Federal Register: December 26, 2001 (Volume 66, Number 247)
DOCID: FR Doc 01-31528
DEPARTMENT OF THE TREASURY
Internal Revenue Service
CFR Citation: 26 CFR Parts 1 and 602
RIN ID: RIN 1545-BA49
TD ID: [TD 8971]
ACTION: Income taxes:
DOCUMENT ACTION: Temporary regulations.
New Markets Tax Credit
DATES: Effective Date: These regulations are effective December 26, 2001.
Date of Applicability: For date of applicability of Sec. 1.45D1T, see Sec. 1.45D1T(h).
This document contains temporary regulations that provide guidance for taxpayers claiming the new markets tax credit under section 45D. A taxpayer making a qualified equity investment in a qualified community development entity that has received a new markets tax credit allocation may claim a 5percent tax credit with respect to the qualified equity investment on each of the first 3 credit allowance dates and a 6percent tax credit with respect to the qualified equity investment on each of the remaining 4 credit allowance dates. The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in REG11943601 published elsewhere in this issue of the Federal Register.
New markets tax credit,
Paperwork Reduction Act
These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collections of information contained in these regulations have been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget under control number 15451765. Responses to these collections of information are mandatory.
An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.
For further information concerning these collections of information, and where to submit comments on the collections of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.
Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103. Background
This document contains temporary regulations relating to the new
markets tax credit under section 45D of the Internal Revenue Code
(Code). This provision was added to the Code by section 121(a) of the Community Renewal Tax Relief Act of 2000
(Pub. L. 106554). The Secretary has delegated certain administrative, application, allocation, monitoring, and other programmatic functions relating to the new markets tax credit program to the Under Secretary (Domestic Finance), who in turn has delegated those functions to the Community Development Financial Institutions Fund (CDFI Fund).
On May 1, 2001, the IRS published an advance notice of proposed
rulemaking in the Federal Register (66 FR 21844) inviting comments
relating to tax issues arising under section 45D. Numerous comments
have been received. The IRS and Treasury Department have reviewed and
considered all the comments in the process of preparing this Treasury
decision. This preamble to the temporary regulations describes many, but not all, of the comments received by the IRS.
Explanation of Provisions
Taxpayers may claim a new markets tax credit on a credit allowance date in an amount equal to the applicable percentage of the taxpayer's qualified equity investment in a qualified community development entity (CDE). The credit allowance date for any qualified equity investment is the date on which the investment is initially made and each of the 6 anniversary dates thereafter. The applicable percentage is 5 percent for the first 3 credit allowance dates and 6 percent for the remaining credit allowance dates.
A CDE is any domestic corporation or partnership if: (1) The primary mission of the entity is serving or providing investment capital for lowincome communities or lowincome persons; (2) the entity maintains accountability to residents of lowincome communities through their representation on any governing board of the entity or on any advisory board to the entity; and (3) the entity is certified by the Secretary for purposes of section 45D as being a CDE.
The new markets tax credit may be claimed only for a qualified equity investment in a CDE. A qualified equity investment is any equity investment in a CDE for which the CDE has received an allocation from the Secretary if, among other things, the CDE uses substantially all of the cash from the investment to make qualified lowincome community investments. Under a safe harbor, the substantiallyall requirement is treated as met if at least 85 percent of the aggregate gross assets of the CDE are invested in qualified lowincome community investments. [[Page 66308]]
Qualified lowincome community investments consist of: (1) Any capital or equity investment in, or loan to, any qualified active low income community business; (2) the purchase from another CDE of any loan made by such entity that is a qualified lowincome community investment; (3) financial counseling and other services to businesses located in, and residents of, lowincome communities; and (4) certain equity investments in, or loans to, a CDE.
In general, a qualified active lowincome community business is a corporation or a partnership if for the taxable year: (1) At least 50 percent of the total gross income of the entity is derived from the active conduct of a qualified business within any lowincome community; (2) a substantial portion of the use of the tangible property of the entity is within any lowincome community; (3) a substantial portion of the services performed for the entity by its employees is performed in any lowincome community; (4) less than 5 percent of the average of the aggregate unadjusted bases of the property of the entity is attributable to certain collectibles; and (5) less than 5 percent of the average of the aggregate unadjusted bases of the property of the entity is attributable to certain nonqualified financial property. Substantially All
As indicated above, a CDE must use substantially all of the cash
from a qualified equity investment to make qualified lowincome community investments. Most commentators suggest that the
substantiallyall test should require that at least 85 percent of the taxpayer's cash be committed to, or invested in, qualified lowincome community investments. Some commentators propose that in order to provide CDEs with financial flexibility in managing their investments, the percentage should be reduced for the later years of the 7year credit period. The temporary regulations adopt the suggestion to define substantially all as 85 percent or more and reduce the substantially all percentage to 75 percent for the seventh year of the 7year credit period.
Some commentators suggest that a CDE's costs of obtaining equity investments in the CDE (such as underwriters' fees and broker fees) and the CDE's overhead expenses (such as staff salaries) should count toward satisfying the substantiallyall requirement. Some commentators suggest that reserves maintained by the CDE of up to 10 percent of the taxpayer's cash investment in the CDE should count toward satisfying the substantiallyall requirement. The temporary regulations do not include issuance costs or CDE overhead expenses as counting toward the substantiallyall requirement. However, the temporary regulations provide that reserves (but not in excess of 5 percent of the taxpayer's cash investment) for loan losses and for additional investments in existing qualified lowincome community investments are treated as invested in a qualified lowincome community investment.
