Section 1256.—Section — Internal Revenue Bulletin 2004-38

Dealers in securities futures con- tracts. This ruling holds that Tier 1, Tier 2, and Tier 3 NQLX LLC Market Makers that satisfy the market maker requirements described in the ruling perform functions similar to the functions performed by options dealers (as defined in section 1256(g)(8)(A) of the Code) and that these NQLX LLC Market Makers are therefore dealers in securities futures contracts within the meaning of section 1256(g)(9)(B).

Rev. Rul. 2004–94

ISSUE

If a Tier 1, Tier 2, or Tier 3 NQLX LLC (NQLX) Market Maker satisfies the requirements described below, is it a dealer in securities futures contracts (SFCs) within the meaning of § 1256(g)(9)(B) of the Internal Revenue Code?

FACTS

NQLX has been designated by the Commodity Futures Trading Commission (CFTC) as a contract market that is permitted to list SFCs. As such, NQLX is a “qualified board or exchange” within the meaning of § 1256(g)(7). NQLX has a market maker program under which NQLX members may qualify as NQLX Market Makers. NQLX Market Makers are obligated to provide liquidity for their specifically assigned SFC products that trade on NQLX. For this purpose, an SFC product consists of contracts that may have varying maturities but that all relate to a particular underlying security or a particular narrow-based index of securities. NQLX Market Makers fall into one of three classes: Tier 1, Tier 2, and Tier 3. Tier 1 Market Makers are assigned at least 50, if not all, SFC products listed on NQLX. Tier 2 Market Makers are assigned

erty’s 6-digit product class is referred to as the property’s NAICS code.

(4) Modifications of NAICS product classes . The product classes of the NAICS Manual may be updated or otherwise modified from time to time as the manual is updated, effective on or after the date of the modification. The NAICS Manual generally is modified every five years, in years ending in a 2 or 7 (such as 2002, 2007, and 2012). The applicability date of the modified NAICS Manual is announced in the Federal Register and generally is January 1 of the year the NAICS Manual is modified. Taxpayers may rely on these modifications as they become effective in structuring exchanges under this section. Taxpayers may rely on the previous NAICS Manual for transfers of property made by a taxpayer during the one-year period following the effective date of the modification. For transfers of property made by a taxpayer on or after January 1, 1997, and on or before January 1, 2003, the NAICS Manual of 1997 may be used for determining product classes of the exchanged property.

(5) Administrative procedures for re- vising general asset classes and product classes . The Commissioner may, through published guidance of general applicability, supplement, modify, clarify, or update the guidance relating to the classification of properties provided in this paragraph (b). (See §601.601(d)(2) of this chapter.) For example, the Commissioner may determine not to follow (in whole or in part) a general asset class for purposes of identifying property of like class, may determine not to follow (in whole or in part) any modification of product classes published in the NAICS Manual, or may determine that other properties not listed within the same or in any product class or general asset class nevertheless are of a like class. The Commissioner also may determine that two items of property that are listed in separate product classes or in product classes with a last digit of 9 are of a like class, or that an item of property that has a NAICS code is of a like class to an item of property that does not have a NAICS code.

(6) No inference outside of section 1031 . The rules provided in this section concerning the use of general asset classes or product classes are limited to exchanges

under section 1031. No inference is intended with respect to the classification of property for other purposes, such as depreciation.

(7) Examples . The provisions of this paragraph (b) are illustrated by the following examples:

Example 1 and Example 2 [Reserved]. For further guidance, see §1.1031(a)–2(b)(7), Example 1 and Ex- ample 2 .

Example 3 . Taxpayer E transfers a grader to F in exchange for a scraper. Neither property is within any of the general asset classes. However, both properties are within the same product class (NAICS code 333120). The grader and scraper are of a like class and deemed to be of a like kind for purposes of section 1031.

