Part I. Rulings — Internal Revenue Bulletin 2000-8

with a complete liquidation. Section 337(d) directs the Secretary to prescribe regulations as may be necessary to carry out the purposes of General Utilities repeal, including rules to “ensure that such purposes shall not be circumvented ... through the use of a regulated investment company [RIC], a real estate investment trust [REIT], or a tax exempt entity....” The transfer of the assets of a C corporation to a RIC or REIT could result in permanently removing the built-in gain inherent in those assets from the reach of the corporate income tax because RIC and REIT income is not subject to a corporate-level income tax if such income is distributed to the RIC or REIT shareholders.

Accordingly, on February 4, 1988, the IRS issued Notice 88–19 (1988–1 C.B. 486). Notice 88–19 announced that the IRS intended to promulgate regulations under the authority of section 337(d) with respect to transactions or events that result in the ownership of C corporation assets by a RIC or REIT with a basis determined by reference to the corporation’s basis (a carryover basis). Notice 88–19 served as an “administrative pronouncement,” and could be relied upon to the same extent as a revenue ruling or revenue procedure. Notice 88–19 also indicated that the regulations would be applicable retroactively to June 10, 1987. See also Notice 88–96 (1988–2 C.B. 420).

As a result of the issuance of Notice 88–19, many taxpayers have become uncertain about the current law applicable to their transactions, as well as the proper method of making a valid election to be subject to the rules of section 1374 and the regulations thereunder. In order to resolve this uncertainty and to provide taxpayers with guidance, the IRS and Treasury are issuing these temporary regulations.

Explanation of Provisions

These regulations implement Notice 88–19 by providing that when a C corporation (1) qualifies to be taxed as a RIC or REIT, or (2) transfers assets to a RIC or REIT in a carryover basis transaction, the C corporation is treated as if it sold all of its assets at their respective fair market

Section 337.—Nonrecognition for Property Distributed to Parent in Complete Liquidation of Subsidiary

26 CFR 1.337(d)–5T: Tax on C assets becoming RIC or REIT assets (temporary).

T.D. 8872

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602

Certain Asset Transfers to Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations that apply with respect to the net built-in gain of C corporation assets that become assets of a Regulated Investment Company [RIC] or Real Estate Investment Trust [REIT] by the qualification of a C corporation as a RIC or REIT or by the transfer of assets of a C corporation to a RIC or REIT in a carryover basis transaction. The regulations generally require the corporation to recognize gain as if it had sold the assets transferred or converted to RIC or REIT assets at fair market value and immediately liquidated. The regulations permit the transferee RIC or REIT to elect, in lieu of liquidation treatment, to be subject to the rules of section 1374 of the Internal Revenue Code and the regulations thereunder. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking REG–209135–88 on page 681.

DATES: Effective Date : These regulations are effective February 4, 2000.

Applicability Dates : For dates of applicability, see the Effective Dates portion of the preamble under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CON

TACT: Christopher W. Schoen, (202) 622-7750 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. section 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 1545-1672. Responses to this collection of information are required to obtain a benefit, i.e., to elect to be subject to section 1374 of the Internal Revenue Code (Code) and the regulations thereunder.

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 OMB control number.

For further information concerning this collection of information, and where to submit comments on the collection of information and the accuracy of the estimated burden, and suggestions as to reducing this burden, please refer to the preamble to the cross-referencing notice of proposed rulemaking, REG–209135–88, on page 681.

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. section 6103.

Background

Sections 631 and 633 of the Tax Reform Act of 1986 (the 1986 Act) (Public Law 99-514), as amended by sections 1006(e) and (g) of the Technical and Miscellaneous Revenue Act of 1988 (the 1988 Act) (Public Law 100-647), amended the Code to repeal the General Utilities doctrine. The 1986 Act amended sections 336 and 337 of the Code, generally requiring corporations to recognize gain when appreciated property is distributed in connection

2000–8 I.R.B. 639 February 22, 2000

values and immediately liquidated, unless the RIC or REIT elects to be subject to tax under section 1374. Any resulting net built-in gain is recognized by the C corporation and the bases of the assets in the hands of the RIC or REIT are generally adjusted to their fair market values to reflect the recognized net built-in gain. The regulations do not permit a C corporation to recognize a net built-in loss, and, in this case, the carryover bases of the assets in the hands of the RIC or REIT are preserved.

If the RIC or REIT elects to be subject to treatment under section 1374, its builtin gain, and the corporate-level tax imposed on that gain, is subject to rules similar to the rules applying to the net income of foreclosure property of REITs.

Effective Dates

In the case of carryover basis transactions involving the transfer of property of a C corporation to a RIC or REIT, the regulations apply to transactions occurring on or after June 10, 1987. In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the regulations apply to such qualifications that are effective for taxable years beginning on or after June 10, 1987.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 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 collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Code, these temporary regulations will be submitted to the Chief Counsel of Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Christopher W. Schoen of the Office of Assistant Chief Counsel (Corpo

rate). Other personnel from the IRS and Treasury participated in their development.

Adoption of Amendments to the Regulations

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

PART I–INCOME TAXES

Paragraph 1. The authority citation for 26 CFR part 1 is amended by adding an entry in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * * Section 1.337(d)–5T also issued under 26 U.S.C. 337. * * * Par. 2. Section 1.337(d)–5T is added to read as follows: §1.337(d)–5T Tax on C assets becoming RIC or REIT assets (temporary).

(a) Treatment of C corporations --(1) Scope . This section applies to the net built-in gain of C corporation assets that become assets of a RIC or REIT by—

(i) The qualification of a C corporation as a RIC or REIT; or

(ii) The transfer of assets of a C corporation to a RIC or REIT in a transaction in which the basis of such assets are determined by reference to the C corporation’s basis (a carryover basis).

(2) Net built-in gain . Net built-in gain is the excess of aggregate gains (including items of income) over aggregate losses.

(3) General rule . Unless an election is made pursuant to paragraph (b) of this section, the C corporation will be treated, for all purposes including recognition of net built-in gain, as if it had sold all of its assets at their respective fair market values on the deemed liquidation date described in paragraph (a)(7) of this section and immediately liquidated.

(4) Loss . Paragraph(a)(3) of this section shall not apply if its application would result in the recognition of net built-in loss.

(5) Basis adjustment . If a corporation is subject to corporate-level tax under paragraph (a)(3) of this section, the bases of the assets in the hands of the RIC or REIT will be adjusted to reflect the recognized net built-in gain. This adjustment is made by taking the C corporation’s basis in each asset, and, as appropriate, increasing it by the amount of any built-in gain

attributable to that asset, or decreasing it by the amount of any built-in loss attributable to that asset.

(6) Exception —(i) In general . Paragraph (a)(3) of this section does not apply to any C corporation that—

(A) Immediately prior to qualifying to be taxed as a RIC was subject to tax as a C corporation for a period not exceeding one taxable year; and

(B) Immediately prior to being subject to tax as a C corporation was subject to the RIC tax provisions for a period of at least one taxable year.

(ii) Additional requirement . The exception described in paragraph (a)(6)(i) of this section applies only to assets acquired by the corporation during the year when it was subject to tax as a C corporation in a transaction that does not result in its basis in the asset being determined by reference to a corporate transferor’s basis.

(7) Deemed liquidation date —(i) Con- versions . In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the deemed liquidation date is the last day of its last taxable year before the taxable year in which it qualifies to be taxed as a RIC or REIT.

(ii) Carryover basis transfers . In the case of a C corporation that transfers property to a RIC or REIT in a carryover basis transaction, the deemed liquidation date is the day before the date of the transfer.

(b) Section 1374 treatment —(1) In general . Paragraph (a) of this section will not apply if the transferee RIC or REIT elects (as described in paragraph (b)(3) of this section) to be subject to the rules of section 1374, and the regulations thereunder. The electing RIC or REIT will be subject to corporate-level taxation on the built-in gain recognized during the 10year period on assets formerly held by the transferor C corporation. The built-in gains of electing RICs and REITs, and the corporate-level tax imposed on such gains, are subject to rules similar to the rules relating to net income from foreclosure property of REITs. See sections 857(a)(1)(A)(ii), and 857(b)(2)(B), (D), and (E). An election made under this paragraph (b) shall be irrevocable.

