Foreign electronic derivatives exchange recognized as a "qualified board or exchange" under section 1256

Plain-English summary

A foreign, all-electronic derivatives exchange asked the IRS to confirm it is a "qualified board or exchange" under section 1256(g)(7)(C). That status matters because futures contracts traded on such an exchange are "section 1256 contracts," which get favorable tax treatment: they are marked to market at year-end and taxed at a blended 60% long-term / 40% short-term capital gains rate. The exchange showed it is registered with the Commodity Futures Trading Commission as a foreign board of trade, that its contracts are marked to market daily, and that it made a series of representations giving the IRS access to records and taxpayer identification information about U.S. participants. Because the Secretary can designate any market with rules adequate to carry out the purposes of section 1256, the IRS determined the exchange qualifies, conditioned on those representations. The letter also revokes an old 1985 ruling that had been issued to a now-dormant affiliated exchange, applying that revocation prospectively from October 2, 2000 under section 7805(b). This lets U.S. traders on the exchange claim section 1256 tax treatment.

Ruling snapshot

• Question: Is the foreign electronic derivatives exchange a "qualified board or exchange" within the meaning of section 1256(g)(7)(C)?
• Outcome: approved
• Key authorities: IRC §§ 1256(g)(7)(C), 7805(b); CFTC foreign-board-of-trade registration rules (17 C.F.R. Part 48)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 202451018                                              Third Party Communication: None
Release Date: 12/20/2024                                       Date of Communication: Not Applicable
Index Number: 1256.07-05
                                                               Person To Contact:
-------------------                                            -----------------------------
-------------------------                                      ID No. -----------------
--------------------------------                               Telephone Number:
------------------------------------------------------------   --------------------
------------                                                   Refer Reply To:
----------------                                               CC:FIP:B03
------------------------                                       PLR-119100-21
----------------------------                                   Date:
                                                               September 25, 2024




LEGEND


Exchange 1                         = --------------------------------

Exchange 2                         = ------------------------------------------------------------------

Country                            = ----------

City                               = ------------

Foreign Jurisdiction A             = ----------

Foreign Jurisdiction B             = ----------

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

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

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

Foreign Commission                 = ------------------------------------------

Foreign Act                        = ------------------------------------------------------

Political Subdivision              = ------------

Date 1                             = -------------------------
 Date 2                     = ----------------------

 Year 1                     = -------

 Year 2                     = -------

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

 Income Tax Treaty          = -------------------------------------------------------------------------
                              -----------------

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


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

        This is in reply to your letter dated September 10, 2021, and subsequent
correspondence, requesting a ruling that Exchange 1 is a “qualified board or exchange”
within the meaning of section 1256(g)(7)(C) of the Internal Revenue Code.

                                           FACTS

       Exchange 1 is an all-electronic derivatives exchange that is a corporation
incorporated under the laws of Foreign Jurisdiction A. Exchange 1 is a wholly-owned
subsidiary of Entity A. Entity A is the parent of a group of companies and operates cash
and derivative markets for multiple asset classes through its subsidiaries, including
Exchange 1. Entity A is a corporation incorporated under the laws of Foreign
Jurisdiction B. Exchange 1 does not conduct any activities directly in the United States.
Neither Exchange 1 nor Entity A files a United States federal income tax return or has a
United States taxpayer identification number.

      On April 18, 1985, the Internal Revenue Service (the Service) issued PLR
8528072 to Exchange 2. PLR 8528072 ruled that Exchange 2 was a qualified board or
exchange within the meaning of section 1256(g)(7)(C). Exchange 2 was an exchange
associated with Exchange 1 that has ceased operations and is now dormant.

         Exchange 1 provides electronic trading for various classes of financial
instruments, including futures and options on futures. Trading on Exchange 1 may only
be effected through Exchange 1’s proprietary trading system that Exchange 1
developed and maintains. Entity B, a wholly owned subsidiary of Exchange 1, is
regulated as a clearing house and clearing agency in Country. Entity B provides central
counterparty clearing for all derivative contracts traded on Exchange 1. Entity B
facilitates the settlement and clearing, and issues and guarantees, all derivative
contracts traded on Exchange 1. All transactions on Exchange 1, and the clearing of
such transactions, are governed by the law of Foreign Jurisdiction A and Exchange 1’s
rules and procedures. Each Exchange 1 participant is subject to approval by Exchange
1 (“Exchange Participant”).

       Exchange 1 is subject to regulation by Foreign Commission. In Year 1, Foreign
Commission recognized Exchange 1 as a self-regulatory organization. In Year 2,
following the merger of Exchange 1 and Entity C, Foreign Commission re-recognized
Exchange 1 as an exchange and as a self-regulatory organization.

       In a letter dated Date 1, the Commodity Futures Trading Commission (“CFTC”)
granted no-action relief to Exchange 1 permitting it to make its electronic trading and
matching system available in the United States to Exchange Participants,
notwithstanding that Exchange 1 was not designated as a contract market or registered
as a derivatives transaction execution facility pursuant to sections 5 or 5a of the
Commodity Exchange Act (“CEA”). Subsequently, the CFTC finalized rules that require
registration of foreign boards of trade (“FBOTs”) that wish to provide U.S. participants
direct access to the FBOT’s electronic trading system, including those with existing no-
action letters. Registration of Foreign Boards of Trade, 76 Fed. Reg. 80674 (Dec. 23,
2011).

       On Date 2, the CFTC granted an Order of Registration to Exchange 1 as an
FBOT permitting Exchange 1 to provide identified members and other participants
located in the United States to enter trades directly into Exchange 1’s order entry and
trade matching system.

