any taxable

year beginning on or after February 20, 1996, and before June 20, 1996.

Under these regulations, a taxpayer may be a dealer in securities

based solely on transactions with other members of its consolidated

group. The IRS requests comments on whether certain consolidated groups

should be allowed to disregard inter-member transactions in determining

a member's status as a dealer in securities. For instance, a group

might be allowed to disregard inter-member transactions if the group,

considered as a single corporation, would not be a dealer in securities

for purposes of section 475. It is likely that the election, if

permitted by the final regulations, would be made by attaching an

appropriate statement to the taxpayer's return. (See the Paperwork

Reduction Act section of this preamble, which requests comments on the

burden that might be imposed by this requirement.) The IRS hereby

requests comments on the desirability and potential terms and

conditions of any such election. Comments could also address whether

such an election should apply in determining whether a taxpayer had

made more than negligible sales for purposes of reproposed

Sec. 1.475(c)-1(c). Further, the IRS requests comments on whether the

election should be available only to groups that have not made a

separate-entity election under Sec. 1.1221-2(d)(2).

Miscellaneous

Some of the 1993 and 1995 proposed regulations are reordered.

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) 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, 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 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. All

comments will be available for public inspection and copying.

A public hearing has been scheduled for October 15, 1996, at 10

a.m. in the Commissioner's Conference Room, room 3313, Internal Revenue

Building, 1111 Constitution Avenue NW., Washington, DC 20224. Because

of access restrictions, visitors will not be admitted beyond the

Internal Revenue Building lobby more than 15 minutes before the hearing

starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit written comments and submit an outline of the topics to be

discussed and the time to be devoted to each topic (signed original and

eight (8) copies) by September 18, 1996.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Jo Lynn L. Ricks and

Robert B. Williams, Office of Assistant Chief Counsel (Financial

Institutions & Products). 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, as proposed on

January 4, 1995, at 60 FR 401, is further amended by revising the

entries for ``Section 1.475(b)-1'', ``Section 1.475(b)-2'', and

``Section 1.475(b)-4'' to read as follows:

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

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

U.S.C. 475(e).

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

U.S.C. 475(e). * * *

Section 1.475(b)-4 also issued under 26 U.S.C. 475(b)(2), 26

U.S.C. 475(e), and 26 U.S.C. 6001. * * *

Par. 2. Section 1.475-0, as proposed on January 4, 1995 (60 FR

401), is amended by:

[[Page 31477]]

1. Revising the heading and entries for Secs. 1.475(b)-1, 1.475(b)-

2, and 1.475(b)-4.

2. Revising the entries under Secs. 1.475(c)-1 and 1.475(c)-2.

3. Removing the entries under Sec. 1.475(e)-1.

The revisions read as follows:

Sec. 1.475-0 Table of contents.

* * * * *

Sec. 1.475(b)-1 Scope of exemptions from mark-to-market

requirement.

(a) Securities held for investment or not held for sale.

(b) Securities deemed identified as held for investment.

(1) In general.

(2) Relationships.

(i) General rule.

(ii) Attribution.

(iii) Trusts treated as partnerships.

(3) Securities traded on certain established financial markets.

(4) Changes in status.

(i) Onset of prohibition against marking.

(ii) Termination of prohibition against marking.

(iii) Examples.

(c) Securities deemed not held for investment.

(1) General rule for dealers in notional principal contracts and

derivatives.

(2) Exception for securities not acquired in dealer capacity.

(d) Special rules.

(1) Stock, partnership, and beneficial ownership interests in

certain controlled corporations, partnerships, and trusts.

(i) In general.

(ii) Control defined.

(iii) Applicability.

(2) [Reserved].

Sec. 1.475(b)-2 Exemptions--Identification requirements.

(a) Identification of the basis for exemption.

(b) Time for identifying a security with a substituted basis.

(c) Securities involved in integrated transactions under

Sec. 1.1275-6.

(1) Definitions.

(2) Synthetic debt held by a taxpayer as a result of legging in.

(3) Securities held after legging out.

* * * * *

Sec. 1.475(b)-4 Exemptions--Transitional issues.

(a) Transitional identification.

(1) Certain securities previously identified under section 1236.

(2) Consistency requirement for other securities.

(b) Corrections on or before January 31, 1994.

(1) Purpose.

(2) To conform to Sec. 1.475(b)-1(a).

(i) Added identifications.

(ii) Limitations.