(2) Ten-year recognition period . In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the 10-year recognition period described in section 1374(d)(7) begins on the first day of the

February 22, 2000 640 2000–8 I.R.B.

RIC’s or REIT’s taxable year for which the corporation qualifies to be taxed as a RIC or REIT. In the case of a C corporation that transfers property to a RIC or REIT in a carryover basis transaction, the 10-year recognition period begins on the day the assets are acquired by the RIC or REIT.

(3) Making the election . A RIC or REIT validly makes a section 1374 election with the following statement: “[Insert name and employer identification number of electing RIC or REIT] elects under §1.337(d)–5T(b) to be subject to the rules of section 1374 and the regulations thereunder with respect to its assets which formerly were held by a C corporation, [insert name and employer identification number of the C corporation, if different from name and employer identification number of RIC or REIT].” This statement must be signed by an official authorized to sign the income tax return of the RIC or REIT and attached to the RIC’s or REIT’s Federal income tax return for the first taxable year in which the assets of the C corporation become assets of the RIC or REIT.

(c) Special rule . In cases where the first taxable year in which the assets of the C corporation become assets of the RIC or

REIT ends after June 10, 1987 but before March 8, 2000, the section 1374 election may be filed with the first Federal income tax return filed by the RIC or REIT after March 8, 2000.

(d) Effective date . In the case of carryover basis transactions involving the transfer of property of a C corporation to a RIC or REIT, the regulations apply to transactions occurring on or after June 10, 1987. In the case of a C corporation that qualifies to be taxed as a RIC or REIT, the regulations apply to such qualifications that are effective for taxable years beginning on or after June 10, 1987.

Par. 3. In §1.852–12, paragraph (d) is added to read as follows: §1.852–12 Non-RIC earnings and profits .

(d) For treatment of net built-in gain assets of a C corporation that become assets of a RIC, see §1.337(d)–5T.

Par. 4. In §1.857–11, paragraph (e) is added to read as follows: §1.857–11 Non-REIT earnings and prof- its.

(e) For treatment of net built-in gain assets of a C corporation that become assets

of a REIT, see §1.337(d)–5T.

PART 602–OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 4. In §602.101, paragraph (b) is amended by adding an entry in numerical order to the table to read as follows: §602.101––OMB Control numbers .

(b) ***

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue.

Approved January 21, 2000.

Jonathan Talisman, Acting Assistant Secretary

for Tax Policy.

(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue of the Federal Register for February 7, 2000, 65 F.R. 5775)

CFR part or section where Current OMB identified and described control No.

1.337(d)–5T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1672

sponsors of qualified retirement plans, employers that maintain qualified retirement plans, and qualified retirement plan participants.

EFFECTIVE DATES: These regulations are effective February 4, 2000.

FOR FURTHER INFORMATION CONTACT: Linda S.F. Marshall at (202)6226030 or Lisa A. Tavares at (202) 6226090 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains amendments to the Income Tax Regulations (26 CFR part 1) under section 401(b). These regulations provide guidance to clarify the

Section 401.—Qualified Pensions, Profit-sharing, and Stock Bonus Plans

26 CFR 1.401(b)–1: Certain retroactive changes in plan.

T.D. 8871

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Remedial Amendment Period

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

SUMMARY: This document contains regulations relating to the remedial amendment period, during which a sponsor of a qualified retirement plan or an employer that maintains a qualified retirement plan can make retroactive amendments to the plan to eliminate certain qualification defects for the entire period. These final regulations clarify the scope of the Commissioner’s authority to provide relief from plan disqualification under the regulations. These clarifications confirm the Commissioner’s authority to provide appropriate relief for plan amendments relating to changes to the plan qualification rules made in recent legislation. These final regulations affect

2000–8 I.R.B. 641 February 22, 2000

ously provided in the temporary regulations, regarding the beginning of the remedial amendment period for disqualifying provisions described in §1.401(b)–1(b)(3).

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 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 regulation does not impose a 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 preceding these regulations was submitted to the Small Business Administration for comment on its impact on small businesses.

Drafting Information

The principal authors of these regulations are Linda S. F. Marshall and Lisa A. Tavares, Office of the Associate Chief Counsel (Employee Benefits and Exempt Organizations). However, other personnel from the IRS and Treasury Department participated in their development.

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 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.401(b)–1 is amended by:

Revising paragraphs (b)(3), (c), and (d)(1)(iv).
Adding paragraph (d)(1)(v). The addition and revisions read as follows: §1.401(b)–1 Certain retroactive changes in plan.

(b) * * *

scope of the Commissioner’s authority to provide relief from plan disqualification under section 401(b) and the regulations. On August 1, 1997, temporary regulations (T.D. 8727, 1997–2 C.B. 47) under section 401(b) were published in the Federal Register (62 F.R. 41272). A notice of proposed rulemaking (REG–106043–97, 1997–2 C.B. 654) cross-referencing the temporary regulations, was published in the Federal Register (62 F.R. 41322) on the same day. The temporary regulations enabled the Commissioner to provide appropriate relief concerning the timing of plan amendments relating to changes to the plan qualification rules made in recent legislation, as well as for other plan amendments that may be needed as a result of future changes to the Internal Revenue Code (Code).

No written comments responding to the notice of proposed rulemaking were received. No public hearing was requested or held. The proposed regulations under section 401(b) are adopted by this Treasury decision, and the corresponding temporary regulations are removed.

Explanation of Provisions

Section 401(b) provides that a plan is considered to satisfy the qualification requirements of section 401(a) for the period beginning with the date on which it was put into effect, or for the period beginning with the earlier of the date on which any amendment that caused the plan to fail to satisfy those requirements was adopted or put into effect, and ending with the time prescribed by law for filing the employer’s return for the taxable year in which that plan or amendment was adopted (including extensions) or such later time as the Secretary may designate, if all provisions of the plan needed to satisfy the qualification requirements are in effect by the end of the specified period and have been made effective for all purposes for the entire period.

Section 1.401(b)–1(b) lists the plan provisions that may be amended retroactively pursuant to the rules of section 401(b). These plan provisions, termed disqualify- ing provisions, include the plan provisions described in section 401(b), as well as plan provisions that result in failure of a plan to satisfy the qualification requirements of the Code by reason of a change

in those requirements effected by the legislation listed in §1.401(b)–1(b)(2)(i) and (ii). Under §1.401(b)–1(b)(2)(ii), a disqualifying provision also includes a plan provision that is integral to a qualification requirement changed by specified legislation. As in effect prior to the previously issued final and temporary regulations, §1.401(b)–1(b)(2)(iii) provided that a disqualifying provision includes a plan provision that results in failure of the plan to satisfy the Code’s qualification requirements by reason of a change in those requirements effected by amendments to the Code, that is designated by the Commissioner, at the Commissioner’s discretion, as a disqualifying provision.

Section 1.401(b)–1(d) provides rules for determining the period for which the relief provided under section 401(b) applies (the “remedial amendment period”). Section 1.401(b)–1(d)(1) defines the beginning of the remedial amendment period for the disqualifying provisions listed in §§1.401(b)–(1)(b)(1) and 1.401(b)–1(b)(2)(i) and (ii). The final regulations retain the rules set forth in the temporary regulations to clarify the scope of the Commissioner’s authority to provide relief from plan disqualification under section 401(b). These changes are needed to clarify the rules relating to the plan provisions that may be designated by the Commissioner as disqualifying provisions based on amendments to the plan qualification requirements of the Internal Revenue Code. Section 1.401(b)–1(b)(3) retains the rule set forth in the temporary regulations to provide that a disqualifying provision includes a plan provision designated by the Commissioner, at the Commissioner’s discretion, as a disqualifying provision that either (1) results in the failure of the plan to satisfy the qualification requirements of the Code by reason of a change in those requirements; or (2) is integral to a qualification requirement of the Code that has been changed. Section 1.401(b)–1(c)(2) retains the rule set forth in the temporary regulations to provide the Commissioner with explicit authority to impose limits and provide additional rules regarding the amendments that may be made with respect to disqualifying provisions during the remedial amendment period. Section 1.401(b)–1(d)(1)(iv) and (v) provide conforming rules, as previ

February 22, 2000 642 2000–8 I.R.B.