      Section 48.2(b) of the final CFTC rules regarding FBOTs provides, in part, that
an FBOT must possess the attributes of an established, organized exchange; adhere to
appropriate rules prohibiting abusive trading practices; and enforce appropriate rules to
maintain market and financial integrity.

       Section 48.5(d)(2) provides that the CFTC evaluates, among other things,
whether the FBOT and its clearing organization are subject to comprehensive
supervision and regulation by the appropriate governmental authorities in their home
country or countries that is comparable to the comprehensive supervision and
regulation to which designated contract markets (“DCMs”) and derivatives clearing
organizations (“DCOs”) are respectively subject under the CEA, CFTC regulations, and
other applicable United States laws and regulations.

       Section 48.5(d)(5) provides that the CFTC will look to determine if the
government authorities support and enforce regulatory objectives in the oversight of the
FBOT and the clearing organization that are substantially equivalent to the regulatory
objectives supported and enforced by the CFTC in its oversight of DCMs and DCOs.

       Section 48.7 provides, in part, that the CFTC requirements for registration
include rules providing that the automated trading system of the FBOT meets certain
international standards, that contracts to be made available in the United States contain
specified terms and conditions, that the clearing organization complies with certain
international standards or the clearing organization registers with the CFTC as a DCO,
and that the FBOT has implemented and enforces rules to ensure compliance with
these and other CFTC requirements.

      Exchange 1 makes the following representations.

      (1) Exchange 1 holds a valid CFTC Order of Registration as an FBOT.

      (2) All Exchange 1 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 Service may gain access to
      information held by Exchange 1 with respect to U.S. taxpayers.

      (4) Exchange 1 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 Exchange
      1 by any person.

      (5) The supplying by Exchange 1 of its records to a U.S. grand jury or to the
      Service will not be a violation of, or inconsistent with the application of, the law of
      Country or any Political Subdivision thereof in which Exchange 1 has offices or
      maintains records.

      (6) Exchange 1 will retain its records respecting derivatives trading on Exchange
      1 for a minimum of five years.

      (7) Exchange 1 will collect from all Exchange Participants that either have or are
      required to have United States taxpayer identification numbers their United
      States taxpayer identification numbers and, on request, will provide such
      information to the Service.

      (8) Exchange 1 will identify a senior management contact of each Exchange
      Participant and, on request, will make such information available to the Service.
      On request, Exchange 1 will ask Exchange Participants to identify their other
      executive officers to the Service.

      (9) Exchange 1 will provide such further information and assurances as may
      from time to time be requested by the Service in order to verify Exchange 1’s
      entitlement to the determination under section 1256(g)(7)(C) of the Code.

        (10) The Exchange Rulebook requires, and will be maintained to require, the
       following:

              a) Exchange Participants that 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, Exchange 1 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. Failure of an Exchange
              Participant to comply with this provision will result in immediate
              suspension of such Participant’s membership privileges on Exchange 1
              (and the privileges of any successor to such Participant) until the
              Participant 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 Exchange 1, Exchange Participants (with respect to
              transactions occurring on Exchange 1) will supply to Exchange 1 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
              (hereinafter collectively referred to as “records”). Such requests will be
              made by Exchange 1 whenever Exchange 1 receives a written request,
              summons or subpoena to produce such records from the Service or from
              any grand jury. Failure of an Exchange Participant to comply with this
              provision will result in immediate suspension of such Participant’s trading
              privileges on Exchange 1 (and the privileges of any successor to such
              Participant) until the Participant complies with these reporting
              requirements in all respects.

                                  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.

        Section 601.201(l) of the Statement of Procedural Rules provides in part that a
ruling, except to the extent incorporated in a closing agreement, may be revoked or
modified at any time in the wise administration of the taxing statutes. If a ruling is
revoked or modified, the revocation or modification applies to all open years under the
statutes, unless the Commissioner or his delegate exercises the discretionary authority
under section 7805(b) to limit the retroactive effect of the revocation or modification.

       Section 7805(b)(8) provides that the Secretary may prescribe the extent, if any,
to which any ruling (including any judicial decision or any administrative determination
other than by regulation) relating to the internal revenue laws shall be applied without
retroactive effect.

        Under section 11.06 of Rev. Proc. 2021-1, 2021-1 I.R.B. 1, if the revocation or
modification of a letter ruling is for reasons other than a change in facts as described in
section 11.05 of Rev. Proc. 2021-1, the revocation or modification generally will not be
applied retroactively to the taxpayer for whom the letter ruling was issued or to a
taxpayer whose tax liability was directly involved in the letter ruling provided that (1)
there has been no change in the applicable law; (2) the letter ruling was originally
issued for a proposed transaction; and (3) the taxpayer directly involved in the letter
ruling acted in good faith in relying on the letter ruling, and revoking or modifying the
letter ruling retroactively would be to the taxpayer’s detriment.

      This letter revokes PLR 8528072 that was issued to Exchange 2 on April 18,
1985. The Service has decided under section 7805(b) to limit the effect of the
revocation of PLR 8528072. The revocation of PLR 8528072 will apply beginning as of
October 2, 2000.

     Based on the foregoing and the CFTC Order of Registration of Exchange 1 as an
FBOT, we determine that Exchange 1 has rules adequate to carry out the purposes of
section 1256 of the Code and is thus a qualified board or exchange within the meaning
of section 1256(g)(7)(C) of the Code. This ruling is conditioned on the representations
set forth above and compliance therewith.

        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.

      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 a 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,


                                       __________________________
                                       Bernard J. Audet, Jr.
                                       Chief, Branch 2
                                       Office of the Associate Chief Counsel
                                       (Financial Institutions and Products)




cc: