Part IV. Items — Internal Revenue Bulletin 2012-8

Notice of Proposed Rulemaking by Cross-Reference to Temporary Regulations

Reporting of Specified Foreign Financial Assets

REG–130302–10

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: In this issue of the Bulletin, the Internal Revenue Service is issuing temporary regulations (T.D. 9567) relating to the requirement that individuals attach a statement to their income tax return to provide required information regarding foreign financial assets in which they have an interest. The text of the temporary regulations also serves as the text of these proposed regulations. This notice of proposed rulemaking also includes a proposed regulation setting forth requirements for certain domestic entities to report foreign financial assets in the same manner as an individual.

DATE: Written or electronic comments and requests for a public hearing must be received by March 19, 2012.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG–130302–10), room 5205, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–130302–10), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC, or sent electronically, via the Federal eRulemaking Portal at www.regulations.gov (IRS REG–130302–10).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed

regulations, Joseph S. Henderson, (202) 622–3880; concerning submission of comments and/or requests for a hearing, Olawafunmilayo (Funmi) Taylor, at (202) 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Rev- enue Service, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:M:S, Washington, DC 20224. Comments on the collection of information should be received by February 13, 2012. Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility;

The accuracy of the estimated burden associated with the proposed collection of information;

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance and purchase of service to provide information.

The collection of information in these proposed regulations is in §§1.6038D–2 and 1.6038D–4. The collection of information is mandatory with respect to a specified person that has an interest in specified foreign financial assets and the value of those assets is more than the applicable reporting threshold. The respondents are

U.S. citizens, U.S. residents, certain nonresidents and, to the extent provided in future regulations, certain domestic entities. The collection of information is satisfied by filing Form 8938, “Statement of Spec- ified Foreign Financial Assets,” OMB No. 1545–2195, with the respondent’s income tax return.

Estimated total annual reporting burden: 378,000 hours.

Estimated annual burden per respondent: 1 hour and 5 minutes.

Estimated number of respondents: 350,000. Estimated annual frequency of responses: once.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a valid control number assigned by the Office of Management and Budget.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential as required by 26 U.S.C. 6103.

Background

Section 6038D was enacted by section 511 of the Hiring Incentives to Restore Employment (HIRE) Act, Public Law 111–147 (124 Stat. 71). Section 6038D(a) requires an individual who holds any interest in a specified foreign financial asset during the taxable year to attach a statement to that individual’s return of tax imposed by subtitle A of the Internal Revenue Code (Code) to report the information identified in section 6038D(c), if the aggregate value of the specified foreign financial assets in which the individual holds an interest exceeds $50,000 for the taxable year, or such higher dollar amount as the Secretary may prescribe.

Section 6038D(f) provides that, to the extent provided by the Secretary in regulations or other guidance, section 6038D shall apply to any domestic entity which is formed of availed of for purposes of holding, directly or indirectly, specified foreign financial assets, in the same manner as if the entity were an individual.

2012–8 I.R.B. 412 February 21, 2012

The determination of whether a corporation or partnership is a specified domestic entity is made annually for each taxable year of such corporation or partnership.

B. Domestic trusts

A domestic trust is considered a specified domestic entity if it has an interest in specified foreign financial assets (other than assets excepted from reporting as provided in §1.6038D–7T) with an aggregate value exceeding the reporting threshold in §1.6038D–2T(a)(1) and one or more specified persons as current beneficiaries. For purposes of section 6038D, a current beneficiary is any person who, during the taxable year, is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent that such power remains unexercised at the end of the taxable year). As discussed in section 2 of this explanation, certain domestic trusts are not specified domestic entities.

The determination of whether a domestic trust is a specified domestic entity is made annually for each taxable year of such trust.

Excepted Specified Domestic Entities

A domestic entity is not considered to be a specified domestic entity if it is described in section 1473(3) and the regulations as excepted from the definition of the term “specified United States person”. This exception does not apply to any trust that is exempt from tax under section 664(c). A domestic trust is not considered a specified domestic entity if the trustee is a bank, financial institution, or domestic corporation that is subject to certain examination, oversight or registration requirements, has supervisory authority over or fiduciary obligations with regard to the trust’s specified foreign financial assets, and files income tax returns and information returns on behalf of the trust. In addition, a domestic trust or any portion of the trust that is treated as owned by one or more specified persons under sections 671 through 678 and the regulations issued under those sections is not considered to be a specified domestic entity.

Temporary regulations in this issue of the Bulletin contain amendments to the Income Tax Regulations (26 CFR Part 1) providing guidance to individuals required to report specified foreign financial assets with their annual return pursuant to section 6038D of the Code. The text of those regulations also serves as the text of the regulations contained in this document that are proposed by cross-reference to the temporary regulations, that is §§1.6038D–0 through 1.6038D–5, §1.6038D–7, and §1.6038D–8. The preamble to the temporary regulations explains the amendments added by the temporary regulations.

This document also contains a proposed amendment to the Income Tax Regulations (26 CFR Part 1) that sets out the conditions under which a domestic entity will be considered a “specified domestic entity.” A domestic entity that is a specified domestic entity pursuant to Prop. Reg. §1.6038D–6 is required to report specified foreign financial assets in which it holds an interest.

