IRS ruling expands scope of debt obligations in registered form.

• Author: Hermann, Jared A.

The Internal Revenue Code contains a number of tax provisions that hinge on whether a debt instrument is in registered form (see, e.g., Secs. 149, 163, 165, 1287, and 4701). The requirement that certain debt obligations be "in registered form" is intended to create a record of ownership and to discourage the use of bearer instruments (i.e., obligations not in registered form) as a potential means of avoiding taxes.

Registration Requirements

Usually, these registration requirements are easily met for standard instruments trading in the capital market; by contrast, most consumer loans (including mortgage loans), which generally do not require registration, typically are not issued in registered form. Therefore, for investments in mortgage loans, U.S.-source interest paid to a foreign investor on those mortgage loans may not qualify for the portfolio interest exemption in Secs. 871(h)(1) and 881(c)(1), which apply only to debt in registered form.

Fortunately, at least in the context of mortgage loans, Temp. Regs. Sec. 1.1635T(d)(l) seeks to resolve this problem by providing that evidence of an interest in a pool of mortgage loans that is treated as a grantor trust "or similar evidence of interest in a similar pooled fund or pooled trust treated as a grantor trust" (i.e., a "pass-through certificate") is considered to be in registered form if the passthrough certificate is in registered form "without regard to whether any obligation held by the fund or trust to which the pass-through certificate relates" is in registered form.

Although it is not expressly referred to in Sec. 871 or 881 or the related regulations, practitioners and the IRS routinely look to the Sec. 163 definition of a passthrough certificate to apply the portfolio interest exemption to interest paid on pools of mortgage loans (see Regs. Sec. 1.871-14(d)(l), providing that interest received on a passthrough certificate qualifies as portfolio interest if the interest satisfies the conditions in Regs. Sec. 1.871-14(c)(l), which are identical to the registration requirements described in Regs. Sec. 5f.103-1, without regard to whether any obligation held by the fund or trust to which the passthrough certificate relates is described in Regs. Sec. 1.871-14(c)(l)(ii)).

Due to the ambiguous definition of a passthrough certificate in Temp. Regs. Sec. 1.163-5T(d)(l), however, it is not clear what types of arrangements can qualify as passthrough certificates--i.e., it is not obvious what...