us internal revenue service: irb05-32

8/14/2019 US Internal Revenue Service: irb05-32

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Bulletin No. 2005-3August 8, 200

HIGHLIGHTS

OF THIS ISSUEThese 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. 200547, page 261. ATM surcharge fees. This ruling holds that, for federalincome tax purposes, a credit card issuer treats third-partyATM surcharge fees incurred by its cardholders as additionalamounts loaned to those cardholders. Further, this is so

whether the credit card issuer reflects the ATM surchargefee on the cardholders account as part of the amount ofthe cardholders cash advance (as in Situation 1) or as aseparately stated amount (as in Situation 2).

Rev. Rul. 200548, page 259.Restricted property received for services; securities law.This ruling clarifies that, except as otherwise provided by sec-tion 83 of the Code, transfer restrictions on restricted stockor other section 83 property do not prevent the property frombeing substantially vested for purposes of section 83.

Notice 200553, page 263.This notice provides supplemental guidance for foreign banksconcerning interest expense allocation. The notice also indi-cates that the Treasury Department and the IRS are evaluat-ing foreign banking industry data to determine whether the93-percent fixed ratio in step 2 of the interest expense allo-cation formula under regulations section 1.8825 should beincreased, and whether the fair market value election for valu-ing U.S. assets should require the use of the actual ratio in step2. The notice also permits taxpayers who use the adjustedU.S. book liability method to calculate excess interest by ref-erence to a published LIBOR rate rather than the taxpayersactual non-U.S.-based dollar borrowing rate.

Notice 200555, page 265.2005 marginal production rates. This notice announcthe applicable percentage under section 613A of the Code be used in determining percentage depletion for marginal proerties for the 2005 calendar year.

Notice 200556, page 266.

2005 enhanced oil recovery credit. The enhanced oil covery credit for taxable years beginning in the 2005 calendyear is determined without regard to the phase-out for cruoil price increases provided in section 43(b) of the Code.

Notice 200557, page 267.Tobacco quota termination payments. This notice providguidance in a Q&A format regarding the tax treatment of paments made to eligible tobacco quota holders for the termnation of tobacco marketing quotas and related price suppoprograms under the American Jobs Creation Act of 2004. Ntice 200551 modified and superseded.

Rev. Proc. 200547, page 269.This procedure provides automatic consent procedures for ctain taxpayers to change their method of accounting for crecard cash advance fees to treat these fees as creating or creasing OID on a pool of credit card loans that includes tcash advances that give rise to these fees. The procedualso sets forth the conditions under which the Commissionwill not challenge a taxpayers treatment of such fees. ReProc. 20029 modified and amplified.

(Continued on the next pag

Announcements of Disbarments and Suspensions begin on page 275.

Finding Lists begin on page ii.


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EXEMPT ORGANIZATIONS

Announcement 200554, page 283.American Islamic College, Inc., of Chicago, IL; Athena Sports ofArvada, CO; National Consumer Council, Inc., of Las Vegas, NV;National Consumer Council, Inc., of Los Angeles, CA; NorthernServices Group, Inc., of Monsey, NY; Project Homestead, Inc.,of High Point, NC; and University of Baltimore Athletic Founda-

tion, Inc., of Baltimore, MD, no longer qualify as organizationsto which contributions are deductible under section 170 of theCode.

EXCISE TAX

Announcement 200551, page 283.The Service will not assert the penalty under section 6715of the Code with respect to dyed diesel fuel that is sold foruse or used for highway use in Florida counties west of theApalachicola River during the period July 8, 2005, through July

18, 2005.

TAX CONVENTIONS

Notice 200553, page 263.This notice provides supplemental guidance for foreign banksconcerning interest expense allocation. The notice also indi-cates that the Treasury Department and the IRS are evaluat-ing foreign banking industry data to determine whether the93-percent fixed ratio in step 2 of the interest expense allo-cation formula under regulations section 1.8825 should be

increased, and whether the fair market value election for valu-ing U.S. assets should require the use of the actual ratio in step2. The notice also permits taxpayers who use the adjustedU.S. book liability method to calculate excess interest by ref-erence to a published LIBOR rate rather than the taxpayersactual non-U.S.-based dollar borrowing rate.

ADMINISTRATIVE

Notice 200553, page 263.This notice provides supplemental guidance for foreign banks

concerning interest expense allocation. The notice also indi-cates that the Treasury Department and the IRS are evaluat-ing foreign banking industry data to determine whether the93-percent fixed ratio in step 2 of the interest expense allo-cation formula under regulations section 1.8825 should beincreased, and whether the fair market value election for valu-ing U.S. assets should require the use of the actual ratio in step2. The notice also permits taxpayers who use the adjustedU.S. book liability method to calculate excess interest by ref-erence to a published LIBOR rate rather than the taxpayersactual non-U.S.-based dollar borrowing rate.

Rev. Proc. 200548, page 271.This procedure provides the maximum vehicle values using thespecial valuation rules under sections 1.6121(d) and (e) of theregulations. These values are indexed for inflation and mustbe adjusted annually by referring to the Consumer Price Index(CPI).

Rev. Proc. 200550, page 272.This procedure prescribes how an eligible educational institu-

tion may obtain automatic consent from the Service to changeits method of reporting under section 6050S of the Code andsection 1.6050S1 of the regulations. For calendar years be-ginning after December 31, 2003, an eligible educational in-stitution must elect to report either the aggregate amount ofpayments received, or the aggregate amount billed, for qual-ified expenses during the calendar year for students enrolledfor any academic period. Section 1.6050S1(b)(1) providesthat once an eligible educational institution elects to report ei-ther amounts billed, or payments received, it must continue touse the same method of reporting for all subsequent calendaryears for which it is required to file information returns, and fur-

nish information statements, unless permission is granted tochange its reporting method. An eligible educational institutionthat complies with all of the conditions and procedures of thisrevenue procedure has obtained consent to change its methodof reporting as required by section 1.6050S1(b)(1).

August 8, 2005 200532 I.


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The IRS Mission

Provide Americas taxpayers top quality service by helpingthem understand and meet their tax responsibilities and by

applying the tax law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly and may be obtained from theSuperintendent of Documents on a subscription basis. Bulletincontents are compiled semiannually into Cumulative Bulletins,which are sold on a single-copy basis.

It is the policy of the Service to publish in the Bulletin all sub-

stantive rulings necessary to promote a uniform application ofthe tax laws, including all rulings that supersede, revoke, mod-ify, or amend any of those previously published in the Bulletin.All published rulings apply retroactively unless otherwise indi-cated. Procedures relating solely to matters of internal man-agement are not published; however, statements of internalpractices and procedures that affect the rights and duties oftaxpayers are published.

Revenue rulings represent the conclusions of the Service on theapplication of the law to the pivotal facts stated in the revenueruling. In those based on positions taken in rulings to taxpayersor technical advice to Service field offices, identifying detailsand information of a confidential nature are deleted to preventunwarranted invasions of privacy and to comply with statutoryrequirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considereand Service personnel and others concerned are cautionagainst reaching the same conclusions in other cases unlethe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

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

Part II.Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart Tax Conventions and Other Related Items, and Subpart B, Leislation and Related Committee Reports.

Part III.Administrative, Procedural, and MiscellaneouTo the extent practicable, pertinent cross references to thesubjects are contained in the other Parts and Subparts. Alincluded in this part are Bank Secrecy Act Administrative Rings. Bank Secrecy Act Administrative Rulings are issued the Department of the Treasurys Office of the Assistant Se

retary (Enforcement).

Part IV.Items of General Interest.This part includes notices of proposed rulemakings, disbment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative indfor the matters published during the preceding months. Themonthly indexes are cumulated on a semiannual basis, and apublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropria

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

200532 I.R.B. August 8, 200


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Part I. Rulings and Decisions Under the Internal Revenue Codeof 1986Section 83.PropertyTransferred in Connection With Performance ofServices

26 CFR 1.833: Meaning and use of certain terms substantially vested.

Restricted property received for ser-

vices; securities law. This ruling clarifies

that, except as otherwise provided by sec-

tion 83 of the Code, transfer restrictions on

restricted stock or other section 83 prop-

erty do not prevent the property from being

substantially vested for purposes of section

83.

Rev. Rul. 200548

ISSUE

If an employee exercises a nonstatutory

option more than six months after grant,

but is subject to restrictions on his abil-

ity to sell the stock obtained through ex-

ercise of the option under rule 10b5 un-

der the Securities Exchange Act of 1934

and the contractual provisions described

below, is the employee required to recog-

nize income under section 83 of the Inter-

nal Revenue Code at the time of the exer-

cise of the option?

