IRS Revenue Ruling
1997-39

Code Secs. 475, 446, 475, 7805

<<FULL TEXT>>

26 CFR 1.475(b)-2: Exemptions -- identification requirements.
(Also sections 446, 475, 7805; 1.446-1, 1.475(c)-1, 301.7805-1.)

Mark-to-market accounting method for dealers in securities. This ruling
provides guidance to enable taxpayers to comply with the mark-to-market
requirements of section 475 of the Code. Rev. Ruls. 94-7 and 93-76
clarified, modified, partially obsoleted, and superseded.


REV. RUL. 97-39

PURPOSE

This revenue ruling provides guidance under section 475 of the Internal
Revenue Code to enable taxpayers to comply with the mark-to-market
requirements of section 475. Rev. Rul. 93-76, 1993-2 C.B. 235 (which was
previously modified by Rev. Rul. 94-7, 1994-1 C.B. 151), is clarified,
modified, partially obsoleted, and superseded.


LAW

Section 475 of the Code was enacted on August 10, 1993, in the Omnibus
Budget Reconciliation Act of 1993 (the "1993 Act"), section 13223, 1993-3
C.B. 1, 69. It requires mark-to-market accounting treatment for certain
securities held by a "dealer in securities" as defined in section
475(c)(1). This requirement is effective for all taxable years ending on
or after December 31, 1993. Section 475 was amended on August 5, 1997, in
the Taxpayer Relief Act of 1997 (the "1997 Act"), section 1001(b)
(redesignating old section 475(e) as section 475(g) and adding new section
475(e) and (f) to allow dealers in commodities and traders in securities
and commodities to elect mark-to-market accounting, effective for taxable
years ending after August 5, 1997). This revenue ruling is limited to
issues arising under the 1993 Act and does not address issues arising
under the 1997 Act.

Section 475(a) sets forth two mark-to-market rules. First, any security
that is inventory in the hands of a dealer must be included in inventory
at its fair market value. Second, any security that is not inventory in
the hands of a dealer and that is held at the close of any taxable year is
treated as sold by the dealer for its fair market value on the last
business day of that taxable year, and any gain or loss is required to be
taken into account for that taxable year.

Section 475(b)(1) provides that the mark-to-market rules do not apply
to: (1) any security held for investment; (2) any evidence of indebtedness
that is acquired (including originated), or any obligation to acquire an
evidence of indebtedness that is entered into, by a dealer in the ordinary
course of its trade or business, but only if the evidence of indebtedness
or obligation to acquire an evidence of indebtedness is not held for sale;
(3) any security that is a hedge with respect to a security that is not
subject to the mark-to-market rules; and (4) any security that is a hedge
of a position, right to income, or liability that is not a security in the
hands of the taxpayer. Under section 475(b)(2), a security must be clearly
identified in the dealer's records as being covered by one of the
exceptions described in section 475(b)(1) before the close of the day on
which the dealer acquired, originated, or entered into the security.

In addition to the identification requirements in section 475(b),
section 475(c)(2)(F)(iii) requires a dealer in securities to identify a
position that is not a security described in section 475(c)(2)(A)-(E), but
that is treated as a security because it is a hedge with respect to such a
security.


ISSUES AND HOLDINGS

Issue 1: If a taxpayer is not otherwise a dealer in securities within
the meaning of section 475(c)(1) but, nevertheless, timely identifies all
of its securities as being covered by one of the exceptions in section
475(b)(1), does that "protective identification" cause the taxpayer to be
treated as a dealer?

Holding 1: No. A taxpayer that is not a dealer in securities within the
meaning of section 475(c)(1) does not become a dealer in securities or
create an inference that it is a dealer in securities by making a
protective identification of its securities.

Issue 2: Is a bank or an insurance company excepted from the
mark-to-market rules on the grounds that it is, per se, not a dealer in
securities within the meaning of section 475(c)(1)?

Holding 2: No. A bank or an insurance company is subject to the
mark-to-market rules if its activities bring it within the definition of a
dealer in securities in section 475(c)(1). For example, many banks are
dealers because they regularly originate and sell loans. As another
example, an insurance company that regularly makes and sells policyholder
loans is a dealer for purposes of section 475.

Issue 3: If a taxpayer's sole business consists of trading in
securities (that is, the taxpayer does not purchase from, sell to, or
otherwise enter into transactions with customers), is the taxpayer a
dealer in securities within the meaning of section 475(c)?

