(a) In general.—This section provides
rules permitting certain shareholders to make a special election under section 1295 (special
preferred QEF election) in lieu of the election described in § 1.1295-1 1 and Notice 88-125, 1988-2
C.B. 535 (see § 601.601(d)(2)(ii)(b) of this chapter), with respect to certain preferred shares
(qualified preferred shares) of a foreign corporation that certifies either that it is a PFIC (as
defined in § 1.1291-1(b)(1)(i))1 or that it reasonably believes that it is a PFIC. In order to make a
special preferred QEF election, a shareholder must satisfy the stock ownership requirement of
paragraph (c)(2) of this section. A special preferred QEF election of a shareholder applies only to
those qualified preferred shares acquired and held directly by the shareholder in the taxable year
of the shareholder for which the election is made. A shareholder making a special preferred QEF
election must account for dividend income on shares subject to the election under the special
income inclusion rules described in § 1.1293-2, rather than under the general income inclusion
rules of section 1293 and § 1.1293-1. In addition, for purposes of determining the tax consequences
of owning shares subject to the special preferred QEF election, an electing shareholder must treat
the foreign corporation as a PFIC for the entire period during which the shareholder continues to
hold any of such shares. Paragraph (b) of this section defines qualified preferred share. Paragraph
(c) of this section provides rules for determining who may make the special preferred QEF
election. Paragraph (d) of this section provides rules concerning the effect of the election.
Paragraph (e) of this section provides rules for the time and manner of making the election.
Paragraph (f) of this section sets forth the annual reporting requirement for the election.
Paragraph (g) of this section provides rules concerning the possible termination or invalidation of
the election. For the applicability date of this section, see paragraph (h) of this section.

(b) Qualified preferred share defined.—

(1) In general.—For purposes of this section, a share
of a foreign corporation is a qualified preferred share only if—

(i) The share was originally issued for cash or in exchange for qualified preferred
shares of the foreign corporation in a transaction to which section 354(a)(1) applied;

(ii) If the share were to constitute a debt obligation, the share would be in
registered form within the meaning of § 5f.103-1(c) of this chapter;

(iii) All amounts payable with respect to the share are denominated in U.S. dollars
and are not determined by reference to the value of a currency other than the U.S. dollar;

(iv) The share is limited and preferred as to dividends and does not participate in
corporate growth to any significant extent within the meaning of section 1504(a)(4)(B);

(v) The share has a fixed redemption or liquidation price;

(vi) The share provides for cumulative or noncumulative dividend rights that are
limited to an annual (or shorter period) amount computed by multiplying either the redemption or
liquidation price of the share by a specified index described in § 1.446-3(c)(2)(i), (iii), or (iv)
(specified index), or by a specified index periodically re-established pursuant to an auction reset
mechanism, set in advance of the period with respect to which the specified index applies;

(vii) If the share may be redeemed under circumstances described in § 1.305-5(b)
such that redemption premium (as described in § 1.305-5(b)) could be treated under section
305(c) as a constructive distribution (fixed term preferred stock), the share was not issued with
redemption premium exceeding the de minimis amount described in section 305(c)(1) and
§ 1.305-5(b)(1);

(viii) If the share may not be redeemed under circumstances described in
§ 1.305-5(b) such that redemption premium would not be treated under section 305 as a construc-
tive distribution (perpetual preferred stock), the share does not provide shareholders with the
right to receive an amount upon liquidation or redemption that exceeds the issue price of the
share (as determined under the principles of section 1273(b)) by an amount in excess of 5 percent
of such liquidation or redemption amount;

(ix) If redeemable, the share is redeemable only in whole and not in part and is not
subject to mandatory redemption within five years of the issue date of the share. Further, the
share is not subject to a holder put or issuer call that, based on all the facts and circumstances as
of the issue date of the share, is more likely than not to be exercised at a time within five years of
the issue date;

(x) If convertible, the share is not convertible into a share other than a share
meeting all the conditions set forth in paragraphs (b)(1)(i) through (b)(1)(ix) of this section; and

(xi) The issuer of the share has indicated in an offering document relating to the
original issuance of the share or in a written statement available to U.S. holders that the issuer has
no current intention or belief that it will not pay dividends on the share on a current basis and that
the share meets the conditions set forth in paragraphs (b)(1)(i) through (b)(1)(x) of this section
and this paragraph (b)(1)(xi).

