General Rules for Making and Maintaining Qualified Electing Fund Elections

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-115795-97]

RIN 1545-AV39

General Rules for Making and Maintaining Qualified Electing Fund

Elections

AGENCY: Internal Revenue Service (IRS), Treasury

ACTION: Notice of proposed rulemaking by cross-reference to temporary

regulations and notice of public hearing.

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SUMMARY: In the Rules and Regulations section of this issue of the

Federal Register, the IRS is issuing temporary regulations that provide

guidance to a passive foreign investment company (PFIC) shareholder

that makes the election under section 1295 (section 1295 election) to

treat the PFIC as a qualified electing fund (QEF). The temporary

regulations also provide guidance for shareholders that wish to make a

section 1295 election that will apply on a retroactive basis

(retroactive election). The temporary regulations also include a rule

concerning the taxation under section 1291 of an exempt organization

that is a shareholder of a PFIC that is not a pedigreed QEF. This rule

was originally proposed in 1992. The text of the temporary regulations

also serves as the text of these proposed regulations. In addition,

this document proposes amendments to proposed regulation Sec. 1.1296-

4(e), concerning the treatment of interbank deposits as loans for

purposes of the exception to passive income characterization of income

derived in the active conduct of a banking business. This document also

provides notice of a public hearing on these proposed regulations.

DATES: Written comments must be received by April 2, 1998. Requests to

speak and outlines of oral comments to be discussed at the public

hearing scheduled for April 16, 1998, must be received by March 26,

1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-115795-97), room

5226, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. Submissions may be hand delivered between the

hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-115795-97), Courier's

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

Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting the ``Tax Regs'' option on

the IRS Home Page, or by submitting comments directly to the IRS

Internet site at http://www.irs.ustreas.gov/prod/tax______regs/

comments.html. The public hearing will be held in Room 3313, Internal

Revenue Service, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Gayle

Novig, (202) 622-3840; concerning submissions and the hearing,

Evangelista Lee, (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(d)).

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 March

3, 1998. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the

proper performance of the functions of the Internal Revenue Service,

including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed

collection of information (see below);

How the quality, utility, and clarity of the information to be

collected may be enhanced;

How the burden of complying with the proposed collection of

information may be minimized, including through the application of

automated collection techniques or other forms of information

technology; and

Estimates of capital or start-up costs and costs of operation,

maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in

proposed regulation Secs. 1.1295-1(f), 1.1295-1(g), 1.1295-3(c), and

1.1295-3(g). The information required in Sec. 1.1295-1 (f) and (g) will

notify the Internal Revenue Service that certain shareholders have made

the section 1295 election, and will enable the Internal Revenue Service

to determine if a shareholder is satisfying the election and annual

reporting requirements and is reporting income as required under

section 1293.

The information required in proposed regulation Sec. 1.1295-3(c)

will notify the IRS that certain shareholders of foreign corporations

have filed a Protective Statement to preserve their ability to make a

retroactive section 1295 election, and that those shareholders have

extended the periods of limitations for their taxable years to which

the Protective Statement will apply. The information will enable the

IRS to verify that the shareholders filing the Protective Statement had

the requisite reasonable belief at the time they filed the statement.

The information required in proposed regulation Sec. 1.1295-3(g) will

notify the IRS that a shareholder has made the retroactive election

and, in the case of a shareholder that filed a Protective Statement,

that the shareholder's waiver of the periods of

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limitations will terminate within three years of making the election.

The information will enable the Service to verify that the requirements

for making a retroactive election have been satisfied.

The collection of information and responses to these collections of

information are mandatory. The likely respondents are individuals,

businesses, and other for-profit organizations.

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 assigned by the Office of

Management and Budget.

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/recordkeeping burden: 623 hours.

The estimated annual burden per respondent varies from 15 minutes

to three hours, depending on individual circumstances, with an

estimated average of 29 minutes.

Estimated number of respondents: 1,290.

Estimated annual frequency of responses: Annually or one time only.

Background

Sections 1291, 1293, 1295, and 1297

Temporary regulations in the Rules and Regulations section of this

issue of the Federal Register amend the Income Tax Regulations (26 CFR

part 1) relating to sections 1291, 1293, 1295, and 1297. The temporary

regulations contain rules concerning the taxation of exempt

organizations under section 1291, elections under section 1295 to treat

passive foreign investment companies as qualified electing funds

(QEFs), the calculation of net capital gain for purposes of section

1293, and the inclusion of the pro rata shares of the earnings and

profits of QEFs held through pass through entities. The temporary

regulations amend Sec. 1.1297-3T, permitting in certain cases the

application of the rules of section 1291(d)(2)(B) to an election made

under section 1297(b)(1).

The text of those temporary regulations also serves as the text of

these proposed regulations. The preamble to the temporary regulations

explains the temporary regulations.

