Passive Foreign Investment Companies;
Definition of marketable stock

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [TD 8867] RIN 1545-AW69

TITLE: Passive Foreign Investment Companies; Definition of
marketable stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final Regulations.

SUMMARY: This document contains final regulations under section 1296
relating to the new mark-to-market election for stock of a passive
foreign investment company (PFIC). The final regulations interpret
changes made by the Taxpayer Relief Act of 1997. The final
regulations affect persons holding PFIC stock that is regularly
traded on certain U.S. or foreign exchanges or markets or holding
stock in certain PFICs comparable to U.S. regulated investment
companies (RICs).

DATES: Effective Date: January 25, 2000.

Applicability Dates: For dates of applicability see section
1.1296(e)-1(g) of these regulations.

FOR FURTHER INFORMATION CONTACT: Robert Laudeman, (202) 622-3840
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On February 2, 1999, the IRS published in the Federal Register
proposed regulations (REG-113744-98, 64 FR 5014) regarding the
taxation of U.S. holders of PFIC stock. Three written comments
regarding the proposed regulations were received. Because no one
requested to speak at a public hearing, no hearing was held. After
consideration of all of the comments received, the proposed
regulations under section 1296 are adopted as final regulations with
some changes. The changes are discussed below.

The preamble to the proposed regulations (64 FR 5014) provides a
detailed discussion of the mark-to-market election for shareholders
of PFIC stock and the proposed regulations.

Summary of Public Comments and Changes

Exchange or Other Market

The proposed regulations require that a foreign exchange or market
be regulated or supervised by a governmental authority of the
country in which the market is located. The proposed regulations
also list additional characteristics that the foreign exchange or
market must have for stock that is regularly traded on the exchange
or market to be marketable stock for purposes of section 1296.
Specifically, the proposed regulations require that the exchange
have trading volume, listing, financial disclosure and other
requirements designed to prevent fraud, perfect the mechanism of a
free and open market, and protect investors.

The final regulations add a surveillance requirement and add the
concept of perfecting a fair and orderly market to the requirements
for exchanges. These changes are intended to clarify the
characteristics that an exchange or other market must have in order
to be a qualified exchange or market for purposes of section 1296
and to more closely represent common characteristics of foreign
markets. See International Federation of Stock Exchanges (FIBV),
1998 Market Principles, available by request from
[email protected], and International Organization of Securities
Commissions (IOSCO), Supervisory Framework for Markets, Report by
the Technical Committee, May 1999 (visited Oct. 5, 1999) <
http://www.iosco.org/iosco.html>.

Stock in Certain PFICs

The proposed regulations provide that stock in certain PFICs is
marketable stock if the PFIC both is a corporation described in
section 1296(e)(1)(B) (foreign corporations comparable to RICs) and
offers for sale or has outstanding stock of which it is the issuer
and which is redeemable at its net asset value. The proposed
regulations further provide that a PFIC is a corporation described
in section 1296(e)(1)(B) only if the PFIC satisfies eight conditions
listed in the proposed regulations with respect to the class of
shares held by the electing taxpayer. The conditions are intended to
describe PFICs that are comparable to RICs in relevant respects and
to implement the intent of the statute by ensuring that the net
asset valuations of such companies represent legitimate and sound
fair market values for the companies' stock.

Two commentators asserted that the statute and legislative history
indicate that Congress was only concerned that PFICs redeem stock at
net asset values and that such values represent sound and legitimate
fair market values and, therefore, it is not necessary that the PFIC
resemble a RIC. The commentators suggest that the regulations be
modified to include PFICs that redeem their stock at its net asset
value but do not otherwise resemble RICs. Because the plain language
of the statute clearly requires that the stock in any foreign
corporation be comparable to a RIC, the final regulations retain the
approach of requiring PFICs to be comparable to RICs in order for
their stock to be marketable stock for purposes of section 1296(e)
(1)(B).

The proposed regulations provide that a foreign corporation must
have one hundred or more unrelated shareholders. One commentator
recommended that the number be reduced to ten unrelated
shareholders, arguing that a corporation with ten unrelated
shareholders as opposed to one hundred unrelated shareholders has
the same susceptibility to legal liabilities if valuations are
inaccurate. Requiring that a PFIC have one hundred or more unrelated
shareholders is comparable to the requirement imposed on RICs by
section 851(a). In addition, the IRS and the Treasury Department
believe that there will be less likelihood of share price
manipulation with corporations that have one hundred or more
unrelated shareholders. Consequently, the above described rule in
the proposed regulations is not changed except that A one hundred or
more @ is corrected to read A more than one hundred @ unrelated
shareholders.

