[Federal Register Volume 75, Number 235 (Wednesday, December 8, 2010)]
[Rules and Regulations]
[Pages 76262-76263]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-30895]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9508]
RIN 1545-BJ85
Source of Income From Qualified Fails Charges
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Temporary regulations.
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SUMMARY: This document contains temporary regulations which set forth
the source of income attributable to qualified fails charges. The
temporary regulations provide guidance about the treatment of fails
charges for purposes of sections 871 and 881, which generally require
gross-basis taxation of foreign persons not otherwise subject to U.S.
net-basis taxation and the withholding of such tax under sections 1441
and 1442. The text of the temporary regulations also serves as the text
of the proposed regulations set forth in the notice of proposed
rulemaking on this subject in the Proposed Rules section in this issue
of the Federal Register.
DATES: Effective Date. These regulations are effective on December 8,
2010.
Applicability Date. These regulations apply to qualified fails
charges paid or accrued on or after December 8, 2010.
FOR FURTHER INFORMATION CONTACT: Sheila Ramaswamy or Anthony J. Marra,
Office of Associate Chief Counsel (International) (202) 622-3870 (not a
toll free call).
SUPPLEMENTARY INFORMATION:
Background
In response to persistent delivery failures in delivery-versus-
payment transactions involving U.S. Treasury securities (Treasury
securities), a trading practice governing failed deliveries of Treasury
securities was published in 2008 by the Treasury Market Practices Group
(TMPG) and the Securities Industry and Financial Markets Association
(SIFMA). This trading practice, which was recommended by the Federal
Reserve Bank of New York in addition to TMPG and SIFMA, has
subsequently been voluntarily adopted by almost every participant in
the Treasury securities market. Transactions that involve delivery-
versus-payment include a sale, a purchase, a sale and repurchase
transaction (commonly known as a ``repo''), a securities lending
transaction, and an option.
The trading practice addresses the problem that in certain
situations, including a low interest rate environment, a party to a
delivery-versus-payment transaction may lack the economic incentive to
deliver Treasury securities in a timely manner. Under the trading
practice, the parties to a contract that provides for delivery-versus-
payment of Treasury securities agree that if one party fails to deliver
Treasury securities at the time specified in the contract, the failing
party will pay an amount (a ``fails charge'') to the party entitled to
receive the Treasury securities. The fails charge is calculated using a
formula that takes into account current interest rates and trade
proceeds, and accrues each day that the failure to deliver continues.
The trading practice is generally expected to impose a fails charge
whenever the interest rate on a repo that can be settled with any of a
variety of securities (referred to in the market as the ``general
collateral rate'') falls below a certain level.
As noted in this preamble, the delivery-versus-payment market
encompasses a variety of transactions, each of which can generate a
fails charge. Some transactions, such as a repo, where delivery is
required both at inception and at settlement, can produce more than one
fails charge. In back-to-back transactions, it can also be difficult to
determine whether a party that incurs a fails charge is acting as an
intermediary or a principal. As a result, there is considerable
uncertainty about the treatment of fails charges for purposes of
sections 871 and 881, which generally impose gross-basis taxation at a
rate of 30 percent on certain U.S. source income of foreign persons
that is not effectively connected with the conduct of a trade or
business in the United States and the withholding of such tax under
sections 1441 and 1442.
Notice 2009-61, (2009 IRB 181), issued in July 2009, addressed the
issue temporarily by providing that the Internal Revenue Service (IRS)
will not challenge the position taken by a taxpayer or a withholding
agent that a fails charge that is paid on or before December 31, 2010
is not subject to U.S. gross-basis taxation. Notice 2009-61 further
announced that the Treasury Department and the IRS were considering
issuing prospective guidance on the circumstances, if any, that would
cause a fails charge to be subject to U.S. gross-basis taxation. These
temporary regulations provide further guidance on the treatment of
fails charges. The text of the temporary regulations also serves as the
text of the proposed regulations set forth in the notice of proposed
rulemaking on this subject in the Proposed Rules section of this issue
of the Federal Register. See Sec. 601.601(d)(2).
Explanation of Provisions
In order to provide certainty and consistency in the treatment of
fails charges for purposes of sections 871, 881, 1441 and 1442, these
temporary regulations establish source rules for qualified fails
charges that arise in the delivery-versus-payment market for Treasury
securities. The temporary regulations provide that the source of income
from a qualified fails charge is generally determined by reference to
the residence of the taxpayer that is the recipient of the qualified
fails charge income, with two exceptions. Qualified fails charge income
earned by a qualified business unit (QBU) of a taxpayer is sourced to
the country in which the QBU is engaged in a trade or business, and
qualified fails charge income that arises from a transaction that is
effectively connected to a United States trade or business is sourced
in the United States and treated as effectively connected to the
conduct of a United States trade or business.
