PLR 1322033: IRS recognizes a foreign electronic exchange as a qualified board or exchange

Plain-English summary

The IRS determined that a foreign electronic futures and options exchange was a qualified board or exchange under section 1256(g)(7)(C). The exchange represented that its contracts were marked to market, that it would provide records and taxpayer information to the IRS, and that its rules required members to comply with applicable reporting requirements. The determination was conditioned on those representations, continued operation under existing CFTC no-action relief, and approval of the exchange's registration under the CFTC foreign board of trade system. The ruling allows contracts traded on the exchange to meet the qualified-exchange requirement for regulated futures contract treatment under section 1256.

Ruling snapshot

• Question: Did the foreign exchange have rules adequate to qualify as a board or exchange under section 1256(g)(7)(C)?
• Outcome: Approved, subject to stated conditions
• Key authorities: IRC §§ 1256, 6045, 6110(k)(3), and 7602.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201322033 Third Party Communication: None
Release Date: 5/31/2013 Date of Communication: Not Applicable
Index Number: 1256.07-05
Person To Contact:
------------------------------------------------------------ ------------------------, ID No. ------------------
--------- ----------------------------------------------------
--------------------------- Telephone Number:
-------------------------------- ----------------------
------------------------------ Refer Reply To:
---------------- CC:FIP:B02
PLR-147298-10
Date:
February 25, 2013

Legend:

The Exchange = ---------------------------

Entity A = ---------------------------

Entity B = --------------

Entity C = --------------------------

Entity D = -------------------------------------

Country X = --------------

Country Y = -----------------

Date A = ------------------

Date B = -----------------------

Date C = ------------------------

Date D = --------------------

Date E = -----------------------

Article X = --------------

Income Tax Treaty = ------------------------------------------------------------------------
PLR-147298-10 2

Exchange Rulebook = ------------------------------------------------------------------------
------------------------------------------------

Dear ---------------:

  This is in reply to your letter dated October 25, 2010, and subsequent

correspondence, requesting a ruling that the Exchange is a “qualified board or
exchange” within the meaning of section 1256(g)(7)(C) of the Internal Revenue Code.

Facts:

   The Exchange is an all-electronic futures and option exchange that is a Country

X public-law institution. As a Country X public-law institution, the Exchange itself does
not have an owner, but is operated by Entity A, the Exchange’s administrative and
operating institution. Entity A is owned by Entity B, a Country Y futures and option
exchange.

   All of the Exchange’s transactions are cleared and settled through Entity C, a

wholly-owned subsidiary of Entity A. Entity C is incorporated in Country X. Although
Entity A is owned by a Country Y entity, the operations of the Exchange and of Entity C
are not subject to Country Y law or regulation with respect to transactions conducted on
the Exchange and cleared by Entity C. All transactions on the Exchange, and the
clearing of such transactions, are governed by the law of Country X and the Exchange’s
rules and procedures.

    The Exchange was originally named Entity D, but changed its name on Date A.

In a letter dated Date B (hereafter referred to as “the CFTC Date B letter”), the CFTC
granted no-action relief to Entity D, the Exchange’s predecessor, allowing United States
members to trade through the Exchange’s electronic trading system, notwithstanding
that the Exchange was not designated as a contract market pursuant to sections 5 and
5a of the Commodity Exchange Act. The CFTC Date B letter was later amended on
Date C and Date D by CFTC no-action letters.

   On November 2, 2006, the CFTC published in the Federal Register a Statement

of Policy that affirmed the use of the no-action process to permit foreign boards of trade
to provide direct access to their electronic trading systems to U.S. members or
authorized participants without seeking designation under the Commodity Exchange Act
as a contract market. In the policy statement, the CFTC endorsed the scope of the
review under the no-action process, which in part, it described as follows:

           The scope of review that was established by Commission staff in
     the DTB no-action letter and refined in subsequent no-action letters

PLR-147298-10 3

 focuses on establishing the “bona fide” status of the foreign board of trade
 and finding that no public interest would be adversely affected by persons
 in the U.S. directly accessing the foreign board of trade.

