n-08-71.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Sec. 475 Valuation Safe Harbor

Notice 2008-71

SECTION 1. PURPOSE
This notice requests comments with respect to possible expansion of §1.475(a)-4
of the Income Tax Regulations (safe harbor valuation regulations) so that financial
institutions headquartered outside the United States can qualify to make the election
described in Treas. Reg. § 1.475(a)-4(b).
SECTION 2. BACKGROUND
On June 12, 2007, the Treasury Department and the Internal Revenue Service
(Service) published the safe harbor valuation regulations in the Federal Register
(TD 9328; 72 FR 32172; 2007–27 I.R.B. 1). For dealers in securities and for dealers in
commodities that elect to mark to market under section 475(e), those regulations
provide an elective safe harbor for valuations under section 475. Specifically, if an
eligible taxpayer makes the safe harbor election, the values of certain positions that the
taxpayer reports on an eligible financial statement in a manner consistent with the
requirements of the safe harbor valuation regulations are treated as those positions’ fair
market values for purposes of section 475. See
Treas. Reg. § 1.475(a)-4(b).
Any tax regulatory regime that permits use of values from a financial statement
for tax purposes must ensure that the financial accounting regime’s standards that are
used by taxpayers are consistent with the requirements of applicable sections of the
Internal Revenue Code (Code) (in this case section 475). The safe harbor valuation
regulations are based on the conclusion that use of financial statement values for tax
purposes is justified to the extent that the taxpayer satisfies certain basic criteria:
1. The financial accounting method used in the taxpayer’s financial statement
must be sufficiently consistent with what section 475 requires for tax purposes
(and therefore is an “eligible method,” see
Treas. Reg. § 1.475(a)-4(d)).
2. The taxpayer’s financial statement must have sufficient indicia of reliability to
ensure that the taxpayer carefully and consistently follows the financial
accounting method being used in the statement (and therefore is an
“applicable financial statement,” see
Treas. Reg. § 1.475(a)-4(h)).
3. The taxpayer’s record keeping and record production must enable the Service
to verify that the values used for tax purposes were the same as the values

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reported on the financial statement; and, when the values to be reported on
the tax return are required to incorporate adjustments to the raw values in the
financial statement, the taxpayer’s record keeping and record production must
enable the Service to reconcile the two sets of values.
See generally
the preamble to TD 9328 (discussing the broad policies underlying the
particular requirements in the safe harbor valuation regulations).
Internationally Headquartered Financial Institutions

Some financial institutions that are chartered outside of the United States and are
engaged in a trade or business within the United States (internationally headquartered
financial institutions) have commented that certain of the requirements set forth in the
safe harbor valuation regulations prevent them from using the safe harbor. The
Treasury Department and the Service are considering expanding the regulatory safe
harbor if the basic criteria above are satisfied and are requesting comments regarding
that expansion.
Two definitions in the current regulations would need to be amended in order to
expand the safe harbor valuation regime potentially to include internationally
headquartered financial institutions.
Internationally headquartered financial institutions generally prepare financial
statements in accordance with the International Financial Reporting Standards (“IFRS”).
The definition of “eligible method” (see Treas. Reg. § 1.475(a)-4(d)) excludes non-U.S.
GAAP accounting systems by including only accounting methods that determine value
in accordance with U.S. GAAP. Therefore, in order for internationally headquartered
financial institutions generally to be eligible to use the safe harbor, the definition of
eligible method would have to be amended to include IFRS (or more specifically the
version of IFRS the U.S. Securities and Exchange Commission (SEC) is considering for
adoption).
Second, internationally headquartered financial institutions generally do not
prepare financial statements that satisfy the current regulatory requirements for being
an “applicable financial statement” (within the meaning of Treas. Reg. § 1.475(a)-4(h)).
The definition of “applicable financial statement” requires preparation of the statement in
accordance with U.S. GAAP and use of the statement in filings with the SEC or with any
agency of the Federal government other than the Service. Internationally
headquartered financial institutions generally file complete, non-U.S.-GAAP-based
financial statements with a home country supervisor or market regulator, not with a
Federal agency other than the Service as required by the safe harbor valuation
regulations. Thus, the home country financial statement is not an “applicable financial
statement.” Therefore, in order for internationally headquartered financial institutions
generally to be eligible to use the safe harbor, the definition of applicable financial
statement would have to be amended to include non-U.S.-GAAP financial statements

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filed with the institution’s home country regulator or some other financial statement that
is filed by that taxpayer with other appropriate regulatory authorities.
Expansion of the Safe Harbor Valuation Regulations to Include IFRS

The decision whether to expand the definition of “eligible method” to include
IFRS (or, more specifically, the version of IFRS ultimately adopted by the SEC) will be
based on the criteria identified above that justify use of financial statement values for tax
purposes. The current regulatory definition of “eligible method” attempts to ensure that
a financial statement may serve as the basis of valuation for tax purposes only if the
accounting method used in that statement is sufficiently consistent with the accounting
method that section 475 requires for tax purposes. The definition of “eligible method,”
which requires that an eligible method be a mark-to-mark method, recognizes that the
central difference between a mark-to-market and a realization accounting method is
that, under the former but not under the latter, the taxpayer’s income statement
currently accounts for unrealized changes in value. Moreover, in crafting the current
safe harbor the Treasury Department and the Service “concluded that the requirements
and limitations of the safe harbor ensure sufficient consistency when applied to financial
statements prepared according to U.S. GAAP. This conclusion is less clear when the
requirements and limitations are applied to financial statements prepared under other
accounting regimes.” T.D. 9328, 72 FR 32172, 32176; 2007–27 I.R.B. 1, 5.
The Treasury Department and the Service continue to evaluate the issue of
whether to expand the definition of “eligible method” to include IFRS and are therefore
interested in comments on the differences between U.S. GAAP valuation standards and
those in IFRS, especially differences between mark-to-market valuation under IFRS and
under U.S. GAAP (including whether IFRS permits voluntary adoption of alternative
valuation standards).
Understanding these differences is necessary in evaluating whether any IFRS
standards are sufficiently consistent both with the three criteria described above that
underlie the safe harbor and with the policies of other sections of the Code and the
Regulations (e.g., section 861 and Treas. Reg. § 1.882-5) that rely on asset values
determined under section 475. For example, if a financial accounting method arrives at
a value by including funding costs (including any management allocation of expenses)
or permits those costs to be taken into account pursuant to a voluntary convention,
allowing that method might significantly erode the policies of other sections of the Code
and the Regulations.
Expansion of “Applicable Financial Statement”