(2) Special rules for shares acquired in secondary market transactions.—

(i) Fixed term preferred stock.—A share of fixed term preferred stock (as described in paragraph (b)(1)(vii) of
this section) that satisfies the conditions set forth in paragraph (b)(1) of this section and that is
acquired in a transaction other than in connection with the initial issuance of the share (a
secondary market transaction), shall constitute a qualified preferred share with respect to a
shareholder, but only if the shareholder acquires the share for cash and the share has preferred
discount (as defined below) that is less than or equal to an amount equal to 1 percent of the
redemption price, multiplied by the number of complete years from the date of acquisition of the
share to the redemption date as established under the principles of § 1.305-5(b). Sales of shares to
bond houses, brokers, or similar persons or organizations acting in the capacity as underwriters,
placement agents, or wholesalers are ignored for purposes of determining whether a share is
acquired in connection with the initial issuance of the share. For purposes of this section, the
preferred discount for a share is the excess of the redemption price of the share payable on the
redemption date over the shareholder’s acquisition cost for the share.

(ii) Perpetual preferred stock.—A share of perpetual preferred stock, within the
meaning of paragraph (b)(1)(viii) of this section, that satisfies the conditions set forth in para-
graph (b)(1) of this section and that is acquired in a secondary market transaction, shall constitute
a qualified preferred share with respect to the shareholder, but only if the shareholder acquires
the share for cash and the amount payable upon liquidation of the share exceeds the shareholder’s
acquisition cost for the share by an amount less than or equal to 10 percent of such liquidation
amount.

(iii) Examples.—The following examples illustrate the rules of this paragraph (b)(2).

Example 1—

(i) Facts. On May 1, 1998, A, an individual who files her return on a
calendar year basis, purchases for $9000 cash in a single secondary market transaction (as defined
in paragraph (b)(2)(i) of this section) 100 shares of nonconvertible Class A $100 par value
preferred stock (Class A Stock) of FC, a foreign corporation with a taxable year ending March 31.
The terms of the Class A Stock satisfy all the conditions described in paragraph (b)(1) of this
section and provide for a mandatory redemption of the Class A Stock by the issuer in U.S. dollars
at par on June 1, 2012. The Class A Stock is not redeemable pursuant to an issuer call or holder
put on any other date.

(ii) Analysis. In order for A to make a special preferred QEF election with respect to
the Class A Stock acquired by A, the Class A Stock acquired must constitute qualified preferred
shares. Although the Class A Stock meets the requirements for qualified preferred shares set
forth in paragraph (b)(1) of this section, the stock also must satisfy the requirements described in
paragraph (b)(2) because A acquired the stock in a secondary market transaction. Because the
terms of the Class A Stock provide that the stock will be redeemed by the issuer on June 1, 2012,
the stock constitutes fixed term preferred stock within the meaning of paragraph (b)(1)(vii) of this
section. A purchased the Class A Stock for $90 per share, representing a $10 discount ($100 June
1, 2012, per share redemption price less $90 acquisition cost). Because this $10 discount, which
constitutes preferred discount within the meaning of paragraph (b)(2)(i) of this section, is less
than $14 (1 percent of the redemption price multiplied by 14 (the number of complete years until
the mandatory redemption date)), the Class A Stock acquired by A satisfies the conditions of
paragraph (b)(2)(i) of this section and therefore constitutes qualified preferred shares.

Example 2—

(i) Facts. The facts are the same as in Example 1, except that A
acquires the 100 shares of Class A Stock for $8000.

(ii) Analysis. In this case, A purchased the Class A Stock for $80 per share,
representing a $20 discount ($100 June 1, 2012, redemption price less $80 acquisition cost).
Because this $20 of preferred discount is greater than $14 (1 percent of the redemption price
multiplied by 14 (the number of complete years until the mandatory redemption date)), the Class
A Stock fails to satisfy the conditions of paragraph (b)(2)(i) of this section and therefore fails to
qualify as qualified preferred shares.

