relied upon as authoritative interpretations. · meaning of various code provisions in light of the...

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Bulletin No. 1996–14April 1, 1996

HIGHLIGHTSOF THIS ISSUE

These synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

Rev. Rul. 96–19, page 24.Federal rates; adjusted federal rates; adjusted federallong-term rate, and the long-term exempt rate. Forpurposes of sections 1274, 1288, 382, and othersections of the Code, tables set forth the rates for April1996.

T.D. 8657, page 4.INTL–0054–95, page 39.Final, temporary, and proposed regulations undersections 864 and 884 of the Code relating to thedetermination of effectively connected income and thebranch profits tax. A public hearing on the proposedregulations will be held on June 6, 1996.

T.D. 8658, page 13.INTL–0054–95, page 39.Final and proposed regulations under section 882 ofthe Code relating to the determination of the interestexpense deduction of foreign corporations engaged in atrade or business within the United States.

ADMINISTRATIVE

Notice 96–18, page 27.Interest netting study. This notice invites public com-ment in connection with the Internal Revenue Serviceand Treasury study of interest netting. This study wasinitially described in Announcement 96–5, 1996–4I.R.B. 99 (Jan. 22, 1996).

Notice 96–19, page 28.Joint return study. This notice invites public comment inconnection with the Internal Revenue Service andTreasury study of certain joint return and communityproperty issues, particularly as they affect divorced or

Finding Lists begins on page 46.Announcement of Disbarments and Suspensions begins on page 43.Quarterly Index for January, February and March begins on page 48.

3

separated taxpayers. This study was initially describedin Announcement 96–5, 1996–4 I.R.B. 99 (Jan. 22,1996).

Notice 96–20, page 30.Rev. Proc. 96–11, 1996–2 I.R.B. 18 relating toSpecifications for Filing Form 1042–S, Foreign Per-son’s U.S. Source Income Subject to Withholding,Magnetically or Electronically, is corrected.

Notice 96–21, page 30.T.D. 8636, 1996–4 I.R.B. 64, relating to the time forfurnishing wage statements to employees and for filingwage statements with the Social Security Administra-tion on termination of an employer’s operations, iscorrected.

Notice 96–22, page 30.T.D. 8630, 1996–3 I.R.B. 19, relating to income,estate, and gift tax regulations regarding exceptions tothe use of valuation tables, is corrected.

Rev. Proc. 96–28, page 31.Per diem allowances. This procedure provides rulesunder which the amount of ordinary and necessarybusiness expenses of an employee for lodging, meals,and/or incidental expenses incurred while away fromhome will be deemed substantiated when a payorprovides a reimbursement or other expense allowance topay for such expenses. It also provides an optionalmethod for employees and self-employed individuals touse in computing the deductible costs of business mealand incidental expenses paid or incurred while travelingaway from home. Rev. Proc. 94–77 is superseded.

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Mission of the ServiceThe purpose of the Internal Revenue Service is tocollect the proper amount of tax revenue at the leastcost; serve the public by continually improving the

quality of our products and services; and perform in amanner warranting the highest degree of publicconfidence in our integrity, efficiency and fairness.

Statement of Principlesof Internal RevenueTax Administration
The function of the Internal Revenue Service is toadminister the Internal Revenue Code. Tax policy
The Service also has the responsibility of applyingand administering the law in a reasonable,

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service tocarry out that policy by correctly applying the lawsenacted by Congress; to determine the reasonablemeaning of various Code provisions in light of theCongressional purpose in enacting them; and toperform this work in a fair and impartial manner,with neither a government nor a taxpayer point ofview.

At the heart of administration is interpretation of theCode. It is the responsibility of each person in theService, charged with the duty of interpreting thelaw, to try to find the true meaning of the statutoryprovision and not to adopt a strained construction inthe belief that he or she is ‘‘protecting the revenue.’’The revenue is properly protected only when we as-certain and apply the true meaning of the statute.

practical manner. Issues should only be raised byexamining officers when they have merit, neverarbitrarily or for trading purposes. At the sametime, the examining officer should never hesitateto raise a meritorious issue. It is also importantthat care be exercised not to raise an issue or toask a court to adopt a position inconsistent withan established Service position.

Administration should be both reasonable andvigorous. It should be conducted with as littledelay as possible and with great courtesy andconsiderateness. It should never try to overreach,and should be reasonable within the bounds of lawand sound administration. It should, however, bevigorous in requiring compliance with law and itshould be relentless in its attack on unreal taxdevices and fraud.

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IntroductionThe Internal Revenue Bulletin is the authoritativeinstrument of the Commissioner of Internal Revenue forannouncing official rulings and procedures of theInternal Revenue Service and for publishing TreasuryDecisions, Executive Orders, Tax Conventions, legisla-

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based onprovisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

it

sh

tion, court decisions, and other items of generalinterest. It is published weekly and may be obtainedfrom the Superintendent of Documents on a subscrip-tion basis. Bulletin contents of a permanent nature areconsolidated semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletinall substantive rulings necessary to promote a uniformapplication of the tax laws, including all rulings thatsupersede, revoke, modify, or amend any of thosepreviously published in the Bulletin. All publishedrulings apply retroactively unless otherwise indicated.Procedures relating solely to matters of internalmanagement are not published; however, statements ofinternal practices and procedures that affect the rightsand duties of taxpayers are published.

Revenue rulings represent the conclusions of theService on the application of the law to the pivotal factsstated in the revenue ruling. In those based onpositions taken in rulings to taxpayers or technicaladvice to Service field offices, identifying details andinformation of a confidential nature are deleted toprevent unwarranted invasions of privacy and to complywith statutory requirements.

Rulings and procedures reported in the Bulletin do nothave the force and effect of Treasury DepartmentRegulations, but they may be used as precedents.Unpublished rulings will not be relied on, used, or citedas precedents by Service personnel in the disposition ofother cases. In applying published rulings and proce-dures, the effect of subsequent legislation, regulations,court decisions, rulings, and procedures must beconsidered, and Service personnel and others con-cerned are cautioned against reaching the sameconclusions in other cases unless the facts andcircumstances are substantially the same.

The contents of this publication are not copyrighted and may be reprinted freely. A c

For sale by the Superintendent of Documents U.S. Government Printing Office, Wa

3

This part is divided into two subparts as follows:Subpart A, Tax Conventions, and Subpart B, Legislationand Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references tothese subjects are contained in the other Parts andSubparts. Also included in this part are Bank SecrecyAct Administrative Rulings. Bank Secrecy Act Admin-istrative Rulings are issued by the Department of theTreasury’s Office of the Assistant Secretary(Enforcement).

Part IV.—Items of General Interest.With the exception of the Notice of Proposed Rulemak-ing and the disbarment and suspension list included inthis part, none of these announcements are consoli-dated in the Cumulative Bulletins.

The first Bulletin for each month includes an index forthe matters published during the preceding month.These monthly indexes are cumulated on a quarterlyand semiannual basis, and are published in the firstBulletin of the succeeding quarterly and semi-annualperiod, respectively.

The Bulletin Index-Digest System, a research andreference service supplementing the Bulletin, may beobtained from the Superintendent of Documents on asubscription basis. It consists of four Services: ServiceNo. 1, Income Tax; Service No. 2, Estate and GiftTaxes; Service No. 3, Employment Taxes; Service No.4, Excise Taxes. Each Service consists of a basicvolume and a cumulative supplement that provides (1)finding lists of items published in the Bulletin, (2)digests of revenue rulings, revenue procedures, andother published items, and (3) indexes of Public Laws,Treasury Decisions, and Tax Conventions.

ation of the Internal Revenue Bulletin as the source would be appropriate.

ington, D.C. 20402.

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Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 42.—Low-Income HousingCredit

The adjusted applicable federal short-term,mid-term, and long-term rates are set forth forthe month of April 1996. See Rev. Rul. 96–19,page 24.

expenses. See Rev. Proc. 96–28, 1996–14 I.R.B.page 31.

26 CFR 1.274–5T: Substantiation requirements(temporary).

Rules are set forth for substantiating theamount of ordinary and necessary business

Section 483.—Interest on CertainDeferred Payments


Section 62.—Adjusted Gross IncomeDefined

26 CFR 1.62–2: Reimbursements and otherexpense allowance arrangements.

Rules are set forth under which a reimburse-ment or other expense allowance arrangement forthe cost of lodging, meal, and/or incidental
expenses incurred by an employee while travel-ing away from home will satisfy the require-ments of § 62(c) of the Code as to substantiationof the amount of expenses. See Rev. Proc. 96–28, 1996–14 I.R.B. page 31.
Section 162.—Trade or BusinessExpense

26 CFR 1.162–17: Reporting and substantia-tion of certain business expenses of employees.

The rules for substantiating the amount of adeduction or expense for lodging, meal, and/orincidental expenses incurred while traveling
away from home that most nearly representscurrent costs are set forth. See Rev. Proc. 96–28,1996–14 I.R.B. page 31.
Section 267.—Losses, Expenses, andInterest With Respect to TransactionsBetween Related Taxpayers

26 CFR 1.267(a)–1: Deductions disallowed.

When a payor provides a per diem allowanceto an employee who is a related party, the rulesset forth for the deemed substantiation to the

Sf

mtp

SfR

m

payor of the amount of the employee’s ordinaryand necessary business expenses for lodging,meal, and/or incidental expenses incurred whiletraveling away from home do not apply. SeeRev. Proc. 96–28, 1996–14 I.R.B. page 31.

Section 274.—Disallowance ofCertain Entertainment, etc., Expenses

26 CFR 1.274(d)–1(a): Substantiationrequirements.

Rules are set forth for substantiating theamount of ordinary and necessary businessexpense of an employee for lodging, meal, and/

tp

or incidental expenses incurred while travelingaway from home when a payor provides a perdiem allowance under a reimbursement or otherexpense allowance arrangement to pay for such

expense of an employee for lodging, meal, and/or incidental expenses incurred while travelingaway from home when a payor provides a perdiem allowance under a reimbursement or otherexpense allowance arrangement to pay for suchexpenses. Rules are also set forth for an optionalmethod for employees and self-employed indi-viduals to use in computing the deductible costsof business meal and incidental expenses paid orincurred while traveling away from home. SeeRev. Proc. 96–28, 1996–14 I.R.B. page 31.

Section 280G.—Golden ParachutePayments

Federal short-term, mid-term, and long-termrates are set forth for the month of April 1996.See Rev. Rul. 96–19, page 24.

Section 382.—Limitation on Net
Operating Loss Carryforwards andCertain Built-In Losses FollowingOwnership Change
The adjusted federal long-term rate is set forthfor the month of April 1996. See Rev. Rul. 96–19, page 24.

Section 412.—Minimum FundingStandards


ection 467.—Certain Paymentsor the Use of Property or Services

The adjusted applicable federal short-term,id-term, and long-term rates are set forth for

he month of April 1996. See Rev. Rul. 96–19,age 24.

ection 468.—Special Rulesor Mining and Solid Wasteeclamation and Closing Costs

The adjusted applicable federal short-term,id-term, and long-term rates are set forth for

he month of April 1996. See Rev. Rul. 96–19,age 24.

4

Section 807.—Rules for CertainReserves


Section 846.—Discounted UnpaidLosses Defined


Section 864.—Definitions andSpecial Rules

26 CFR 1.864–4: U.S. source incomeeffectively connected with U.S. business.

T.D. 8657

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Parts 1 and 602

Regulations on Effectively ConnectedIncome and the Branch Profits Tax

AGENCY: Internal Revenue Service(IRS), Treasury.

ACTION: Final and temporaryregulations.

SUMMARY: This document containsfinal Income Tax Regulations relatingto the determination of effectivelyconnected income under section 864and final and temporary Income TaxRegulations relating to the branchprofits tax and branch-level interest taxunder section 884 of the InternalRevenue Code of 1986 (Code). Section884 was added to the Code by section1241 of the Tax Reform Act of 1986.This document also contains conform-ing changes to sections 861, 871 and897.


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EFFECTIVE DATE: June 6, 1996.

FOR FURTHER INFORMATIONCONTACT: Gwendolyn A. Stanley,(202) 622-3860 (not a toll-freenumber).

752]) to the Income Tax Regulations(26 CFR part 1) under sections 864 and884 of the Internal Revenue Code werepublished in the Federal Register (57FR 41707) on the same day. Writtencomments were received on the pro-posed amendments. After considerationof all the comments, § 1.884–2(a)(2)(ii)

the changes to sections 871 and 897corresponds to the effective date of thechanges to section 864.

II. Branch profits tax.

A. Interest in a partnership. Currently,

5

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information con-tained in these final regulations havebeen reviewed and approved by theOffice of Management and Budget inaccordance with the Paperwork Reduc-tion Act (44 U.S.C. 3507) undercontrol number 1545–1070.

An agency may not conduct orsponsor, and a person is not required torespond to, a collection of informationunless the collection of informationdisplays a valid control number.

The estimated annual burden perrespondent is .25 hours.

Comments concerning the accuracyof this burden estimate and suggestionsfor reducing this burden should be sentto the Internal Revenue Service, Attn:IRS Reports Clearance Officer, T:FP,Washington, DC 20224, and to theOffice of Management and Budget,Attn: Desk Officer for the Departmentof the Treasury, Office of Informationand Regulatory Affairs, Washington,DC 20503.

Books or records relating to thiscollection of information must be re-tained as long as their contents may bematerial in the administration of anyinternal revenue law. Generally, taxreturns and tax information are con-fidential, as required by 26 U.S.C.6103.

Background

On September 2, 1988, proposed andtemporary regulations (TD 8223 andINTL–934–86 [1988–2 C.B. 825]) un-der section 884 were published in theFederal Register (53 FR 34045). Writ-ten comments were received on theproposed amendments. On September11, 1992, temporary regulations under§ 1.884–2T were amended and finalregulations (1992 final regulations) (TD8432 [1992–2 C.B. 157]) under section884 of the Code were published in theFederal Register (57 FR 41644). Pro-posed amendments (1992 proposed reg-ulations) (INTL–0003–92 [1992–2 C.B.

and § 1.884–2(c)(2)(iii) of the 1988proposed regulations and the 1992proposed regulations are adopted asfinal regulations as amended by thisTreasury decision. The revisions andconforming changes are discussedbelow.

Explanation of the Provisions

I. Section 864 stock rule.

The proposed regulations under sec-tion 864 provided that stock of acorporation shall not be treated as anasset used in, or held for use in, theconduct of a U.S. trade or business.Accordingly, the regulations proposedto delete the example of stock acquiredand held to assure a constant source ofsupply as an asset that satisfies theasset-use test under § 1.864–4(c)(2).Commenters criticized this rule andcited to the legislative history to theForeign Investors Tax Act of 1966 ascontemplating that stock may satisfythe asset-use test. The IRS and Treas-ury continue to believe, however, thatstock does not satisfy the asset-use test.Therefore § 1.864–4(c)(2)(iii) adoptsthe rule contained in the proposedregulations.

In response to our request for com-ments on whether insurance companiesrequire an exception to the stock rulefor their portfolio stock, one commen-ter suggested that foreign life insurancecompanies be permitted to refer to theNational Association of InsuranceCommissioners (NAIC) Annual State-ment to determine whether their assetsare used in, or held for use in, theconduct of a U.S. trade or business.The IRS and Treasury will continue toconsider whether modifications to theregulations under section 864 are ap-propriate for foreign insurance com-panies and reserve on the treatment ofstock held by a foreign insurancecompany.

Conforming changes have been madeto regulations under section 864, aswell as regulations under sections 871and 897 to reflect the clarification of§ 1.864–4(c)(2). The effective date of

a foreign corporation engaged in a U.S.trade or business through a partnershipapplies different rules to determine itsU.S. assets depending on whether thedetermination is for purposes of section884 or § 1.882–5. For purposes ofcomputing its interest expense under§ 1.882–5, the rules of § 1.861–9T(e)(7) apply. Therefore a foreigncorporation takes into account either itspro rata share of partnership assets andliabilities or applies the rules of§ 1.882–5 as if the partnership were aforeign corporation, depending on thenature of its interest in the partnership.In contrast, for purposes of section 884,a foreign corporation generally takesinto account its adjusted basis in itspartnership interest as a starting pointfor determining its U.S. assets.

Final regulations under section 882published elsewhere in this issue of theFederal Register remove the temporaryregulations under § 1.861–9T(e)(7)(i).These final regulations provide a newU.S. asset rule for partnership interestsfor purposes of determining the U.S.assets of a foreign corporate partnerunder sections 882 and 884. The finalregulations under § 1.882–5 contain acorresponding rule to determine thevalue of a partnership interest held by aforeign corporation for purposes ofcomputing its worldwide assets.

In the event that a partnershipderives any income that is not effec-tively connected with a U.S. trade orbusiness, or otherwise holds non-U.S.assets, the rules in § 1.884–1(d)(3)continue to provide a rule that allocatesthe basis in the partnership interestbetween U.S. and non-U.S. assets.However, the allocation rule is moreflexible than the rule contained ineither the 1992 final regulations or theproposed regulations under section 884.The rule allows a foreign corporationto use either an income method or anasset method to determine the propor-tionate share of its partnership interestthat is a U.S. asset, regardless of itsownership interest in the partnership.This is a change from the previous1992 final regulations, which requiredall foreign corporate partners to use anincome method, and from the 1992


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proposed regulations, which requiredmore than 10% partners to use the assetmethod.

Based on commenters’ suggestions,other clarifying changes have beenmade to the asset method. For example,the final regulations clarify that the

that is a foreign bank may treat aminimum of 85% of its excess interestas interest on deposits, regardless of itsactual ratio of deposits to interestbearing liabilities. The IRS and Treas-ury believe this rule should be applica-ble only to a foreign bank engaging in

* * * * * *

Adoption of amendments to theRegulations

Accordingly, 26 CFR parts 1 and602 are amended as follows:

6

adjusted bases of partnership assetsreflect any adjustment under section754 with respect to a foreign corporatepartner.

B. Interest in a trust or estate. Therules applicable to interests in a trust orestate in § 1.884–1(d)(4) are finalizedas proposed.

C. Nonrecourse indebtedness and inte-grated financial transactions. Becausethe final regulations under § 1.882–5incorporate the special allocation rulesof § 1.861–10T, certain changes to thefinal regulations under § 1.884–1(e) areneeded to maintain the proper U.S. netequity of a foreign corporation thatelects to directly allocate any portion ofits interest expense. These regulationsinclude a conforming change thatprovides that liabilities giving rise tosuch interest will be considered U.S.liabilities for purposes of section 884,notwithstanding that such liabilities arenot taken into account in Step 2 of§ 1.882–5.

In addition, a new provision hasbeen added in § 1.884–4(b) so thatbranch interest continues to includeinterest paid with respect to liabilitiesthat are subject to the special allocationrules, notwithstanding that such lia-bilities are not considered U.S. bookedliabilities for purposes of Step 3 of the§ 1.882–5 calculation.

D. Structural changes to conformbranch interest rules to final regula-tions under § 1.882–5. These regula-tions adopt the changes made by the1992 proposed regulations under§ 1.884–4(b), and thus incorporate therules in § 1.882–5(d)(2) (relating toU.S. booked liabilities) in defining theterm branch interest of a foreigncorporation. Although certain changeswere made to the definition of U.S.booked liabilities in the final regula-tions under § 1.882–5, the manner inwhich a foreign corporation computesits branch interest and excess interestremains substantially unchanged.

E. Excess interest—definition of aforeign bank. A foreign corporation

substantial deposit-taking activities,taking into account its activities in theUnited States as well as other countriesin which it operates. The definitionused in the 1992 final regulations didnot clearly convey this limitation. Thus,§ 1.884–4(a)(2)(iii) now defines a for-eign bank by reference to section585(a)(2)(B) of the Code, but alsorequires that a substantial part of itsbusiness consists of receiving depositsand making loans and discounts.

III. Complete termination rules.

The rules in § 1.884–2T(a)(5), appli-cable to a foreign corporation whosebeneficial interest in a trust terminates,are finalized as proposed by the 1992regulations. In addition the waiverprovisions contained in § 1.884–2 ofthe 1988 proposed regulations arefinalized as amended by this Treasurydecision.

Special Analyses

It has been determined that thisTreasury decision is not a significantregulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It has also beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) and the Regulatory Flex-ibility Act (5 U.S.C. chapter 6) do notapply to these regulations, and, there-fore, a Regulatory Flexibility Analysisis not required. Pursuant to section7805(f) of the Internal Revenue Code,the notice of proposed rulemakingpreceding these regulations was submit-ted to the Chief Counsel for Advocacyof the Small Business Administrationfor comment on its impact on smallbusiness.

Drafting Information

The principal author of these regula-tions is Gwendolyn A. Stanley, Officeof Associate Chief Counsel (Interna-tional), within the Office of ChiefCounsel, IRS. However, other person-nel from the IRS and Treasury Depart-ment participated in their development.

PART 1—INCOME TAXES.

Paragraph 1. The authority citationfor part 1 is amended by adding anentry in numerical order to read asfollows:

Authority: 26 U.S.C. 7805.Section 1.884–2 also issued under 26

U.S.C. 884(g)Par. 2. Section 1.864–4 is amended

as follows:1. The third sentence in paragraph

(c)(2)(i) is revised.2. Paragraph (c)(2)(ii) is revised.3. Paragraphs (c)(2)(ii i) and

(c)(2)(iv) are redesignated as (c)(2)(iv)and (c)(2)(v) respectively.

4. New paragraph (c)(2)(iii) is added.5. Newly designated paragraph

(c)(2)(v) is amended by:a. Revising the introductory text.b. Removing Example (2) through

Example (4).c. Redesignating ‘‘Example (5)’’ as

‘‘Example (2)’’. d. Amending newly designated Ex-

ample (2) by:i. Revising the fifth and sixth

sentences.ii. Removing the date ‘‘1968’’ and

adding the date ‘‘1997’’ where itappears in the second, third, and eighthsentences.

6. The last sentence of paragraph(c)(6)(i) is removed.

7. Paragraph (c)(7) is added. The additions and revisions read as

follows:

§ 1.864–4 U.S. source income effec-tively connected with U.S. business.

* * * * * *

(c) * * *(2) * * *(i) * * * The asset-use test is of

primary significance where, for exam-ple, interest income is derived fromsources within the United States by anonresident alien individual or foreigncorporation that is engaged in the


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business of manufacturing or sellinggoods in the United States. * * *

(ii) Cases where applicable. Or-dinarily, an asset shall be treated asused in, or held for use in, the conductof a trade or business in the UnitedStates if the asset is—

2. Removing Example 1.3. Removing the designation ‘‘(2)’’

in Example (2).The revision reads as follows:

§ 1.871–12 Determination of tax ontreaty income.

(1) Definition of branch interest.(2) [Reserved](3) * * *(4) [Reserved]

* * * * * *

(e) * * *

7

(a) Held for the principal purpose ofpromoting the present conduct of thetrade or business in the United States;or

(b) Acquired and held in the ordinarycourse of the trade or business con-ducted in the United States, as, forexample, in the case of an account ornote receivable arising from that tradeor business; or

(c) Otherwise held in a direct rela-tionship to the trade or business con-ducted in the United States, as deter-mined under paragraph (c)(2)(iv) ofthis section.

(iii) Application of asset-use test tostock—(a) In general. Except asprovided in paragraph (c)(2)(iii)(b) ofthis section, stock of a corporation(whether domestic or foreign) shall notbe treated as an asset used in, or heldfor use in, the conduct of a trade orbusiness in the United States.

(b) Stock held by foreign insurancecompanies. [Reserved] * * * * *

(v) Illustration. The application ofparagraph (iv) may be illustrated by thefollowing examples:

* * * * * *

Example (2). * * * During 1997, the branchoffice derives from sources within the UnitedStates interest on these securities, and gains andlosses resulting from the sale or exchange ofsuch securities. Since the securities were ac-quired with amounts generated by the businessconducted in the United States, the interest isretained in that business, and the portfolio ismanaged by personnel actively involved in theconduct of that business, the securities arepresumed under paragraph (c)(2)(iv)(b) of thissection to be held in a direct relationship to thatbusiness. * * *

* * * * * *

(7) Effective date. Paragraphs (c)(2)and (c)(6)(i) of this section are effec-tive for taxable years beginning on orafter June 6, 1996.

* * * * * *

Par. 3. In § 1.871–12, paragraph (d)is amended by:

1. Revising the paragraph headingand introductory text.

* * * * * *

(d) Illustration. The application ofthis section may be illustrated by thefollowing example:

* * * * * *

Par. 4. Section 1.884–0(b) isamended by revising the entries for§§ 1.884–1(d)(4), 1.884–2T(a)(5),1.884–4(b)(1), and 1.884–4(b)(2) andadding entries for §§ 1.884–1(i)(4),1.884–2T(a)(6), 1.884–4(e)(1) and1.884–4(e)(2) to read as follows:

§ 1.884–0 Overview of regulationprovisions for section 884.

* * * * * *

(b) * * *

§ 1.884–1 Branch profits tax.

* * * * * *

(d) * * *(4) Interest in a trust or estate.

* * * * * *

(i) * * *(4) Special rule for certain U.S.

assets and liabilities.

§ 1.884–2T Special Rules for termina-tion or incorporation of a U.S. trade orbusiness or liquidation or reorganiza-tion of a foreign corporation or itsdomestic subsidiary (temporary).

(a) * * *(5) Special rule if a foreign corpora-

tion terminates an interest in a trust.[Reserved]

(6) Coordination with second-levelwithholding tax.

* * * * * *

§ 1.884–4 Branch-level interest tax.

* * * * * *

(b) * * *

(1) General rule.(2) Special rule.

* * * * * *

Par. 5. Section 1.884–1 is amendedas follows:

1. Paragraph (c)(2) is amended asfollows:

a. The text of paragraph (c)(2) isredesignated as paragraph (c)(2)(i) anda paragraph heading for (c)(2)(i) isadded.

b. New paragraph (c)(2)(ii) is added.2. In paragraph (d)(2)(xi), Example 2

through Example 4 are redesignatedExample 3 through Example 5, respec-tively, and new Example 2 is added.

3. Paragraph (d)(3) is revised.4. The text of paragraph (d)(4) is

added.5. Paragraph (d)(5)(iii) is revised.6. In Paragraph (d)(6)(iii) the refer-

ence to ‘‘(d)(3)(iv)’’ is removed and‘‘(d)(3)(vi)’’ is added in its place.

7. Paragraph (d)(6)(v) is redesignatedas paragraph (d)(6)(vi).

8. New paragraph (d)(6)(v) is addedand reserved.

9. Paragraph (e)(2) is amended asfollows:

a. The paragraph heading and text ofparagraph (e)(2) are redesignated asparagraph (e)(2)(i).

b. In newly designated paragraph(e)(2)(i) the language ‘‘(e)(2)’’ is re-moved and ‘‘(e)(2)(i)’’ is added in itsplace.

c. A new paragraph heading forparagraph (e)(2) is added.

d. Paragraph (e)(2)(ii) is added.10. Paragraph (e)(3)(ii) is revised.11. Paragraph (e)(5) is amended as

follows:a. The second sentence in Example 1

is revised. b. In the list below, for each

sentence in Example 1 indicated in theleft column, remove the language in themiddle column and add the language inthe right column:


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sentence Remove Add

first and third sentence 1993 1997

first sentence § 1.882–5(b) § 1.882–5(c)

fourth and fifth sentence § 1.882–5(b)(2) § 1.882–5(c)(2)

seventh sentence amount value

seventh sentence § 1.882–5(b)(1) § 1.882–5(b)(2)

8

c. The second sentence in paragraph (i) of Example 2 is revised.d. In the list below, for each paragraph in Example 2 indicated in the left column, remove the language in the middle

column and add the language in the right column:

Paragraph Remove Add

(i) first sentence 1993 1997(i) third and fifth sentence 1994 1998(ii) first, second, and third sentence 1995 1999(ii) second sentence 1994 1998(iii) first sentence 1995 1999(iii) last sentence 1994 1998

12. Paragraph (i)(4) is added.The additions and revisions read as

follows:


* * * * * *

(c) * * * (2) * * * (i) In general. * * *(ii) Bad debt reserves. A bank

described in section 585(a)(2)(B) (with-out regard to the second sentencethereof) that uses the reserve method ofaccounting for bad debts for U.S.federal income tax purposes shall de-crease the amount of loans that qualifyas U.S. assets by any reserve that ispermitted under section 585.

(d) * * *(2) * * *(xi) * * *Example 2. U.S. real property interest con-

nected to a U.S. business. FC is a foreigncorporation that is a bank, within the meaning ofsection 585(a)(2)(B) (without regard to thesecond sentence thereof), and is engaged in thebusiness of taking deposits and making loansthrough its branch in the United States. In 1996,FC makes a loan in the ordinary course of itslending business in the United States, securingthe loan with a mortgage on the U.S. realproperty being financed by the borrower. In1997, after the borrower has defaulted on theloan, FC takes title to the real property thatsecures the loan. On December 31, 1997, FCcontinues to hold the property, classifying it onits financial statement as Other Real EstateOwned. Because all income and gain from theproperty would be ECI to FC under theprinciples of section 864(c)(2), the U.S. realproperty constitutes a U.S. asset within themeaning of paragraph (d) of this section.

* * * * * *

(3) Interest in a partnership—(i) Ingeneral. A foreign corporation that is apartner in a partnership must take intoaccount its interest in the partnership(and not the partnership assets) indetermining its U.S. assets. For pur-poses of determining the proportion ofthe partnership interest that is a U.S.asset, a foreign corporation may electto use either the asset method describedin paragraph (d)(3)(ii) of this section orthe income method described in para-graph (d)(3)(iii) of this section.

(ii) Asset method—(A) In general. Apartner’s interest in a partnership shallbe treated as a U.S. asset in the sameproportion that the sum of the partner’sproportionate share of the adjustedbases of all partnership assets as of thedetermination date, to the extent thatthe assets would be treated as U.S.assets if the partnership were a foreigncorporation, bears to the sum of thepartner’s proportionate share of theadjusted bases of all partnership assetsas of the determination date. Generallya partner’s proportionate share of apartnership asset is the same as itsproportionate share of all items ofincome, gain, loss, and deduction thatmay be generated by the asset.

