SECTION 2. BACKGROUND

On June 12, 2007, the Treasury Department and the Internal Revenue Service (Service) published the safe harbor valuation regulations in the Federal Register (T.D. 9328, 2007–27 I.R.B. 1 [72 FR 32172]). For dealers in securities and for dealers in commodities that elect to mark to market under section 475(e), those regulations provide an elective safe harbor for valuations under section 475. Specifically, if an eligible taxpayer makes the safe harbor election, the values of certain positions that the taxpayer reports on an eligible financial statement in a manner consistent with the requirements of the safe harbor valuation regulations are treated as those positions’ fair market values for purposes of section 475. See Treas. Reg. § 1.475(a)–4(b).

Any tax regulatory regime that permits use of values from a financial statement for tax purposes must ensure that the financial accounting regime’s standards that are used by taxpayers are consistent with the requirements of applicable sections of the Internal Revenue Code (Code) (in this case section 475). The safe harbor valuation regulations are based on the conclusion that use of financial statement values for tax purposes is justified to the extent that the taxpayer satisfies certain basic criteria:

1. The financial accounting method used in the taxpayer’s financial statement must be sufficiently consistent with what section 475 requires for tax purposes (and therefore is an “eligible method,” see Treas. Reg. § 1.475(a)–4(d)).

2. The taxpayer’s financial statement must have sufficient indicia of reliability to ensure that the taxpayer carefully and consistently follows the financial accounting method being used in the statement (and therefore is an “applicable financial statement,” see Treas. Reg. § 1.475(a)–4(h)).

3. The taxpayer’s record keeping and record production must enable the Service to verify that the values used for tax purposes were the same as the values reported on the financial statement; and, when the values to be reported on the tax return are required to incorporate adjustments to the raw values in the financial statement, the taxpayer’s record keeping and record production must enable the Service to reconcile the two sets of values. See generally the preamble to T.D. 9328 (discussing the broad policies underlying the particular requirements in the safe harbor valuation regulations).

Internationally Headquartered Financial Institutions

Some financial institutions that are chartered outside of the United States and are engaged in a trade or business within the United States (internationally headquartered financial institutions) have commented that certain of the requirements set forth in the safe harbor valuation regulations prevent them from using the safe harbor. The Treasury Department and the Service are considering expanding the regulatory safe harbor if the basic criteria above are satisfied and are requesting comments regarding that expansion.

Two definitions in the current regulations would need to be amended in order to expand the safe harbor valuation regime potentially to include internationally headquartered financial institutions.

Internationally headquartered financial institutions generally prepare financial statements in accordance with the International Financial Reporting Standards (“IFRS”). The definition of “eligible method” (see Treas. Reg. § 1.475(a)–4(d)) excludes non-U.S. GAAP accounting systems by including only accounting methods that determine value in accordance with U.S. GAAP. Therefore, in order for

internationally headquartered financial institutions generally to be eligible to use the safe harbor, the definition of eligible method would have to be amended to include IFRS (or more specifically the version of IFRS the U.S. Securities and Exchange Commission (SEC) is considering for adoption).

Second, internationally headquartered financial institutions generally do not prepare financial statements that satisfy the current regulatory requirements for being an “applicable financial statement” (within the meaning of Treas. Reg. § 1.475(a)–4(h)). The definition of “applicable financial statement” requires preparation of the statement in accordance with U.S. GAAP and use of the statement in filings with the SEC or with any agency of the Federal government other than the Service. Internationally headquartered financial institutions generally file complete, non-U.S.-GAAP-based financial statements with a home country supervisor or market regulator, not with a Federal agency other than the Service as required by the safe harbor valuation regulations. Thus, the home country financial statement is not an “applicable financial statement.” Therefore, in order for internationally headquartered financial institutions generally to be eligible to use the safe harbor, the definition of applicable financial statement would have to be amended to include non-U.S.-GAAP financial statements filed with the institution’s home country regulator or some other financial statement that is filed by that taxpayer with other appropriate regulatory authorities.

Expansion of the Safe Harbor Valuation Regulations to Include IFRS

The decision whether to expand the definition of “eligible method” to include IFRS (or, more specifically, the version of IFRS ultimately adopted by the SEC) will be based on the criteria identified above that justify use of financial statement values for tax purposes. The current regulatory definition of “eligible method” attempts to ensure that a financial statement may serve as the basis of valuation for tax purposes only if the accounting method used in that state

2008–35 I.R.B. 462 September 2, 2008

ment and the Service continue to welcome answers to those questions.