Bulletin No. 1998–15

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Internal Revenue

bulletin

Bulletin No. 1998–15

April 13, 1998

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

EXEMPT ORGANIZATIONS

Rev. Rul. 98–19, page 5.

Announcement 98–28, page 30.

Relocation payments; Housing and Community Development Act. A relocation payment, authorized by section

105(a)(11) of the Housing and Community Development Act

and funded under the 1997 Emergency Supplemental Appropriations Act for Recovery From Natural Disasters, made by

a local jurisdiction to an individual moving from a flood-damaged residence to another residence, is not includible in the

individual’s gross income.

ADMINISTRATIVE

Rev. Rul. 98–20, page 8.

LIFO; price indexes; department stores. The February

1998 Bureau of Labor Statistics price indexes are accepted

for use by department stores employing the retail inventory

and last-in, first-out inventory methods for valuing inventories

for tax years ended on, or with reference to, February 28,

1998.

T.D. 8763, page 5.

Final regulations under section 166 of the Code deem a

charge-off and allow a deduction for a partially worthless

debt when the terms of a debt instrument have been modified.

T.D. 8764, page 9.

REG–102144–98, page 25.

Temporary and proposed regulations under sections 925

and 927 of the Code provide guidance to taxpayers who

have made an election to be treated as a foreign sales corporation (FSC). A public hearing on the proposed regulations will be held on June 24, 1998.

A list is given of organizations now classified as private foundations.

REG–209322–82, page 26.

Proposed regulations under sections 6031 and 6063 of the

Code revise the partnership filing requirement to reflect

changes to the law made by the Taxpayer Relief Act of 1997

(TRA). LR–198–82, 1986–1 C.B. 778 is withdrawn. A public

hearing will be held on May 19, 1998.

Rev. Proc. 98–27, page 15.

This procedure provides guidance to foreign financial institutions that desire to enter into a withholding agreement

with the Service in order to be treated as qualified intermediaries under new section 1.1441–1(e)(5) of the Income Tax

Regulations. It describes the application procedures for becoming a qualified intermediary and the terms that the Service will ordinarily require in a withholding agreement.

Rev. Proc. 98–28, page 14.

Qualified mortgage bonds; mortgage credit certificates; national median gross income. Guidance is provided concerning the use of the national and area median

gross income figures by issuers of qualified mortgage

bonds and mortgage credit certificates in determining the

housing cost/income ratio described in section 143(f)(5) of

the Code. Rev. Proc. 97–26 is obsolete except as provided

in section 5.02 of this revenue procedure.

Continued on page 4

Finding Lists begin on page 35.

Department of the Treasury

Internal Revenue Service

Mission of the Service

ucts and services; and perform in a manner warranting

the highest degree of public confidence in our integrity, efficiency, and fairness.

The purpose of the Internal Revenue Service is to collect

the proper amount of tax revenue at the least cost; serve

the public by continually improving the quality of our prod-

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the 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

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a semiannual basis

and are published in the first Bulletin of the succeeding semiannual period, respectively.

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 appropriate.

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

HIGHLIGHTS

OF THIS ISSUE—Continued

ADMINISTRATIVE—Continued

Notice 98–21, page 14.

Extension of the effective date of the Classification

Settlement Program. The Service is extending the Classification Settlement Program or “CSP” until further notice.

Rev. Proc. 98–29, page 22.

Inventory shrinkage estimates. Guidance, including a “retail safe harbor method,” is provided for a taxpayer that

wants to change to a method of accounting for estimating

inventory “shrinkage” in computing ending inventory.

Announcement 98–27, page 30.

The Service announces that Forms W–9 and W–9S can be

filed electronically.

Notice 98–16, page 12.

This notice announces that the Service will amend the effective date of the section 1441 withholding regulations to

apply to payments made after December 31, 1999.

April 13, 1998

1998–15 I.R.B.

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

Section 25.—Interest on Certain

Home Mortgages

26 CFR 1.25–4T: Qualified mortgage credit

certificate program (temporary).

Guidance is provided for the use of the national

and area median gross income figures by issuers of

qualified mortgage bonds and mortgage credit certificates in determining the housing cost/income

ratio described in section 143(f)(5) of the Code. See

Rev. Proc. 98–28, page 14.