Example 4 . Taxpayer G transfers a personal computer (asset class 00.12), an airplane (asset class 00.21) and a sanding machine (NAICS code 333210), to H in exchange for a printer (asset class 00.12), a heavy general purpose truck (asset class 00.242) and a lathe (NAICS code 333210). The personal computer and the printer are of a like class because they are within the same general asset class; the sanding machine and the lathe are of a like class because they are within the same product class (although neither property is within any of the general asset classes). The airplane and the heavy general purpose truck are neither within the same general asset class nor within the same product class, and are not of a like kind.

(8) Transition rule . Properties within the same product classes based on the 4-digit codes contained in Division D of the Executive Office of the President, Office of Management and Budget, Standard Industrial Classification Manual (1987), will be treated as property of a like class for transfers of property made by taxpayers on or before the date these regulations are published as final regulations in the Federal Register .

(d) Effective dates . This section applies to transfers of property made by taxpayers on or after August 12, 2004. However, taxpayers may apply this section to transfers of property made by taxpayers on or after January 1, 1997, in taxable years for which the period of limitation for filing a claim for refund or credit under section 6511 has not expired. For all other exchanges occurring prior to August 12, 2004, see §1.1031(a)–2(d).

Linda M. Kroening, Acting Deputy Commissioner for

Services and Enforcement .

Approved July 28, 2004.

2004–38 I.R.B. 491 September 20, 2004

relevant factors, including providing market liquidity for such contracts (and options), indicate that the market functions of the traders is comparable to that of equity options dealers. H.R. Conf. Rep. No. 106–1033, at 1036 (2000).

HOLDING

It is determined that Tier 1, Tier 2, and Tier 3 NQLX Market Makers that satisfy the requirements described above perform functions similar to the functions performed by options dealers (as defined in § 1256(g)(8)(A)) and that these NQLX Market Makers are therefore dealers in SFCs within the meaning of § 1256(g)(9)(B). This determination will cease to apply in the event of material changes in the NQLX Market Maker program affecting the Tier 1, Tier 2, or Tier 3 Market Makers described above. See § 601.601(d)(2)(v) of the Income Tax Regulations.

EFFECTIVE DATE

The effective date of this ruling is the date of publication in the Internal Revenue Bulletin. Because this ruling is prospective only, the holding applies to SFCs that are entered into by a dealer in SFCs on or after the effective date of this ruling.

DRAFTING INFORMATION

The principal author of this revenue ruling is K. Scott Brown of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact K. Scott Brown at (202) 622–3920 (not a toll-free call).

Dealers in securities futures con- tracts. This ruling holds that Category 1 and Category 2 OneChicago LLC Market Makers that satisfy the Market Maker requirements described in the ruling and satisfy the section 1256 Dealer Qualification quotation requirements described in the ruling perform functions similar to the functions performed by options dealers (as defined in section 1256(g)(8)(A) of the Code) and that these OneChicago LLC Market Makers are therefore dealers

25 to 49 SFC products listed on NQLX. Tier 3 Market Makers are assigned fewer than 25 SFC products listed on NQLX. In each case, the SFC products assigned to a Market Maker in the aggregate must account for at least 20% of the total volume in all SFCs traded on NQLX for the preceding calendar quarter.

An NQLX Market Maker must meet all of the following requirements:

(1) Be a member of NQLX; (2) Be registered as a floor trader or floor broker with the CFTC or as a dealer with the Securities Exchange Commission (SEC);

(3) Maintain records sufficient to prove compliance with the NQLX Market Maker requirements, including, but not limited to, documents concerning personnel effecting relevant orders, relevant trade and cash blotters, relevant stock records, and documents concerning applicable internal system capacity and performance; and

(4) Hold itself out as willing to buy and sell SFCs for its own account on a regular or continuous basis.