(B) Non-uniform proportionateshares. If a partner’s proportionateshare of all items of income, gain, loss,and deduction that may be generated bya single asset of the partnershipthroughout the period that includes thetaxable year of the partner is notuniform, then, for purposes of deter-mining the partner’s proportionate

share of the adjusted basis of that asset,a partner must take into account theportion of the adjusted basis of theasset that reflects the partner’seconomic interest in that asset. Apartner’s economic interest in an assetof the partnership must be determinedby applying the following presump-tions. These presumptions may, how-ever, be rebutted if the partner or theInternal Revenue Service shows thatthe presumption is inconsistent with thepartner’s true economic interest in theasset during the corporation’s taxableyear.

(1) If a partnership asset ordinarilygenerates directly identifiable income, apartner’s economic interest in the assetis determined by reference to itsproportionate share of income that maybe generated by the asset for thepartnership’s taxable year ending withor within the partner’s taxable year.

(2) If a partnership asset ordinarilygenerates current deductions and or-dinarily generates no directly identifia-ble income, for example because theasset contributes equally to the genera-tion of all the income of the part-nership (such as an asset used ingeneral and administrative functions), apartner’s economic interest in the assetis determined by reference to itsproportionate share of the total deduc-tions that may be generated by theasset for the partnership’s taxable yearending with or within the partner’staxable year.

(3) For other partnership assets notdescribed in paragraph (d)(3)(ii)(B)(1)or (2) of this section, a partner’seconomic interest in the asset is deter-


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mined by reference to its proportionateshare of the total gain or loss to whichit would be entitled if the asset weresold at a gain or loss in the part-nership’s taxable year ending with orwithin the partner’s taxable year.

(C) Partnership election under sec-tion 754. If a partnership files an

use the asset method with respect to aninterest in a partnership, and thatpartnership is a partner in a lower-tierpartnership, the foreign corporationmay apply either the asset method orthe income method to determine theproportion of the upper-tier part-nership’s interest in the lower-tier

sum of FC’s proportionate share of the adjustedbases of all ABC’s U.S. assets (50% of $100),bears to the sum of FC’s proportionate share ofthe adjusted bases of all of ABC’s assets (50%of $200). Under the asset method, the amount ofFC’s interest in ABC that is a U.S. asset is $50($100 2 $50/$100).

Example 2. Special allocation of gain withrespect to real property—(i) Facts. The facts arethe same as in Example 1, except that under the

9

election in accordance with section754, then for purposes of this para-graph (d)(3)(ii), the basis of partnershipproperty shall reflect adjustments madepursuant to sections 734 (relating todistributions of property to a partner)and 743 (relating to the transfer of aninterest in a partnership). However,adjustments made pursuant to section743 may be made with respect to atransferee partner only.

(iii) Income method. Under the in-come method, a partner’s interest in apartnership shall be treated as a U.S.asset in the same proportion that itsdistributive share of partnership ECIfor the partnership’s taxable year thatends with or within the partner’staxable year bears to its distributiveshare of all partnership income for thattaxable year.

(iv) Manner of election—(A) Ingeneral. In determining the proportionof a foreign corporation’s interest in apartnership that is a U.S. asset, aforeign corporation must elect one ofthe methods described in paragraph(d)(3) of this section on a timely filedreturn for the first taxable year begin-ning on or after the effective date ofthis section. An amended return doesnot qualify for this purpose, nor shallthe provisions of § 301.9100–1 of thischapter and any guidance promulgatedthereunder apply. An election shall bemade by the foreign corporation cal-culating its U.S. assets in accordancewith the method elected. An electedmethod must be used for a minimumperiod of five years before the foreigncorporation may elect a differentmethod. To change an election beforethe end of the requisite five-yearperiod, a foreign corporation mustobtain the consent of the Commissioneror her delegate. The Commissioner orher delegate will generally consent to aforeign corporation’s request to changeits election only in rare and unusualcircumstances. A foreign corporationthat is a partner in more than onepartnership is not required to elect touse the same method for each part-nership interest.

(B) Elections with tiered partner-ships. If a foreign corporation elects to

partnership that is a U.S. asset.(v) Failure to make proper election.

If a foreign corporation, for any reason,fails to make an election to use one ofthe methods required by paragraph(d)(3) of this section in a timelyfashion, the district director or theAssistant Commissioner (International)may make the election on behalf of theforeign corporation and such electionshall be binding as if made by thatcorporation.

(vi) Special rule for determining apartner’s adjusted basis in a part-nership interest. For purposes of para-graphs (d)(3) and (6) of this section, apartner’s adjusted basis in a partnershipinterest shall be the partner’s basis insuch interest (determined under section705) reduced by the partner’s share ofthe liabilities of the partnership deter-mined under section 752 and increasedby a proportionate share of eachliability of the partnership equal to thepartner’s proportionate share of theexpense, for income tax purposes,attributable to such liability for thetaxable year. A partner’s adjusted basisin a partnership interest cannot be lessthan zero.

(vii) E&P basis of a partnershipinterest. See paragraph (d)(6)(iii) ofthis section for special rules governingthe calculation of a foreign corpora-tion’s E&P basis in a partnershipinterest.

(viii) The application of this para-graph (d)(3) is illustrated by thefollowing examples:

Example 1. General rule—(i) Facts. Foreigncorporation, FC, is a partner in partnership ABC,which is engaged in a trade or business withinthe United States. FC and ABC are both calendaryear taxpayers. ABC owns and manages twooffice buildings located in the United States,each with an adjusted basis of $50. ABC alsoowns a non-U.S. asset with an adjusted basis of$100. ABC has no liabilities. Under the part-nership agreement, FC has a 50 percent interestin the capital of ABC and a 50 percent interest inall items of income, gain, loss, and deductionthat may be generated by the partnership’sassets. FC’s adjusted basis in ABC is $100. Indetermining the proportion of its interest in ABCthat is a U.S. asset, FC elects to use the assetmethod described in paragraph (d)(3)(ii) of thissection.

(ii) Analysis. FC’s interest in ABC is treatedas a U.S. asset in the same proportion that the

partnership agreement, FC is allocated 20 percentof the income from the partnership property but80 percent of the gain on disposition of thepartnership property.

(ii) Analysis. Assuming that the buildingsordinarily generate directly identifiable income,there is a rebuttable presumption under paragraph(d)(3)(ii)(B)(1) of this section that FC’s propor-tionate share of the adjusted basis of thebuildings is FC’s proportionate share of theincome generated by the buildings (20%) ratherthan the total gain that it would be entitled tounder the partnership agreement (80%) if thebuildings were sold at a gain on the determina-tion date. Thus, the sum of FC’s proportionateshare of the adjusted bases in ABC’s U.S. assets(the buildings) is presumed to be $20 [(20% of$50) + (20% of $50)]. Assuming that the non-U.S. asset is not income-producing and does notgenerate current deductions, there is a rebuttablepresumption under paragraph (d)(3)(ii)(B)(3) ofthis section that FC’s proportionate share of theadjusted basis of that asset is FC’s interest in thegain on the disposition of the asset (80%) ratherthan its proportionate share of the income thatmay be generated by the asset (20%). Thus, FC’sproportionate share of the adjusted basis ofABC’s non-U.S. asset is presumed to be $80(80% of $100). FC’s proportionate share of theadjusted bases of all of the assets of ABC is$100 ($20 + $80). The amount of FC’s interestin ABC that is a U.S. asset is $20 ($100 2$20/$100).

Example 3. Tiered partnerships (assetmethod)—(i) Facts. The facts are the same as inExample 1, except that FC’s adjusted basis inABC is $175 and ABC also has a 50 percentinterest in the capital of partnership DEF. DEFowns and operates a commercial shopping centerin the United States with an adjusted basis of$200 and also owns non-U.S. assets with anadjusted basis of $100. DEF has no liabilities.ABC’s adjusted basis in its interest in DEF is$150 and ABC has a 50 percent interest in allthe items of income, gain, loss and deductionthat may be generated by the assets of DEF.

(ii) Analysis. Because FC has elected to usethe asset method described in paragraph (d)(3)(ii)of this section, it must determine what proportionof ABC’s partnership interest in DEF is a U.S.asset. As permitted by paragraph (d)(3)(iv)(B) ofthis section, FC also elects to use the assetmethod with respect to ABC’s interest in DEF.ABC’s interest in DEF is treated as a U.S. assetin the same proportion that the sum of ABC’sproportionate share of the adjusted bases of allDEF’s U.S. assets (50% of $200), bears to thesum of ABC’s proportionate share of theadjusted bases of all of DEF’s assets (50% of$300). Thus, the amount of ABC’s interest inDEF that is a U.S. asset is $100 ($150 2$100/$150). FC must then apply the rules ofparagraph (d)(3)(ii) of this section to all theassets of ABC, including ABC’s interest in DEFthat is treated in part as a U.S. asset ($100) andin part as a non-U.S. asset ($50). FC’s interest inABC is treated as a U.S. asset in the same


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proportion that the sum of FC’s proportionateshare of the adjusted bases of the U.S. assets ofABC (including ABC’s interest in DEF), bears tothe sum of FC’s proportionate share of theadjusted bases of all ABC’s assets (includingABC’s interest in DEF). Thus, the amount ofFC’s interest in ABC that is a U.S. asset is $100(FC’s adjusted basis in ABC ($175) multipliedby FC’s proportionate share of the sum of theadjusted bases of ABC’s U.S. assets ($100)) over

determined under this paragraph(e)(2)(ii) is the amount (as of thedetermination date) of liabilities de-scribed in § 1.882–5(a)(1)(ii) (relatingto liabilities giving rise to interestexpense that is directly allocated toincome from a U.S. asset).

(3) * * *

able year. This form shall include suchinformation as is required by the formand accompanying instructions. Thewaiver must be signed by the personauthorized to sign the income taxreturns for the foreign corporation(including an agent authorized to do sounder a general or specific power of

10

FC’s proportionate share of the sum of theadjusted bases of ABC’s assets ($175)).

Example 4. Tiered partnerships (incomemethod)—(i) Facts. The facts are the same as inExample 3, except that FC has elected to use theincome method described in paragraph (d)(3)(iii)of this section to determine the proportion of itsinterest in ABC that is a U.S. asset. The twooffice buildings located in the United Statesgenerate $60 of income that is ECI for thetaxable year. The non-U.S. asset is not-incomeproducing. In addition ABC’s distributive shareof income from DEF consists of $40 of incomethat is ECI and $140 of income that is not ECI.

(ii) Analysis. Because FC has elected to usethe income method it does need to determinewhat proportion of ABC’s partnership interest inDEF is a U.S. asset. FC’s interest in ABC istreated as a U.S. asset in the same proportionthat its distributive share of ABC’s income forthe taxable year that is ECI ($50) ($30 earneddirectly by ABC + $20 distributive share fromDEF) bears to its distributive share of all ABC’sincome for the taxable year ($55) ($30 earneddirectly by ABC + $25 distributive share fromDEF). Thus, FC’s interest in ABC that is a U.S.asset is $159 ($175 2 $50/$55).

(4) Interest in a trust or estate—(i)Estates and non-grantor trusts. A for-eign corporation that is a beneficiary ofa trust or estate shall not be treated ashaving a U.S. asset by virtue of itsinterest in the trust or estate.

(ii) Grantor trusts. If, under sections671 through 678, a foreign corporationis treated as owning a portion of a trustthat includes all the income and gainthat may be generated by a trust asset(or pro rata portion of a trust asset), theforeign corporation will be treated asowning the trust asset (or pro rataportion thereof) for purposes of deter-mining its U.S. assets under thissection.

(5) * * *(iii) Interbranch transactions. A

transaction of any type between sepa-rate offices or branches of the sametaxpayer does not create a U.S. asset.

(6) * * *(v) Computation of E&P basis of

financial instruments. [Reserved]

* * * * * *

(e) * * *(2) Additional liabilities—(i) * * *(ii) Liabilities described in § 1.882–

5(a)(1)(ii). The amount of liabilities

(ii) Limitation. For any taxable year,a foreign corporation may elect toreduce the amount of its liabilitiesdetermined under paragraph (e)(1) ofthis section by an amount that does notexceed the excess, if any, of theamount of liabilities in paragraph (e)(1)of this section over the amount, as ofthe determination date, of U.S. bookedliabilities (determined under § 1.882–5(d)(2)) and liabilities described inparagraph (e)(2) of this section.

* * * * * *

(5) * * * Example 1. * * * For purposes of computing

its U.S.- connected liabilities under § 1.882–5(c),A must determine the average total value of itsassets that are U.S. assets. * * *

Example 2. * * * A has $800 of liabilitiesunder paragraph (e)(1) of this section and $300of liabilities properly reflected on the books ofits U.S. trade or business under § 1.882–5(d)(2).* * *

* * * * * *

(i) * * *(4) Special rules for certain U.S.

assets and liabilities. Paragraphs(c)(2)(i) and (ii), (d)(3), (d)(4),(d)(5)(iii), (d)(6)(iii), (d)(6)(vi), (e)(2),and (e)(3)(ii), of this section areeffective for taxable years beginning onor after June 6, 1996.

Par. 6. § 1.884–2 is added to read asfollows:

§ 1.884–2 Special rules for terminationor incorporation of a U.S. trade orbusiness or liquidation or reorganiza-tion of a foreign corporation or itsdomestic subsidiary.

(a) through (a)(2)(i) [Reserved] Forfurther information, see § 1.884–2T(a)through (a)(2)(ii).

(a)(2)(ii) Waiver of period of limita-tions. The waiver referred to in§ 1.884–2T(a)(2)(i)(D) shall be ex-ecuted on Form 8848, or substituteform, and shall extend the period forassessment of the branch profits tax forthe year of complete termination to adate not earlier than the close of thesixth taxable year following that tax-

attorney). The waiver must be filed onor before the date (including exten-sions) prescribed for filing the foreigncorporation’s income tax return for theyear of complete termination. Withrespect to a complete termination oc-curring in a taxable year ending priorto June 6, 1996, a foreign corporationmay also satisfy the requirements ofthis paragraph (a)(2)(ii) by applying§ 1.884–2T(a)(2)(ii) of the temporaryregulations (as contained in the CFRedition revised as of April 1, 1995). Aproperly executed Form 8848, sub-stitute form, or other form of waiverauthorized by this paragraph (a)(2)(ii)shall be deemed to be consented to andsigned by a Service Center Director orthe Assistant Commissioner (Interna-tional) for purposes of § 301.6501(c)–1(d) of this chapter.

(a)(3) through (a)(4) [Reserved] Forfurther information, see § 1.884–2T(a)(3) through (a)(4).

(a)(5) Special rule if a foreigncorporation terminates an interest in atrust. A foreign corporation whosebeneficial interest in a trust terminates(by disposition or otherwise) in anytaxable year shall be subject to thebranch profits tax on ECEP attributableto amounts (including distributions ofaccumulated income or gain) treated asECI to such beneficiary in such taxableyear notwithstanding any other provi-sion of § 1.884–2T(a).

(b) through (c)(2)(ii) [Reserved] Forfurther information, see § 1.884–2T(b)through (c)(2)(ii).

(c)(2)(iii) Waiver of period of limita-tions and transferee agreement. In thecase of a transferee that is a domesticcorporation, the provisions of § 1.884–2T(c)(2)(i) shall not apply unless, aspart of the section 381(a) transaction,the transferee executes a Form 2045(Transferee Agreement) and a waiverof period of limitations as described inthis paragraph (c)(2)(iii), and files bothdocuments with its timely filed (includ-ing extensions) income tax return forthe taxable year in which the section381(a) transaction occurs. The waivershall be executed on Form 8848, orsubstitute form, and shall extend the


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period for assessment of any additionalbranch profits tax for the taxable yearin which the section 381(a) transactionoccurs to a date not earlier than theclose of the sixth taxable year follow-ing the taxable year in which suchtransaction occurs. This form shallinclude such information as is required

ning after December 31, 1986. Para-graph (a)(5) of this section is effectivefor taxable years beginning on or afterJune 6, 1996.

Par. 7. Section 1.884–2T is amendedas follows:

1. Paragraph (a)(2)(ii) is revised.

rules relating to this paragraph.

* * * * * *

(c) * * * (2) * * *(iii) Waiver of period of limitations

and transferee agreement. [Reserved]

11

by the form and accompanying instruc-tions. The waiver must be signed bythe person authorized to sign Form2045. With respect to a completetermination occurring in a taxable yearending prior to June 6, 1996, a foreigncorporation may also satisfy the re-quirements of this paragraph (c)(2)(iii)by applying § 1.884–2T(c)(2)(iii) of thetemporary regulations (as contained inthe CFR edition revised as of April 1,1995). A properly executed Form 8848,substitute form, or other form of waiverauthorized by this paragraph (c)(2)(iii)shall be deemed to be consented to andsigned by a Service Center Director orthe Assistant Commissioner (Interna-tional) for purposes of § 301.6501(c)–1(d) of this chapter.

(c)(3) through (f) [Reserved] Forfurther information, see § 1.884–2T(c)(3) through (f).

(g) Effective dates. Paragraphs(a)(2)(ii) and (c)(2)(iii) of this sectionare effective for taxable years begin-

2. Paragraph (a)(5) is redesignated as(a)(6).

3. New paragraph (a)(5) is added.4. Paragraph (c)(2)(iii) is revised.The additions and revisions read as

follows:

§ 1.884–2T Special rules for termina-tion or incorporation of a U.S. trade orbusiness or liquidation or reorganiza-tion of a foreign corporation or itsdomestic subsidiary (Temporary).

(a) * * * (2) * * *(ii) Waiver of period of limitations.

[Reserved] See § 1.884–2(a)(2)(ii) forrules relating to this paragraph.

* * * * * *

(5) Special rule if a foreign corpora-tion terminates an interest in a trust.[Reserved] See § 1.884–2(a)(5) for

See § 1.884–2(c)(2)(iii) for rules relat-ing to this paragraph.


1. In paragraph (a)(1), the fifthsentence is revised.

2. Paragraph (a)(2)(iii) is revised.3. Paragraph (b)(1) is revised and

paragraph (b)(2) is removed and re-served.

4. Paragraph (b)(3) is amended by: a . R e m o v i n g t h e r e f e r e n c e

‘‘(b)(1)(v)’’ and adding the language‘‘(b)(1)(ii)’’ in the following:

i. Paragraph (b)(3)(i), first sentence.ii. Paragraph (b)(3)(ii), introductory

text.iii. Paragraph (b)(3)(iii), heading and

introductory text.b. Adding a sentence at the end of

paragraph (b)(3)(i).5. Paragraph (b)(4) is removed and

reserved.

6. In the list below, for each paragraph indicated in the left column, remove the language in the middle column and addthe language in the right column:


(a)(2)(i)(A) apportioned allocated or apportioned

(a)(4) Example 1 first sentence (b)(2) (a)(2)(iii)

(a)(4) Example 1 first and seventh sentence apportioned allocated or apportioned

(a)(4) Example 1 first, second, and eighth sentence 1993 1997

(a)(4) Example 2 first sentence (b)(2) (a)(2)(iii)

(a)(4) Example 2 second and third sentence 1993 1997

(b)(5)(i) last sentence apportioned allocated or apportioned

(b)(5)(ii) Example first, fifth, and last sentence apportioned allocated or apportioned

(b)(6) paragraph heading apportioned allocated or apportioned

(b)(6)(i) first and last sentence apportioned allocated or apportioned

(b)(6)(i) second sentence (b)(1)(v) (b)(1)(ii)

(b)(6)(ii) first and second sentence (b)(1)(v) (b)(1)(ii)

(b)(6)(ii) first and second sentence paragraphs (b)(1)(i)through (b)(i)(iv)

paragraph (b)(1)(i)


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(b)(6)(iv) Example 1 introductory text,paragraphs (i), (iii), and (iv), flush lan-guage first, fourth, and seventh sentence

1993 1997

(b)(6)(iv) Example 1 paragraph (ii) 1992 1996

(b)(6)(iv) Example 1 flush language sec-ond, and sixth sentence

(b)(1)(v) (b)(1)(ii)

12

(c)(1)(iv) Example 1 first sentence apportioned allocated or apportioned

(c)(1)(iv) Example 1 first, second, third,fifth, sixth, and seventh sentence

1993 1997

(c)(1)(iv) Example 1 third, fourth, andseventh sentence

1994 1998

(c)(1)(iv) Example 2 second sentence apportioned allocated or apportioned

(c)(1)(iv) Example 2 first, second, third,and last sentence

1993 1997

(c)(1)(iv) Example 2 second and last sen-tence

1994 1998

(c)(2)(i) first sentence apportioned allocated or apportioned

(c)(4) Example third, fourth, fifth, sixth,and eighth sentence

1993 1997

(c)(4) Example fifth sentence allocated allocated or apportioned

7. Paragraph (e) is amended asfollows:

a. The text of paragraph (e) isredesignated as paragraph (e)(1) and aparagraph heading for (e)(1) is added.

b. The first sentence of newlydesignated paragraph (e)(1) is revised.

8. Paragraph (e)(2) is added.The revisions and additions read as

follows:

§ 1.884–4 Branch-level interest tax.

(a) * * * (1) * * * For purposes ofthis section, a foreign corporation alsoshall be treated as engaged in trade orbusiness in the United States if, at anytime during the taxable year, it owns anasset taken into account under § 1.882–5(a)(1)(ii) or (b)(1) for purposes ofdetermining the amount of the foreigncorporation’s interest expense allocatedor apportioned to ECI. * * *

(2) * * *(iii) Treatment of a portion of the

excess interest of banks as interest ondeposits. A portion of the excessinterest of a foreign corporation that isa bank (as defined in section585(a)(2)(B) without regard to thesecond sentence thereof) provided thata substantial part of its business in theUnited States, as well as all othercountries in which it operates, consistsof receiving deposits and making loansand discounts, shall be treated asinterest on deposits (as described in

section 871(i)(3)), and shall be exemptfrom the tax imposed by section 881(a)as provided in such section. Theportion of the excess interest of theforeign corporation that is treated asinterest on deposits shall equal theproduct of the foreign corporation’sexcess interest and the greater of—

(A) The ratio of the amount ofinterest bearing deposits, within themeaning of section 871(i)(3)(A), of theforeign corporation as of the close ofthe taxable year to the amount of allinterest bearing liabilities of the foreigncorporation on such date; or

(B) 85 percent.

* * * * * *

(b) Branch interest—(1) Definitionof branch interest. For purposes of thissection, the term ‘‘branch interest’’means interest that is —

(i) Paid by a foreign corporation withrespect to a liability that is—

(A) A U.S. booked liability withinthe meaning of § 1.882–5(d)(2) (otherthan a U.S. booked liability of apartner within the meaning of § 1.882–5(d)(2)(vii)); or

(B) Described in § 1.884–1(e)(2)(relating to insurance liabilities on U.S.business and liabilities giving rise tointerest expense that is directly allo-cated to income from a U.S. asset); or

(ii) In the case of a foreign corpora-tion other than a corporation described

in paragraph (a)(2)(iii) of this section, aliability specifically identified (asprovided in paragraph (b)(3)(i) of thissection) as a liability of a U.S. trade orbusiness of the foreign corporation onor before the earlier of the date onwhich the first payment of interest ismade with respect to the liability or thedue date (including extensions) of theforeign corporation’s income tax returnfor the taxable year, provided that—

(A) The amount of such interest doesnot exceed 85 percent of the amount ofinterest of the foreign corporation thatwould be excess interest before takinginto account interest treated as branchinterest by reason of this paragraph(b)(1)(ii);

(B) The requirements of paragraph(b)(3)(ii) of this section (relating tonotification of recipient of interest) aresatisfied; and

(C) The liability is not described inparagraph (b)(3)(iii) of this section(relating to liabilities incurred in theordinary course of a foreign business orsecured by foreign assets) or paragraph(b)(1)(i) of this section.

(2) [Reserved](3)(i) * * * A foreign corporation

that is subject to this section mayidentify a liability under paragraph(b)(1)(ii) of this section whether or notit is actually engaged in the conduct ofa trade or business in the United States.* * *


778/20042/17APR96/C34-004

* * * * * *

(4) [Reserved]

* * * * * *

(e) Effective dates—(1) General rule.Except as provided in paragraph (e)(2)of this section, this section is effectivefor taxable years beginning October 13,

* * * * * *

(f) * * *(2) * * *(i) Held for the principal purpose of

promoting the present conduct of thetrade or business,

of changes to the applicable tax lawmade by the Tax Reform Act of 1986,and because of changes in internationalfinancial markets.

EFFECTIVE DATE: June 6, 1996.

FOR FURTHER INFORMATION
1992, and for payments of interestdescribed in section 884(f)(1)(A) made(or treated as made under paragraph(b)(7) of this section) during taxableyears of the payor beginning after suchdate. * * *
(2) Special rule. Paragraphs (a)(1),(a)(2)(i)(A), (a)(2)(iii), (b)(1), (b)(3),(b)(5)(i), (b)(6)(i), (b)(6)(ii), and(c)(2)(i) of this section are effective fortaxable years beginning on or afterJune 6, 1996.

Par. 9. In section 1.884–5, para-graphs (e)(4)(ii) and (g) are revised toread as follows:

§ 1.884–5 Qualified resident

* * * * * *

(e) * * *(4) * * * (ii) Presumption for banks. A U.S.

trade or business of a foreign corpora-tion that is described in § 1.884–4(a)(2)(iii) shall be presumed to be anintegral part of an active bankingbusiness conducted by the foreigncountry in its country of residenceprovided that a substantial part of thebusiness of the foreign corporation inboth its country of residence and theUnited States consists of receivingdeposits and making loans and dis-counts. This paragraph shall be effec-tive for taxable years beginning on orafter June 6, 1996.

* * * * * *

(g) * * * Except as provided inparagraph (e)(4)(ii) of this section, thissection is effective for taxable yearsbeginning on or after October 13, 1992.* * *

* * * * * *


1. In paragraph (f)(1)(iii) the lan-guage ‘‘stock,’’ is removed.

2. Paragraph (f)(2)(i) is revised toread as follows:

§ 1.897–1 Taxation of foreign invest-ments in United States real propertyinterests, definition of terms.

* * * * * *

PART 602—OMB CONTROLNUMBERS UNDER THEPAPERWORK REDUCTION ACT

Par. 11. The authority for part 602continues to read as follows:

Authority: 26 U.S.C. 7805.Par. 12. In § 602.101, the table in

paragraph (c) is amended by adding innumerical order ‘‘§ 1.884–2 . . . 1545–1070’’.

Margaret Milner Richardson,Commissioner of Internal Revenue.

Approved February 28, 1996.

Leslie Samuels,Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register onMarch 5, 1996, 8:45 a.m., and published in theissue of the Federal Register for March 8,1996, 61 F.R. 9336)

Section 882.—Tax on Income ofForeign Corporations Connected WithUnited States Business

26 CFR 1.882–5: Determination of interestdeduction.

T.D. 8658

13

DEPARTMENT OF THE TREASURYInternal Revenue Service26 CFR Part 1

Determination of Interest Expense De-duction of Foreign Corporations


ACTION: Final regulations.

SUMMARY: This document containsIncome Tax Regulations relating to thedetermination of the interest expensededuction of foreign corporations andapplies to foreign corporations engagedin a trade or business within the UnitedStates. This action is necessary because

CONTACT: Ahmad Pirasteh orRichard Hoge, (202) 622-3870 (not atoll-free number).


Background

On April 24, 1992, the IRS pub-lished proposed amendments (INTL–309–88, 1992–1 C.B. 1157) to theIncome Tax Regulations (26 CFR parts1) under section 882 of the InternalRevenue Code in the Federal Register(57 FR 15308). A public hearing washeld on October 30, 1992. Numerouswritten comments were received. Afterconsideration of all of the comments,the regulations proposed by INTL–309–88 are adopted as amended by thisTreasury decision, and the prior regula-tions are withdrawn. The revisions arediscussed below.

Discussion of Major Comments andChanges to the Regulations.

1. Introduction.

Section 882(c) of the Internal Reve-nue Code provides that a foreigncorporation is allowed a deduction onlyto the extent that the expense isconnected with income that is effec-tively connected with the conduct of aU.S. trade or business within theUnited States (ECI), and that the properallocation is to be determined asprovided in regulations. The proposed§ 1.882–5 regulations that were issuedin 1992 generally followed the ap-proach adopted in the 1981 finalregulations, with various changes in-tended to clarify and update theregulations.

The proposed regulations attracted asubstantial number of comments, ad-dressing both general and specificaspects of the regulations. In responseto these comments, the Treasury De-partment and the IRS simplified theregulations, coordinated them moreclosely with other regulations, andgenerally responded to the concerns of


778/20042/17APR96/C34-004

foreign corporations doing business inthe United States. For example, U.S.assets are defined in the first step ofthe three-step formula to coincideclosely with the definition of a U.S.asset used for purposes of section 884.The computation of the actual ratio inStep 2 has been simplified consider-

should be required to use the rules of§ 1.882–5 for purposes of determiningthe amount of interest expense alloca-ble to the foreign corporation’s incomeattributable to its U.S. permanentestablishment. The IRS and the Treas-ury Department believe that the meth-odology provided in these regulations

§ 1.882–5 calculations in cases where,under the authority of § 1.881–3, thedistrict director has determined that ataxpayer has acted as a conduit entityin a conduit financing arrangement.The IRS and Treasury do not believethat it is appropriate in this regulationto alleviate the consequences of

14

ably, minimizing both the number andthe frequency of required computations.In Step 3, consistent with the emphasisin the regulations on the use of actualratios and rates rather than prescribedones whenever possible, the final reg-ulations allow taxpayers to use eithertheir actual interest rate on U.S. dollarliabilities, or, if they elect, to use theiractual rates on liabilities denominatedin each of the currencies in which theirU.S. assets are denominated. TheTreasury and the IRS believe that thefinal regulations strike a reasonablebalance between the concerns of for-eign corporate taxpayers and the inter-ests of the United States government.