FACTS

On January 2, 2005, Employee E, an

employee of Company M, is granted a non-

statutory option to purchase M common

stock. Although the option is immediately

exercisable, it has no readily ascertainable

fair market value when it is granted. Un-

der the option, Employee E has the right to

purchase 100 shares of M stock for $10 per

share, which is the fair market value of an

M share on the date of grant of the option.On May 1, 2005, M sells its common

stock in an initial public offering. As re-

quired under the Underwriting Agreement,

Employee E agrees not to sell, otherwise

dispose of, or hedge any common shares,

options, warrants, or convertible securities

of M from May 1 through November 1 of

2005 (the lock-up period).

Also on May 1, 2005, M adopts an In-

sider Trading Compliance Program, under

which, as applied to 2005, insiders (such

as Employee E) may trade M shares only

between November 5 and November 30

of that year (the trading window). Un-

der the Program, if Employee E trades M

shares outside the trading window with-out Ms permission, M has the right to ter-

minate Employee Es employment. How-

ever, the exercise of nonstatutory options

for M shares is not prohibited under the

referenced agreements.

On August 15, 2005 (during the lock-up

period and outside the trading window), M

stock is trading on an established securi-

ties market at more than $10 per share. On

that date, Employee E fully exercises the

option, paying the exercise price in cash,

and receives 100 M shares. Employee Es

rights in the shares received as a result of

the exercise are not conditioned upon the

future performance of substantial services.

As of that date, Employee E is in the pos-

session of material nonpublic information

concerning M that would subject him to li-

ability under Rule 10b5 under the Secu-

rities Exchange Act of 1934 (Exchange

Act), 17 C.F.R. 240.10b5, if Employee

E sold the M shares while in possession of

such information.

LAW AND ANALYSIS

Section 83(a) provides that if, in con-

nection with the performance of services,

property is transferred to any person other

than the person for whom such services

are performed, the excess of the fair mar-

ket value of the property at the first time

that the rights to the property are either

transferable or not subject to a substantial

risk of forfeiture (substantially vested),

whichever occurs earlier, over the amount

paid for the property is included in the

gross income of the service provider in thefirst taxable year in which the rights to the

property are substantially vested.

For purposes of section 83, a transfer

of property occurs when a person acquires

a beneficial ownership interest in the prop-

erty (disregarding any lapse restriction).

Seesection 1.833(a)(1) of theIncome Tax

Regulations.

Under section 1.833(h), a restriction

which, by its terms, will never lapse (also

referred to as a nonlapse restriction) is

permanent limitation on the transferabilit

of property that will require the transfere

of the property to sell (or offer to sell) th

property at a price determined under a for

mula and that will continue to apply and benforced against the transferee or any sub

sequent holder (other than the transferor)

An obligation to resell (or to offer to sell

the transferred property to a specific per

son or persons at its fair market value a

the time of the sale is not a nonlapse re

striction.

The term lapse restriction means a re

striction other than a nonlapse restriction

and includes (but is not limited to) a re

striction that carries a substantial risk o

forfeiture. See section 1.833(i).

For purposes of section 83, propert

is substantially nonvested when it is bot

subject to a substantial risk of forfei

ture and is nontransferable within th

meaning of sections 1.833(c) and (d), re

spectively. Property is substantially veste

when it is either transferable or not subjec

to a substantial risk of forfeiture.

Whether a risk of forfeiture is substan

tial (or not) depends upon the facts and cir

cumstances. A substantial risk of forfei

ture exists where rights in property that ar

transferred are conditioned, directly or indirectly, upon the future performance (o

refraining from performance) of substan

tial services by any person or the occur

rence of a condition related to the purpos

of the transfer, and the possibility of for

feiture is substantial if such condition i

not satisfied. Property is not subject to

substantial risk of forfeiture to the exten

that the employer is required to pay the fai

market value of a portion of the property t

the employee upon the return of the prop

erty. The risk that the value of propert

will decline during a certain period of timdoes not constitute a substantial risk of for

feiture. A nonlapse restriction, standing b

itself, is not a substantial risk of forfeiture

See section 1.833(c)(1).

For purposes of section 83, the right

of a person in property are transferable

if the person can transfer any interest in

the property to any person other than th

transferor of the property, but only if th

transferees rights in the property are no

200532 I.R.B. 259 August 8, 200


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subject to a substantial risk of forfeiture.

Accordingly, property is transferable if the

person performing the services or receiv-

ing the property can sell, assign, or pledge

(as collateral for a loan, or as security for

the performance of an obligation, or for

any other purpose) his interest in the prop-

erty to any person other than the trans-

feror of the property, and if the transferee

is not required to give up the property or

its value in the event that the substantial

risk of forfeiture materializes. See section

1.833(d).

Section 83(e)(3) provides that section

83(a) does not apply to the transfer of an

option without a readily ascertainable fair

market value. However, section 83(a) does

apply to such an option at the time that it is

exercised, sold, or otherwise disposed of.

If the option is exercised, section 83(a) ap-

plies to the transfer of property pursuant to

the exercise. If the option is sold or other-wise disposed of in an arms length trans-

action, section 83(a) applies to the transfer

of money or other property received in the

same manner as it would have applied to

the transfer of property pursuant to an ex-

ercise of the option. See section 1.837(a)

of the regulations.

Under section 83(c)(3) of the Code

and section 1.833(j) of the regulations, if

the sale of property at a profit within six

months after the purchase of the property

could subject a person to suit under sec-

tion 16(b) of the Exchange Act, 15 U.S.C. 78p(b), the persons rights in the prop-

erty are treated as subject to a substantial

risk of forfeiture, and as not transferable,

until the earlier of (1) the expiration of

such six-month period, or (2) the first

day on which the sale of the property at

a profit will not subject the person to suit

under section 16(b). Because, when en-

acting section 83(c)(3), Congress decided

that the only provision of the securities

law that would delay taxation under that

section would be section 16(b), potential

liability for insider trading under Rule10b5, for example, does not cause rights

in property taxable under section 83 to be

substantially nonvested.

Section 16(b) liability is triggered by

either a purchase and sale or a sale

and purchase of a security registered

under section 12 of the Exchange Act,

15 U.S.C. 78l, within a period of less

than six months by an officer, director, or

greater-than-10-percent owner of the cor-

poration that issued the security. 15 U.S.C.

78p(a) and (b). The combination of a

purchase and a sale event (in either order)

within a six-month period is what triggers

section 16(b) liability.

Before May 1, 1991, the acquisition of

stock as the result of the exercise of an op-

tion was viewed as a purchase for sec-

tion 16(b) purposes. Thus, the six-month

period under section 16(b) was measured

from the date an option was exercised.

However, effective May 1, 1991, the

Securities and Exchange Commission

(SEC) adopted new rules under section

16; thereafter, for purposes of that section,

derivative securities, including options,

generally were treated as the functional

equivalents of stock ownership. Own-

ership Reports and Trading by Officers,

Directors and Principal Security Hold-

ers, SEC Release No. 3428869, 56 Fed.

Reg. 7242, 7248 (Feb. 21, 1991). Statedanother way, the SEC recognized that

holding derivative securities is function-

ally equivalent to holding the underlying

equity securities for purposes of Section

16, since the value of the derivative se-

curities is a function of or related to the

value of the underlying equity security.

Id. Accordingly, the SEC determined that

the acquisition of an option should be

deemed the significant event for purposes

of section 16(b), not the exercise. Id.

In implementing this change, the SEC

provided that any acquisition or dispo-sition of an option involves either a

purchase or sale for section 16(b)

purposes. 17 C.F.R. 240.16b6(a),

240.16a1(c), and 240.16a1(b). The SEC

exempted from section 16(b) exercises and

conversions of options that (like Employee

Es) have a fixed exercise price due at the

exercise or conversion, other than op-

tions that are out-of-the-money at the time

of exercise. 17 C.F.R. 240.16b6(b).

In other words, after May 1, 1991, the

six-month holding period under section

16(b) is measured from the date an op-tion is granted, not when it is exercised

(with exceptions not applicable here).

Thus, after May 1, 1991, section 16(b)

interacts with section 83 as follows: if,

for example, shares are acquired through

the exercise of a nonstatutory option in a

transfer taxable under the rules of section

83, the holder of the shares would not be

subject to section 16(b) liability as a result

of an immediate sale of the shares unless

the sale occurred during the six-month

period beginning with the date of grant

of the option. Even if an optionee exer-

cises an option and sells the underlying

shares within six months of the date of

grant of the option, an exemption from

liability under section 16(b) may be avail-

able under other provisions of the SEC

rules. See 17 C.F.R. 240.16b3(d)(1)

and (2). If such an exemption is available

within six months of the date of grant,

the compensation income attributable to

the employees exercise of the option is

includable in the employees gross income

on the later of the date of exercise and the

date the exemption becomes available. If

such an exemption is not available within

six months from the date of grant, the

compensation income attributable to the

employees exercise of the option would

be includable in the employees gross in-

come on the later of the date of exercise orthe date that is six months from the date

of grant.