Explanation of Provisions

Application of Section 6038D to Domestic Entities

Under the proposed regulations, domestic entities that are subject to the reporting requirements of section 6038D are designated as specified domestic entities and include certain domestic corporations, domestic partnerships, and trusts described in section 7701(a)(30)(E), generally referred to as domestic trusts for purposes of this explanation. Specified domestic entities do not include domestic estates.

A. Domestic corporations and partnerships

For a domestic corporation or partnership to be considered a specified domestic entity, it must satisfy three conditions. First, the domestic corporation or domestic partnership must have an interest in specified foreign financial assets (other than assets excepted from reporting as provided in §1.6038D–7T) with an aggregate value exceeding the reporting threshold in §1.6038D–2T(a)(1). Second, it must be closely held by a specified individual (as defined in §1.6038D–1T(a)(2)). A domestic corporation is closely held if a specified individual owns at least 80 per

cent of the corporation’s stock (by vote or value) on the last day of the corporation’s taxable year. A domestic partnership is closely held if a specified individual owns at least 80 percent of the capital or profits interest in the partnership on the last day of its taxable year. Direct, indirect, and constructive ownership rules apply in determining whether the corporation or partnership is closely held for this purpose.

Finally, a domestic corporation or partnership must also meet either of the following two conditions:

(A) At least 50 percent of the corporation’s or partnership’s gross income for the taxable year is passive income or at least 50 percent of the assets held by the corporation or partnership at any time during the taxable year are assets that produce or are held for the production of passive income; or

(B) At least 10 percent of the corporation’s or partnership’s gross income for the taxable year is passive income or at least 10 percent of the assets held by the corporation or partnership at any time during the taxable year are assets that produce or are held for the production of passive income, and the corporation or partnership is formed or availed of by a specified individual with a principal purpose of avoiding the reporting obligations under section 6038D. The determination of whether a corporation or partnership is formed or availed of with a principal purpose of avoiding reporting under section 6038D takes into account all facts and circumstances.

Two different aggregation rules apply for purposes of determining whether a domestic corporation or domestic partnership is a specified domestic entity. First, in determining whether a domestic corporation or domestic partnership meets the reporting thresholds in §1.6038D–2T(a)(1), domestic corporations and domestic partnerships that are closely held by the same specified individual are treated as a single entity. Second, for purposes of determining whether a corporation or partnership meets the passive income or asset test, domestic corporations and domestic partnerships that are closely held by the same individual and that are connected through stock or partnership interest ownership with a common parent corporation or partnership are treated as a single entity.

February 21, 2012 413 2012–8 I.R.B.

Par. 2. Section 1.6038D–0 is added to read as follows:

§1.6038D–0 Outline of regulation provisions .

The text of proposed §1.6038D–0 is the same as the text of §1.6038D–0T published elsewhere in this issue of the Bulletin.

Par. 3. Section 1.6038D–1 is added to read as follows:

§1.6038D–1 Reporting with respect to specified foreign financial assets, definition of terms .

The text of proposed §1.6038D–1 is the same as the text of paragraphs (a) and (b) in §1.6038D–1T published elsewhere in this issue of the Bulletin.

Par. 4 Section 1.6038D–2 is added to read as follows:

§1.6038D–2 Requirement to report specified foreign financial assets .

The text of proposed §1.6038D–2 is the same as the text of paragraphs (a) through (e) in §1.6038D–2T published elsewhere in this issue of the Bulletin.

Par. 5 Section 1.6038D–3 is added to read as follows:

§1.6038D–3 Specified foreign financial assets .

The text of proposed §1.6038D–3 is the same as the text of paragraphs (a) through (e) in §1.6038D–3T published elsewhere in this issue of the Bulletin.

Par. 6. Section 1.6038D–4 is added to read as follows:

§1.6038D–4 Information required to be reported .

The text of proposed §1.6038D–4 is the same as the text of paragraphs (a) and (b) in §1.6038D–4T published elsewhere in this issue of the Bulletin.

Par. 7. Section 1.6038D–5 is added to read as follows:

§1.6038D–5 Valuation guidelines .

The text of proposed §1.6038D–5 is the same as the text of paragrahs (a) through (g) in §1.6038D–5T published elsewhere in this issue of the Bulletin.

Proposed Effective Date

Section 1.6083D–6 is proposed to apply to taxable years beginning after December 31, 2011.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. 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.

It is hereby certified that the collection of information in this notice of proposed rulemaking will not have a significant economic impact on a substantial number of small entities within the meaning of section 601(6) of the Regulatory Flexibility Act (5 U.S.C. chapter 6). Small entities generally hold specified foreign financial assets (that is, financial accounts, stocks, securities, financial instruments, contracts, or interests in foreign entities) for use in their trade or business and therefore generally would not have a filing requirement. The burden is further reduced because small entities that do hold specified foreign financial assets generally will be excepted from reporting such assets under these proposed rules if the assets are reported on one or more of the following forms: Form 3520, “An- nual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts” ; Form 3520–A, “Annual Information Return of Foreign Trust With a U.S. Owner” ; Form 5471 , “Informa- tion Return of U.S. Persons With Respect To Certain Foreign Corporations” ; Form 8621, “Information Return by a Share- holder of a Passive Foreign Investment Company or Qualified Electing Fund” ; Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships” ; or Form 8891, “U.S. Information Return for Beneficiaries of Certain Canadian Registered Retirement Plans.” Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act is not required. Pursuant to section 7805(f) of the Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

The Internal Revenue Service invites the public to comment on this certification.