(3) To conform to Sec. 1.475(b)-1(c).

(c) Effect of corrections.

Sec. 1.475(c)-1 Definitions--Dealer in securities.

(a) Dealer-customer relationship.

(1) [Reserved].

(2) Transactions described in section 475(c)(1)(B).

(i) In general.

(ii) Examples.

(3) Related parties.

(i) In general.

(ii) Example.

(b) Sellers of nonfinancial goods and services.

(c) Taxpayers that purchase securities but do not sell more than

a negligible portion of the securities.

(1) Exemption from dealer status.

(2) Negligible portion.

(3) Special rules.

(d) Issuance of life insurance products.

Sec. 1.475(c)-2 Definitions--Security.

(a) In general.

(b) Synthetic debt held by a taxpayer as a result of an

integrated transaction under Sec. 1.1275-6.

(c) Negative value REMIC residuals.

(d) Special rules.

* * * * *

Sec. 1.475(e)-1 Effective dates.

Par. 3. Section 1.475(b)-1 as proposed on December 29, 1993 (58 FR

68798), is amended by revising paragraph (b) and adding paragraph (d)

to read as follows:

Sec. 1.475(b)-1 Scope of exemptions from mark-to-market requirement.

* * * * *

(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) Except as provided in paragraph (b)(3) of this section, stock

in a corporation, or a partnership or beneficial ownership interest in

a widely held or publicly traded partnership or trust, to which the

taxpayer has a relationship specified in paragraph (b)(2) of this

section; or

(ii) A contract that is treated for federal income tax purposes as

an annuity, endowment, or life insurance contract (see sections 817 and

7702).

(2) Relationships--(i) General rule. The relationships specified in

this paragraph (b)(2) are--

(A) those described in section 267(b)(2), (3), (10), (11), or (12);

or

(B) those described in section 707(b)(1) (A) or (B).

(ii) Attribution. The relationships described in paragraph

(b)(2)(i) of this section are determined taking into account sections

267(c) and 707(b)(3), as appropriate.

(iii) Trusts treated as partnerships. For purposes of this

paragraph (b)(2), the phrase partnership or trust is substituted for

the word partnership in sections 707(b)(1) and 707(b)(3), and a

reference to beneficial ownership interest is added to each reference

to capital interest or profits interest in those sections.

(3) Securities traded on certain established financial markets.

Paragraph (b)(1)(i) of this section does not apply to a security if--

(i) The security is actively traded within the meaning of

Sec. 1.1092(d)-1(a) taking into account only established financial

markets identified in Sec. 1.1092(d)-1(b)(1) (i) or (ii) (describing

national securities exchanges and interdealer quotation systems), and

(ii) The taxpayer owns less than 5 percent of all of the shares or

interests in the same class.

(4) Changes in status--(i) Onset of prohibition against marking--

(A) Once a security begins to be described in paragraph (b)(1) of this

section and for so long as it continues to be so described, section

475(a) does not apply to the security in the hands of the taxpayer.

(B) If a security has not been timely identified under section

475(b)(2) and, after the last day on which such an identification would

have been timely, the security begins to be described in paragraph

(b)(1) of this section, then the dealer must recognize gain or loss on

the security as if it were sold for its fair market value as of the

close of business of the last day before the security begins to be

described in paragraph (b)(1) of this section, and gain or loss is

taken into account at that time.

(ii) Termination of prohibition against marking. If a taxpayer did

not timely identify a security under section 475(b)(2) and paragraph

(b)(1) of this section applies to the security on the last day on which

such an identification would have been timely but it thereafter ceases

to apply--

(A) An identification of the security under section 475(b)(2) is

timely if made on or before the close of the day paragraph (b)(1) of

this section ceases to apply; and

(B) Unless the taxpayer timely identifies the security under

section 475(b)(2) (taking into account the additional time for

identification that is provided by paragraph (b)(4)(ii)(A) of this

section), section 475(a) applies to changes in value of the security

after the cessation in the same manner as under section 475(b)(3).

(iii) Examples. These examples illustrate this paragraph (b)(4):

[[Page 31478]]

Example 1. Onset of prohibition against marking--(A) Facts.

Corporation H owns 75 percent of the stock of corporation D, a

dealer in securities within the meaning of section 475(c)(1). On

December 1, 1995, D acquired less than half of the stock in

corporation X. D did not identify the stock for purposes of section

475(b)(2). On July 17, 1996, H acquired from other persons 70

percent of the stock of X. As a result, D and X became related

within the meaning of paragraph (b)(2)(i) of this section. The stock

of X is not described in paragraph (b)(3) of this section

(concerning securities traded on certain established financial

markets).