2. § 1.882–5(a): Rules of generalapplication.

Section 1.882–5(a) provides generalrules for determining a foreign corpora-tion’s interest expense allocable to ECI.The final regulations specify that theprovisions of § 1.882–5 constitute theexclusive rules for allocating interestexpense to the income from the U.S.trade or business of all foreign corpora-tions, including foreign corporationsthat are residents of countries withwhich the United States has an incometax treaty. In general, this requires allforeign corporations to use the three-step methodology described in the finalregulations. In response to commenters’questions, however, § 1.882–5(a)(1)(ii)now provides that a foreign corporationthat is engaged in a U.S. trade orbusiness, either directly or through apartnership, and that satisfies certainrequirements may allocate interest ex-pense directly to income generated by aparticular asset to the same extent thata U.S. corporation is permitted todirectly allocate interest expense underthe rules of § 1.861–10T. When aforeign corporation directly allocatesinterest expense under this rule, thefinal regulations require adjustments toall three steps of the calculation toavoid double counting of assets andliabilities.

Numerous commenters questionedwhether a taxpayer that is entitled tothe benefits of a U.S. income tax treaty

is fully consistent with all of theUnited States’s treaty obligations, in-cluding the Business Profits article ofour tax treaties. Generally, the BusinessProfits article requires that, in deter-mining the business profits of a perma-nent establishment, there shall be al-lowed as deductions expenses that areincurred for the purposes of the perma-nent establishment, including interestexpense. Section 1.882–5(a)(2) of thefinal regulations is a reasonable methodof implementing that general directive,as our treaties do not compel the use ofany particular method.

Most of the other changes to thegeneral rules of § 1.882–5(a) are clar-ifications in response to commenters’questions. For example, the final reg-ulations clarify certain aspects of therules that limit a foreign corporation’sallocable interest expense to theamount actually paid or accrued by thecorporation in a taxable year, and therules that coordinate the provisions of§ 1.882–5 with any other section thatdisallows, defers, or capitalizes interestexpense, and include examples thatillustrate how § 1.882–5 applies to anasset that produces income exemptfrom U.S. taxation.

Many commenters requested that theregulations clarify how and when tomake the various elections allowedunder § 1.882–5. The final regulationsprovide uniform rules for changing anyelection prescribed under § 1.882–5,and give all taxpayers an opportunity tomake new elections, if desired, for thefirst taxable year beginning after theeffective date of these regulations. Theregulations provide that, once a methodis elected, a taxpayer must use themethod for five years, unless theCommissioner or her delegate consentsto an earlier change based on extenuat-ing circumstances. The final regulationsreflect the current practice of the IRSby providing that if the taxpayer failsto make a timely election, the districtdirector or the Assistant Commissioner(International) may make any and allelections on the taxpayer’s behalf.

Several commenters asked that thefinal regulations allow taxpayers tomake correlative adjustments to their

§ 1.881–3 if a taxpayer has engaged ina transaction one of the principalpurposes of which is to avoid U.S.withholding tax. Allowing such correla-tive adjustments in this regulationwould prevent § 1.881–3 from servingits function as an anti-abuse rule.

3. § 1.882–5(b): Determination of totalamount of U.S. assets for the taxableyear (Step 1).

As in the proposed regulations, thefinal regulations provide that the classi-fication of an item as a U.S. assetunder § 1.884–1(d) generally governsits classification as a U.S. asset forpurposes of § 1.882–5. Under the rulesof § 1.884–1(d), an item generally istreated as a U.S. asset if all of theincome it generates (or would generate)and all of the gains that it wouldgenerate (if sold at a gain) are ECI.Since the proposed § 1.882–5 regula-tions were issued in 1992, the regula-tions under § 1.884–1 were amendedand released in final form. In light ofthose new regulations, the inclusionsand exclusions enumerated in the pro-posed regulations were largely elimi-nated, so that the final § 1.882–5regulations now closely conform to the§ 1.884–1(d) definition of a U.S. asset.

Section 1.882–5(b)(3) of the finalregulations continues the requirementthat a foreign corporation must valueits U.S. assets at the most frequent,regular intervals for which data arereasonably available. However, the ruleis applied separately with respect toeach U.S. asset. Paragraph (b)(3) spec-ifies that the value of a U.S. asset mustbe computed at least monthly by alarge bank and at least semi-annuallyby other taxpayers.

Many questions have been raisedabout how § 1.882–5 applies to part-nership interests held by foreign corpo-rations. With the elimination of§ 1.861–9T(e)(7)(i) by these regula-tions, § 1.884–1(d)(3) and § 1.882–5now provide the exclusive rules fordetermining a foreign corporation’sinterest expense allocable to an interestin a partnership. The new regulations


778/20042/17APR96/C34-004

under § 1.884–1(d)(3) provide that aforeign corporation determines its U.S.assets by reference to its basis in thepartnership, and expand the methodsavailable for determining the portion ofits partnership basis that is a U.S. asset.

Numerous commenters were con-cerned that the provisions of the

effect of treating all stock as debt-financed under the principles of section246A. This stock cut-back rule iseliminated from the final § 1.882–5regulations. The elimination of the rule,however, will affect only those tax-payers whose stock satisfies thebusiness-activities test or the banking,

how these requirements apply areprovided. With regard to materialitems, however, the final regulationsspecify that a foreign corporation mustcompute the value of U.S. assets andthe amount of worldwide liabilities inSteps 1 and 2 in a consistent manner.

The proposed regulations would have

15

proposed regulations relating to realestate would treat international banksunfairly, since banks frequently acquirereal estate through foreclosure, or ownthe buildings in which their offices arelocated. Commenters stated that it isunclear whether such real estate wouldqualify as a U.S. asset. Commentersalso objected to the rule in theproposed regulations that provides thatan interest in a U.S. real propertyholding company, which is not treatedas a U.S. asset under § 1.884–1(d),would be treated as a U.S. asset only inthe year of disposition. Commentersargued that banks frequently hold prop-erty acquired by foreclosure in specialpurpose subsidiaries in order to limittheir exposure to environmental orother liabilities. However, such banksmust service the debt they incurred toacquire the real property throughout theperiod they hold the stock, not merelyupon disposition.

In response to these comments, anexample is added under § 1.884–1(d)(2) to clarify that U.S. real estateacquired as a result of foreclosure by abank acting in the ordinary course ofits business is generally a U.S. asset,because the property would produceECI to the bank under section864(c)(2). Similarly, the building inwhich a bank’s offices are locatedgenerally qualifies as a U.S. asset,because gain from the sale of thebuilding generally would constituteeffectively connected income under theasset-use test of § 1.864–4(c)(2). Inaddition, the final regulations specifythat a taxpayer may achieve the sameresult under § 1.882–5 whether it holdsforeclosure property or the office build-ing it occupies directly or indirectlythrough a corporation. Section 1.882–5(b)(1)(iii)(A) provides a look-throughrule that treats such real property as aU.S. asset for purposes of § 1.882–5 tothe extent that it would have qualifiedas a U.S. asset if held directly by thetaxpayer.

Commenters noted that the rule inthe proposed regulations that reducesthe value of shares of stock claimed asa U.S. asset by a percentage of thedividends received deduction had the

financing or similar-business test of§ 1.864–4(c). This is because the finalregulations under § 1.864–4, which arebeing issued contemporaneously withthese regulations elsewhere in this issueof the Bulletin, generally eliminate anyinference that stock can produce effec-tively connected income under theasset-use test of § 1.864–4(c)(2).

The final regulations add an anti-abuse rule similar to the rule in§ 1.884–1(d)(5)(ii) to prevent taxpayersfrom artificially increasing the amountof their U.S. assets.

4. § 1.882–5(c): Determination of totalamount of U.S. liabilities for thetaxable year (Step 2).

Commenters objected to many of therequirements in Step 2 of the proposedregulations on the grounds that therules effectively prevented foreignbanks from using their actual ratio ofliabilities to assets by imposing exces-sive administrative burdens and cap-ping the actual ratio at 96%. Becausethe IRS and Treasury believe that ataxpayer’s interest deduction should bebased on the taxpayer’s actual ratio ofliabilities to assets whenever possible,the final regulations adopt rules that areintended to encourage taxpayers to usetheir actual ratio. Accordingly, the finalregulations drop the 96% cap on theactual ratio that was in the proposedregulations. The final regulations alsosubstantially ease the administrativeburden associated with computing theactual ratio.

Many commenters objected to therequirement in the proposed regulationsthat a taxpayer’s worldwide liabilitiesto assets ratio be computed strictly inaccordance with U.S. tax principles,citing the substantial burden that such acalculation would entail. In light ofthese comments, the final regulationsrequire that only the classification ofassets and liabilities must be strictly inaccordance with U.S. tax principles.The value of worldwide assets and theamount of worldwide liabilities needonly be substantially in accordancewith U.S. tax principles. Examples of

required that a foreign bank computeits actual ratio monthly. Commenterswere concerned that the burden of thisrule would be excessive. In response,the final regulations decrease the re-quired frequency of the computationsof the actual ratio to semi-annually forlarge banks, and to annually for othertaxpayers.

Commenters also were concernedthat the rules in the proposed regulationrequiring basis adjustments for 20%owned subsidiaries would be too bur-densome. These rules, which serve asomewhat different purpose in section864(e)(4), have been removed from thefinal regulations.

Commenters pointed out that theelection provided by the proposedregulations to compute the actual ratioof a bank on the basis of a hypotheticaltax year ending six months prior to thebeginning of the actual year does notserve its intended purpose. The sixmonth lagging ratio election has there-fore been eliminated.

Section 1.882–5(c)(3) of the finalregulations provides that the districtdirector or the Assistant Commissioner(International) may make appropriateadjustments to prevent the artificialincrease of a corporation’s actual ratio.This rule, in conjunction with morespecific anti-abuse rules in Steps 1 and3, replaces the general anti-abuse rulein § 1.882–5(e) of the proposedregulations.

Commenters criticized the 93% fixedratio for banks as too low, anddisagreed with the reasons provided inthe preamble to the proposed regula-tions supporting the 93% ratio. Thefinal regulations, however, retain theelective fixed ratio at 93%. In conjunc-tion with the more relaxed rulesregarding the computation of a foreigncorporation’s actual ratio, Treasury be-lieves that a 93% fixed ratio, whichremains purely elective, represents anappropriate safe harbor for banks.

Section 1.882–5(c)(4) also modifiesthe definition of a bank for thesepurposes to clarify the previous defini-tion and to limit the 93% fixed ratio tothe intended class of businesses.


778/20042/17APR96/C34-004

5. § 1.882–5(d): Determination ofamount of interest expense allocable toECI (Step 3).

Commenters were concerned thatStep 3 of the proposed regulationsfailed to reflect business realities, in-creased administrative costs and created

for a booked liability. The special rulesfor banks in the proposed regulationshave otherwise been eliminated.

In response to comments, the com-putation of the scaling ratio that appliesto taxpayers with excess liabilities hasalso been simplified, and its applicationhas been reduced in scope. Under the

each currency as funded by the world-wide liabilities of the taxpayer in thatsame currency. This new separatecurrency pools method, which is elec-tive, is an alternative to the Step 3approach based on U.S. booked lia-bilities in § 1.882–5(d). To preventdistortions, taxpayers that have more

16

uncertainty. In particular, they objectedto the rules that eliminated certain highinterest rate liabilities and certain lia-bilities denominated in a non-functionalcurrency from the definition of bookedliabilities, and the rules that prescribedan interest rate applicable to the extentthat a taxpayer’s U.S.-connected lia-bilities exceed booked liabilities (ex-cess liabilities).

As noted above, the IRS and Treas-ury believe that the calculation of ataxpayer’s interest deduction shouldreflect, to the greatest extent possible,the taxpayer’s economic interest ex-pense. Accordingly, these commentshave been largely accepted.

The final regulations eliminate thefixed interest rates assigned to excessliabilities, and instead require thattaxpayers compute their actual interestrate outside the United States. The IRSanticipates issuing regulations undersection 6038C describing the recordsneeded to verify the taxpayer’s actualinterest rate, among other things.

The final regulations also respond tocommenters’ requests for simplificationand clarification in the Step 3 calcula-tion. Under § 1.882–5(d)(2), a liabilityis a U.S. booked liability if the liabilityis properly reflected on the books ofthe U.S. trade or business. The finalregulations set out two standards, onefor non-banks and another for banks, todetermine whether a liability is prop-erly reflected on the foreign corpora-tion’s U.S. books. In general, the finalregulations use a facts and circum-stances test to determine whether aliability is properly booked in theUnited States. In response to requestsfrom commenters for additional guid-ance on the requirement that thebooking of a liability be ‘‘reasonablycontemporaneous’’ with the time thatthe liability is incurred, the regulationsspecify that a bank is generally re-quired to book a liability before theend of the day in which the liability isincurred. Section 1.882–5(d)(2)(iii)(B)provides a relief rule, however, for asituation where, due to inadvertenterror, a bank fails to book a liabilitythat otherwise would meet the criteria

final regulations, the scaling ratio iscomputed by simply dividing U.S.-connected liabilities by U.S. bookedliabilities, and multiplying that fractionby the interest paid or accrued by theforeign corporation. The final regula-tions also delete the provision in theproposed regulations that applied thescaling ratio to section 988 exchangegain or loss from an unhedged liability.The amount and source of exchangegain or loss from a section 988transaction will therefore continue to bedetermined under section 988, withoutany reduction as a result of the scalingratio in § 1.882–5.

The rules in the proposed regulationsrelating to high interest rate liabilitiesand nonfunctional currency liabilitieshave been replaced in the final regula-tions by a simpler anti-abuse rule thatprovides that U.S. booked liabilitieswill not include a liability if one of theprincipal purposes of incurring or hold-ing the liability is to increase ar-tificially the interest expense on U.S.booked liabilities. Factors relevant tothat determination are whether theinterest rate on a liability is excessiveand whether, from an economic stand-point, the currency denomination ofU.S. booked liabilities matches thecurrency denomination of U.S. assets.

6. § 1.882–5(e): Separate currencypools method.

Most commenters argued for retain-ing the separate currency pools method,which was deleted from Step 3 in theproposed regulations. After consideringthe comments, the IRS and Treasuryagree that taxpayers should be permit-ted to use a methodology that looks toworldwide interest rates in all relevantcurrencies. Because the separate cur-rency pools rate in the 1981 regulationsignored the currency denomination ofU.S. assets and was based instead onthe currency denomination of U.S.booked liabilities, however, it wassubject to manipulation. The new sepa-rate currency pools method in § 1.882–5(e) of the final regulations allowstaxpayers to treat their U.S. assets in

than 10% of their U.S. assets denomi-nated in a hyperinflationary currencyare precluded from using the separatecurrency pools method.

The anti-abuse rule of proposedregulation § 1.882–5(e) has been re-placed by three separate rules thatappear under each of the three steps ofthis section.

Special Analyses

It has been determined that thisTreasury decision is not a significantregulatory action as defined in EO12866. Therefore, a regulatory assess-ment is not required. It also has beendetermined that section 553(b) of theAdministrative Procedure Act (5 U.S.C.chapter 5) and the Regulatory Flex-ibility Act (5 U.S.C. chapter 6) do notapply to these regulations, and, there-fore, a Regulatory Flexibility Analysisis not required. Pursuant to section7805(f) of the Internal Revenue Code,the notice of proposed rulemakingpreceding these regulations was submit-ted to the Small Business Administra-tion for comment on its impact onsmall business.


Several persons from the Office ofChief Counsel and the Treasury De-partment participated in drafting theseregulations.

* * * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 isamended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 is amended by adding anentry in numerical order to read asfollows:

Authority: 26 U.S.C. 7805 * * *Section 1.882–5 also issued under 26

U.S.C. 882, 26 U.S.C. 864(e), 26


778/20042/17APR96/C34-004

U.S.C. 988(d), and 26 U.S.C. 7701(l). ** *

§ 1.861–9T [Amended]

Par. 2. Section 1.861–9T, paragraph(e)(7) is amended as follows:

(1) Inclusions.(2) Exchange transactions.(3) Exclusions.

(b) Foreign corporations notengaged in U.S. business.

(c) Foreign corporations engagedin U.S. business.

(d) Effective date.

(2) Determination of the valueof a U.S. asset.(i) General rule.(ii) Fair-market value

election.(A) In general.(B) Adjustment to

partnership basis.
1. Paragraph (e)(7)(i) is removed.2. The heading in paragraph (e)(7)(ii)
is removed.3. Paragraph (e)(7)(ii) is redesignated

as the text of paragraph (e)(7).Par. 3. Sections 1.882–0 is added to

read as follows:

§ 1.882–0 Table of contents.

This section lists captions containedin §§ 1.882–1, 1.882–2, 1.882–3,1.882–4 and 1.882–5.

§ 1.882–1 Taxation of foreign corpora-tions engaged in U.S. business or offoreign corporations treated as havingeffectively connected income.

(a) Segregation of income.(b) Imposition of tax.

(1) Income not effectively con-nected with the conduct ofa trade or business in theUnited States.

(2) Income effectively con-nected with the conduct ofa trade or business in theUnited States.(i) In general.(ii) Determination of tax-

able income.(iii) Cross references.

(c) Change in trade or businessstatus.

(d) Credits against tax.(e) Payment of estimated tax.(f) Effective date.

§ 1.882–2 Income of foreign corpora-tion treated as effectively connectedwith U.S. business.

(a) Election as to real propertyincome.

(b) Interest on U.S. obligations re-ceived by banks organized inpossessions.

(c) Treatment of income.(d) Effective date.

§ 1.882–3 Gross income of a foreigncorporation.

(a) In general.

§cr

§de

17

1.882–4 Allowance of deductions andedits to foreign corporations.

(a) Foreign corporations.(1) In general.(2) Return necessary.(3) Filing deadline for return.(4) Return by Internal Revenue

Service.(b) Allowed deductions and credits.

(1) In general.(2) Verification.

1.882–5 Determination of interestduction.

(a) Rules of general application.(1) Overview.

(i) In general.(ii) Direct allocations.

(A) In general.(B) Partnership

interest.(2) Coordination with tax

treaties.(3) Limitation on interest

expense.(4) Translation convention for

foreign currency.(5) Coordination with other

sections.(6) Special rule for foreign

governments.(7) Elections under § 1.882–5.

(i) In general.(ii) Failure to make the

proper election.(8) Examples.

(b) Step 1: Determination of totalvalue of U.S. assets for thetaxable year.(1) Classification of an asset

as a U.S. asset.(i) General rule.(ii) Items excluded from

the definition of U.S.asset.

(iii) Items included in thedefinition of U.S.asset.

(iv) Interbranchtransactions.

(v) Assets acquired toincrease U.S. assetsartificially.

(iii) Reduction of totalvalue of U.S. assetsby amount of baddebt reserves undersection 585.(A) In general.(B) Example.

(iv) Adjustment to basisof financialinstruments.

(3) Computation of total valueof U.S. assets.

(c) Step 2: Determination of totalamount of U.S.-connected lia-bilities for the taxable year.(1) General rule.(2) Computation of the actual

ratio.(i) In general.(ii) Classification of

items.(iii) Determination of

amount of worldwideliabilities.

(iv) Determination ofvalue of worldwideassets.

(v) Hedging transactions.(vi) Treatment of part-

nership interests andliabilities.

(vii) Computation of ac-tual ratio of insur-ance companies.

(viii) Interbranchtransactions.

(ix) Amounts must be ex-pressed in a singlecurrency.

(3) Adjustments.(4) Elective fixed ratio method

of determining U.S.liabilities.

(5) Examples.(d) Step 3: Determination of

amount of interest expenseallocable to ECI under theadjusted U.S. booked lia-bilities method.

(1) General rule.(2) U.S. booked liabilities.

(i) In general.(ii) Properly reflected on

the books of theU.S. trade or busi-ness of a foreigncorporation that isnot a bank.


778/20042/17APR96/C34-004

(A) In general.(B) Identified lia-

bilities not prop-erly reflected.

(iii) Properly reflected onthe books of theU.S. trade or busi-ness of a foreign

(

(f) Effective date.(1) General rule.(2) Special rules for financial

products.

Par. 4. Section 1.882–5 is revised toread as follows:

graph (a)(1)(ii)(A) shall reduce thebasis of the asset that meets therequirements of § 1.861–10T(b) and (c)by the principal amount of the in-debtedness that meets the requirementsof § 1.861–10T(b) and (c). The foreigncorporation shall also disregard anyindebtedness that meets the require-

corporation that is abank.(A) In general.(B) Inadvertent error.

(iv) Liabilities of insur-ance companies.

(v) Liabilities used to in-crease artificially in-terest expense onU.S. bookedliabilities.

(vi) Hedging transactions.(vii) Amount of U.S.

booked liabilities ofa partner.

(viii) Interbranchtransactions.

(3) Average total amount ofU.S. booked liabilities.

(4) Interest expense whereU.S. booked liabilitiesequal or exceed U.S.liabilities.(i) In general.(ii) Scaling ratio.(iii) Special rules for in-

surance companies.(5) U.S.-connected interest rate

where U.S. booked lia-bilities are less than U.S.-connected liabilities.(i) In general.(ii) Interest rate on ex-

cess U.S.-connectedliabilities.

(6) Examples.e) Separate currency pools

method.(1) General rule.

(i) Determine the valueof U.S. assets ineach currency pool.

(ii) Determine the U.S.-connected liabilitiesin each currencypool.

(iii) Determine the inter-est expense attributa-ble to each currencypool.

(2) Prescribed interest rate.(3) Hedging transactions.(4) Election not available if

excessive hyperinflationaryassets.

(5) Examples.

18

§ 1.882–5 Determination of interestdeduction.

(a) Rules of general application—(1)Overview—(i) In general. The amountof interest expense of a foreign corpo-ration that is allocable under section882(c) to income which is (or is treatedas) effectively connected with theconduct of a trade or business withinthe United States (ECI) is the sum ofthe interest paid or accrued by theforeign corporation on its liabilitiesbooked in the United States, as ad-justed under the three-step process setforth in paragraphs (b), (c) and (d) ofthis section and the specially allocatedinterest expense determined under sec-tion (a)(1)(ii) of this section. Theprovisions of this section provide theexclusive rules for allocating interestexpense to the ECI of a foreigncorporation. Under the three-step proc-ess, the total value of the U.S. assets ofa foreign corporation is first determinedunder paragraph (b) of this section(Step 1). Next, the amount of U.S.-connected liabilities is determined un-der paragraph (c) of this section (Step2). Finally, the amount of interest paidor accrued on liabilities booked in theUnited States, as determined underparagraph (d)(2) of this section, isadjusted for interest expense attributa-ble to the difference between U.S.-connected liabilities and U.S. bookedliabilities (Step 3). Alternatively, aforeign corporation may elect to deter-mine its interest rate on U.S.-connectedliabilities by reference to its U.S.assets, using the separate currencypools method described in paragraph(e) of this section.

(ii) Direct allocations—(A) In gen-eral. A foreign corporation that has aU.S. asset and indebtedness that meetthe requirements of § 1.861–10T(b) and(c), as limited by § 1.861–10T(d)(1),may directly allocate interest expensefrom such indebtedness to income fromsuch asset in the manner and to theextent provided in § 1.861–10T. Forpurposes of paragraphs (b)(1) or (c)(2)of this section, a foreign corporationthat allocates its interest expense underthe direct allocation rule of this para-

ments of § 1.861–10T(b) and (c) indetermining the amount of the foreigncorporation’s liabilities under para-graphs (c)(2) and (d)(2) of this section,and shall not take into account anyinterest expense paid or accrued withrespect to such a liability for purposesof paragraphs (d) or (e) of this section.

(B) Partnership interest. A foreigncorporation that is a partner in apartnership that has a U.S. asset andindebtedness that meet the requirementsof § 1.861–10T(b) and (c), as limitedby § 1.861–10T(d)(1), may directlyallocate its distributive share of interestexpense from that indebtedness to itsdistributive share of income from thatasset in the manner and to the extentprovided in § 1.861–10T. A foreigncorporation that allocates its distribu-tive share of interest expense under thedirect allocation rule of this paragraph(a)(1)(ii)(B) shall disregard any part-nership indebtedness that meets therequirements of § 1.861–10T(b) and (c)in determining the amount of itsdistributive share of partnership lia-bilities for purposes of paragraphs(b)(1), (c)(2)(vi), and (d)(2)(vii) or(e)(1)(ii) of this section, and shall nottake into account any partnership inter-est expense paid or accrued withrespect to such a liability for purposesof paragraph (d) or (e) of this section.For purposes of paragraph (b)(1) of thissection, a foreign corporation thatdirectly allocates its distributive shareof interest expense under this paragraph(a)(1)(ii)(B) shall—

(1) Reduce the partnership’s basis insuch asset by the amount of suchindebtedness in allocating its basis inthe partnership under § 1.884–1(d)(3)(ii); or

(2) Reduce the partnership’s incomefrom such asset by the partnership’sinterest expense from such indebted-ness under § 1.884–1(d)(3)(iii).

(2) Coordination with tax treaties.The provisions of this section providethe exclusive rules for determining theinterest expense attributable to thebusiness profits of a permanentestablishment under a U.S. income taxtreaty.


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(3) Limitation on interest expense. Inno event may the amount of interestexpense computed under this sectionexceed the amount of interest onindebtedness paid or accrued by thetaxpayer within the taxable year (trans-lated into U.S. dollars at the weightedaverage exchange rate for each cur-

controlled commercial entities withinthe meaning of § 1.892–5T.

(7) Elections under § 1.882–5—(i) Ingeneral. A corporation must make eachelection provided in this section on thecorporation’s federal income tax returnfor the first taxable year beginning onor after the effective date of this

the value of FC’s assets under paragraphs (b)(1)and (c)(2)(vi) of this section, FC’s basis in P isreduced by the 8002 liability as determinedunder section 752, but is not increased by the800x liability that is directly allocated underparagraph (a)(1)(ii)(B) of this section. Similarly,pursuant to paragraph (a)(1)(ii)(B) of this sec-tion, the 800x liability is disregarded forpurposes of determining FC’s liabilities underparagraphs (c)(2)(vi) and (d)(2)(vii) of this

rency prescribed by § 1.989(b)–1 forthe taxable year).

(4) Translation convention for for-eign currency. For each computationrequired by this section, the taxpayershall translate values and amounts intothe relevant currency at a spot rate or aweighted average exchange rate consis-tent with the method such taxpayeruses for financial reporting purposes,provided such method is applied con-sistently from year to year. Interestexpense paid or accrued, however, shallbe translated under the rules of§ 1.988–2. The district director or theAssistant Commissioner (International)may require that any or all computa-tions required by this section be madein U.S. dollars if the functional cur-rency of the taxpayer’s home office isa hyperinflationary currency, as definedin § 1.985–1, and the computation inU.S. dollars is necessary to preventdistortions.

(5) Coordination with other sections.Any provision that disallows, defers, orcapitalizes interest expense applies af-ter determining the amount of interestexpense allocated to ECI under thissection. For example, in determiningthe amount of interest expense that isdisallowed as a deduction under section265 or 163(j), deferred under section163(e)(3) or 267(a)(3), or capitalizedunder section 263A with respect to aUnited States trade or business, ataxpayer takes into account only theamount of interest expense allocable toECI under this section.

(6) Special rule for foreign govern-ments. The amount of interest expenseof a foreign government, as defined in§ 1.892–2T(a), that is allocable to ECIis the total amount of interest paid oraccrued within the taxable year by theUnited States trade or business on U.S.booked liabilities (as defined in para-graph (d)(2) of this section). Interestexpense of a foreign government, how-ever, is not allocable to ECI to theextent that it is incurred with respect toU.S. booked liabilities that exceed 80percent of the total value of U.S. assetsfor the taxable year (determined underparagraph (b) of this section). Thisparagraph (a)(6) does not apply to

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section. An amended return does notqualify for this purpose, nor shall theprovisions of § 301.9100–1 of thischapter and any guidance promulgatedthereunder apply. Each election underthis section, whether an election for thefirst taxable year or a subsequentchange of election, shall be made bythe corporation calculating its interestexpense deduction in accordance withthe methods elected. An elected methodmust be used for a minimum period offive years before the taxpayer mayelect a different method. To change anelection before the end of the requisitefive-year period, a taxpayer must ob-tain the consent of the Commissioneror her delegate. The Commissioner orher delegate will generally consent to ataxpayer’s request to change its elec-tion only in rare and unusualcircumstances.

(ii) Failure to make the properelection. If a taxpayer, for any reason,fails to make an election provided inthis section in a timely fashion, thedistrict director or the Assistant Com-missioner (International) may make anyor all of the elections provided in thissection on behalf of the taxpayer, andsuch elections shall be binding as ifmade by the taxpayer.

(8) Examples. The following exam-ples illustrate the application of para-graph (a) of this section:

Example 1. Direct allocations. (i) Facts: FC isa foreign corporation that conducts businessthrough a branch, B, in the United States. AmongB’s U.S. assets is an interest in a partnership, P,that is engaged in airplane leasing solely in theU.S. FC contributes 2002 to P in exchange forits partnership interest. P incurs qualified non-recourse indebtedness within the meaning of§ 1.861–10T to purchase an airplane. FC’s shareof the liability of P, as determined under section752, is 8002.

(ii) Analysis : Pursuant to paragraph(a)(1)(ii)(B) of this section, FC is permitted todirectly allocate its distributive share of theinterest incurred with respect to the qualifiednonrecourse indebtedness to FC’s distributiveshare of the rental income generated by theairplane. A liability the interest on which isallocated directly to the income from a particularasset under paragraph (a)(1)(ii)(B) of this sectionis disregarded for purposes of paragraphs (b)(1),(c)(2)(vi), and (d)(2)(vii) or (e)(1)(ii) this sec-tion. Consequently, for purposes of determining

section.Example 2. Limitation on interest expense—(i)

FC is a foreign corporation that conducts a realestate business in the United States. In its 1997tax year, FC has no outstanding indebtedness,and therefore incurs no interest expense. FCelects to use the 50% fixed ratio under paragraph(c)(4) of this section.