Applying the above rules, because the

option is granted to Employee E on Jan-

uary 2, 2005, the section 16(b) period ap-

plicable to the option expires on July 2 of

that year. Accordingly, the section 16(b)

period expires before the date that Em-

ployee E exercises the option and the M

shares are transferred to Employee E (on

August 15). Thus, the shares are not sub-

ject to a substantial risk of forfeiture un-

der section 83(c)(3) as a result of sec-tion 16(b). Moreover, neither the Under-

writing Agreement nor the Insider Trad-

ing Compliance Program imposes a sub-

stantial risk of forfeiture, because the pro-

visions of those agreements do not con-

dition Employee Es rights in the shares

upon anyones future performance (or re-

fraining from performance) of substantial

services or on a condition related to a

purpose of the transfer of the shares to

Employee E. Accordingly, neither section

83(c)(3) nor the provisions of those agree-

ments preclude taxation under section 83when the shares resulting from exercise of

the option are transferred to Employee E.

These conclusions are consistent with the

courts decision in Tanner v. Commr., 117

T.C. 237 (2001), affd, No. 0260463 (5th

Cir. Mar. 26, 2003); but see Robinson

v. Commr., 805 F.2d 38 (1st Cir. 1986),

revg, 82 T.C. 444 (1984).

Additionally, the restrictions imposed

by the referenced agreements and Rule

August 8, 2005 260 200532 I.R


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10b5 on Employee Es sales (or other

trading) of the M shares are lapse restric-

tions, because the restrictions imposed

by the Underwriters Agreement and Rule

10b5 are temporary and the restrictions

imposed by the Insider Trading Compli-

ance Program are inapplicable during the

window period. Accordingly, these re-

strictions are ignored when valuing the

shares. See section 83(a).

The Department of the Treasury and the

Internal Revenue Service intend to amend

the 83 regulations to explicitly set forth

the holdings in this revenue ruling.

HOLDING

Under section 83, the compensation in-

come attributable to Employee Es exer-

cise of the option for M shares is includible

in Employee Es gross income when the

shares obtained through exercise of the op-

tion are transferred to Employee E, and theamount of compensation income is deter-

mined without regard to the share-transfer

restrictions imposed by the Underwriters

Agreement and the Insider Trading Com-

pliance Program.

DRAFTING INFORMATION

The principal author of this revenue rul-

ing is Michael Hughes of the Office of

Division Counsel/Associate Chief Coun-

sel (Tax Exempt and Government Enti-

ties). For further information regardingthis revenue ruling, contact Mr. Hughes

or Robert Misner at (202) 6226030 (not

a toll-free number).

Section 446.General Rulefor Methods of Accounting

Rev. Proc. 200547, 200532 I.R.B. dated August

8, 2005, provides automatic consent procedures for

certain taxpayers to change their method of account-

ing for credit card cash advance fees to treat these

fees as creating or increasing OID on a pool of credit

card loans that includes the cash advances that giverise to these fees. This revenue procedure also sets

forth the conditions under which the Commissioner

willnot challenge a taxpayerstreatmentof these fees

as creating or increasing OID on a pool of credit card

loans that includes the cash advances that give rise to

the fees. See Rev. Proc. 2005-47, page 269.

Section 1272.CurrentInclusion in Income ofOriginal Issue Discount

Rev. Proc. 200547, 200532 I.R.B.dated August


certain taxpayers to change their method of account-

ing for credit card cash advance fees to treat these


card loans that includes the cash advances that give

rise to these fees. This revenue procedure also sets


willnot challengea taxpayerstreatmentof these fees




Section 1273.Determina-tion of Amount of OriginalIssue Discount

Rev. Proc. 200547, 200532 I.R.B.dated August


certain taxpayers to change their method of account-ing for credit card cash advance fees to treat these


card loans that includes the cash advances that give

rise to these fees. This revenue procedure also sets


will not challenge a taxpayerstreatmentof these fees




26 CFR 1.12732: Determination of issue price and

issue date.

ATM surcharge fees. This ruling holdsthat, for federal income tax purposes, a

credit card issuer treats third-party ATM

surcharge fees incurred by its cardhold-

ers as additional amounts loaned to those

cardholders. Further, this is so whether

the credit card issuer reflects the ATM sur-

charge fee on the cardholders account as

part of the amount of the cardholders cash

advance (as in Situation 1) or as a sepa-

rately stated amount (as in Situation 2).

Rev. Rul. 200547

ISSUE

If a credit card holder uses the credit

card to obtain a cash advance froman ATM

and, as a result, incurs a liability for an

ATM surcharge fee, how does the credit

card issuer treat for federal income tax pur-

poses the amount that it remits to the owner

or operator of the ATM in satisfaction of

the cardholders liability?

FACTS

X issues credit cards. Each credit car

allows the cardholder to access a revolvin

line of credit to make purchases of good

and services and to obtain cash advances

Cardholders may obtain cash advances, fo

example, by using their credit cards to ob

tain cash from an automated teller ma

chine (ATM). X does not own or operatany ATMs and does not impose any ATM

transaction fees on its cardholders under it

cardholder agreements.

Situation 1: X issues a credit card t

cardholderA, and A uses the credit card t

obtain a cash advance of $100 at an ATM

owned by Y. After A initiates the transac

tion requesting $100, A is informed that, i

the transaction is completed, an ATM sur

charge fee of $5 will be deducted from th

$100 cash advance requested by A. A ac

cepts liability for the $5 ATM surcharg

fee, and the transaction, in which $95 o

funds are disbursed to A, is completed

Upon Ys request to X for reimbursemen

for As ATM cash advance transaction, X

remits $100 to Y and reflects a $100 cas

advance on As account.

Situation 2: The facts are the same a

in Situation 1 except that A uses an ATM

operated by Z to obtain a cash advance o

$125 and that the transaction is handle

as follows. After A initiates the transac

tion requesting $125, A is informed that

if A completes the transaction, a $5 ATMsurcharge fee will be charged to As credi

card in addition to the $125 cash advanc

requested by A. A accepts liability for th

$5 ATM surcharge fee, and the transac

tion, in which $125 of funds are disbursed

to A, is completed. Upon Zs request fo

reimbursement forAs ATM cash advanc

transaction, which includes a $5 ATM sur

charge fee, Xremits $130 to Zand reflect

on As account both a $125 cash advanc

and a $5 ATM surcharge fee.

LAW AND ANALYSIS

Section 1.12732(g) of the Income Ta

Regulations provides rules for determin

ing the treatment of certain cash payment

made incident to lending transactions

Section 1.12732(g)(4) provides rules fo

determining the treatment of these pay

ments when made between the lende

and a person other than the borrower (th

third party). If, as part of a lendin

200532 I.R.B. 261 August 8, 200


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transaction, the lender makes a payment

to a third party, that payment is treated in

appropriate circumstances as an additional

amount loaned to the borrower and then

paid by the borrower to the third party.

In both Situations 1 and 2, the $5 ATM

surcharge fee is imposed on A by the third

party owner or operator of the ATM, not

by X. When X remits an amount inclusive

of the ATM surcharge fee to Y in Situa-

tion 1 and to Z in Situation 2, X is making

those payments on behalf of A. Therefore,

in both Situations 1 and 2, the $5 ATM sur-

charge fee is appropriately treated under

1.12732(g)(4) as an additional amount

loaned by Xto A and then paid by A to Yor

Z. This is so whetherXreflects the $5 ATM

surcharge fee on As account as part of the

amount of As cash advance (as in Situa-

tion 1) or as a separately stated amount (as

in Situation 2).

HOLDING

In both Situations 1 and 2, for federal

income tax purposes the credit card is-

suer treats third-party ATM surcharge fees

incurred by its cardholders as additional

amounts loaned to those cardholders.


The principal authors of this rev-

enue ruling are Jonathan Silver and

Tina Jannotta of the Office of Chief Coun-

sel (Financial Institutions and Products).

For further information regarding this rev-enue ruling, contact the principal authors

at (202) 6223930 (not a toll-free call).