Section 61.—Gross Income

Defined

26 CFR 1.61–1: Gross income.

Relocation payments; Housing and

Community Development Act. A relocation payment, authorized by section

105(a)(11) of the Housing and Community Development Act and funded under

the 1997 Emergency Supplemental Appropriations Act for Recovery From Natural Disasters, made by a local jurisdiction to an individual moving from a

flood-damaged residence to another residence, is not includible in the individual’s

gross income.

Rev. Rul. 98–19

ISSUE

Is a relocation payment authorized pursuant to section 105(a)(11) of Title I of

the Housing and Community Development Act of 1974 (Act), 42 U.S.C.

§ 5305(a)(11), funded under the 1997

Emergency Supplemental Appropriations

Act for Recovery From Natural Disasters

(Supplemental Act), Pub. L. No. 105–18,

111 Stat. 158, 198–199, and made by a

local jurisdiction to an individual moving

from a flood-damaged residence to another residence, includible in the individual’s gross income under § 61 of the Internal Revenue Code?

FACTS

Pursuant to the Act and the Supplemental Act, a resident of a local jurisdiction,

within a Presidentially-declared disaster

area in the upper Midwest, received a relocation payment from the local jurisdiction to help defray the expenses of mov-

1998–15 I.R.B.

ing from the resident’s flood-damaged

residence to another residence.

According to section 101(c) of the Act,

the primary objective of Title I “is the development of viable urban communities,

by providing decent housing and a suitable

living environment and expanding economic opportunities, principally for persons of low and moderate income.” 42

U.S.C. § 5301(c). Section 105(a)(11) of

the Act provides, in part, that a community

development program may provide relocation payments and assistance for displaced

individuals and families as authorized

under the Act. 42 U.S.C. § 5305(a)(11).

The Supplemental Act provides funding, for displaced individuals and families

as authorized under the Act, to certain

communities affected by the flooding in

the upper Midwest and other Presidentially-declared disasters occurring during

the federal government’s fiscal year ending September 30, 1997.

of Assistant Chief Counsel (Income Tax

and Accounting). For further information

regarding this revenue ruling, contact Mr.

Iskow on (202) 622-4920 (not a toll-free

call).

Section 103.—State and Local

Bonds

26 CFR 1.103–1: Interest upon obligations of a

State, Territory, etc.

Guidance is provided for the use of the national

and area median gross income figures by issuers of

qualified mortgage bonds and mortgage credit certificates in determining the housing cost/income

ratio described in section 143(f)(5) of the Code. See

Rev. Proc. 98–28, page 14.

Section 143.—Mortgage

Revenue Bonds: Qualified

Mortgage Bond and Qualified

Veterans’ Mortgage Bond

LAW AND ANALYSIS

Section 61 and the Income Tax Regulations thereunder provide that, except as

otherwise provided by law, gross income

means all income from whatever source

derived.

The Service has held that payments

made under legislatively provided social

benefit programs for the promotion of general welfare are not includible in a recipient’s gross income. See Rev. Rul. 76–373,

1976–2 C.B. 16, which holds that relocation payments received by individuals pursuant to section 105(a)(11) of the Act are in

the nature of general welfare and are not includible in the gross incomes of recipients.

HOLDING

26 CFR 6a.103A–2: Qualified mortgage bond.

Guidance is provided for the use of the national

and area median gross income figures by issuers of

qualified mortgage bonds and mortgage credit certificates in determining the housing cost/income

ratio described in section 143(f)(5) of the Code. See

Rev. Proc. 98–28, page 14.

Section 166.—Bad Debts

26 CFR 1.166–3: Partial or total worthlessness.

T.D. 8763

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

A relocation payment authorized pursuant to section 105(a)(11) of the Act,

funded under the Supplemental Act, and

made by a local jurisdiction to an individual moving from a flood-damaged residence to another residence, is in the nature of general welfare and is not

includible in the individual’s gross income under § 61.

Modifications of Bad Debts and

Dealer Assignments of Notional

Principal Contracts

DRAFTING INFORMATION

SUMMARY: This document contains

regulations that deem a charge-off and

allow a deduction for a partially worthless

debt when the terms of a debt instrument

The principal author of this revenue

ruling is Sheldon A. Iskow of the Office

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final and temporary regulations.