(3) A plan provision designated by the Commissioner, at the Commissioner’s discretion, as a disqualifying provision that either—

(i) Results in the failure of the plan to satisfy the qualification requirements of the Internal Revenue Code by reason of a change in those requirements; or

(ii) Is integral to a qualification requirement of the Internal Revenue Code that has been changed.

(c) Special rules applicable to disquali- fying provisions - – (1) Absence of plan provision . For purposes of paragraphs (b)(2) and (3) of this section, a disqualifying provision includes the absence from a plan of a provision required by, or, if applicable, integral to the applicable change to the qualification requirements of the Internal Revenue Code, if the plan was in effect on the date the change became effective with respect to the plan.

(2) Method of designating disqualifying provisions . The Commissioner may designate a plan provision as a disqualifying provision pursuant to paragraph (b)(3) of this section only in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See §601.601(d)(2) of this chapter.

(3) Authority to impose limitations . In the case of a provision that has been designated as a disqualifying provision by the Commissioner pursuant to paragraph (b)(3) of this section, the Commissioner may impose limits and provide additional rules regarding the amendments that may be made with respect to that disqualifying provision during the remedial amendment period. The Commissioner may provide

guidance in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See §601.601(d)(2) of this chapter.

(d) *** (1) *** (iv) In the case of a disqualifying provision described in paragraph (b)(3)(i) of this section, the date on which the change effected by an amendment to the Internal Revenue Code became effective with respect to the plan; or

(v) In the case of a disqualifying provision described in paragraph (b)(3)(ii) of this section, the first day on which the plan was operated in accordance with such provision, as amended, unless another time is specified by the Commissioner in revenue rulings, notices, and other guidance published in the Internal Revenue Bulletin. See §601.601(d)(2) of this chapter.

§1.401(b)–1T [Removed]

Par. 3. Section 1.401(b)–1T is removed.

John M. Dalrymple, Acting Deputy Commissioner

of Internal Revenue.

Approved January 19, 2000.

Jonathan Talisman, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on February 3, 2000, 8:45 a.m., and published in the issue of the Federal Register for February 4, 2000, 65 F.R. 5432)

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The December 1999 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, December 31, 1999.

Rev. Rul. 2000–10

The following Department Store Inventory Price Indexes for December 1999 were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, December 31, 1999.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Percent Change Groups Dec. Dec. from Dec. 1998 1998 1999 to Dec. 1999 ¹

1. Piece Goods - - - - - - - - - - - - - - - - - - - - - - - - - 546.8 512.9 -6.2 2. Domestics and Draperies - - - - - - - - - - - - - - - - - 631.2 619.5 -1.9 3. Women’s and Children’s Shoes - - - - - - - - - - - - - 660.9 631.0 -4.5 4. Men’s Shoes - - - - - - - - - - - - - - - - - - - - - - - - - 905.3 887.4 -2.0 5. Infants’ Wear - - - - - - - - - - - - - - - - - - - - - - - - - 628.7 650.0 3.4 6. Women’s Underwear - - - - - - - - - - - - - - - - - - - - 559.6 561.6 0.4 7. Women’s Hosiery - - - - - - - - - - - - - - - - - - - - - - 304.1 325.0 6.9 8. Women’s and Girls’Accessories - - - - - - - - - - - - 536.4 526.2 -1.9 9. Women’s Outerwear and Girls’ Wear - - - - - - - - - 401.0 393.5 -1.9 10. Men’s Clothing - - - - - - - - - - - - - - - - - - - - - - - 603.3 610.1 1.1

2000–8 I.R.B. 643 February 22, 2000

Men’s Furnishings - - - - - - - - - - - - - - - - - - - - - 591.9 626.0 5.8
Boys’ Clothing and Furnishings - - - - - - - - - - - - - 493.7 506.4 2.6
Jewelry - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 953.0 924.8 -3.0
Notions - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 771.9 768.3 -0.5
Toilet Articles and Drugs - - - - - - - - - - - - - - - - - 939.4 981.7 4.5
Furniture and Bedding - - - - - - - - - - - - - - - - - - - 691.1 688.5 -0.4
Floor Coverings - - - - - - - - - - - - - - - - - - - - - - - 602.5 602.7 0.0
Housewares - - - - - - - - - - - - - - - - - - - - - - - - - - 806.5 786.9 -2.4
Major Appliances - - - - - - - - - - - - - - - - - - - - - - 236.0 234.9 -0.5
Radio and Television - - - - - - - - - - - - - - - - - - - - 69.6 63.2 -9.2
Recreation and Education ² - - - - - - - - - - - - - - - - 101.6 95.3 -6.2
Home Improvements ² - - - - - - - - - - - - - - - - - - - 130.6 129.3 -1.0
Auto Accessories ² - - - - - - - - - - - - - - - - - - - - - - 107.7 107.3 -0.4

Groups 1 - 15: Soft Goods - - - - - - - - - - - - - - - - - - 595.0 596.7 0.3

Groups 16 - 20: Durable Goods - - - - - - - - - - - - - - - - 458.0 445.6 -2.7

Groups 21 - 23: Misc. Goods ² - - - - - - - - - - - - - - - - - 106.6 102.1 -4.2

Store Total ³ - - - - - - - - - - - - - - - - - - - - - - - - - 544.8 540.2 -0.8

1 Absence of a minus sign before the percentage change in this column signifies a price increase. 2 Indexes on a January 1986=100 base. 3 The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Alan J. Tomsic of the Office of Assistant Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Tomsic on (202) 622-4970 (not a toll-free call).

Section 513.—Unrelated Trade or Business

26 CFR 1.513–7: Travel and tour activities of tax exempt organizations.

T.D. 8874

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Travel and Tour Activities of Tax-Exempt Organizations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations clarifying when the travel and tour activities of tax-exempt organizations are substantially related to the purposes for which exemption was granted. This action provides needed

guidance for tax-exempt organizations concerning when travel tour activities may be subject to tax as an unrelated trade or business. This action affects tax-exempt organizations that engage in travel tour activities.

DATES: Effective Date : These regulations are effective on February 7, 2000.

Applicability Date : These regulations are applicable for taxable years beginning after February 7, 2000.

FOR FURTHER INFORMATION CONTACT: Robin Ehrenberg, (202) 622-6080 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On April 23, 1998, the IRS published in the Federal Register (63 F.R. 20156) a notice of proposed rulemaking (REG–121268–97, 1998–20 I.R.B. 12) under section 513 to clarify when the travel and tour activities of tax-exempt organizations are substantially related to the purposes for which exemption was granted. The notice of proposed rulemaking added Treas. Reg. §1.513–7, which provides that whether travel tour activities are substantially related to an organization’s exempt purposes is determined by examining all the relevant facts and circumstances. The proposed regulations also contain examples applying the facts and circumstances test.

The notice of proposed rulemaking solicited comments from the public. Nineteen commentators submitted written comments. A public hearing was held on February 10, 1999, at which eight speakers presented testimony. After consideration of all the comments, the proposed regulations under section 513 are adopted as revised by this Treasury Decision. The comments and revisions are discussed below.

Explanation of Provisions and Summary of Comments

Many of the commentators welcomed the proposed regulationsas workable guidance that will promote tax compliance. Commentators differed on the approach that the IRS should adopt in final regulations. Some commentators suggested that the final regulations should adopt specific, weighted standards to be used in evaluating relatedness to exempt purpose. Other commentators recommended against adopting specific standards, arguing that no single set of standards would be appropriate given the broad range of tax-exempt organizations. One commentator suggested that the final regulations adopt a set of specific standards that would apply to test relatedness of tours in the educational context and a more general consistency standard that would evaluate whether the marketing, location, and execution of a tour are consistent with the organization’s core exempt activities.