The temporary regulations provide a source rule only for income
from a qualified fails charge. In order to be a qualified fails charge,
the fails charge must satisfy two requirements. First, it must be paid
pursuant to a trading practice or similar guidance approved by a U.S.
government agency or the Treasury Market Practices Group (which is
sponsored by the Federal Reserve Bank of New York), or published in
separate guidance by the IRS. Second, the transaction that generates
the fails charge must be with respect to a bill, note, or other
evidence of indebtedness issued by the United States Treasury
Department. These temporary regulations do not address the source of
any other type of damages payment, including a fails charge that is not
a qualified fails charge.
Although there is not currently a fails charge trading practice
relating to securities other than Treasury securities, one may be
considered in the future for agency securities (including mortgage-
backed securities). If a fails charge trading practice pertaining to
agency securities is endorsed by the Treasury Market Practices Group or
an agency of the United States government and widely adopted, the
Treasury Department and the IRS will consider
[[Page 76263]]
whether fails charges paid with respect to such a trading practice
should be sourced under these regulations.
Effective/Applicability Date
These regulations apply to qualified fails charges paid or accrued
on or after December 8, 2010.
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 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, and because
these regulations do not impose a collection of information on small
entities, the provisions of the Regulatory Flexibility Act (5 U.S.C.
chapter 6) do not apply. Pursuant to section 7805(f) of the Internal
Revenue Code, these temporary regulations will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.
Drafting Information
The principal authors of these regulations are Sheila Ramaswamy and
Anthony J. Marra, Office of the Associate Chief Counsel
(International). However, other persons from the Office of Associate
Chief Counsel (International) and the Treasury Department have
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
0
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 863(a) and 7805 * * *
0
Par. 2. Section 1.863-10T is added to read as follows:
Sec. 1.863-10T Source of income from a qualified fails charge
(temporary).
(a) In general. Unless paragraph (b) or (c) of this section
applies, the source of income from a qualified fails charge shall be
determined by reference to the residence of the taxpayer as determined
under section 988(a)(3)(B)(i).
(b) Qualified business unit exception. The source of income from a
qualified fails charge shall be determined by reference to the
residence of a qualified business unit of a taxpayer if--
(1) The taxpayer's residence, determined under section
988(a)(3)(B)(i), is the United States;
(2) The qualified business unit's residence, determined under
section 988(a)(3)(B)(ii), is outside the United States;
(3) The qualified business unit is engaged in the conduct of a
trade or business in the country where it is a resident; and
(4) The transaction to which the qualified fails charge relates is
attributable to the qualified business unit. A transaction will be
treated as attributable to a qualified business unit if it satisfies
the principles of Sec. 1.864-4(c)(5)(iii) (substituting ``qualified
business unit'' for ``U.S. office'').
(c) Effectively connected income exception. Income from a qualified
fails charge that arises from a transaction that under the principles
described in Sec. 1.864-4(c) is effectively connected with a United
States trade or business shall be sourced in the United States and the
income from the qualified fails charge shall be treated as effectively
connected to the conduct of a United States trade or business to the
same extent as the transaction from which it arises.
(d) Definitions.--(1) Qualified fails charge. For purposes of this
section, a qualified fails charge is a payment that
(i) Compensates a party to a transaction that provides for delivery
of a Treasury security in exchange for the payment of cash (delivery-
versus-payment settlement) for another party's failure to deliver the
specified Treasury security on the settlement date specified in the
relevant agreement; and
(ii) Is made pursuant to:
(A) A trading practice or similar guidance approved or adopted by
either an agency of the United States government or the Treasury Market
Practices Group, or
(B) Any trading practice, program, policy or procedure approved by
the Commissioner in guidance published in the Internal Revenue
Bulletin.
(2) Treasury security. For purposes of this section, a Treasury
security is any bill, note, or other evidence of indebtedness issued by
the United States Treasury Department.
(e) Effective/applicability date. This section applies to qualified
fails charges paid or accrued on or after December 8, 2010.
(f) Expiration date. This section expires on December 9, 2013.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
Approved: December 2, 2010.
Michael Mundaca,
Assistant Secretary of the Treasury.
[FR Doc. 2010-30895 Filed 12-7-10; 8:45 am]
BILLING CODE 4830-01-P