For an NQLX Market Maker to fulfill the regular or continuous requirement in paragraph (4) above, it must satisfy the following criteria for each of its assigned SFC products:

(i) Provide continuous two-sided quotations for the first two delivery months of each assigned SFC product throughout the trading day, except during unusual market conditions as determined by NQLX (such as a fast market in either the SFC product or the security underlying the SFC product) at which times the Market Maker must use its best efforts to quote continuously and competitively;

(ii) Quote for the first two delivery months, with (A) a Maximum Bid/Ask Spread of no more than the greater of $0.10 or 150% of the bid/ask spread in the primary market for the security underlying the SFC product and (B) a Minimum Number of Contacts of no less than the lesser of 10 contracts or the corresponding contract size equivalent of the best bid and best offer for the security underlying the SFC product; and

(iii) Respond to requests for quotation in each assigned SFC product within 5 seconds for all delivery months other than the first two delivery months with a two-sided quotation that has (A) a Maximum Bid/Ask Spread of no more than the

greater of $0.20 or 150% of the bid/ask spread in the primary market for the security underlying the SFC product and (B) a Minimum Number of Contracts of no less than the lesser of 5 contracts or the corresponding contract size equivalent of the best bid and best offer for the security underlying the SFC product.

Any NQLX Market Maker that fails to comply with the NQLX rules, CFTC rules, or SEC rules, as applicable, is subject to disciplinary action in accordance with NQLX rules.

LAW

Section 1256(g)(8)(A) defines the term “options dealer” to mean any person registered with an appropriate national securities exchange as a market maker or specialist in listed options. Section 1256(g)(9)(B) provides that a person shall be treated as a dealer in SFCs or options on such contracts if the Secretary determines that such person performs, with respect to such contracts or options, as the case may be, functions similar to the functions performed by an options dealer. Section 1256(g)(9)(B) further provides that such determination shall be made to the extent appropriate to carry out the purposes of that section.

The legislative history for § 1256(g)(9) states the following with respect to the determination process:

The determination of who is a dealer in securities futures contracts is to be made in a manner that is appropriate to carry out the purposes of the provision, which generally is to provide comparable tax treatment between dealers in securities futures contracts, on the one hand, and dealers in equity options, on the other. Although traders in securities futures contracts (and options on such contracts) may not have the same market-making obligations as market makers or specialists in equity options, many traders are expected to perform analogous functions to such market makers or specialists by providing market liquidity for securities futures contracts (and options) even in the absence of a legal obligation to do so. Accordingly, the absence of market-making obligations is not inconsistent with a determination that a class of traders are dealers in securities futures contracts (and options), if the

September 20, 2004 492 2004–38 I.R.B.

Section 1256 Dealer Qualification . Category 1 and Category 2 Market Makers seeking to qualify as a § 1256(g)(9)(B) dealer under OneChicago’s market maker program must agree to meet minimum quotation size requirements for all of their assigned SFC products that are specified for purposes of the market maker exclusion provided in OneChicago’s margin rules. Category 1 and Category 2 Market Makers must provide continuous two-sided quotations or respond to requests for quotations in accordance with the applicable obligations set forth above by quoting:

(a) ten contracts for each product not covered by (b) or (c);

(b) five contracts for each product specified by the member to the extent such quotations are provided for delivery months other than the next two delivery months then trading; and

(c) one contract for any single stock futures contract where the average market price for the underlying stock was $100 or higher for the preceding calendar month or for any narrow-based stock index futures contract, as defined by § 1a(25) of the Commodity Exchange Act.

LAW

The legislative history for § 1256(g)(9) states the following with respect to the determination process:

in securities futures contracts within the meaning of section 1256(g)(9)(B).

Rev. Rul. 2004–95

ISSUE

If a Category 1 or Category 2 OneChicago LLC (OneChicago) Market Maker satisfies the Market Maker requirements described below and satisfies the Section 1256 Dealer Qualification quotation requirements described below, is it a dealer in securities futures contracts (SFCs) within the meaning of § 1256(g)(9)(B) of the Internal Revenue Code?

FACTS

OneChicago has been designated by the Commodity Futures Trading Commission (CFTC) as a contract market that is permitted to list SFCs. As such, OneChicago is a “qualified board or exchange” within the meaning of § 1256(g)(7). OneChicago has a market maker program under which OneChicago members may qualify as OneChicago Market Makers eligible for the market maker exclusion provided in OneChicago’s customer margin rules. OneChicago Market Makers are obligated to provide liquidity for their specifically assigned SFC products that trade on OneChicago. For this purpose, an SFC product consists of contracts that may have varying maturities but that all relate to a particular underlying security or a particular narrow-based index of securities.