February 22, 2000 644 2000–8 I.R.B.

as to whether income received by a taxexempt organization from travel tour activities is excludable from unrelated business taxable income as a royalty, see generally Treas. Reg. §1.512(b)–1(b) and Sierra Club v. Commissioner, 86 F.3d 1526 (9 ^th Cir. 1996). Some commentators suggested that the final regulations should contain provisions that prevent tax-exempt organizations from competing unfairly with taxable travel businesses. However, the test under section 513 is substantial relatedness to exempt purposes, not the presence or absence of unfair competition. Section 513 was enacted to prevent unfair competition between exempt organizations and taxable businesses. H.R. Rep. No. 2319, 81 ^st

Cong., 2d Sess. (1950), reprinted in 1950-2 C.B. 380, 409; S. Rep. No. 2375, 81 ^st

Cong., 2d Sess. (1950), reprinted in 1950-2 C.B. 483, 504; Portland Golf Club v. Com- missioner, 497 U.S. 154, 161-162, fn. 12 (1990); Treas. Reg. §1.513–1(b). Nevertheless, “Congress did not force exempt organizations to abandon all commercial ventures”, but rather imposed a tax on ventures that are not substantially related to an organization’s exempt purposes. United States v. American College of Physicians, 475 U.S. 834, 838 (1986). See also Louisiana Credit Union League v. United States, 693 F.2d 525, 541 (5 ^th Cir. 1982). Following this approach, the section 513(a) regulations, published in 1967, state that “any activity of a section 511 organization which is carried on for the production of income and which otherwise possesses the characteristics required to constitute ‘trade or business’ within the meaning of section 162– and which, in addition, is not substantially related to the performance of exempt functions— presents sufficient likelihood of unfair competition to be within the policy of the tax [imposed by section 511(a)].” Treas. Reg. §1.513–1(b). In expanding the categories of organizations subject to unrelated business income tax in 1969, Congress revisited the unfair competition issue. “[A] business competing with taxpaying organizations should not be granted an unfair competitive advantage by operating tax free unless the business contributes importantly to the exempt function.” H.R. Rep. No. 413 (Part 1), 91 ^st Cong., 1 ^st Sess., 44, 50 (1969), reprinted in 1969 U.S.C.C.A.N. 1645, 1689, 1695 (emphasis added). If an organization’s trade or business is substan

Section 513(a) generally defines an unrelated trade or business as any trade or business the conduct of which is not substantially related to the exercise or performance by the organization of its charitable, educational, or other purpose or function constituting the basis for its exemption under section 501(a). See also United States v. American Bar Endow- ment, 477 U.S. 105, 109-110 (1986). Treas Reg. § 1.513–1(d)(2) provides that, for the conduct of a trade or business to be substantially related to the purposes for which exemption was granted, the production or distribution of the goods or the performance of services must contribute importantly to the accomplishment of those purposes. Whether activities generating gross income contribute importantly to accomplishing any purpose for which an organization was granted exemption depends in each case upon the particular facts and circumstances. Id . This rule applies to travel tours.

Organizations exempt from tax under section 501(a) have diverse exempt purposes (for example: charities; social welfare organizations; labor, agricultural and horticultural organizations; business leagues; fraternal beneficiary societies). Accordingly, no one set of factors could be sufficiently comprehensive as to define relatedness for the variety of exempt organizations to which these travel tour regulations apply. Even among exempt organizations that share a common exempt purpose, such as education, the methods of accomplishing that purpose vary considerably. For this reason, the final regulations do not enumerate any specific factors that determine relatedness of travel tour activities to exempt purposes. The final regulations adopt the general facts and circumstances approach of the proposed regulations. See e.g, Hi-Plains Hospital v. United States, 670 F.2d 528 (5 ^th Cir. 1982) (need for case-by-case analysis identifying exempt purpose and analysis of how activity in each case contributes to exempt purpose); Louisiana Credit Union League v. United States, 693 F.2d 525, 534 (5 ^th Cir. 1982) (resolution of the substantial relationship test requires “an examination of the relationship between the business activities that generate the income in question ... and the accomplishment of the organization’s exempt purposes”). However, as discussed

below, the final regulations include new examples that provide additional guidance regarding the application of this facts and circumstances approach in both educational and noneducational contexts.

Another commentator suggested that the final regulations should clarify that the manner in which an organization develops and promotes a tour is relevant to determining whether the tour activity is substantially related to exempt purposes. The development, promotion and operation of a tour are all indicators of whether an organization’s offering of a tour is related or unrelated to its exempt purpose. See International Postgraduate Medical Found. v. Commissioner, 1989-36 T.C. Memo., 56 T.C.M. (CCH) 1140 (1989) (brochures promoting the trips emphasized recreational sightseeing activity and omitted educational course descriptions). Language has been added to the final regulations stating that relevant facts and circumstances include (but are not limited to) how a travel tour is developed, promoted and operated. Examples in the final regulations also illustrate the relevance of these factors.

Many commentators requested more examples addressing specific areas. As noted above, examples have been added that further illustrate the application of the facts and circumstances rule. Some commentators raised concerns regarding the number of hours of related activities a travel tour must offer. Examples in the final regulation clarify that the number of hours spent on any related travel tour activity is only one factor in determining relatedness of the tour as a whole to exempt purposes and is not by itself determinative. Examples in the final regulation clarify that the nature of the related activities, and the practicalities of engaging in such activities (for example, the hours during which the activity normally would be conducted), must also be taken into account.

One commentator suggested adding an example addressing whether income from travel tour activity is a royalty under section 512(b)(2) where the exempt organization does not operate the tour, but provides member names to a for-profit tour operator. Section 512(b)(2) excludes royalties from the computation of unrelated business taxable income. The question of what constitutes a royalty is beyond the scope of these regulations. For guidance

2000–8 I.R.B. 645 February 22, 2000

§1.513–1(b) may result in different treatment for individual tours within an organization’s travel tour program.

(b) Examples . The provisions of this section are illustrated by the following examples. In all of these examples, the travel tours are priced to produce a profit for the exempt organization. The examples are as follows:

Example 1 . O, a university alumni association, is exempt from federal income tax under section 501(a) as an educational organization described in section 501(c)(3). As part of its activities, O operates a travel tour program. The program is open to all current members of O and their guests. O works with travel agencies to schedule approximately 10 tours annually to various destinations around the world. Members of O pay $x to the organizing travel agency to participate in a tour. The travel agency pays O a per person fee for each participant. Although the literature advertising the tours encourages O’s members to continue their lifelong learning by joining the tours, and a faculty member of O’s related university frequently joins the tour as a guest of the alumni association, none of the tours includes any scheduled instruction or curriculum related to the destinations being visited. The travel tours made available to O’s members do not contribute importantly to the accomplishment of O’s educational purpose. Rather, O’s program is designed to generate revenues for O by regularly offering its members travel services. Accordingly, O’s tour program is an unrelated trade or business within the meaning of section 513(a).

Example 2 . N is an organization formed for the purpose of educating individuals about the geography and culture of the United States. It is exempt from federal income tax under section 501(a) as an educational and cultural organization described in section 501(c)(3). N engages in a number of activities to accomplish its purposes, including offering courses and publishing periodicals and books. As one of its activities, N conducts study tours to national parks and other locations within the United States. The study tours are conducted by teachers and other personnel certified by the Board of Education of the State of P. The tours are directed toward students enrolled in degree programs at educational institutions in P, as reflected in the promotional materials, but are open to all who agree to participate in the required study program. Each tour’s study program consists of instruction on subjects related to the location being visited on the tour. During the tour, five or six hours per day are devoted to organized study, preparation of reports, lectures, instruction and recitation by the students. Each tour group brings along a library of material related to the subject being studied on the tour. Examinations are given at the end of each tour and the P State Board of Education awards academic credit for tour participation. Because the tours offered by N include a substantial amount of required study, lectures, report preparation, examinations and qualify for academic credit, the tours are substantially related to N’s educational purpose. Accordingly, N’s tour program is not an unrelated trade or business within the meaning of section 513(a).

