Revenue Reconciliation Act
page3
 
5. Tax certain alternative fuels based on energy equivalency
to gasoline (sec. 705 of the bill and sec. 4041 of
the Code)
Present
Law
Excise taxes are imposed on gasoline, diesel fuel,
and special motor fuels used in highway vehicles.
4.3 cents per gallon of each of these taxes is
retained in the General Fund, with the balance of
the revenues being dedicated to one or more Trust
Funds. The tax on gasoline is 18.3 cents per gallon;
the tax on diesel fuel is 24.3 cents per gallon; and
the tax on special motor fuels generally is 18.3
cents per gallon. Taxable special motor fuels
include liquefied petroleum gas
("propane"), liquefied natural gas
("LNG"), methanol from natural gas, and
compressed natural gas ("CNG"). Special
rates apply to methanol from natural gas (exempt
from 7 cents of the 14-cents-per-gallon Highway
Trust Fund component of the special motor fuels
tax), and compressed natural gas (exempt from the
entire Highway Trust Fund component of the tax).
In general, these four special motor fuels contain
less energy (i.e., fewer Btu's) per gallon than does
gasoline.
Reasons
for Change
The largest portion of the excise tax on propane,
LNG, and methanol from natural gas is imposed to
finance Federal highway programs through the Highway
Trust Fund. A basic principle of the highway taxes
is that users of the highway system should be taxed
in relation to their use of the system. Adjusting
the tax rates on these three special motor fuels is
consistent with that principle because consumers
must purchase more gallons of these
lower-energy-content fuels than gallons of gasoline
to travel the same number of miles
Explanation
of Provision
The tax rates on propane, LNG, and methanol from
natural gas are adjusted to reflect the respective
energy equivalence of the fuels to gasoline. The
revised tax rates on these fuels are: propane, 13.6
cents per gallon; LNG 11.9 cents per gallon, and
methanol from natural gas, 9.15 cents per gallon.
Effective
Date
The provision is effective for fuels sold or used
after
September 30, 1997
.
6.
Study feasibility of moving collection point for
distilled spirits excise tax (sec. 706 of the bill)
Present
Law
Distilled spirits are subject to tax at $13.50 per
proof gallon. (A proof gallon is a liquid gallon
consisting of 50 percent alcohol.) In the case of
domestically produced distilled spirits and
distilled spirits imported in to the
United States
in bulk containers for domestic bottling, the tax is
imposed on removal of the beverage from the
distillery (without regard to whether a sale occurs
at that time). Bottled distilled spirits that are
imported into the
United States
comprise approximately 15 percent of the current
market for these beverages; tax is imposed on these
imports when the distilled spirits are removed from
the first customs bonded warehouse in which they are
deposited upon entry into the
United States
.
In the case of certain distilled spirits products, a
tax credit for alcohol derived from fruit is
allowed. This credit reduces the effective tax paid
on those beverages. The credit is determined when
the tax is paid (i.e., at the distillery or on
importation).
Explanation
of Provision
The Treasury Department is directed to study options
for changing the point at which the distilled
spirits excise tax is collected. One of the options
evaluated should be collecting the tax at the point
at which the distilled spirits are removed from
registered wholesale warehouses. As part of this
study, the Treasury is to focus on administrative
issues associated with the identified options,
including the effects on tax compliance. For
example, the Treasury is to evaluate the actual
compliance record of wholesale dealers that
currently paid the excise tax on imported bottled
distilled spirits, and the compliance effects of
allowing additional wholesale dealers to be
distilled spirts taxpayers. The study also is to
address the number of taxpayers involved, the types
of financial responsibility requirements that might
be needed, any special requirements regarding
segregation of non-tax-paid distilled spirits from
other products carried by the potential new
taxpayers. The study further is to review the
effects of the options on Treasury staffing and
other budgetary resources as well as projections of
the time between when tax currently is collected and
the time when tax otherwise would be collected.
The study is required to be completed and
transmitted to the Committee on Finance and the
Committee on Ways and Means no later than
January 31, 1998
.
7.
Extend and modify tax benefits for ethanol (sec.707
of the bill and secs. 40, 4041, 4081, 4091, and 6427
of the Code)
Present
Law
Present law provides a 54-cents-per-gallon income
tax credit for ethanol and a 60-cents-per-gallon
income tax credit for methanol produced from
renewable sources (e.g., biomass) that are used as a
motor fuel or that are blended with other fuels
(e.g., gasoline) for such a use. As an alternative
to claiming the income tax credits directly, these
tax benefits may be claimed as a reduction in the
amount of excise tax paid on gasoline or diesel fuel
with which the ethanol or renewable source methanol
are blended or as a reduction in the special motor
fuels rate applicable to "neat" ethanol or
renewable source methanol fuels. The excise tax
delivery of the benefits occurs either through
reduced tax rate sales to registered blenders of
e.g., gasoline or diesel fuel, or through expedited
refunds of gasoline or diesel fuel tax paid.
In addition to these general ethanol benefits, a
separate 10-cents-per-gallon credit is provided for
small ethanol producers, defined generally as
persons whose production does not exceed 15 million
gallons per year and whose production capacity does
not exceed 30 million gallons per year. No
comparable small producer credit is provided for
small renewable source methanol producers.
Treasury Department regulations provide that ethyl
tertiary butyl ether ("ETBE"), which is
made using ethanol, qualifies for the blender income
tax credit and the excise tax exemption.
The alcohol fuels tax benefits are scheduled to
expire after
December 31, 2000
. The provision allowing the ethanol blender
benefits to be claimed through the motor fuels
excise tax system is scheduled to expire after
September 30, 2000
.
Reasons
for Change
The Committee believes that continued assurance of
tax benefits for ethanol are an important signal to
encourage the use of alternative fuels..
Explanation
of Provision
The bill extends the 54-cents-per-gallon income tax
credit for ethanol through
December 31, 2007
, and the excise tax provisions allowing that
benefit to be claimed through reduced-tax-rate
gasoline sales (or expedited refunds of gasoline tax
paid) through
September 30, 2007
. In addition, the bill phases down the rates of the
benefits during the period 2001 through 2007. Under
the bill, the tax benefit per gallon of ethanol will
be --
2001 and 2002 53 cents per gallon
2003 and 2004 52 cents per gallon
2005, 2006, and 2007 51 cents per gallon.
Effective
Date
The provision is effective on the date of enactment.
8.
Codify Treasury Department regulations regulating
wine labels (sec. 708 of the bill and sec. 5388 of
the Code)
Present
Law
The Code includes provisions regulating the labeling
of wine when it is removed from a winery for
marketing. In general, the regulations under these
provisions allow the use of semi-generic names for
wine that reflect geographic identifications
understood in the industry, provided that the labels
include clear indication of any deviation from that
which is generally understood in the source of the
grapes or the process by which the wine is produced.
Reasons
for Change
The Committee determined that the Treasury
Department regulations governing the use of
semi-generic designations such as
"Chablis" and "burgundy" in wine
labeling should be codified to add clarity to the
existing Code provisions.
Explanation
of Provision
The current Treasury Department regulations
governing the use of semi-generic wine designations
which reflect geographic origin are codified into
the Code's wine labeling provisions.
Effective
Date
The provision is effective on the date of enactment.
B.
Provisions Relating to Pensions
1.
Treatment of multiemployer plans under section 415
(sec. 711 of the bill and sec. 415(b) of the Code)
Present
Law
Present law imposes limits on contributions and
benefits under qualified plans based on the type of
plan. In the case of defined benefit pension plans,
the limit on the annual retirement benefit is the
lesser of (1) 100 percent of compensation or (2)
$125,000 (indexed for inflation).
Reasons
for Change
The limits on contributions and benefits create
unique problems for multiemployer defined benefit
pension plans.
Explanation
of Provision
The bill eliminates the application of the 100
percent of compensation limitation for multiemployer
defined benefit pension plans. Such plans will only
be subject to the dollar limitation.
Effective
Date
The provision is effective for years beginning after
December 31, 1997
.
2.
Modification of partial termination rules (sec. 712
of the bill and sec. 552 of the Deficit Reduction
Act of 1984)
Present
Law
Under the Internal Revenue Code, pension plan
benefits are required to become fully vested upon
termination or partial termination of the plan. The
plan document is required to contain a provision
reflecting this rule. Under section 552 of the
Deficit Reduction Act of 1984 ("DEFRA"),
for purposes of this rule, a partial termination is
treated as not occurring if (1) the partial
termination is a result of a decline in plan
participation which occurs by reason of the
completion of the Trans-Alaska Oil Pipeline
construction project and occurred after
December 31, 1975
, and before
January 1, 1980
, with respect to participants employed in Alaska;
(2) no discrimination occurred with respect to the
partial termination; and (3) it is established to
the satisfaction of the Secretary of the Treasury
that the benefits of the provision will not accrue
to the employers under the plan.