(ii) Under paragraph (a)(3) of this section, FCis not allowed to deduct any interest expense thatexceeds the amount of interest on indebtednesspaid or accrued in that taxable year. Since FCincurred no interest expense in taxable year1997, FC will not be entitled to any interestdeduction for that year under § 1.882–5, notwith-standing the fact that FC has elected to use the50% fixed ratio.

Example 3. Coordination with other sections—(i) FC is a foreign corporation that is a bankunder section 585(a)(2) and a financial institutionunder section 265(b)(5). FC is a calendar yeartaxpayer, and operates a U.S. branch, B.Throughout its taxable year 1997, B holds onlytwo assets that are U.S. assets within themeaning of paragraph (b)(1) of this section. FCdoes not make a fair-market value election underparagraph (b)(2)(ii) of this section, and, there-fore, values its U.S. assets according to theirbases under paragraph (b)(2)(i) of this section.The first asset is a taxable security with anadjusted basis of $100. The second asset is anobligation the interest on which is exempt fromfederal taxation under section 103, with anadjusted basis of $50. The tax-exempt obligationis not a qualified tax-exempt obligation asdefined by section 265(b)(3)(B).

(ii) FC calculates its interest expense under§ 1.882–5 to be $12. Under paragraph (a)(5) ofthis section, however, a portion of the interestexpense that is allocated to FC’s effectivelyconnected income under § 1.882–5 is disallowedin accordance with the provisions of section265(b). Using the methodology prescribed undersection 265, the amount of disallowed interestexpense is $4, calculated as follows:

$12 2$50 Tax-exempt U.S. assets

= $4$150 Total U.S. assets

(iii) Therefore, FC deducts a total of $8 ($12— $4) of interest expense attributable to itseffectively connected income in 1997.

Example 4. Treaty exempt asset—(i) FC is aforeign corporation, resident in Country X, thatis actively engaged in the banking business inthe United States through a permanent establish-ment, B. The income tax treaty in effect betweenCountry X and the United States provides thatFC is not taxable on foreign source incomeearned by its U.S. permanent establishment. Inits 1997 tax year, B earns $90 of U.S. sourceincome from U.S. assets with an adjusted taxbasis of $900, and $12 of foreign source interestincome from U.S. assets with an adjusted taxbasis of $100. FC’s U.S. interest expensededuction, computed in accordance with§ 1.882–5, is $500.


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(ii) Under paragraph (a)(5) of this section, FCis required to apply any provision that disallows,defers, or capitalizes interest expense afterdetermining the interest expense allocated to ECIunder § 1.882–5. Section 265(a)(2) disallowsinterest expense that is allocable to one or moreclasses of income that are wholly exempt fromtaxation under subtitle A of the Internal RevenueCode. Section 1.265–1(b) provides that income

ings or is U.S. real property occupiedby the foreign corporation (the value ofwhich shall be adjusted by the amountof any indebtedness that is reflected inthe value of the property);

(B) An asset that produces incometreated as ECI under section 921(d) or926(b) (relating to certain income of a

methodology prescribed in § 1.861–9T(h). Once elected, the fair marketvalue must be used by the taxpayer forboth Step 1 and Step 2 described inparagraphs (b) and (c) of this section,and must be used in all subsequenttaxable years unless the Commissioneror her delegate consents to a change.
wholly exempt from taxes includes both income
excluded from tax under any provision of subtitleA and income wholly exempt from taxes underany other law. Section 894 specifies that theprovisions of subtitle A are applied with dueregard to any relevant treaty obligation of theUnited States. Because the treaty between theUnited States and Country X exempts foreignsource income earned by B from U.S. tax, FChas assets that produce income wholly exemptfrom taxes under subtitle A, and must thereforeallocate a portion of its § 1.882–5 interestexpense to its exempt income. Using themethodology prescribed under section 265, theamount of disallowed interest expense is $50,calculated as follows:

$500 2$100 Treaty-exempt U.S. assets

= $50$1000 Total U.S. assets

(iii) Therefore, FC deducts a total of $450($500 — $50) of interest expense attributable toits effectively connected income in 1997.

(b) Step 1: Determination of totalvalue of U.S. assets for the taxableyear—(1) Classification of an asset asa U.S. asset—(i) General rule. Exceptas otherwise provided in this paragraph(b)(1), an asset is a U.S. asset forpurposes of this section to the extentthat it is a U.S. asset under § 1.884–1(d). For purposes of this section, theterm determination date, as used in§ 1.884–1(d), means each day forwhich the total value of U.S. assets iscomputed under paragraph (b)(3) ofthis section.

(ii) Items excluded from the defini-tion of U.S. asset. For purposes of thissection, the term U.S. asset excludes anasset to the extent it produces incomeor gain described in sections 883(a)(3)and (b).

(iii) Items included in the definitionof U.S. asset. For purposes of thissection, the term U.S. asset includes—

(A) U.S. real property held in awholly-owned domestic subsidiary of aforeign corporation that qualifies as abank under section 585(a)(2)(B) (with-out regard to the second sentencethereof), provided that the real propertywould qualify as used in the foreigncorporation’s trade or business withinthe meaning of § 1.864–4(c)(2) or (3)if held directly by the foreign corpora-tion and either was initially acquiredthrough foreclosure or similar proceed-

20

FSC and certain dividends paid by aFSC to a foreign corporation);

(C) An asset that produces incometreated as ECI under sect ion953(c)(3)(C) (relating to certain incomeof a captive insurance company that acorporation elects to treat as ECI) thatis not otherwise ECI; and

(D) An asset that produces incometreated as ECI under section 882(e)(relating to certain interest income ofpossessions banks).

(iv) Interbranch transactions. Atransaction of any type between sepa-rate offices or branches of the sametaxpayer does not create a U.S. asset.

(v) Assets acquired to increase U.S.assets artificially. An asset shall not betreated as a U.S. asset if one of theprincipal purposes for acquiring orusing that asset is to increase ar-tificially the U.S. assets of a foreigncorporation on the determination date.Whether an asset is acquired or usedfor such purpose will depend upon allthe facts and circumstances of eachcase. Factors to be considered indetermining whether one of the princi-pal purposes in acquiring or using anasset is to increase artificially the U.S.assets of a foreign corporation includethe length of time during which theasset was used in a U.S. trade orbusiness, whether the asset was ac-quired from a related person, andwhether the aggregate value of the U.S.assets of the foreign corporation in-creased temporarily on or around thedetermination date. A purpose may bea principal purpose even though it isoutweighed by other purposes (takentogether or separately).

(2) Determination of the value of aU.S. asset—(i) General rule. The valueof a U.S. asset is the adjusted basis ofthe asset for determining gain or lossfrom the sale or other disposition ofthat item, further adjusted as providedin paragraph (b)(2)(iii) of this section.

(ii) Fair-market value election—(A)In general. A taxpayer may elect tovalue all of its U.S. assets on the basisof fair market value, subject to therequirements of § 1.861–9T(g)(1)(iii),and provided the taxpayer uses the

(B) Adjustment to partnership basis.If a partner makes a fair market valueelection under paragraph (b)(2)(ii) ofthis section, the value of the partner’sinterest in a partnership that is treatedas an asset shall be the fair marketvalue of his partnership interest, in-creased by the fair market value of thepartner’s share of the liabilities deter-mined under paragraph (c)(2)(vi) ofthis section. See § 1.884–1(d)(3).

(iii) Reduction of total value of U.S.assets by amount of bad debt reservesunder section 585—(A) In general. Thetotal value of loans that qualify as U.S.assets shall be reduced by the amountof any reserve for bad debts additionsto which are allowed as deductionsunder section 585.

(B) Example. The following exampleillustrates the provisions of paragraph(b)(2)(iii)(A) of this section:

Example. Foreign banks; bad debt reserves.FC is a foreign corporation that qualifies as abank under section 585(a)(2)(B) (without regardto the second sentence thereof), but is not a largebank as defined in section 585(c)(2). FCconducts business through a branch, B, in theUnited States. Among B’s U.S. assets are aportfolio of loans with an adjusted basis of $500.FC accounts for its bad debts for U.S. federalincome tax purposes under the reserve method,and B maintains a deductible reserve for baddebts of $50. Under paragraph (b)(2)(iii) of thissection, the total value of FC’s portfolio of loansis $450 ($500 — $50).

(iv) Adjustment to basis of financialinstruments. [Reserved]

(3) Computation of total value ofU.S. assets. The total value of U.S.assets for the taxable year is theaverage of the sums of the values(determined under paragraph (b)(2) ofthis section) of U.S. assets. For eachU.S. asset, value shall be computed atthe most frequent, regular intervals forwhich data are reasonably available. Inno event shall the value of any U.S.asset be computed less frequently thanmonthly by a large bank (as defined insection 585(c)(2)) and semi-annually byany other taxpayer.

(c) Step 2: Determination of totalamount of U.S.-connected liabilities forthe taxable year—(1) General rule.


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The amount of U.S.-connected lia-bilities for the taxable year equals thetotal value of U.S. assets for thetaxable year (as determined underparagraph (b)(3) of this section) multi-plied by the actual ratio for the taxableyear (as determined under paragraph(c)(2) of this section) or, if the

same manner as the basis of U.S. assetsare adjusted under paragraphs (b)(2)(ii)through (iv) of this section.

(v) Hedging transactions. [Reserved](vi) Treatment of partnership inter-

ests and liabilities. For purposes ofcomputing the actual ratio, the value ofa partner’s interest in a partnership that

ration from intentionally and artificiallyincreasing its actual ratio. For example,the District Director or the AssistantCommissioner (International) may off-set a loan made from or to one personwith a loan made to or from anotherperson if any of the parties to the loansare related persons, within the meaning

taxpayer has made an election inaccordance with paragraph (c)(4) ofthis section, by the fixed ratio.

(2) Computation of the actualratio—(i) In general. A taxpayer’sactual ratio for the taxable year is thetotal amount of its worldwide liabilitiesfor the taxable year divided by the totalvalue of its worldwide assets for thetaxable year. The total amount ofworldwide liabilities and the total valueof worldwide assets for the taxableyear is the average of the sums of theamounts of the taxpayer’s worldwideliabilities and the values of its world-wide assets (determined under para-graphs (c)(2)(iii) and (iv) of thissection). In each case, the sums mustbe computed semi-annually by a largebank (as defined in section 585(c)(2))and annually by any other taxpayer.

(ii) Classification of items. The clas-sification of an item as a liability or anasset must be consistent from year toyear and in accordance with U.S. taxprinciples.

(iii) Determination of amount ofworldwide liabilities. The amount of aliability must be determined consist-ently from year to year and must besubstantially in accordance with U.S.tax principles. To be substantially inaccordance with U.S. tax principles, theprinciples used to determine theamount of a liability must not differfrom U.S. tax principles to a degreethat will materially affect the value oftaxpayer’s worldwide liabilities or thetaxpayer’s actual ratio.

(iv) Determination of value of world-wide assets. The value of an asset mustbe determined consistently from year toyear and must be substantially inaccordance with U.S. tax principles. Tobe substantially in accordance withU.S. tax principles, the principles usedto determine the value of an asset mustnot differ from U.S. tax principles to adegree that will materially affect thevalue of the taxpayer’s worldwideassets or the taxpayer’s actual ratio.The value of an asset is the adjustedbasis of that asset for determining thegain or loss from the sale or otherdisposition of that asset, adjusted in the

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will be treated as an asset is thepartner’s adjusted basis in its part-nership interest, reduced by the part-ner’s share of liabilities of the part-nership as determined under section752 and increased by the partner’sshare of liabilities determined underthis paragraph (c)(2)(vi). If the partnerhas made a fair market value electionunder paragraph (b)(2)(ii) of this sec-tion, the value of its interest in thepartnership shall be increased by thefair market value of the partner’s shareof the liabilities determined under thisparagraph (c)(2)(vi). For purposes ofthis section a partner shares in anyliability of a partnership in the sameproportion that it shares, for income taxpurposes, in the expense attributable tothat liability for the taxable year. Apartner’s adjusted basis in a partnershipinterest cannot be less than zero.

(vii) Computation of actual ratio ofinsurance companies. [Reserved]

(viii) Interbranch transactions. Atransaction of any type between sepa-rate offices or branches of the sametaxpayer does not create an asset or aliability.

(ix) Amounts must be expressed in asingle currency. The actual ratio mustbe computed in either U.S. dollars orthe functional currency of the homeoffice of the taxpayer, and that cur-rency must be used consistently fromyear to year. For example, a taxpayerthat determines the actual ratio an-nually using British pounds convertedat the spot rate for financial reportingpurposes must translate the U.S. dollarvalues of assets and amounts of lia-bilities of the U.S. trade or businessinto pounds using the spot rate on thelast day of its taxable year. The districtdirector or the Assistant Commissioner(International) may require that theactual ratio be computed in dollars ifthe functional currency of the tax-payer’s home office is a hyperinflation-ary currency, as defined in § 1.985–1,that materially distorts the actual ratio.

(3) Adjustments. The District Direc-tor or the Assistant Commissioner(International) may make appropriateadjustments to prevent a foreign corpo-

of section 267(b) or 707(b)(1), and oneof the principal purposes for enteringinto the loans was to increase ar-tificially the actual ratio of a foreigncorporation. A purpose may be aprincipal purpose even though it isoutweighed by other purposes (takentogether or separately).

(4) Elective fixed ratio method ofdetermining U.S. liabilities. A taxpayerthat is a bank as defined in section585(a)(2)(B)(without regard to the sec-ond sentence thereof) may elect to usea fixed ratio of 93 percent in lieu ofthe actual ratio. A taxpayer that isneither a bank nor an insurance com-pany may elect to use a fixed ratio of50 percent in lieu of the actual ratio.

(5) Examples. The following exam-ples illustrate the application of para-graph (c) of this section:

Example 1. Classification of item not inaccordance with U.S. tax principles. Bank Z, aresident of country X, has a branch in the UnitedStates through which it conducts its bankingbusiness. In preparing its financial statements incountry X, Z treats an instrument documented asperpetual subordinated debt as a liability. UnderU.S. tax principles, however, this instrument istreated as equity. Consequently, the classificationof this instrument as a liability for purposes ofparagraph (c)(2)(iii) of this section is not inaccordance with U.S. tax principles.

Example 2. Valuation of item not substantiallyin accordance with U.S. tax principles. Bank Z, aresident of country X, has a branch in the UnitedStates through which it conducts its bankingbusiness. Bank Z is a large bank as defined insection 585(c)(2). The tax rules of country Xallow Bank Z to take deductions for additions tocertain reserves. Bank Z decreases the value ofthe assets on its financial statements by theamounts of the reserves. The additions to thereserves under country X tax rules cause thevalue of Bank Z’s assets to differ from the valueof those assets determined under U.S. taxprinciples to a degree that materially affects thevalue of taxpayer’s worldwide assets. Conse-quently, the valuation of Bank Z’s worldwideassets under country X tax principles is notsubstantially in accordance with U.S. tax princi-ples. Bank Z must increase the value of itsworldwide assets under paragraph (c)(2)(iii) ofthis section by the amount of its country Xreserves.

Example 3. Valuation of item substantially inaccordance with U.S. tax principles. Bank Z, aresident of country X, has a branch in the UnitedStates through which it conducts its bankingbusiness. In determining the value of its world-wide assets, Bank Z computes the adjusted basis


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of certain non-U.S. assets according to thedepreciation methodology provided under coun-try X tax laws, which is different than thedepreciation methodology provided under U.S.tax law. If the depreciation methodologyprovided under country X tax laws does notdiffer from U.S. tax principles to a degree thatmaterially affects the value of Bank Z’s world-wide assets or Bank Z’s actual ratio as computedunder paragraph (c)(2) of this section, then the

within the meaning of paragraph(d)(2)(ii) or (iii) of this section.

(ii) Properly reflected on the booksof the U.S. trade or business of aforeign corporation that is not abank—(A) In general. A liability,whether interest bearing or non-interestbearing, is properly reflected on the

(B) Inadvertent error. If a bank failsto enter a liability in the books of theactivity that produces ECI before theclose of the day on which the liabilitywas incurred, the liability may betreated as a U.S. booked liability onlyif, under the facts and circumstances,the taxpayer demonstrates a direct

valuation of Bank Z’s worldwide assets underparagraph (c)(2)(iv) of this section is substan-tially in accordance with U.S. tax principles.

Example 4. [Reserved]Example 5. Adjustments. FC is a foreign

corporation engaged in the active conduct of abanking business through a branch, B, in theUnited States. P, an unrelated foreign corpora-tion, deposits $100,000 in the home office of FC.Shortly thereafter, in a transaction arranged bythe home office of FC, B lends $80,000 bearinginterest at an arm’s length rate to S, a whollyowned U.S. subsidiary of P. The district directoror the Assistant Commissioner (International)determines that one of the principal purposes formaking and incurring such loans is to increaseFC’s actual ratio. For purposes of this section,therefore, P is treated as having directly lent$80,000 to S. Thus, for purposes of paragraph (c)of this section (Step 2), the District Director orthe Assistant Commissioner (International) mayoffset FC’s liability and asset arising from thistransaction, resulting in a net liability of $20,000that is not a booked liability of B. Because theloan to S from B was initiated and arranged bythe home office of FC, with no materialparticipation by B, the loan to S will not betreated as a U.S. asset.

(d) Step 3: Determination of amountof interest expense allocable to ECIunder the adjusted U.S. booked lia-bilities method—(1) General rule. Theadjustment to the amount of interestexpense paid or accrued on U.S.booked liabilities is determined bycomparing the amount of U.S.-connected liabilities for the taxableyear, as determined under paragraph (c)of this section, with the average totalamount of U.S. booked liabilities, asdetermined under paragraphs (d)(2) and(3) of this section. If the average totalamount of U.S. booked liabilitiesequals or exceeds the amount of U.S.-connected liabilities, the adjustment tothe interest expense on U.S. bookedliabilities is determined under para-graph (d)(4) of this section. If theamount of U.S.-connected liabilitiesexceeds the average total amount ofU.S. booked liabilities, the adjustmentto the amount of interest expense paidor accrued on U.S. booked liabilities isdetermined under paragraph (d)(5) ofthis section.

(2) U.S. booked liabilities—(i) Ingeneral. A liability is a U.S. bookedliability if it is properly reflected on thebooks of the U.S. trade or business,

22

books of the U.S. trade or business of aforeign corporation that is not a bankas described in section 585(a)(2)(B)(without regard to the second sentencethereof) if—

(1) The liability is secured predomi-nantly by a U.S. asset of the foreigncorporation;

(2) The foreign corporation entersthe liability on a set of books relatingto an activity that produces ECI at atime reasonably contemporaneous withthe time at which the liability isincurred; or

(3) The foreign corporation main-tains a set of books and recordsrelating to an activity that producesECI and the District Director or Assist-ant Commissioner (International) deter-mines that there is a direct connectionor relationship between the liability andthat activity. Whether there is a directconnection between the liability and anactivity that produces ECI depends onthe facts and circumstances of eachcase.

(B) Identified liabilities not prop-erly reflected. A liability is not prop-erly reflected on the books of the U.S.trade or business merely because aforeign corporation identifies the lia-bility pursuant to § 1.884–4(b)(1)(ii)and (b)(3).

(iii) Properly reflected on the booksof the U.S. trade or business of aforeign corporation that is a bank—(A)In general. A liability, whether interestbearing or non-interest bearing, isproperly reflected on the books of theU.S. trade or business of a foreigncorporation that is a bank as describedin section 585(a)(2)(B) (without regardto the second sentence thereof) if—

(1) The bank enters the liability on aset of books relating to an activity thatproduces ECI before the close of theday on which the liability is incurred;and

(2) There is a direct connection orrelationship between the liability andthat activity. Whether there is a directconnection between the liability and anactivity that produces ECI depends onthe facts and circumstances of eachcase.

connection or relationship between theliability and the activity that producesECI and the failure to enter the liabilityin those books was due to inadvertenterror.

(iv) Liabilities of insurance com-panies. [Reserved]

(v) Liabilities used to increase ar-tificially interest expense on U.S.booked liabilities. U.S. booked lia-bilities shall not include a liability ifone of the principal purposes forincurring or holding the liability is toincrease artificially the interest expenseon the U.S. booked liabilities of aforeign corporation. Whether a liabilityis incurred or held for the purpose ofartificially increasing interest expensewill depend upon all the facts andcircumstances of each case. Factors tobe considered in determining whetherone of the principal purposes forincurring or holding a liability is toincrease artificially the interest expenseon U.S. booked liabilities of a foreigncorporation include whether the interestexpense on the liability is excessivewhen compared to other liabilities ofthe foreign corporation denominated inthe same currency and whether thecurrency denomination of the liabilitiesof the U.S. branch substantiallymatches the currency denomination ofthe U.S. branch’s assets. A purposemay be a principal purpose eventhough it is outweighed by otherpurposes (taken together or separately).

( v i ) H e d g i n g t r a n s a c t i o n s .[Reserved]

(vii) Amount of U.S. booked lia-bilities of a partner. A partner’s shareof liabilities of a partnership is consid-ered a booked liability of the partnerprovided that it is properly reflected onthe books (within the meaning ofparagraph (d)(2)(ii) of this section) ofthe U.S. trade or business of thepartnership.

(viii) Interbranch transactions. Atransaction of any type between sepa-rate offices or branches of the sametaxpayer does not result in the creationof a liability.

(3) Average total amount of U.S.booked liabilities. The average total


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amount of U.S. booked liabilities forthe taxable year is the average of thesums of the amounts (determined underparagraph (d)(2) of this section) of U.S.booked liabilities. The amount of U.S.booked liabilities shall be computed atthe most frequent, regular intervals forwhich data are reasonably available. In

connected liabilities (as determinedunder paragraph (c) of this section(Step 2)) exceeds the average totalamount of U.S. booked liabilities, theinterest expense allocable to ECI is thetotal amount of interest paid or accruedwithin the taxable year by the U.S.trade or business on U.S. booked

U.S. assets for the taxable year is $2,500, thevalue of Asset 2.

(iii) Step 2. Under paragraph (c)(1) of thissection, the amount of FC’s U.S.-connectedliabilities for the taxable year is determined bymultiplying $2,500 (the value of U.S. assetsdetermined under Step 1) by the actual ratio forthe taxable year. The actual ratio is the averageamount of FC’s worldwide liabilities divided by

no event shall the amount of U.S.booked liabilities be computed lessfrequently than monthly by a largebank (as defined in section 585(c)(2))and semi-annually by any othertaxpayer.

(4) Interest expense where U.S.booked liabilities equal or exceed U.S.liabilities—(i) In general. If the aver-age total amount of U.S. bookedliabilities (as determined in paragraphs(d)(2) and (3) of this section) exceedsthe amount of U.S.-connected liabilities(as determined under paragraph (c) ofthis section (Step 2)), the interestexpense allocable to ECI is the productof the total amount of interest paid oraccrued within the taxable year by theU.S. trade or business on U.S. bookedliabilities and the scaling ratio set outin paragraph (d)(4)(ii) of this section.For purposes of this section, thereduction resulting from the applicationof the scaling ratio is applied pro-ratato all interest expense paid or accruedby the foreign corporation. A similarreduction in income, expense, gain, orloss from a hedging transaction (asdescribed in paragraph (d)(2)(vi) of thissection) must also be determined bymultiplying such income, expense,gain, or loss by the scaling ratio. If theaverage total amount of U.S. bookedliabilities (as determined in paragraph(d)(3) of this section) equals theamount of U.S.-connected liabilities (asdetermined under Step 2), the interestexpense allocable to ECI is the totalamount of interest paid or accruedwithin the taxable year by the U.S.trade or business on U.S. bookedliabilities.

(ii) Scaling ratio. For purposes ofthis section, the scaling ratio is afraction the numerator of which is theamount of U.S.-connected liabilitiesand the denominator of which is theaverage total amount of U.S. bookedliabilities.

(iii) Special rules for insurancecompanies. [Reserved]

(5) U.S.-connected interest ratewhere U.S. booked liabilities are lessthan U.S.-connected liabilities—(i) Ingeneral. If the amount of U.S.-

23

liabilities, plus the excess of theamount of U.S.-connected liabilitiesover the average total amount of U.S.booked liabilities multiplied by theinterest rate determined under para-graph (d)(5)(ii) of this section.

(ii) Interest rate on excess U.S.-connected liabilities. The applicableinterest rate on excess U.S.-connectedliabilities is determined by dividing thetotal interest expense paid or accruedfor the taxable year on U.S.-dollarliabilities shown on the books of theoffices or branches of the foreigncorporation outside the United Statesby the average U.S.-dollar denominatedliabilities (whether interest-bearing ornot) shown on the books of the officesor branches of the foreign corporationoutside the United States for thetaxable year.

(6) Examples. The following exam-ples illustrate the rules of this section:

Example 1. Computation of interest expense;actual ratio—(i) Facts. (A) FC is a foreigncorporation that is not a bank and that activelyconducts a real estate business through a branch,B, in the United States. For the taxable year,FC’s balance sheet and income statement is asfollows (assume amounts are in U.S. dollars andcomputed in accordance with paragraphs (b)(2)and (b)(3) of this section):

Value

Asset 1 $2,000Asset 2 $2,500Asset 3 $5,500

Amount InterestExpense

Liability 1 $ 800 56Liability 2 $3,200 256Capital $6,000 0

(B) Asset 1 is the stock of FC’s wholly-owneddomestic subsidiary that is also actively engagedin the real estate business. Asset 2 is a buildingin the United States producing rental income thatis entirely ECI to FC. Asset 3 is a building inthe home country of FC that produces rentalincome. Liabilities 1 and 2 are loans that bearinterest at the rates of 7% and 8%, respectively.Liability 1 is a booked liability of B, andLiability 2 is booked in FC’s home country.Assume that FC has not elected to use the fixedratio in Step 2.

(ii) Step 1. Under paragraph (b)(1) of thissection, Assets 1 and 3 are not U.S. assets, whileAsset 2 qualifies as a U.S. asset. Thus, underparagraph (b)(3) of this section, the total value of

the average value of FC’s worldwide assets. Theamount of Liability 1 is $800, and the amount ofLiability 2 is $3,200. Thus, the numerator of theactual ratio is $4,000. The average value ofworldwide assets is $10,000 (Asset 1 + Asset 2 +Asset 3). The actual ratio, therefore, is 40%($4,000/$10,000), and the amount of U.S.-connected liabilities for the taxable year is$1,000 ($2,500 U.S. assets 2 40%).

(iv) Step 3. Because the amount of FC’s U.S.-connected liabilities ($1,000) exceeds the averagetotal amount of U.S. booked liabilities of B($800), FC determines its interest expense inaccordance with paragraph (d)(5) of this sectionby adding the interest paid or accrued on U.S.booked liabilities, and the interest expenseassociated with the excess of its U.S.-connectedliabilities over its average total amount of U.S.booked liabilities. Under paragraph (d)(5)(ii) ofthis section, FC determines the interest rateattributable to its excess U.S.-connected lia-bilities by dividing the interest expense paid oraccrued by the average amount of U.S.-dollardenominated liabilities, which produces an inter-est rate of 8% ($256/$3200). Therefore, FC’sallocable interest expense is $72 ($56 of interestexpense from U.S. booked liabilities plus $16($200 2 8%) of interest expense attributable toits excess U.S.-connected liabilities).

Example 2. Computation of interest expense;fixed ratio—(i) The facts are the same as inExample 1, except that FC makes a fixed ratioelection under paragraph (c)(4) of this section.The conclusions under Step 1 are the same as inExample 1.

(ii) Step 2. Under paragraph (c)(1) of thissection, the amount of U.S.-connected liabilitiesfor the taxable year is determined by multiplying$2,500 (the value of U.S. assets determinedunder Step 1) by the fixed ratio for the taxableyear, which, under paragraph (c)(4) of thissection is 50 percent. Thus, the amount of U.S.-connected liabilities for the taxable year is$1,250 ($2,500 U.S. assets 2 50%).

(iii) Step 3. As in Example 1, the amount ofFC’s U.S.-connected liabilities exceed the aver-age total amount of U.S. booked liabilities of B,requiring FC to determine its interest expenseunder paragraph (d)(5) of this section. In thiscase, however, FC has excess U.S.-connectedliabilities of $450 ($1,250 of U.S.-connectedliabilities — $800 U.S. booked liabilities). FCtherefore has allocable interest expense of $92($56 of interest expense from U.S. bookedliabilities plus $36 ($450 2 8%) of interestexpense attributable to its excess U.S.-connectedliabilities).

Example 3. Scaling ratio.—(i) Facts. Bank Z,a resident of country X, has a branch in theUnited States through which it conducts itsbanking business. For the taxable year, Z hasU.S.-connected liabilities, determined under para-graph (c) of this section, equal to $300. Z,however, has U.S. booked liabilities of $300 andU500. Therefore, assuming an exchange rate ofthe U to the U.S. dollar of 5:1, Z has U.S.booked liabilities of $400 ($300 + (U500 3 5)).

(ii) U.S.-connected liabilities. Because Z’sU.S. booked liabilities of $400 exceed its U.S.-

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connected liabilities by $100, all of Z’s interestexpense allocable to its U.S. trade or businessmust be scaled back pro-rata. To determine thescaling ratio, Z divides its U.S.-connectedliabilities by its U.S. booked liabilities, asrequired by paragraph (d)(4) of this section. Z’sinterest expense is scaled back pro rata by theresulting ratio of 3⁄4 ($300 3 $400). Z’s income,expense, gain or loss from hedging transactionsdescribed in paragraph (d)(2)(vi) of this section

foreign corporation’s worldwide lia-bilities denominated in that currency,by the foreign corporation’s averageworldwide liabilities (whether interestbearing or not) denominated in thatcurrency. The interest expense andliabilities are to be stated in thatcurrency.

liabilities by the relevant interest rates. Accord-

ingly, Z’s allocable interest expense for the year

is $1140 ($19,000 2 6%), the sum of the

expense associated with its U.S. dollar liabilities,

plus U570 (U4750 2 12%), the interest expense

associated with its liabilities denominated in U. Z

must translate its interest expense denominated in

U in accordance with the rules provided in

Federal rates; adjusted federal rates;

must be similarly reduced.Example 4. [Reserved]

(e) Separate currency poolsmethod—(1) General rule. If a foreigncorporation elects to use the method inthis paragraph, its total interest expenseallocable to ECI is the sum of theseparate interest deductions for each ofthe currencies in which the foreigncorporation has U.S. assets. The sepa-rate interest deductions are determinedunder the following three-step process.