Comments and Requests for Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The Department of the Treasury and the Internal Revenue Service request comments on all aspects of the proposed regulations. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register .

Drafting Information

The principal author of these proposed regulations is Joseph S. Henderson, Office of Associate Chief Counsel (International). However, other personnel from the Internal Revenue Service and the Department of the Treasury participated in their development.

- - - -

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1 — INCOME TAXES

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 * * * Section 1.6038D–1 also issued under 26 U.S.C. 6038D Section 1.6038D–2 also issued under 26 U.S.C. 6038D Section 1.6038D–3 also issued under 26 U.S.C. 6038D Section 1.6038D–4 also issued under 26 U.S.C. 6038D Section 1.6038D–5 also issued under 26 U.S.C. 6038D Section 1.6038D–6 also issued under 26 U.S.C. 6038D Section 1.6038D–7 also issued under 26 U.S.C. 6038D Section 1.6038D–8 also issued under 26 U.S.C. 6038D* * *

2012–8 I.R.B. 414 February 21, 2012

this section, section 267(c) and (e)(3) apply for the purpose of determining the interest of a specified individual in a corporation or partnership, except that section 267(c)(4) is applied as if the family of an individual includes the spouses of the individual’s family members.

(iv) Example . The following example illustrates the application of paragraph (b)(3) of this section:

Example . (1) Facts . DC1 is a domestic corporation the total value of the stock of which is owned 60% by A, a specified individual, 30% by B, a member of A’s family for purposes of section 267(c)(2) who is not a specified individual, and 10% by FC1, a foreign corporation. DC1 owns 90% of the total value of the stock of DC2, a domestic corporation. FC2, a foreign corporation, owns 10% of DC2. Neither A nor B owns, directly, indirectly, or constructively, any stock in FC1 or FC2.

(2) Ownership determination . DC2 is closely held by A within the meaning of paragraphs (b)(1)(ii) and (b)(3) of this section because A, a specified person, owns more than 80% of its total value. A is considered to own 81% of the total value of DC2 by application of the rules of section 267(c) and this section.

(4) Treatment of related corporations and partnerships —(i) Determination of reporting threshold . For purposes of applying paragraph (b)(1)(i) of this section and determining whether a domestic corporation or domestic partnership satisfies the reporting threshold in §1.6038D–2T(a)(1), all domestic corporations and domestic partnerships that have an interest in any specified foreign financial asset and are closely held by the same specified individual as determined under paragraphs (b)(1)(ii) and (b)(3) of this section are treated as a single entity, and each such related corporation or partnership will be treated as owning the specified foreign financial assets held by all such related corporations or partnerships.

(ii) Determination of passive income and asset thresholds . For purposes of applying the passive income and asset thresholds of paragraph (b)(1)(iii) of this section, all domestic corporations and domestic partnerships that are closely held by the same specified individual as determined under paragraphs (b)(1)(ii) and (b)(3) of this section and that are connected through stock or partnership interest ownership with a common parent corporation or partnership (as determined under this paragraph (b)(4)(ii)) are treated as a single entity. A domestic corporation or a domestic partnership is considered

Par. 8. Section 1.6038D–6 is added to read as follows:

§1.6038D–6 Specified domestic entities .

(a) Specified domestic entity . A specified domestic entity is a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E), if such corporation, partnership, or trust is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets. Whether a domestic corporation, a domestic partnership, or a trust described in section 7701(a)(30)(E) is a specified domestic entity is determined annually.

(b) Corporations and partner- ships —(1) Formed or availed of . Except as otherwise provided in paragraph (d) of this section, a domestic corporation or a domestic partnership is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if—

(i) The corporation or partnership has an interest in specified foreign financial assets (other than assets excepted from reporting as provided in §1.6038D–7T) with an aggregate value exceeding the reporting threshold in §1.6038D–2T(a)(1);

(ii) The corporation or partnership is closely held by a specified individual as determined under paragraph (b)(3) of this section; and

(iii) One of the following two conditions is satisfied:

(B)( 1 ) At least 10 percent of the corporation’s or partnership’s gross income for the taxable year is passive income or at least 10 percent of the assets held by the corporation or partnership at any time during the taxable year are assets that produce or are held for the production of passive income, and

( 2 ) The corporation or partnership is formed or availed of by the specified individual identified in paragraphs (b)(1)(ii) and (b)(3) of this section with a principal purpose of avoiding the reporting obliga

tions under section 6038D. For purposes of determining whether a corporation or partnership is formed or availed of with a principal purpose of avoiding reporting under section 6038D, all facts and circumstances are taken into account.