Section 1296

On April 28, 1995, proposed regulations were published providing

guidance for the exceptions to passive income characterization of

certain income derived by active foreign banks and foreign security

dealers provided in section 1296 (b)(2)(A) and (b)(3), respectively.

The proposed section 1296 regulations reflect comments received with

respect to Notice 89-81, 1989-2 C.B. 399. That notice established tests

for determining whether a foreign corporation qualified for the active

foreign bank exception. The notice specifically stated that interbank

deposits would not be treated as loans made in the ordinary course of a

banking business.

After consideration of the comments received with respect to the

Notice, the IRS and Treasury determined that interbank deposits were

made and accepted in the ordinary course of a banking business, and

therefore should be treated as such for purposes of section

1296(b)(2)(A). Accordingly, proposed regulation Sec. 1.1296-4(d)(3)

specifically includes interbank deposits with other deposits for

purposes of determining whether the foreign corporation satisfies the

deposit-taking requirements of Sec. 1.1296-4(d). Also in response to

comments, proposed regulation Sec. 1.1296-4(e) is clarified to

specifically provide that interbank deposits made with banks in the

ordinary course of business constitute loans for purposes of

Sec. 1.1296-4. This clarification is favorable to taxpayers, and is

proposed to be effective for taxable years beginning after December 31,

1994. It is also proposed that taxpayers may apply it to a taxable year

beginning after December 31, 1986, provided it is consistently applied

to that taxable year and all subsequent taxable years. The dates for

applying proposed regulation Sec. 1.1296-4(e) coincide with the dates

for which Sec. 1.1296-4 is proposed to be effective. See proposed

regulation Sec. 1.1296-4(k).

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment 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. It has been determined that an initial regulatory flexibility

analysis is required for the collection of information in this notice

of proposed rulemaking under 5 U.S.C. Sec. 603. This analysis is set

forth below under the heading ``Initial Regulatory Flexibility

Analysis.''

Initial Regulatory Flexibility Analysis

This initial analysis is provided pursuant to the Regulatory

Flexibility Act (5 U.S.C. chapter 6). The major objective of the

proposed regulations is to provide guidance to PFIC shareholders that

wish to elect under section 1295 to treat their PFICs as QEFs, and

provide guidance to those PFICs about the requirements imposed on them.

The legal basis for these requirements is contained in sections 1293,

1294, and 1295. The IRS and Treasury are not aware of any federal rules

that duplicate, overlap, or conflict with the proposed regulations.

The recordkeeping and reporting requirements of the proposed

regulations enable the Internal Revenue Service to identify those

taxpayers that are treating their PFICs as QEFs; to verify that those

U.S. taxpayers are currently including their shares of QEF earnings in

income, as required in section 1293 of the Internal Revenue Code; to be

informed of those QEF shareholders that are not paying their section

1293 tax liability because they made the section 1294 election to defer

the time for payment; to identify those shareholders of foreign

corporations that are preserving their right to make a retroactive

section 1295 election; to identify those shareholders making

retroactive elections and verify that they are satisfying the

requirements of a retroactive election; and, in the case of

shareholders that have filed Protective Statements, the dates by which

the shareholders' extensions of periods of limitations will terminate.

These proposed regulations will affect those small entities that

are PFICs, at least one shareholder of which makes the section 1295

election. The proposed regulations also will affect those small

entities that are PFIC shareholders that make the section 1295

election. The IRS and Treasury believe that affected small entities

generally will be small businesses, as local governments are not likely

to invest in PFICs. Also, few, if any, affected small entities likely

will be tax exempt organizations, because only a tax exempt entity that

is taxable under subchapter F on dividends received from the PFIC

generally would need to consider making the section 1295 election.

The collections of information in these proposed regulations would

impact a small entity that is treated as a QEF principally by requiring

the

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entity to calculate annually its ordinary earnings and net capital gain

according to federal income tax accounting principles, as required by

section 1293, and report that information to its shareholders that are

U.S. persons. With the enactment of section 1(h), the QEF also must

calculate each type of long term capital gain that it derived and the

applicable rates of tax for proper inclusion of the QEF's net capital

gain by the QEF shareholders. Alternatively, the regulations permit the

QEF to provide its shareholders with its books, records and other

documents necessary for the shareholders to calculate the ordinary

earnings and net capital gain amounts. This alternative will enable a

small entity that is a QEF to avoid the burden of calculating its net

capital gain by providing its shareholders with information with which

the shareholders can make the calculations.