(i) Determine the value of U.S. assetsin each currency pool. First, theforeign corporation must determine theamount of its U.S. assets, using themethodology in paragraph (b) of thissection, in each currency pool. Theforeign corporation may convert intoU.S. dollars any currency pool inwhich the foreign corporation holdsless than 3% of its U.S. assets. Atransaction (or transactions) that hedgesa U.S. asset shall be taken into accountfor purposes of determining the cur-rency denomination and the value ofthe U.S. asset.

(ii) Determine the U.S.-connectedliabilities in each currency pool. Sec-ond, the foreign corporation must de-termine the amount of its U.S.-connected liabilities in each currencypool by multiplying the amount of U.S.assets (as determined under paragraph(b)(3) of this section) in the currencypool by the foreign corporation’s actualratio (as determined under paragraph(c)(2) of this section) for the taxableyear or, if the taxpayer has made anelection in accordance with paragraph(c)(4) of this section, by the fixed ratio.

(iii) Determine the interest expenseattributable to each currency pool.Third, the foreign corporation mustdetermine the interest expense attributa-ble to each currency pool by multiply-ing the U.S.-connected liabilities ineach currency pool by the prescribedinterest rate as defined in paragraph(e)(2) of this section.

(2) Prescribed interest rate. For eachcurrency pool, the prescribed interestrate is determined by dividing the totalinterest expense that is paid or accruedfor the taxable year with respect to the

24

(3) Hedging transactions. [Reserved](4) Election not available if excessive

hyperinflationary assets. The election touse the separate currency pools methodof this paragraph (e) is not available ifthe value of the foreign corporation’sU.S. assets denominated in a hyperinfla-tionary currency, as defined in § 1.985–1,exceeds ten percent of the value of theforeign corporation’s total U.S. assets. Ifa foreign corporation made a validelection to use the separate currencypools method in a prior year but nolonger qualifies to use such methodpursuant to this paragraph (e)(4), the tax-payer must use the method provided byparagraphs (b) through (d) of this section.

(5) Examples. The separate currencypools method of this paragraph (e) isillustrated by the following examples:

Example 1. Separate currency pools method—(i) Facts. (A) Bank Z, a resident of country X,has a branch in the United States through whichit conducts its banking business. For its 1997taxable year, Z has U.S. assets, as defined inparagraph (b) of this section, that are denomi-nated in U.S. dollars and in U, the country Xcurrency. Accordingly, Z’s U.S. assets are asfollows:

Average ValueU.S. Dollar Assets $20,000U Assets U 5,000

(B) Z’s worldwide liabilities are also denomi-nated in U.S. dollars and in U. The averageinterest rates on Z’s worldwide liabilities, includ-ing those in the United States, are 6% on its U.S.dollar liabilities, and 12% on its liabilitiesdenominated in U. Assume that Z has properlyelected to use its actual ratio of 95% todetermine its U.S.-connected liabilities in Step 2,and has also properly elected to use the separatecurrency pools method provided in paragraph (e)of this section.

(ii) Determination of interest expense. Zdetermines the interest expense attributable to itsU.S.-connected liabilities according to the stepsdescribed below.

(A) First, Z separates its U.S. assets into twocurrency pools, one denominated in U.S. dollars($20,000) and the other denominated in U(U5,000).

(B) Second, Z multiplies each pool of assetsby the applicable ratio of worldwide liabilities toassets, which in this case is 95%. Thus, Z hasU.S.-connected liabilities of $19,000 ($20,000 295%), and U4750 (U5000 2 95%).

(C) Third, Z calculates its interest expense bymultiplying each pool of its U.S.-connected

section 988, and then must determine whether it

is subject to any other provision of the Code that

would disallow or defer any portion of its

interest expense so determined.

Example 2. [Reserved]

(f) Effective date—(1) General rule.This section is effective for taxableyears beginning on or after June 6,1996.

(2) Special rules for financial prod-ucts. [Reserved]


Approved February 28, 1996.

Leslie Samuels,Assistant Secretary of the Treasury.


Section 1274.—Determination ofIssue Price in the Case of CertainDebt Instruments Issued for Property

(Also Sections 42, 280G, 382, 412, 467, 468,482, 483, 807, 846, 1288, 7520, 7872.)

adjusted federal long-term rate, andthe long-term exempt rate. For pur-poses of sections 1274, 1288, 382, andother sections of the Code, tables setforth the rates for April 1996.

Rev. Rul. 96–19

This revenue ruling provides variousprescribed rates for federal income taxpurposes for April 1996 (the currentmonth.) Table 1 contains the short-term, mid-term, and long-term applica-ble federal rates (AFR) for the currentmonth for purposes of section 1274(d)of the Internal Revenue Code. Table 2contains the short-term, mid-term, andlong-term adjusted applicable federalrates (adjusted AFR) for the currentmonth for purposes of section 1288(b).


778/20042/17APR96/C34-005

Table 3 sets forth the adjusted federallong-term rate and the long-term tax-exempt rate described in section 382(f).Table 4 contains the appropriate per-centages for determining the low-

income housing credit described insection 42(b)(2) for buildings placed inservice during the current month. Fi-nally, Table 5 contains the federal ratefor determining the present value of an

annuity, an interest for life or for aterm of years, or a remainder or areversionary interest for purposes ofsection 7520.

9

ding

Appl

Annual

REV. RUL. 96–19 TABLE 1

icable Federal Rates (AFR) for April 1

Period for Compoun

Semiannual Q

96

uarterly Monthly

25

Short-Term AFR 5.33% 5.26% 5.23% 5.20%

110% AFR 5.87% 5.79% 5.75% 5.72%120% AFR 6.41% 6.31% 6.26% 6.23%130% AFR 6.96% 6.84% 6.78% 6.74%

Mid-Term AFR 5.88% 5.80% 5.76% 5.73%

110% AFR 6.48% 6.38% 6.33% 6.30%120% AFR 7.08% 6.96% 6.90% 6.86%130% AFR 7.68% 7.54% 7.47% 7.42%150% AFR 8.89% 8.70% 8.61% 8.55%175% AFR 10.41% 10.15% 10.02% 9.94%

Long-Term AFR 6.51% 6.41% 6.36% 6.33%

110% AFR 7.17% 7.05% 6.99% 6.95%120% AFR 7.84% 7.69% 7.62% 7.57%130% AFR 8.50% 8.33% 8.25% 8.19%


Adjusted AFR for April 1996

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Termadjusted AFR

3.40% 3.37% 3.36% 3.35%

Mid-termadjusted AFR

4.37% 4.32% 4.30% 4.28%

Long-termadjusted AFR

5.31% 5.24% 5.21% 5.18%


Rates Under Section 382 for April 1996

Adjusted federal long-term rate for the current month 5.31%

Long-term tax-exempt rate for ownership changes during the current month (the highest of theadjusted federal long-term rates for the current month and the prior two months.) 5.31%


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Appropriate Percentages Under Section 42(b)(2)for April 1996

Appropriate percentage for the 70% present value low-income housing credit 8.45%

Appropriate percentage for the 30% present value low-income housing credit 3.62%

REV. RUL. 96-19 TABLE 5

Rate Under Section 7520 for April 1996

Applicable federal rate for determining the present value of an annuity, an interest for life or a termof years, or a remainder or reversionary interest 7.0%

Section 1288.—Treatment of OriginalIssue Discount on Tax-ExemptObligations


Section 7520.—Valuation Tables


Section 7872.—Treatment of Loanswith Below-Market Interest Rates


26

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Part III. Administrative, Procedural, and Miscellaneous

Interest Netting Study

Notice 96–18

This Notice invites public commentin connection with the Internal Reve-nue Service’s and Treasury’s study of‘‘interest netting.’’ This study was

interest shall be imposed . . . on theportion of the tax so satisfied for anyperiod during which, if the credit hadnot been made, interest would havebeen allowable with respect to suchoverpayment.

Section 6402(a) provides generalauthority for the IRS to credit an

(b) The Service permits crediting ofoverpayments against underpaymentsfor the period of time when theunderpayments and overpayments areboth unpaid and outstanding, even ifthey are from different tax years or fordifferent types of tax. This procedurefor interest netting is referred to as

initially described in Announcement96–5, ‘‘Administrative Initiatives toEnhance Taxpayer Rights,’’ 1996–4I.R.B. 99 at 101 (January 22, 1996).

BACKGROUND

The Internal Revenue Code providesthat taxpayers who underpay their taxesgenerally must pay interest to thegovernment for the period of theunderpayment. Section 6601. The IRShas limited authority to abate theinterest that is required by statute.Section 6404.

The Code likewise generally requiresthe government to pay interest totaxpayers with respect to any overpay-ment of taxes. Section 6611. There are,however, a number of limitations onthe government’s liability for interest,including the rule that no interest ispayable with respect to a tax refundclaimed for a current year if the refundis issued within 45 days of the last dayprescribed for filing a return claimingthe refund. Section 6611(e).

Prior to enactment of the Tax Re-form Act of 1986, the same interestrate applied to underpayments andoverpayments. The Tax Reform Act of1986, however, provided for the inter-est rate charged on underpayments tobe one percentage point higher than theinterest rate paid on overpayments. See§§ 6621(a)(1) and (2). The OmnibusBudget Reconciliation Act of 1990added that, under certain conditions,the interest rate on large corporateunderpayments would be 3 percentagepoints higher than the interest rate onoverpayments. The Uruguay RoundAgreements Act, enacted in 1994,increased the differential between largecorporate underpayments and certaincorporate overpayments to 4.5 percent-age points. See §§ 6621(a)(1) and (c).

If an overpayment is credited againstan underpayment, the effect of theseinterest rate differences is reduced.Section 6601(f) provides:

If any portion of a tax is satisfied bycredit of an overpayment, then no

27

overpayment against an underpayment.This section states:

In the case of any overpayment, theSecretary, within the applicable periodof limitations, may credit the amount ofsuch overpayment, including any inter-est allowed thereon, against any lia-bility in respect of an internal revenuetax on the part of the person who madethe overpayment and shall . . . refundany balance to such person.

Section 301.6402–1 of the Regula-tions on Procedure and Administrationprovides that the Commissioner maycredit any overpayment of tax againstany ‘‘outstanding liability’’ for any tax.

Congress has recognized the poten-tial burden that the interest rate dif-ferential places on taxpayers who haveboth overpayments and underpayments.Thus, each time Congress has increasedthe interest rate differential, Congresshas stated in legislative history that theService should implement the mostcomprehensive procedures ‘‘consistentwith sound administrative practice’’ toallow overpayments to be creditedagainst underpayments. See H.R. Conf.Rep. No. 841, 99th Cong., 2d. Sess.,1986–3 C.B. (Vol. 4) 785 (accompany-ing the Tax Reform Act of 1986); H.R.Conf. Rep. No. 964, 101st Cong., 2dSess., 1991–2 C.B. 591 (accompanyingthe Omnibus Budget Reconciliation Actof 1990); H.R. Rep. No. 826, 103dCong., 2d Sess., 1995–1 C.B. 254(accompanying the Uruguay RoundAgreements Act).

The Service has developed substan-tial crediting procedures to implementinterest netting. For example:

(a) The Service will consider allincreases and decreases in a taxpayer’sliabilities within a single tax yearbefore applying the statutory interestrules to that year. Rev. Proc. 94–60,1994–2 C.B. 774, provides that ataxpayer will not be charged thedifferential interest rate under§ 6621(a) on an underpayment that issatisfied by credit of an overpaymentarising in the same taxable year. Thisinterest netting procedure is referred toas ‘‘annual interest netting.’’

‘‘offsetting.’’The Service, however, generally does

not net interest where a taxpayerrealizes an overpayment in one tax yearthat overlaps with a deficiency that ataxpayer has already paid for a dif-ferent tax year. Likewise, the Servicegenerally does not net interest where anunpaid deficiency in one tax yearoverlaps with an overpayment that theService has already paid for a differenttax year. This kind of interest netting isreferred to as ‘‘global interest netting.’’

The Eighth Circuit recently ad-dressed whether the Service is requiredto perform global interest netting cal-culations. Northern States Power Co.v. United States, 73 F.3d 764 (8th Cir.1996). Interpreting §§ 6402(a) and301.6402–1, the Eighth Circuit heldthat where the taxpayer’s liability wasfully paid, there was no ‘‘outstandingliability’’ against which to net thetaxpayer’s subsequent overpayment.The court further held that the Service,in any event, has the discretion whetherto credit overpayments against under-payments.

REQUEST FOR PUBLIC COMMENT

Many taxpayers and practitionershave suggested that the Service adoptglobal interest netting procedures.Global interest netting, however, raisesa number of legal, policy and admin-istrative issues. Thus, Announcement96–5 states that the Service willconduct a study of these issues andsolicit public comments for the study.

Legal and Policy Issues of GlobalInterest Netting

As described above, global interestnetting would allow the taxpayer or theService to recalculate interest for acertain period of time whenever ataxpayer has either a new overpaymentthat overlaps with an underpaymentthat the taxpayer has already paid tothe Service, or a new underpaymentthat overlaps with an overpayment that


778/20042/17APR96/C34-006

the Service has already paid to thetaxpayer. The Service requests com-ments on the following issues:

1. In view of the policy generallyfavoring the finality of tax determina-tions, should a rule concerning thefinality of global interest netting com-putations be adopted, and, if so, what

system but must instead retrieve thedata on paid deficiencies and paidrefunds from its computer storage filesand then manually make the interestcalculations. This procedure could en-tail a significant additional commitmentof IRS resources, primarily because ofthe need to verify the accuracy and

for a study being conducted by theService and Treasury on certain jointreturn and community property issues,particularly as they affect divorced andseparated taxpayers. This study wasinitially described in Announcement96–5, ‘‘Administrative Initiatives toEnhance Taxpayer Rights,’’ 1996–4

should that rule be? What effect, ifany, should the statute of limitationshave on global interest netting, par-ticularly considering the language in§ 6402(a) regarding the applicableperiod of limitations? Should the stat-ute of limitations be kept open longerin light of global interest netting?

2. When would it be appropriate forthe Service to net interest globally for aparticular tax year or period? Forexample, would it be appropriate to netinterest globally before the final deci-sion of an appeal or court decision for atax period overlapping with the periodat issue that might affect the interestcalculation for such period? Would it beappropriate to net interest globally be-fore the final decision of an appeal orcourt decision for a tax period that doesnot overlap with the period at issue, ifsuch decision could produce an adjust-ment, such as a net operating loss orcredit, that might affect the interestcalculation for such period?

3. What would be the effect ofcarrybacks and carryforwards (e.g., netoperating losses, various credits, etc.)on the global interest netting calcula-tion for a certain period? Wouldcarrybacks and carryforwards alwaysrequire a recalculation of interest forsuch period? Or should global interestnetting calculations only be made aftercarryforwards and carrybacks thatmight affect the period at issue arefinally determined? How would theanalysis be affected by the restrictedinterest provisions of §§ 6601(d) and6611(f)?

4. Does global interest netting pres-ent any unique implications for tax-payers filing consolidated returns?

5. How would global interest nettingaffect § 861 allocations or interact withother U.S. international tax provisions?

Administrative Issues

The Service’s computer system doesnot have the data storage capacity tokeep information concerning paid defi-ciencies and paid refunds on line. TheService thus cannot make global inter-est netting calculations on its computer

completeness of the data necessary tomake a global interest netting calcula-tion and ensure an accurate calculation.Accordingly, the Service requests thefollowing comments:

1. To the extent that taxpayers orpractitioners currently make global in-terest netting calculations for them-selves or their clients, the Servicewould like to receive a detailed de-scription of how those calculations areperformed, the cost of performing thosecalculations, and the reasons why themethod used by particular taxpayers orpractitioners would be appropriate forthe Service to apply to large numbersof taxpayers without requiring signifi-cant additional Service resources.

2. How should the Service fulfill itsobligation to verify the accuracy andcompleteness of all taxpayer data rele-vant to make a global interest nettingcalculation for a particular period,given the Service’s computer datastorage limitations?

Time and Address for Comments

The Service and Treasury wouldappreciate written comments on theabove issues. Comments should besubmitted by June 30, 1996, to:

Internal Revenue ServiceP.O. Box 7604Ben Franklin StationAttn: CC:DOM:CORP:T:R:IT&A

(Branch 1) Room 5228Washington, DC 20044

The comments you submit will beavailable for public inspection andcopying.

DRAFTING INFORMATION

For further information regardingthis notice, contact Joel Rutstein on(202) 622-4530 (not a toll-free call).

Study of Certain Joint Return andCommunity Property Issues ForDivorced and Separated Taxpayers

Notice 96–19

This Notice invites public comments

28

I.R.B. 99 at 101 (Jan. 22, 1996).

BACKGROUND

Section 6013(a) of the Internal Reve-nue Code generally provides thatspouses may file a joint return eventhough one of the spouses has neithergross income nor deductions. Section6013(d)(3) states that spouses arejointly and severally liable for the taxeson a joint return.

For married taxpayers who filedjointly but then divorce or separate,joint and several liability means that aformer spouse remains liable for alltaxes, additions to tax, penalties andinterest due with respect to the jointreturn even if all the income wasearned by the other spouse. Thisliability remains regardless of the termsof any divorce decree or separationagreement.

Congress was concerned that thejoint and several liability standardcould unfairly attribute tax liability ona joint return to a spouse who shouldnot be held liable for such taxes undercertain circumstances. Congress thusenacted the innocent spouse provisionsof § 6013(e). Section 6013(e), however,establishes a detailed set of require-ments that must be met to obtaininnocent spouse relief. As a result, theinnocent spouse provisions do notapply in many situations.

‘‘Community property’’ laws alsopresent unique issues for divorced orseparated taxpayers. Community prop-erty laws generally consider eachspouse to own one-half of the com-munity income of the spouses. Consis-tent with these general principles ofcommunity property laws, the SupremeCourt in 1930 held that spouses wholive in community property jurisdic-tions but file separate returns must eachinclude half of the community incomein his or her return, even if all theincome was earned by one spouse. Poev. Seaborn, 282 U.S. 101 (1930).Under this rule, each spouse would beliable for taxes, additions to tax,penalties and interest due with respect

Joe Harding

hey there...this is a note....


778/20042/17APR96/C34-006

to the amount required to be reportedon his or her return.

Congress recognized that the rule ofPoe v. Seaborn could cause hardshipfor taxpayers in community propertystates. Congress thus amended theInternal Revenue Code to provide thatunder certain conditions, the com-

advantage of the tax system by inter-spousal property transfers, particularlyin view of the nonrecognition of gainon such transfers under § 1041?

3. Under a proportionate liabilitystandard, how would the Service traceassets and allocate deductions andcredits between the spouses to deter-

the specific requirements of §§ 66 and6013(e), particularly with respect todivorced and separated taxpayers.

1. Are there situations in which theinnocent spouse provisions do notfunction in an appropriate manner?Describe these situations.

2. Are there situations in which
munity property laws would be dis-regarded in determining certain typesof income for federal income taxpurposes. In particular, §§ 66 and879(a) overrule Poe v. Seaborn, in part,generally by taxing income to thespouse who earned, managed or con-trolled such income. The requirementsof these sections, however, can bedifficult to meet and they do not applyin many situations.
The community property laws alsopresent unique issues regarding whichassets and income may be collected tosatisfy federal tax liabilities. For exam-ple, all or a portion of the communityproperty of the spouses may be used tosatisfy a separate tax obligation of onespouse, even if the tax arose before themarriage or even during a previousmarriage.

REQUEST FOR PUBLIC COMMENT

The Service and Treasury are study-ing the effects of certain proposals tochange current law regarding the taxtreatment of divorced and separatedtaxpayers. The Service and Treasuryrequest comments on the followingproposals:

A. Replace the Joint and Several Lia-bility Standard with a ProportionateLiability Standard

A proportionate liability standardwould hold each spouse liable for onlythat portion of the tax attributable to ajoint return that relates to that spouse’scontribution to the aggregate jointreturn tax liability of both spouses.Please comment on the effects ofchanging the current joint and severalliability standard to a proportionateliability standard, particularly as itwould affect divorced and separatedtaxpayers. Comments on the followingissues would be particularly helpful:

1. How would such a system work ifthe former spouses are not cooperatingwith one another, or with the Service,regarding their respective shares of thetax liability?

2. Would a proportionate liabilitystandard allow taxpayers to take undue

29

mine each spouse’s correct tax liabilityand to collect amounts due in the mostefficient manner possible?

4. Would a proportionate liabilitystandard create burdensome filing re-quirements by requiring additionalschedules or columns for reporting theitems attributable to each spouse, suchas those on some state income taxreturns?

5. If a proportionate liability stand-ard is adopted, what changes would benecessary to the current rules concern-ing communications with taxpayers,examinations, assessments, collections,payments and refunds of tax, penaltiesand interest?

6. How would adoption of a propor-tionate liability standard affect state,local, and other tax systems?

B. Base the Respective Spouses’ TaxObligations and Liabilities on theTerms of a Divorce Decree, Separa-tion Agreement or Other PropertySettlement

Please comment on the effects ofbasing the respective spouses’ taxobligations and liabilities on the termsof a divorce decree, separation agree-ment or other property settlement. Inparticular, please comment on thefollowing:

1. Would the Service be required tobe a party to divorce or separationproceedings? If not, how could theinterests of the government be repre-sented in such cases?

2. What rule would apply if thedivorce decree or separation agreementdid not provide for allocation of taxliability?

3. How would this proposal affectthose spouses less able to influence theterms of a divorce decree or separationagreement (e.g., because of limitedfinancial or legal resources)?

C. Reform the Innocent SpouseProvisions

Under the current joint and severalliability standard, please comment on

expanded innocent spouse relief couldbe abused by taxpayers seeking inap-propriate relief? If so, what limitationswould prevent such abuses?

3. Are there changes to the Service’sadministrative practices that should bemade with respect to the innocentspouse provisions?

D. Further Limit the Income-SplittingEffect of Poe v. Seaborn in Com-munity Property Jurisdictions

Please comment on the effects offurther limiting the income splittingrule of Poe v. Seaborn in favor ofsome form of income tracing, such asin § 879, particularly as it would affectdivorced and separated taxpayers.

1. Would this proposal present thesame issues as those raised above withrespect to proportionate liability? Whyor why not?

2. How would this proposal work ifthe divorced or separated taxpayers livein different jurisdictions with differentproperty laws?

3. Would further limiting Poe v.Seaborn affect the assets or income ofa divorced or separated spouse thatcould be collected to satisfy the federalincome tax liability of each spouse?

E. Limit the Amount of CommunityProperty Subject to CollectionActions

Please comment on the effects oflimiting the amount of communityproperty that is subject to collectionactions to satisfy the separate taxliabilities of one of the spouses thatarose before the couple’s marriage.

1. Would this proposal requirechanges to state or federal law?

2. What specific changes, if any,would be required?

Time and Address for Comments

The Service and Treasury wouldappreciate written comments on the


778/20042/17APR96/C34-006

above issues. Comments should besubmitted by June 30, 1996, to:

Internal Revenue ServiceP.O. Box 7604Ben Franklin StationAttn: CC:CORP:T:R:ITA (Branch


For further information regardingthis notice, contact Joel Rutstein on(202) 622-4530 (not a toll-free call).

Specifications for filing Form 1042–

postal codes (positions 324–332 of the‘‘Q’’ record) was listed incorrectly inInternal Revenue Bulletin 1996–2, Rev-enue Procedure 96–11, January 8,1996, reprinted as Publication 1187(Rev. 1–96), Specifications for FilingForm 1042–S, Foreign Person’s U.S.Source Income Subject to Withholding,

sa

t

4), Room 5228Washington, D.C. 20044

The comments you submit will beavailable for public inspection andcopying.

RECORD N

Positions Field Title

324–332 Postal Code


S, Foreign Person’s U.S. SourceIncome Subject to Withholding,Magnetically or Electronically

Notice 96–20

The format for the country and

AME: RECIPIENT ‘‘Q’’ RECORD—CO

Length Description and Remarks

9 Enter a Foreign or U.S. PoREQUIRED for United StAustralian addresses. Withhobtain postal codes for all o

Background

Magnetically and Electronically. Listedbelow is the correct format to be usedin the ‘‘Q’’ record when submitting theForm 1042–S magnetically or elec-tronically:

NTINUED

tal Code (ZIP Code). A Postal Code istes and U.S. Territories, Canadian, andolding Agents should make an effort toher countries. Only alphabetic, numeric,

and blank characters are valid. Do not omit any blanks that mayappear in the ZIP code. Use the following table to format PostalCodes for the three required countries (‘‘a’’ denotes alphacharacters, ‘‘n’’ denotes numerics, ‘‘b’’ denotes a blank). All postalcodes should be left-justified and blank filled.

Country Postal Code Format

United States andU.S. TerritoriesCanadianAustralian

nnnnnbbbb or nnnnnnnnnanabnanbbnnnnbbbbb

Time for Furnishing Wage Statementson Termination of Employer’sOperations; Correction

Notice 96–21

FOR FURTHER INFORMATIONCONTACT: Jean M. Casey, (202)622-6040 (not a toll-free number).


final regulations which is the subject ofFR Doc. 95–30685, is corrected asfollows:

On page 66140, column 2, in thepreamble under the paragraph heading‘‘Additional month to provide Forms
W–2 and W–3 to SSA’’, last line, thelanguage ‘‘the final Form 941 is due.’’
ACTION: Correc t ion to f ina lregulations.

SUMMARY: This document contains acorrection to final regulations [TD8636 (1996–4 I.R.B. 64)] which werepublished in the Federal Register forThursday, December 21, 1995 (60 FR66139). The final regulations relate tothe time for furnishing wage statementsto employees and for filing wage state-ments with the Social Security Admin-istration upon the termination of anemployer’s operations.

EFFECTIVE DATE: January 1, 1997.

30

The final regulations that are thesubject of this correction are undersection 6051, 6071, and 6081 of theInternal Revenue Code.

Need for Correction

As published, TD 8636 contains atypographical error that is in need ofclarification.

Correction of Publication

Accordingly, the publication of the

is corrected to read ‘‘the end of thequarter.’’

Cynthia E. Grigsby,Chief, Regulations Unit,

Assistant Chief Counsel (Corporate).

(Filed by the Office of the Federal Register onFebruary 26, 1996, 8:45 a.m., and published inthe issue of the Federal Register for February27, 1996, 61 F.R. 7214)

Actuarial Tables Exceptions;Correction

Notice 96–22AGENCY: Internal Revenue Service(IRS), Treasury.


778/20042/17APR96/C34-006

ACTION: Correction to final regu-lations.

SUMMARY: This document contains acorrection to final regulations [TD8630 (1996–3 I.R.B. 19)] which werepublished in the Federal Register forWednesday, December 13, 1995 (60

Rev. Proc. 96–28

SECTION 1. PURPOSE

This revenue procedure updates Rev.Proc. 94–77, 1994–2 C.B. 825, byproviding rules under which theamount of ordinary and necessary

relating to reimbursement arrangementsor per diem allowances for ordinaryand necessary expenses paid or in-curred while traveling away fromhome. Pursuant to this grant of au-thority, the Commissioner may pre-scribe rules under which such arrange-ments or allowances, if in accordance

FR 63913). The final regulations relateto income, estate, and gift tax regula-tions regarding exceptions to the use ofvaluation tables.

EFFECTIVE DATE: December 13,1995.

FOR FURTHER INFORMATIONCONTACT: William L. Blodgett, (202)622-3090 (not a toll-free number).


Background

The final regulations that are thesubject of this correction are undersections 170, 642, 664, 2031, 2512 and7520 of the Internal Revenue Code.

Need for Correction

As published, TD 8630 contains atypographical error that is in need ofclarification.

Correction of Publication

Accordingly, the publication of thefinal regulations which is the subject ofFR Doc. 95–30272, is corrected asfollows:

On page 63913, column 1, in thepreamble in the caption ‘‘EFFECTIVEDATE,’’ line 2, the language ‘‘effec-tive December 13, 1995.’’ is correctedto read ‘‘effective December 13, 1995,and applicable for transfers after De-cember 13, 1995.’’

Cynthia E. Grigsby,Chief, Regulations Unit,

Assistant Chief Counsel (Corporate).

(Filed by the Office of the Federal Register onFebruary 29, 1996, 8:45 a.m., and published inthe issue of the Federal Register for March 1,1996, 61 F.R. 7991)

26 CFR 601.105: Examination of returns andclaims for refund, credit, or abatement;determination of correct tax liability.(Also Part I, Sections 62, 162, 267, 274;1.62–2, 1.162–17, 1.267(a)–1, 1.274–5T,1.274(d)–1(a).)

31

business expenses of an employee forlodging, meal, and/or incidental ex-penses incurred while traveling awayfrom home will be deemed substanti-ated under § 1.274–5T of the tempo-rary Income Tax Regulations when apayor (the employer, its agent, or athird party) provides a per diem al-lowance under a reimbursement orother expense allowance arrangementto pay for such expenses. This revenueprocedure also provides an optionalmethod for employees and self-employed individuals to use in comput-ing the deductible costs of businessmeal and incidental expenses paid orincurred while traveling away fromhome. Use of a method described inthis revenue procedure is not manda-tory and a taxpayer may use actualallowable expenses if the taxpayermaintains adequate records or othersuff ic ient evidence for propersubstantiation.