Example 3 . R is a section 501(c)(4) social welfare organization devoted to advocacy on a particu

tially related to its exempt purposes, the tax under section 511 is not imposed, regardless of the existence of competition with taxable entities. Accordingly, the final regulations continue to focus on relatedness to exempt purposes, as required by section 513. The preamble to the proposed regulations requested comments on whether the final regulations should include documentation and recordkeeping requirements specific to travel tours. Commentators split on the preferred approach. Some commentators requested general guidance as to the types of records that an organization should keep to establish a tour’s purpose, but did not want the IRS to mandate specific recordkeeping requirements. Other commentators asked that the IRS specify what documentation is required. Section 6001 authorizes the Secretary to prescribe regulations that require taxpayers to keep records sufficient to establish whether a taxpayer is liable for any tax imposed under the Code. Currently, any person subject to tax under subtitle A of the Code, including the tax imposed under section 511, or required to file a return of information with respect to income, must keep permanent books or records sufficient to establish the amount of gross income, deductions, credits or other matters required to be shown by such person in any return of tax or information. See Treas. Reg. §1.6001–1(a). In addition, every organization exempt from tax under section 501(a) must keep permanent books of account or records sufficient to show specifically items of gross income, receipts and disbursements, and to substantiate the information required by section 6033. See Treas. Reg. §1.6001– 1(c). The IRS and Treasury Department believe that, with respect to travel tours, it is unnecessary to supplement the existing recordkeeping requirements under sections 6001 and 6033. Therefore, the final regulations do not impose additional recordkeeping requirements. However, in response to commentators’ suggestions, examples in the final regulations illustrate that contemporaneous documentation showing how an organization develops, promotes and operates the travel tour is relevant to the facts and circumstances analysis.

Special Analyses

It has been determined that these final

regulations are not a significant regulatory action as defined in Executive Order 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, the notice of proposed rulemaking preceding 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 Robin Ehrenberg, Office of Associate Chief Counsel (Employee Benefits and Exempt Organizations). However, other personnel from the IRS and the Treasury Department participated in their development.

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 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * * Par. 2. Section 1.513–7 is added to read as follows: §1.513–7 Travel and tour activities of tax exempt organizations.

(a) Travel tour activities that constitute a trade or business, as defined in §1.513–1(b), and that are not substantially related to the purposes for which exemption has been granted to the organization constitute an unrelated trade or business with respect to that organization. Whether travel tour activities conducted by an organization are substantially related to the organization’s exempt purpose is determined by looking at all relevant facts and circumstances, including, but not limited to, how a travel tour is developed, promoted and operated. Section 513(c) and §1.513–1(b) also apply to travel tour activity. Application of the rules of section 513(c) and

February 22, 2000 646 2000–8 I.R.B.

lar issue. On a regular basis throughout the year, R organizes travel tours for its members to Washington, DC. While in Washington, the members follow a schedule according to which they spend substantially all of their time during normal business hours over several days attending meetings with legislators and government officials and receiving briefings on policy developments related to the issue that is R’s focus. Members do have some time on their own in the evenings to engage in recreational or social activities of their own choosing. Bringing members to Washington to participate in advocacy on behalf of the organization and learn about developments relating to the organization’s principal focus is substantially related to R’s social welfare purpose. Therefore, R’s operation of the travel tours does not constitute an unrelated trade or business within the meaning of section 513(a).

Example 4 . S is a membership organization formed to foster cultural unity and to educate X Americans about X, their country of origin. It is exempt from federal income tax under section 501(a) and is described in section 501(c)(3) as an educational and cultural organization. Membership in S is open to all Americans interested in the X heritage. As part of its activities, S sponsors a program of travel tours to X. The tours are divided into two categories. Category A tours are trips to X that are designed to immerse participants in the X history, culture and language. Substantially all of the daily itinerary includes scheduled instruction on the X language, history and cultural heritage, and visits to destinations selected because of their historical or cultural significance or because of instructional resources they offer. Category B tours are also trips to X, but rather than offering scheduled instruction, participants are given the option of taking guided tours of various X locations included in their itinerary. Other than the optional guided tours, Category B tours offer no instruction or curriculum. Destinations of principally recreational interest, rather than historical or cultural interest, are regularly included on Category B tour itineraries. Based on the facts and circumstances, sponsoring Category A tours is an activity substantially related to S’s exempt purposes, and does not constitute an unrelated trade or business within the meaning of section 513(a). However, sponsoring Category B tours does not contribute importantly to S’s accomplishment of its exempt purposes and, thus, constitutes an unrelated trade or business within the meaning of section 513(a). Example 5 . T is a scientific organization engaged in environmental research. T is exempt from federal income tax under section 501(a) as an organization described in section 501(c)(3). T is engaged in a long-term study of how agricultural pesticide and fertilizer use affects the populations of various bird species. T collects data at several bases located in an important agricultural region of country U. The minutes of a meeting of T’s Board of Directors state that, after study, the Board has determined that nonscientists can reliably perform needed data collection in the field, under supervision of T’s biologists. The Board minutes reflect that the Board approved offering one-week trips to T’s bases in U, where participants will assist T’s biologists in collecting data for the study. Tour participants collect data during the same hours as T’s biologists. Normally, data collection occurs during the early morning and evening

hours, although the work schedule varies by season. Each base has rustic accommodations and few amenities, but country U is renowned for its beautiful scenery and abundant wildlife. T promotes the trips in its newsletter and on its Internet site and through various conservation organizations. The promotional materials describe the work schedule and emphasize the valuable contribution made by trip participants to T’s research activities. Based on the facts and circumstances, sponsoring trips to T’s bases in country U is an activity substantially related to T’s exempt purpose, and, thus, does not constitute an unrelated trade or business within the meaning of section 513(a).

Example 6 . V is an educational organization devoted to the study of ancient history and cultures and is exempt from federal income tax under section 501(a) as an organization described in section 501(c)(3). In connection with its educational activities, V conducts archaeological expeditions around the world, including in the Y region of country Z. In cooperation with the National Museum of Z, V recently presented an exhibit on ancient civilizations of the Y region of Z, including artifacts from the collection of the Z National Museum. V instituted a program of travel tours to V’s archaeological sites located in the Y region. The tours were initially proposed by V staff members as a means of educating the public about ongoing field research conducted by V. V engaged a travel agency to handle logistics such as accommodations and transportation arrangements. In preparation for the tours, V developed educational materials relating to each archaeological site to be visited on the tour, describing in detail the layout of the site, the methods used by V’s researchers in exploring the site, the discoveries made at the site, and their historical significance. V also arranged special guided tours of its exhibit on the Y region for individuals registered for the travel tours. Two archaeologists from V (both of whom had participated in prior archaeological expeditions in the Y region) accompanied the tours. These experts led guided tours of each site and explained the significance of the sites to tour participants. At several of the sites, tour participants also met with a working team of archaeologists from V and the National Museum of Z, who shared their experiences. V prepared promotional materials describing the educational nature of the tours, including the daily trips to V’s archaeological sites and the educational background of the tour leaders, and providing a recommended reading list. The promotional materials do not refer to any particular recreational or sightseeing activities. Based on the facts and circumstances, sponsoring trips to the Y region is an activity substantially related to V’s exempt purposes. The scheduled activities, which include tours of archaeological sites led by experts, are part of a coordinated educational program designed to educate tour participants about the ancient history of the Y region of Z and V’s ongoing field research. Therefore, V’s tour program does not constitute an unrelated trade or business within the meaning of section 513(a).

Example 7 . W is an educational organization devoted to the study of the performing arts and is exempt from federal income tax under section 501(a) as an organization described in section 501(c)(3). In connection with its educational activities, W presents public performances of musical and theatrical works. Individuals become members of W by mak

ing an annual contribution to W of $q. Each year, W offers members an opportunity to travel as a group to one or more major cities in the United States or abroad. In each city, tour participants are provided tickets to attend a public performance of a play, concert or dance program each evening. W also arranges a sightseeing tour of each city and provides evening receptions for tour participants. W views its tour program as an important means to develop and strengthen bonds between W and its members, and to increase their financial and volunteer support of W. W engaged a travel agency to handle logistics such as accommodations and transportation arrangements. No educational materials are prepared by W or provided to tour participants in connection with the tours. Apart from attendance at the evening cultural events, the tours offer no scheduled instruction, organized study or group discussion. Although several members of W’s administrative staff accompany each tour group, their role is to facilitate member interaction. The staff members have no special expertise in the performing arts and play no educational role in the tours. W prepared promotional materials describing the sightseeing opportunities on the tours and emphasizing the opportunity for members to socialize informally and interact with one another and with W staff members, while pursuing shared interests. Although W’s tour program may foster goodwill among W members, it does not contribute importantly to W’s educational purposes. W’s tour program is primarily social and recreational in nature. The scheduled activities, which include sightseeing and attendance at various cultural events, are not part of a coordinated educational program. Therefore, W’s tour program is an unrelated trade or business within the meaning of section 513(a).

Robert E. Wenzel, Deputy Commissioner

of Internal Revenue.