August 8, 2005 262 200532 I.R


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Part III. Administrative, Procedural, and Miscellaneous

Foreign Bank Interest Expense Allocation to EffectivelyConnected Income

Notice 200553

SECTION 1. OVERVIEW

On March 8, 1996, final regulations

were published in the Federal Register

(T.D. 8658, 19961 C.B. 161 [61 FR

9326]; Treas. Dec. Int. Rev. 8658), under

section 1.8825 regarding the determina-

tion of the interest expense deduction of

a foreign corporation engaged in a U.S.

trade or business. The Treasury Depart-

ment and the Internal Revenue Service

have monitored these provisions to ensure

that they continue to produce results that

are consistent with the policies under-

lying the regulations, in light of current

economic circumstances. The Treasury

Department and the IRS believe that, in

the context of the banking industry, certain

changes to the regulations will facilitate

compliance. This notice describes such

changes, which will apply to determine

the interest expense deduction of a for-

eign corporation that is a bank, within

the meaning of section 585(a)(2)(B) with-

out regard to the second sentence thereof

(hereafter foreign bank). The TreasuryDepartment and IRS intend to issue regu-

lations consistent with this notice.

The remainder of this notice is divided

into seven sections. Section 2 provides

relevant legal background. Section 3 pro-

vides guidance on the coordination of sec-

tion 1.8825 with treaties. Section 4 in-

vites the submission of data and other in-

formation relevant to the consideration of

a revised fixed ratio available for purposes

of determination of U.S.-connected liabil-

ities in Step 2 of section 1.8825. Sec-

tion 5 provides guidance on the determina-tion of the applicable rate for excess inter-

est under the adjusted U.S.-booked liabil-

ities method in Step 3 of section 1.8825.

Section 6 solicits comments on coordina-

tion of Step 1 determination of U.S. assets

on the adjusted or fair market value ba-

sis with Step 2 determination of U.S.-con-

nected liabilities using the fixed or actual

ratio. Section 7 provides information on

submitting comments. Finally, section 8

provides drafting information.

SECTION 2. LEGAL BACKGROUND

Section 1.8825 generally requiresa foreign corporation to determine the

amount of interest expense that is al-

locable under section 882(c) to income

effectively connected (or treated as effec-

tively connected) with the conduct of the

foreign corporations trade or business in

the United States by a three step calcula-

tion.

Step 1 determines the total value of the

U.S. assets of the foreign corporation, gen-

erally the assets that produce (or would

produce) income effectively connected

with the conduct of the U.S. trade or busi-

ness of the foreign corporation. The value

of the U.S. assets is their adjusted basis,

unless the taxpayer makes an election to

value the assets on the basis of their fair

market value.

Step 2 determines the U.S.-connected

liabilities of the foreign corporation as the

product of the U.S. assets multiplied ei-

ther by the actual ratio of worldwide lia-

bilities to worldwide assets or, if the tax-

payer makes an election, by a fixed ratio,

currently 93-percent. If the taxpayer haselected to value U.S. assets on the basis

of fair market value for purposes of Step

1, then the taxpayer must value worldwide

assets on a fair market value basis for pur-

poses of Step 2.

Step 3 determines the allocable amount

of interest expense under the adjusted U.S.

booked liabilities (AUSBL) method, or,

if the taxpayer makes an election, under

the separate currency pools method. Un-

der the AUSBL method, the foreign corpo-

rations interest expense is based on the in-

terest expense on the foreign corporationsU.S. books. If the U.S. booked liabilities

exceed the U.S.-connected liabilities, then

the foreign banks U.S. booked interest ex-

pense is scaled down. If the U.S.-con-

nected liabilities exceed the U.S.-booked

liabilities, interest expense in addition to

the U.S. booked interest expense is allo-

cated by reference to the foreign U.S. dol

lar borrowing rate multiplied by the exces

U.S.-connected liabilities. Under the sepa

rate currency pools method, the worldwid

interest expense is allocated to effectivel

connected income based on the U.S.-con

nected liabilities in each currency multiplied by the foreign banks worldwide rat

for liabilities in such currency.

Rules on the time and manner of mak

ing and changing the various elections ar

provided in sections 1.8825(a)(7) an

1.8825(b)(2).

SECTION 3. COORDINATION OF THE

DETERMINATION OF THE INTEREST

EXPENSE DEDUCTION FOR

FOREIGN BANKS AND TREATIES

Section 1.8825(a)(2) currently state

that [t]he provisions of this section pro

vide the exclusive rules for determinin

the interest expense attributable to th

business profits of a permanent establish

ment under a U.S. income tax treaty.

This statement is no longer accurate i

light of the income tax treaties entere

into with the United Kingdom and Japan,

and, therefore, will be eliminated by th

amendments to the regulations.

The Exchange of Notes to the curren

United States-United Kingdom and Unite

States-Japan income tax treaties adopt thprinciples of Article 9(1) for determining

the profits attributable to a permanent es

tablishment.2 Both Notes address the al

location of the capital of financial insti

tutions to their permanent establishments

stating in pertinent part that the Contract

ing States may treat the permanent estab

lishment

as having the same amount of capita

that it would need to support its activi

ties if it were a distinct and separate en

terprise engaged in the same or simila

activities. With respect to financial institutions other than insurance compa

nies, a Contracting State may determin

the amount of capital to be attribute

to a permanent establishment by allo

cating the institutions total equity be

tween its various offices on the basis o

the proportion of the financial institu

1 See United States-United Kingdom Income Tax Treaty, Article 7 (July 24, 2001); United States-Japan Income Tax Treaty, Article 7 (November 6, 2003) and accompanying Exchange o

Notes.

2 Exchange of Notes, United States-Japan Income Tax Treaty, para. 2 (July 24, 2001) and United States-United Kingdom Income Tax Treaty (July 24, 2001).

200532 I.R.B. 263 August 8, 200


9/31

tions risk-weighted assets attributable

to each of them.3

The Treasury Technical Explanations of

the United Kingdom and Japan treaties ac-

knowledge that the allocation method pro-

vided by section 1.8825 does not take into

account the relative riskiness of assets that

are attributable to a permanent establish-

ment and that equal weighting of risk, in

some cases, may require a taxpayer to al-

locate more capital to the United States

(and therefore would reduce the taxpayers

interest expense deduction) than is appro-

priate.4

Accordingly, the two treaties permit

United Kingdom and Japanese resident

financial institutions the use of an alter-

native approach to the determination of

their taxable income, without the sec-

tion 1.8825 determination of interest

expense, for purposes of establishing theupper limit with respect to the amount of

tax that may be imposed on a U.S. per-

manent establishment of a foreign bank.

Such an alternative approach under the

treaties would incorporate risk-weighting

of the foreign banks assets as well as

other consequential deviations from the

rules of section 1.8825 in line with the

arms length principles of Articles 7 and

9(1) of those treaties.

As reflected in the Notes and Technical

Explanations, the two treaties require an

allocation of sufficient equity capital in de-termining the profits attributable to a per-

manent establishment. The amount of eq-

uity capital shown on a taxpayers books

is not determinative. Therefore, it will be

acceptable only to the extent such allot-

ment is sufficient to support the assets and

risks attributable to the permanent estab-

lishment.

The Treasury Department and IRS con-

tinue to believe that application of sec-

tion 1.8825 also results in a sufficient

allocation of equity capital to a perma-

nent establishment, and is simpler to ap-ply than an alternative approach under the

treaties. As stated in both Technical Ex-

planations, taxpayers are not required to

use the risk-weighted approach for allocat-

ing equity capital provided by the treaties.

Rather, taxpayers may continue to use sec-

tion 1.8825 in lieu of an alternative ap-

proach under the treaties.

SECTION 4. DETERMINATION OF

U.S.-CONNECTED LIABILITIES

UNDER THE FIXED RATIO FOR

FOREIGN BANKS

As noted, Step 2 of the calculation is

used to determine the amount of U.S.-con-nected liabilities. Section 1.8825(c)(1)

provides that [t]he amount of U.S.-con-

nected liabilities for the taxable year

equals the total value of U.S. assets for the

taxable year (as determined under para-

graph (b)(3) of this section) multiplied

by the actual ratio for the taxable year

(as determined under paragraph (c)(2) of

this section) or, if the taxpayer has made

an election in accordance with paragraph

(c)(4) of this section, by the fixed ratio. In

1996, the final regulations established the

fixed ratio for foreign banks at 93 percent.The Treasury Department and IRS have

considered data from more recent years to

determine whether the 93 percent fixed ra-

tio continues to be appropriate. Based on

that examination, it appears that a fixed ra-

tio of between 94 and 96 percent may be

more appropriate. The Treasury Depart-

ment and IRS invite the submission of data

and other information relevant to the con-

sideration of a revised fixed ratio, includ-

ing information about the nature of the as-

sets and risks related to the U.S. trade or

business as compared to the business con-

ducted outside the United States.

It is expected that taxpayers will be per-

mitted to make new elections with respect

to section 1.8825 to take into account

these changes.