(2) Passive income . For purposes of paragraph (b) of this section, passive income means the portion of gross income that consists of—

(i) Dividends; (ii) Interest; (iii) Rents and royalties, other than rents and royalties derived in the active conduct of a trade or business conducted by employees of the corporation or partnership;

(iv) Annuities; (v) The excess of gains over losses from the sale or exchange of property that gives rise to passive income described in paragraphs (b)(2)(i), (b)(2)(ii), (b)(2)(iii), and (b)(2)(iv) of this section;

(vi) The excess of gains over losses from transactions (including futures, forward, and similar transactions) in any commodity, but not including any commodity hedging transaction described in section 954(c)(5)(A) determined by treating the corporation or partnership as a controlled foreign corporation;

(vii) The excess of foreign currency gains over foreign currency losses (as defined in section 988(b)) attributable to any section 988 transaction; and

(viii) Net income from notional principal contracts.

(3) Closely held —(i) Domestic corpo- ration . A domestic corporation is closely held by a specified individual for purposes of paragraph (b)(1)(ii) of this section if at least 80 percent of the total combined voting power of all classes of stock of the corporation entitled to vote, or at least 80 percent of the total value of the stock of the corporation, is owned, directly, indirectly, or constructively, by one specified individual on the last day of the corporation’s taxable year.

(ii) Domestic partnership . A partnership is closely held by a specified individual for purposes of paragraph (b)(1)(ii) of this section if at least 80 percent of the capital or profits interest in the partnership is held, directly, indirectly, or constructively, by one specified individual on the last day of the partnership’s taxable year.

(iii) Constructive ownership . For purposes of paragraphs (b)(1)(ii) and (b)(3) of

February 21, 2012 415 2012–8 I.R.B.

connected through stock or partnership interest ownership with a common parent corporation or partnership if stock representing at least 80 percent of the voting power or value of each such corporation, or partnership interests representing at least 80 percent of the profits interests or capital interests of the partnership, in each case other than stock of or partnership interests in the common parent, is owned by one or more of the other connected corporations, connected partnerships, or the common parent. For purposes of applying paragraph (b)(1)(iii) of this section, each member of a closely held and connected group as determined under this paragraph (b)(4)(ii) is treated as owning the combined assets and receiving the combined income of all members of that group. For purposes of the preceding sentence, any contract, equity, or debt existing between members of such a group, as well as any items arising under or from such contract, equity, or debt relevant to the determination of the passive income percentage under paragraph (b) of this section, are eliminated.

(5) Examples . The following examples illustrate the application of the rules of paragraph (b) of this section:

Example 1 . (1) Facts . L is a specified individual. In Year X, L wholly owns DC1, a domestic corporation, and also owns a 90% capital interest in DP, a domestic partnership. DC1 owns 80% of the sole class of stock of DC2, a domestic corporation. DC1 has no assets other than its interest in DC2. DC2’s only assets are assets that produce passive income, with a maximum value in Year X of $40,000 on October 12. DC2’s assets are comprised in relevant part on October 12, Year X, of $15,000 of specified foreign financial assets. DP’s only assets are assets that produce passive income and that are specified foreign financial assets with a maximum value of $90,000 on October 12, Year X and have a value of $20,000 on December 31, Year X. DC1 and DC2 do not file a consolidated annual return.

(2) Determination of reporting threshold . DC1, DC2, and DP are closely held by L for purposes of applying paragraph (b)(1)(ii) and (b)(3) of this section. Under §1.6038D–3T, DC2 and DP each has an interest in specified foreign financial assets; DC1 does not have an interest in specified foreign financial assets. For purposes of applying paragraph (b)(1)(i) of this section and §1.6038D–2T(a)(1)—

(i) DC1 . DC1 is not treated as a single entity with DC2 and DP under paragraph (b)(4)(i) of this section. As a result, DC1 does not satisfy the reporting threshold of paragraph (b)(1)(i) of this section; and

sets of DP, and DP is considered as owning in addition to its own assets the assets of DC2. As a result, DC2 and DP each satisfies the reporting threshold of §1.6038D–2T(a)(1), because the value of the specified foreign financial assets each is considered as owning under paragraph (b)(4)(i) of this section exceeds $100,000 on October 12, Year X.

(3) Determination of passive income or passive asset percentage —(i) DC1 and DC2 . DC1 and DC2 are treated as members of a closely held and connected group of entities under paragraph (b)(4)(ii) of this section, because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 though DC1’s ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, DC1 and DC2 are considered a single entity for purposes of applying paragraph (b)(1)(iii) of this paragraph, and each of DC1 and DC2 is considered as owning the combined assets, and receiving the combined income, of both DC1 and DC2 (under paragraph (b)(4)(ii) of this section). Therefore, DC1 and DC2 each satisfies the passive asset threshold of paragraph (b)(1)(iii)(A) of this section.