The proposed regulations require that the class of shares of the
foreign corporation be readily available for purchase by the general
public at its net asset value by new investors in initial amounts
not greater than $10,000 (U.S.). One commentator recommended that
this condition not be included in the final regulations because an
investment ceiling will not make the valuation easier or less likely
to be manipulated.

The condition in the proposed regulations regarding initial
investments is not an investment ceiling. Rather, the condition
specifies that the foreign corporation not require a minimum initial
investment of greater than $10,000 (U.S.) and that shares of the
foreign corporation be readily available for purchase by the general
public at net asset values. For example, a foreign corporation that
requires new investors to purchase shares for a minimum initial
investment of $5,000 (U.S.) satisfies the condition. However, a
foreign corporation that requires new investors to purchase shares
for a minimum initial investment of $20,000 (U.S.) does not satisfy
the condition. There is not any limit, however, on the total amount
that a shareholder can invest. The final regulations clarify that
this condition is not an investment ceiling.

Two additional requirements in the proposed regulations are that
shares be available for purchase by the general public and that, no
less frequently than annually, financial statements prepared by
independent auditors be available to the public. One commentator
asserted that availability to the general public of the shares of
the foreign corporation and of the financial statements is not
necessary and should not be required because it will not necessarily
ensure a legitimate and sound fair market value for the foreign
corporation's stock.

Availability of shares for purchase by the general public is
comparable to the requirement of availability of shares of RICs for
purchase by the general public. In addition, availability of shares
for purchase by the the general public for net asset value (in
addition to current investors being able to redeem shares for the
same net asset value), will ensure that the net asset values are
legitimate and sound. However, shares will not be considered
available for purchase by the general public if the shares are only
available to individuals with high annual incomes or high net worth.
For example, limiting investors to individuals with annual incomes
in excess of $200,000 or net worth in excess of $1 million will not
be considered available for purchase by the general public.

Similarly, availability to the general public of audited financial
statements is comparable to conditions imposed on RICs and will help
to ensure that the foreign corporation's financial information is
readily available to potential and current investors, which, in
turn, will help ensure that the net asset values are legitimate and
sound. Availability of financial statements to the general public
requires no more than that the statements be available upon request
to potential and current investors.

The proposed regulations require that quotations for the shares of
the foreign corporation be determined and published on a daily basis
in a widely-available medium, such as a newspaper of general
circulation. One commentator asserted that the condition is not
necessary because the mark-to-market election is made on an annual
basis at the close of the taxpayer's taxable year. The commentator
recommended that the condition be changed to require that values be
communicated to shareholders, on at least an annual basis, in
written form that serves as support for such valuation.

The final regulations do not adopt the commentator's recommendation.
The publication of quotations for the shares is not intended to
serve solely as a means for a current shareholder of the PFIC to
determine the value of the PFIC on the mark date.

The publication of quotations for the shares is comparable to the
practice of RICs and helps to ensure that asset valuations are
legitimate and sound by allowing potential investors as well as
current shareholders to have ready access to price information.

Because quotations for the shares of some PFICs may not be published
on a daily basis, the daily publication requirement in the proposed
regulations is changed to require that quotations for the shares of
the foreign corporation be determined and published no less
frequently than weekly. In addition, the publication requirement is
changed to clarify that the quotations must be published in a
permanent medium not controlled by the issuer of the shares, such as
an independent trade publication.

The requirement that the medium be permanent does not require the
medium to be saved in a printed form; archived electronic data not
susceptible to subsequent alteration are permanent. This change is
intended to assist shareholders and the IRS in verifying valuations.

The proposed regulations require that the foreign corporation be
supervised or regulated as an investment company by a foreign
government or instrumentality thereof. One commentator suggested
that the condition be clarified with respect to the meaning of
governmental supervision. In particular, the commentator asks
whether a foreign jurisdiction that requires a local corporation to
file information upon incorporation with the local government or
agency would qualify as supervision or regulation.

The condition in the proposed regulations is intended to require
that the PFIC be supervised or regulated as an investment company in
a manner comparable, but not identical, to RICs.