Holding 3: No. A taxpayer whose sole business consists of trading in
securities is not a dealer in securities within the meaning of section
475(c) because that taxpayer does not purchase from, sell to, or enter
into transactions with, customers in the ordinary course of a trade or
business.

Issue 4: Does the classification of a security under financial
accounting principles, including FASB Statement No. 115 (Accounting for
Certain Investments in Debt and Equity Securities), determine whether the
security qualifies for one of the exceptions to the mark-to-market rules
under section 475(b)(1)?

Holding 4: No. The classification of a security under financial
accounting principles is not dispositive of the treatment of the security
for federal income tax purposes. For example, for purposes of section 475,
a security may in certain cases qualify for the held-for-investment
exception to the mark-to-market rules even though, under applicable
financial accounting principles, the security is classified as available
for sale.

Issue 5: Does an identification of a security as "held for investment"
under section 1236 serve to identify that security as "held for
investment" (within the meaning of section 475(b)(1)(A)) or as "not held
for sale" (within the meaning of section 475(b)(1)(B))?

Holding 5: No. Taxpayers may choose not to identify under section
475(b)(2) some or all of the securities that they identify under section
1236(a)(1). (For a transitional rule applicable to securities held as of
the close of the last taxable year ending before December 31, 1993,
however, see section 1.475(b)-4(a) of the Income Tax Regulations.)
Accordingly, even if a section 1236 identification has been made, an
identification of a security or hedge is a valid identification for
purposes of section 475(b)(2) only if it contains a specific reference to
section 475; this specific reference, however, may be effected by any
reasonable method. For instance, certain accounts may be identified in
such a way that placing a security or hedge in the account identifies the
security or hedge for purposes of both section 1236(a)(1) and section
475(b)(1)(A), (B), or (C). See Holding 6 below. See Holding 15 below for a
transitional rule that requires less specificity for identification of
securities held by certain taxpayers that were not dealers in securities
under section 1.475(c)-1T (as contained in 26 CFR part 1 revised April 1,
1996).

Issue 6: Is a dealer in securities required to use a special procedure
to comply with the identification requirements under section 475?

Holding 6: No. Unless the Commissioner otherwise prescribes, a dealer
may comply with the identification requirements under section 475 using
any reasonable method (see, for example, guidance concerning
identification requirements under sections 988(a)(1)(B), 1221, 1236(a)(1),
and 1256(e)(2)(C)). The identification, however, must be made on, and
retained as part of, the dealer's books and records. The dealer's books
and records must clearly indicate the specific security or hedge being
identified, and the identification must clearly indicate that it is being
made for purposes of section 475. Alternatively, the dealer may identify
specific accounts as containing only securities or hedges that are covered
by a particular exception, so that placing a security or hedge in the
account identifies the security or hedge as being covered by that
exception. Under section 1.475(b)-2(a), an identification need not
distinguish between an exception under section 475(b)(1)(A) (concerning
certain securities held for investment) and one under section 475(b)(1)(B)
(concerning securities not held for sale). Exceptions under either of
these provisions, however, must be distinguished from exceptions under
section 475(b)(1)(C) (concerning securities held as hedges).

In addition, rather than identifying specific securities or accounts as
being covered by an exception described in section 475(b)(1), a dealer may
comply with the identification requirement under section 475(b) by clearly
indicating the specific securities or accounts that are not covered by a
particular exception (that is, indicating that they are covered by some
other exception or that they are not exempt) and identifying all other
securities or accounts as being covered by a particular exception.

For example, a dealer may place on its books and records a statement
that, unless otherwise identified, all of its securities for which an
identification is still timely (including securities yet to be acquired)
are identified as exempt under either section 475(b)(1)(A) or (B). This
statement is effective to identify under section 475(b)(1)(A) or (B) each
security covered by its terms unless, before the expiration of the period
during which the security may be timely identified, the dealer identifies
it as not exempt or as exempt under section 475(b)(1)(C).

Analogously, under Rev. Rul. 64-160, 1964-1 (Part I) C.B. 306, modified
by Rev. Rul. 76-489, 1976-2 C.B. 250, dealers can identify specified
accounts as containing only securities held for investment for purposes of
section 1236(a)(1). Accordingly, dealers can satisfy the identification
requirements of section 475(b)(2) by unambiguously indicating that all of
the securities in one or more of these accounts are also described, for
example, in section 475(b)(1)(A) or (B). Once such an identification of an
account is made, placing a security in the account identifies the security
not only as being "held for investment" for purposes of section 1236 but
also as being described in the applicable subparagraph of section
475(b)(1).