Reasons
for Change
The Committee is concerned that section 552 of DEFRA
has not operated as intended because of a conflict
between section 552 and the requirement that a plan
document provide that plan benefits become
nonforfeitable upon a full or partial plan
termination. The Committee bill eliminates this
conflict by clarifying that section 552 of DEFRA
applies notwithstanding any other provision of law
or of the plan or trust.
Explanation
of Provision
The bill clarifies that section 552 of DEFRA applies
for the Code, any other provision of law, and any
plan or trust provision.
Effective
Date
The provision is effective as if included in section
552 of DEFRA.
3.
Increase in full funding limit (sec. 713 of the bill
and sec. 412 of the Code)
Present
Law
Under present law, defined benefit pension plans are
subject to minimum funding requirements. In
addition, there is a maximum limit on contributions
that can be made to a plan, called the full funding
limit. The full funding limit is the lesser of a
plan's accrued liability and 150 percent of current
liability. In general, current liability is all
liabilities to plan participants and beneficiaries.
Current liability represents benefits accrued to
date, whereas the accrued liability full funding
limit is based on projected benefits.
Reasons
for Change
The 150-percent of full funding limit was enacted to
limit and allocate efficiently the Federal tax
revenue associated with the special tax treatment
provided to tax-qualified plans. However, the
Committee believes that the 150-percent of current
liability full funding limit unduly restricts
funding.
Explanation
of Provision
The bill increases the 150-percent of full funding
limit as follows: 155 percent for plan years
beginning in 1999 or 2000, 160 percent for plan
years beginning in 2001 or 2002, 165 percent for
plan years beginning in 2003 and 2004, and 170
percent for plan years beginning in 2005 and
thereafter.
Effective
Date
The provision is effective for plan years beginning
after
December 31, 1998
.
4.
Spousal consent required for distributions from
section 401(k) plans (sec. 714 of the bill and secs.
411 and 417 of the Code)
Present
Law
Under present law, pension plans that provide
automatic survivor benefits (i.e., joint and
survivor annuities and preretirement survivor
annuities) require spousal consent to the payment of
a participant's benefit in a form other than a
survivor annuity. A qualified cash or deferred
arrangement (a "section 401(k) plan") is
not subject to the automatic survivor benefit rules
if the plan provides that the spouse of a
participant is the beneficiary of the participant's
entire account under the plan, the participant's
benefit is not paid in the form or an annuity, and
the participant's account does not include amounts
transferred from another plan that was subject to
the automatic survivor benefit rules. In general,
spousal consent is not required for an involuntary
cash-out of a participant's benefit or distributions
made to satisfy the minimum distribution rules.
Reasons
for Change
The Committee believes that spouses of participants
in 401(k) plans who are entitled to benefits under
the plan should be afforded similar protection as
spouses in pension plans that provide automatic
survivor benefits.
Explanation
of Provision
The bill provides that written spousal consent is
required for all distributions, including plan
loans, from plans containing a qualified cash or
deferred arrangement. As under present law, spousal
consent is not required for an involuntary cash-out
of a participant's benefit or for the payment of
distributions required under the minimum
distribution rules. If spousal consent is not
obtained, the benefit must be distributed in equal
periodic payments over the life (or life expectancy)
of the participant, the lives (or life expectancies)
of the participant and beneficiary, or over a period
of 10 years or more. A plan which complies with the
spousal consent requirement will not be treated as
failing to satisfy the anti-cutback rules related to
optional forms of benefit. The bill also will make
the corresponding changes to the Employment Income
Security Act of 1974, as amended ("ERISA").
Effective
Date
The provision is effective for plan years beginning
after
December 31, 1998
.
5.
Contributions on behalf of a minister to a church
plan (sec. 715 of the bill and sec. 414(e) of the
Code)
Present
Law
Under present law, contributions made to retirement
plans by ministers who are self-employed are
deductible to the extent such contributions do no
exceed certain limitations applicable to retirement
plans. These limitations include the limit on
elective deferrals, the exclusion allowance, and the
limit on annual additions to a retirement plan.
Reasons
for Change
The Committee believes that the unique
characteristics of church plans and the procedures
associated with contributions made by ministers who
are self-employed create particular problems with
respect to plan administration.
Explanation
of Provision
The bill provides that in the case of a contribution
made on behalf of a minister who is self-employed to
a church plan, the contribution will be excludable
from the income of the minister to the extent that
the contribution would be excludable if the minister
was an employee of a church and the contribution was
made to the plan.
Effective
Date
The provision is effective for years beginning after
December 31, 1997
.
6.
Exclusion of ministers from discrimination testing
of certain non-church retirement plans (sec. 715 of
the bill and sec. 414(e) of the Code)
Present
Law
Under present law ministers who are employed by an
organization other than a church are treated as if
employed by the church and may participate in the
retirement plan sponsored by the church. If the
organization also sponsors a retirement plan, such
plan does not have to include the ministers as
employees for purposes of satisfying the
nondiscrimination rules applicable to qualified
plans provided the organization is not eligible to
participate in the church plan.
Reasons
for Change
The Committee believes it is appropriate to extend
the same relief to other non-church organizations
that may be eligible to participate in a church plan
but elect not to do so. Such organizations will not
be required to treat ministers as employees for
purposes of satisfying the nondiscrimination rules
applicable to their retirement plan.
Explanation
of Provision
The bill provides that if a minister is employed by
an organization other than a church and the
organization is not otherwise participating in the
church plan then, the minister does not have to be
included as an employee under the retirement plan of
the organization for purposes of the
nondiscrimination rules.
Effective
Date
The provision is effective for years beginning after
December 31, 1997
.
7.
Repeal application of UBIT to ESOPs of S
corporations (sec. 716 of the bill and sec. 512 of
the Code)
Present
Law
Under present law, for taxable years beginning after
December 31, 1997
, certain tax-exempt organizations, including
employee stock ownership plans ("ESOPs")
can be a shareholder of an S corporation. Items of
income or loss of the S corporation will flow
through to qualified tax-exempt shareholders as
unrelated business taxable income ("UBTI"),
regardless of the source of the income.
Reasons
for Change
The Committee believes that treating S corporation
income as UBTI is not appropriate because such
amounts would be subject to tax at the ESOP level,
and also again when benefits are distributed to ESOP
participants.
Explanation
of Provision
The bill repeals the provision treating items of
income or loss of an S corporation as unrelated
business taxable income in the case of an employee
stock ownership plan that is an S corporation
shareholder.
Effective
Date
The provision is effective for taxable years
beginning after
December 31, 1997
.
C.
Provisions Relating to Disasters
1.
Treatment of livestock sold on account of
weather-related conditions (sec. 721 of the bill and
secs. 451 and 1033 of the Code)
Present
Law
In general, cash-method taxpayers report income in
the year it is actually or constructively received.
However, present law contains two special rules
applicable to livestock sold on account of drought
conditions. Code section 451(e) provides that a
cash-method taxpayer whose principal trade or
business is farming who is forced to sell livestock
due to drought conditions may elect to include
income from the sale of the livestock in the taxable
year following the taxable year of the sale. This
elective deferral of income is available only if the
taxpayer establishes that, under the taxpayer's
usual business practices, the sale would not have
occurred but for drought conditions that resulted in
the area being designated as eligible for Federal
assistance. This exception is generally intended to
put taxpayers who receive an unusually high amount
of income in one year in the position they would
have been in absent the drought.
In addition, the sale of livestock (other than
poultry) that is held for draft, breeding, or dairy
purposes in excess of the number of livestock that
would have been sold but for drought conditions is
treated as an involuntary conversion under section
1033(e). Consequently, gain from the sale of such
livestock could be deferred by reinvesting the
proceeds of the sale in similar property within a
two-year period.
Reasons
for Change
The Committee believes that the present-law
exceptions to gain recognition for livestock sold on
account of drought should apply to livestock sold on
account of floods and other weather-related
conditions as well.
Explanation
of Provision
The bill amends Code section 451(e) to provide that
a cash-method taxpayer whose principal trade or
business is farming and who is forced to sell
livestock due not only to drought (as under present
law), but also to floods or other weather-related
conditions, may elect to include income from the
sale of the livestock in the taxable year following
the taxable year of the sale. This elective deferral
of income is available only if the taxpayer
establishes that, under the taxpayer's usual
business practices, the sale would not have occurred
but for the drought, flood or other weather-related
conditions that resulted in the area being
designated as eligible for Federal assistance.