(ii) DP . DP is not treated as a member of the DC1 and DC2 closely held and connected group of entities because DC1 and DP are not owned by a common parent corporation or partnership. Therefore, whether the passive income or passive asset threshold of paragraph (b)(1)(iii) of this section is met with respect to DP is determined solely by reference to DP’s separately earned passive income and separately held passive assets. DP has only passive assets on October 12, Year X, and, therefore, satisfies paragraph (b)(1)(iii)(A) of this section.

(4) Reporting requirements —(i) DC1 . DC1 is not a specified domestic entity for Year X, and is not required to file Form 8938, because DC1 does not satisfy the reporting threshold of paragraph (b)(1)(i) of this section and §1.6038D–2T(a)(1).

(ii) DC2 and DP . DC2 and DP are specified domestic entities for Year X, because they each meet the conditions of paragraph (b)(1) of this section: each is closely held by L, a specified individual; each has an interest in specified foreign financial assets with an aggregate value exceeding the reporting threshold of §1.6038D–2T(a)(1); and each satisfies the passive asset threshold. DC2 and DP must each file Form 8938 for Year X to report their respective specified foreign financial assets and disclose their maximum values as provided in §1.6038D–4T.

Example 2 . (1) Facts . The facts are the same as in Example 1, except that DC2 also has assets and income from a trade or business. The income from such business is not passive income and constitutes 60% of the gross income generated by DC2 in Year X. The assets attributable to such trade or business constitute at least 60% of the value of DC2’s assets at all times during Year X. Assume that neither DC1 nor DC2 is formed or availed of by L with a principal purpose of avoiding the reporting obligations under section 6038D.

(ii) DC2 and DP . DC2 and DP are treated as a single entity under paragraph (b)(4)(i) of this section. Therefore, for purposes of applying the reporting threshold of §1.6038D–2T(a)(1), DC2 is considered as owning in addition to its own assets the assets of DP, and DP is considered as owning in addition to its own assets the assets of DC2. As a result, DC2 and DP each satisfies the reporting threshold of §1.6038D–2T(a)(1) because the value of the specified foreign financial assets each is considered as owning under paragraph (b)(4)(i) of this section exceeds $100,000 on October 12, Year X.

(3) Determination of passive income or passive asset percentage —(i) DC1 and DC2 . DC1 and DC2 are treated as members of a closely held and connected group of entities under paragraph (b)(4)(ii) of this section, because DC1 and DC2 are closely held by L, and DC2 is connected with DC1 though DC1’s ownership of stock of DC2 representing at least 80% of the voting power or value of DC2. As a result, DC1 and DC2 are considered a single entity for purposes of applying paragraph (b)(1)(iii) of this paragraph, and each of DC1 and DC2 is considered as owning the combined assets, and receiving the combined income, of both DC1 and DC2 (as determined under paragraph (b)(4)(ii) of this section). DC1 and DC2 do not have sufficient passive income or passive assets to satisfy the thresholds of paragraph (b)(1)(iii)(A) of this section. In addition, because neither DC1 nor DC2 is formed or availed of by L with a principal purpose of avoiding the reporting obligations under section 6038D, neither DC1 nor DC2 meets the conditions described in paragraph (b)(1)(iii)(B) of this section.

(ii) DP . DP is not treated as a member of the DC1 and DC2 closely held and connected group of entities, because DC1 and DP are not owned by a common parent corporation or partnership. Therefore, whether the passive income or asset threshold of paragraph (b)(1)(iii) of this section is met with respect to DP is determined solely by reference to DP’s separately earned passive income and separately held passive assets. DP has only passive assets that are specified foreign financial assets on October 12, Year X, and satisfies paragraph (b)(1)(iii)(A) of this section.

(ii) DC2 . DC2 is not a specified domestic entity for Year X, and is not required to file Form 8938, because DC2 does not satisfy the passive income or passive asset threshold of paragraph (b)(1)(iii)(A) of this section and is not formed or availed of with a principal purpose of avoiding the reporting obligations under section 6038D.

(iii) DP . DP is a specified domestic entity for Year X because DP meets the conditions of paragraph (b)(1) of this section: DP is closely held by L, a specified individual; DP has an interest in specified foreign financial assets with an aggregate value exceeding the reporting threshold of §1.6038D–2T(a)(1); and DP satisfies the passive asset threshold of paragraph (b)(1)(iii)(A) of this section. DP must file Form 8938

2012–8 I.R.B. 416 February 21, 2012

for Year X to report its specified foreign financial assets and disclose their maximum value as provided in §1.6038D–4T.

(c) Domestic trusts . Except as provided in paragraph (d) of this section, a trust described in section 7701(a)(30)(E) is a specified domestic entity that is formed or availed of for purposes of holding, directly or indirectly, specified foreign financial assets if and only if the trust—

(1) Has an interest in specified foreign financial assets (other than assets excepted from reporting as provided in §1.6038D–7T) with an aggregate value exceeding the reporting threshold in §1.6038D–2T(a)(1), and

(2) Has one or more specified persons as a current beneficiary. For purposes of this paragraph(c)(2), the term current beneficiary means, with respect to the taxable year, any person who at any time during such taxable year is entitled to, or at the discretion of any person may receive, a distribution from the principal or income of the trust (determined without regard to any power of appointment to the extent that such power remains unexercised at the end of the taxable year).