Issue 7 in Rev. Rul. 93-76 concerned transitional identification issues
for securities acquired, originated, or entered into between August 10,
1993, and October 31, 1993. As the transition period has now ended, Issue
7 is obsolete and is not reprinted in this revenue ruling.

Issue 8: If a dealer in securities originates or acquires an evidence
of indebtedness in the ordinary course of a trade or business, are there
any exceptions to the requirement that the dealer make an identification
under section 475(b)(2) before the close of the day on which it originates
or acquires the security?

Holding 8: Yes. Pending further guidance, if a financial institution
(as defined in section 265(b)(5)) originates or acquires an evidence of
indebtedness in the ordinary course of a trade or business, an
identification of the evidence of indebtedness is timely if it is made in
accordance with the dealer's accounting practice, but no later than 30
calendar days after the date of origination, or acquisition, by the
financial institution. The preceding sentence applies to any dealer in
securities for evidences of indebtedness that are mortgage loans.

Also, pending further guidance, a dealer in securities that enters into
commitments to acquire mortgage loans may identify those commitments as
being held for investment if the dealer acquires the mortgage loans and
holds the mortgages as investments. This identification of commitments to
acquire mortgage loans must be made in accordance with the dealer's
accounting practice, but no later than 30 calendar days after the date of
acquisition of the mortgage loans.

Issues 9, 10, and 11 discussed transitional issues concerning proper
identification, computation of adjustments, and the period over which to
spread any adjustments, for taxable years that included December 31, 1993.
As the transition period has now passed, Issues 9, 10, and 11 are obsolete
and are not reprinted in this revenue ruling.

Issue 12: May a taxpayer use an amended return to make an election
under section 1.475(c)-1(c)(1)(ii) (which concerns taxpayers that purchase
securities from customers but make no more than negligible sales of
securities)?

<<END RULING>>


Holding 12: For any taxable year for which an original federal income
tax return is filed after October 31, 1997, an election under section
1.475(c)-1(c)(1)(ii) must be made on an original federal income tax return
that is filed on or before the due date (including any extensions of time)
for that return. For any taxable year for which an original federal income
tax return was filed on or before October 31, 1997, an election under
section 1.475(c)-1(c)(1)(ii) also may be made on an amended return filed
not later than October 31, 1997. Not later than December 15, 1997,
compliance with section 475 must be reflected on an original or amended
return for every other taxable year which is subject to the election and
the original return for which is due on or before October 31, 1997. Note
that amended returns must be filed before the expiration of the statute of
limitations on assessment under section 6501(a).

As is noted in Holding 17 below, a taxpayer subject to more than one
exemption must affirmatively elect out of all applicable exemptions to be
treated as a dealer in securities.

Issue 13: If a taxpayer wishes to use an amended return to make an
election out of the customer paper exemption under section
1.475(c)-1(b)(4)(i)(B), by what date must the taxpayer file the amended
return?

Holding 13: Section 1.475(c)-1(b)(4)(i)(B) provides a June 23, 1997,
deadline to make the customer paper election on an amended return. Notice
97-37, 1997-27 I.R.B. 8, provides that additional guidance will extend
that deadline. Accordingly, that deadline to file an amended return is
extended to October 31, 1997. Not later than December 15, 1997, compliance
with section 475 must be reflected on an original or amended return for
every other taxable year which is subject to the election and the original
return for which is due on or before October 31, 1997. Note that amended
returns must be filed before the expiration of the statute of limitations
on assessment under section 6501(a).

Issue 14: What is the general rule for identifying a security as
excepted from mark-to-market accounting?

Holding 14: For a security to be exempt from mark-to-market accounting,
the taxpayer must make an identification that is timely under section
475(b)(2), which generally requires a security to be identified before the
close of the day on which it is acquired. For the only current exceptions
to this rule, see Holding 8 above (identifications of securities by
financial institutions and dealers in mortgages), section
1.475(b)-1(b)(4)(ii)(A) (identification of securities to which section
1.475(b)-1(b)(1) ceases to apply), and Holding 15 below (special
identification rules for taxpayers not treated as dealers under section
1.475(c)-1T). For information about the required specificity of the
identification, see Holding 5 above.

Issue 15: If a taxpayer makes an election out of either section
1.475(c)-1(b)(1) (customer paper exemption) or section 1.475(c)-1(c)(1)
(negligible sales exemption) and the election has the effect of causing
the taxpayer to be treated as a dealer in securities for a taxable year
starting before the date the taxpayer filed the documentation effecting
the election (date of the election), how does the taxpayer identify
securities that were acquired before the date of the election?