SECTION 2. BACKGROUND

.01 Section 162(a) of the InternalRevenue Code allows a deduction forall the ordinary and necessary expensespaid or incurred during the taxable yearin carrying on any trade or business.Under that provision, an employee orself-employed individual may deductexpenses paid or incurred while travel-ing away from home in pursuit of atrade or business. However, under§ 262, no portion of such travel ex-penses that is attributable to personal,living, or family expenses is deductible.

.02 Section 274(d) provides, in part,that no deduction shall be allowedunder § 162 for any traveling expense(including meals and lodging whileaway from home) unless the taxpayercomplies with certain substantiationrequirements. The section furtherprovides that regulations may prescribethat some or all of the substantiationrequirements do not apply to an ex-pense that does not exceed an amountprescribed by such regulations.

.03 Section 1.274(d)–1(a) of theregulations, in part, grants the Commis-sioner the authority to prescribe rules

with reasonable business practice, willbe regarded (1) as equivalent to sub-stantiation, by adequate records orother sufficient evidence, of the amountof such travel expenses for purposes of§ 1.274–5T(c), and (2) as satisfying therequirements of an adequate accountingto the employer of the amount of suchtravel expenses for purposes of§ 1.274–5T(f).

.04 Section 1.274–5T(j) grants theCommissioner the authority to establisha method under which a taxpayer mayelect to use a specified amount formeals paid or incurred while travelingaway from home in lieu of substantiat-ing the actual cost of meals.

.05 For purposes of determiningadjusted gross income, § 62(a)(2)(A)allows an employee a deduction forexpenses allowed by Part VI (§ 161and following), subchapter B, chapter 1of the Code, paid or incurred by theemployee in connection with the per-formance of services as an employeeunder a reimbursement or other ex-pense allowance arrangement with apayor.

.06 Section 62(c) provides that anarrangement will not be treated as areimbursement or other expense al-lowance arrangement for purposes of§ 62(a)(2)(A) if it—

(1) does not require the employeeto substantiate the expenses covered bythe arrangement to the payor, or

(2) provides the employee with theright to retain any amount in excess ofthe substantiated expenses covered un-der the arrangement.

Section 62(c) further provides thatthe substantiation requirements de-scribed therein shall not apply to anyexpense to the extent that, under thegrant of regulatory authority prescribedin § 274(d), the Commissioner hasprovided that substantiation is notrequired for such expense.

.07 Under § 1.62–2(c)(1) a reim-bursement or other expense allowancearrangement satisfies the requirementsof § 62(c) if it meets the requirementsof business connection, substantiation,and returning amounts in excess ofexpenses as specified in the regula-


778/20042/17APR96/C34-006

tions. Section 1.62–2(e)(2) specificallyprovides that substantiation of certainbusiness expenses in accordance withrules prescribed under the authority of§ 1.274(d)–1(a) or 1.274–5T(j) will betreated as substantiation of the amountof such expenses for purposes of§ 1.62–2. Under § 1.62–2(f)(2), the

(1) paid with respect to ordinary andnecessary business expenses incurred,or which the payor reasonably antici-pates will be incurred, by an employeefor lodging, meal, and/or incidentalexpenses for travel away from home inconnection with the performance ofservices as an employee of the

at a flat rate or stated schedule if it isprovided on a uniform and objectivebasis with respect to the expensesdescribed in section 3.01. Such al-lowance may be paid with respect tothe number of days away from home inconnection with the performance ofservices as an employee or on any

Commissioner may prescribe rules un-der which an arrangement providingper diem allowances will be treated assatisfying the requirement of returningamounts in excess of expenses, eventhough the arrangement does not re-quire the employee to return theportion of such an allowance thatrelates to days of travel substantiatedand that exceeds the amount of theemployee’s expenses deemed substanti-ated pursuant to rules prescribed under§ 274(d), provided the allowance isreasonably calculated not to exceed theamount of the employee’s expenses oranticipated expenses and the employeeis required to return any portion ofsuch an allowance that relates to daysof travel not substantiated.

.08 Section 1.62–2(h)(2)(i)(B)provides that if a payor pays a perdiem allowance that meets the require-ments of § 1.62–2(c)(1), the portion, ifany, of the allowance that relates todays of travel substantiated in accord-ance with § 1.62–2(e), that exceeds theamount of the employee’s expensesdeemed substantiated for such travelpursuant to rules prescribed under§ 274(d) and § 1.274(d)–1(a) or§ 1.274–5T(j), and that the employee isnot required to return, is subject towithholding and payment of employ-ment taxes. See §§ 31.3121(a)–3,31.3231(e)–3, 31.3306(b)–2, and31.3401(a)–4. Because the employee isnot required to return this excessportion, the reasonable period of timeprovisions of § 1.62–2(g) (relating tothe return of excess amounts) do notapply to this portion.

.09 Under § 1.62–2(h)(2)(i)(B)(4),the Commissioner may, in his or herdiscretion, prescribe special rules re-garding the timing of withholding andpayment of employment taxes on perdiem allowances.

SECTION 3. DEFINITIONS

.01 Per diem allowance. The term‘‘per diem allowance’’ means a pay-ment under a reimbursement or otherexpense allowance arrangement thatmeets the requirements specified in§ 1.62–2(c)(1) and that is:

32

employer,(2) reasonably calculated not to

exceed the amount of the expenses orthe anticipated expenses, and

(3) paid at the applicable Federal perdiem rate, a flat rate or stated schedule,or in accordance with any otherService-specified rate or schedule.

.02 Federal per diem rate.(1) General rule. The Federal per

diem rate is equal to the sum of theFederal lodging expense rate and theFederal meal and incidental expense(M&IE) rate for the locality of travel.Each of these rates for a particularlocality in the continental United States(‘‘CONUS’’) is set forth in AppendixA of 41 C.F.R., Chapter 301, asamended. See 41 C.F.R. Part 301–7(1995), as amended, for specific rulesregarding these Federal rates. Each ofthese rates is established by the Secre-tary of Defense for a particular non-foreign locality outside the continentalUnited States (‘‘OCONUS’’) (includingAlaska, Hawaii, Puerto Rico, theNorthern Mariana Islands, and thepossessions of the United States), andby the Secretary of State for a particu-lar foreign OCONUS locality. Each ofthese OCONUS rates is published inthe Per Diem Supplement to theStandardized Regulations (GovernmentCivilians, Foreign Areas). See, e.g.,Maximum Travel Per Diem Allowancesfor Foreign Areas, PD Supplement 382,issued March 1, 1996.

(2) Locality of travel. The term‘‘locality of travel’’ means the localitywhere an employee traveling awayfrom home in connection with theperformance of services as anemployee of the employer stops forsleep or rest.

(3) Incidental expenses. The term‘‘incidental expenses’’ includes, but isnot limited to, expenses for laundry,cleaning and pressing of clothing, andfees and tips for services, such as forporters and baggage carriers. The term‘‘incidental expenses’’ does not includetaxicab fares or the costs of telegramsor telephone calls.

.03 Flat rate or stated schedule. (1) In general. Except as provided

in section 3.03(2), an allowance is paid

other basis that is consistently appliedand in accordance with reasonablebusiness practice. Thus, for example,an hourly payment to cover meal andincidental expenses paid to a pilot orflight attendant who is traveling awayfrom home in connection with theperformance of services as anemployee is an allowance paid at a flatrate or stated schedule. Likewise, apayment based on the number of milestraveled (e.g., cents per mile) to covermeal and incidental expenses paid to anover-the-road truck driver who is trav-eling away from home in connectionwith the performance of services as anemployee is an allowance paid at a flatrate or stated schedule.

(2) Limitation. For purposes ofthis revenue procedure, an allowancethat is computed on a basis similar tothat used in computing the employee’swages or other compensation (e.g., thenumber of hours worked, miles trav-eled, or pieces produced) does not meetthe business connection requirement of§ 1.62–2(d), is not a per diem al-lowance, and is not paid at a flat rateor stated schedule, unless, as of De-cember 12, 1989, (a) the allowance wasidentified by the payor either bymaking a separate payment or byspecifically identifying the amount ofthe allowance, or (b) an allowancecomputed on that basis was commonlyused in the industry in which theemployee is employed. See § 1.62–2(d)(3)(ii).

SECTION 4. PER DIEMSUBSTANTIATION METHOD

.01 Per diem allowance. If a payorpays a per diem allowance in lieu ofreimbursing actual expenses for lodg-ing, meal, and incidental expensesincurred or to be incurred by anemployee for travel away from home,the amount of the expenses that isdeemed substantiated for each calendarday (or part of the calendar day, seesection 6.04) is equal to the lesser ofthe per diem allowance for such day orthe amount computed at the Federal perdiem rate for the locality of travel forsuch day (or part of such day, seesection 6.04).


778/20042/17APR96/C34-006

.02 Meals only per diem allowance.If a payor pays a per diem allowanceonly for meal and incidental expensesin lieu of reimbursing actual expensesfor meal and incidental expenses in-curred or to be incurred by anemployee for travel away from home,the amount of the expenses that is

employed individual in the transporta-tion industry who computes the amountallowable as a deduction for meal andincidental expenses for travel awayfrom home in accordance with section4.03.

(2) Rates. A taxpayer described insection 4.04(1) may treat $32 as the

regularly requires travel away fromhome which, during any single tripaway from home, usually involvestravel to localities with differing Fed-eral M&IE rates. For purposes of thepreceding sentence, a payor must deter-mine that an employee or a group ofemployees is ‘‘in the transportation

deemed substantiated for each calendarday (or part of the calendar day, seesection 6.04) is equal to the lesser ofthe per diem allowance for such day orthe amount computed at the FederalM&IE rate for the locality of travel forsuch day (or part of such day, seesection 6.04). A per diem allowance istreated as paid only for meal andincidental expenses if (1) the payorpays the employee for actual expensesfor lodging, (2) the payor provides thelodging in kind, (3) the payor pays theactual expenses for lodging directly tothe provider of the lodging, (4) thepayor does not have a reasonable beliefthat lodging expenses were or will beincurred by the employee, or (5) theallowance is computed on a basissimilar to that used in computing theemployee’s wages or other compensa-tion (e.g., the number of hours worked,miles traveled, or pieces produced).

.03 Optional method for meals onlydeduction. In lieu of using actualexpenses, employees and self-employedindividuals, in computing the amountallowable as a deduction for ordinaryand necessary meal and incidentalexpenses paid or incurred for travelaway from home, may use an amountcomputed at the Federal M&IE rate forthe locality of travel for each calendarday (or part thereof, see section 6.04)the employee or self-employed individ-ual is away from home. Such amountwill be deemed substantiated for pur-poses of paragraphs (b)(2) (travel awayfrom home) and (c) of § 1.274–5T,provided the employee or self-employed individual substantiates theelements of time, place, and businesspurpose of the travel expenses inaccordance with those regulations.

.04 Special rules for transportationindustry.

(1) In general. This section 4.04applies to (a) a payor that pays a perdiem allowance only for meal andincidental expenses for travel awayfrom home as described in section 4.02to an employee in the transportationindustry, or (b) an employee or self-

33

Federal M&IE rate for any locality oftravel in CONUS, and/or $36 as theFederal M&IE rate for any locality oftravel OCONUS. A payor that useseither (or both) of these special rateswith respect to an employee must usethe special rate(s) for all amountssubject to section 4.02 paid to thatemployee for travel away from homewithin CONUS and/or OCONUS, asthe case may be, during the calendaryear. Similarly, an employee or self-employed individual that uses either (orboth) of these special rates must usethe special rate(s) for all amountscomputed pursuant to section 4.03 fortravel away from home within CONUSand/or OCONUS, as the case may be,during the calendar year.

(3) Periodic rule. A payor de-scribed in section 4.04(1) may computethe amount of the employee’s expensesthat is deemed substantiated undersection 4.02 periodically (not lessfrequently than monthly), rather thandaily, by comparing the total per diemallowance paid for the period to thesum of the amounts computed at theFederal M&IE rate(s) for the localitiesof travel for the days (or partial days,see section 6.04) the employee is awayfrom home during the period. Forexample, assume an employee in thetransportation industry travels awayfrom home within CONUS on 17 days(including partial days under section6.04) during a calendar month andreceives a per diem allowance only formeal and incidental expenses from apayor that uses the special rule undersection 4.04(2). The amount deemedsubstantiated under section 4.02 isequal to the lesser of the total per diemallowance paid for the month or $544(17 days at $32 per day).

(4) Transportation industry defined.For purposes of this section 4.04, anemployee or self-employed individualis ‘‘in the transportation industry’’ onlyif the employee’s or individual’s work(a) is of the type that directly involvesmoving people or goods by airplane,barge, bus, ship, train, or truck, and (b)

industry’’ by using a method that isconsistently applied and in accordancewith reasonable business practice.

SECTION 5. HIGH-LOWSUBSTANTIATION METHOD

.01 General rule. If a payor pays aper diem allowance in lieu of reimburs-ing actual expenses for lodging, meal,and incidental expenses incurred or tobe incurred by an employee for travelaway from home and the payor usesthe high-low substantiation method de-scribed in this section 5 for travelwithin CONUS, the amount of theexpenses that is deemed substantiatedfor each calendar day (or part of thecalendar day, see section 6.04) is equalto the lesser of the per diem allowancefor such day or the amount computedat the rate set forth in section 5.02 forthe locality of travel for such day (orpart of such day, see section 6.04).This high-low substantiation methodmay be used in lieu of the per diemsubstantiation method provided in sec-tion 4.01, but may not be used in lieuof the meals only substantiation methodprovided in section 4.02 or 4.03.

.02 Specific high-low rates. The perdiem rate set forth in this section 5.02is $152 for travel to any ‘‘high-costlocality’’ specified in section 5.03, or$95 for travel to any other localitywithin CONUS. Whichever per diemrate applies, it is applied as if it werethe Federal per diem rate for thelocality of travel. For purposes ofapplying the high-low substantiationmethod, the Federal M&IE rate shall betreated as $36 for a high-cost localityand $28 for any other locality withinCONUS.

.03 High-cost localities. The followinglocalities have a Federal per diem rate of$123 or more for all or part of thecalendar year, and are high-cost localitiesfor all of the calendar year or the portionof the calendar year specified in paren-thesis under the key city name:


778/20042/17APR96/C34-006

Key city County and other defined location

AlabamaGulf Shores Baldwin

(May 1–September 30)

ArizonaGrand Canyon All points in the Grand Canyon National Park and Kaibab National Forest

within Coconino County

34

Phoenix/Scottsdale Maricopa(October 1–May 14)

CaliforniaGualala/Point Arena MendocinoLos Angeles Los Angeles, Kern, Orange, and Ventura Counties; Edwards Air Force Base;

Naval Weapons Center and Ordnance Test Station, China LakePalo Alto/San Jose Santa ClaraSan Francisco San FranciscoSanta Barbara Santa Barbara

(June 1–September 30)South Lake Tahoe El DoradoYosemite Nat’l Park Mariposa

ColoradoAspen Pitkin

(January 15–March 31)Boulder Boulder

(May 1–October 31)Denver Denver, Adams, Arapahoe and JeffersonKeystone/Silverthorne SummitSteamboat Springs Routt(December 15–March 31)

Telluride San Miquel(November 1–March 31)

Vail Eagle

ConnecticutBridgeport/Danbury Fairfield

District of ColumbiaWashington, D.C. Washington, D.C.; the cities of Alexandria, Falls Church, and Fairfax, and

the counties of Arlington, Loudoun, and Fairfax in Virginia; and the countiesof Montgomery and Prince Georges in Maryland

FloridaKey West MonroeNaples Collier

(December 15–April 30)

IllinoisChicago Du Page, Cook, and Lake

IndianaNashville Brown

(June 1–October 31)Maine

Bar Harbor Hancock(July 1–September 14)

Rockport Knox(June 15–October 31)

MarylandAnnapolis Anne ArundelBaltimore Baltimore and HarfordOcean City Worcester


MassachusettsBoston Suffolk


778/20042/17APR96/C34-006


Cambridge/Lowell MiddlesexHyannis Barnstable

(July 1–September 30)Martha’s Vineyard/ Dukes and Nantucket

Nantucket

Michigan

35

Detroit WayneLeland Leelanau

(May 1–September 30)Mackinac Island Mackinac

(June 1–September 30)Traverse City Grand Traverse


NevadaIncline Village Incline VillageStateline Douglas

New JerseyAtlantic City Atlantic

(April 1–November 30)Newark Bergen, Essex, Hudson, Passaic and UnionOcean City/Cape May Cape MayParsippany/Dover Morris County; Picatinny Arsenal

Princeton/Trenton Mercer

New MexicoSanta Fe Santa Fe

New YorkLake Placid Essex

(June 1–November 14)New York City The boroughs of Bronx, Brooklyn, Manhattan, Queens, and Staten Island;

Nassau and Suffolk CountiesWhite Plains Westchester

North CarolinaDuck/Outer Banks Dare


OhioSandusky Erie


OregonCrater Lake/Klamath Klamath

Falls

PennsylvaniaPhiladephia Philadelphia; city of Bala Cynwyd in Montgomery CountyValley Forge/Malvern Chester

Rhode IslandNewport Newport

(May 1–October 14)Providence Providence

South CarolinaMyrtle Beach Horry County; Myrtle Beach Air Force

(May 1–September 30) Base

UtahBullfrog Garfield

(April 1–October 31)Park City Summit

(December 1–March 31)


778/20042/17APR96/C34-006


VirginiaVirginia Beach Virginia Beach, Norfolk, Portsmouth

and Chesapeake(May 1–September 30)

Wintergreen Nelson

Wisconsin

travel from 12:01 a.m. to 12:00 mid-night. For purposes of determining theamount deemed substantiated undersection 4 or 5 with respect to partialdays of travel away from home, eitherof the following methods may be usedto prorate the Federal M&IE rate to

Wisconsin Dells Columbia(June 1–September 14)

WyomingJackson Teton

(June 1–October 14)

.04 Changes in high-cost localities.The list of high-cost localities insection 5.03 of this Revenue Procedurediffers from the list of high-costlocalities in section 5.03 of Rev. Proc.94–77. The following localities havebeen added to the list of high-cost

Columbia, Maryland; and Chestor/Radnor, Pennsylvania.

.05 Specific limitation. A payor thatuses the high-low substantiationmethod with respect to an employeemust use that method for all amountspaid to that employee for travel away

localities: Phoenix/Scottsdale, Arizona from home within CONUS during the determine the Federal per diem rate or
(October 1–May 14); Palo Alto/SanJose, California, and Santa Barbara,California (June 1–September 30);Boulder, Colorado, Denver, Colorado,and Telluride, Colorado (November 1–March 31); Bridgeport/Danbury, Con-necticut; Nashville, Indiana (June 1–October 31); Annapolis, Maryland, andBaltimore, Maryland; Detroit, Michi-gan, Leland, Michigan (May 1–September 30), and Traverse City,Michigan (May 1–September 30); In-cline Village, Nevada; Parsippany/Dover, New Jersey, and Princeton/Trenton, New Jersey; Outer Banks,North Carolina (May 1–September 30);Sandusky, Ohio (May 1–September30); Crater Lake/Klamath, Oregon;Valley Forge/Malvern, Pennsylvania;Providence, Rhode Island; and ParkCity, Utah (December 1–March 31).The portion of the year for which thefollowing are high-cost localities hasbeen changed: Gulf Shores, Alabama(May 1–September 30); South LakeTahoe, California (all year); SteamboatSprings, Colorado (December 15–March 31), and Vail, Colorado (allyear); Naples, Florida (December 15–April 30); Bar Harbor, Maine (July 1–September 14), and Rockport, Maine(June 15–October 31); Hyannis, Massa-chusetts (July 1–September 30); State-line, Nevada (all year); Ocean City/Cape May, New Jersey (all year); SantaFe, New Mexico (all year); and Bull-frog, Utah (April 1–October 31). Thefollowing localities have been removedfrom the list of high-cost localities:Chinle, Arizona; Death Valley, Califor-nia, and Santa Cruz, California; Du-rango, Colorado; Fort Myers, Florida;
36

calendar year. However, with respect tothat employee, the payor may stillreimburse actual expenses or use themeals only per diem method describedin section 4.02 for any travel awayfrom home, and may use the per diemsubstantiation method described in sec-tion 4.01 for any OCONUS travel awayfrom home.

SECTION 6. LIMITATIONS ANDSPECIAL RULES

.01 In general. The Federal per diemrate, the Federal lodging expense rate,and the Federal M&IE rate described insection 3.02 for the locality of travelwill be applied in the same manner asapplied under the Federal Travel Reg-ulations, 41 C.F.R. Part 301–7 (1995),except as provided in sections 6.02through 6.04.

.02 Federal per diem rate. A receiptfor lodging expenses is not required inorder to apply the Federal per diemrate for the locality of travel.

.03 Federal per diem or M&IE rate.A payor is not required to reduce theFederal per diem rate or the FederalM&IE rate for the locality of travel formeals provided in kind, provided thepayor has a reasonable belief that mealand incidental expenses were or will beincurred by the employee.

.04 Proration of the Federal perdiem or M&IE rate. Pursuant to theFederal Travel Regulations, in deter-mining the Federal per diem rate or theFederal M&IE rate for the locality oftravel, the full applicable FederalM&IE rate is available for a full day of

the Federal M&IE rate for the partialdays of travel:

(1) Such rate may be proratedusing the method prescribed by theFederal Travel Regulations underwhich one-fourth of the applicableFederal M&IE rate is allowed for each6-hour quarter of the day (i.e., midnightto 6 a.m., 6 a.m. to noon, noon to 6p.m., and 6 p.m. to midnight) duringany portion of which the employee orself-employed individual is travelingaway from home in connection with theperformance of services as an em-ployee or self-employed individual; or

(2) Such rate may be proratedusing any method that is consistentlyapplied and in accordance with reason-able business practice. For example, ifan employee travels away from homefrom 9 a.m. one day to 5 p.m. the nextday, a method of proration that resultsin an amount equal to 2 times theFederal M&IE rate will be treated asbeing in accordance with reasonablebusiness practice (even though only 11/2 times the Federal M&IE rate wouldbe allowed under the Federal TravelRegulations). Similarly, if a self-employed individual travels away fromhome from 7 p.m. one day to 9 p.m.the next day, a method of proration thatresults in an amount equal to 1 1/2times the Federal M&IE rate will betreated as being in accordance withreasonable business practice (eventhough only 1 1/4 times the FederalM&IE rate would be allowed under theFederal Travel Regulations).

.05 Application of the 50-percentlimitation on meal expenses. When aper diem allowance is paid only for


778/20042/17APR96/C34-006

meal and incidental expenses or whenan amount for meal and incidentalexpenses is computed pursuant to sec-tion 4.03, an amount equal to the lesserof the per diem allowance for eachcalendar day (or part of the calendarday, see section 6.04) or the FederalM&IE rate for the locality of travel for

the payor for the employee’s portion ofthe business entertainment meal ex-pense is treated as paid under anonaccountable plan, is reported aswages or other compensation on theemployee’s Form W-2, and is subjectto withholding and payment of employ-ment taxes.

ates 3 full days of business travel. Therequirement to return excess amountswill be treated as satisfied if theemployee is required to return within areasonable period of time (as defined in§ 1.62–2(g)) the portion of the al-lowance that is attributable to the 2unsubstantiated days of travel ($80),

such day (or part of such day, seesection 6.04) is treated as an expensefor food and beverages. When a perdiem allowance is paid for lodging,meal, and incidental expenses, thepayor must treat an amount equal to theFederal M&IE rate for the locality oftravel for each calendar day (or part ofthe calendar day, see section 6.04) theemployee is away from home as anexpense for food and beverages. Forpurposes of the preceding sentence,when a per diem allowance for lodging,meal, and incidental expenses for a fullday of travel is paid at a rate that isless than the Federal per diem rate forthe locality of travel, the payor maytreat an amount equal to 40 percent ofsuch per diem allowance for a full dayof travel as the Federal M&IE rate forthe locality of travel.

.06 No double reimbursement ordeduction. If a payor pays a per diemallowance in lieu of reimbursing actualexpenses for lodging, meal, and/orincidental expenses in accordance withsection 4 or 5, any additional paymentwith respect to such expenses is treatedas paid under a nonaccountable plan, isincluded in the employee’s gross in-come, is reported as wages or othercompensation on the employee’s FormW–2, and is subject to withholding andpayment of employment taxes. Sim-ilarly, if an employee or self-employedindividual computes the amount allow-able as a deduction for meal andincidental expenses for travel awayfrom home in accordance with section4.03 or 4.04, no other deduction isallowed to the employee or self-employed individual with respect tosuch expenses. For example, assume anemployee receives a per diem al-lowance from a payor for lodging,meal, and/or incidental expenses in-curred while traveling away fromhome. During that trip, the employeepays for dinner for the employee andtwo business associates. The payorreimburses as a business entertainmentmeal expense the meal expense for theemployee and the two business associ-ates. Because the payor also pays a perdiem allowance to cover the cost of theemployee’s meals, the amount paid by

37

.07 Related parties. Sections 4.01,4.02, 4.04 (to the extent it relates tosection 4.02), and 5 of this revenueprocedure will not apply in any case inwhich a payor and an employee arerelated within the meaning of § 267(b),but for this purpose the percentage ofownership interest referred to in§ 267(b)(2) shall be 10 percent.

SECTION 7. APPLICATION

.01 If the amount of travel expensesis deemed substantiated under the rulesprovided in section 4 or 5, and theemployee actually substantiates to thepayor the elements of time, place, andbusiness purpose of the travel expensesin accordance with paragraphs (b)(2)(travel away from home) and (c) (otherthan subparagraph (2)(iii)(A) thereof)of § 1.274–5T, the employee is deemedto satisfy the adequate accountingrequirements of § 1.274–5T(f) as wellas the requirement to substantiate byadequate records or other sufficientevidence for purposes of § 1.274–5T(c). See § 1.62–2(e)(1) for the rulethat an arrangement must require busi-ness expenses to be substantiated to thepayor within a reasonable period oftime.

.02 An arrangement providing perdiem allowances will be treated assatisfying the requirement of § 1.62–2(f)(2) with respect to returningamounts in excess of expenses if theemployee is required to return within areasonable period of time (as defined in§ 1.62–2(g)) any portion of such anallowance that relates to days of travelnot substantiated, even though thearrangement does not require theemployee to return the portion of suchan allowance that relates to days oftravel substantiated and that exceedsthe amount of the employee’s expensesdeemed substantiated. For example,assume a payor provides an employeean advance per diem allowance formeal and incidental expenses of $200,based on an anticipated 5 days ofbusiness travel at $40 per day to alocality for which the Federal M&IErate is $34, and the employee substanti-

even though the employee is notrequired to return the portion of theallowance ($18) that exceeds theamount of the employee’s expensesdeemed substantiated under section4.02 ($102) for the 3 substantiated daysof travel. However, the $18 excessportion of the allowance is treated aspaid under a nonaccountable plan asdiscussed in section 7.04.

.03 An employee is not required toinclude in gross income the portion ofa per diem allowance received from apayor that is less than or equal to theamount deemed substantiated under therules provided in section 4 or 5 if theemployee substantiates the businesstravel expenses covered by the perdiem allowance in accordance withsection 7.01. See § 1.274–5T(f)(2)(i).In addition, such portion of the al-lowance is treated as paid under anaccountable plan, is not reported aswages or other compensation on theemployee’s Form W–2, and is exemptfrom the withholding and payment ofemployment taxes. See § 1.62–2(c)(2)and (c)(4).

.04 An employee is required toinclude in gross income only theportion of the per diem allowancereceived from a payor that exceeds theamount deemed substantiated under therules provided in section 4 or 5 if theemployee substantiates the businesstravel expenses covered by the perdiem allowance in accordance withsection 7.01. See § 1.274–5T(f)(2)(ii).In addition, the excess portion of theallowance is treated as paid under anonaccountable plan, is reported aswages or other compensation on theemployee’s Form W–2, and is subjectto withholding and payment of employ-ment taxes. See § 1.62–2(c)(3)(ii),(c)(5), and (h)(2)(i)(B).

.05 If the amount of the expensesthat is deemed substantiated under therules provided in section 4.01, 4.02, or5 is less than the amount of theemployee’s business expenses for travelaway from home, the employee mayclaim an itemized deduction for theamount by which the business travelexpenses exceed the amount that isdeemed substantiated, provided the


778/20042/17APR96/C34-006

employee substantiates all the businesstravel expenses, includes on Form2106, Employee Business Expenses,the deemed substantiated portion of theper diem allowance received from thepayor, and includes in gross income theportion (if any) of the per diemallowance received from the payor that

SECTION 8. WITHHOLDING ANDPAYMENT OF EMPLOYMENTTAXES.

.01 The portion of a per diemallowance, if any, that relates to thedays of business travel substantiatedand that exceeds the amount deemed

(4) For example, assume that apayor pays an employee a per diemallowance to cover business expensesfor meals and lodging for travel awayfrom home at a rate of 120 percent ofthe Federal per diem rate for thelocalities to which the employee

exceeds the amount deemed substanti-ated. See § 1.274–5T(f)(2)(iii). How-ever, for purposes of claiming thisitemized deduction with respect to mealand incidental expenses, substantiationof the amount of the expenses is notrequired if the employee is claiming adeduction that is equal to or less thanthe amount computed under section4.03 minus the amount deemed sub-stantiated under section 4.02 and sec-tion 7.01. The itemized deduction issubject to the 50-percent limitation onmeal and entertainment expensesprovided in § 274(n) and the 2-percentfloor on miscellaneous itemized deduc-tions provided in § 67.

.06 An employee who does notreceive a per diem allowance for mealand incidental expenses may deduct anamount computed pursuant to section4.03 only as an itemized deduction.This itemized deduction is subject tothe 50-percent limitation on meal andentertainment expenses provided in§ 274(n) and the 2-percent floor onmiscellaneous itemized deductionsprovided in § 67.

