Dealers in Securities Futures Contracts;
Request for Comments

DEPARTMENT OF THE TREASURY
Internal Revenue Service [BPG-132413-00] 

TITLE: Dealers in Securities Futures Contracts; request for comments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of solicitation of comments.

SUMMARY: The IRS and Treasury Department are soliciting comments on
the criteria that should be used to determine whether a taxpayer is
a dealer in securities futures contracts (or options on such
contracts) for purposes of section 1256 of the Internal Revenue
Code.

DATES: Written and electronic comments are requested on or before
May 5, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (BPG-132413-00), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU (BPG-132413-00), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by submitting comments directly to
the IRS Internet site at http://www.irs.gov/tax_regs/regslist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the notice, Patrick E.
White (202) 622-3920; concerning submission and delivery of
comments, Treena Garrett, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The Commodities Futures Modernization Act of 2000, enacted as part
of the Consolidated Appropriations Act, 2001 (Public Law 106-554,
114 Stat. 2763), authorizes the trading of securities futures
contracts, a new type of derivative financial product. Another
portion of the same enactment - the Community Renewal Tax Relief Act
of 2000 (the Act) - prescribes the tax treatment of these financial
products. In general, gain or loss is recognized on securities
futures contracts upon disposition, and the character of such gain
or loss is determined by newly enacted section 1234B.

The timing and character of gains and losses on dealer securities
futures contracts, however, is determined by section 1256. Thus,
dealer securities futures contracts are subject to mark-to-market
treatment, and capital gains or losses are treated as 60 percent
long-term capital gain or loss and 40 percent short-term capital
gain or loss. Section 1256(g)(9) defines dealer securities futures
contracts as securities futures contracts (and options on such
contracts) that are traded on a qualified board or exchange and are
entered into by a dealer in the normal course of the dealer's
business of dealing in such contracts or options. For this purpose,
a person is a dealer in securities futures contracts or options on
such contracts if the Secretary of the Treasury determines that the
person performs functions with respect to such contracts or options
similar to the functions performed with respect to stock options by
persons registered with a national securities exchange as a market
maker or specialist in listed options. The Act requires the
Secretary of the Treasury or his delegate to make this determination
no later than July 1, 2001. The legislative history of the Act
states the following with respect to the determination process:

The determination of who is a dealer in securities futures contracts
is to be made in a manner that is appropriate to carry out the
purposes of the provision, which generally is to provide comparable
tax treatment between dealers in securities futures contracts, on
the one hand, and dealers in equity options, on the other. Although
traders in securities futures contracts (and options on such
contracts) may not have the same market-making obligations as market
makers or specialists in equity options, many traders are expected
to perform analogous functions to such market makers or specialists
by providing market liquidity for securities futures contracts (and
options) even in the absence of a legal obligation to do so.
Accordingly, the absence of market-making obligations is not
inconsistent with a determination that a class of traders are
dealers in securities futures contracts (and options), if the
relevant factors, including providing market liquidity for such
contracts (and options), indicate that the market functions of the
traders is comparable to that of equity options dealers.

H.R. Conf. Rep. No. 106-1033, 106 Cong., 2d Sess. 1036 (2000).

The IRS and Treasury Department, therefore, seek taxpayers'
suggestions concerning both the substance of these determinations
and the manner in which they should be made. As described in more
detail below, of particular interest are comments that will aid in
establishing objective criteria and processes for making the
determinations. In addition, comments are solicited in certain
specific areas.

First, comments are requested about the activities and obligations
of equity options dealers, especially those activities and
obligations that contribute to the establishment and maintenance of
an orderly market. For purposes of this notice, the term equity
options dealer means a market maker or specialist described in
section 1256(g)(8) with respect to options that are described in
section 1256(g)(6) without regard to the requirement that indices be
narrow based. Any relevant way in which the activities and
obligations of market makers differ from those of specialists should
be described; and the significance of this difference for any
comment or other response to this notice should be explained when
relevant.

Among the questions on which information is sought are the
following: What are the activities imposed on, or undertaken by,
equity option dealers that are considered making a market? Do equity
option dealers engage in activities that extend beyond making a
market but that contribute to the establishment and maintenance of
orderly markets? For example, equity options dealers trading for
their own accounts (and not in response to orders placed by an off-
exchange customer) may be a significant source of market volume. Is
that the case? If so, to what extent does this added volume
contribute to market liquidity? Are there other ways in which these
dealers contribute to the markets in which they participate? What
differences are there, in scale or kind, between the activities of
equity options dealers and similar activities of other market
participants?

Although some relevant activities of equity options dealers may be
ongoing, other critical activities may commence, or change
significantly in nature or scope, during periods of market
disequilibrium. Information with respect to equity options dealers'
activities at these times will be particularly welcome.

Second, information is requested regarding activities of traders1 on
futures markets. Although traders on futures markets may not have
specific market-making obligations, their trading activities may
contribute to the establishment and maintenance of orderly markets.
Is that typically the case? Descriptions of trading activities on
futures markets generally will be helpful, and insights and
supporting data on the nature and extent of trading by specific
groups of futures traders will be particularly useful. Relevant
groups for this purpose may be based on the type of contract traded,
the extent of trading for one's own account (as opposed to trading
in response to orders from off-exchange customers), and the class of
exchange membership.

This discussion should be accompanied, if possible, by an
explanation of the extent to which the activities of traders in
securities futures contracts are expected to resemble the activities
of the specific groups described. In general, expectations of how
trading in securities futures contracts may or may not differ from
trading in current products will also be helpful. Third, comments
are solicited on administrable and economically meaningful criteria
for identifying any traders that should be treated as dealers in
securities futures contracts. Criteria for identifying these persons
might include, among others, the nature and extent of trading
activities (including the extent to which the person's trading is
concentrated in certain products), class of exchange membership,
capital, and share of net income derived from trading activities.
Should it be possible for a person to be a dealer in securities
futures contracts with respect to some such contracts but not with
respect to others?

If a taxpayer's satisfaction of the suggested criteria may vary over
time, comments are also requested respecting rules for determining
when a taxpayer becomes, or ceases to be, a dealer in securities
futures contracts. For example, should it be possible for the status
as a dealer in securities futures contracts to change within a
single taxable year or only between taxable years? Does a taxpayer
need to know before it enters a transaction whether it is treated as
a dealer for purposes of that transaction? Will special rules be
required for taxpayers who have not previously. traded in the
contracts? (Initially, all taxpayers fall into this category.)
Comments regarding both substantive criteria and the method of
application will be useful.

Comments

Written or electronic comments (a signed original and eight (8)
copies, if written) should be timely submitted (in the manner
described in the ADDRESSES portion of this notice) to the IRS. All
comments will be available for public inspection and copying.

Drafting Information

The principal authors of this notice are Patrick E. White, Office of
Associate Chief Counsel (Financial Institutions and Products), and
Matthew J. Eichner, Office of Tax Analysis, United States

DEPARTMENT OF THE TREASURY. However, other personnel from the IRS
and Treasury Department participated in its development.

__________________________________

Lon B. Smith
Acting Associate Chief Counsel
(Financial Institutions & Products)

The references here, and in the following paragraphs, to traders are
not intended to exclude any taxpayers who are not treated as traders
for tax purposes but who may perform functions similar to the
functions performed by equity options dealers.

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