Consequently, the final regulations clarify the type of supervision
or regulation required. The final regulations provide that
sufficient supervision or regulation requires that the government or
agency have broad inspection and enforcement authority and effective
oversight over investment companies to ensure that such companies
provide complete and accurate disclosure of relevant financial
information to shareholders and potential investors and to provide
adequate sanctions for false or inadequate disclosure. The mere
filing of information upon incorporation does not qualify as
supervision or regulation. Finally, the proposed regulations require
that the foreign corporation have no senior securities authorized or
outstanding, including any debt other than de minimis amounts. In
addition, the proposed regulations require that the foreign
corporation meet the PFIC income and asset tests in sections 1297(a)
(1) and (2) with the requisite percentages increased from 75 percent
to 90 percent and from 50 percent to 90 percent respectively. One
commentator asserted that these conditions not be included in the
final regulations because there is no basis for requiring a PFIC to
have the same borrowing restrictions, asset composition, and
characteristics of RICs in order for the PFIC's stock to be
marketable stock under section 1296.

Conditions regarding debt and asset composition are essential
characteristics of RICs. The IRS and the Treasury Department believe
that Congress intended to provide mark-to-market treatment to shares
of PFICs that are, in fact, comparable to RICs.

Special Rules for RICs The proposed regulations provide that if
shares in a PFIC are owned directly or indirectly by a RIC, that is
offering for sale, or has outstanding any stock of which it is the
issuer, and which is redeemable at net asset value, the PFIC shares
shall be treated as marketable stock for purposes of section 1296.

Section 1296(e)(2) further provides that except as provided in
regulations, similar treatment as marketable stock shall apply in
the case of any other RIC which publishes net asset valuations at
least annually. The IRS and Treasury Department invited comments
regarding situations where PFIC stock held by other RICs that
publish asset valuations at least annually should not be treated as
marketable stock for purposes of section 1296.

One commentator explained why PFIC stock held by any closed-end RIC
that publishes net asset values at least annually should be treated
as marketable stock. In particular, that commentator pointed out
that closed-end RICs are subject to many of the same regulatory
requirements as open-end RICs. In addition, that commentator
explained that an industry practice has developed under which
closed-end RICs typically determine and publish current share
prices, together with net asset values, on a weekly basis in print
and other media.

At this time, the IRS and Treasury Department know of no reason not
to treat PFIC stock held by closed-end funds that publish net asset
values at least annually as marketable stock.

Consequently, as provided by section 1296(e)(2), PFIC stock held by
any closed-end RIC that publishes net asset values at least annually
shall be treated as marketable stock. The final regulations,
however, continue to reserve this issue in the event that it is
determined that situations exist where PFIC stock held by closed-end
RICs that publish net asset valuations at least annually should not
be treated as marketable stock for purposes of section 1296. If such
a situation is found to exist, the reservation will be replaced at
that time by a new regulatory exception. Special Analyses It has
been determined that these regulations are not significant
regulatory actions 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) does not apply to these regulations, and,
because the regulations do not impose a requirement for the
collection of information on small entities, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to
section 7805(f) of the Internal Revenue Code, the notice of proposed
rulemaking preceeding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.

Drafting Information The principal author of these regulations is
Robert Laudeman of the Office of the Associate Chief Counsel
(International).

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.

Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1
is amended as follows: PART 1--INCOME TAXES Paragraph 1. The
authority citation for part 1 is amended by adding an entry in
numerical order to read as follows: Authority: 26 U.S.C. 7805 * * *
Section 1.1296(e)-1 also issued under 26 U.S.C. 1296(e). * * * Par.
2. Section 1.1296(e)-1 is added to read as follows: �1.1296(e)-1
Definition of marketable stock.

(a) General rule. For purposes of section 1296, the term marketable
stock means--

(1) Passive foreign investment company (PFIC) stock that is
regularly traded, as defined in paragraph (b) of this section, on a
qualified exchange or other market, as defined in paragraph (c) of
this section;

(2) Stock in certain PFICs, as described in paragraph (d) of this
section; and

(3) Options on stock that is described in paragraph (a)(1) or (2) of
this section, to the extent provided in paragraph (e) of this
section.

(b) Regularly traded--(1) General rule. For purposes of paragraph
(a)(1) of this section, a class of stock that is traded on one or
more qualified exchanges or other markets, as defined in paragraph
(c) of this section, is regularly traded on such exchanges or
markets for any calendar year during which such class of stock is
traded, other than in de minimis quantities, on at least 15 days
during each calendar quarter.

(2) Anti-abuse rule. Trades that have as one of their principal
purposes the meeting of the trading requirement of paragraph (b)(1)
of this section shall be disregarded. Further, a class of stock
shall not be treated as meeting the trading requirement of paragraph
(b)(1) of this section if there is a pattern of trades conducted to
meet the requirement of paragraph (b)(1) of this section.