April 13, 1998

have been modified. The regulations provide guidance to certain taxpayers that

have claimed a deduction for a partially

worthless debt and then modified the

terms of the debt instrument. This document also contains regulations relating to

certain assignments of notional principal

contracts by dealers in those contracts.

The regulations provide guidance to taxpayers relating to the consequences of

these assignments.

DATES: Effective date: These regulations are effective January 29, 1998.

Applicability date: These regulations

apply to significant modifications of debt

instruments and assignments of interest

rate swaps, commodity swaps, and other

notional principal contracts occurring on

or after September 23, 1996.

FOR FURTHER INFORMATION CONTACT: Concerning the modifications of

bad debts, Craig Wojay, (202) 622-3920,

and concerning dealer assignments of notional principal contracts, Thomas M.

Preston, (202) 622-3940 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Background

On June 25, 1996, temporary regulations (T.D. 8676 [1996–2 C.B. 9]) relating

to modifications of bad debts and dealer

assignments of notional principal contracts under sections 166 and 1001 of the

Internal Revenue Code (Code) were published in the Federal Register (61 F.R.

32653). A notice of proposed rulemaking

(REG–209743–94, formerly FI–59–94

[1996–2 C.B. 442]) cross-referencing the

temporary regulations was published in

the Federal Register for the same day

(61 F.R. 32728). No public hearing was

requested or held.

Written comments responding to the

notice were received. After consideration

of the comments, the regulations proposed by REG–209743–94 are adopted

by this Treasury decision, and the corresponding temporary regulations are removed.

Explanation of Provisions

The preamble to the temporary regulations sets forth limited circumstances

under which a taxpayer will be permitted

April 13, 1998

to deduct an amount on account of a partially worthless debt even though an

amount has not been charged off within

the taxable year.

Section 166(a)(2) and §1.166–3(a) provide that a deduction for a partially worthless debt is allowed only to the extent the

debt is charged off in the taxable year.

The charge-off requirement is satisfied

when a portion of the debt is removed

from the taxpayer’s books and records.

This generally is accomplished by reducing the debt’s book basis. Thus, when an

amount has been deducted for partial

worthlessness, there is generally a reduction of both the book basis and the tax

basis of a debt.

When a taxpayer is required to recognize gain under §1.1001–1 because of a

modification of a debt instrument, the taxpayer’s tax basis in the debt is increased

by the amount of gain recognized. However, regulatory and general accounting

principles generally would not permit a

corresponding increase in the book basis

of the debt. Because the prior charge-off

is not restored (that is, the book basis of

the debt is not increased), there is no opportunity for the taxpayer to take a new

charge-off for pre-existing worthlessness.

The purpose of the temporary regulations is to preserve a portion of a taxpayer’s bad debt deduction with respect to

a partially worthless debt. The portion

preserved corresponds to the amount the

taxpayer would have been entitled to

deduct for partial worthlessness with respect to the modified debt if the book

basis of the modified debt were increased

to the same extent as the tax basis of that

debt. Thus, if all the conditions of the

temporary regulations are satisfied, then a

modified debt is deemed to have been

charged off in the year in which gain is

recognized. The amount of the deemed

charge-off, however, is limited to the difference between the tax basis of the debt

and the greater of the book basis or the

fair market value of the debt. The temporary regulations also address debt that

constitutes transferred basis property

under section 7701(a)(43).

In addition, the temporary regulations

provide a limited rule dealing with a

dealer’s assignment of its position in an

interest rate swap, commodity swap, or

other notional principal contract to another dealer. If the assignment is permit-

ted by the terms of the contract, the assignment is not treated as a deemed exchange by the nonassigning party of the

original contract for a new contract that

differs materially either in kind or in extent. Thus, an assignment to which the

rule applies does not trigger gain or loss

to the dealer’s counterparty.

