On September 15, 2017, the Internal Revenue Service (IRS) issued proposed regulations (REG-125374-16) amending the definition of obligations that are in registered form to take into account current market practices and changes made by the Hiring Incentives to Restore Employment Act. In addition, the proposed regulations clarify the types of arrangements that qualify as "pass-through certificates," as well as the types of obligations that are "of a type offered to the public," such that they require registration.

These rules are of particular importance to issuers, as well as to funds and other investors (particularly foreign investors) that invest in debt obligations or certificates collateralized by debt obligations. As explained in the preamble to the proposed regulations, the classification of an obligation as in "bearer" or in "registered form" has significant tax implications because a number of Internal Revenue Code provisions impose sanctions on issuers and holders of registration-required obligations that are not issued in registered form. The proposed regulations, if finalized, would help bring much needed comfort to taxpayers and practitioners, and may help reduce some of the administrative costs associated with complying with current law.

Proposed modifications to "registration-required obligations" ‒ pass-through certificates

Many debt instruments, such as residential mortgage loans and student loans, are not typically issued in registered form. Prior to 2015 the only guidance issued by the IRS was in a temporary regulation, which provided that a pass-through certificate or participation certificate evidencing an interest in a pool of mortgage loans that is treated as a grantor trust is considered to be a "registration-required obligation" regardless of whether its underlying assets are themselves registration-required obligations. To the extent that a pass-through certificate is in registered form, interest payable on it may qualify for the Portfolio Interest Exemption, which would result in no withholding on interest payments made to qualifying non-US holders.

Historically, many practitioners and their clients have debated whether other types of pass-through certificates that are not issued by a grantor trust could qualify as "registration-required obligations." Since a grantor trust has a limited time period during which it can acquire new assets, other pass-through arrangements, such as partnerships or disregarded entities, are more flexible and desirable from a business standpoint.

Recently, however, the IRS issued various private letter rulings, including PLR 201504004 and PLR 201610015, which found that certain pass-through certificates still qualified as such even though they were not grantor trusts for tax purposes. Since only the taxpayers that applied for the private letter rulings can rely on them, there was uncertainty as to their applicability to other taxpayers.

The proposed regulations provide that a pass-through certificate may be issued not only by a grantor trust but also by a "similar fund," which includes entities that are partnerships or disregarded for US federal income tax purposes. As such, a pass-through certificate need not be an interest in a grantor trust for tax purposes in order for its holder to benefit from the Portfolio Interest Exception. This proposed regulation is consistent with the related holdings in recent private letter rulings, such as PLR 201504004 and PLR 201610015, and it brings taxpayers much-needed formal guidance.

Proposed modifications to "registration-required obligations" ‒ of a type offered to the public

In addition, one exception to the definition of a registration-required obligation is an obligation not "of a type offered to the public." Given the lack of a corresponding definition, and given that the Internal Revenue Code defines similar terms differently, practitioners have sought guidance as to what constitutes such an obligation.

The proposed regulations clarify what constitutes "an obligation not of a type offered to the public" and generally adopt the "traded on an established market" standard contained in the original issue discount regulations in order to determine if an obligation is "not of a type offered to the public." This "traded on an established market" standard includes (but is not limited to) certain property for which a firm quote or indicative quote is available from at least one broker, dealer or pricing service, as well as debt instruments if the sales price appears in a medium available to issuers or brokers. As such, if an obligation is not "traded on an established market," then it is "not of a type offered to the public" for purposes being excepted from the definition of registration-required obligation.

Proposed modifications to "registered form" ‒ clearing organization

IRS Notice 2012-20 provided, in part, that two methods by which an obligation is considered to be in registered form include obligations that may only be transferred through a book entry system maintained by a clearing organization, or through a clearing system in which the obligation is effectively immobilized. The proposed regulations confirm these methods.

Effective date

The proposed regulations will generally be effective for obligations issued after March 18, 2012. However, the rules relating to pass-through certificates and obligations not of a type offered to the public generally only apply to obligations issued after the Treasury Department adopts and publishes final regulations in the Federal Register.


Given the ever-changing logistical landscape of the financial product world, the proposed regulations are a welcomed change. They largely address the concerns of commenters and help bring the related provisions up to date with current law and business practices. They simplify related provisions and provide greater certainty for those taxpayers who issue or hold certain obligations. They also potentially reduce administrative costs for taxpayers who previously formed a new grantor trust every 90 days in order to ensure their interests in a trust qualified as pass-through certificates.

Comments and requests for a public hearing related to the proposed regulations will be accepted until December 18, 2017.