The decision whether to expand the definition of “applicable financial statement”
likewise will be based on the criteria identified above that justify the use of financial
statement values for tax purposes. Many internationally headquartered financial
institutions file a U.S. GAAP-based balance sheet (a “call report”) with a United States
bank regulator. Some commentators have urged that this financial statement be

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permitted to be an “applicable financial statement’ to the extent that the other
requirements of the regulations are satisfied. This partial financial statement does not
satisfy the current regulatory requirements of the safe harbor. In particular, this partial
financial statement does not contain an income statement and, as a result, changes in
the values of the taxpayer’s positions are not currently reflected in income. The partial
financial statement, therefore, does not employ an “eligible method,” and so the values
reported on that partial statement are not eligible to be used in the safe harbor. It has
been suggested, however, that when a taxpayer files a U.S. GAAP-based call report
with a U.S. bank regulator and the values on the call report correspond to the values on
the taxpayer’s home country IFRS-based financial statements that include an income
statement, these circumstances should nevertheless satisfy the definition of an
“applicable financial statement” to the extent that the other requirements of the
regulations are satisfied.
This suggestion raises the question whether the basic criteria described above
would be satisfied by the combination of a call report filed with a U.S. regulator and the
reporting party’s home country income statement. In order for this to be the case, the
mark-to-market method in the home country income statement would have to be an
eligible method and the filing with a U.S. regulator would have to give the statement
sufficient indicia of reliability that the financial accounting method is being carefully and
consistently followed. In expressing uncertainty whether non-U.S.-GAAP financial
statements satisfy the criteria underlying the regulations, the preamble to the final
regulations asked a number of questions to solicit public comment. TD 9328, 72 FR at
32176; 2007–27 at 5. The Treasury Department and the Service continue to welcome
answers to those questions.
SECTION 3. REQUEST FOR COMMENTS
In particular, to aid in the consideration of whether to expand the safe harbor
valuation regulations so that internationally headquartered financial institutions can
make the safe harbor valuation election, the Treasury Department and the Service
request answers to the following questions:
1. If the existing regulatory requirements discussed above were expanded to permit
internationally headquartered financial institutions to make the election described
in Treas. Reg. § 1.475(a)-4(b), are a significant number of these institutions likely
to make the election?
2. If the safe harbor were expanded to include circumstances where the values
reported in the U.S. call report of a foreign bank are the same values that are
reported in a mark-to-market income statement filed in the bank's home country,
how will the Service be able to match the values used for tax purposes with those
on the home country income statement?
3. What is the relationship between the call report and the home-country income
statement? Are there foreign currency translation considerations between the

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two? How might those be resolved so that the Service can effectively and
efficiently audit the records?
4. If the definition of “applicable financial statement” is expanded, should the
applicable financial statement be the one filed by the foreign bank with its home
country bank regulator rather than with a home country market regulator (like the
SEC)?
5. How, if at all, does mark-to-market valuation under IFRS take expenses into
account, including funding costs or any similar amount (e.g., cost of carry)?
a. Does IFRS allow these amounts to be taken into account pursuant to a
voluntary accounting convention under any circumstances?
b. What regulatory amendments, if any, should be considered if those costs
are taken into account, keeping in mind the interaction of section 475 with
other sections of the Code and Income Tax Regulations (e.g., section 861
and Treas. Reg. § 1.882-5)?
6. In what circumstances is section 475 relevant for other purposes of the Code and
in what circumstances do the policies of other sections of the Code and the
Regulations that rely on asset values determined under section 475 (including
those determined pursuant to an election under Treas. Reg. § 1.475(a)-4(b))
require special adjustment to the amount determined under section 475?
7. Should the definition of “eligible method” go beyond the accounting methods that
the SEC has accepted? If so, what is an appropriate (and administrable)
framework for evaluating whether such a method complies with the basic criteria
outlined above?
SECTION 4. INSTRUCTIONS
Comments should be submitted on or before November 1, 2008, and should
include a reference to Notice 2008-71. Send submissions to CC:PA:LPD:PR (Notice
2008-71), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, D.C. 20044. Submissions may be hand-delivered Monday through Friday
between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (Notice 2008-71),
Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington,
DC 20224, or sent electronically via the following email address:
Notice.Comments@irscounsel.treas.gov. Please include the notice number 2008-71 in
the subject line of any electronic communication. All materials submitted will be
available for public inspection and copying.
DRAFTING INFORMATION

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The principal author of this notice is Sheila Ramaswamy of the Office of
Associate Chief Counsel (International). For further information regarding this notice
contact Sheila Ramaswamy on (202) 622-3870 (not a toll-free call).