Par. 2. Sections 1.643(i)-1, 1.643(i)-2, 1.643(i)-3, 1.643(i)-4, and 1.643(i)-5 are added to read as follows:
(a) In general. A loan of cash or use of trust property will not be treated as a section 643(i) distribution if the loan of cash or use of trust property is one of the following:
(1) Loan of cash in exchange for a qualified obligation. A loan of cash that is in exchange for a qualified obligation (within the meaning of paragraph (b)(2)(iii) of this section).
(2) Compensated use of trust property —(i) In general. Use of trust property, other than a loan of cash or marketable securities, to the extent that the trust is paid the fair market value of such use within a reasonable period from the start of the use of the property. A determination as to the fair market value of the use of such property and as to whether a fair market value payment is made within a reasonable period must be based on all the facts and circumstances, including the type of property used and the period of use. In appropriate cases, such as rental of real property, payments may be made on a periodic basis consistent with arm's length dealings between unrelated parties.
(ii) Safe harbor. For purposes of paragraph (a)(2)(i) of this section, a payment is made within a reasonable period if the payment is made or periodic payments commence within 60 days of the start of the use of trust property.
(3) De minimis use of trust property. Use of trust property, other than a loan of cash or marketable securities, if such use is de minimis. Use of trust property will be considered de minimis if aggregate use by members of the group consisting of the U.S. grantors, U.S. beneficiaries, and the U.S. persons related to any U.S. grantor or beneficiary does not exceed 14 days during the calendar year.
(4) Certain loans made by a foreign corporation. A loan of cash that is made by a foreign corporation to a U.S. beneficiary of the foreign trust to the extent the aggregate amount of all such loans to the beneficiary does not exceed undistributed earnings and profits of the foreign corporation attributable to amounts that are, or have been, included in the beneficiary's gross income under section 951, 951A, or 1293.
(b) Qualified obligations —(1) In general. The rules in this paragraph (b) apply to determine whether a loan of cash is in exchange for a qualified obligation.
(2) Definitions. The following definitions apply for purposes of this section and §§ 1.643(i)-1 and 1.643(i)-3 through 1.643(i)-5:
(i) Obligation. The term obligation means any instrument or contractual arrangement that constitutes indebtedness under general principles of Federal income tax law (for example, a bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other evidence of indebtedness), and any annuity contract that would not otherwise be classified as indebtedness under general principles of Federal income tax law.
(ii) Obligor. The term obligor means the person who issues an obligation to a foreign trust in exchange for a loan of cash.
(iii) Qualified obligation —(A) General requirements. The term qualified obligation means an obligation that at all times satisfies all of the following requirements:
( 1 ) The obligation is reduced to writing in an express written agreement.
( 2 ) The term of the obligation does not exceed five years. For purposes of determining the term of an obligation, the obligation's maturity date is the last possible date that the obligation can be outstanding under the terms of the obligation.
( 3 ) All payments on the obligation must be made in cash in U.S. dollars.
( 4 ) The obligation is issued at par and provides for stated interest at a fixed rate or a qualified floating rate within the meaning of § 1.1275-5(b).
( 5 ) The yield to maturity of the obligation is not less than 100 percent of the applicable Federal rate and not greater than 130 percent of the applicable Federal rate. The applicable Federal rate for an obligation is the applicable Federal rate in effect under section 1274(d) for the day on which the obligation is issued, as published in the Internal Revenue Bulletin (see § 601.601(d)(2) of this chapter). The yield to maturity and the applicable Federal rate must be based on the same compounding period. If an obligation is a variable rate debt instrument that provides for stated interest at a qualified floating rate, the equivalent fixed rate debt instrument rules in § 1.1274-2(f)(1) or § 1.1275-5(e), whichever is applicable, apply to determine the obligation's yield to maturity.
( 6 ) All stated interest on the obligation is qualified stated interest within the meaning of § 1.1273-1(c).
(B) Additional requirements to remain a qualified obligation. An obligation will remain a qualified obligation only if, for the first year and each succeeding year that the obligation remains outstanding, the following requirements are satisfied:
( 1 ) The U.S. grantor or beneficiary timely extends the period for assessment of any income tax attributable to the obligation and any consequent income tax changes for each year that the obligation is outstanding to a date not earlier than three years after the maturity date of the obligation. This extension of the period for assessment is not necessary with respect to the taxable year of the U.S. grantor or beneficiary in which the maturity date of the obligation falls, provided that the obligation is paid in cash in U.S. dollars within that year. The period of assessment is extended by completing and filing Part III of Form 3520, Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, for every year that the obligation is outstanding. The waiver in Part III of Form 3520 shall also contain such other terms with respect to assessment as may be considered necessary by the Commissioner to ensure the assessment and collection of the correct tax liability for each year for which the waiver is required. When Part III of Form 3520 is properly executed and filed, the consent to extend the period for assessment of tax will be deemed to be agreed upon and executed by the Commissioner for purposes of § 301.6501(c)-1(d).