SECTION 5. DETERMINATION OF

EXCESS INTEREST OF BANKS

UNDER THE ADJUSTED U.S.-BOOK

LIABILITY METHOD

Under the Adjusted U.S. Booked Lia-

bilities (AUSBL) method taxpayers maybe required under certain facts and circum-

stances to calculate a portion of their in-

terest expense allocation by reference to

the average U.S. dollar borrowing rate in-

curred outside the United States. Sec-

tion 1.8825(d)(5) provides that where the

U.S.-connected liabilities exceed the tax-

payers U.S. booked liabilities (as defined

for banks in section 1.8825(d)(2)(iii)), the

excess U.S.-connected liabilities are multi-

plied by the taxpayers average U.S. dollar

borrowing rate with respect to interest ex-

pense and liabilities shown on the books of

the taxpayers offices or branches outside

the United States. This portion of the Step

3 allocation is referred to as the excess in-

terest.

In prior regulations (the 1980 regu-

lations), section 1.8825 provided that

where information necessary to compute

the actual foreign U.S. dollar borrowing

rate could not be reasonably obtained,

then any method that reasonably approx-

imates the actual rate could be substi-

tuted so long as it was consistently ap-

plied from year to year.5 The 1980 reg-

ulations provided that the 30-day LIBOR

rate may constitute an appropriate proxyfor an actual foreign borrowing rate but did

not specify that the use of the published

LIBOR rate could be used outright if the

actual foreign borrowing rate was capa-

ble of being proved. Where the total for-

eign U.S. dollar borrowings were de min-

imis, the prior regulations substituted the

actual average borrowing rate of the for-

eign corporations trade or business within

the United States.

Where a foreign corporation elects

both the fixed ratio under Step 2 and the

AUSBLmethod under Step 3, it is possiblefor the taxpayers entire interest expense

allocation to be determined by reference

to the books and records of its trade or

business within the United States. This

may be true under the current regulations

if the allocation for the taxpayer does

not result in excess interest but, instead,

is subject to the scale-down rule under

section 1.8825(d)(4). Otherwise, when

these elections are made together, resort

may still be necessary to information typi-

cally maintained outside the United States.

In many cases, the information would becollected only for purposes of computing

the taxpayers excess interest.

To facilitate administrability both for

foreign bank taxpayers and the IRS, the

amendments to the regulations will pro-

vide that such taxpayers who are already

3 Id.

4 Technical Explanation of the United States-United Kingdom Income Tax Treaty, Art. 7, para. 3, CCH, p. 201,301; United States-Japan Income Tax Treaty, Art. 7, para. 3, CCH, p. 113,320.

5 1.8825(b)(2)(i)(B), T.D. 7749, 19811 C.B. 390, 394.

August 8, 2005 264 200532 I.R


10/31

eligible to use the AUSBL method for a

particular year may make a binding an-

nual election to calculate excess interest

under the AUSBL method by reference to

the published 30-day average LIBOR rate

for such year, rather than the actual for-

eign U.S. dollar borrowing rate prescribed

in 1.8825(d)(5), by using such rate to

calculate its interest expense deduction on

a timely filed original Federal income tax

return for such year. The election provi-

sions of 1.8825(a)(7) shall apply on an

annual basis without regard to the binding

5-year minimum period. Such taxpayers

may begin using such rate for tax years

ending on or after the date on which this

notice is published.

SECTION 6. COORDINATION

OF DETERMINATION OF U.S.

ASSETS ON AN ADJUSTED OR

FAIR MARKET VALUE BASIS

WITH DETERMINATION OF

U.S.-CONNECTED LIABILITIES

USING THE FIXED OR ACTUAL

RATIO

The Treasury Department and the IRS

recognize that an increase in the fixed ra-

tio, as contemplated by section 3 of this no-

tice, will render the fixed ratio relatively

more attractive as compared to the actual

ratio for purposes of the Step 2 determina-

tion of the U.S.-connected liabilities of for-

eign banks. Pursuant to the existing reg-

ulations, foreign banks may combine an

election of the fixed ratio for the Step 2

determination of U.S.-connected liabilities

with an election of the fair market value

basis for the Step 1 determination of U.S.

assets.

The Treasury Department and the IRS

are reconsidering whether combining

these elections is consistent with the poli-

cies underlying the regulations. In partic-

ular, it is unclear that such a combination

of elections would produce an appropri-

ate result in light of the prevalence and

significance of intangibles in the banking

industry. The Step 2 determination of

U.S.-connected liabilities using an actual

ratio determined on a fair market value

basis reflects in a balanced manner the

effect of intangibles because such intangi-

bles would be taken into account at their

fair market in both steps. The Step 2 de-

termination of U.S.-connected liabilities

using the fixed ratio in conjunction with a

fair market value election in Step 1 may

not similarly reflect in a balanced manner

the effect of intangibles. The Treasury

Department and the IRS are concerned,

therefore, that the current ability to apply

a fair market value election in conjunction

with a fixed ratio election may distort the

Step 2 determination of U.S.-connectedliabilities. The Treasury Department and

the IRS solicit comments to assist them in

their review of this matter.

SECTION 7. SUBMISSION OF

COMMENTS

Taxpayers may submit comments to:

CC:ITA:RU (PGP12511102), Room

5226, Internal Revenue Service, POB

7604, Ben Franklin Station, Washington,

DC 20044. Submissions may be hand

delivered between the hours of 8 a.m. and

5 p.m. to CC:ITA:RU (PGP12511102),

Couriers Desk, Internal Revenue Ser-

vice, 1111 Constitution Avenue, NW,

Washington, DC. Alternatively, tax-

payers may submit comments electron-

ically via the Internet by submitting com-

ments directly to the IRS Internet site at

http://www.irs.gov/tax_regs/regslist.htm.

SECTION 8. DRAFTING

INFORMATION

The principal author of this notice i

Paul S. Epstein of the Office of Associat

Chief Counsel (International). Howeve

other personnel from the IRS and the Trea

sury Department participated in its devel

opment. For further information regard

ing this notice, contact Paul S. Epstein anGregory Spring at (202) 6223870 (not

toll-free call).

2005 Marginal ProductionRates

Notice 200555

Section 613A(c)(6)(C) of the Interna

Revenue Code defines the term applica

ble percentage for purposes of determin

ing percentage depletion for oil and gaproduced from marginal properties. Th

applicable percentage is the percentag

(not greater than 25 percent) equal to th

sum of 15 percent, plus one percentag

point for each whole dollar by which $2

exceeds the reference price (determine

under 29(d)(2)(C)) for crude oil fo

the calendar year preceding the calenda

year in which the taxable year begins

The reference price determined unde

29(d)(2)(C) for the 2004 calendar yea

is $36.75.

Table 1 contains the applicable percent

ages for marginal production for taxabl

years beginning in calendar years 199

through 2005.

200532 I.R.B. 265 August 8, 200


11/31

Notice 200555 Table 1

APPLICABLE PERCENTAGE FOR MARGINAL PRODUCTION

Calendar Year Applicable Percentage

1991 15 percent1992 18 percent1993 19 percent1994 20 percent

1995 21 percent1996 20 percent1997 16 percent1998 17 percent1999 24 percent2000 19 percent2001 15 percent2002 15 percent2003 15 percent2004 15 percent2005 15 percent

The principal author of this notice is

Kelly R. Morrison-Lee of the Office ofAssociate Chief Counsel (Passthroughs

and Special Industries). For further in-

formation regarding this notice, contact

Ms. Morrison-Lee at (202) 6223120 (not

a toll-free call).

2005 Section 43 InflationAdjustment

Notice 200556

Section 43(b)(3)(B) of the InternalRevenue Code requires the Secretary to

publish an inflation adjustment factor.

The enhanced oil recovery credit under 43 for any taxable year is reduced if

the reference price, determined under

29(d)(2)(C), for the calendar year pre-

ceding the calendar year in which the

taxable year begins, is greater than $28

multiplied by the inflation adjustment fac-

tor for that year.

The term inflation adjustment factor

means, with respect to any calendar year,

a fraction the numerator of which is the

GNP implicit price deflator for the preced-

ing calendar year and the denominator of

which is the GNP implicit price deflatorfor 1990.

Because the reference price for the 2004

calendar year ($36.75) does not exceed$28 multiplied by the inflation adjustment

factor for the 2005 calendar year, the en-

hanced oil recovery credit for qualified

costs paid or incurred in 2005 is deter-

mined without regard to the phase-out for

crude oil price increases.

Table 1 contains the GNP implicit price

deflator used for the 2005 calendar year,

as well as the previously published GNP

implicit price deflators used for the 1991

through 2004 calendar years.