In addition, the bill amends Code section 1033(e) to
provide that the sale of livestock (other than
poultry) that are held for draft, breeding, or dairy
purposes in excess of the number of livestock that
would have been sold but for drought (as under
present law), flood or other weather-related
conditions is treated as an involuntary conversion.
Effective
Date
The provision applies to sales and exchanges after
December 31, 1996
.
2.
Rules relating to denial of earned income credit on
basis of disqualified income (sec. 722 of the bill
and sec. 32(i) of the Code)
Present
Law
For taxable years beginning after
December 31, 1995
, an individual is not eligible for the earned
income credit if the aggregate amount of
"disqualified income" of the taxpayer for
the taxable year exceeds $2,200. This threshold is
indexed for inflation. Disqualified income is the
sum of:
(1) interest (taxable and tax-exempt);
(2) dividends;
(3) net rent and royalty income (if greater than
zero);
(4) capital gain net income and;
(5) net passive income (if greater than zero) that
is not self-employment income.
Reasons
for Change
The Committee believes that lower-income farmers
should not be disqualified from the earned income
credit due to certain sales of livestock.
Explanation
of Provision
The bill clarifies that gain or loss from the sale
of livestock (as defined under section 1231(b)(3) of
the Code) is disregarded for purposes of the
calculation of capital gain net income under the
disqualified income test of the earned income
credit.
Effective
Date
The provision is effective for taxable years
beginning after
December 31, 1995
.
3.
Mortgage financing for residences located in
Presidentially declared disaster areas (sec. 723 of
the bill and sec. 143 of the Code)
Present
Law
Qualified mortgage bonds are private activity
tax-exempt bonds issued by States and local
governments acting as conduits to provide mortgage
loans to first-time home buyers who satisfy
specified income limits and who purchase homes that
cost less than statutory maximums.
Present law waives the three buyer targeting
requirements for a portion of the loans made with
proceeds of a qualified mortgage bond issue if the
loans are made to finance homes in statutorily
prescribed economically distressed areas.
Reasons
for Change
The Committee believes that availability of mortgage
subsidy financing may help survivors of
Presidentially declared disasters rebuild their
homes.
Explanation
of Provision
The bill waives the first time homebuyer
requirement, the income limits, and the purchase
price limits for loans to finance homes in certain
Presidentially declared disaster areas. The waiver
applies only during the one-year period following
the date of the disaster declaration.
Effective
Date
The provision applies to loans financed with bonds
issued after
December 31, 1996
, and before
January 1, 1999
.
D.
Provisions Relating to Small Business
1.
Delay imposition of penalties for failure to make
payments electronically through EFTPS until after
June 30, 1998
(sec. 731 of the bill and sec. 6302 of the Code)
Present
Law
Employers are required to withhold income taxes and
FICA taxes from wages paid to their employees.
Employers also are liable for their portion of FICA
taxes, excise taxes, and estimated payments of their
corporate income tax liability.
The Code requires the development and implementation
of an electronic fund transfer system to remit these
taxes and convey deposit information directly to the
Treasury (Code sec. 6302(h)53
). The Electronic Federal Tax Payment System ("EFTPS")
was developed by Treasury in response to this
requirement.54
Employers must enroll with one of two private
contractors hired by the Treasury. After enrollment,
employers generally initiate deposits either by
telephone or by computer.
The new system is phased in over a period of years
by increasing each year the percentage of total
taxes subject to the new EFTPS system. For fiscal
year 1994, 3 percent of the total taxes are required
to be made by electronic fund transfer. These
percentages increased gradually for fiscal years
1995 and 1996. For fiscal year 1996, the percentage
was 20.1 percent (30 percent for excise taxes and
corporate estimated tax payments). For fiscal year
1997, these percentages increased significantly, to
58.3 percent (60 percent for excise taxes and
corporate estimated tax payments). The specific
implementation method required to achieve the target
percentages is set forth in Treasury regulations.
Implementation began with the largest depositors.
Treasury had originally implemented the 1997
percentages by requiring that all employers who
deposit more than $50,000 in 1995 must begin using
EFTPS by January 1, 1997. The Small Business Job
Protection Act of 1996 provided that the increase in
the required percentages for fiscal year 1997
(which, pursuant to Treasury regulations, was to
take effect on January 1, 1997) will not take effect
until July 1, 1997.55
This was done to provide additional time prior to
implementation of the 1997 requirements so that
employers could be better informed about their
responsibilities.
On June 2, 1997, the
IRS
announced56
that it will not impose penalties through December
31, 1997, on businesses that make timely deposits
using paper federal tax deposit coupons while
converting to the EFTPS system.
Reasons
for Change
The Committee believes that it is necessary to
provide small businesses with additional time prior
to implementation of the requirements so that these
employers may be better informed about their
responsibilities.
Explanation
of Provision
The bill provides that no penalty shall be imposed
solely by reason of a failure to use EFTPS prior to
July 1, 1998
, if the taxpayer was first required to use the
EFTPS system on or after
July 1, 1997
.
Effective
Date
The provision is effective on the date of enactment.
2.
Repeal installment method adjustment for farmers
(sec. 732 of the bill and sec. 56 of the Code)
Present
Law
The installment method allows gain on the sale of
property to be recognized as payments are received.
Under the regular tax, dealers in personal property
are not allowed to defer the recognition of income
by use of the installment method on the installment
sale of such property. For this purpose, dealer
dispositions do not include sales of any property
used or produced in the trade or business of
farming. For alternative minimum tax purposes, the
installment method is not available with respect to
the disposition of any property that is the stock in
trade of the taxpayer or any other property of a
kind which would be properly included in the
inventory of the taxpayer if held at year end, or
property held by the taxpayer primarily for sale to
customers. No explicit exception is provided for
installment sales of farm property under the
alternative minimum tax.
Reasons
for Change
The Committee understands that the Internal Revenue
Service ("
IRS
") takes the position that the installment
method may not be used for sales of property
produced on a farm for alternative minimum tax
purposes. The Committee further understands that the
IRS
has announced that it generally will not enforce
this position for taxable years beginning before
January 1, 1997
, so long as the farmer changes its method of
accounting for installment sales for taxable years
beginning after
December 31, 1996
.57
The Committee disagrees with the
IRS
position and believes that this issue should be
clarified in favor of the farmer.
Explanation
of Provision
The bill generally provides that for purposes of
computing alternative minimum taxable income,
taxpayers may use the installment method of
accounting.
Effective
Date
The provision generally is effective for
dispositions in taxable years beginning after
December 31, 1987
.
E.
Foreign Tax Provisions
1.
Eligibility of licenses of computer software for
foreign sales corporation benefits (sec. 741 of the
bill and sec. 927 of the Code)
Present
Law
Under special tax provisions that provide an export
benefit, a portion of the foreign trade income of an
eligible foreign sales corporation ("FSC")
is exempt from Federal income tax. Foreign trade
income is defined as the gross income of a FSC that
is attributable to foreign trading gross receipts.
The term "foreign trading gross receipts"
includes the gross receipts of a FSC from the sale,
lease, or rental of export property and from
services related and subsidiary to such sales,
leases, or rentals.
For purposes of the FSC rules, export property is
defined as property (1) which is manufactured,
produced, grown, or extracted in the United States
by a person other than a FSC; (2) which is held
primarily for sale, lease, or rental in the ordinary
conduct of a trade or business by or to a FSC for
direct use, consumption, or disposition outside the
United States; and (3) not more than 50 percent of
the fair market value of which is attributable to
articles imported into the United States. Intangible
property generally is excluded from the definition
of export property for purposes of the FSC rules;
this exclusion applies to copyrights other than
films, tapes, records, or similar reproductions for
commercial or home use. The temporary Treasury
regulations provide that a license of a master
recording tape for reproduction outside the United
States is not excluded from the definition of export
property (Treas. Reg. sec. 1.927(a)-1T(f)(3)). The
statutory exclusion for intangible property does not
contain any specific reference to computer software.
However, the temporary Treasury regulations provide
that a copyright on computer software does not
constitute export property, and that standardized,
mass marketed computer software constitutes export
property if such software is not accompanied by a
right to reproduce for external use (Treas. Reg.
sec. 1.927(a)-1T(f)(3)).
Reasons
for Change
For purposes of the FSC provisions, films, tapes,
records and similar reproductions explicitly are
included within the definition of export property.
In light of technological developments, the
Committee believes that computer software is
virtually indistinguishable from the enumerated
films, tapes, and records. Accordingly, the
Committee believes that the benefits of the FSC
provisions similarly should be available to computer
software.
