The IRS issued proposed regulations (REG-125734-16) that provide guidance related to registration-required obligations that are registered in form.
A registration-required obligation is defined in Section 163(f)(2) to mean any obligation other than:
(i) an obligation issued by a natural person;
(ii) an obligation not of a type offered to the public; or
(iii) an obligation that has a maturity (at issue) of not more than one year.
The classification of a registration-required obligation that is not in “registered form” may have significant tax implications under several Code provisions. These provisions include: (i) Section 163(f), which provides no deduction for interest on such an obligation; (ii) Section 149(a), which provides that interest is not exempt from tax on such an obligation if it would be otherwise; (iii) Section 4701, which imposes an excise tax on such an obligation; (iv) Section 312(m), which provides that earnings and profits is not decreased by interest paid on such an obligation; (v) Section 165(j), which denies a loss to the holder on such an obligation; and (vi) Section 1287, which provides that a holder’s gain on the sale of such an obligation is ordinary income.
Sections 871(h) and 881(c) also exempt certain portfolio interest from U.S. tax only if such interest is from an obligation that is in registered in form.
The proposed regulations clarify the definition of a registration-required obligation. Specifically, the proposed regulations stipulate that an obligation is not of a type offered to the public unless the obligation is traded on an established market as determined under Treas. Reg. Sec. 1.1273-2(f) without regard to Treas. Reg. Sec. 1.1273-2(f)(6). The definition of registration-required obligation generally applies to obligations issued after March 18, 2012, but the definition of an “obligation not of a type offered to the public” applies to obligations issued after the adoption of final regulations.
The proposed regulations also provide guidance for when a pass-through certificate (an instrument evidencing an interest in a grantor trust, or similar fund, which principally holds debt instruments), a participation interest (an ownership interest in some or all of one or more obligations) and a regular interest in a REMIC as defined in Sections 860D and 860G, each constitute registration-required obligations. . These rules apply to pass-through certificates, participation interests and regular interests in REMICs issued after the adoption of final regulations.
The proposed regulations also clarify when an obligation is in registered form. The definition of registered form is currently provided in Treas. Reg. Sec. 5f.103-1(c). Since the publication of Treas. Reg. Sec. 5f.103-1, market practices have changed with respect to how interests in obligations are recorded and transferred. The proposed regulations, if finalized, will relocate the definition to Treas. Reg. Sec. 1.163-5, and will modify the current definition to provide when an obligation is in registered form if recorded in an electronic register maintained by the issuer, its agent, or a clearing organization.
The definition of registered form will generally apply to obligations issued after March 18, 2012. However, taxpayers may apply the rules of section 3 of Notice 2012-20 for obligations issued prior to the adoption of final regulations.
Partner, Washington National Tax Office
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Partner, Washington National Tax Office
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