2.2 Financial statements and business use
The ANPRM states that a taxpayer has strong incentive to report the values of securities and commodities if such values are reported on a financial statement and there is significant use of those reported values in the taxpayer’s business. According to the ANPRM, there are three classes of financial statements under consideration for the safe harbour, namely:
- a financial statement required to be filed with the SEC (10k or annual statement to shareholders);
- a financial statement required to be provided to the federal government or any of its agencies (other than the SEC or IRS); and
- a certified audited financial statement no required to be filed with the SEC or another federal agency.
With regard to financial statements, issues that the IRS was looking into were whether financial statements required to be filed with a state government or any of its agencies, a political subdivision of a state, or possibly a foreign regulatory authority should be considered. Comments were requested regarding the extent to which any of these categories of financial statements are appropriate for a safe harbour, and if any other classes of financial instruments may be appropriate, as well. This issue of related-party transactions is also raised, indicating a concern that financial consolidation between related parties may cause certain transactions to be eliminated or incompletely reported on financial statements.
2.3 Record keeping and record production
Under the safe harbour, dealers would have to show that:
- the same value used on the financial statement was used on the tax return;
- no security subject to Sec. 475 and reported under the required methodology on the financial statement was excluded in the application of the safe harbour; and
- only securities or commodities subject to Sec. 475 has been carried out on the tax return under the safe harbour.
The Notice states that:
give the complexity of the business operation of many taxpayers, comparing a single line of the financial statement to a single line on the tax return will not suffice to verify that the same line used on the financial statement was used on the tax return. Therefore, a safe harbour will impose specific verification and reconciliation requirements.
Area of expressed concern including the following Valuation issues arising from the pooling of securities and commodities. This would include how such items are pooled for financial reporting, how they are pooled for tax, and how the basis of a single position contained in the pool can be determined if that position is sold in the year following the mark and the other position are not sold, The IRS was also concerned about the impact of consolidation and de-consolidation, and the determination of whether the same securities and commodities will be reflected on both the financial statement and the tax return.
Taxpayers making a safe harbour election would be required to maintain the following records, which would have to be provided at the COmmissioner’s request:
- books and records clearly establishing that the same values were used for Sec. 475(a) and the financial statement;
- for taxpayers filing a Form 1120, a reconciliation of the amount of net income on the financial statement to the amount reported on line 1 of the M-1 on the Form 1120; and
- for other taxpayers, a similar reconciliation schedule.