Source: https://webiis06.mondaq.com/unitedstates/Tax/247746/Fractional-Taxation-IRS-Releases-Technical-Advice-Addressing-The-10-Securities-Rule-Applicable-To-Foreign-Bank-Branches
Timestamp: 2020-02-23 00:46:07
Document Index: 58488819

Matched Legal Cases: ['§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 1', '§ 864', '§ 871', '§ 881', '§ 871', '§ 882']

If securities meet the five-part test described above, but do not fall into one of these five categories, the securities fall into the catch-all or residual category of Treasury Regulation § 1.864-4(c)(5)(ii)(b)(3). Interest income on loans described in Treasury Regulation § 1.864- 4(c)(5)(ii)(b)(3) and held by a US branch of a non-US entity engaged in a banking, financing or similar business is not fully taxable in the United States. Instead, applicable Treasury regulations determine the amount of interest income earned on securities described in Treasury Regulation § 1.864-4(c)(5)(ii)(b)(3) that is taxable in the United States by multiplying such interest income by a fraction. The numerator of such fraction is 10%.8 The denominator of such fraction is the percentage derived by dividing the book value of such securities held by the US office by the total book value of the total assets held by the US banking office of the taxpayer.9 The fraction is capped at 1. The fraction is also used to determine the amount of gain or loss from dispositions of securities described in Treasury Regulation § 1.864-4(c)(5)(ii)(b)(3) that is considered to be attributable to the US banking, financing or similar business conducted by the taxpayer in the US Securities described in Treasury Regulation § 1.864-4(c)(5)(ii)(b)(3) are sometimes referred to as "10% securities" in reference to the numerator of this fraction.
The use of the fraction described in the flush language of Treasury Regulation § 1.864- 4(c)(5)(ii)(b)(3) can result in a significant portion of the interest income and gain or loss attributable to 10% securities not being subject to US federal income tax income. For example, if the book value of 10% securities held by a taxpayer engaged in a banking, financing, or similar business constituted 50% of the total assets held by the US banking office of the taxpayer, the denominator of the applicable fraction would be 50%. Thus, the fraction would be 10%/50% or 20%. On these facts, only 20% of the interest income and gain or loss from dispositions of 10% securities would be subject to US federal income tax. Accordingly, the determination as to whether securities are described in Treasury Regulation § 1.864- 4(c)(5)(ii)(a)(1) or Treasury Regulation § 1.864- 4(c)(5)(b)(3) can have significant federal income tax consequences.
In T.A.M. 201325012, a US bank branch of a non-US bank ("Branch") was regularly engaged in making loans to the public and other activities described in Treasury Regulation § 1.864- 4(c)(5)(i). As part of its US banking business, Branch wrote liquidity and credit-support commitments, including the issuance of letters of credit and standby bond and asset purchase agreements. The income from these activities was treated as effectively connected to the conduct of a US trade or business and included in the US taxable income of Branch.
The IRS held that the MTNs were not securities described in Treasury Regulation § 1.864- 4(c)(5)(ii)(a)(1). The IRS explicitly held that "when the US banking business acquires a security on an exchange or an OTC market, the security is not considered to have been acquired as a result of, or in the course of, making loans to the public." The IRS found that the interbank market is an "organized OTC market through which banks loan funds to one another."10 Furthermore, the IRS held that "acquisitions on the exchange or organized OTC markets are not acquisitions from customers and are not acquired through the origination of a customer loan or incident to the terms of such original customer loan." Accordingly, the IRS held that the acquisition of the MTNs in secondary market transactions was not undertaken in the course of making loans to the public, apparently even when the Branch was providing original funds to the borrowers.
The facts and conclusion of T.A.M. 201325012, however, must be considered in light of the IRS's audit guidance in AM2009-010 (PRENO- 119800-09) (September 22, 2009). In AM2009- 010, the IRS considered whether a non-US corporation that acquired loans made to US persons within the United States was engaged in a banking, financing or similar business in the United States within the meaning of Treasury Regulation § 1.864-4(c)(5)(i). The non-US corporation had no office or employees located in the US It retained an origination company, pursuant to a service agreement, to originate loans to US borrowers. The origination company solicited US borrowers, then negotiated the terms of the loans, performed credit analyses with respect to US borrowers , and all other activities relating to loan origination other than the final approval and signing of the loan documents. The funding of the loans and final approval were undertaken by the non-US corporation from outside of the US
Although the conclusion of AM2009-010 has detractors, the view of the IRS was that the conduct of these activities in the US by the agent was attributable to the non-US corporation. As a result, the non-US corporation was considered to be engaged in a banking or financing business in the United States. AM2009-010 does not address whether the loans should be considered to be described in Treasury Regulation § 1.864- 4(c)(5)(ii)(a)(1). Based upon the IRS's discussion of the issues, however, it seems clear that the IRS found that the loans originated by the origination company should be considered to have been acquired as a result of making loans to the public. Thus, the critical distinction (a thin line indeed) between the two conclusions appears to rest on the fact that in AM2009-010, the non-US person was attributed with the loan origination while in T.A.M. 201325012 the non-US person was not attributed with the origination activity.
Since the taxpayer in T.A.M. 201325012 did not act as an underwriter or market maker with respect to the MTNs, the IRS held that the Branch did not acquire the loans in connection with the distribution of securities. Accordingly, the MTNs were not treated as described in Treasury Regulation § 1.864-4(c)(5)(ii)(a)(2).
The last issue considered by the IRS was whether the MTNs were held as reserve assets. The IRS began by noting that prior to 1980, states could impose requirements on non-US banks to hold various assets as reserve assets. (After the passage of the International Banking Act of 1978, only the Federal government could impose reserve requirements on non-US banks.) The IRS noted that the broad language of Treasury Regulation § 1.864-4(c)(5)(ii)(a)(3) was intended to reach assets held in reserve pursuant to these rules.
1 The 10% rule is contained in Treasury Regulation § 1.864- 4(c)(5)(ii)(b)(3).
2 Treasury Regulation § 1.864-4(c)(5)(v) defines a security as "any bill, note, bond, debenture or other evidence of indebtedness, or any evidence of an interest in . . . any of the foregoing items."
3 Treas. Reg. § 1.864-4(c)(5)(ii)(a)(1).
4 Treas. Reg. § 1.864-4(c)(5)(ii)(a)(2).
5 Treas. Reg. § 1.864-4(c)(5)(ii)(a)(3).
6 Treas. Reg. § 1.864-4(c)(5)(ii)(b)(1).
7 Treas. Reg. § 1.865-4(c)(5)(ii)(b)(2).
8 Treas. Reg. § 1.864-4(c)(5)(ii)(flush lang.).
10 See Treas. Reg. § 1.864-4(c)(5)(iv)(c).
11 See Code § 864(b)(2), Code § 871(a)(1)(A) and Code § 881(a)(1).
12 See Code § 871(b) and Code § 882(a).
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United States Finance and Banking Financial Services Tax Corporate Tax