(c) Qualified exchange or other market--(1) General rule.

For purposes of paragraph (a)(1) of this section, the term qualified
exchange or other market means, for any calendar year--

(i) A national securities exchange that is registered with the
Securities and Exchange Commission or the national market system
established pursuant to section 11A of the Securities Exchange Act
of 1934 (15 U.S.C. 78f); or

(ii) A foreign securities exchange that is regulated or supervised
by a governmental authority of the country in which the market is
located and which has the following characteristics--

(A) The exchange has trading volume, listing, financial disclosure,
surveillance, and other requirements designed to prevent fraudulent
and manipulative acts and practices, to remove impediments to and
perfect the mechanism of a free and open, fair and orderly, market,
and to protect investors; and the laws of the country in which the
exchange is located and the rules of the exchange ensure that such
requirements are actually enforced; and

(B) The rules of the exchange effectively promote active trading of
listed stocks.

(2) Exchange with multiple tiers. If an exchange in a foreign
country has more than one tier or market level on which stock may be
separately listed or traded, each such tier shall be treated as a
separate exchange.

(d) Stock in certain PFICs--(1) General rule. Except as provided in
paragraph (d)(2) of this section, a foreign corporation is a
corporation described in section 1296(e)(1)(B), and paragraph (a)(2)
of this section, if the foreign corporation offers for sale or has
outstanding stock of which it is the issuer and which is redeemable
at its net asset value and if the foreign corporation satisfies the
following conditions with respect to the class of shares held by the
electing taxpayer--

(i) At all times during the calendar year, the foreign corporation
has more than one hundred shareholders with respect to the class,
other than shareholders who are related under section 267(b);

(ii) At all times during the calendar year, the class of shares of
the foreign corporation is readily available for purchase by the
general public at its net asset value and the foreign corporation
does not require a minimum initial investment of greater than
$10,000 (U.S.);

(iii) At all times during the calendar year, quotations for the
class of shares of the foreign corporation are determined and
published no less frequently than on a weekly basis in a widely-
available permanent medium not controlled by the issuer of the
shares, such as a newspaper of general circulation or a trade
publication;

(iv) No less frequently than annually, independent auditors prepare
financial statements of the foreign corporation that include balance
sheets (statements of assets, liabilities, and net assets) and
statements of income and expenses, and those statements are made
available to the public;

(v) The foreign corporation is supervised or regulated as an
investment company by a foreign government or an agency or
instrumentality thereof that has broad inspection and enforcement
authority and effective oversight over investment companies;

(vi) At all times during the calendar year, the foreign corporation
has no senior securities authorized or outstanding, including any
debt other than in de minimis amounts;

(vii) Ninety percent or more of the gross income of the foreign
corporation for its taxable year is passive income, as defined in
section 1297(a)(1) and the regulations thereunder; and

(viii) The average percentage of assets held by the foreign
corporation during its taxable year which produce passive income or
which are held for the production of passive income, as defined in
section 1297(a)(2) and the regulations thereunder, is at least 90
percent.

(2) Anti-abuse rule. If a foreign corporation undertakes any actions
that have as one of their principal purposes the manipulation of the
net asset value of a class of its shares, for the calendar year in
which the manipulation occurs, the shares are not marketable stock
for purposes of paragraph (d)(1) of this section.

(e) [Reserved]

(f) Special rules for regulated investment companies (RICs) --(1)
General rule. In the case of any RIC that is offering for sale, or
has outstanding, any stock of which it is the issuer and which is
redeemable at net asset value, if the RIC owns directly or
indirectly, as defined in sections 958(a)(1) and (2), stock in any
passive foreign investment company, that stock will be treated as
marketable stock owned by that RIC for purposes of section 1296.
Except as provided in paragraph (f)(2) of this section, in the case
of any other RIC that publishes net asset valuations at least
annually, if the RIC owns directly or indirectly, as defined in
sections 958(a)(1) and (2), stock in any passive foreign investment
company, that stock will be treated as marketable stock owned by
that RIC for purposes of section 1296.

(2) [Reserved]

(g) Effective date. This section applies to shareholders whose
taxable year ends on or after January 25, 2000 for stock in a
foreign corporation whose taxable year ends with or within the
shareholder's taxable year. In addition, shareholders.may elect to
apply these regulations to any taxable year beginning after December
31, 1997, for stock in a foreign corporation whose taxable year ends
with or within the shareholder's taxable year.

Deputy Commissioner of Internal Revenue
Approved:
Assistant Secretary of the Treasury

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