Explanation
of Provision
The bill provides that computer software licensed
for reproduction abroad is not excluded from
the definition of export property for purposes of
the FSC provisions. Accordingly, computer software
that is exported with a right to reproduce is
eligible for the benefits of the FSC provisions. In
light of the rapid innovations in the computer and
software industries, the Committee intends that the
term "computer software" be construed
broadly to accommodate technological changes in the
products produced by both industries. No inference
is intended regarding the qualification as export
property of computer software licensed for
reproduction abroad under present law.
Effective
Date
The provision applies to gross receipts from
computer software licenses attributable to periods
after
December 31, 1997
. Accordingly, in the case of a multi-year license,
the provision applies to gross receipts attributable
to the period of such license that is after
December 31, 1997
.
2.
Regulations to limit treaty benefits for payments to
hybrid entities (sec. 742 of the bill and sec. 894
of the Code)
Present
Law
Nonresident alien individuals and foreign
corporations (collectively, foreign persons) that
are engaged in business in the
United States
are subject to
U.S.
tax on the income from such business in the same
manner as a
U.S.
person. In addition, the
United States
imposes tax on certain types of
U.S.
source income, including interest, dividends and
royalties, of foreign persons not engaged in
business in the
United States
. Such tax is imposed on a gross basis and is
collected through withholding. The statutory rate of
this withholding tax is 30 percent. However, most
U.S.
income tax treaties provide for a reduction in the
rate, or elimination, of this withholding tax.
Treaties generally provide for different applicable
withholding tax rates for different types of income.
Moreover, the applicable withholding tax rates
differ among treaties. The specific withholding tax
rates pursuant to a treaty are the result of
negotiations between the
United States
and the treaty partner.
The application of the withholding tax is more
complicated in the case of income derived through an
entity, such as a limited liability company, that is
treated as a partnership for
U.S.
tax purposes but may be treated as a corporation for
purposes of the tax laws of a treaty partner. The
Treasury regulations include specific rules that
apply in the case of income derived through an
entity that is treated as a partnership for
U.S.
tax purposes. In the case of a payment of an item of
U.S. source income to a U.S. partnership, the
partnership is required to impose the withholding
tax to the extent the item of income is includible
in the distributive share of a partner who is a
foreign person. Tax-avoidance opportunities may
arise in applying the reduced rates of withholding
tax provided under a treaty to cases involving
income derived through a limited liability company
or other hybrid entity (e.g., an entity that is
treated as a partnership for
U.S.
tax purposes but as a corporation for purposes of
the treaty partner's tax laws). Regulations that
have been proposed but not yet finalized would
address certain aspects of this issue in the case of
an item received by a foreign entity by allowing an
interest holder in that entity to claim a reduced
rate of withholding tax with respect to that item
under a treaty only if the treaty partner requires
the interest holder to include in income its
distributive share of the entity's income on a
flow-through basis (Prop. Treas. Reg. Sec.
1.1441-6(b)(4)). This provision in the proposed
regulations does not apply in the case of a
U.S.
entity.
Reasons
for Change
The Committee is concerned about the potential
tax-avoidance opportunities available for foreign
persons that invest in the
United States
through hybrid entities. In particular, the
Committee understands that the interaction of the
tax laws and the applicable tax treaty may provide a
business structuring opportunity that would allow
foreign corporations with
U.S.
subsidiaries to avoid both
U.S.
and foreign income taxes with respect to those
U.S.
operations. The Committee believes that the
Secretary of the Treasury should prescribe
regulations to eliminate such tax-avoidance
opportunities.
Explanation
of Provision
The bill provides that the Secretary of the Treasury
shall prescribe regulations to determine the extent
to which a taxpayer shall be denied benefits under
an income tax treaty of the United States with
respect to any payment received by, or income
attributable to activities of, an entity that is
treated as a partnership for U.S. federal income tax
purposes (or is otherwise treated as fiscally
transparent for such purposes) but is treated as
fiscally non-transparent for purposes of the tax
laws of the jurisdiction of residence of the
taxpayer.
The bill addresses the potential tax-avoidance
opportunity that may arise in applying the reduced
rates of withholding tax provided under a treaty to
cases involving income derived through a limited
liability company or other hybrid entity (e.g., an
entity that is treated as a partnership for U.S. tax
purposes but as a corporation for purposes of the
treaty partner's tax laws). Such a tax-avoidance
opportunity may arise, for example, for Canadian
corporations with
U.S.
subsidiaries because of the interaction between the
U.S.
tax law, the Canadian tax law, and the income tax
treaty between the
United States
and
Canada
. Through the use of a U.S. limited liability
company, which is treated as a partnership for U.S.
tax purposes but as a corporation for Canadian tax
purposes, a payment of interest (which is deductible
for U.S. tax purposes) may be converted into a
dividend (which is excludable for Canadian tax
purposes). Accordingly, interest paid by a U.S.
subsidiary through a U.S. limited liability company
to a Canadian parent corporation would be deducted
by the U.S. subsidiary for U.S. tax purposes and
would be excluded by the Canadian parent corporation
for Canadian tax purposes; the only tax on such
interest would be a U.S. withholding tax, which may
be imposed at a reduced rate of 10 percent (rather
than the full statutory rate of 30 percent) pursuant
to the income tax treaty between the United States
and Canada. It is expected that the regulations will
impose withholding tax at the full statutory rate of
30 percent in such case.
Effective
Date
The provision is effective upon date of enactment.
3.
Treatment of certain securities positions under the
subpart F investment in
U.S.
property rules (sec. 743 of the bill and sec. 956 of
the Code)
Present
Law
Under the rules of subpart F (secs. 951-964), the
U.S. 10-percent shareholders of a controlled foreign
corporation (CFC) are required to include in income
currently for U.S. tax purposes certain earnings of
the CFC, whether or not such earnings are
distributed currently to the shareholders. The
U.S.
10-percent shareholders of a CFC are subject to
current
U.S.
tax on their shares of certain income earned by the
CFC (referred to as "subpart F income").
The
U.S.
10-percent shareholders also are subject to current
U.S.
tax on their shares of the CFC's earnings to the
extent invested by the CFC in certain
U.S.
property.
A shareholder's current income inclusion with
respect to a CFC's investment in
U.S.
property for a taxable year is based on the CFC's
average investment in
U.S.
property for such year. For this purpose, the
U.S.
property held by the CFC must be measured as of the
close of each quarter in the taxable year.
U.S.
property generally is defined to include tangible
property located in the
United States
, stock of a
U.S.
corporation, obligations of a
U.S.
person, and the right to use certain intellectual
property in the
United States
. Exceptions are provided for, among other things,
obligations of the
United States
, U.S. bank deposits, certain trade or business
obligations, and stock or debts of certain unrelated
U.S.
corporations.
Reasons
for Change
The Committee believes that guidance is needed
regarding the treatment of certain transactions
entered into by securities dealers in the ordinary
course of business under the investment in
U.S.
property provisions of subpart F. The Committee
believes that deposits of collateral or margin in
the ordinary course of business should not give rise
to an income inclusion as an investment in
U.S.
property under the provisions of subpart F.
Similarly, the Committee believes that repurchase
agreements entered into in the ordinary course of
business should not give rise to an income inclusion
as an investment in
U.S.
property.
Explanation
of Provision
The bill provides two additional exceptions from the
definition of
U.S.
property for purposes of the subpart F rules. Both
exceptions relate to transactions entered into by a
securities or commodities dealer in the ordinary
course of its business as a securities or
commodities dealer.
The first exception covers the deposit of collateral
or margin by a securities or commodities dealer, or
the receipt of such a deposit by a securities or
commodities dealer, if such deposit is made or
received on commercial terms in the ordinary course
of the dealer's business as a securities or
commodities dealer. This exception applies to
deposits of margin or collateral for securities
loans, notional principal contracts, options
contracts, forward contracts, futures contracts, and
any other financial transaction with respect to
which the Secretary of the Treasury determines that
the posting of collateral or margin is customary.
The second exception covers repurchase agreement
transactions and reverse repurchase agreement
transactions entered into by or with a securities or
commodities dealer in the ordinary course of its
business as a securities or commodities dealer. The
exception applies only to the extent that the
obligation under the transaction does not exceed the
fair market value of readily marketable securities
transferred or otherwise posted as collateral.
Effective
Date
The provision is effective for taxable years of
foreign corporations beginning after
December 31, 1997
, and taxable years of
U.S.
shareholders with or within which such taxable years
of foreign corporations end.
4.