(c) Who may make the election.—

(1) In general.—A U.S. person that acquires qualified
preferred shares for cash or in a nonrecognition transaction described in § 1.1291-6(a)2 (nonrecog-
nition transaction) and that holds such shares directly may make a special preferred QEF election,
provided that, in the case of shares acquired in a nonrecognition transaction, either the qualified
preferred shares are treated as stock of a pedigreed QEF, as defined in § 1.1291-1(b)(2)(ii),
immediately prior to the nonrecognition transaction, or the gain, if any, realized on the transaction
would be recognized under § 1.1291-6(b) with respect to the nonrecognition transaction. A special
preferred QEF election will not apply to any shares with respect to which the electing shareholder
is an indirect shareholder, within the meaning of § 1.1291-1(b)(8). Solely for purposes of this
section, partnerships, S corporations, trusts and estates (pass-through entities) that directly own
qualified preferred shares are treated as shareholders that may make a special preferred QEF
election. A shareholder may not make a special preferred QEF election if at any time the
shareholder made a section 1295 election (other than a special preferred QEF election) with
respect to the foreign corporation. A shareholder may not make a special preferred QEF election
unless the shareholder satisfies the stock ownership requirements set forth in paragraph (c)(2) of
this section, and the shareholder receives from the foreign corporation the statement described in
paragraph (c)(3) of this section.

(2) Ownership requirement.—A holder of qualified preferred shares of a foreign corpora-
tion may make a special preferred QEF election only if, at all times during the taxable year of the
shareholder, the shareholder does not own, directly, indirectly, or constructively, within the
meaning of section 958, five percent or more of the vote or value of any class of stock of the
foreign corporation. The five percent vote or value limitation must be satisfied for each taxable
year of the shareholder during which the shareholder continues to hold shares subject to the
special preferred QEF election.

(3) Statement from corporation.—A shareholder may make the special preferred QEF
election only if the foreign corporation has provided a written statement relating to the taxable
year of the corporation that ends with or within the taxable year of the shareholder for which the
election is made certifying either that the foreign corporation is, or that it reasonably believes that
it is, a PFIC, and that it is not a controlled foreign corporation within the meaning of section 957(a)
for such taxable year of the corporation. The statement must be provided directly to the electing
shareholder or in a disclosure or other document generally available to all U.S. holders. Electing
shareholders must retain a copy of the statement for their records.

(d) Effect of election.—

(1) In general.—Unless terminated or invalidated pursuant to para-
graph (g) of this section, shares subject to a special preferred QEF election will be treated as
shares of a pedigreed QEF (as defined in § 1.1291-1(b)(2)(ii)) for all taxable years of the foreign
corporation that are included wholly or partly in the shareholder’s holding period of the shares. A
special preferred QEF election applies to all qualified preferred shares owned directly by the
shareholder that are acquired in the taxable year of the election. Separate special preferred QEF
elections may be made for qualified preferred shares acquired in other taxable years of the
taxpayer. A special preferred QEF election is personal to the shareholder that made the election
and does not apply to a transferee of the shares. A shareholder that has made a special preferred
QEF election may not make, with respect to the foreign corporation, any other election permitted
under sections 1291 through 1297 and the regulations under those sections, including a section
1295 election as described in § 1.1295-1 and Notice 88-125, 1988-2 C.B. 535 (see
§ 601.601(d)(2)(ii)(b) of this chapter), for any period during which the special preferred QEF
election remains in effect with respect to any shares of the shareholder.

(2) Continued PFIC Characterization.—By making the special preferred QEF election,
the shareholder agrees to treat the foreign corporation as a PFIC with respect to qualified
preferred shares subject to the election at all times during its holding period for such shares,
without regard to whether the foreign corporation is a PFIC for any taxable year of the foreign
corporation during which the preferred QEF election remains in effect.