         In general, staff reviews information and representations provided
 by the applicant that relate to, among other things, the rules and structure
 of the applicant exchange (with an emphasis on the exchange’s financial
 integrity, market surveillance, trade practice and rule enforcement regime),
 various system integrity protections that govern the foreign board of
 trade’s electronic trading system (using as a template the 1990 Principles
 for the Oversight of Screen-Based Trading Systems), the system’s related
 clearing and customer default protections, and information concerning the
 regulatory structure in the applicant’s jurisdiction, with a specific emphasis
 on market regulation. The staff also reviews the adequacy of information
 sharing with the Commission by the market and its regulator. Based upon
 its review of the documents and representations submitted by the
 applicant, and subject to compliance with various conditions (e.g.,
 representations governing access to books and records and the
 appointment of a U.S. agent for service of process), staff might conclude
 that granting no-action relief would not be contrary to the public interest.

         Essentially, as it has evolved, the staff review seeks to determine
 that the applicant foreign board of trade is subject to governmental
 authorization, appropriate rules prohibiting abusive trading practices, and
 continuing oversight by a regulator that has powers to intervene in the
 market and share information with the Commission. This review generally
 reflects the internationally accepted approaches used by many developed
 market jurisdictions to govern access to foreign electronic exchanges.
 These approaches generally are based upon a review of, and ongoing
 reliance upon, the foreign market’s “home” regulatory regime, and are
 designed to maintain regulatory protections while avoiding the imposition
 of duplicative regulation.

         The Commission finds that the staff review appropriately addresses
 the Commission’s concern that relief will only be granted with respect to
 bona fide foreign boards of trade. The Commission also finds that the
 staff’s review of foreign board of trade representations and the related
 information submitted with respect to system integrity, clearing procedures
 and default protections is appropriately focused and respects the
 prohibitions of section 4(b). Finally, the various terms and conditions that
 have been imposed in the no-action letters have been reasonably and
 appropriately tailored to the factual circumstances raised by the
 applications for no-action relief.

PLR-147298-10 4

Boards of Trade Located Outside of the United States and No-Action Relief From the
Requirement To Become a Designated Contract Market or Derivatives Transaction
Execution Facility, 71 Fed. Reg. 64,443, 64,446-47 (Nov. 2, 2006) (footnotes omitted).

   On February 20, 2012, the CFTC finalized rules regarding the registration of

foreign boards of trade, including those with existing no-action letters, with the CFTC
(“the CFTC FBOT registration system”). (See Registration of Foreign Boards of Trade,
76 Fed. Reg. 80674 (Dec. 23, 2011). The CFTC FBOT registration system will replace
the no-action relief system.

  The Exchange makes the following representations.

  (1) The Exchange has satisfied, and continues to satisfy, all CFTC conditions
  necessary to retain its no-action relief from contract market designation, and has
  submitted an application for registration under the CFTC FBOT registration
  system.

  (2) All Exchange contracts are subject to a system of marking to market whereby
  gains are credited to accounts and losses are subjected to margin calls on a daily
  basis.

  (3) Under Article X of the Income Tax Treaty, the Internal Revenue Service (the
  Service) may gain access to information held by the Exchange with respect to
  U.S. taxpayers.

  (4) The Exchange will maintain an agent for service within the United States, to
  receive and accept any request for information, summons, or subpoena from the
  Service or from any grand jury properly convened within the United States, which
  is related to the taxation of transactions in futures contracts traded on the
  Exchange by any person.

  (5) The supplying by the Exchange of its records, as required herein, to a U.S.
  grand jury or to the Service will not be a violation of, or inconsistent with, the law
  of Country X.

  (6) The Exchange will retain its records respecting derivatives trading on the
  Exchange for a minimum of five years.

  (7) The Exchange will collect from all Exchange Members that either have or are
  required to have U.S. taxpayer identification numbers their U.S. taxpayer
  identification numbers and, upon request, will provide such information to the
  Service.

PLR-147298-10 5

 (8) The Exchange will identify a senior management contact of each Exchange
 Member and, on request, will make such information available to the Service. On
 request, the Exchange will ask Exchange Members to identify their other
 executive officers to the Service.