(d) Excepted domestic entities . An entity is not considered to be a specified domestic entity if the entity is—

(1) Certain persons described in section 1473(3) . An entity, except for a trust that is exempt from tax under section 664(c), that is excepted from the definition of the term “specified United States person” under section 1473(3) and the regulations issued under that section;

(2) Certain domestic trusts . A trust described in section 7701(a)(30)(E) provided that the trustee of the trust—

(i) Has supervisory authority over or fiduciary obligations with regard to the specified foreign financial assets held by the trust;

(ii) Timely files (including any applicable extensions) annual returns and information returns on behalf of the trust; and

(iii) Is (A) A bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, or the National Credit Union Association;

(B) A financial institution that is registered with and regulated or examined by

the Securities and Exchange Commission; or

(3) Domestic trusts owned by one or more specified persons . A trust described in section 7701(a)(30)(E) to the extent such trust or any portion thereof is treated as owned by one or more specified persons under sections 671 through 678 and the regulations issued under those sections.

(e) Effective/applicability dates . This section applies to taxable years beginning after December 31, 2011.

Par. 9. Section 1.6038D–7 is added to read as follows:

§1.6038D–7 Exceptions from the reporting of certain assets under Section 6038D .

The text of proposed §1.6038D–7 is the same as the text of paragraphs (a) through (d) in §1.6038D–7T published elsewhere in this issue of the Bulletin.

Par. 10. Section 1.6038D–8 is added to read as follows:

§1.6038D–8 Penalties for failure to disclose .

The text of proposed §1.6038D–8 is the same as the text of paragraphs (a) through (g) in §1.6038D–8T published elsewhere in this issue of the Bulletin.

Steven T. Miller, Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on December 14, 2011, 4:15 p.m., and published in the issue of the Federal Register for December 19, 2011, 76 F.R. 78594)

Notice of Proposed Rulemaking

Corporate Reorganizations; Guidance on the Measurement of Continuity of Interest

REG–124627–11

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

SUMMARY: This document contains proposed regulations concerning the continuity of interest requirement for corporate reorganizations. The guidance is necessary to clarify the manner in which the continuity of interest requirement is measured in particular circumstances. The proposed regulations affect corporations and their shareholders.

DATES: Written or electronic comments and requests for a public hearing must be received by March 19, 2012.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG–124627–11), room 5205, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand-delivered Monday through Friday between the hours of 8:00 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–124627–11), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC, or electronically, via the Federal e-Rulemaking Portal at http://www.regulations.gov/ (IRS REG–124627–11).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Richard Starke (202) 622–3497, and concerning submission of comments, Oluwafunmilayo Taylor (202) 622–7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

This notice of proposed rulemaking accompanies publication of final regulations regarding the continuity of interest requirement (COI) for corporate reorganizations that are published in this issue of the Bulletin (the 2011 regulations). In general, the 2011 regulations provide the circumstances under which the consideration to be exchanged for the proprietary interests in the target corporation is valued on the last business day before the first date there is a binding contract (the signing date rule). The preamble explains that the signing date rule is based on the principle that where a binding contract provides for fixed consideration, the target corporation shareholders can generally be viewed as being subject to the economic fortunes of the issuing corporation as of

February 21, 2012 417 2012–8 I.R.B.

reorganization, but not later than the date of the reorganization exchange. In determining whether the target shareholders are fully subject to market appreciation and depreciation, certain circumstances, such as the risk of not closing, would be disregarded. The IRS and the Treasury Department request comments on the propriety of such an approach.

Effective Date

These regulations are proposed to apply to transactions occurring on or after the date the regulations are published as final regulations in the Federal Register, unless completed pursuant to a binding agreement that was in effect immediately before the date such final regulations are published and all times afterwards.

Special Analysis

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866 as supplemented by Executive Order 13563. Therefore, a regulatory assessment is not required. It has also been determined that 5 U.S.C. 553(b) 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. 601 et seq.) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small entities.

Comments and Requests for Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and 8 copies) or electronic comments that are submitted timely to the IRS. The IRS and the Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the

the last business day before the signing date (the Pre-Signing Date). However, if the contract does not provide for fixed consideration, the signing date value of the issuing corporation stock is not relevant for purposes of determining the extent to which a proprietary interest in the target corporation is preserved. For additional background regarding the signing date rule, see the preamble to the 2011 regulations published elsewhere in this issue of the Bulletin.