(B) Holding. Under paragraph (b)(4)(i) of this section, D

recognizes gain or loss on its X stock as if the stock were sold for

its fair market value at the close of business on July 16, 1996, and

the gain or loss is taken into account at that time. As with any

application of section 475(a), proper adjustment is made in the

amount of any gain or loss subsequently realized. After July 16,

1996, section 475(a) does not apply to D's X stock while D and X

continue to be related to each other.

Example 2. Termination of prohibition against marking; retained

securities identified as held for investment--(A) Facts. On July 1,

1996, corporation H owned 60 percent of the stock of corporation Y

and all of the stock of corporation D, a dealer in securities within

the meaning of section 475(c)(1). Thus, D and Y are related within

the meaning of paragraph (b)(2)(i) of this section. Also on July 1,

1996, D acquired, as an investment, 10 percent of the stock of Y.

The stock of Y is not described in paragraph (b)(3) of this section

(concerning securities traded on certain established financial

markets). When D acquired its shares of Y stock, it did not identify

them for purposes of section 475(b)(2). On December 27, 1996, D

identified its shares of Y stock as held for investment under

section 475(b)(2). On December 30, 1996, H sold all of its shares of

stock in Y to an unrelated party. As a result, D and Y cease to be

related within the meaning of paragraph (b)(2)(i) of this section.

(B) Holding. Under paragraph (b)(4)(ii)(A) of this section,

identification of the Y shares is timely if done on or before the

close of December 30, 1996. Because D timely identified its Y shares

under section 475(b)(2), it continues to refrain from marking to

market its Y stock after December 30, 1996.

Example 3. Termination of prohibition against marking; retained

securities not identified as held for investment--(A) Facts. The

facts are the same as in Example 2 above, except that D did not

identify its stock in Y for purposes of section 475(b)(2) on or

before December 30, 1996. Thus, D did not timely identify these

securities under section 475(b)(2) (taking into account the

additional time for identification provided in paragraph

(b)(4)(ii)(A) of this section).

(B) Holding. Under paragraph (b)(4)(ii)(B) of this section,

section 475(a) applies to changes in value of D's Y stock after

December 30, 1996, in the same manner as under section 475(b)(3).

Thus, any appreciation or depreciation that occurred while the

securities were prohibited from being marked to market is suspended.

Further, section 475(a) applies only to those changes occurring

after December 30, 1996.

* * * * *

(d) Special rules--(1) Stock, partnership, and beneficial ownership

interests in certain controlled corporations, partnerships, and

trusts--(i) 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)--

(A) Stock in a corporation that the taxpayer controls (within the

meaning of paragraph (d)(1)(ii) of this section); or

(B) 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 (d)(1)(ii) of this section).

(ii) Control defined. Control means the ownership, directly or

indirectly through persons described in section 267(b) (taking into

account section 267(c)), of--

(A) 50 percent or more of the total combined voting power of all

classes of stock entitled to vote; or

(B) 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.

(iii) Applicability. The rules of this paragraph (d)(1) apply only

before the date 30 days after final regulations on this subject are

published in the Federal Register.

(2) [Reserved].

Sec. 1.475 [Amended]

Par. 4. Section 1.475(b)-2, as proposed on December 29, 1993 (58 FR

68798), is redesignated as Sec. 1.475(b)-4.

Par. 5. Section 1.475(b)-4, as proposed on January 4, 1995 (60 FR

404), is redesignated as Sec. 1.475(b)-2.

Par. 6. Section 1.475(c)-1, as proposed on December 29, 1993 (58 FR

68798), and amended on January 4, 1995 (60 FR 405), is amended as

follows:

1. Paragraph (c) is removed.

2. Paragraphs (a) and (b) are redesignated as paragraphs (b) and

(c), respectively.

2. New paragraph (a) is added to read as follows:

Sec. 1.475(c)-1 Definitions--Dealer in securities.

(a) Dealer-customer relationship. Whether a taxpayer is transacting

business with customers is determined on the basis of all of the facts

and circumstances.

(1) [Reserved].

(2) Transactions described in section 475(c)(1)(B)--(i) In general.