.07 A self-employed individual maydeduct an amount computed pursuant tosection 4.03 in determining adjustedgross income under § 62(a)(1). Thisdeduction is subject to the 50-percentlimitation on meal and entertainmentexpenses provided in § 274(n).

.08 If a payor’s reimbursement orother expense allowance arrangementevidences a pattern of abuse of therules of § 62(c) and the regulationsthereunder, all payments under thearrangement will be treated as madeunder a nonaccountable plan. Thus,such payments are included in theemployee’s gross income, are reportedas wages or other compensation on theemployee’s Form W–2, and are subjectto withholding and payment of employ-ment taxes. See § 1.62–2(c)(3), (c)(5),and (h)(2).

38

substantiated for those days undersection 4.01, 4.02, or 5 is subject towithholding and payment of employ-ment taxes. See § 1.62–2(h)(2)(i)(B).

(1) In the case of a per diemallowance paid as a reimbursement, theexcess described in this section 8.01 issubject to withholding and payment ofemployment taxes in the payroll periodin which the payor reimburses theexpenses for the days of travel substan-tiated. See § 1.62–2(h)(2)(i)(B)(2).

(2) In the case of a per diemallowance paid as an advance, theexcess described in this section 8.01 issubject to withholding and payment ofemployment taxes no later than the firstpayroll period following the payrollperiod in which the days of travel withrespect to which the advance was paidare substantiated. See § 1.62–2(h)-(2)(i)(B)(3). If some or all of the daysof travel with respect to which theadvance was paid are not substantiatedwithin a reasonable period of time andthe employee does not return theportion of the allowance that relates tothose days within a reasonable periodof time, the portion of the allowancethat relates to those days is subject towithholding and payment of employ-ment taxes no later than the firstpayroll period following the end of thereasonable period. See § 1.62–2(h)-(2)(i)(A).

(3) In the case of a per diemallowance only for meal and incidentalexpenses for travel away from homepaid to an employee in the transporta-tion industry by a payor that uses therule in section 4.04(3), the excess ofthe per diem allowance paid for theperiod over the amount deemed sub-stantiated for the period under section4.02 (after applying section 4.04(3)), issubject to withholding and payment ofemployment taxes no later than the firstpayroll period following the payrollperiod in which the excess is com-puted. See § 1.62–2(h)(2)(i)(B)(4).

travels. The employer does not requirethe employee to return the 20 percentby which the reimbursement for thoseexpenses exceeds the Federal per diemrate. The employee substantiates 6 daysof travel away from home: 2 days in alocality in which the Federal per diemrate is $100 and 4 days in a locality inwhich the Federal per diem rate is$125. The employer reimburses theemployee $840 for the 6 days of travelaway from home (2 2 (120% 2 $100)+ 4 2 (120% 2 $125)), and does notrequire the employee to return theexcess payment of $140 ((2 days 2$20 ($120–$100) + 4 days 2 $25($150–$125)). For the payroll period inwhich the employer reimburses theexpenses, the employer must withholdand pay employment taxes on $140.

SECTION 9. EFFECT ON OTHERDOCUMENTS

Rev. Proc. 94–77 is hereby super-seded for per diem allowances paid toan employee on or after April 1, 1996,with respect to lodging, meal, and/orincidental expenses paid or incurred fortravel while away from home on orafter April 1, 1996, and, for purposesof computing the amount allowable asa deduction, for meal and incidentalexpenses paid or incurred by anemployee or self-employed individualfor travel while away from home on orafter April 1, 1996.


The principal author of this revenueprocedure is G. Channing Horton of theOffice of Assistant Chief Counsel(Income Tax and Accounting). Forfurther information regarding this reve-nue procedure, contact Mr. Horton on(202) 622-1585 (not a toll-free call).

SEQ 0103 JOB C34-007-005 PAGE-0039 PART IV PAGE 39 REVISED 17APR96 AT 08:43 BY AT DEPTH: 66.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20042/17APR96/C34-007

Part IV. Items of General Interest

Notice of Proposed Rulemaking andNotice of Public Hearing

Proposed Amendments to theRegulations on the Determination ofInterest Expense Deduction ofForeign Corporations and BranchProfits Tax

tions, Ahmad Pirasteh or RichardHoge, (202) 622-3870; and the hearing,Michael Slaughter (202) 622-7190 (nottoll-free numbers).


Background

definition of a security under section475(c)(2), as well as section 1256contracts, that may produce such splitincome. Accordingly, a foreign corpo-ration that, under an Advance PricingAgreement, is permitted to apply a‘‘profit split’’ methodology to deter-mine the portion of its income from a

INTL–0054–95


ACTION: Notice of proposed rulemak-ing and notice of public hearing.

SUMMARY: This document containsproposed Income Tax Regulations re-lating to the determination of theinterest expense deduction of foreigncorporations under section 882 and thebranch profits tax under section 884 ofthe Internal Revenue Code of 1986.These proposed regulations are neces-sary to provide guidance that coordi-nates with guidance provided in finalregulations under sections 882 and 884published in * * * [T.D. 8657, page 4,and T.D. 8658, page 13, this Bulletin].These regulations will affect foreigncorporations engaged in a U.S. trade orbusiness. This document also providesnotice of a public hearing on theseproposed regulations.

DATES: Written comments must bereceived by June 6, 1996. Outlines oftopics to be discussed at the publichearing scheduled for Thursday, June6, 1996, at 10:00 a.m. must be receivedby May 23, 1996.

ADDRESSES: Send submissions to:CC:DOM:CORP:R (INTL–0054–95),room 5228, Internal Revenue Service,POB 7604, Ben Franklin Station,Washington DC 20044. In the alterna-tive, submissions may be hand deliv-ered between the hours of 8 a.m. and 5p.m. to CC:DOM:CORP:R (INTL–0054–95), Courier’s Desk, InternalRevenue Service, 1111 ConstitutionAvenue NW., Washington DC. Thepublic hearing will be held in theAuditorium, Internal Revenue Building,1111 Constitution Avenue NW., Wash-ington DC.

FOR FURTHER INFORMATIONCONTACT: Concerning the regula-

39

This document contains proposedregulations amending the Income TaxRegulations (26 CFR Part 1) undersections 882 and 884 of the InternalRevenue Code. In final regulationsunder sections 882 and 884, publishedelsewhere in this issue of the FederalRegister, various sections were re-served. These proposed regulationswould provide guidance under thosereserved sections, as well as amendother sections, to coordinate with thefinal regulations.

Explanation of the Provisions

I. Financial products.

The proposed regulations includeseveral provisions that take into ac-count recent developments in the taxtreatment of financial instruments, suchas the enactment of section 475, thedevelopment of hedging rules and theintroduction of profit split meth-odologies in global trading AdvancePricing Agreements. The IRS andTreasury intend to issue regulationsunder section 864 that will addressthese recent developments as theyaffect the determination of a foreigncorporation’s effectively connected in-come. Comments are solicited on theseproposed regulations as they relate tofinancial products and on their interac-tion with the determination of effec-tively connected income.

A. ‘‘Split asset’’ rule for section 475securities and section 1256 contracts.Currently § 1.884–1(d)(2)(vii) providesa ‘‘split asset’’ rule for certain se-curi t ies descr ibed in § 1.864–4(c)(5)(ii)(b)(3) that produce incomeonly a portion of which is treated aseffectively connected with the conductof a U.S. trade or business. Since othersecurities may also produce incomesplit between effectively connected andnon-effectively connected income, therule has been broadened to cover allfinancial instruments that meet the

1996–17 I.R.B.

portfolio of securities that is effectivelyconnected with the conduct of a U.S.trade or business would apply this rule.This rule will also apply to determinethe portion of a foreign corporation’sportfolio of securities that is a U.S.asset for purposes of § 1.882–5.

B. Hedging transactions. Proposed§ 1.884–1(c)(2)(ii) introduces a newrule for hedging transactions for pur-poses of section 884. The new rulerequires that a taxpayer increase ordecrease, as the case may be, theamount of their U.S. assets by theamount of any gain or loss on anytransaction that hedges the U.S. assets.If the hedging transaction is undertakenoutside the United States, perhaps aspart of a global hedging strategy of theforeign corporation, then the hedgingtransaction is only taken into accountto the extent that income from thetransaction would be treated as incomeeffectively connected with the U.S.trade or business of the taxpayer. If,however, the hedging transaction isentered into by the U.S. branch, it willonly affect the amount of U.S. assets ifit is contemporaneously identified as ahedging transaction in accordance withthe provisions of § 1.1221–2.

In response to comments, hedgingrules also have been added to theinterest allocation rules of § 1.882–5.These rules provide that a transactionthat hedges a U.S. booked liability willbe taken into account in determiningthe amount, currency denomination,and interest rate associated with thatliability for purposes of performing thesecond and third steps of the interestexpense calculation.

C. Securities marked-to-market. Sec-tion 1.884–1(d)(6), which provides‘‘E&P basis’’ rules for specific typesof U.S. assets, has been clarified toprovide rules for securities subject tomark-to-market accounting. The newprovision in § 1.884–1(d)(6)(v) spec-ifies that securities subject to section475, as well as section 1256 contracts,have an E&P basis equal to their mark-to-market value as of the determination


778/20042/17APR96/C34-007

date. Proposed § 1.882–5(b)(2)(iv)provides a basis adjustment rule underwhich such assets are treated as havingbeen marked-to-market on each deter-mination date. Examples are containedin the proposed regulations that illus-trate the effect of these rules on thecalculation of worldwide assets and

access restrictions, visitors will not beadmitted beyond the building lobbymore than 15 minutes before thehearing starts.

The rules of 26 CFR 601.601(a)(3)apply to the hearing. Persons that wishto present oral comments at the hearingmust submit written comments by June

§ 1.882–5 Determination of interestdeduction.

* * * * * *

(b) * * *(2) * * *(iv) Adjustment to basis of financial

1996 –17 I.R.B.

liabilities.

II. Transactions between partners andpartnerships.

Example 4 in proposed § 1.882–5(c)(5) would clarify that an obligationof a partnership to make payments toits partner for the use of capital, whichgives rise to guaranteed paymentsunder section 707(c), is not a liabilityfor purposes of § 1.882–5. The Serviceand Treasury solicit comments on thetreatment of loans between partners andpartnerships as part of Treasury’s re-view of the international tax aspects ofpass-through entities.

Special Analyses

It has been determined that thisnotice of proposed rulemaking is not asignificant regulatory action as definedin EO 12866. Therefore, a regulatoryassessment is not required. It has alsobeen determined that section 553(b) ofthe Administrative Procedures Act (5U.S.C. chapter 5) and the RegulatoryFlexibility Act (5 U.S.C. chapter 6) donot apply to these regulations, and,therefore, a Regulatory FlexibilityAnalysis is not required. Pursuant tosection 7805(f) of the Internal RevenueCode, this notice of proposed rulemak-ing will be submitted to the ChiefCounsel for Advocacy of the SmallBusiness Administration for commenton its impact on small business.

Comments and Request for a PublicHearing

Before these proposed regulationsare adopted as final regulations, consid-eration will be given to any writtencomments (signed original and eight(8) copies) that are timely submitted tothe IRS. All comments will be avail-able for public inspection and copying.

A public hearing has been scheduledfor Thursday, June 6, 1996, at 10:00a.m. in the Auditorium, Internal Reve-nue Building, 1111 Constitution Ave-nue NW., Washington DC. Because of

40

6, 1996, and submit an outline oftopics to be discussed and time to bedevoted to each topic (signed originaland eight (8) copies) by May 23, 1996.

A period of 10 minutes will beallotted to each person for makingcomments.

An agenda showing the schedulingof the speakers will be prepared afterthe deadline for receiving outlines haspassed. Copies of the agenda will beavailable free of charge at the hearing.


Several persons from the Office ofChief Counsel and the Treasury De-partment participated in drafting theseregulations.

* * * * * *

Proposed Amendments to the Regu-lations

Accordingly, 26 CFR part 1 isproposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citationfor part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. * * * Par. 2. Section 1.882–5 is amended

as follows:1. The text of paragraph (b)(2)(iv) is

added.2. The text of paragraph (c)(2)(v) is

added.3. In paragraph (c)(5), Example 4,

Example 6, and Example 7 are added.4. The text of paragraph (d)(2)(vi) is

added.5. In paragraph (d)(6), Example 4 is

added.6. The text of paragraph (e)(3) is

added.7. In paragraph (e)(5), Example 2 is

added.8. The text of paragraph (f)(2) is

added. The added provisions read as fol-

lows:

instruments. The basis of a security orcontract that is marked to marketpursuant to section 475 or section 1256will be determined as if each deter-mination date were the last businessday of the taxpayer’s taxable year. Afinancial instrument with a fair marketvalue of less than zero is a liability, notan asset, for purposes of this section.

* * * * * *

(c) * * *(2) * * *(v) Hedging transactions. A transac-

tion (or transactions) that hedges anasset or liability, or a pool of assets ora pool of liabilities, will be taken intoaccount in determining the value,amount and currency denomination ofthe asset or liability that it hedges. Atransaction will be considered to hedgean asset or liability only if the transac-tion meets the requirements of§ 1.1221–2.

* * * * * *

(5) * * *

Example 4. Partnership liabilities. X and Y areeach foreign corporations engaged in the activeconduct of a trade or business within the UnitedStates through a partnership, P. Under thepartnership agreement, X and Y each have a 50%interest in the capital and profits of P, and X isalso entitled to a return of 6% per annum on itscapital account that is a guaranteed paymentunder section 707(c). In addition, P has incurreda liability of $100x to an unrelated bank, B.Under paragraph (c)(2)(vi) of this section, X andY each share equally in P’s liability to B. Inaccordance with U.S. tax principles, P’s obliga-tion to make guaranteed payments to X does notconstitute a liability of P, and therefore neither Xnor Y take into account that obligation of thepartnership in computing their actual ratio.

* * * * * *

Example 6. Securities in ratio as assets. FC isa foreign corporation engaged in a trade orbusiness in the United States through a U.S.branch. FC is a dealer in securities within themeaning of section 475(c)(1)(B) because itregularly offers to enter into positions incurrency spot and forward contracts withcustomers in the ordinary course of its trade orbusiness. FC has not elected to use the fixedratio. On December 31, 1996, the end of FC’staxable year, the mark-to-market value of thespot and forward contracts entered into by FCworldwide is 1000x, which includes a mark-to-


778/20042/17APR96/C34-007

market gain of 500x with respect to the spot andforward contracts that are shown on the books ofits U.S. branch and that produce effectivelyconnected income. On its December 31, 1996,determination date, FC includes 500x in its U.S.assets, and 1000x in its worldwide assets.

Example 7. Securities in ratio as assets andliabilities. The facts are the same as in Example4, except that on December 31, 1996, the mark-to-market value of the spot and forward contracts

the currency denomination, amount, and interestrate associated with those liabilities. Accord-ingly, FC must treat the Japanese yen liabilitiesbooked in the United States on December 31,1998, as U.S. dollar liabilities to determine boththe amount of the liabilities and the interest paidor accrued on U.S. booked liabilities forpurposes of this section. Moreover, in applyingthe scaling ratio prescribed in paragraph (d)(4)(i)of this section, FC must scale back both the U.S.

(f) * * *(2) Special rules for financial prod-

ucts. Paragraphs (b)(2)(iv), (c)(2)(v),(d)(2)(vi), and (e)(3) of this sectionwill be effective for taxable yearsbeginning on or after the date theseregulations are published as final reg-ulations in the Federal Register.

entered into by FC worldwide is 1000x, and FChas a mark-to-market loss of 500x with respectto the spot and forward contracts that are shownon the books of its U.S. branch and that wouldproduce effectively connected income. On itsDecember 31, 1996, determination date, FCincludes the 1000x in its worldwide assets forpurposes of determining its ratio of worldwideliabilities to worldwide assets. For purposes ofStep 3, however, FC has U.S-booked liabilities inthe United States equal to the 500x U.S. lossposition.

(d) * * *(2) * * *(vi) Hedging transactions. A transac-

tion (or transactions) that hedges a U.S.booked liability, or a pool of U.S.booked liabilities, will be taken intoaccount in determining the currencydenomination, amount of, and interestrate associated with, that liability. Atransaction will be considered to hedgea U.S. booked liability only if thetransaction meets the requirements of§ 1.1221–2(a), (b), and (c), and isidentified in accordance with the re-quirements of §1.1221–2(e).

* * * * * *

(6) * * *

Example 4. Liability hedge—(i) Facts. FC is aforeign corporation that meets the definition of abank, as defined in section 585(a)(2)(B) (withoutregard to the second sentence thereof), and thatis engaged in a banking business in the UnitedStates through its branch, B. FC’s corporatepolicy is to match the currency denomination ofits assets and liabilities, thereby minimizingpotential gains and losses from currency fluctua-tions. Thus, at the close of each business day,FC enters into one or more hedging transactionsas needed to maintain a balanced currencyposition, and instructs each branch to do thesame. At the close of business on December 31,1998, B has 100x of U.S. dollar assets, and U.S.booked liabilities of 90x U.S. dollars and 1000xJapanese yen (exchange rate: $1 = ¥100). Toeliminate the currency mismatch in this situation,B enters into a forward contract with anunrelated third party that requires FC to pay 10xdollars in return for 1000x yen. Through thishedging transaction, FC has effectively convertedits 1000x Japanese yen liability into a U.S. dollarliability. FC uses its actual ratio of 90% in 1998for Step 2, the adjusted U.S. booked liabilitiesmethod for purposes of Step 3, and is a calendaryear taxpayer.

(ii) Analysis. Under paragraph 1.882–5(d)(2)(vi), FC is required to take into accounthedges of U.S. booked liabilities in determining

41

booked liabilities and the hedge(s) of thoseliabilities. Assuming that FC’s average U.S.booked liabilities for the year ending December31, 1998, exceed its U.S.-connected liabilitiesdetermined under paragraphs (a)(1) through(c)(5) of this section by 10%, FC must scaleback by 10% both its interest expense associatedwith U.S. booked liabilities, and any income orloss from the forward contract to purchaseJapanese yen that hedges its U.S. bookedliabilities.

(e) * * *(3) Hedging transactions. A transac-

tion (or transactions) that hedges aliability, or a pool of liabilities, will betaken into account in determining theamount of, or interest rate associatedwith, that liability. A transaction willbe considered to hedge a liability onlyif the transaction meets the require-ments of § 1.1221–2(a), (b), and (c).

* * * * * *

(5) * * *

Example 2. Asset hedge—(i) Facts. FC is aforeign corporation that meets the definition of abank, as defined in section 585(a)(2)(B) (withoutregard to the second sentence thereof), and thatis engaged in the banking business in the UnitedStates through its branch, B. FC’s corporatepolicy is to match the currency denomination ofits assets and liabilities, thereby minimizingpotential gains and losses from currency fluctua-tions. Thus, at the close of each business day,FC enters into one or more hedging transactionsas needed to maintain a balanced currencyposition, and instructs each branch to do thesame. At the close of business on December 31,1998, B has two U.S. assets, a loan of 90x U.S.dollars and a loan of 1000x Japanese yen(exchange rate: $1 = ¥100). B has U.S. bookedliabilities, however, of 100x U.S. dollars. Toeliminate the currency mismatch, B enters into aforward contract with an unrelated third partythat requires FC to pay 1000x yen in return for10x dollars. Through this hedging transaction,FC has effectively converted its 1000x Japaneseyen asset into a U.S. dollar asset. FC uses itsactual ratio of 90% in 1998 for Step 2, haselected the separate currency pools method inparagraph (e) of this section, and is a calendaryear taxpayer.

(ii) Analysis. Under paragraph (e)(1)(i) of thissection, FC must take into account any transac-tion that hedges a U.S. asset in determining thecurrency denomination and value of that asset.FC’s Japanese yen asset will therefore be treatedas a U.S. dollar asset in determining its U.S.assets in each currency. Accordingly, FC will betreated as having only U.S. dollar assets inmaking its separate currency pools computation.

1996 –17 I.R.B.


1. Paragraph (c)(2)(iii) is added.2. Paragraph (d)(2) is amended as

follows:a. Paragraph (d)(2)(vii) is revised.b. In paragraph (d)(2)(xi), Example 6

through Example 8 are added. 3. The text of paragraph (d)(6)(v) is

added.4. In paragraph (i)(4), a sentence is

added at the end of the existing text.The revised and added provisions

read as follows:


* * * * * *

(c) * * *(2) * * *(iii) Hedging transactions. A transac-

tion that hedges a U.S. asset, or a poolof U.S. assets, will be taken intoaccount in determining the amount ofthat asset (or pool of assets) to theextent that income or loss from thehedging transaction produces ECI orreduces ECI. A transaction that hedgesa U.S. asset, or pool of U.S. assets, isalso taken into account in determiningthe currency denomination of the U.S.asset (or pool of U.S. assets). Atransaction will be considered to hedgea U.S. asset only if the transactionmeets the requirements of § 1.1221–2(a), (b), and (c), and is identified inaccordance with the requirements of§ 1.1221–2(e).

(d) * * *(2) * * *(vii) Financial instruments. A finan-

cial instrument, including a security asdefined in section 475 and a section1256 contract, shall be treated as a U.S.asset of a foreign corporation in thesame proportion that the income, gain,or loss from such security is ECI forthe taxable year.

* * * * * *

(xi) * * *

Example 6. Hedging transactions—(i) Facts.FC is a foreign corporation engaged in a trade or


778/20042/17APR96/C34-007

business in the United States through a U.S.branch. The functional currency of FC’s U.S.branch is the U.S. dollar. On January 1, 1997, inthe ordinary course of its business, the U.S.branch of FC enters into a forward contract withan unrelated party to purchase 100 Germanmarks (DM) on March 31, 1997, for $50. Tohedge the risk of currency fluctuation on thistransaction, the U.S. branch also enters into aforward contract with another unrelated party to

100 DM is entered into with an unrelated thirdparty by the home office of FC. FC includes thecontract to sell 100 DM in a pool of assetstreated as producing income effectively con-nected with the U.S. trade or business of FC.Therefore, under paragraph (c)(2)(iii) of thissection, at its next determination date FC willreport a U.S. asset of $2, computed as inExample 5.

Example 8. Securities. FC is a foreign

account gains and losses recog-nized by reason of section 475 orsection 1256. The E&P basis must befurther adjusted to take into account atransaction that hedges a U.S. asset, asprovided in paragraph (c)(2)(ii) of thissection.

* * * * * *
sell 100 DM on March 31, 1997, for $52,identifying this contract as a hedging transactionin accordance with the requirements of § 1.1221–2(e). FC marks its foreign currency transactionsto market for U.S. tax purposes.
(ii) Net assets. At the end of FC’s taxableyear, the value of the forward contract topurchase 100 DM is marked to market, resultingin gain of $10 being realized and recognized asU.S. source effectively connected income by FC.Similarly, FC marks to market the contract tosell 100 DM, resulting in $8 of realized andrecognized loss by FC. Pursuant to paragraph(c)(2)(iii) of this section, FC must increase ordecrease the amount of its U.S. assets to takeinto account any transaction that hedges thecontract to purchase 100 DM. Consequently, FChas a U.S. asset of $2 ($10 (the adjusted basis ofthe contract to purchase 100 DM) –$8 (the losson the contract to sell 100 DM)).

Example 7. Split hedge. The facts are the sameas in Example 5, except that the contract to sell

1996 –17 I.R.B.

corporation engaged in a U.S. trade or businessthrough a branch in the United States. During thetaxable year 1997, FC derives $100 of incomefrom securities, of which $60 is treated as U.S.source effectively connected income under theterms of an Advance Pricing Agreement that usesa profit split methodology. Accordingly, pursuantto paragraph (d)(2)(vii) of this section, FC has aU.S. asset equal to 60% ($60 of ECI divided by$100 of gross income from securities) of thevalue of the securities.

* * * * * *

(6) * * *(v) Computation of E&P basis of

financial instruments. For purposes ofthis section, the E&P basis of asecurity that is marked to market undersection 475 and a section 1256 contractshall be adjusted to take into

42

(i) * * *(4) * * * Paragraphs (c)(2)(iii),

(d)(2)(vii), and (d)(6)(v) of this sectionwill be effective for taxable yearsbeginning on or after the date theseregulations are published as final reg-ulations in the Federal Register.

* * * * * *



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778/20042/17APR96/C34-008

Announcement of the Disbarment, Suspension, or Consent to VoluntarySuspension of Attorneys, Certified Public Accountants, Enrolled Agents andEnrolled Actuaries From Practice Before the Internal Revenue Service

Under 31 Code of Federal Regula-tions, Part 10, an attorney, certified

Revenue Service matter from directlyor indirectly employing, accepting

ney, certified public accountant, en-rolled agent or enrolled actuary and

n. This an-the weeklyticable datecontinue toins for five

public accountant, enrolled agent or en-rolled actuary, in order to avoid the in-stitution or conclusion of a proceedingfor his disbarment or suspension frompractice before the Internal Revenue

assistance from, being employed by,or sharing fees with, any practi-tioner disbarred or suspended frompractice before the Internal RevenueService.

date or period of suspensionouncement will appear in Bulletin at the earliest pracafter such action and will appear in the weekly Bullet

Service, may offer his consent to To enable attorneys, certified public successive weeks or for as many weeks

a

d

d, d

suspension from such practice. TheDirector of Practice, in his discretion,may suspend an attorney, certifiedpublic accountant, enrolled agent orenrolled actuary in accordance with theconsent offered.

Attorneys, certified public account-ants, enrolled agents and enrolled actu-aries are prohibited in any Internal

Name Address

Miller, Gorden A. MineralBarnes, Charles E. Louisvil

Polizzi, Angelo J. Grosse Pegler, Charles R. IslandiaFoster, David M. Birming
definite from February 9, 1996
and regulations governing the recogni-ticaR

aaR

accountants, enrolled agents and en-rolled actuaries to identify practitionersunder consent suspension from practicebefore the Internal Revenue Service,the Director of Practice will announcein the Internal Revenue Bulletin thenames and addresses of practitionerswho have been suspended from suchpractice, their designation as attor-

Designation D

Wells, WV CPA Fele, KY Enrolled

AgentIn

Point, MI Attorney In NY CPA Inham, MI Attorney In

43

accountants, enrolled agents and

as is practicable for each attorney,certified public accountant, enrolledagent or enrolled actuary so suspendedand will be consolidated and publishedin the Cumulative Bulletin.

The following individuals have beenplaced under consent suspension frompractice before the Internal RevenueService:

te of Suspension

bruary 1, 1996 to April 30, 1996efinite from February 1, 1996

efinite from February 6, 1996efinite from February 7, 1996

Smith, Jerry A. Evansville, IN CPA February 9, 1996 to November 8, 1996Penn, Michael J. Dearborn, MI CPA February 9, 1996 to February 8, 1997Mueller, E. Laird Seal Beach, CA CPA February 12, 1996 to June 11, 1996Zezima, Paul P. Norwalk, CT CPA April 1, 1996 to May 31, 1996Van Houten, Robert R. Danbury, CT CPA May 1, 1996 to April 30, 1997

Under Section 330, Title 31 of theUnited States Code, the Secretary ofthe Treasury, after due notice andopportunity for hearing, is authorizedto suspend or disbar from practicebefore the Internal Revenue Serviceany person who has violated the rules

or indirectly employing, accepting as-sistance from, being employed by orsharing fees with, any practitionerdisbarred or under suspension frompractice before the Internal RevenueService.

To enable attorneys, certified public

agent or enrolled actuary, and the dateof disbarment or period of suspension.This announcement will appear in theweekly Bulletin for five successiveweeks or as long as it is practicable foreach attorney, certified public account-ant, enrolled agent or enrolled actuary
so suspended or disbarred and will be
on of attorneys, certified public ac-ountants, enrolled agents or enrolledctuaries to practice before the Internalevenue Service.Attorneys, certified public account-

nts, enrolled agents, and enrolledctuaries are prohibited in any Internalevenue Service matter from directly

enrolled actuaries to identify suchdisbarred or suspended practitioners,the Director of Practice will announcein the Internal Revenue Bulletin thenames and addresses of practitionerswho have been suspended from suchpractice, their designation as attorney,certified public accountant, enrolled

consolidated and published in theCumulative Bulletin.

After due notice and opportunityfor hearing before an administrativelaw judge, the following individualshave been disbarred from further prac-tice before the Internal RevenueService:

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778/20042/17APR96/C34-008

Name Address Designation Effective Date

Gimbel, Stephen Columbia, SC CPA January 20, 1996Tropsa, Donna C. Stamford, CT Attorney January 20, 1996Seifert, Frank J. Birmingham, AL CPA January 20, 1996Hansen, Joe B. Lubbock, TX CPA March 2, 1996

Announcement of the Expedited Suspension of Attorneys, Certified PublicAccountants, Enrolled Agents, and Enrolled Actuaries From Practice Before theInternal Revenue Service

Under title 31 of the Code of Federal Revenue Service matter from directly agent, or enrolled actuary, and date or
Regulations, section 10.76, the Directorof Practice is authorized to immediately
or indirectly employing, accepting as-sistance from, being employed by, or

period of suspension. This announce-ment will appear in the weekly Bulletin

afterppearcces-

as is

suspend from practice before the Inter-nal Revenue Service any practitionerwho, within five years, from the datethe expedited proceeding is instituted,

sharing fees with, any practitionerdisbarred or suspended from practicebefore the Internal Revenue Service.

To enable attorneys, certified public

at the earliest practicable date such action and will continue to ain the weekly Bulletins for five susive weeks or for as many weeks

(1) has had a license to practice as an practicable for each attorney, certified

s

r

attorney, certified public accountant, oractuary suspended or revoked forcause; or (2) has been convicted of anycrime under title 26 of the UnitedStates Code or, of a felony under title18 of the United States Code involvingdishonesty or breach of trust.