( 2 ) The U.S. grantor or beneficiary timely reports the status of the obligation, including principal and interest payments, on Part III of Form 3520 for each year that the obligation is outstanding.
( 3 ) The obligor timely makes all payments of principal and interest on the obligation according to the terms of the obligation (which may include a reasonable grace period of no more than thirty days for a late payment).
(3) Modification of a qualified obligation. If the terms of a qualified obligation are modified and the modification is treated as an exchange under § 1.1001-3, the new obligation that is deemed issued in the exchange under § 1.1001-3 must satisfy all the requirements in paragraph (b)(2)(iii) of this section to be a qualified obligation using the original obligation's issue date. If the modification is not treated as an exchange under § 1.1001-3, then the obligation must be retested as of the date of the modification to determine whether the obligation, as modified, continues to satisfy the requirements in paragraph (b)(2)(iii) of this section to be a qualified obligation.
(4) Additional loans. If a qualified obligation is outstanding and the obligor directly or indirectly issues an additional obligation to the foreign trust in exchange for cash, the outstanding obligation is deemed to have the maturity date of the additional obligation in determining whether the outstanding obligation exceeds the specified five-year term. The outstanding obligation must be retested as of the issue date of the additional obligation to determine whether it would have satisfied, as of the outstanding obligation's issue date, all the requirements in paragraph (b)(2)(iii) of this section to be a qualified obligation. If there is more than one qualified obligation outstanding, the determination is made based on the outstanding obligation with the earliest issue date. The additional obligation also must be separately tested to see if it satisfies the requirements in paragraph (b)(2)(iii) of this section to be a qualified obligation.
(5) Anti-abuse rule. Notwithstanding paragraphs (b)(3) and (4) of this section, if the Commissioner determines, based on all of the facts and circumstances, that two or more obligations issued by a U.S. obligor are structured with a principal purpose to avoid the application of section 643(i), the Commissioner may treat the obligations as a single obligation that is not a qualified obligation.
(6) Obligations that cease to be qualified —(i) In general. If an obligation ceases to be a qualified obligation (for example, because an obligation is modified so that the term of the obligation exceeds 5 years), the U.S. grantor or beneficiary is treated as receiving a section 643(i) distribution from the trust.
(ii) Amount of section 643(i) distribution. Except as otherwise provided in this paragraph (b)(6)(ii), the amount of the section 643(i) distribution treated as received pursuant to paragraph (b)(6)(i) of this section is equal to the obligation's outstanding stated principal amount plus any accrued but unpaid qualified stated interest (within the meaning of § 1.1273-1(c)) as of the date of the event that causes the obligation to no longer be a qualified obligation. In the case of an obligation that ceases to be a qualified obligation because the Commissioner treats two or more obligations as a single obligation pursuant to paragraph (b)(5) of this section, the amount of the section 643(i) distribution will not exceed the sum of the outstanding stated principal amount plus any accrued but unpaid qualified stated interest on each of the obligations as of the date determined by the Commissioner under paragraph (b)(6)(iii) of this section.
(iii) Date of section 643(i) distribution. In general, the U.S. grantor or beneficiary is treated as receiving a section 643(i) distribution on the date of the event that causes an obligation to no longer be a qualified obligation. However, based on all of the facts and circumstances, if an obligation (or obligations) is structured with a principal purpose to avoid the application of section 643(i), the Commissioner may deem a section 643(i) distribution to have occurred on any date on or after the issue date of the obligation(s).
(c) Trust property attributable to nongrantor trust portion —(1) In general. A loan or use of trust property from a partial nongrantor trust must be apportioned between the nongrantor and grantor portions of the trust in a manner that is reasonable in light of all the facts and circumstances, including the terms of the governing instrument, local law, and the practice of the trustee if it is reasonable and consistent.
(2) Specific property. If a loan of cash or marketable securities, or a use of trust property, can be made from only one portion of the foreign trust because the type of property loaned or used is held only by that portion, then the loan or use of property is deemed to be attributable to that portion.
(d) Reporting. A loan of cash or marketable securities from, or the use of any property of, a foreign grantor or nongrantor trust to or by a U.S. person is a distribution for purposes of § 1.6048-4(b)(3) or (4), as applicable, and must be reported by the U.S. person, and if the trust is a foreign nongrantor trust, by the U.S. grantor or beneficiary, under § 1.6048-4(a), irrespective of whether the loan or use of trust property is a section 643(i) distribution.