For purposes of section 475(c)(1)(B), the term dealer in securities

includes, but is not limited to, a taxpayer that, in the ordinary

course of the taxpayer's trade or business, regularly holds itself out

as being willing and able to enter into either side of a transaction

enumerated in section 475(c)(1)(B).

(ii) Examples. The following examples illustrate the rules of this

paragraph (a)(2). In the following examples, B is a bank:

Example 1. B regularly offers to enter into interest rate swaps

with other persons in the ordinary course of its trade or business.

B is willing to enter into interest rate swaps under which it either

pays a fixed interest rate and receives a floating rate or pays a

floating rate and receives a fixed rate. B is a dealer in securities

under section 475(c)(1)(B), and the counterparties are its

customers.

Example 2. B, in the ordinary course of its trade or business,

regularly holds itself out as being willing and able to enter into

either side of positions in a foreign currency with other banks in

the interbank market. B's activities in the foreign currency make it

a dealer in securities under section 475(c)(1)(B), and the other

banks in the interbank market are its customers.

Example 3. B engages in frequent transactions in a foreign

currency in the interbank market. Unlike the facts in Example 2,

however, B does not regularly hold itself out as being willing and

able to enter into either side of positions in the foreign currency,

and all of B's transactions are driven by its internal need to

adjust its position in the currency. No other circumstances are

present to suggest that B is a dealer in securities for purposes of

section 475(c)(1)(B). B's activity in the foreign currency does not

qualify it as a dealer in securities for purposes of section

475(c)(1)(B), and its transactions in the interbank market are not

transactions with customers.

(3) Related parties--(i) In general. A taxpayer's transactions with

members of its consolidated group or with other related persons may be

transactions with customers for purposes of section 475. For example,

transactions enumerated in section 475(c)(1)(B) between members of a

consolidated group are transactions with customers if, in the ordinary

course of its business, the taxpayer holds itself out as being willing

and able to engage in these transactions on a regular basis. A taxpayer

may be a dealer in securities within the meaning of section 475(c)(1)

even if its only customer transactions are transactions with other

members of its consolidated group.

(ii) Example. The following example illustrates this paragraph

(a)(3):

Example. Risk management transactions--(1) Facts. HC, a hedging

center, provides

[[Page 31479]]

interest rate hedges to all of the members of its consolidated

group. Because of the efficiencies created by having a centralized

risk manager, group policy prohibits members other than HC from

entering into derivative interest rate positions with outside

parties. HC regularly holds itself out as being willing and able to,

and in fact does, enter into either side of interest rate swaps with

its fellow members. HC periodically computes its aggregate position

and hedges the net risk with an unrelated party. HC does not

otherwise enter into interest rate positions with persons that are

not members of the consolidated group. Because HC attempts to

operate at cost and the terms of its swaps do not factor in any risk

of default by the affiliate, HC's affiliates receive somewhat more

favorable terms then they would receive from an unrelated swaps

dealer.

(2) Holding. Because HC regularly holds itself out as being

willing and able to enter into transactions enumerated in section

475(c)(1)(B), HC is a dealer in securities for purposes of section

475(c)(1)(B) and the other members are its customers.

* * * * *

Sec. 1.475 [Amended]

Par. 7. Section 1.475(c)-2, as proposed on December 29, 1993 (58 FR

68798), and amended on January 4, 1995 (60 FR 405), is amended as

follows:

1. Paragraphs (b), (c), and (d) are redesignated as paragraphs (c),

(d), and (b), respectively.

2. Paragraph (a) and newly designated paragraph (c) are revised by

removing the phrase ``paragraph (b)'' each place it appears and

replacing it with ``paragraph (c)'' each place it appeared.

3. Newly designated paragraph (d) is revised by removing the phrase

``paragraphs (a)(3) and (b)'' and replacing it with ``paragraphs (a)(3)

and (c)''. Newly designated paragraph (d) is further revised by

removing the phrase ``this paragraph (c)(1)).'' and replacing it with

the phrase ``this paragraph (d)(1)).''.

4. Newly designated paragraph (b) is revised by removing the words

``See Sec. 1.475(b)-4(c)'' and replacing them with the words ``See

Sec. 1.475(b)-2(c)''.

Par. 8. Section 1.475(e)-1, as proposed on December 29, 1993 (58 FR

68798), and amended on January 4, 1995 (60 FR 405), is revised to read

as follows:

Sec. 1.475(e)-1 Effective dates.

(a) Section 1.475(a)-1 (concerning mark-to-market for debt

instruments) applies to taxable years beginning on or after January 1,

1995.

