Par. 6. Section 1.679-4 is amended by revising paragraph (d) to read as follows:
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(d) Qualified obligations —(1) In general —(i) Requirements of the obligation. For purposes of this section, an obligation is treated as a qualified obligation only if the obligation at all times satisfies all of the following requirements—
(A) The obligation is reduced to writing in an express written agreement;
(B) 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;
(C) All payments on the obligation must be made in cash in U.S. dollars;
(D) 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);
(E) 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; and
(F) All stated interest on the obligation is qualified stated interest within the meaning of § 1.1273-1(c).
(ii) 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 trust 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) and the U.S. transferor fulfills the requirements of this paragraph (d)(1)(ii):
(A) The U.S. transferor 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. transferor 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 I 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. Part I of Form 3520 also may 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 extension of the period of assessment is required. When Part I 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); and
(B) The U.S. transferor timely reports the status of the obligation, including principal and interest payments, on Part I of Form 3520 for each year that the obligation is outstanding.
(2) 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 (d)(1) 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 (d)(1) of this section to be a qualified obligation.
(3) Additional loans. If a qualified obligation is outstanding and the U.S. transferor directly or indirectly obtains an additional obligation issued by the foreign trust in exchange for cash, or if the U.S. transferor directly or indirectly obtains an additional obligation issued by a person related to the trust, 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 (d)(1) 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 of (d)(1) of this section to be a qualified obligation.
(4) Anti-abuse rule. Notwithstanding paragraphs (2) and (3) of this section, if the Commissioner determines, based on all the facts and circumstances, that two or more obligations issued by a foreign trust or a person related to the trust are structured with a principal purpose to avoid the application of section 679, the Commissioner may treat the obligations as a single obligation that is not a qualified obligation.
(5) 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 exceeds 5 years), the U.S. transferor is treated as making a transfer to the foreign trust.
(ii) Amount transferred to the trust. The amount that the U.S. transferor is treated as having transferred to the trust will be 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 (d)(4) of this section, the U.S. transferor is treated as making a transfer to the trust in an amount not to exceed the sum of the outstanding stated principal amount of the obligations plus any accrued but unpaid qualified stated interest for each of the obligations as of the date determined by the Commissioner under paragraph (d)(5)(iii) of this section.
(iii) Timing of transfers resulting from failed qualified obligations. In general, a U.S. transferor is treated as making a transfer to the foreign trust 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 679, the Commissioner may deem a transfer to have occurred on any date on or after the issue date of the obligation(s).
(6) Examples. The following example illustrates the rules of this paragraph (d). In these examples, A and B are U.S. residents and FT is a foreign trust.
(i) Example 1: Demand loan. A is a related person (as defined in § 1.679-1(c)(5)) with respect to FT. A transfers $50,000 to FT in exchange for a demand note that permits A to require repayment by FT at any time. Because FT 's obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section and, pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A's transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, § 1.679-1 applies to treat A as the owner of the portion of FT attributable to the full $50,000 transfer to FT.
(ii) Example 2: Private annuity. A is a related person (as defined in § 1.679-1(c)(5)) with respect to FT. A transfers $40,000 to FT in exchange for an annuity from FT that will pay A $100x per year for the rest of A's life. Because FT's obligation to A could remain outstanding for more than five years, the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section and, pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A's transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, § 1.679-1 applies to treat A as the owner of the portion of FT attributable to the full $40,000 transfer to FT.
(iii) Example 3: Transfer to unrelated foreign trust in exchange for an obligation. B is not a related person (as defined in § 1.679-1(c)(5)) with respect to FT. B transfers $10,000 to FT in exchange for an obligation of the trust. The term of the obligation is fifteen years. Because B is not a related person with respect to FT, paragraph (c) of this section does not apply. The fair market value of the obligation received by B is taken into account for purposes of the fair market value exception of paragraph (a)(4) of this section even though the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section.
(iv) Example 4: Transfer for an obligation with term in excess of 5 years. A is a related person (as defined in § 1.679-1(c)(5)) with respect to FT. A transfers property that has a fair market value of $50,000 to FT in exchange for an obligation of FT. The term of the obligation is ten years. Because the term of the obligation exceeds five years, the obligation is not a qualified obligation within the meaning of paragraph (d)(1) of this section, and pursuant to paragraph (c) of this section, it is not taken into account for purposes of determining whether A's transfer is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, § 1.679-1 applies to treat A as the owner of the portion of FT attributable to the full $50,000 transfer to FT.
(v) Example 5: Transfer for a qualified obligation. The facts are the same as in paragraph (d)(6)(iv) of this section ( Example 4 ), except that the term of the obligation is three years. Assuming the other requirements of paragraph (d)(1) of this section are satisfied, the obligation is a qualified obligation, and its stated principal amount is taken into account for purposes of determining whether A's transfer is eligible for the fair market value exception of paragraph (a)(4) of this section.
(vi) Example 6: Effect of modification treated as an exchange. A is a related person (as defined in § 1.679-1(c)(5)) with respect to FT. A transfers property that has a fair market value of $10,000 to FT in exchange for an obligation with a term of four years that satisfies the requirements of paragraph (d)(1) of this section. Two years later, a significant modification of the obligation within the meaning of § 1.1001-3, including an extension of the obligation by an additional term of three years, occurs, 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 the requirements of paragraph (d)(1) of this section to be a qualified obligation as of the original obligation's issue date. Because the new obligation would not satisfy the five-year requirement of paragraph (d)(1), the obligation ceases to be treated as a qualified obligation.
(vii) Example 7: Effect of subsequent obligation on original obligation. A is a related person (as defined in § 1.679-1(c)(5)) with respect to FT. On January 1, Year 1, A transfers $100,000 to FT in exchange for Obligation 1 from FT, an obligation with a maturity date of January 1, Year 6, that satisfies the requirements of paragraph (d)(1) of this section. On June 30, Year 1, A transfers an additional $50,000 to FT in exchange for Obligation 2, an obligation with a maturity date of June 30, Year 6, that independently satisfies the requirements of paragraph (d)(1) of this section. Under paragraph (d)(3) of this section, Obligation 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 (d)(1) of this section. Pursuant to paragraph (c) of this section, because Obligation 1 is not a qualified obligation, it is not taken into account for purposes of determining whether A's transfer of $100,000 is eligible for the fair market value exception of paragraph (a)(4) of this section. Accordingly, § 1.679-1 applies to treat A as the owner of the portion of FT attributable to the $100,000 transferred to FT. Obligation 2 is separately tested to determine whether it satisfies the qualified obligation rules of paragraph (d)(1) of this section and to the extent it does, A is treated as eligible for the fair market value exception of paragraph (a)(4) of this section and is not treated as the owner of the portion of FT attributable to the $50,000 transferred to FT.