Explanation of Provisions

In response to comments, the IRS and the Treasury Department have reconsidered the scope of the signing date rule, and agree that its underlying principles support additional methods for determining whether COI is satisfied. For example, a contract to effect a potential reorganization may provide that the amount of an item of consideration will vary as the value of issuing corporation stock declines between the stock’s Pre-Signing Date value and some lower value provided for in the contract (Floor Price), but will not vary below the Floor Price. If the closing date value is less than the Floor Price in such a case, the target shareholders have been subjected to the economic fortunes of owning the consideration received in the exchange in the same manner as if the contract had fixed the consideration based upon the contract’s stated Floor Price. Accordingly, these proposed regulations generally provide that if, pursuant to a binding contract, an item of consideration varies as the value of issuing corporation stock declines between the stock’s Pre-Signing Date value and a Floor Price, and the closing date value is less than the Floor Price, COI is determined as if the consideration that would have been delivered at the Floor Price were issued and valued based upon the Floor Price. Applying the same principle, these proposed regulations provide that if, pursuant to a binding contract, an item of consideration varies as the value of issuing corporation stock increases between the stock’s signing date value and some higher value provided for in the contract (Ceiling Price), and the closing date value is greater than the Ceiling Price, COI is determined as if the consideration that would have been delivered at the Ceiling Price were issued and valued based upon the Ceiling Price.

For purposes of this rule, the Closing Date means the date upon which the exchange of consideration in the potential reorganization occurs.

In response to comments, these proposed regulations also permit, in lieu of the value of issuing corporation stock on the Closing Date, the use of an average value for issuing corporation stock in certain circumstances. The proposed regulations provide that an average value may be used if it is based upon issuing corporation stock values occurring after the signing date and before the Closing Date, and the binding contract utilizes the average price, so computed, in determining the number of shares of each class of stock of the issuing corporation, the amount of money, and the other property to be exchanged for all the proprietary interests in the target corporation, or to be exchanged for each proprietary interest in the target corporation. This rule also applies signing date rule principles because the average value fixes the number of shares and amount of other consideration. Accordingly, the target shareholders become subject to the fortunes of the issuer’s stock across the range of dates being averaged.

Request for Comments

As previously stated, the signing date rule and these proposed regulations are based upon the concept that for purposes of measuring COI, in certain circumstances an item of consideration provided by the issuing corporation can generally be valued on the date that the target shareholders become subject to the economic fortunes of owning the item, assuming the exchange ultimately occurs. Depending upon the contract’s terms, this may occur on a date between the signing date and the closing date, and may occur for different items of consideration on different dates. Accordingly, for purposes of COI, it may be appropriate to value an item of consideration on a date between the signing date and the closing date, and to value different items on different dates. For example, future guidance could provide that an item of consideration is valued for COI purposes at the earliest date on which the target shareholders (in the aggregate) become fully subject to the appreciation and depreciation in the value of that item pursuant to a binding contract to effect the potential

2012–8 I.R.B. 418 February 21, 2012

date, time, and place for the public hearing will be published in the Federal Register .

Drafting Information

The principal author of these regulations is Richard Starke of the Office of Associate Chief Counsel (Corporate), IRS. However, other personnel from the IRS and the Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.368–1 is amended by adding new paragraphs (e)(2)(vi), (e)(2)(vii), and revising (e)(9) to read as follows:

§1.368–1 Purpose and scope of exception of reorganization exchanges.

- - - (e) - - (2) - - (vi) Special Rules —(A) Floors . This paragraph (e)(2)(vi)(A) applies if, pursuant to a binding contract, the amount of an item of consideration to be exchanged for all the proprietary interests in the target corporation, or to be exchanged for each proprietary interest in the target corporation, changes as the value of a share of the issuing corporation varies above a specified price (Floor Price), but does not vary below the Floor Price. If the value of the share is greater than or equal to the Floor Price on the Pre-Signing Date (as defined in paragraph (e)(2)(i) of this section) but below the Floor Price on the Closing Date (as defined in paragraph (e)(2)(vi)(D) of this section), whether a proprietary interest is preserved is determined as if the consideration was issued and valued based upon the Floor Price.

(B) Ceilings . This paragraph (e)(2)(vi)(B) applies if, pursuant to a binding contract, the amount of an item

of consideration to be exchanged for all the proprietary interests in the target corporation, or to be exchanged for each proprietary interest in the target corporation, changes as the value of a share of the issuing corporation varies below a specified price (Ceiling Price), but does not vary above the Ceiling Price. If the value of the share is less than or equal to the Ceiling Price on the Pre-Signing Date (as defined in paragraph (e)(2)(i) of this section) but above the Ceiling Price on the Closing Date (as defined in paragraph (e)(2)(vi)(D) of this section), whether a proprietary interest is preserved is determined as if the consideration was issued and valued based upon the Ceiling Price.

(C) Closing Date value - average val- ues between signing date and Closing Date . In determining the Closing Date value of issuing corporation stock for purposes of determining whether a proprietary interest in the target corporation is preserved, an average of prices may be used in lieu of the Closing Date price if —

( 1 ) The average price is based upon prices of issuing corporation stock occurring after the signing date and before the Closing Date, and

( 2 ) The binding contract utilizes the average price, so computed, in determining the number of shares of each class of stock of the issuing corporation, the amount of money, and the other property to be exchanged for all the proprietary interests in the target corporation, or to be exchanged for each proprietary interest in the target corporation.

(D) Closing Date . For purposes of paragraphs (e)(2)(vi) and (e)(2)(vii) of this section, the Closing Date means the date upon which the exchange of consideration in the potential reorganization occurs.