Exception from foreign personal holding company
income under subpart F for active financing income
(sec. 744 of the bill and sec. 954 of the Code)
Present
Law
Under the subpart F rules, certain
U.S.
shareholders of a controlled foreign corporation
("CFC") are subject to
U.S.
tax currently on certain income earned by the CFC,
whether or not such income is distributed to the
shareholders. The income subject to current
inclusion under the subpart F rules includes, among
other things, "foreign personal holding company
income" and insurance income. The
U.S.
10-percent shareholders of a CFC also are subject to
current inclusion with respect to their shares of
the CFC's foreign base company services income
(i.e., income derived from services performed for a
related person outside the country in which the CFC
is organized).
Foreign personal holding company income generally
consists of the following: dividends, interest,
royalties, rents and annuities; net gains from sales
or exchanges of (1) property that gives rise to the
preceding types of income, (2) property that does
not give rise to income, and (3) interests in
trusts, partnerships, and REMICs; net gains from
commodities transactions; net gains from foreign
currency transactions; and income that is equivalent
to interest.
Insurance income subject to current inclusion under
the subpart F rules includes any income of a CFC
attributable to the issuing or reinsuring of any
insurance or annuity contract in connection with
risks located in a country other than the CFC's
country of organization. Subpart F insurance income
also includes income attributable to an insurance
contract in connection with risks located within the
CFC's country of organization, as the result of an
arrangement under which another corporation receives
a substantially equal amount of consideration for
insurance of other-country risks. Investment income
of a CFC that is allocable to any insurance or
annuity contract related to risks located outside
the CFC's country of organization is taxable as
subpart F insurance income (Prop. Treas. reg. sec.
1.953-1(a)). Investment income allocable to risks
located within the CFC's country of organization
generally is taxable as foreign personal holding
company income.
Reasons
for Change
The subpart F rules historically have been aimed at
requiring current inclusion by the
U.S.
shareholders of income of a CFC that is either
passive or easily movable. Prior to the enactment of
the 1986 Act, exceptions from foreign personal
holding company income were provided for income
derived in the conduct of a banking, financing, or
similar business or derived from certain investments
made by an insurance company. The Committee is
concerned that the 1986 Act's repeal of these
exceptions has resulted in the extension of the
subpart F provisions to income that is neither
passive nor easily moveable. The Committee believes
that the provision of exceptions from foreign
personal holding company income for income from the
active conduct of an insurance, banking, financing
or similar business is appropriate.
Explanation
of Provision
The bill provides a temporary exception from foreign
personal holding company income for subpart F
purposes for certain income that is derived in the
active conduct of an insurance, banking, financing
or similar business. Such exception is applicable
only for taxable years beginning in 1998.
Under the bill, foreign personal holding company
income does not include income that is derived in or
incident to the active conduct of a banking,
financing or similar business by a CFC that is
predominantly engaged in the active conduct of such
business. For this purpose, income derived in the
active conduct of a banking, financing, or similar
business generally is determined under the
principles applicable in determining financial
services income for foreign tax credit limitation
purposes. Moreover, the Secretary of the Treasury
shall prescribe regulations applying look-through
treatment in characterizing for this purpose
dividends, interest, income equivalent to interest,
rents, and royalties from related persons. A CFC is
considered to be predominantly engaged in the active
conduct of a banking, financing, or similar business
if (1) more than 70 percent of its gross income is
derived from transactions with unrelated persons and
more than 20 percent of its gross income from that
business is derived from transactions with unrelated
persons located within the country in which the CFC
is organized or incorporated, or (2) the CFC is
predominantly engaged in the active conduct of a
banking or securities business, or is a qualified
bank or securities affiliate, as defined for
purposes of the passive foreign investment company
provisions.
Under the bill, foreign personal holding company
income also does not include certain investment
income of a qualifying insurance company with
respect to risks located within the CFC's country of
organization. These exceptions apply to income
derived from investments of assets equal to the
total of (1) unearned premiums and reserves ordinary
and necessary for the proper conduct of the CFC's
insurance business, (2) one-third of premiums earned
during the taxable year on insurance contracts
regulated in the country in which sold as property,
casualty, or health insurance contracts, and (3) the
greater of $10 million or 10 percent of reserves for
insurance contracts regulated in the country in
which sold as life insurance or annuity contracts.
For this purpose, a qualifying insurance company is
an entity that is subject to regulation as an
insurance company under the laws of its country of
incorporation and that realizes at least 50 percent
of its gross income (other than income from
investments) from premiums related to risks located
within such country. The bill's exceptions for
insurance investment income do not apply to
investment income which is received by the CFC from
a related person. Similarly, the exceptions do not
apply to investment income that is attributable
directly or indirectly to the insurance or
reinsurance of risks of related persons. The bill
does not change the rule of present law that
investment income of a CFC that is attributable to
the issuing or reinsuring any insurance or annuity
contract related to risks outside of its country of
organization is taxable as Subpart F insurance
income.
The bill also provides an exception from foreign
base company services income for income derived from
services performed in connection with the active
conduct of a banking, financing, insurance or
similar business by a CFC that is predominantly
engaged in the active conduct of such business.
Effective
Date
The provision applies only to taxable years of
foreign corporations beginning in 1998, and to
taxable years of
United States
shareholders with or within which such taxable years
of foreign corporations end.
5.
Treat service income of nonresident alien
individuals earned on foreign ships as foreign
source income and disregard the
U.S.
presence of such individuals (sec. 745 of the bill
and secs. 861, 863, 872, 3401, and 7701 of the Code)
Present
Law
Nonresident alien individuals generally are subject
to
U.S.
taxation and withholding on their
U.S.
source income. Compensation for labor and personal
services performed within the
United States
is considered
U.S.
source unless such income qualifies for a de minimis
exception. To qualify for the exception, the
compensation paid to a nonresident alien individual
must not exceed $3,000, the compensation must
reflect services performed on behalf of a foreign
employer, and the individual must be present in the
United Sates for not more than 90 days during the
taxable year. Special rules apply to exclude certain
items from the gross income of a nonresident alien.
An exclusion applies to gross income derived by a
nonresident alien individual from the international
operation of a ship if the country in which such
individual is resident provides a reciprocal
exemption for
U.S.
residents. However, this exclusion does not apply to
income from personal services performed by an
individual crew member on board a ship.
Consequently, wages exceeding $3,000 in a taxable
year that are earned by nonresident alien individual
crew members of a foreign ship while the vessel is
within U.S. territory are subject to income taxation
by the United States.
U.S.
residents are subject to
U.S.
tax on their worldwide income. In general, a non-U.S.
citizen is considered to be a resident of the United
States if the individual (1) has entered the United
States as a lawful permanent U.S. resident or (2) is
present in the United States for 31 or more days
during the current calendar year and has been
present in the United States for a substantial
period of time --183 or more days --during a
three-year period computed by weighting toward the
present year (the "substantial presence
test"). An individual generally is treated as
present in the
United States
on any day if such individual is physically present
in the
United States
at any time during the day. Certain categories of
individuals (e.g., foreign government employees and
certain students) are not treated as
U.S.
residents even if they are present in the
United States
for the requisite period of time. Crew members of a
foreign vessel who are on board the vessel while it
is stationed within
U.S.
territorial waters are treated as present in the
United States
.
Reasons
for Change
The Committee understands that
U.S.
tax rules impose a significant compliance burden on
nonresident alien individuals who are present in the
United States
for short periods of time as members of the regular
crew of a foreign vessel and who may not be
permitted to leave such vessel during those periods.
The Committee believes that an exemption from
U.S.
tax is appropriate for the income earned by a
nonresident alien individual from personal services
performed as a member of the regular crew of a
foreign vessel. Moreover, the Committee believes
that such an individual's presence in the
United States
as a regular crew member of a foreign vessel should
not be taken into account for purposes of
determining whether the individual is treated as a
resident alien for
U.S.
tax purposes.
Explanation
of Provision
The bill treats gross income of a nonresident alien
individual, who is present in the
United States
as a member of the regular crew of a foreign vessel,
from the performance of personal services in
connection with the international operation of a
ship as income from foreign sources. Thus, such
income is exempt from
U.S.
income and withholding tax. However, such persons
are not excluded for purposes of applying the
minimum participation standards of section 410 to a
plan of the employer. In addition, for purposes of
determining whether an individual is a
U.S.
resident under the substantial presence test, the
bill provides that the days that such individual is
present as a member of the regular crew of a foreign
vessel are disregarded.
Effective
Date
The provision is effective for taxable years
beginning after
December 31, 1997
.
6.
Modification of passive foreign investment company
provisions to eliminate overlap with subpart F and
to allow mark-to-market election (secs. 751-753 of
the bill and secs. 1291-1297 of the Code)
Present
Law
Overview
U.S. citizens and residents and U.S. corporations
(collectively, "U.S. persons") are taxed
currently by the United States on their worldwide
income, subject to a credit against U.S. tax on
foreign income based on foreign income taxes paid
with respect to such income. A foreign corporation
generally is not subject to
U.S.
tax on its income from operations outside the
United States
.