Notice 200556 TABLE 1

GNP IMPLICIT PRICE DEFLATORS

Calendar Year GNP Implicit Price Deflator

1990 112.9 (used for 1991)1991 117.0 (used for 1992)1992 120.9 (used for 1993)1993 124.1 (used for 1994)1994 126.0 (used for 1995)

1995 107.5 (used for 1996)1996 109.7 (used for 1997)1997 112.35 (used for 1998)1998 112.64 (used for 1999)1999 104.59 (used for 2000)2000 106.89 (used for 2001)2001 109.31 (used for 2002)2002 110.63 (used for 2003)2003 105.67 (used for 2004)2004 108.23 (used for 2005)

August 8, 2005 266 200532 I.R


12/31

* Beginning in 1995, the GNP implicit price deflator was rebased relative to 1992. The 1990 GNP implicit price deflator used to

compute the 1996 43 inflation adjustment factor is 93.6.

** Beginning in 1997, two digits follow the decimal point in the GNP implicit price deflator. The 1990 GNP price deflator used to

compute the 1998 43 inflation adjustment factor is 93.63.

*** Beginning in 1999, the GNP implicit price deflator was rebased relative to 1996. The 1990 GNP implicit price deflator used

to compute the 2000 43 inflation adjustment factor is 86.53.

**** Beginning in 2003, the GNP implicit price deflator was rebased relative to 2000. The 1990 GNP implicit price deflator usedto compute the 2004 43 inflation adjustment factor is 81.59.

Notice 200556 TABLE 2

INFLATION ADJUSTMENT FACTORS AND PHASE-OUT AMOUNTS

Calendar Year Inflation Adjustment Factor Phase-out Amount

1991 1.0000 01992 1.0363 01993 1.0708 01994 1.0992 01995 1.1160 0

1996 1.1485 01997 1.1720 01998 1.1999 01999 1.2030 02000 1.2087 02001 1.2353 02002 1.2633 02003 1.2785 02004 1.2952 02005 1.3266 0

Table 2 contains the inflation adjust-

ment factor and the phase-out amount

for taxable years beginning in the 2005

calendar year as well as the previously

published inflation adjustment factors and

phase-out amounts for taxable years be-

ginning in 1991 through 2004 calendar

years.



Kelly R. Morrison-Lee of the Office of

Associate Chief Counsel (Passthroughs

and Special Industries). For further in-

formation regarding this notice, contact

Ms. Morrison-Lee at (202) 6223120 (nota toll-free call).

Termination of TobaccoQuotas and Price Support

ProgramsNotice 200557

INTRODUCTION

This notice modifies and supersedes

Notice 200551, 200528 I.R.B. 74, dated

July 11, 2005. The modifications to Notice

200551 are effective as of June 21, 2005,

the date Notice 200551 was released.

PURPOSE

This notice provides answers to fre-quently asked questions regarding the tax

treatment of federal payments made pur-

suant to 622 of the Fair and Equitable

Tobacco Reform Act of 2004, Title VI of

the American Jobs Creation Act of 2004,

Pub. L. No. 108357, 118 Stat. 1418,

152136 (2004) (the Act).

BACKGROUND

Sections 611 and 612 of the Act ter

minate the tobacco marketing quota program and the tobacco price support pro

gram. Section 622 of the Act provides tha

the United States Department of Agricul

ture (USDA) will offer to enter into a con

tract with an eligible tobacco quota holde

(Owner) under which the Owner may re

ceive total payments of $7 per pound o

quota in 10 equal annual payments in fis

cal years 2005 through 2014 (Owner Pay

ments) in exchange for the termination o

the tobacco marketing quotas and relate

price support. Section 622 does not pro

vide for stated interest on payments du

under the contracts.

For federal income tax purposes

Owner Payments are the proceeds from

a sale of an Owners tobacco quota as o

the date on which the Owner and USDA

enter into a contract for Owner Payment

with respect to the quota (Sale Date). Se

Q & A12 for a special rule regardin

when a transfer of a quota is deemed t

200532 I.R.B. 267 August 8, 200


13/31

occur, under certain circumstances, for

purposes of 1031 of the Internal Rev-

enue Code.

QUESTIONS AND ANSWERS

Q1. Are Owner Payments received un-

der the Act subject to federal income tax?

A1. Yes, Owner Payments are sub-

ject to federal income tax. If the amountsreceived by the Owner are more than the

Owners adjusted basis in the quota, the

Owner has a taxable gain; if the Owner

receives less than the Owners adjusted

basis, the Owner has a loss that may

be deductible for tax purposes if the re-

quirements for deduction under 165

are satisfied. In determining an Owners

gain or loss, the amount received for the

quota does not include any amount treated

as interest for federal tax purposes. See

Q & A7 for help in determining whetherany portion of an Owner Payment is

treated as interest for federal tax purposes.

Q2. How does an Owner determine

the adjusted basis of a quota?

A2. The adjusted basis of a quota

is determined differently depending upon

how the Owner acquired the quota.

An Owner who holds a quota that isderived from an original grant by the

federal government has a basis of zero

in the quota.

The basis of a purchased quota is theprice the Owner paid for it.

Generally an Owner who received aquota as a gift has the same basis in

the quota as the person who gave the

quota to the Owner. Under certain cir-

cumstances, the basis is increased by

an amount related to the amount of gift

tax paid. If the basis is greater than

the fair market value of the quota at the

time of the gift, the basis for determin-

ing loss is that fair market value.

The basis of a quota that an Ownerinherited generally is the fair market

value of the quota at the time of the

decedents death.

The basis of a tobacco quota is not sub-

ject to adjustment through amortization,

depletion, or depreciation. However, if

an Owner improperly has deducted any

amount for these purposes, the Owner

must reduce the basis by the amount de-

ducted before determining the Owners

gain or loss. A similar reduction in the ba-

sis ofa quota mustbe madeforany amount

previously deducted as a loss because of

a reduction in the number of pounds of

tobacco allowable under the quota. If an

Owner purchased a quota and deducted

the entire cost in the year of purchase, then

the Owners basis in the quota is zero.

Q3. If an Owner has a gain and re-

ports Owner Payments under the install-

ment method, when must the gain be in-

cluded in income?

A3. The installment method may

be used to report gain if an Owner re-

ceives at least one Owner Payment after

the close of the Owners taxable year that

includes the Sale Date. The amount of the

gain is the excess of the total amount of

Owner Payments to be received, reducedby any amount treated as interest, over

the Owners adjusted basis in the quota.

Under the installment method, a propor-

tionate amount of the gain is taken into

account in each year in which an Owner

Payment is received. See the instructions

for Form 6252, Installment Sale Income.

Q4. If an Owner has a gain and elects

not to report Owner Payments under the

installment method, when must the gain be

included in income?

A4. The Owner must report the entire

gain on the Owners federal income taxreturn for the taxable year that includes the

Sale Date.

Q5. Is the gain or loss with respect to

a quota ordinary or capital gain or loss?

A5. Whether the gain or loss with

respect to a quota is ordinary or capital

depends on how the Owner used the quota.

If an Owner used a quota in the tradeor business of farming and, on the

Sale Date, the Owners holding pe-

riod for the quota was more than one

year, then the transaction is reportedunder 1231 on Form 4797, Sales of

Business Property. If an Owner has no

other 1231 transactions reportable

on Form 4797, any gain is treated as

long-term capital gain and any loss

is treated as ordinary loss. Even if

an Owner has other reportable 1231

transactions, the net result of all 1231

transactions reported generally is ei-

ther long-term capital gain or ordinary

loss. See the instructions for Form

4797 for more detailed information.

If an Owner held a quota for invest-ment purposes, or for the production

of income, but did not use the quota in

a trade or business, any gain or loss is

capital gain or loss.

Under certain circumstances, some or

all of the gain must be recharacterized andreported as ordinary income. If an Owner

previously deducted (1) the cost of acquir-

ing a quota, (2) amounts for amortization,

depletion, or depreciation, or (3) amounts

to reflect a reduction in the quota pounds,

any gain is taxed as ordinary income up

to the amount previously deducted. The

Owner must report this amount of ordinary

income on the Owners return for the tax-

able year that includes the Sale Date, even

if the Owner uses the installment method

to report the remainder of the gain.

Q6. Are Owner Payments received

under the Act subject to Self-Employ-

ment Contributions Act (SECA) tax (see

1402)?

A6. No.

Q7. Is any portion of an Owner Pay-

ment treated as interest for federal tax pur-

poses?

A7. (a) If the total amount to be paid

under a contract does not exceed $3,000,

no portion of an Owner Payment is treated

as interest for federal tax purposes.