Holding 15: A special identification regime applies to taxpayers that
satisfy the following criteria:

First, the taxpayer is making an election out of the customer paper
exemption, the negligible sales exemption, or both.

Second, the taxpayer was not treated as a dealer in securities under
section 1.475(c)-1T (as contained in 26 CFR part 1 revised April 1, 1996).

The special identification regime applies only to securities
("transition securities") for which an identification would have been
timely under the general rule (described in Holding 14 above) only if made
on or before October 31, 1997. In applying the preceding sentence, a
taxpayer may choose to substitute any earlier date that is on or after
December 24, 1996. To make this substitution, the taxpayer must place in
its books and records no later than October 31, 1997, an unambiguous
statement that the taxpayer chooses to apply the general identification
rule described in Holding 14 for all securities acquired on or after the
specific date selected by the taxpayer.

Under the special identification regime, a transition security was
properly identified as exempt for the purposes of section 475(b)(2) or
(c)(2)(F)(iii) if the information that is contained in the taxpayer's
books and records and that was entered substantially contemporaneously
with the date of acquisition of the transition security supports a
conclusion that the transition security was described by section
475(b)(1)(A), (B), or (C). This rule applies even if the information in
the books and records does not meet the specificity that Holding 5
generally requires for identification. The status of a transition security
that was acquired before the first day of the taxable year for which the
election is being made is determined by examining the books and records as
of the last day of the preceding taxable year.

The taxpayer must, by October 31, 1997, place in its books and records
a statement resolving ambiguities, if any, concerning which transition
securities are properly identified within the meaning of the preceding
paragraph. Any information that supports treating a transition security as
being described in section 475(b)(2) or (c)(2)(F)(iii) must be applied
consistently.

A taxpayer, in determining whether a transition security must be
identified, must apply the following principles: if the transition
security was identified under section 1.1221-2 or section 1256(e) and the
item being hedged is described in section 475(b)(1)(C)(i) or (ii), the
section 1.1221-2 or section 1256(e) identification constitutes an
identification for purposes of section 475(b)(2); and, if the item being
hedged was ordinary property, as defined in section 1.1221-2, and the
taxpayer did not identify the transition security as a hedging
transaction, the transition security cannot be identified under section
475(b)(1)(C)

If a taxpayer made a protective identification (as described in Issue 1
above) of a transition security, and subsequent to the protective
identification the taxpayer makes an election that causes the taxpayer to
be a dealer in securities for purposes of section 475, the protective
identification is recognized and the taxpayer is subject to the general
rules governing identifications for all transition securities that were
eligible to be timely identified after the date that the taxpayer began
making protective identifications. Thus, if a transition security was
properly and timely identified as exempt from being marked to market and
remains eligible for the exemption claimed, that transition security is
not marked to market even though section 475 applies to the taxpayer. If a
transition security was properly and timely identified and thereafter
ceases to be held for investment or as a hedge, see section 475(b)(3). If
a transition security was not eligible to be identified as exempt, see
section 475(d)(2).

Issue 16: If an issuer of an evidence of indebtedness has the right to
prepay at any time without a penalty (for example, a revolving credit card
balance), does that right preclude that indebtedness from having a fair
market value that is greater than the face value of the obligation?

Holding 16: No. Securities must be marked to fair market value based on
all the facts and circumstances. For example, in light of contractual
interest rates and general payment history on customer obligations, the
fair market value of a customer obligation may be greater than the face
amount, even if the customer has the right to repay the debt at its face
amount at any time.

Issue 17: If a taxpayer would meet the definition of a dealer in
securities under section 475 but otherwise satisfies more than one
exemption from dealer status, must the taxpayer elect out of all
applicable exemptions to be a dealer in securities for the purpose of
section 475?

Holding 17: Generally, a taxpayer must make an election out of all
applicable exemptions in order to be treated as a dealer under section
475. A taxpayer subject to multiple exemptions from section 475 must file
all the documentation required to elect out of each applicable exemption.
Sometimes, the documentation required for one election satisfies all of
the filing requirements for another election. For example, if a taxpayer
is subject to both the customer paper exemption under section
1.475(c)-1(b) and the negligible sales exemption under section
1.475(c)-1(c), the taxpayer may make an election under section
1.475(c)-1(b)(4) that is effective as of January 1, 1993, and timely file
an amended 1993 federal income tax return using mark-to-market accounting
for securities. The amended 1993 return itself represents an election out
of the negligible sales exemption.

Issue 18: How does a taxpayer that is in its first year of existence
elect out of an exemption from dealer status under section 475?