Attorneys, certified public account-ants, enrolled agents, and enrolled ac-tuaries are prohibited in any Internal

Name Addre

Ginsberg, Melvin R. Univ. Lahey, Charles W. South DePiano, Robert VeniceKraig, Jerry B. ShakeBrown, David M. Los A
Hanke Jr., Dale L. Duluth
accountants, enrolled agents, and en-rolled actuaries to identify practitionersunder expedited suspension from prac-tice before the Internal Revenue Serv-ice, the Director of Practice will an-nounce in the Internal Revenue Bulletinthe names and addresses of practition-ers who have been suspended from suchpractice, their designation as attorney,certified public accountant, enrolled

s Designation

Heights, OH AttorneyBend, IN Attorney, CA Attorney Hgts, OH Attorneyngeles, CA Attorney, MN Attorney

44

public accountant, enrolled agent, orenrolled actuary so suspended and willbe consolidated and published in theCumulative Bulletin.

The following individuals have beenplaced under suspension from practicebefore the Internal Revenue Service byvirtue of the expedited proceedingprovisions of the applicable regulations:

Date of Suspension

Indefinite from January 24, 1996Indefinite from January 24, 1996Indefinite from January 24, 1996Indefinite from January 29, 1996Indefinite from January 29, 1996Indefinite from February 1, 1996

Guillory, Patrick R. San Francisco, CA Attorney Indefinite from February 1, 1996Miller, Brian R. Grove, OK CPA Indefinite from February 23, 1996McLeod, Timothy R. Saginaw, MI Attorney Indefinite from February 26, 1996Simone, Robert F. Philadelphia, PA Attorney Indefinite from February 26, 1996Bowen, David Lee Frisco City, AL CPA Indefinite from February 27, 1996Lindley, Clarkson Wayazata, MN Attorney Indefinite from February 27, 1996

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Definition of TermsRevenue rulings and revenue proce-dures (hereinafter referred to as ‘‘rul-ings’’) that have an effect on previousrulings use the following defined termsto describe the effect:

Amplified describes a situation where

ruling is modified because it corrects apublished position. (Compare with am-plified and clarified, above).

Obsoleted describes a previouslypublished ruling that is not considereddeterminative with respect to futuretransactions. This term is most com-monly used in a ruling that lists

If the new ruling does more thanrestate the substance of a prior ruling, acombination of terms is used. Forexample, modified and superseded de-scribes a situation where the substanceof a previously published ruling isbeing changed in part and is continuedwithout change in part and it is desired

no change is being made in a priorpublished position, but the prior posi-tion is being extended to apply to avariation of the fact situation set forththerein. Thus, if an earlier ruling heldthat a principle applied to A, and thenew ruling holds that the same princi-ple also applies to B, the earlier rulingis amplified. (Compare with modified,below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position ina prior ruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previouslypublished ruling and points out anessential difference between them.

Modified is used where the substanceof a previously published position isbeing changed. Thus, if a prior rulingheld that a principle applied to A butnot to B, and the new ruling holds thatit applies to both A and B, the prior

AbbreviationsThe following abbreviations in current use andformerly used will appear in material publishedin the Bulletin.

A—Individual.Acq.—Acquiescence.
B—Individual.
previously published rulings that areobsoleted because of changes in law orregulations. A ruling may also beobsoleted because the substance hasbeen included in regulations subse-quently adopted.

Revoked describes situations wherethe position in the previously publishedruling is not correct and the correctposition is being stated in the newruling.

Superseded describes a situationwhere the new ruling does nothingmore than restate the substance andsituation of a previously publishedruling (or rulings). Thus, the term isused to republish under the 1986 Codeand regulations the same position pub-lished under the 1939 Code and regula-tions. The term is also used when it isdesired to republish in a single ruling aseries of situations, names, etc., thatwere previously published over aperiod of time in separate rulings.

E.O.—Executive Order.ER—Employer.ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
to restate the valid portion of thepreviously published ruling in a newruling that is self contained. In thiscase the previously published ruling isfirst modified and then, as modified, issuperseded.

Supplemented is used in situations inwhich a list, such as a list of the namesof countries, is published in a rulingand that list is expanded by addingfurther names in subsequent rulings.After the original ruling has beensupplemented several times, a newruling may be published that includesthe list in the original ruling and theadditions, and supersedes all priorrulings in the series.

Suspended is used in rare situationsto show that the previous publishedrulings will not be applied pendingsome future action such as the issuanceof new or amended regulations, theoutcome of cases in litigation, or theoutcome of a Service study.

PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.PRS—Partnership.PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C.—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.

45

FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign Corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—GrantorIC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.

Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statements of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D.—Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z—Corporation.

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Numerical Finding List1

Bulletins 1996–1 through 1996–13

Announcements:

96–1, 1996–2 I.R.B. 5796–2, 1996–2 I.R.B. 5796–3, 1996–2 I.R.B. 57

,.,7l.

Proposed Regulations—Continued

INTL–9–95, 1996–5 I.R.B. 25PS–2–95, 1996–7 I.R.B. 50

Revenue Procedures:

96–1, 1996–1 I.R.B. 896–2, 1996–1 I.R.B. 60

Treasury Decisions—Continued

8633, 1996–4 I.R.B. 208634, 1996–3 I.R.B. 178635, 1996–3 I.R.B. 58636, 1996–4 I.R.B. 648637, 1996–4 I.R.B. 298638, 1996–5 I.R.B. 58656, 1996–13 I.R.B. 9

96–4, 1996–3 I.R.B. 5096–5, 1996–4 I.R.B. 9996–6, 1996–5 I.R.B. 4396–7, 1996–5 I.R.B. 4496–8, 1996–7 I.R.B. 5696–9, 1996–8 I.R.B. 3096–10, 1996–8 I.R.B. 3096–11, 1996–9 I.R.B. 1196–12, 1996–11 I.R.B. 3096–13, 1996–12 I.R.B. 3396–14, 1996–12 I.R.B. 3596–15, 1996–13 I.R.B. 2296–16, 1996–13 I.R.B. 2296–17, 1996–13 I.R.B. 22

Delegations Orders:

232 (Rev. 2), 1996–7 I.R.B. 49239 (Rev. 1), 1996–7 I.R.B. 49

Notices:

96–2, 1996–2 I.R.B. 1596–1, 1996–3 I.R.B. 3096–4, 1996–4 I.R.B. 6996–5, 1996–6 I.R.B. 2296–6, 1996–5 I.R.B. 2796–7, 1996–6 I.R.B. 2296–8, 1996–6 I.R.B. 2396–9, 1996–6 I.R.B. 2696–10, 1996–7 I.R.B. 4796–11, 1996–8 I.R.B. 1996–12, 1996–10 I.R.B. 2996–13, 1996–10 I.R.B. 2996–14, 1996–12 I.R.B. 1196–15, 1996–13 I.R.B. 1996–16, 1996–13 I.R.B. 2096–17, 1996–13 I.R.B. 20

Proposed Regulations:

DL–1–95, 1996–6 I.R.B. 28EE–20–95, 1996–5 I.R.B. 15EE–34–95, 1996–3 I.R.B. 49EE–35–95, 1996–5 I.R.B. 19EE–53–95, 1996–5 I.R.B. 23EE–55–95, 1996–12 I.R.B. 12EE–106–82, 1996–10 I.R.B. 31EE–142–87, 1996–12 I.R.B. 13EE–148–81, 1996–11 I.R.B. 29IA–41–93, 1996–11 I.R.B. 29IA–33–95, 1996–4 I.R.B. 99INTL–3–95, 1996–6 I.R.B. 29

1A cumulative list of all Revenue RulingsRevenue Procedures, Treasury Decisions, etcpublished in Internal Revenue Bulletins 1995–2through 1995–52 will be found in InternaRevenue Bulletin 1996–1, dated January 2, 1996

45

96–3, 1996–1 I.R.B. 8296–4, 1996–1 I.R.B. 9496–5, 1996–1 I.R.B. 12996–6, 1996–1 I.R.B. 15196–7, 1996–1 I.R.B. 18596–8, 1996–1 I.R.B. 18796–8A, 1996–9 I.R.B. 1096–9, 1996–2 I.R.B. 1596–10, 1996–2 I.R.B. 1796–11, 1996–2 I.R.B. 1896–12, 1996–3 I.R.B. 3096–13, 1996–3 I.R.B. 3196–14, 1996–3 I.R.B. 4196–15, 1996–3 I.R.B. 4196–16, 1996–3 I.R.B. 4596–17, 1996–4 I.R.B. 6996–18, 1996–4 I.R.B. 7396–19, 1996–4 I.R.B. 8096–20, 1996–4 I.R.B. 8896–21, 1996–4 I.R.B. 9696–22, 1996–5 I.R.B. 2796–23, 1996–5 I.R.B. 2796–24, 1996–5 I.R.B. 2896–25, 1996–8 I.R.B. 1996–26, 1996–8 I.R.B. 2296–27, 1996–11 I.R.B. 27

Revenue Rulings:

96–1, 1996–1 I.R.B. 796–2, 1996–2 I.R.B. 596–3, 1996–2 I.R.B. 1496–6, 1996–2 I.R.B. 896–4, 1996–3 I.R.B. 1696–5, 1996–3 I.R.B. 2996–7, 1996–3 I.R.B. 1296–8, 1996–4 I.R.B. 6296–9, 1996–4 I.R.B. 596–10, 1996–4 I.R.B. 2796–11, 1996–4 I.R.B. 2896–12, 1996–9 I.R.B. 496–13, 1996–10 I.R.B. 1996–14, 1996–6 I.R.B. 2096–15, 1996–11 I.R.B. 996–16, 1996–11 I.R.B. 496–17, 1996–13 I.R.B. 596–18, 1996–13 I.R.B. 4

Treasury Decisions:

8630, 1996–3 I.R.B. 198631, 1996–3 I.R.B. 78632, 1996–4 I.R.B. 6

8639, 1996–5 I.R.B. 128640, 1996–2 I.R.B. 108641, 1996–6 I.R.B. 48642, 1996–7 I.R.B. 48643, 1996–11 I.R.B. 48644, 1996–7 I.R.B. 168645, 1996–8 I.R.B. 48646, 1996–8 I.R.B. 108647, 1996–9 I.R.B. 78648, 1996–10 I.R.B. 238649, 1996–9 I.R.B. 58650, 1996–10 I.R.B. 58651, 1996–11 I.R.B. 248652, 1996–11 I.R.B. 118653, 1996–12 I.R.B. 48654, 1996–11 I.R.B. 148655, 1996–12 I.R.B. 98656, 1996–13 I.R.B. 9

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46

Finding List of Current Action onPreviously Published Items1

Bulletins 1996–1 through 1996–13

*Denotes entry since last publication

Delegation Orders:

232 (Rev. 1)

uslynue

beated

Revenue Procedures—Continued

92–85Modified by96–1, 1996–1 I.R.B. 8

93–16Superseded by96–11, 1996–2 I.R.B. 18

Revenue Procedures—Continued



Superseded by232 (Rev. 2), 1996–7 I.R.B. 49

239Amended by239 (Rev. 1), 1996–7 I.R.B. 49

Revenue Procedures:

65–17Modified by96–14, 1996–3 I.R.B. 41

66–49Modified by96–15, 1996–3 I.R.B. 41

88–32Obsoleted by96–15, 1996–3 I.R.B. 41

88–33Obsoleted by96–15, 1996–3 I.R.B. 41


89–48Superseded in part by96–17, 1996–4 I.R.B. 69

91–22Modified by96–1, 1996–1 I.R.B. 8

91–22Amplified by96–13, 1996–3 I.R.B. 31




92–20Modified by96–1, 1996–1 I.R.B. 8

1A cumulative finding list for previopublished items mentioned in Internal ReveBulletins 1995–27 through 1995–52 will found in Internal Revenue Bulletin 1996–1, dJanuary 2, 1996.


Superseded by96–18, 1996–4 I.R.B. 73














96–3Amplified by96–12, 1996–3 I.R.B. 30

Revenue Rulings:

66–307Obsoleted by96–3, 1996–2 I.R.B. 14

72–437Modified by96–13, 1996–3 I.R.B. 31

80–80Obsoleted by96–3, 1996–2 I.R.B. 14

82–80Modified by96–14, 1996–3 I.R.B. 41

92–19Supplemented in part96–2, 1996–2 I.R.B. 5

92–75Clarified by96–13, 1996–3 I.R.B. 31

95–10Supplemented and superseded by96–4, 1996–3 I.R.B. 16

95–11Supplemented and superseded by96–5, 1996–3 I.R.B. 29

SEQ 0112 JOB C34-053-015 PAGE-0047 INDEX REVISED 17APR96 AT 08:43 BY AT DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20042/17APR96/C34-053

INDEX

Internal Revenue Bulletins 1996–1Through 1996–13

For index of items published during

EMPLOYMENT TAXES—Continued

Regulations—Continued26 CFR 31 .3406–0 rev ised ;

31 .3406(a)–1—31.3406( i )–1 ,31.6051–4, 31.6413(a)–3, added;

ESTATE & GIFT TAXES—Continued

ADMINISTRATIVE—Continued

the last six months of 1995, seeI.R.B. 1996–1, dated January 2,1996.

The abbreviation and number in pa-rentheses following the index entryrefer to the specific item; numbersin roman and italic type following theparentheses refer to the InternalRevenue Bulletin in which the itemmay be found and the page numberon which it appears.

Key to Abbreviations:

RR Revenue RulingRP Revenue ProcedureTD Treasury DecisionCD Court DecisionPL Public LawEO Executive OrderDO Delegation OrderTDO Treasury Department OrderTC Tax ConventionSPR Statement of Procedural

RulesPTE Prohibited Transaction

Exemption

EMPLOYMENT TAXES

Backup withholding:Substitute Form W–9 (RP 26) 8, 22Forms, electronic filing, magnetic

media, Form 1042–S (RP 11) 2, 18Proposed regulations:

26 CFR 31.3306(r)(2)–1, added;FUTA taxation of amounts underemployee benefit plans (EE–55–95) 12, 12

26 CFR 31.9999–0, added; effectivedate of temporary backup with-holding regs (IA–33–95) 4, 99

Partial withdrawal of proposed regula-tions INTL–52–86 (Notice 4) 4, 69

Regulations:26 CFR 31.3402(r)–1 added;

31.3402(r)–IT, removed; withhold-ing on distributions of Indiangaming profits to tribal members(TD 8634) 3, 17

47

35a.9999.OT, 35a.3406–2, re-moved; 301.6109–1, amended;backup withholding statementmailing requirements, and due dili-gence (TD 8637) 4, 29

26 CFR 31.6051–1(d), 31.6071(a)–1(a)(3), amended; 31.6051–2(c),31.6081(a)–1(a)(3), 301.6011–2(c)(4)(i), revised; time for fur-nishing wage statements on termi-nation of employer’s operations(TD 8636) 4, 64

26 CFR 33 and 38, removed; partsdeclared obsolete (TD 8655) 12, 9

26 CFR 301.6109–1, amended gran-tor trust reporting requirements(TD 8633) 4, 20

26 CFR 301.7507–1, 301.7507–0,amended; treatment of acquisitionof certain financial institutions(TD 8641) 6, 4

26 CFR 301.7701–3, amended; costsharing arrangements (TD 8632) 4,6

26 CFR 301.9100–7T, amended;generation-skipping transfer tax(TD 8644) 7, 16

Returns:Information, electronic filing; Form

941 (RP 19) 4, 80Magnetic tape reporting: Forms 940,

941, and 945 (RP 18) 4, 73Reporting agents, Form 8655 (RP

17) 4, 69

ESTATE & GIFT TAXES

ADMINISTRATIVE

Proposed regulations:26 CFR 301.6103(n)–1, amended;

disclosure of returns and returninformation to procure property orservices for tax administration pur-poses (DL–1–95) 6, 28

Regulations:26 CFR 20.2035–1; 26 CFR 23 and

24, 25.2517–1, removed; regula-tions declared obsolete (TD 8655)12, 9

Regulations:—Continued26 CFR 301.6109–1, amended; gran-

tor trust reporting requirements(TD 8633) 4, 20

26 CFR 301.6011–2(c)(4)(i), revised;time for furnishing wage state-m e n t s o n t e r m i n a t i o n o femployer’s operations (TD 8636)4, 64

26 CFR 301.7507–1, 301.7507–0,amended; treatment of acquisitionof certain financial institutions(TD 8641) 6, 4



ESTATE TAXES

Annuities, valuation, terminally illmeasured life (RR 3) 1, 14

Regulations:26 CFR 20.2035–1, removed; regula-

tions declared obsolete (TD 8655)12, 9

26 CFR 20.7520–3, amended; ac-turial tables exceptions (TD 8630)3, 19

26 CFR Part 26, revised; 301.9100–7T, amended; generation-skippingtransfer tax (TD 8644) 7, 16

Tax conventions, competent authorityprocedures (RP 13) 3, 31

GIFT TAXES

Annuities, valuation, terminally illmeasured life (RR 3) 1, 14

Regulations:26 CFR 25.2517–1, removed; regula-

tions declared obsolete (TD 8655)12, 9

26 CFR 25.2522(c)–3, 25.7520–3amended; actuarial tables excep-tions (TD 8630) 3, 19

26 CFR 25.2702–3, amended; gran-tor trust reporting requirements(TD 8633) 4, 20


778/20042/17APR96/C34-053

GIFT TAXES—Continued

Regulations—ContinuedTax conventions, competent authority

procedures (RP 13) 3, 31

INCOME TAX—Continued

Books and records—Continued

Capital expenditures (Notice 7) 6, 22

Consolidated returns, single-entity elec-tion (RP 21) 4, 96


Investment:

Inflation adjustment for 1996 (RR 4)3, 16

EXCISE TAXES

Proposed regulations:26 CFR 301.6103(n)–1, amended;

disclosure of returns and returninformation to procure property orservices for tax administration pur-poses (DL–1–95) 6, 28

Regulations:26 CFR 301.7507–1, 301.7507–0,

amended; treatment of acquisitionof certain financial institutions(TD 8641) 6, 4


26 CFR 53.4941(d)–2, amended;self-dealing for private foundations(TD 8639) 5, 12

26 CFR 301.6011–2(c)(4)(i), revised;time for furnishing wage state-ments on termination of em-ployer’s operations (TD 8636) 4,64

26 CFR 301.6109–1, amended; gran-tor trust reporting requirements(TD 8633) 4, 20


INCOME TAX

Administration:Advance valuation of art (RP 15) 3,

41Delegation of authority:

Authority of Taxpayer Ombuds-man (DO 239 [Rev. 1]) 7, 49

Authority to modify or rescindTAO (DO 232 [Rev. 2]) 7, 49

Unagreed issues, referral to Appeals(RP 9) 2, 15

Annuities and pensions, valuation, ter-minally ill measured life (RR 3) 2,14

Automobiles:Owners and lessees, limitations on

depreciation (RP 25) 8, 19Books and records:

Imaging systems (Notice 10) 7, 47

C

D

E

E

F

I

I

I

48

redit against tax:

Enpowerment zone employment, in-tent to issue regulations (Notice 1)3, 30

ifferential earnings rate (Notice 15)13, 19

mployee plans:

Administrative, COBRA premium is-sues (RR 8) 4, 62

Determination letters (RP 6) 1, 51

Funding:

Full funding limitations, weightedaverage interest rate, Dec. 1995(Notice 2) 2, 15; Jan. 1996(Notice 9) 6, 26; Feb. 1996(Notice 11) 8, 19; March 1996(Notice 16) 13, 20

Mortality tables (RR 7) 3, 12

Single sum distributions amounts,cash balance plans (Notice 8) 6,23

Estimate tax payments for individ-uals (Notice 5) 6, 22

state and trusts:

Valuations, transfers to pooled in-come funds (RR 1) 1, 7

Foreign insurance companies, domes-tic asset/liability and investmentyield (RP 23) 5, 27

orms:

Substitute Forms W–2 and W–3,specifications (RP 24) 5, 28

nsurance companies:

Life, interest rate tables (RR 2) 2, 5

nterest:

Investment:

Federal short-term, mid-term andlong-term rates, Jan. 1996 (RR6) 2, 8; Feb. 1996 (RR 14) 6,20; March 1996 (RR 15) 11, 9

Rates, underpayments and over-payments (RR 17) 13, 5

nventories:

LIFO:

Price indexes, department stores,Nov. 1995 (RR 9) 4, 5; Dec.1995 (RR 12) 9, 4; Jan. 1996(RR 18) 13, 4

L

L

M

oans:

CPI adjustment for below marketloans—1996 (RR 5) 3, 29

ow-income housing credit:

Bond factor amounts Jan.–Mar. 1996(RR 16) 11, 4

Tax credit (RR 27) 11, 27

ajor disaster areas (RR 13) 10, 19

Mark to market, securities dealers(Notice 12) 10, 29

Partnerships:

Charitable contribution of property(RR 11) 4, 28

Sales between partners, basis (RR10) 4, 27

Payments from Presidential ElectionCampaign Fund (Notice 13) 10, 29

Property (contributed or other) distribu-tion; recognition of gain or loss bycontributing partner; correction(Notice 17) 13, 20

Proposed regulations:

26 CFR 1.72–17A, amended: 1.72–17A(d)(1), added; 1.72(p)–1,added; loans to plan participants(EE–106–82) 10, 31

26 CFR 1.125–3, added; effect ofFamily and Medical Leave Act of1993 on the operation of cafeteriaplans (EE–20–95) 5, 15

26 CFR 1.367–9, added (INTL–9–95) 5, 24

26 CFR 1.409–1(b)(2)(i), retirementbonds withdrawn (EE–118–81) 11,29

26 CFR 1.411(c)–1, amended; alloca-tion of accrued benefits betweenemployer and employee contribu-tions (EE–20–95) 5, 15

26 CFR 1.411(d)(6), added; futurebenefit accrual (EE–34–95) 3, 49

26 CFR 1.501(c)(5)–1, amended;requirements for tax-exempt orga-nizations (EE–53–95) 5, 23

26 CFR 1.731–2, added; distributionof marketable securities by a part-nership (PS–2–95) 7, 50


778/20042/17APR96/C34-053


Proposed regulations—Continued

26 CFR 1.863–0, added; 1.863–1, –2,–3, revised; 1.863–4, amended;1.863–5, removed; source of in-

INCOME TAX—ContinuedRegulations—Continued

26 CFR 1.401–12(n) redesignated1.408–2(e); 1.401–12T, removed;1.401(f)–1, 1.408–2, amended;nonbank trustee net worth require-

INCOME TAX—ContinuedRegulations—Continued

26 CFR 1.1445–1, 1.1445–8(c)(2)(i),revised; 1.1445–5, amended; with-holding of tax on dispositions ofU.S. real property interests byforeign persons (TD 8647) 9, 7
come from sales of inventory and
natural resources produced in onejurisdiction and sold in another(INTL–3–95) 6, 29

26 CFR 1.1254–0, 1.1254–4,amended; treatment of gain fromdisposition of interest in certainnatural resource recapture propertyby S corporations (PS–7–89) 8, 24

26 CFR 1.6081–4(a), revised:1.6081–4(d), added; automatic ex-tension of time for filing individ-ual tax returns (IA–41–93) 11, 29

26 CFR 31.3121(v)(2)–1, –2, added;FICA taxation amounts underemployee benefit plans (EE–142–87) 12, 13

26 CFR 31.3306(r)(2)–1, added;FUTA taxation amounts underemployee benefit plans (EE–55–95) 12, 12

26 CFR 301.6651–1(c)(3), revised;failure to file return or pay tax(IA–41–93) 11, 29

26 CFR 301.6103(n)–1, amended;disclosure of returns and returninformation to procure property orservices for tax administration pur-poses (DL–1–95) 6, 28

Property (contributed or other) distribu-tion; recognition of gain or loss bycontributing partner; correction(Notice 17) 13, 20

Regulations:

26 CFR 1.162–27, added; dis-allowance of deductions foremployee remuneration in excessof $1,000,000 (TD 8650) 10, 5;TD 8650 corrected (Notice 14) 12,11

26 CFR 1.305–3, –5, –7, amended;distribution of stock and stockrights (TD 8643) 11, 4

26 CFR 1.367(a)–3T, amended; cer-tain transfers of domestic stock orsecurities by U.S. persons to for-eign corporations (TD 8638) 5, 5

26 CFR 1.385–2(d), removed; 1.358–6, 1.1032–2, 1.1502–30, added;controlling corporation’s basis ad-justment (TD 8648) 10, 23

49

ments (TD 8635) 3, 526 CFR 1.411(d)–6T, added; notice

of significant reduction in the rateof future benefit accrual (TD8631) 3, 7

26 CFR 1.469–0, 1.469–4, 1.469–11,amended; 1.469–9, revised; rulesfor certain rental real estate ac-tivities (TD 8645) 8, 4

26 CFR 1.482–0, 301.7701–3,amended; 1.482–7, added; 1.482–7T, removed; section 482 costsharing arrangements (TD 8632) 4,6

26 CFR 1.508–1, 1.6033–2 amended;exempt organization not requiredto file annual returns, integratedauxiliaries of churches (TD 8640)2, 10

26 CFR 1.597–1—1.597–7, added;301.7507–1, 301.7507–9, amended;treatment of acquisition of certainfinancial institutions (TD 8641) 6, 4

26 CFR 1.671–4, revised; 1.6012–3,301.6109–1, amended; grantortrust reporting requirements (TD8633) 4, 20

26 CFR 1.704–4, 1.737–1 through1.737–5, added; recognition of gainor loss by contributing partner ondistribution of contributed propertyor other property (TD 8642) 7, 4

26 CFR 1.861–8, amended; 1.861–17,added; allocation and apportion-ment of research and experimentalexpenditures (TD 8646) 8, 10

26 CFR 1.1258–1, added; conversiontransactions (TD 8649) 9, 5

26 CFR 1.1301–1, 1.32–1, 1.103–12,1.110–1, 1.114–1, 1.115–1, 1.116–1, –2, 1.367(a)–7T, 1.383–1A,–2A, –3A, 1.804–1, 1.805–1through –8 and intermediate sec-tions, 1.820–1, –2, –3, 1.824–1,–2, –3, removed; 1.907–0,amended; 1.907(e)(1), 1.907(a)–0A, –1A, 1.907(b)–1A, –2A,1.907(c)–1A, –2A, –3A, 1.907(d)–1A, 1.907(e)–1A, 1.907(f)–1A,1.995–7, 1301–0 through –3 andintermediate sections, 1.1303–1,1.1304–1 through –6 and inter-mediate sections, removed; regula-tions declared obsolete (TD 8655)12, 9

26 CFR 1.6042–4, 1.6044–5, revised;1.6049–6, 301.6109–1, amended;1.6050N–1, added Backup with-holding, statement mailing require-ments and due diligence (TD8637) 4, 29

26 CFR 1.6050I–0T, –2T, removed;1.6050I–0, –2, added; cash report-ing by court clerks (TD 8652) 11,11

26 CFR 1.6050P–0, –1, added,1.6050P–0T, –1T, removed; infor-mation reporting for discharges ofindebtedness (TD 8654) 11, 14

26 CFR 1.6081–4, amended; 1.6081–4T, added; automatic extension oftime for filing income tax returns(TD 8651) 11, 24

26 CFR 1.6662–0, –6T, removed;1.6662.5T, revised; 1.6662–6,added; imposition of accuracy-related penalty (TD 8656) 13, 9

26 CFR 301.6011–2(c)(4)(i), revised;time for furnishing wage state-ments upon termination ofemployer’s operations (TD 8636)4, 64

26 CFR 1.7520–3, amended; actu-arial tables exceptions (TD 8630)3, 19

26 CFR 301.6676–1, 301.7424–1,removed; regulations declared ob-solete (TD 8655) 12, 9


Returns:Form 990, church affiliated organiza-

tions exempt from filing (RP 10)2, 17

On-line service electronic filing pro-gram; Form 1040 (RP 20) 4, 88

Rulings:Areas in which advance rulings

willing to be issued:Associate Chief Counsel (Domes-

tic), Associate Chief Counsel(Employee Benefits and ExemptOrganizations) (RP 3) 1, 86

Associate Chief Counsel (Interna-tional) (RP 7) 1, 185

Areas in which rulings will not beissued (RP 12) 3, 30


778/20042/17APR96/C34-053


Rulings—ContinuedEmployee plans and exempt organi-

zations user fees correction (RP8A) 9, 10


Rulings—ContinuedTax-exempt bonds, issuance pro-

cedrues (RP 16) 3, 45Technical advice, employee plans


Rulings—ContinuedRulings and determination letters, issu-

ance procedures (RP 4) 1, 94Tax conventions:

Competent authority procedure (RP
Letter rulings, determination letters,and information letters, AssociateChief Counsel (Domestic), Associ-ate Chief Counsel (Employee Ben-efits and Exempt Organizations),Associate Chief Counsel (Enforce-ment Litigation) and AssociateChief Counsel (International) (RP1) 1, 8
No-rule provision, combining trans-actions (RP 22) 5, 27 (Notice 6) 5,27

and exempt organizations (RP 5)1, 129

Technical advice to the District Direc-tors and Chiefs, Appeals Offices,from the Associate Chief Counsel(Domestic), Associate Chief Counsel(Employee Benefits and ExemptOrganizations), Associate ChiefCounsel (Enforcement Litigation),and Associate Chief Counsel (Inter-national) (RP 2) 1, 60

U

50

13) 3, 31Relief in treaty cases (RP 14) 3, 41

ser fees for employee plans and exemptorganizations (RP 8) 1, 187

SEQ 0116 JOB C34-053-015 PAGE-0051 INDEX REVISED 17APR96 AT 08:43 BY AT DEPTH: 65.01 PICAS WIDTH 32.10 PICAS COMPOSITE COLOR

778/20042/17APR96/C34-053

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NOTES


778/20042/17APR96/C34-053

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NOTES


778/20042/17APR96/C34-053

53

NOTES

SEQ 0012 JOB IRSBCOV-001-003 PAGE-0004 IRS BUL BACK COVREVISED 18APR96 AT 10:06 BY LR DEPTH: 65.01 PICAS WIDTH 46 PICAS COMPOSITE COLOR

778/20043/18APR96/IRSBCOV-001

4

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