Income of a foreign corporation generally is taxed
by the
United States
when it is repatriated to the
United States
through payment to the corporation's
U.S.
shareholders, subject to a foreign tax credit.
However, a variety of regimes imposing current
U.S.
tax on income earned through a foreign corporation
have been reflected in the Code. Today the principal
anti-deferral regimes set forth in the Code are the
controlled foreign corporation rules of subpart F (secs.
951-964) and the passive foreign investment company
rules (secs. 1291-1297). Additional anti-deferral
regimes set forth in the Code are the foreign
personal holding company rules (secs. 551-558); the
personal holding company rules (secs. 541-547); the
accumulated earnings tax (secs. 531-537); and the
foreign investment company and electing foreign
investment company rules (secs. 1246-1247). The
anti-deferral regimes included in the Code overlap
such that a given taxpayer may be subject to
multiple sets of anti-deferral rules.
Controlled
foreign corporations
A controlled foreign corporation (CFC) is defined
generally as any foreign corporation if U.S. persons
own more than 50 percent of the corporation's stock
(measured by vote or value), taking into account
only those U.S. persons that own at least 10 percent
of the stock (measured by vote only) (sec. 957).
Stock ownership includes not only stock owned
directly, but also stock owned indirectly or
constructively (sec. 958).
Certain income of a CFC (referred to as
"subpart F income") is subject to current
U.S.
tax. The
United States
generally taxes the
U.S.
10-percent shareholders of a CFC currently on their
pro rata shares of the subpart F income of the CFC.
In effect, the Code treats those
U.S.
shareholders as having received a current
distribution out of the CFC's subpart F income. Such
shareholders also are subject to current
U.S.
tax on their pro rata shares of the CFC's earnings
invested in
U.S.
property. The foreign tax credit may reduce the
U.S.
tax on these amounts.
Passive
foreign investment companies
The Tax Reform Act of 1986 established an
anti-deferral regime for passive foreign investment
companies (PFICs). A PFIC is any foreign corporation
if (1) 75 percent or more of its gross income for
the taxable year consists of passive income, or (2)
50 percent or more of the average fair market value
of its assets consists of assets that produce, or
are held for the production of, passive income. Two
alternative sets of income inclusion rules apply to
U.S.
persons that are shareholders in a PFIC. One set of
rules applies to PFICs that are "qualified
electing funds," under which electing
U.S.
shareholders include currently in gross income their
respective shares of the PFIC's total earnings, with
a separate election to defer payment of tax, subject
to an interest charge, on income not currently
received. The second set of rules applies to PFICs
that are not qualified electing funds
("nonqualified funds"), under which the
U.S.
shareholders pay tax on income realized from the
PFIC and an interest charge that is attributable to
the value of deferral.
Overlap
between subpart F and the PFIC provisions
A foreign corporation that is a CFC is also a PFIC
if it meets the passive income test or the passive
asset test described above. In such a case, the
10-percent U.S. shareholders are subject both to the
subpart F provisions (which require current
inclusion of certain earnings of the corporation)
and to the PFIC provisions (which impose an interest
charge on amounts distributed from the corporation
and gains recognized upon the disposition of the
corporation's stock, unless an election is made to
include currently all of the corporation's
earnings).
Reasons
for Change
The anti-deferral rules for
U.S.
persons owning stock in foreign corporations are
very complex. Moreover, the interactions between the
anti-deferral regimes cause additional complexity.
The overlap between the subpart F rules and the PFIC
provisions is of particular concern to the
Committee. The PFIC provisions, which do not require
a threshold level of ownership by
U.S.
persons, apply where the U.S.-ownership requirements
of subpart F are not satisfied. However, the PFIC
provisions also apply to a
U.S.
shareholder that is subject to the current inclusion
rules of subpart F with respect to the same
corporation. The Committee believes that the
additional complexity caused by this overlap is
unnecessary.
The Committee also understands that the
interest-charge method for income inclusion provided
in the PFIC rules is a substantial source of
complexity for shareholders of PFICs. Even without
eliminating the interest-charge method, significant
simplification can be achieved by providing an
alternative income inclusion method for shareholders
of PFICs. Further, some taxpayers have argued that
they would have preferred choosing the
current-inclusion method afforded by the qualified
fund election, but were unable to do so because they
could not obtain the necessary information from the
PFIC. Accordingly, the Committee believes that a
mark-to-market election would provide PFIC
shareholders with a fair alternative method for
including income with respect to the PFIC.
Explanation
of Provision
Elimination
of overlap between subpart F and the PFIC provisions
In the case of a PFIC that is also a CFC, the bill
generally treats the corporation as not a PFIC with
respect to certain 10-percent shareholders. This
rule applies if the corporation is a CFC (within the
meaning of section 957(a)) and the shareholder is a
U.S. shareholder (within the meaning of section
951(b)) of such corporation (i.e., if the
shareholder is subject to the current inclusion
rules of subpart F with respect to such
corporation). Moreover, the rule applies for that
portion of the shareholder's holding period with
respect to the corporation's stock which is after
December 31, 1997 and during which the corporation
is a CFC and the shareholder is a
U.S.
shareholder. Accordingly, a shareholder that is
subject to current inclusion under the subpart F
rules with respect to stock of a PFIC that is also a
CFC generally is not subject also to the PFIC
provisions with respect to the same stock. The PFIC
provisions continue to apply in the case of a PFIC
that is also a CFC to shareholders that are not
subject to subpart F (i.e., to shareholders that are
U.S. persons and that own (directly, indirectly, or
constructively) less than 10 percent of the
corporation's stock by vote).
If a shareholder of a PFIC is subject to the rules
applicable to nonqualified funds before becoming
eligible for the special rules provided under the
proposal for shareholders that are subject to
subpart F, the stock held by such shareholder
continues to be treated as PFIC stock unless the
shareholder makes an election to pay tax and an
interest charge with respect to the unrealized
appreciation in the stock or the accumulated
earnings of the corporation.
If, under the bill, a shareholder is not subject to
the PFIC provisions because the shareholder is
subject to subpart F and the shareholder
subsequently ceases to be subject to subpart F with
respect to the corporation, for purposes of the PFIC
provisions, the shareholder's holding period for
such stock is treated as beginning immediately after
such cessation. Accordingly, in applying the rules
applicable to PFICs that are not qualified electing
funds, the earnings of the corporation are not
attributed to the period during which the
shareholder was subject to subpart F with respect to
the corporation and was not subject to the PFIC
provisions.
Mark-to-market
election
The bill allows a shareholder of a PFIC to make a
mark-to-market election with respect to the stock of
the PFIC, provided that such stock is marketable (as
defined below). Under such an election, the
shareholder includes in income each year an amount
equal to the excess, if any, of the fair market
value of the PFIC stock as of the close of the
taxable year over the shareholder's adjusted basis
in such stock. The shareholder is allowed a
deduction for the excess, if any, of the adjusted
basis of the PFIC stock over its fair market value
as of the close of the taxable year. However,
deductions are allowable under this rule only to the
extent of any net mark-to-market gains with respect
to the stock included by the shareholder for prior
taxable years.
Under the bill, this mark-to-market election is
available only for PFIC stock that is
"marketable." For this purpose, PFIC stock
is considered marketable if it is regularly traded
on a national securities exchange that is registered
with the Securities and Exchange Commission or on
the national market system established pursuant to
section 11A of the Securities and Exchange Act of
1934. In addition, PFIC stock is considered
marketable if it is regularly traded on any exchange
or market that the Secretary of the Treasury
determines has rules sufficient to ensure that the
market price represents a legitimate and sound fair
market value. Any option on stock that is considered
marketable under the foregoing rules is treated as
marketable, to the extent provided in regulations.
PFIC stock also is treated as marketable, to the
extent provided in regulations, if the PFIC offers
for sale (or has outstanding) stock of which it is
the issuer and which is redeemable at its net asset
value in a manner comparable to a U.S. regulated
investment company (
RIC
).
In addition, the bill treats as marketable any PFIC
stock owned by a
RIC
that offers for sale (or has outstanding) any stock
of which it is the issuer and which is redeemable at
its net asset value. The bill treats as marketable
any PFIC stock held by any other
RIC
that otherwise publishes net asset valuations at
least annually, except to the extent provided in
regulations. It is believed that even for RICs that
do not make a market in their own stock, but that do
regularly report their net asset values in
compliance with the securities laws, inaccurate
valuation may bring exposure to legal liabilities,
and this exposure may ensure the reliability of the
values such RICs assign to the PFIC stock they hold.