(3) Section 1293 inclusions.—For each taxable year of the shareholder to which an
election under this section applies, the shareholder must include in income the preferred QEF
amount, as defined in § 1.1293-2, in the manner and under the rules provided in that section.

(e) Time for and manner of making the special preferred QEF election.—

(1) Time for making the election.—A special preferred QEF election must be made on or before the due date, as
extended, for filing the shareholder’s return for the taxable year during which the shareholder
acquired the qualified preferred shares for which the election is being made. A special preferred
QEF election may not be made for those shares at any other time pursuant to any other provision
of the Code or regulations.

(2) Manner of making the election.—

(i) In general.—A shareholder makes the special
preferred QEF election under this section for all qualified preferred shares of a foreign corpora-
tion acquired during the shareholder’s taxable year by checking the appropriate box in Form 8621
(Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund),
Part I, for making the section 1295 election, and indicating in the margin of Part I that the
shareholder is making a special preferred QEF election with respect to certain specified shares.
The shareholder also must report the preferred QEF amount for the taxable year of the election
on Line 6a of Part II of Form 8621. In addition, the shareholder must attach to Form 8621 the
statement (preferred QEF statement) described in paragraph (e)(2)(ii) of this section, signed by
the shareholder under penalties of perjury, stating that the information and representations
provided in the preferred QEF statement are true, correct, and complete to the best of the
shareholder’s knowledge and belief.

(ii) Preferred QEF statement contents.—The preferred QEF statement must include
the following information and representations:

(A) The first taxable year of the shareholder for which the special preferred
QEF election is made;

(B) The number of shares subject to the election, their acquisition date(s) and
acquisition price(s), and the class designation(s) of the shares;

(C) A representation by the shareholder that it did not at any time during its
taxable year own directly, indirectly, or constructively, within the meaning of section 958, five
percent or more of the vote or value of any class of stock of the foreign corporation with respect to
which the election applies;

(D) A representation by the shareholder that it has obtained the written
statement described in paragraph (c)(3) of this section; and

(E) A representation by the shareholder that it has never made a section 1295
election other than a special preferred QEF election with respect to the foreign corporation.

(f) Annual reporting requirement.—For each taxable year of a shareholder during which the
shareholder holds shares of a foreign corporation subject to one or more special preferred QEF
elections, the shareholder must file Form 8621 with respect to the foreign corporation regardless
of whether the foreign corporation is or is not a PFIC under section 1296 during any portion of the
taxable year. The shareholder must indicate in the margin of Part I of Form 8621 the number of
special preferred QEF elections of the shareholder that remain in effect with respect to the foreign
corporation. In addition, the shareholder must report, on Line 6a of Part II of Form 8621, the
aggregate of the preferred QEF amounts for all relevant special preferred QEF elections in effect
for the taxable year.

(g) Termination or invalidation of election.—

(1) In general.—A sale, exchange or other
disposition of a share that is subject to a special preferred QEF election will terminate the special
preferred QEF election with respect to that share. In addition, the Commissioner may, in the
Commissioner’s discretion, terminate or invalidate a special preferred QEF election if a share-
holder that made the election fails to satisfy the initial or ongoing requirements of the election.
Once made, a special preferred QEF election may not be terminated or invalidated by the
shareholder.

(2) Effect of termination or invalidation.—Termination of a special preferred QEF elec-
tion by the Commissioner will be effective on the first day of the shareholder’s first taxable year
following the last taxable year of the shareholder for which the requirements of the election are
satisfied. For purposes of sections 1291 through 1297 and the regulations thereunder, the holding
period of qualified preferred shares subject to an election that has been terminated will be treated
as beginning on the effective date of the termination. A shareholder that has made an election that
is invalidated by the Commissioner will be treated for purposes of sections 1291 through 1297 and
the regulations thereunder as if the shareholder never made the election.

(h) Effective date.—An election under this section may only be made with respect to qualified
preferred shares that are issued after the date that is 30 days after the date of publication of this
document as a final regulation. [Prop. Reg. § 1.1295-2.]

[Proposed 12-24-96.]


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