 (9) The Exchange will provide such further information and assurances as may
 from time to time be requested by the Service in order to verify the Exchange’s
 entitlement to the determination under section 1256(g)(7)(C) of the Code.

 (10) The Exchange Rulebook has been amended, approved, and will be
 maintained to require the following:

       a) Exchange Members who are subject to the reporting requirements of
       brokers under section 6045 of the Code and the Treasury Regulations
       thereunder shall comply with such requirements, as amended from time to
       time, with respect to transactions effected on, or otherwise subject to the
       Rules of, the Exchange in the manner prescribed by section 6045 of the
       Code, the regulations thereunder, and such other provisions of the Code
       and regulations that are pertinent thereto. The Exchange shall coordinate
       with Entity B to ensure that a failure of an Exchange Member to comply
       with this provision will result in immediate suspension of such Member’s
       membership privileges on Entity B (and all privileges of any successor to
       such Member), which the Exchange and Entity shall ensure will not allow
       such Member to effect trade through the Exchange, until the Member
       complies with these reporting requirements in all respects. Such
       compliance includes the filing of all returns that were required to have
       been filed under section 6045 but were not filed or were filed improperly.

       b) In addition to the requirements of the Exchange Rulebook, upon
       request by the Exchange, Exchange Members (with respect to
       transactions occurring on the Exchange) will supply to the Exchange or
       directly to the Service or any grand jury properly convened within the
       United States all books, papers, records, or other data as described in
       section 7602 of the Code and the Treasury Regulations thereunder. Such
       requests will be made by the Exchange whenever the Exchange receives
       a written request, summons, or subpoena to produce such records from
       the Service or from any grand jury. The Exchange shall coordinate with
       Entity B to ensure that a failure of an Exchange Member to comply with
       this provision will result in immediate suspension of such Member’s
       membership privileges on Entity B (and all privileges of any successor to
       such Member), which the Exchange and Entity B shall ensure will not
       allow such Member to effect trade through the Exchange, until the
       Member complies with these reporting requirements in all respects.

PLR-147298-10 6

Law and Analysis:

  Section 1256(a) of the Code provides, in general, when gain or loss on section

1256 contracts will be recognized and how such gain or loss will be treated for federal
income tax purposes.

   Section 1256(b) of the Code provides, in part, that for purposes of this section,

the term “section 1256 contract” means any regulated futures contract.

   Section 1256(g)(1) of the Code provides that the term “regulated futures contract”

means a contract (A) with respect to which the amount required to be deposited and the
amount which may be withdrawn depends on a system of marking to market and (B)
which is traded on or subject to the rules of a qualified board or exchange.

  Section 1256(g)(7) of the Code provides that the term “qualified board or

exchange” means –

          (A) a national securities exchange which is registered with the Securities
              and Exchange Commission,

          (B) a domestic board of trade designated as a contract market by the
              Commodity Futures Trading Commission, or

          (C) any other exchange, board of trade, or other market which the
              Secretary determines has rules adequate to carry out the purposes of
              this section.

   Based on the foregoing and the facts in the CFTC Date B letter, as subsequently

amended, we determine that the Exchange has rules adequate to carry out the
purposes of section 1256 and is thus a qualified board or exchange within the meaning
of section 1256(g)(7)(C). This ruling is conditioned on the representations set forth
above and compliance therewith.

    The Exchange submitted an application for registration under the CFTC FBOT

registration system on Date E. This ruling shall be effective for any period during which
the Exchange is allowed to continue to operate pursuant to its existing no-action letter
pending approval of its application by the CFTC. However, the continuing validity of this
ruling is conditioned on the Exchange obtaining approval pursuant to the CFTC FBOT
registration system.

    Except as specifically ruled upon above, no opinion is expressed or implied

concerning the federal tax consequences relating to the facts discussed or referenced in
this letter.
PLR-147298-10 7

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of this request for ruling, it is subject to verification on examination.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

                                               Sincerely,


                                               David B. Silber
                                               David B. Silber
                                               Chief, Branch 2
                                               Office of Associate Chief Counsel
                                               (Financial Institutions and Products)