The shareholder's adjusted basis in the PFIC stock
is adjusted to reflect the amounts included or
deducted under this election. In the case of stock
owned indirectly by a U.S. person through a foreign
entity (as discussed below), the basis adjustments
for mark-to-market gains and losses apply to the
basis of the PFIC in the hands of the intermediary
owner, but only for purposes of the subsequent
application of the PFIC rules to the tax treatment
of the indirect U.S. owner. In addition, similar
basis adjustments are made to the adjusted basis of
the property actually held by the
U.S.
person by reason of which the
U.S.
person is treated as owning PFIC stock.
Amounts included in income pursuant to a
mark-to-market election, as well as gain on the
actual sale or other disposition of the PFIC stock,
is treated as ordinary income. Ordinary loss
treatment also applies to the deductible portion of
any mark-to-market loss on PFIC stock, as well as to
any loss realized on the actual sale or other
disposition of PFIC stock to the extent that the
amount of such loss does not exceed the net
mark-to-market gains previously included with
respect to such stock. The source of amounts with
respect to a mark-to-market election generally is
determined in the same manner as if such amounts
were gain or loss from the sale of stock in the PFIC.
An election to mark to market applies to the taxable
year for which made and all subsequent taxable
years, unless the PFIC stock ceases to be marketable
or the Secretary of the Treasury consents to the
revocation of such election.
Under constructive ownership rules,
U.S.
persons that own PFIC stock through certain foreign
entities may make this election with respect to the
PFIC. These constructive ownership rules apply to
treat PFIC stock owned directly or indirectly by or
for a foreign partnership, trust, or estate as owned
proportionately by the partners or beneficiaries,
except as provided in regulations. Stock in a PFIC
that is thus treated as owned by a person is treated
as actually owned by that person for purposes of
again applying the constructive ownership rules. In
the case of a U.S. person that is treated as owning
PFIC stock by application of this constructive
ownership rule, any disposition by the U.S. person
or by any other person that results in the U.S.
person being treated as no longer owning the PFIC
stock, as well as any disposition by the person
actually owning the PFIC stock, is treated as a
disposition by the U.S. person of the PFIC stock.
In addition, a CFC that owns stock in a PFIC is
treated as a
U.S.
person that may make the election with respect to
such PFIC stock. Any amount includible (or
deductible) in the CFC's gross income pursuant to
this mark-to-market election is treated as foreign
personal holding company income (or a deduction
allocable to foreign personal holding company
income). The source of such amounts, however, is
determined by reference to the actual residence of
the CFC.
In the case of a taxpayer that makes the
mark-to-market election with respect to stock in a
PFIC that is a nonqualified fund after the beginning
of the taxpayer's holding period with respect to
such stock, a coordination rule applies to ensure
that the taxpayer does not avoid the interest charge
with respect to amounts attributable to periods
before such election. A similar rule applies to RICs
that make the mark-to-market election under this
bill after the beginning of their holding period
with respect to PFIC stock (to the extent that the
RIC
had not previously marked to market the stock of the
PFIC).
Except as provided in the coordination rules
described above, the rules of section 1291 (with
respect to nonqualified funds) do not apply to a
shareholder of a PFIC if a mark-to-market election
is in effect for the shareholder's taxable year.
Moreover, in applying section 1291 in a case where a
mark-to-market election was in effect for any prior
taxable year, the shareholder's holding period for
the PFIC stock is treated as beginning immediately
after the last taxable year for which such election
applied.
A special rule applicable in the case of a PFIC
shareholder that becomes a U.S. person treats the
adjusted basis of any PFIC stock held by such person
on the first day of the year in which such
shareholder becomes a U.S. person as equal to the
greater of its fair market value on such date or its
adjusted basis on such date. Such rule applies only
for purposes of the mark-to-market election.
Effective
Date
The provision is effective for taxable years of
U.S.
persons beginning after
December 31, 1997
, and taxable years of foreign corporations ending
with or within such taxable years of
U.S.
persons.
F.
Other Provisions
1.
Tax-exempt status for certain State workmen's
compensation act companies (sec. 761 of the bill and
sec. 501(c)(27) of the Code)
Present
Law
In general, the Internal Revenue Service ("
IRS
") takes the position that organizations that
provide insurance for their members or other
individuals are not considered to be engaged in a
tax-exempt activity. The
IRS
maintains that such insurance activity is either (1)
a regular business of a kind ordinarily carried on
for profit, or (2) an economy or convenience in the
conduct of members' businesses because it relieves
the members from obtaining insurance on an
individual basis.
Certain insurance risk pools have qualified for tax
exemption under Code section 501(c)(6). In general,
these organizations (1) assign any insurance
policies and administrative functions to their
member organizations (although they may reimburse
their members for amounts paid and expenses); (2)
serve an important common business interest of their
members; and (3) must be membership organizations
financed, at least in part, by membership dues.
State insurance risk pools may also qualify for tax
exempt status under section 501(c)(4) as a social
welfare organizations or under section 115 as
serving an essential governmental function of a
State. In seeking qualification under section
501(c)(4), insurance organizations generally are
constrained by the restrictions on the provision of
"commercial-type insurance" contained in
section 501(m). Section 115 generally provides that
gross income does not include income derived from
the exercise of any essential governmental function
and accruing to a State or any political subdivision
thereof.
Reasons
for Change
The Committee believes that eliminating uncertainty
concerning the eligibility of certain State
workmen's compensation act companies for tax-exempt
status will assist States in ensuring that workmen's
compensation coverage is provided for employers with
respect to employees in the State. While tax
exemption may be available under present law for
many of these entities, the Committee believes that
it is appropriate to clarify standards for
tax-exempt status.
Explanation
of Provision
The bill clarifies the tax-exempt status of any
organization that is created by State law, and
organized and operated exclusively to provide
workmen's compensation insurance and related
coverage that is incidental to workmen's
compensation insurance,58
and that meets certain additional requirements. The
workmen's compensation insurance must be required by
State law, or be insurance with respect to which
State law provides significant disincentives if it
is not purchased by an employer (such as loss of
exclusive remedy or forfeiture of affirmative
defenses such as contributory negligence). The
organization must provide workmen's compensation to
any employer in the State (for employees in the
State or temporarily assigned out-of-State) seeking
such insurance and meeting other reasonable
requirements. The State must either extend its full
faith and credit to debt of the organization or
provide the initial operating capital of such
organization. For this purpose, the initial
operating capital can be provided by providing the
proceeds of bonds issued by a State authority; the
bonds may be repaid through exercise of the State's
taxing authority, for example. For periods after the
date of enactment, the assets of the organization
must revert to the State upon dissolution. Finally,
the majority of the board of directors (or
comparable oversight body) of the organization must
be appointed by an official of the executive branch
of the State or by the State legislature, or by
both.
Effective
Date
The provision is effective for taxable years
beginning after
December 31, 1997
. Many organizations described in the provision have
been operating as tax-exempt organizations. No
inference is intended that organizations described
in the provision are not tax-exempt under present
law.
2.
Election to continue exception from treatment of
publicly traded partnerships as corporations (sec.
762 of the bill and sec. 7704 of the Code)
Present
Law
A publicly traded partnership generally is treated
as a corporation for Federal tax purposes (sec.
7704). An exception to the rule treating the
partnership as a corporation applies if 90 percent
of the partnership's gross income consists of
"passive-type income," which includes (1)
interest (other than interest derived in a financial
or insurance business, or certain amounts determined
on the basis of income or profits), (2) dividends,
(3) real property rents (as defined for purposes of
the provision), (4) gain from the sale or other
disposition of real property, (5) income and gains
relating to minerals and natural resources (as
defined for purposes of the provision), and (6) gain
from the sale or disposition of a capital asset (or
certain trade or business property) held for the
production of income of the foregoing types (subject
to an exception for certain commodities income).
The exception for publicly traded partnerships with
"passive-type income" does not apply to
any partnership that would be described in section
851(a) of the Code (relating to regulated investment
companies, or "RICs"), if that partnership
were a domestic corporation. Thus, a publicly traded
partnership that is registered under the Investment
Company Act of 1940 generally is treated as a
corporation under the provision. Nevertheless, if a
principal activity of the partnership consists of
buying and selling of commodities (other than
inventory or property held primarily for sale to
customers) or futures, forwards and options with
respect to commodities, and 90 percent of the
partnership's income is such income, then the
partnership is not treated as a corporation.
A publicly traded partnership is a partnership whose
interests are (1) traded on an established
securities market, or (2) readily tradable on a
secondary market (or the substantial equivalent
thereof).