Approved January 21, 2000.

Jonathan Talisman, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue of the Federal Register for February 7, 2000, 65 F.R. 5772)

Section 1295.—Qualified Electing Fund

26 CFR 1.1295–1: Qualified electing funds.

T.D. 8870

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1 and 602

2000–8 I.R.B. 647 February 22, 2000

Job Protection Act of 1996. In addition, the Taxpayer Relief Act of 1997 (1997 TRA) amended section 1 to provide categories of long-term capital gain and the maximum rates of tax to which the categories are subject. In certain cases, this amendment affects the calculation of net capital gain for purposes of section 1293.

No written comments were received on the proposed regulations, and no public hearing was requested or held. The proposed regulations are adopted as final regulations as revised by this Treasury Decision. The revisions are summarized in the explanations below.

Explanation of Revisions

A foreign corporation is a PFIC for a taxable year if the foreign corporation satisfies either the income or asset test of section 1297(a) for that year. A foreign corporation is a PFIC under the income test if 75 percent or more of its gross income for its taxable year is passive, or investment-type, income. Alternatively, under the asset test, a foreign corporation is a PFIC if 50 percent or more of the average fair market value of its assets during its taxable year are assets that produce or are held for the production of passive income. A shareholder of a foreign corporation that qualifies as a PFIC is subject to the interest charge regime of section 1291 with respect to certain distributions by the PFIC and certain dispositions of its stock. Generally, a shareholder of a PFIC may avoid the interest charge regime by making a timely election under section 1295 to treat a PFIC as a QEF, in which case the shareholder will be taxed annually pursuant to section 1293 on its pro rata share of the ordinary earnings and net capital gain of the PFIC. Under section 1295(a), a section 1295 election will apply with respect to the PFIC if the PFIC complies with requirements prescribed by the Secretary for purposes of determining the ordinary earnings and net capital gain of the PFIC and otherwise carrying out the purposes of the PFIC provisions.

Section 1295(b)(1), as enacted by TAMRA, provides that a shareholder may make a section 1295 election with respect to a PFIC for any taxable year of the shareholder (shareholder election year). Once made, the election will apply to that year and to all subsequent years of the shareholder unless revoked by the share

General Rules for Making and Maintaining Qualified Electing Fund Elections

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final 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), and for PFIC shareholders that wish to make a section 1295 election that will apply on a retroactive basis (retroactive election). In addition, this document contains a final regulation that provides guidance under section 1291 to a PFIC shareholder that is a tax-exempt organization. Lastly, this document contains final regulations under section 1293 for calculating and reporting net capital gain by a QEF, and also clarifies the application of the current income inclusion rules of section 1293 to interest in a QEF held through a domestic pass through entity.

DATES: Effective Date . These regulations are effective February 7, 2000.

Applicability Date . In general, these regulations are applicable as of January 2, 1998. For special dates of applicability see §1.1295–1(k).

FOR FURTHER INFORMATION CONTACT: Margaret A. Fung, (202) 6223840 (not a toll free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507) under control number 1545 - 1555. Responses to these collections of information are mandatory for PFIC shareholders that wish to make the section 1295 election to treat the PFIC as a QEF. Comments on the collections 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, OP:FS:FP, Washington, DC 20224.

The estimated average annual burden per respondent and/or recordkeeper varies from fifteen minutes to three hours, depending on individual circumstances, with an estimated average of twenty-nine minutes.

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.

Background

On January 2, 1998, the Treasury and the IRS published temporary regulations regarding the section 1295 election and rules applicable to a PFIC shareholder under sections 1291, 1293, 1295 and 1297 (redesignated as section 1298 by the Taxpayer Relief Act of 1997, and hereafter referred to as section 1298) (T.D. 8750, 1998–8 I.R.B. 4 [63 F.R. 6]). On that same date, the Treasury and the IRS published a proposed rulemaking (REG–115795–97, 1998–8 I.R.B. 33) in the Federal Register (63 F.R. 35). The text of the temporary regulations served as the text of the proposed regulations.

Sections 1291, 1293, 1295 and 1298 were added by the Tax Reform Act of 1986, effective for taxable years of foreign corporations beginning after December 31, 1986. As originally enacted, the section 1295 election was an election made by the PFIC. The Technical and Miscellaneous Revenue Act of 1988 (TAMRA) amended section 1295, effective for taxable years of foreign corporations beginning after December 31, 1986, to change the section 1295 election to a shareholder-by-shareholder election. Sections 1291, 1293 and 1298 were also amended by TAMRA, and sections 1293 and 1298 were further amended by the Omnibus Budget Reconciliation Act of 1993. Section 1298 also was amended by the Revenue Reconciliation Act of 1989 and the Small Business

February 22, 2000 648 2000–8 I.R.B.

holder with the consent of the Secretary. Section 1295(b)(2) prescribes the time for making the election. In general, for the section 1295 election to be applicable to a taxable year, the shareholder must make the election by the due date, as extended under section 6081, for the shareholder’s return for that taxable year. However, to the extent provided in the regulations, a section 1295 election may be made for a taxable year after the prescribed due date if the shareholder failed to make a timely election because the shareholder reasonably believed that the foreign corporation was not a PFIC.

Under temporary regulations §1.1295–1T(d)(1) and (f)(1), the shareholder, as defined in §1.1291–9(j)(3), of a PFIC makes the section 1295 election by filing a Form 8621 with the shareholder’s Federal income tax return by the election due date for the shareholder election year, and by filing a copy of that form with the Philadelphia Service Center. In addition, under temporary regulation §1.1295–1T(f)(2), the shareholder must file an annual Form 8621 with its Federal income tax return to report the shareholder’s pro rata share of the ordinary earnings and net capital gain of the QEF. Temporary regulation §1.1295–1T(f)(2) also required that a copy of the annual Form 8621 be filed with the Philadelphia Service Center. To reduce taxpayer burden, this final regulation eliminates the requirement for filing a copy of Form 8621 with the Philadelphia Service Center when the shareholder makes the section 1295 election or reports the shareholder’s annual pro rata share of the ordinary earnings and net capital gain of the QEF.

In addition, this final regulation clarifies the rule in temporary regulation §1.1295–1T(c)(2)(ii) for income inclusion by the shareholder of a QEF under section 1293 for any taxable year that the foreign corporation is not a PFIC under section 1297(a) and is not treated as a PFIC under section 1298(b)(1). This final regulation clarifies that in such case, the shareholder is not required to include pursuant to section 1293 the shareholder’s pro rata share of ordinary earnings and net capital gain for such year, and the shareholder shall not be required to satisfy the section 1295 annual reporting requirement for such year. Cessation of a foreign corporation’s status as a PFIC will not,

however, terminate a section 1295 election. Thus, if the foreign corporation is a PFIC in any taxable year after a year in which it is not treated as a PFIC, the shareholder’s original election under section 1295 continues to apply and the shareholder must take into account its pro rata share of ordinary earnings and net capital gain for such year and comply with the section 1295 annual reporting requirement.

The Taxpayer Relief Act of 1997 added section 1296 to provide PFIC shareholders with an alternative method for current income inclusion by making a mark-tomarket election with respect to their PFIC stock that qualifies as marketable stock. The election is available to shareholders whose taxable years begin after December 31, 1997 for stock in a foreign corporation whose taxable year ends with or within the shareholder’s taxable year. The effect of a mark-to-market election on a section 1295 election will be addressed in subsequent regulations under section 1296. In addition, temporary regulation §1.1297–3T(c) governing the deemed dividend election by a United States person that is a shareholder of a PFIC will be finalized in a future regulation project.

Notice 98–22 (1998–17 I.R.B. 5) provides that taxpayers will be permitted to apply the rules of the temporary regulations under §1.1295–1T(b)(4) (section 1295 election by shareholders who file a joint return) and §1.1295–1T(f) and (g) (procedures for making a section 1295 election and annual information requirements by the PFIC or intermediary) to taxable years beginning before January 1, 1998, for which the statute of limitations on the assessment of tax has not expired and, with respect to § 1.1295–1T(b)(4), if certain consistency requirements are met. The rule of Notice 98–22 has been incorporated into §1.1295–1(k) of this regulation. Final regulation §1.1295–1(k) is changed to reflect the special effective dates for §1.1295–1(b)(4), (f) and (g) as provided by Notice 98–22. Accordingly, Notice 98–22 is obsoleted since the effective date provisions are contained in this final regulation.