(e) Examples. The following examples illustrate the rules of paragraphs (b) through (d) of this section:
(1) Example 1: Loan of cash not in exchange for qualified obligation. Y, a nonresident alien, created and funded a foreign nongrantor trust, FT, for the benefit of X, a U.S. person. X is the sole beneficiary of FT. In Year 1, FT makes a loan of cash to X in exchange for a demand note that permits FT to require repayment by X at any time. The demand note issued by X is not a qualified obligation within the meaning of paragraph (b)(2)(iii) of this section because X's obligation to FT could remain outstanding for more than five years. Accordingly, the qualified obligation exception in paragraph (a)(1) of this section does not apply. Under § 1.643(i)-1(b) and § 1.643(i)-3(a), X is treated as receiving a section 643(i) distribution from FT. X must determine the tax consequences of the distribution under § 1.643(i)-3(c). Under § 1.6048-4(a), X is required to report the section 643(i) distribution on Part III of Form 3520 for Year 1, as a distribution from a foreign trust.
(2) Example 2: Beneficiary fails to extend period of assessment and fails to report loan on Form 3520. Y, a nonresident alien, created and funded a foreign nongrantor trust for the benefit of X, a U.S. person. On June 30, Year 1, FT makes a loan of cash to X in exchange for an obligation that satisfies the requirements of paragraph (b)(2)(iii)(A) of this section. However, X fails to timely file Form 3520 and did not request an extension to file. As a result, X has failed to extend the period for assessment of any income tax attributable to the loan through the filing of Form 3520 by its due date as required under paragraph (b)(2)(iii)(B)( 1 ) of this section. X also has failed to report the status of the loan on Form 3520 as required under paragraph (b)(2)(iii)(B)( 2 ) of this section. Either one of X's failures is sufficient to cause the loan to be treated as a section 643(i) distribution under § 1.643(i)-1(b). Because the loan fails to continue to be treated as a qualified obligation, the loan is treated as a section 643(i) distribution from FT as of April 15, Year 2, the date that X's Form 3520 was due.
(3) Example 3: Effect of subsequent obligation on original obligation. Y, a nonresident alien, created and funded a foreign nongrantor trust for the benefit of X, a U.S. person. On January 1, Year 1, FT makes a loan of cash to X in exchange for Note 1, an obligation with a maturity date of January 1, Year 6, that satisfies the requirements of paragraph (b)(2)(iii) of this section. On June 30, Year 1, FT makes an additional loan of cash to X in exchange for Note 2, an obligation with a maturity date of June 30, Year 6. Under paragraph (b)(4) of this section, Note 1 will be deemed to have a maturity date of June 30, Year 6 ( i.e., a greater than five-year term) and will cease to be a qualified obligation. Under paragraph (b)(6)(ii) of this section, X will be treated as receiving a section 643(i) distribution equal to Note 1's outstanding stated principal amount plus any accrued but unpaid qualified stated interest (within the meaning of § 1.1273-1(c)) as of June 30, Year 1. Note 2 will be separately tested to determine whether it satisfies the requirements of paragraph (b)(2)(iii) of this section.
(4) Example 4: Anti-abuse rule. Y, a nonresident alien, created and funded a foreign nongrantor trust for the benefit of X, a U.S. person. On January 1, Year 1, FT makes a loan of cash to X in exchange for Note 1, an obligation with a maturity date of January 1, Year 4 that satisfies the requirements of paragraph (b)(2)(iii) of this section. On January 1, Year 4, FT makes another loan of cash to X in exchange for Note 2, an obligation with a maturity date of January 1, Year 7, but otherwise has the same terms as Note 1. Based on all of the facts and circumstances, the Commissioner determines under paragraph (b)(5) of this section that Notes 1 and 2 are structured with a principal purpose to avoid the application of section 643(i). Therefore, under paragraph (b)(5) and paragraph (b)(6)(ii) and (iii) of this section, the Commissioner may treat Notes 1 and 2 as a single obligation (with a six-year term) that is not a qualified obligation and may treat X as receiving a section 643(i) distribution equal to the combined outstanding stated principal amounts of Note 1 and Note 2 plus any accrued but unpaid qualified stated interest as of any date determined by the Commissioner.
(5) Example 5: Allocation of trust property attributable to partial grantor trust. In Year 1, Y, a nonresident alien, creates and settles a foreign trust, FT, for the benefit of X, a U.S. beneficiary. Y funds the trust with a vacation home valued at $500,000 and $500,000 cash. Under the trust document, Y has the power to revoke the trust as to the vacation home and any income earned by the vacation home at any time without the consent of any person. This power to revoke results in Y being treated as the owner of the portion of the trust comprising the vacation home (the grantor trust portion) under section 676 (after application of § 1.672(f)-3(a)). Y has no powers that would cause Y to be treated as the owner of the portion of the trust comprising the cash Y contributed or any income earned by that cash. X uses the vacation home for 2 months in Year 2 and does not compensate the trust for the use of the vacation home. Under paragraph (c)(2) of this section, the use of the vacation home will be deemed to be attributable to the grantor trust portion and thus will not be treated as a section 643(i) distribution to X. Under paragraph (d) of this section, X must comply with the reporting requirements of § 1.6048-4 with respect to the use of the vacation home. Under § 1.6048-4(b)(4), X is required to report the use of the vacation home on Part III of Form 3520 for Year 2 as a distribution from FT.