Treasury regulations provide detailed guidance as to
when an interest is treated as readily tradable on a
secondary market or the substantial equivalent.
Generally, an interest is so treated "if,
taking into account all of the facts and
circumstances, the partners are readily able to buy,
sell, or exchange their partnership interests in a
manner that is comparable, economically, to trading
on an established securities market" (Treas.
Reg. sec. 1.7704-1(c)(1)).
When the publicly traded partnership rules were
enacted in 1987, a 10-year grandfather rule provided
that the provisions apply to certain existing
partnerships only for taxable years beginning after
December 31, 1997.59
An existing publicly traded partnership is any
partnership, if (1) it was a publicly traded
partnership on December 17, 1987, (2) a registration
statement indicating that the partnership was to be
a publicly traded partnership was filed with the
Securities and Exchange Commission with respect to
the partnership on or before December 17, 1987, or
(3) with respect to the partnership, an application
was filed with a State regulatory commission on or
before December 31, 1987, seeking permission to
restructure a portion of a corporation as a publicly
traded partnership. A partnership that otherwise
would be treated as an existing publicly traded
partnership ceases to be so treated as of the first
day after December 17, 1987, on which there has been
an addition of a substantial new line of business
with respect to such partnership. A rule is provided
to coordinate this grandfather rule with the
exception to the rule treating the partnership as a
corporation applies if 90 percent of the
partnership's gross income consists of passive-type
income. The coordination rule provides that
passive-type income exception applies only after the
grandfather rule ceases to apply (whether by passage
of time or because the partnership ceases to qualify
for the grandfather rule).
Reasons
for Change
The Committee believes that, in important respects,
publicly traded partnerships generally resemble
corporations and should be subject to tax as
corporations, so long as the current corporate
income tax applies to corporate entities.
Nevertheless, in the case of certain publicly traded
partnerships that were existing on
December 17, 1987
, and that are treated as partnerships under the
grandfather rule until
December 31, 1997
, it is appropriate to permit the continuation of
their status as partnerships, so long as they elect
to be subject to a tax that is intended to
approximate the corporate tax they would pay if they
were treated as corporations for Federal tax
purposes.
Explanation
of Provision
In the case of an existing publicly traded
partnership that elects under the provision to be
subject to a tax on gross income from the active
conduct of a trade or business, the rule of present
law treating a publicly traded partnership as a
corporation does not apply. An existing publicly
traded partnership is any publicly traded
partnership that is not treated as a corporation, so
long as such treatment is not determined under the
passive-type income exception of Code section
7704(c)(1). The election to be subject to the tax on
gross trade or business income, once made, remains
in effect until revoked by the partnership, and
cannot be reinstated.
The tax is 3.5 percent of the partnership's gross
income from the active conduct of a trade or
business. The partnership's gross trade or business
income includes its share of gross trade or business
income of any lower-tier partnership. The tax
imposed under the provision may not be offset by tax
credits.
Effective
Date
The provision is effective for taxable years
beginning after
December 31, 1997
.
3.
Exclusion from UBIT for certain corporate
sponsorship payments (sec. 763 of the bill and sec.
513 of the Code)
Present
Law
Although generally exempt from Federal income tax,
tax-exempt organizations are subject to the
unrelated business income tax ("UBIT") on
income derived from a trade or business regularly
carried on that is not substantially related to the
performance of the organization's tax-exempt
functions (secs. 511-514). Contributions or gifts
received by tax-exempt organizations generally are
not subject to the UBIT. However, present-law
section 513(c) provides that an activity (such as
advertising) does not lose its identity as a
separate trade or business merely because it is
carried on within a larger complex of other
endeavors.60
If a tax-exempt organization receives sponsorship
payments in connection with an event or other
activity, the solicitation and receipt of such
sponsorship payments may be treated as a separate
activity. The Internal Revenue Service (
IRS
) has taken the position that, under some
circumstances, such sponsorship payments are subject
to the UBIT.61
Reasons
for Change
In order to reduce the uncertainty regarding the
treatment for UBIT purposes of corporate sponsorship
payments received by tax-exempt organizations, the
Committee believes that it is appropriate to
distinguish sponsorship payments for which the donor
receives no substantial return benefit other than
the use or acknowledgment of the donor's name or
logo as part of a sponsored event (which should not
be subject to the UBIT) from payments made in
exchange for advertising provided by the recipient
organization (which should be subject to the UBIT).
Explanation
of Provision
Under the bill, qualified sponsorship payments
received by a tax-exempt organization (or
State college
or university described in section 511(a)(2)(B)) are
exempt from the UBIT.
"Qualified sponsorship payments" are
defined as any payment made by a person engaged in a
trade or business with respect to which the person
will receive no substantial return benefit other
than the use or acknowledgment of the name or logo
(or product lines) of the person's trade or business
in connection with the organization's activities.62
Such a use or acknowledgment does not include
advertising of such person's products or services
--meaning qualitative or comparative language, price
information or other indications of savings or
value, or an endorsement or other inducement to
purchase, sell, or use such products or services.
Thus, for example, if, in return for receiving a
sponsorship payment, an organization promises to use
the sponsor's name or logo in acknowledging the
sponsor's support for an educational or fundraising
event conducted by the organization, such payment
will not be subject to the UBIT. In contrast, if the
organization provides advertising of a sponsor's
products, the payment made to the organization by
the sponsor in order to receive such advertising
will be subject to the UBIT (provided that the
other, present-law requirements for UBIT liability
are satisfied).
The bill specifically provides that a qualified
sponsorship payment does not include any payment
where the amount of such payment is contingent, by
contract or otherwise, upon the level of attendance
at an event, broadcast ratings, or other factors
indicating the degree of public exposure to an
activity. However, the fact that a sponsorship
payment is contingent upon an event actually taking
place or being broadcast, in and of itself, will not
cause the payment to fail to be a qualified
sponsorship payment. Moreover, mere distribution or
display of a sponsor's products by the sponsor or
the tax-exempt organization to the general public at
a sponsored event, whether for free or for
remuneration, will be considered to be "use or
acknowledgment" of the sponsor's product lines
(as opposed to advertising), and thus will not
affect the determination of whether a payment made
by the sponsor is a qualified sponsorship payment.
The provision does not apply to the sale of
advertising or acknowledgments in tax-exempt
organization periodicals. For this purpose, the term
"periodical" means regularly scheduled and
printed material published by (or on behalf of) the
payee organization that is not related to and
primarily distributed in connection with a specific
event conducted by the payee organization. For
example, the provision will not apply to payments
that lead to acknowledgments in a monthly journal,
but will apply if a sponsor receives an
acknowledgment in a program or brochure distributed
at a sponsored event.
The provision specifically provides that, to the
extent that a portion of a payment would (if made as
a separate payment) be a qualified sponsorship
payment, such portion of the payment will be treated
as a separate payment. Thus, if a sponsorship
payment made to a tax-exempt organization entitles
the sponsor to both product advertising and
use or acknowledgment of the sponsor's name or logo
by the organization, then the UBIT will not apply to
the amount of such payment that exceeds the fair
market value of the product advertising provided to
the sponsor. Moreover, the provision of facilities,
services or other privileges by an exempt
organization to a sponsor or the sponsor's designees
(e.g., complimentary tickets, pro-am playing spots
in golf tournaments, or receptions for major donors)
in connection with a sponsorship payment will not
affect the determination of whether the payment is a
qualified sponsorship payment. Rather, the provision
of such goods or services will be evaluated as a
separate transaction in determining whether the
organization has unrelated business taxable income
from the event. In general, if such services or
facilities do not constitute a substantial return
benefit or if the provision of such services or
facilities is a related business activity, then the
payments attributable to such services or facilities
will not be subject to the UBIT. Moreover, just as
the provision of facilities, services or other
privileges by a tax-exempt organization to a sponsor
or the sponsor's designees (complimentary tickets,
pro-am playing spots in golf tournaments, or
receptions for major donors) will be treated as a
separate transaction that does not affect the
determination of whether a sponsorship payment is a
qualified sponsorship payment, a sponsor's receipt
of a license to use an intangible asset (e.g.,
trademark, logo, or designation) of the tax-exempt
organization likewise will be treated as separate
from the qualified sponsorship transaction in
determining whether the organization has unrelated
business taxable income.
The exemption provided by the provision will be in
addition to other present-law exceptions from the
UBIT (e.g., the exceptions for activities
substantially all the work for which is performed by
volunteers and for activities not regularly carried
on). No inference is intended as to whether any
sponsorship payment received prior to 1998 was
subject to the UBIT.
Effective
Date
The provision applies to qualified sponsorship
payments solicited or received after
December 31, 1997
.
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