(vii) Examples . For purposes of the examples in this paragraph (e)(2)(vii), P is the issuing corporation, T is the target corporation, each corporation has only one class of stock outstanding, no transactions other than those described occur, and the transactions are not otherwise subject to recharacterization. The following examples illustrate the application of paragraph (e)(2)(vi) of this section:

Example 1 . Price adjustment to provide more or less cash . (i) Facts . On January 3 of year 1, P and T sign a binding contract pursuant to which T will be merged into P. Pursuant to the contract, the T shareholders will receive 50 shares of P stock and $50 cash

in exchange for all of the outstanding shares of T stock, subject to the following price adjustment:

(A) If the average price of P stock over the five-day period prior to the Closing Date exceeds $1, the amount of cash will be reduced by 50 times the excess of that price over $1, and

(B) If the average price of P stock during the specified period is less than $1, the amount of cash will be increased by 50 times the excess of $1 over that price, provided that in no event will P deliver cash of less than $40 or more than $60 to the T shareholders. This adjustment ensures that the T shareholders will be entitled to receive aggregate consideration with a value of $100 on the closing date if the average price of P stock during the specified period is between $.80, at which point the T shareholders would receive $60 of cash ($50 + (($1 - $.80) x 50)), and $1.20, at which point the T shareholders would receive $40 of cash ($50 - (($1.20-$1) x 50)).

(C) On January 2 of year 1, the value of the P stock is $1 per share. On June 1 of year 1, T merges into P, when the value of P stock is $.25 per share. The average price of P stock during the specified period is also $.25 per share. In the merger, the T shareholders receive $60 cash and 50 shares of P stock with a value (determined as of the Closing Date) of $12.50. (ii) COI determined at the Floor Price. For purposes of determining whether a proprietary interest in the target corporation is preserved, the rules of paragraph (e)(2)(vi)(A) of this section apply because, pursuant to a binding contract, the amount of cash to be exchanged for all the proprietary interests in the target corporation varies above a Floor Price of $.80 but does not vary below the Floor Price, the Pre-Signing Date value exceeds the Floor Price, and the value on the Closing Date is less than the Floor Price. Accordingly, whether a proprietary interest is preserved is determined as if the consideration that would have been delivered at the Floor Price was issued and valued based upon the Floor Price value. At the Floor Price, the T shareholders would have received, in the aggregate, $60 of cash and $40 of P stock. Therefore, the transaction satisfies the continuity of interest requirement.

Example 2 . No Floor Price . The facts are the same as in Example 1, except that the Pre-Signing Date value is $.50, the Closing Date value is $1.50, and there is no limitation on the amount of additional cash that the T shareholders may receive (that is, there is no Floor Price). For purposes of determining whether a proprietary interest in the target corporation is preserved, the rules of paragraph (e)(2)(vi)(B) of this section apply because, pursuant to a binding contract, the amount of cash to be exchanged for all the proprietary interests in the target corporation varies below a Ceiling Price of $1.20 but does not vary above the Ceiling Price, the Pre-Signing Date value is less than the Ceiling Price, and the value on the Closing Date exceeds the Ceiling Price. Accordingly, whether a proprietary interest is preserved is determined as if the consideration that would have been delivered at the Ceiling Price was issued and valued based upon the Ceiling Price. At the Ceiling Price, the T shareholders would have received, in the aggregate, $40 of cash and $60 of P stock. Therefore, the transaction satisfies the continuity of interest requirement.

February 21, 2012 419 2012–8 I.R.B.

Example 3. No Floor or Ceiling Price . (i) Facts . On January 3 of year 1, P and T sign a binding contract pursuant to which T will be merged into P. Pursuant to the contract, the T shareholders will receive $50 cash and $50 of P stock based upon the P stock value on the Closing Date. On January 2 of year 1, the Pre-Signing Date, the value of the P stock is $1 per share. On June 1 of year 1, when the value of P stock is $5 per share, T merges into P.

(ii) COI determined on the Closing Date . For purposes of determining whether a proprietary interest in the target corporation is preserved, the rules of paragraph (e)(2)(vi) of this section do not apply because the contract does not provide for a either a Floor Price or a Ceiling Price. There is no Floor Price because there is not a value below which the amount of P stock will not vary. There is no Ceiling Price because there

is not a value above which the amount of P stock will not vary. Because the transaction does not satisfy the requirements of paragraph (e)(2)(vi) of this section and does not satisfy the definition of fixed consideration, the consideration will be valued on the Closing Date. The transaction satisfies the continuity of interest requirement because the T shareholders receive, in the aggregate, $50 cash and $50 of P stock.

- - - (9) Effective/Applicability date . Paragraphs (e)(2)(vi) and (e)(2)(vii) are proposed to apply to transactions occurring on or after the date the regulations are published as final regulations in the Federal Register, unless completed pursuant to a

binding agreement that was in effect immediately before the date such final regulations are published and at all times afterwards.

Steven T. Miller, Deputy Commissioner for Services and Enforcement.

(Filed by the Office of the Federal Register on December 16, 2011, 8:45 a.m., and published in the issue of the Federal Register for December 19, 2011, 76 F.R. 78591)

2012–8 I.R.B. 420 February 21, 2012