Holding 18: If a taxpayer decides for its first year of existence to
make an election out of the negligible sales exemption to account for
securities on a mark-to-market basis, the taxpayer should attach to its
original return for that first year the following statement: "[insert name
and taxpayer identification number of the taxpayer] hereby elects not to
be governed by section 1.475(c)-1(c)(1)(i) of the income tax regulations
for the taxable year ending [describe the last day of the year] and for
subsequent taxable years." If a taxpayer decides for its first year of
existence to make an election out of the customer paper exemption or to
make the intragroup-customer election, the taxpayer must meet the
requirements of section 1.475(c)-1.

Issue 19: Which changes of accounting method are covered by the consent
provisions of section 13223(c)(2) of the 1993 Act?

Holding 19: Under section 13223(c)(2) of the 1993 Act, certain changes
of accounting method are treated as made with the consent of the
Commissioner. This treatment extends only to a change in method that was
effected by a taxpayer who (1) became a dealer for the taxable year that
includes December 31, 1993, merely by virtue of the passage of the 1993
Act, and (2) who accounted for securities as a dealer under section 475 on
its original federal income tax return for that year. Consent for other
changes of method to comply with section 475 must be obtained either on a
taxpayer-by-taxpayer basis or as part of automatic consent contained in
published guidance. See Rev. Proc. 97-43, page 12, this Bulletin.

Issue 20: If a taxpayer is accounting for securities by marking them to
market under section 475(a), may the taxpayer, without the consent of the
Commissioner, file a federal income tax return for a later taxable year
that does not account for securities on a mark-to-market basis?

Holding 20: No. Once a taxpayer has used the section 475 mark-to-market
method as its method of accounting for securities, the taxpayer may not
change that method of accounting without obtaining the consent of the
Commissioner. See section 446(e). Unless the Commissioner otherwise
prescribes, to request consent the taxpayer must comply with the
requirements of Rev. Proc. 97-27, 1997-21 I.R.B. 10. For example, if a
taxpayer accounts for securities by marking them to market because the
taxpayer made more than negligible sales of securities and in a later year
makes only negligible sales of securities, the taxpayer must obtain the
consent of the Commissioner to change its method of accounting for
securities. If a taxpayer made no more than negligible sales of securities
but, pursuant to section 1.475(c)-1(c)(1)(ii), accounted for securities on
a mark-to-market basis and the taxpayer makes no more than negligible
sales of securities in a subsequent year, the taxpayer must obtain the
consent of the Commissioner to change its method of accounting for
securities. Especially in the latter example, consent for the change will
be granted only in unusual circumstances.


EFFECT ON OTHER DOCUMENTS

Rev. Rul. 93-76 as modified by Rev. Rul. 94-7, is clarified, modified,
partially obsoleted, and superseded. Notice 97-37, 1997-27 I.R.B. 8, is
obsoleted.


PROSPECTIVE APPLICATION

Pursuant to section 7805(b), if an identification is made on or before
June 30, 1997, and the identification complies with the requirements set
forth in the third paragraph of Holding 6 of Rev. Rul. 93-76, the
identification will not be treated as failing to satisfy the requirements
of section 475(b)(2) solely on the grounds that it failed to identify the
operative subparagraph of that provision.


PAPERWORK REDUCTION ACT

The collections of information contained in this revenue ruling have
been reviewed and approved by the Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control
number 1545-1558.

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

The collections of information in this revenue ruling are in sections
26 CFR 1.475(b)-2, 26 CFR 1.475(b)-4, and 26 CFR 1.475(c)-1. This
information is required to facilitate the administration of section 475 of
the Internal Revenue Code. This information will be used to facilitate
audits of taxpayers that elect to not be governed by certain exemptions
under section 475 of the Code. The collections of information are required
to obtain a benefit. The likely respondents are business or other
for-profit institutions.

The recordkeeping burden described in Holding 6 was reviewed and
approved by the Office of Management and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1496.

The estimated total annual recordkeeping burden described in Holding 15
is 450,000 hours.

The estimated annual burden per recordkeeper varies from 15 hours to 45
hours, depending on individual circumstances, with an estimated average of
22.5 hours. The estimated number of recordkeepers is 20,000.

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


DRAFTING INFORMATION

The principal authors of this revenue ruling are Pamela Lew and Robert
B. Williams of the Office of the Assistant Chief Counsel (Financial
Institutions and Products). For further information regarding this revenue
ruling contact Ms. Lew at (202) 622-3950 or Mr. Williams at (202) 622-3960
(not toll-free calls)

<<END RULING>>

 

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