A Category 1 or Category 2 OneChicago Market Maker must meet all of the following requirements:

(1) Be a member of OneChicago; (2) Be registered as a floor trader or floor broker with the CFTC or as a dealer with the Securities and Exchange Commission (SEC);

(3) Maintain records sufficient to prove compliance with OneChicago Market Maker requirements and the related regulations and rules of the CFTC or SEC, as applicable, including, without limitation, trading account statements and other financial records sufficient to detail activity; and

(4) Hold itself out as willing to buy and sell SFCs for its own account on a regular or continuous basis.

For a OneChicago Market Maker to fulfill the regular or continuous requirement in paragraph (4) above, it must satisfy the following criteria, as applicable, for each of its assigned SFC products:

Category 1 Market Maker - The member provides continuous two-sided quotations throughout the trading day for all delivery months of all assigned SFC products (where such assigned SFC products represent in the aggregate at least a meaningful proportion of the total trading volume on OneChicago), except during unusual market conditions as determined by OneChicago (such as a fast market in either an SFC product or a security underlying an SFC product), at which time the member must use its best efforts to quote continuously and competitively; and, when the member provides quotations, it quotes for a minimum of one SFC with a Maximum Bid/Ask Spread of no more than the greater of $0.20 or 150% of the bid/ask spread in the primary market for the security underlying each SFC product; or

Category 2 Market Maker - The member responds to at least 75% of the requests for quotation (RFQs) for all delivery months of all assigned SFC products (where such assigned SFC products represent in the aggregate at least a meaningful proportion of the total trading volume on OneChicago), except during unusual market conditions as determined by OneChicago (such as a fast market in either an SFC product or a security underlying an SFC product), at which times the member must use its best efforts to quote competitively; and, when the member responds to RFQs, it quotes within five seconds for a minimum of one SFC with a Maximum Bid/Ask Spread of no more than the greater of $0.20 or 150% of the bid/ask spread in the primary market for the security underlying each SFC product.

For purposes of the preceding requirements for Category 1 and Category 2 Market Makers, a “meaningful proportion of the total trading volume on OneChicago” means a minimum of 20% of the trading volume of SFCs traded on OneChicago during the calendar quarter.

Any OneChicago Market Maker that fails to comply with the OneChicago rules, CFTC rules, or SEC rules, as applicable, is subject to disciplinary action in accordance with OneChicago rules.

2004–38 I.R.B. 493 September 20, 2004

on the other. Although traders in securities futures contracts (and options on such contracts) may not have the same market-making obligations as market makers or specialists in equity options, many traders are expected to perform analogous functions to such market makers or specialists by providing market liquidity for securities futures contracts (and options) even in the absence of a legal obligation to do so. Accordingly, the absence of market-making obligations is not inconsistent with a determination that a class of traders are dealers in securities futures contracts (and options), if the relevant factors, including providing market liquidity for such contracts (and options), indicate that the market functions of the traders is comparable to that of equity options dealers. H.R. Conf. Rep. No. 106–1033, at 1036 (2000).

HOLDING

It is determined that Category 1 and Category 2 OneChicago Market Makers that satisfy the Market Maker requirements described above and satisfy the Section 1256 Dealer Qualification quotation requirements described above perform functions similar to the functions performed by options dealers (as defined in § 1256(g)(8)(A)) and that these OneChicago Market Makers are therefore dealers in SFCs within the meaning of § 1256(g)(9)(B). This determination will cease to apply in the event of material changes in the OneChicago Market Maker program affecting the Category 1 or Category 2 Market Makers described above. See § 601.601(d)(2)(v) of the Income Tax Regulations.

EFFECTIVE DATE

DRAFTING INFORMATION

The principal author of this revenue ruling is K. Scott Brown of the Office of Associate Chief Counsel (Financial Institu

tions & Products). For further information regarding this revenue ruling, contact K. Scott Brown at (202) 622–3920 (not a toll-free call).