Several commentators suggest that, for purposes of the ``85 percent of the aggregate gross assets'' safe harbor, aggregate gross assets should be determined according to cost basis and not, for example, fair market value. The temporary regulations adopt this suggestion. Cost basis is defined under the temporary regulations as cost basis under section 1012.
Commentators propose that a CDE should have from 12 months to 5 years to invest the cash from a qualified equity investment in a qualified lowincome community investment, depending upon the type of investment. The temporary regulations adopt a 12month period for investing the taxpayer's cash investment.
Commentators propose that repayments to a CDE of equity or principal from qualified lowincome community investments should have to be reinvested by the CDE within 12 months, but that no reinvestment should be required in the sixth and seventh years of the 7year credit period. One commentator proposes that reinvestment should be encouraged, but not required. Another commentator would limit the time period to 45 days for identifying the investment and 180 days for making the investment. The temporary regulations adopt the suggestion that repayment amounts reinvested within 12 months are treated as continuously invested in qualified lowincome community investments. In addition, repayments received in the seventh year of the 7year credit period are not required to be reinvested.
Qualified Active LowIncome Community Businesses
As indicated above, qualified lowincome community investments include any capital or equity investment in, or loan to, any qualified active lowincome community business. A business is a qualified active lowincome community business only if, among other things: (1) At least 50 percent of the total gross income of the business is derived from the active conduct of a qualified business within any lowincome community; (2) a substantial portion of the use of the tangible property of the business is within any lowincome community; and (3) a substantial portion of the services performed for the business by its employees is performed in any lowincome community.
Commentators propose that, to satisfy the ``50 percent of the total gross income * * * derived from the active conduct'' requirement (50 percent requirement) in the case of a manufacturing business, 50 percent of production, but not sales, should have to occur within a lowincome community. For a services business, commentators recommend a requirement that at least 50 percent of the services be provided by employees of offices in lowincome communities even if the services are provided elsewhere. One commentator suggests that the 50percent requirement should be deemed met if the business is located in the low income community and most of the employees are residents of the low income community. Another commentator suggests that the requirement should be satisfied if 50 percent of the total gross income is derived from: (1) The operation of, or production at, a facility located in a lowincome community; (2) most of the employees are based at such a facility; and (3) the management is located within the lowincome community.
For purposes of the tangible property and services performed requirements, recommendations for the percentage that should constitute a substantial portion range from 20 percent to 50 percent. Alternatively, some commentators propose that the tangible property and services performed requirements should be satisfied if the business satisfies one of the following: (1) The business is located in a qualified area; (2) the business operates a major facility in a qualified area; (3) the business' primary business activity takes place in a qualified area; or (4) the business' primary mission is working with people in qualified areas.
For purposes of the tangible property and services performed requirements, the temporary regulations define a substantial portion as 40 percent. In addition, the temporary regulations provide that the 50 percent requirement is deemed to be satisfied if the entity meets the requirements of either the tangible property test or the services performed test, if 50 percent is substituted for 40 percent. Further, the entity may satisfy the 50percent requirement based on all the facts and circumstances.
Commentators propose that for purposes of determining when a trade or business constitutes a qualified active
lowincome community business, an entity should qualify as a qualified active lowincome community business if the CDE reasonably expects, at the time the CDE makes the capital or equity investment in, or loan to, the entity, that the entity will satisfy the requirements to be a qualified active lowincome community business throughout the entire period of the investment or loan. This proposal has been adopted in the temporary regulations, except in the case where the CDE controls the entity.
If the CDE controls the entity at any time during the 7year credit period, the reasonable expectation test does not apply and the entity must be a qualified active lowincome community business during the entire period the CDE controls the entity. Commentators suggest that control for this purpose should be defined as at least 50 percent of voting power. Some commentators suggest that control should be determined based on whether the CDE is related to the entity within the meaning of sections 267(b) or 707(b)(1). The temporary regulations define control with respect to an entity as direct or indirect ownership (based on value) or control (based on voting or management rights) of 33 percent or more of the entity. However, a CDE does not control an entity if an unrelated person possesses greater control over the entity than the CDE.
Financial Counseling and Other Services
Commentators suggest that the definition of financial counseling and other services should include services for identifying CDE investment opportunities; preparing business owners to use financial products; underwriting loans and investments; helping business owners create viable business plans; and, after loans and investments are made, enhancing business planning, marketing, management, and financial skills of business owners and serving on their boards of directors. The temporary regulations define financial counseling and other services as advice provided by the CDE relating to the organization or operation of a trade or business that is provided to a qualified active lowincome community business or to residents of a lowincome community. Investments in Other CDEs
Commentators propose that, for purposes of the substantiallyall requirement, tracing should not be required when a CDE invests in another CDE, but other mechanisms should be required (for example, decertifying the recipient CDE if it does not use funds properly). Alternatively, commentators propose tracing at the recipient CDE level, but minimizing the reporting and recapture burdens for the recipient CDEs. Some commentators suggest that the recipient CDE should have the same restrictions placed on it as the investing CDE. The temporary regulations provide that an equity investment in, or loan to, another CDE is a qualified lowincome community investment only to the extent that the recipient CDE uses the proceeds: (1) For either an investment in, or a loan to, a qualified active lowincome community business, or financial counseling and other services; and (2) in a manner that would constitute a qualified lowincome community investment if it were made directly by the CDE making the equity investment or loan.
A recapture event requiring an investor to recapture credits previously taken may occur for an equity investment in a CDE if the
FOR FURTHER INFORMATION CONTACT
Paul Handleman, (202) 622-3040.