Notice 88–125 described the requirements a shareholder must satisfy to make and maintain a section 1295 election for taxable years beginning before January 1,

As a result of the procedures and requirements set forth first in the temporary regulations published on January 2, 1998, and now in these final regulations, Notice 88–125 is obsoleted effective February 7, 2000.

Effect On Other Documents

Notice 88–125 and Notice 98–22 are obsoleted as of February 7, 2000.

Special Analyses

It has been determined that the final regulations are not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Further, it is hereby certified, pursuant to sections 603(a) and 605(b) of the Regulatory Flexibility Act (5 U.S.C. chapter 6), that the collection of information contained in these regulations will not have a significant economic impact on substantial number of small entities. The cost of collection of information to small entities is insignificant because the primary reporting burden is on individual PFIC shareholders who make the section 1295 election. Therefore, the collection of information will not have a substantial economic impact. Therefore, a regulatory flexibility analysis under the Regulatory Flexibility Act is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding 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 the final regulations is Margaret A. Fung, Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

Adoption of Amendments to the Regulations

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

2000–8 I.R.B. 649 February 22, 2000

PART 1–INCOME TAXES

graph (h).

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

Authority: 26 U.S.C. 7805 * * * Sec. 1.1291–1 also issued under 26 U.S.C. 1291. * * * Sec. 1.1293–1 also issued under 26 U.S.C. 1293. * * * Sec. 1.1295–3 also issued under 26 U.S.C. 1295. * * *

§1.1291–1T [Redesignated as §1.1291–1]

Par. 2. Section 1.1291–1T is redesignated as §1.1291–1 and the section heading is revised to read as follows: §1.1291–1 Taxation of U.S. persons that are shareholders of PFICs that are not pedigreed QEFs.

Par. 3. Section 1.1293–1T is redesignated as §1.1293–1 and the newly designated section is amended by revising the section heading and the first sentence of paragraph (c)(1) to read as follows: §1.1293–1 Current taxation of income from qualified electing funds.

(c) Application of rules of inclusion with respect to stock held by a pass through entity - (1) In general . If a domestic pass through entity makes a section 1295 election, as provided in paragraph (d)(2) of this section, with respect to the PFIC shares that it owns, directly or indirectly, the domestic pass through entity takes into account its pro rata share of the ordinary earnings and net capital gain attributable to the QEF shares held by the pass through entity. * * *

Par. 4. Section 1.1295–0 is amended by:

Revising the introductory text of the section.
Removing the entry for the heading of §1.1295–1T and adding an entry for the heading of §1.1295–1 in its place.
Revising the entries for §1.1295–1(d)(3) through (d)(5).
Adding entries for §1.1295–1(d)(6) and (e)(1) and (e)(2).
Removing the entry for the heading of §1.1295–3T and adding an entry for the heading of §1.1295–3 in its place.

The revisions and additions read as fol

lows: §1.1295–0 Table of contents.

Par. 5. Section §1.1295–1T is redesignated as §1.1295–1 and the newly designated section is amended by:

Revising the section heading.
Revising paragraph (b)(3)(iv)(B).
Adding paragraph (b)(3)(v).
Adding a sentence to the end of paragraph (b)(4).
Revising paragraphs (c)(2)(ii) and (iii).
Revising the third sentence in paragraph (c)(2)(v) Example 3 .
Redesignating paragraphs (d)(3), (d)(4) and (d)(5) as paragraphs (d)(4), (d)(5) and (d)(6), respectively.
Adding a new paragraph (d)(3).
Revising paragraph (e).
In the last sentence of paragraph (f)(1)(iii), the language “capital gain; and” is removed and the language “capital gain.” is added in its place.
Adding the word “and” at the end of paragraph (f)(1)(ii).
Removing paragraph (f)(1)(iv).
Adding the word “and” at the end of paragraph (f)(2)(i)(B).
In the last sentence of paragraph (f)(2)(i)(C), the language “capital gain; and” is removed and the language “capital gain.” is added in its place.
Removing paragraph (f)(2)(i)(D).
Adding a new paragraph (f)(3).
Revising the introductory language of paragraph (g)(3).
Adding paragraph (g)(5).
Revising the first sentence of para

This section contains a listing of the headings for §§1.1295–1 and 1.1295–3. §1.1295–1 Qualified electing funds.

(d) * * * (3) Indirect ownership of a PFIC through other PFICs.

(4) Member of consolidated return group as shareholder.

(5) Option holder. (6) Exempt organization. (e) * * * (1) General rule. (2) Examples.

§1.1295–3 Retroactive elections.

§1.1295–1T [Redesignated as §1.1295–1]

Revising paragraph (k). The revisions and additions read as follows: §1.1295–1 Qualified electing funds.

(b) * * * (3) * * * (iv) * * * (B) In the case of PFIC stock transferred by an interest holder or beneficiary to a pass through entity in a transaction in which gain is not fully recognized (including pursuant to regulations under section 1291(f)), the pass through entity makes the section 1295 election with respect to the PFIC stock transferred for the taxable year in which the transfer was made. The PFIC stock transferred will be treated as stock of a pedigreed QEF by the pass through entity, however, only if that stock was treated as stock of a pedigreed QEF with respect to the interest holder or beneficiary at the time of the transfer, and the PFIC has been a QEF with respect to the pass through entity for all taxable years of the PFIC that are included wholly or partly in the pass through entity’s holding period of the PFIC stock during which the foreign corporation was a PFIC within the meaning of §1.1291–9(j).

(v) Characterization of stock distrib- uted by a partnership . In the case of PFIC stock distributed by a partnership to a partner in a transaction in which gain is not fully recognized, the PFIC stock will be treated as stock of a pedigreed QEF by the partners only if that stock was treated as stock of a pedigreed QEF with respect to the partnership for all taxable years of the PFIC that are included wholly or partly in the partnership’s holding period of the PFIC stock during which the foreign corporation was a PFIC within the meaning of §1.1291–9(j), and the partner has a section 1295 election in effect with respect to the distributed PFIC stock for the partner’s taxable year in which the distribution was made. If the partner does not have a section 1295 election in effect, the stock shall be treated as stock in a section 1291 fund. See paragraph (k) of this section for special applicability date of paragraph (b)(3)(v) of this section.

(4) * * * See paragraph (k) of this section for special applicability date of paragraph (b)(4) of this section.

February 22, 2000 650 2000–8 I.R.B.

Intermediary Statement issued by an intermediary containing the information described in paragraph (g)(1) of this section and reporting the indirect shareholder’s pro rata share of the ordinary earnings and net capital gain of the QEF as described in paragraph (g)(1)(ii)(A) of this section, may be provided to the indirect shareholder in lieu of the PFIC Annual Information Statement if the following conditions are satisfied —

(5) Effective date . See paragraph (k) of this section for special applicability date of paragraph (g) of this section.

(h) Transition rules . Taxpayers may rely on Notice 88–125 (1988–2 C.B. 535) (see §601.601(d)(2) of this chapter), for rules on making and maintaining elections for shareholder election years (as defined in paragraph (j) of this section) beginning after December 31, 1986, and before January 1, 1998. * * *

(k) Effective dates . Paragraphs (b)(2)(iii), (b)(3), (b)(4) and (c) through (j) of this section are applicable to taxable years of shareholders beginning after December 31, 1997. However, taxpayers may apply the rules under paragraphs (b)(4), (f) and (g) of this section to a taxable year beginning before January 1, 1998, provided the statute of limitations on the assessment of tax has not expired as of April 27, 1998 and, in the case of paragraph (b)(4) of this section, the taxpayers who filed the joint return have consistently applied the rules of that section to all taxable years following the year the election was made. Paragraph (b)(3)(v) of this section is applicable as of February 7, 2000, however a taxpayer may apply the rules to a taxable year prior to the applicable date provided the statute of limitations on the assessment of tax for that taxable year has not expired.

§1.1295–3T [Redesignated as §1.1295–3]

Par. 6. Section §1.1295–3T is redesignated as §1.1295–3 and the newly designated section is amended by revising the section heading and paragraphs (b)(1) and (c)(5)(i) to read as follows: §1.1295–3 Retroactive elections.