(b) If 483 applies to a contract, a por-tion of each Owner Payment (other than

an Owner Payment due within six months

of the Sale Date) is treated as interest for

federal tax purposes. For example, 483

generally applies to a contract if the to-

tal amount to be paid under the contract

does not exceed $250,000 or if a cash

method election is made under 1274A

and 1.1274A1(c). A contract is eligible

for the cash method election only if the

total amount to be paid under the contract

does not exceed the inflation-adjusted

amount for a cash method debt instrument($3,202,100 for 2005).

(c) In all situations not described in (a)

or (b) above, a portion of each Owner Pay-

ment is treated as interest for federal tax

purposes under 1274.

(d) In general, to determine the amount

of an Owner Payment that is treated as

interest, see 483 or 1274, whichever is

applicable, and the regulations thereunder.

You may wish to consult a tax advisor for

August 8, 2005 268 200532 I.R


14/31

assistance in determining the portion of an

Owner Payment that is treated as interest

and the taxable year in which the interest

is includible in income.

Q8. Does an individual Owners gain

or loss from Owner Payments qualify for

farm income averaging?

A8. No. A tobacco quota is consid-

ered an interest in land, and farm income

averaging is not available for gain or loss

arising from the sale or other disposition of

land.

Q9. Are Owner Payments subject to

information reporting?

A9. Yes. Because a tobacco quota

is considered an interest in land, the to-

tal amount received under a contract by

an owner in a taxable year generally will

be reported by USDA on Form 1099S,

Proceeds From Real Estate Transactions,

if the amount is $600 or more. In addi-

tion, any portion of an Owner Paymenttreated as interest for federal tax purposes

generally will be reported by USDA on

Form 1099INT, Interest Income, if the to-

tal amount of interest received in a taxable

year is $600 or more.

Q10. Is the termination of a tobacco

quota under the Act an involuntary conver-

sion of the quota?

A10. No.

Q11. May an Owner enter into a like-

kind exchange of a quota?

A11. Yes. An Owner may postpone

reporting the gain or loss from the termina-tion of a quota by entering into a like-kind

exchange pursuant to 1031 and the reg-

ulations thereunder. The date on which an

Owner and USDA enter into a contract for

Owner Payments with respect to a quota

is treated as the date on which the quota

is transferred for purposes of 1031. An

intermediary is treated as satisfying the re-

quirements of 1.1031(k)1(g)(4)(iii)(B)

(relating to the exchange agreement re-

quired to be entered into by a qualified

intermediary) if the intermediary enters

into a written agreement with the Owner(the exchange agreement) before the date

on which the quota is transferred and

under the exchange agreement the inter-

mediary

(a) is assigned the right to receive all

Owner Payments under the contract made

after the date of the exchange agreement;

(b) acquires the replacement property;

and

(c) transfers the replacement property to

the Owner.

Q12. Is transitional relief available

for purposes of 1031 for an Owner who

could not make timely arrangements for a

like-kind exchange under Notice 200551?

A12. Yes, transitional relief is avail-

able to an Owner who applied by June

17, 2005, to enter into a contract with

USDA for Owner Payments. In determin-

ing whether such Owner has entered into

a like-kind exchange pursuant to 1031

and the regulations thereunder, the date

on which the Owner transfers a quota

is deemed to be September 16, 2005.

To qualify for this transitional relief, an

Owner who receives an Owner Payment

must remit the amount of the Owner Pay-

ment to the qualified intermediary within

5 business days of the later of the date the

exchange agreement is entered into or the

date the Owner Payment is received by theOwner; in such case the Owner Payment is

treated as being received by the qualified

intermediary.

SUBSEQUENT GUIDANCE

Section 623 of the Act provides that

USDA will offer to enter into a con-

tract with an eligible tobacco producer

(Grower) under which the Grower may re-

ceive total payments of up to $3 per pound

of quota in 10 equal annual payments in

fiscal years 2005 through 2014 (Grower

Payments) in exchange for the termina-

tion of the tobacco marketing quotas and

related price support. Grower Payments

are determined by reference to the amount

of quota under which the Grower pro-

duced (or planted) tobacco during the

2002, 2003, and 2004 tobacco market-

ing years and are prorated based on the

number of years that the Grower produced

(or planted) quota tobacco during those

years. The federal tax treatment of Grower

Payments is expected to be addressed in

subsequent guidance.

EFFECT ON OTHER DOCUMENTS

Notice 200551 is modified and, as

modified, is superseded.



Marnette M. Myers of the Office of As-

sociate Chief Counsel (Income Tax &

Accounting). For further information re

garding Q & A7 of this notice, contac

Pamela Lew of the Office of Associat

Chief Counsel (Financial Institution

and Products) at (202) 6223950 (no

a toll-free call). For further informatio

regarding the remainder of this notice

contact Ms. Myers at (202) 6224920 (no

a toll-free call).

26 CFR 601.204: Changes in accountingperiods an

in methods of accounting.

(Also Part 1, 446, 1272, 1273.)

Rev. Proc. 200547

SECTION 1. PURPOSE

This revenue procedure describes con

ditions under which the Commissione

will allow a taxpayer to treat credit car

cash advance fees as creating or increas

ing original issue discount (OID) on

pool of credit card loans that includes th

cash advances that give rise to these fees

This revenue procedure also provides th

exclusive procedure by which a taxpaye

within the scope of this revenue procedur

may obtain the Commissioners consent t

change its method of accounting for credi

card cash advance fees to a method tha

treats these fees as creating or increasin

OID on a pool of credit card loans tha

includes the cash advances that give risto the fees.

SECTION 2. BACKGROUND

.01 Certain taxpayers issue credit card

that allow cardholders to access a revolv

ing line of credit to purchase goods and

services (credit card purchase transac

tions) and to obtain cash advances (cas

advance transactions). The credit car

agreement between the credit card issue

and the cardholder sets forth the terms an

conditions that govern the cardholderuse of the credit card, including identifica

tion of which credit card transactions ar

treated as cash advance transactions.

.02 Under many credit card agree

ments, the credit card issuer imposes

fee (a credit card cash advance fee) o

the cardholder when the cardholder use

the credit card to conduct a cash advanc

transaction. Although the terms of cred

card agreements may vary, a credit car

200532 I.R.B. 269 August 8, 200


15/31

cash advance fee is generally a flat fee

or a percentage of the face amount of the

cash advance (often subject to minimum

and maximum limits). Credit card cash

advance fees are generally imposed in ad-

dition to any stated periodic interest rate

charges.

.03 Under 1273(a)(1) of the Inter-

nal Revenue Code, OID is the excess

of the stated redemption price at matu-

rity (SRPM) of a debt instrument over

the issue price of that instrument. Un-

der 1.12731(b) of the Income Tax

Regulations, the SRPM is the sum of all

payments provided by the debt instrument

other than payments of qualified stated

interest (QSI). Under 1.12731(c), QSI

is stated interest that is unconditionally

payable in cash or property (other than

debt instruments of the issuer) or that will

be constructively received under 451 at

least annually at a single fixed rate. See 1.12732 for rules to determine the issue

price of a debt instrument.

.04 Section 1272(a)(6) provides rules

for determining the daily portions of OID

on certain debt instruments. The instru-

ments covered include REMIC regular in-

terests and qualified mortgages held by

REMICs, debt instruments the payments

under which may be accelerated by reason

of prepayments of other obligations secur-

ing the debt instruments, and any pool of

debt instruments the yield on which may

be affected by reason of prepayments..05 Rev. Proc. 200433, 20041 C.B.

989, describes conditions under which

the Commissioner will allow a taxpayer

within the scope of that procedure to treat

credit card late fees as creating or increas-

ing the amount of OID on a pool of credit

card loans to which those fees relate. Un-

der Rev. Proc. 200433, a credit card late

fee that is a one-time charge or a flat sum

imposed in addition to a stated periodic

interest charge may be treated as creating

or increasing OID if that fee otherwise

satisfies the revenue procedures require-ments.

.06 Any change in the taxpayers treat-

ment of credit card cash advance fees that

affects when income is recognized is a

change in method of accounting to which

the provisions of 446 and 481, and

the regulations thereunder, apply. Under

1.4461(e)(2)(i), a taxpayer generally

must secure the consent of the Commis-

sioner before changing a method of ac-

counting for federal income tax purposes.

Section 1.4461(e)(3)(ii) authorizes the

Commissioner to prescribe administrative

procedures setting forth the terms and

conditions necessary to obtain consent to

change a method of accounting.

.07 Rev. Proc. 20029, 20021 C.B.

327 (as modified and clarified by An-

nouncement 200217, 20021 C.B. 561,

modified and amplified by Rev. Proc.

200219, 20021 C.B. 696, and ampli-

fied, clarified, and modified by Rev. Proc.