(b) Section 1.475(a)-2 (concerning marking a security to market

upon disposition) applies to dispositions or terminations of ownership

occurring on or after January 4, 1995.

(c) Section 1.475(a)-3 (concerning acquisition by a dealer of a

security with a substituted basis) applies to securities acquired,

originated, or entered into on or after January 4, 1995.

(d) Section 1.475(b)-1 (concerning the scope of exemptions from the

mark-to-market requirement) applies as follows:

(1) Section 1.475(b)-1(a) (concerning securities held for

investment or not held for sale) applies to taxable years ending on or

after December 31, 1993.

(2) Except as provided elsewhere in this paragraph (d)(2),

Sec. 1.475(b)-1(b)(1) (concerning securities deemed identified as held

for investment) applies to taxable years ending on or after December

31, 1993.

(i) Section 1.475(b)-1(b)(1)(i) (concerning equity interests issued

by a related person) applies on or after June 19, 1996. If, on June 18,

1996, a security is subject to mark-to-market accounting and, on June

19, 1996, Sec. 1.475(b)-1(b)(1) begins to apply to the security solely

because of the effective dates in this paragraph (d)(2) (rather than

because of a change in facts), then the rules of Sec. 1.475(b)-

1(b)(4)(i)(A) (concerning the prohibition against marking) apply, but

Sec. 1.475(b)-1(b)(4)(i)(B) (imposing a mark to market on the day

before the onset of the prohibition) does not apply.

(ii) Section 1.475(b)-1(b)(2) (concerning relevant relationships

for purposes of determining whether equity interests in related persons

are prohibited from being marked to market) applies on or after June

19, 1996.

(iii) Section 1.475(b)-1(b)(3) (concerning certain activelytraded

securities) generally applies on or after June 19, 1996 to securities

held on or after that date. In the case, however, of securities

described in Sec. 1.475(b)-1(d)(1)(i) (concerning equity interests

issued by controlled entities), Sec. 1.475(b)-1(b)(3) applies on or

after the date thirty days after final regulations on this subject are

published in the Federal Register to securities held on or after that

date. If Sec. 1.475(b)-1(b)(1) ceases to apply to a security by virtue

of the operation of this paragraph (d)(2)(ii), the rules of

Sec. 1.475(b)-1(b)(4)(ii) apply to the cessation.

(iv) Except to the extent provided in paragraph (d)(2)(i) of this

section, Sec. 1.475(b)-1(b)(4) (concerning changes in status) applies

on or after June 19, 1996.

(e) Section 1.475(b)-2 (concerning the identification requirements

for obtaining an exemption from mark-to-market treatment) applies to

identifications made on or after January 4, 1995.

(f) Section 1.475(b)-3 (concerning exemption of securities in

certain securitization transactions) applies to securities acquired,

originated, or entered into on or after January 4, 1995.

(g) Section 1.475(b)-4 (concerning transitional issues relating to

exemptions) applies to taxable years ending on or after December 31,

1993.

(h) Section 1.475(c)-1(a) (concerning the dealer-customer

relationship), except for Sec. 1.475(c)-1(a)(1), (a)(2)(ii), and

(a)(3), applies to taxable years beginning on or after January 1, 1995.

Section 1.475(c)-1(a)(2)(ii) and (a)(3) (concerning certain aspects of

the dealer-customer relationship) apply to taxable years beginning on

or after June 20, 1996.

(i) Section 1.475(c)-1(b) (concerning sellers of nonfinancial goods

and services) and (c) (concerning taxpayers that purchase securities

but do not sell more than a negligible portion of the securities)

applies to taxable years ending on or after December 31, 1993.

(j) Section 1.475(c)-1(d) (concerning the issuance of life

insurance products) applies to taxable years beginning on or after

January 1, 1995.

(k) Section 1.475(c)-2 (concerning the definition of security)

applies to taxable years ending on or after December 31, 1993. Note,

however, that, by its terms, Sec. 1.475(c)-2(a)(3) applies only to

interests or arrangements that are acquired on or after January 4,

1995, and that the integrated transactions to which Sec. 1.475(c)-2(b)

applies will exist only after the effective date of Sec. 1.1275-6.

(l) Section 1.475(d)-1 (concerning the character of gain or loss)

applies to taxable years ending on or after December 31, 1993.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 96-15666 Filed 6-19-96; 8:45 am]

BILLING CODE 4830-01-P