(b) * * * (1) Reasonably believed, within the

(2) * * * (ii) Effect of PFIC status on election . A foreign corporation will not be treated as a QEF for any taxable year of the foreign corporation that the foreign corporation is not a PFIC under section 1297(a) and is not treated as a PFIC under section 1298(b)(1). Therefore, a shareholder shall not be required to include pursuant to section 1293 the shareholder’s pro rata share of ordinary earnings and net capital gain for such year and shall not be required to satisfy the section 1295 annual reporting requirement of paragraph (f)(2) of this section for such year. Cessation of a foreign corporation’s status as a PFIC will not, however, terminate a section 1295 election. Thus, if the foreign corporation is a PFIC in any taxable year after a year in which it is not treated as a PFIC, the shareholder’s original election under section 1295 continues to apply and the shareholder must take into account its pro rata share of ordinary earnings and net capital gain for such year and comply with the section 1295 annual reporting requirement.

(iii) Effect on election of complete ter- mination of a shareholder’s interest in the PFIC . Complete termination of a shareholder’s direct and indirect interest in stock of a foreign corporation will not terminate a shareholder’s section 1295 election with respect to the foreign corporation. Therefore, if a shareholder reacquires a direct or indirect interest in any stock of the foreign corporation, that stock is considered to be stock for which an election under section 1295 has been made and the shareholder is subject to the income inclusion and reporting rules required of a shareholder of a QEF.

(v) * * * Example 3 . * * * If P does not make the section 1295 election with respect to the FC stock, C will continue to be subject, in C’s capacity as an indirect shareholder of FC, to the income inclusion and reporting rules required of shareholders of QEFs in 1999 and subsequent years for that portion of the FC stock C is treated as owning indirectly through the partnership. * * *

(d) * * * (3) Indirect ownership of a PFIC through other PFICs - (i) In general. An election under section 1295 shall apply only to the foreign corporation for which an election is made. Therefore, if a shareholder makes an election under section 1295 to treat a PFIC as a QEF, that

election applies only to stock in that foreign corporation and not to the stock in any other corporation which the shareholder is treated as owning by virtue of its ownership of stock in the QEF.

(ii) Example . The following example illustrates the rules of paragraph (d)(3)(i) of this section:

Example . In 1988, T, a U.S. person, purchased stock of FC, a foreign corporation that is a PFIC. FC also owns the stock of SC, a foreign corporation that is a PFIC. T makes an election under section 1295 to treat FC as a QEF. T’s section 1295 election applies only to the stock T owns in FC, and does not apply to the stock T indirectly owns in SC.

(e) Time for making a section 1295 election - (1) In general . Except as provided in §1.1295–3, a shareholder making the section 1295 election must make the election on or before the due date, as extended under section 6081 (election due date), for filing the shareholder’s income tax return for the first taxable year to which the election will apply. The section 1295 election must be made in the original return for that year, or in an amended return, provided the amended return is filed on or before the election due date.

(2) Examples . The following examples illustrate the rules of paragraph (e)(1) of this section:

Example 1 . In 1998, C, a domestic corporation, purchased stock of FC, a foreign corporation that is a PFIC. Both C and FC are calendar year taxpayers. C wishes to make the section 1295 election for its taxable year ended December 31, 1998. The section 1295 election must be made on or before March 15, 1999, the due date of C’s 1998 income tax return as provided by section 6072(b). On March 14, 1999, C files a request for a three-month extension of time to file its 1998 income tax return under section 6081(b). C’s time to file its 1998 income tax return and to make the section 1295 election is thereby extended to June 15, 1999.

Example 2 . The facts are the same as in Example 1 except that on May 1, 1999, C filed its 1998 income tax return and failed to include the section 1295 election. C may file an amended income tax return for 1998 to make the section 1295 election provided the amended return is filed on or before the extended due date of June 15, 1999.

(f) * * * (3) Effective date . See paragraph (k) of this section for special applicability date of paragraph (f) of this section.

(g) * * * (3) Annual Intermediary Statement . In the case of a U.S. person that is an indirect shareholder of a PFIC that is owned through an intermediary, as defined in paragraph (j) of this section, an Annual

2000–8 I.R.B. 651 February 22, 2000

meaning of paragraph (d) of this section, that as of the election due date , as defined in § 1.1295–1(e), the foreign corporation was not a PFIC for its taxable year that ended during the retroactive election year;

Protective Statement —(i) In general . Except as provided in paragraph (c)(5)(ii) of this section, a Protective Statement must be attached to the shareholder’s federal income tax return for the shareholder’s first taxable year to which the Protective Statement will apply. The shareholder must file its return and the

copy of the Protective Statement by the due date, as extended under section 6081, for the return.

Par. 7. In the list below, for each section indicated in the left column, remove the language in the middle column and add the language in the right column.

Affected Section	Remove	Add
1.1293–1(c)(1), last sentence	§1.1295–1T(j).	§1.1295–1(j).
1.1293–1(c)(2)(i), first sentence	§1.1295–1T(D)(2),	§1.1295–1(d)(2),
1.1295–1(b)(3)(iv)(A)	stock), and	stock) and
1.1295–1(c)(2)(ii), first sentence	1296(a)	1297(a)
1.1295–1(c)(2)(ii), first sentence	1297(b)(1).	1298(b)(1).
1.1295–1(c)(2)(iv), last sentence	§1.1293–1T(c).	§1.1293–1(c).
1.1295–1(d)(1), last sentence	(d)(5)	(d)(6)
1.1295–1(d)(2)(i)(A), last sentence	§1.1293–1T(c)(1),	§1.1293–1(c)(1),
1.1295–1(d)(2)(ii), last sentence	§1.1293–1T(c)(1),	§1.1293–1(c)(1),
1.1295–1(d)(2)(iii), last sentence	§1.1293–1T(c)(1),	§1.1293–1(c)(1),
1.1295–1(d)(6), first sentence	§1.1291–1T(e),	§1.1291–1(e),
1.1295–1(f)(1)(iii), last sentence	QEF calculated the QEF’s	PFIC calculated the PFIC’s
1.1295–1(g)(1) introductory text, second sentence, last word	representation —	representations —
1.1295–1(g)(1)(ii)(A)	§1.1293–1T(a)(2)	§1.1293–1(a)(2)
1.1295–1(h), second sentence	§1.1295–1T	§1.1295–1
1.1295–1(i)(1)(iii), last sentence	never was made.	was never made.
1.1295–1(i)(3)(iii)	through 1297	through 1298
1.1295–3(a), first sentence	§1.1295–1T(j),	§1.1295–1(j),
1.1295–3(a), first sentence	§1.1295–1T(e)	§1.1295–1(e)
1.1295–3(b)(2)	and 1297	and 1298
1.1295–3(c)(3)	§1.1295–1T(d).	§1.1295–1(d).
1.1295–3(c)(4)(i)(A), third sentence	assessment of taxes	assessment of all PFIC related taxes
1.1295–3(c)(6)(i), last sentence	see §1.1295–1T(c)(2)(iii).	see §1.1295–1(c)(2)(iii).
1.1295–3(d)(1), first sentence	section 1296(a)	section 1297(a)
1.1295–3(d)(1), second sentence	section 1296(a)	section 1297(a)
1.1295–3(f)(2)(i) introductory text, second sentence	PFIC and the availability	PFIC and of the availability
1.1295–3(f)(4)(vi), first sentence	§1.1295–1T(d).	§1.1295–1(d).
1.1295–3(g)(3), first sentence	§1.1295–1T(d).	§1.1295–1(d).

February 22, 2000 652 2000–8 I.R.B.

PART 602- - OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 8. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 9. In § 602.101, paragraph (b) is amended by removing the entries for §§1.1295–1T and 1.1295–3T and adding entries in numerical order to the table to read as follows:

§ 602.101 OMB Control numbers .

(b) * * *

Robert E. Wenzel, Deputy Commissioner

of Internal Revenue.

Approved January 14, 2000.

Jonathan Talisman, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue of the Federal Register for February 7, 2000, 65 F.R. 5777)

CFR part or section where Current OMB identified and described control No.

1.1295–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1555 1.1295–3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1555

2000–8 I.R.B. 653 February 22, 2000