The economic impact of other collections of information contained

in these proposed regulations would fall on a small entity that is a

shareholder of a PFIC for which it has made the section 1295 election

or that is a pass through entity to which an interest holder

transferred stock subject to a section 1295 election. The economic

impact would result primarily from the reporting and recordkeeping

requirements pertaining to (1) the manner for making the section 1295

election and the annual election requirements; (2) the calculation by

the shareholder (rather than the QEF) of the QEF's ordinary earnings

and net capital gain according to federal income tax principles, and

its pro rata shares thereof; (3) a request for consent to revoke a

section 1295 election; (4) the preservation of the right to make a

retroactive election under section 1295; (5) a request for consent to

make a retroactive election; (6) making a retroactive election,

including filing amended returns for the affected taxable years; and

(7) providing interest holders with PFIC statements and other

information received by an intermediary shareholder.

The proposed regulations reduce the burden under existing rules for

making the section 1295 election for all taxpayers, including small

businesses and other small entities. Unlike the current requirements

provided in Notice 88-125, the proposed regulations only require

electing shareholders to file Form 8621 to make the section 1295

election, thereby eliminating the shareholder election statement as

well as the requirement to file a copy of the PFIC Annual Information

Statement. The proposed regulations only require shareholders to retain

the PFIC Annual Information Statement or the Annual Intermediary

Statement received as well as a copy of their filings for each year to

which the section 1295 election applies. In addition, the proposed

regulations impose a lesser burden on small shareholders, typically

individuals and small entities, to preserve their right to make a

retroactive election and a lesser burden of making a retroactive

election. A small entity that owns less than five percent of each class

of stock of a foreign corporation and satisfies other requirements is

not required to file a Protective Statement to preserve its right to

make a retroactive election with respect to the foreign corporation.

Similarly, a small entity potentially has fewer amended returns to file

to make a retroactive election than a shareholder that filed a

Protective Statement. These changes in election requirements are

illustrative of IRS efforts to minimize burden, particularly with

respect to small entities.

An estimate of the number of small entities that would be affected

by these regulations is unavailable. In any event, the enactment in

1997 of the mark-to-market election for PFIC shareholders and the

elimination of the overlap in certain cases of subpart F and the PFIC

provisions, will reduce the number of small entities that would be

affected by these regulations.

None of the significant alternatives considered in drafting these

regulations would have significantly altered the economic impact of the

collections of information on small entities. In considering the

significant alternatives that would be permissible under the Code and

would enable the IRS to ensure compliance with the Code, the IRS and

Treasury concluded that the alternatives generally would impose equal

or greater burdens.

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 April 16, 1998, at 10 a.m.,

in room 2615, Internal Revenue Building, 1111 Constitution Avenue, NW,

Washington, DC. Because of access restrictions, visitors will not be

admitted beyond the Internal Revenue 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 by April 2, 1998, 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 March 26, 1998.

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

comments.

An agenda showing the schedule of 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 the proposed regulations are Gayle Novig

and Judith Cavell Cohen, of the Office of the Associate Chief Counsel

(International). Other personnel from the IRS and Treasury Department

also participated in the development of these regulations.

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 continues to read in

part as follows:

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

Par. 2. Section 1.1291-1 is added to read as follows:

[The text of this proposed section is the same as the text of

Sec. 1.1291-1T published elsewhere in this issue of the Federal

Register.]

Par. 3. Section 1.1293-1 is added to read as follows:

Sec. 1.1293-1 Current taxation of income from qualified electing

funds.

[The text of this proposed section is the same as the text of

Sec. 1.1293-1T published elsewhere in this issue of the Federal

Register.]

Par. 4. Section 1.1295-1 is added to read as follows:

Sec. 1.1295-1 Qualified electing funds.

[The text of this proposed section is the same as the text of

Sec. 1.1295-1T published elsewhere in this issue of the Federal

Register.]

Par. 5. Section 1.1295-3 is added to read as follows:

Sec. 1.1295-3 Retroactive elections.

[The text of this proposed section is the same as the text of

Sec. 1.1295-3T published elsewhere in this issue of the Federal

Register.]

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Par. 6. In Sec. 1.1297-3, paragraph (c) is added to read as

follows:

Sec. 1.1297-3 Deemed sale election by a United States person that is a

shareholder of a passive foreign investment company.

[The text of this proposed paragraph (c) is the same as the text of

Sec. 1.1297-3T(c) published elsewhere in this issue of the Federal

Register.]

Par. 7 Section 1.1296-4(e) as proposed at 60 FR 20922 (April 28,

1995) is amended by adding a sentence at the end of the paragraph to

read as follows:

Sec. 1.1296-4 Characterization of certain banking income of foreign

banks as passive.

* * * * *

(e) Lending activities test. * * * An interbank deposit made in the

ordinary course of a corporation's banking business will be treated as

a loan for purposes of this section. For the effective date of this

paragraph (e), see paragraph (k) of this section.

Michael P. Dolan,

Deputy Commissioner of Internal Revenue.

[FR Doc. 97-33984 Filed 12-31-97; 8:45 am]

BILLING CODE 4830-01-U