200254, 20022 C.B. 432), provides

procedures by which taxpayers may ob-

tain automatic consent to change to the

methods of accounting described in the

Appendix of Rev. Proc. 20029. Sec-

tion 5.03 of Rev. Proc. 20029 provides

that, unless otherwise provided, a taxpayer

making a change in method of accounting

under the revenue procedure must takeinto account a section 481(a) adjustment

in the manner provided in section 5.04 of

Rev. Proc. 20029.

SECTION 3. SCOPE

This revenue procedure applies to a tax-

payer if

.01 The taxpayer issues credit cards al-

lowing cardholders to access a revolving

line of credit established by the taxpayer

both to make credit card purchase transac-

tions and to obtain cash advances; and.02 For federal income tax purposes, the

taxpayer does not treat the credit card pur-

chase transactions of its cardholders as cre-

ating debt that is given in consideration for

the sale or exchange of property.

SECTION 4. APPLICATION

.01 Subject to subsection .02 of this sec-

tion 4, if a taxpayer is within the scope of

this revenue procedure, the Commissioner

will not challenge the taxpayers treatment

of credit card cash advance fees as creating

or increasing the amount of OID on a pool

of credit card loans that includes the cash

advances that give rise to those fees.

.02 Subsection .01 of section 4 of this

revenue procedure applies only if the tax-

payer satisfies all of the requirements of

section 5 of this revenue procedure and, if

the taxpayer is changing its method of ac-

counting, all of the requirements of section

6 of this revenue procedure.

SECTION 5. REQUIREMENTS

A taxpayer must be able to demonstrate

the following:

.01 The amount of any credit card cash

advance fee charged to a cardholder by the

taxpayer is separately stated on the card-

holders account when that fee is imposed;

and

.02 Under the credit card agreement,

no amount identified as a credit card cash

advance fee is charged for property or for

specific services performed by the tax-

payer for the benefit of the cardholder.

SECTION 6. CHANGE IN METHOD

OF ACCOUNTING

If a taxpayer within the scope of this

revenue procedure wants to change its

method of accounting for credit card cash

advance fees and if, under the method

to which the taxpayer is changing, thesefees are treated as creating or increasing

the amount of OID on a pool of credit

card loans that includes the cash advances

that give rise to those fees, the taxpayer

must follow the provisions of Rev. Proc.

20029 (or its successor), with the follow-

ing modifications:

.01 The scope limitations in section

4.02 of Rev. Proc. 20029 do not apply to

a taxpayer that makes the change for either

its first or second taxable year ending on

or after December 31, 2004; and

.02 The taxpayer must prepare and file

a Form 3115 in accordance with section 6

of Rev. Proc. 20029 and enter the des-

ignated number (94) for this automatic

change in method in Line 1a of Form 3115.

SECTION 7. AUDIT PROTECTION

.01 If a taxpayer within the scope of this

revenue procedure currently uses a method

of accounting that treats credit card cash

advance fees as creating or increasing the

amount of OID on a pool of credit card

loans that includes the cash advances that

give rise to those fees, the issue of whether

that treatment is proper will not be raised

by the Commissioner for a taxable year

that ends before December 31, 2004.

.02 If a taxpayer within the scope of this

revenue procedure currently uses a method

of accounting that treats credit card cash

advance fees as creating or increasing the

amount of OID on a pool of credit card

August 8, 2005 270 200532 I.R


16/31

loans that includes the cash advances that

give rise to those fees and its use of that

method is an issue under consideration

(within the meaning of section 3.09 of

Rev. Proc. 20029) in examination, be-

fore an appeals office, or before the U.S.

Tax Court for any taxable year that ends

before December 31, 2004, that issue will

not be further pursued by the Service.

.03 Neither the audit protection pro-

vided in connection with a change in

a taxpayers method of accounting for

credit card cash advance fees that is prop-

erly made under section 6 of this revenue

procedure nor the audit protection pro-

vided under sections 7.01 and 7.02 of this

revenue procedure is a determination by

the Commissioner that the taxpayer is

properly accounting for any OID income

on that pool of credit card loans. Thus,

for example, the Service is not precluded

from pursuing the issue of whether, un-der 1272(a)(6), a taxpayer is correctly

accounting for its OID income (including

any OID attributable to credit card cash

advance fees) on its pool of credit card

loans.

SECTION 8. EFFECT ON OTHER

DOCUMENTS

Rev. Proc. 20029 is modified and

amplified to include this automatic change

in the APPENDIX.

SECTION 9. EFFECTIVE DATE

This revenue procedure is effective for

taxable years ending on or after December

31, 2004.


The principal authors of this rev-

enue procedure are Jonathan Silver and

Tina Jannotta of the Office of Associate

Chief Counsel (Financial Institutions and

Products). For further information regard-

ing this revenue procedure, contact theprincipal authors at (202) 6223930 (not a

toll-free call).

26 CFR 601.201: Rulings and determination letters.

(Also: Part I, 61, 280F; 1.6121.)

Rev. Proc. 200548

SECTION 1. PURPOSE

.01 This revenue procedure provides:

(1) the maximum value of employer-pro-vided vehicles first made available to em-

ployees for personal use in calendar year

2005 for which the vehicle cents-per-mile

valuation rule provided under section

1.6121(e) of the Income Tax Regula-

tions may be applicable is $14,800 for a

passenger automobile and $16,300 for a

truck or van; (2) the maximum value of

employer-provided vehicles first made

available to employees for personal use in

calendar year 2005 for which the fleet-av-

erage valuation rule provided under sec-

tion 1.6121(d) of the regulations may

be applicable is $19,600 for a passenger

automobile and $21,300 for a truck or van.

SECTION 2. BACKGROUND

.01 If an employer provides an em-

ployee with a vehicle that is available

to the employee for personal use, the

value of the personal use must generally

be included in the employees income

and wages. Internal Revenue Code 61;

Treas. Reg. 1.6121..02 For employer-provided passen-

ger automobiles (including trucks and

vans) made available to employees for

personal use that meet the requirements

of section 1.6121(e)(1) of the regula-

tions, generally the value of the personal

use may be determined under the vehicle

cents-per-mile valuation rule of section

1.6121(e). However, regulations section

1.6121(e)(1)(iii)(A) provides that for a

passenger automobile first made avail-

able after 1988 to any employee of the

employer for personal use, the value ofthe personal use may not be determined

under the vehicle cents-per-mile valuation

rule for a calendar year if the fair market

value of the passenger automobile (de-

termined pursuant to regulations section

1.6121(d)(5)(i) through (iv)) on the first

date the passenger automobile is made

available to the employee exceeds a spec-

ified dollar limit.

.03 For employer-provided vehicle

available to employees for personal us

for an entire year, generally the value o

the personal use may be determined un

der the automobile lease valuation rul

of section 1.6121(d) of the regulations

Under this valuation rule, the value o

the personal use is the Annual Leas

Value. Provided the requirements of reg

ulations section 1.6121(d)(5)(v) are met

an employer with a fleet of 20 or mor

automobiles may use a fleet-average valu

for purposes of calculating the Annua

Lease Values of the automobiles in th

employers fleet. The fleet-average valu

is the average of the fair market values o

all the automobiles in the fleet. However

section 1.6121(d)(5)(v)(D) of the regula

tions provides that for an automobile firs

made available after 1988 to an employe

of the employer for personal use, the valu

of the personal use may not be determineunder the fleet-average valuation rule for

calendar year if the fair market value of th

automobile (determined pursuant to reg

ulations section 1.6121(d)(5)(i) through

(v)) on the first date the passenger auto

mobile is made available to the employe

exceeds a specified dollar limit.

.04 The maximum passenger auto

mobile values for applying the vehicl

cents-per-mile and the fleet-average valu

rules reflect the automobile price inflatio

adjustment of Code section 280F(d)(7)

The method of calculating this price inflation amount for automobiles other tha

trucks and vans uses the new car com

ponent of the Consumer Price Index (CPI

automobile component. When calcu

lating this price inflation adjustment fo

trucks and vans, the new trucks com

ponent of the CPI is used. This result

in somewhat higher maximum values fo

trucks and vans. This change reflects th

higher rate of price inflation that trucksan

vans have been subject to since 1988, an

is consistent with the change announce

in Rev. Proc. 200375, 20032 C.B. 101for purposes of calculating depreciatio

deductions. See also Rev. Proc. 200420

20041 C.B. 642 and 200513, 200512

I.R.B. 759. For purposes of this revenu

procedure, the term trucks and vans

refers to passenger automobiles that ar

built on a truck chassis, including mini

vans and sport utility vehicles (SUVs) tha

are built on a truck chassis.

200532 I.R.B. 271 August 8, 200


17