Three comments were received on the

§1.166–3T regulations. The first comment requests a deemed charge-off for a

taxpayer that purchased at a discount debt

for which a previous deduction for partial

worthlessness was claimed, and then significantly modified the debt under

§1.1001–3 and recognized gain on the

modification. Whenever debt is purchased for less than the stated redemption

price, recognized gain from a significant

modification is attributable to market discount as defined in section 1278(a)(2)(A)

and not to a previously claimed deduction

for partial worthlessness. In addition, the

temporary regulations refer to §1.166–

3(a)(1) and (2) for guidance relating to

prior charge-offs and deductions for partial worthlessness. Extending the temporary regulations to cover a discount purchase would significantly expand the

regulations beyond their intended scope

and create a situation that would be extremely difficult to administer. The regulations do not adopt the request to extend

the regulations to cover such a purchase.

The second comment requests a

deemed charge-off for a member of a consolidated group that purchased debt, for

which a previous deduction for partial

worthlessness was claimed, from another

member of the group, then significantly

modified the debt under §1.1001–3 and

recognized gain on the modification.

Whenever debt is purchased for less than

the stated redemption price, subsequently

recognized gain from a significant modification is attributable to market discount

as defined in section 1278(a)(2)(A) and

not to a previously claimed deduction for

partial worthlessness. Extending the temporary regulations to cover a purchase

from another member of the consolidated

group would significantly expand the regulations beyond their intended scope. The

regulations do not adopt the request to extend the regulations to cover an intercompany transaction.

The third comment requests expanding

the temporary regulations to include other

1998–15 I.R.B.

situations in which a taxpayer has tax basis

in a debt but no corresponding book basis.

The first situation involves the accrual of

interest income on loans that have been

placed on non-accrual status for book purposes. The second situation involves the

requirement to accrue interest on original

issue discount obligations even if the loan

has become uncollectible. This comment

deals with situations other than the modification of a debt instrument and is beyond

the scope of this regulation project.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not

apply to these regulations, and because the

regulation does not impose a collection of

information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)

does not apply. Pursuant to section

7805(f) of the Internal Revenue Code, the

notice of proposed rulemaking preceding

these regulations was submitted to the

Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of the regulations

concerning the modifications of bad debts

is Craig Wojay, Office of the Assistant

Chief Counsel (Financial Institutions and

Products), IRS. The principal author of

the regulations concerning the dealer assignments of notional principal contracts

is Thomas M. Preston, Office of the Assistant Chief Counsel (Financial Institutions

and Products), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is amended

as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

1998–15 I.R.B.

Par. 2. In §1.166–3, paragraph (a)(3) is

added to read as follows:

§1.166–3 Partial or total worthlessness.

(a) * * *

(3) Significantly modified debt—(i)

Deemed charge-off. If a significant modification of a debt instrument (within the

meaning of §1.1001–3) during a taxable

year results in the recognition of gain by a

taxpayer under §1.1001–1(a), and if the

requirements of paragraph (a)(3)(ii) of

this section are met, there is a deemed

charge-off of the debt during that taxable

year in the amount specified in paragraph

(a)(3)(iii) of this section.

(ii) Requirements for deemed chargeoff. A debt is deemed to have been

charged off only if—

(A) The taxpayer (or, in the case of a

debt that constitutes transferred basis

property within the meaning of section

7701(a)(43), a transferor taxpayer) has

claimed a deduction for partial worthlessness of the debt in any prior taxable year;

and

(B) Each prior charge-off and deduction for partial worthlessness satisfied the

requirements of paragraphs (a)(1) and (2)

of this section.

(iii) Amount of deemed charge-off. The

amount of the deemed charge-off, if any,

is the amount by which the tax basis of

the debt exceeds the greater of the fair

market value of the debt or the amount of

the debt recorded on the taxpayer’s books

and records reduced as appropriate for a

specific allowance for loan losses. The

amount of the deemed charge-off, however, may not exceed the amount of recognized gain described in paragraph

(a)(3)(i) of this section.

(iv) Effective date. This paragraph

(a)(3) applies to significant modifications

of debt instruments occurring on or after

September 23, 1996.

party on an interest rate or commodity

swap, or other notional principal contract

(as defined in §1.446–3(c)(1)), is not

treated as a deemed exchange by the

nonassigning party of the original contract for a modified contract that differs

materially either in kind or in extent if—

(1) The party assigning its rights and

obligations under the contract and the

party to which the rights and obligations

are assigned are both dealers in notional

principal contracts, as defined in

§1.446–3(c)(4)(iii); and

(2) The terms of the contract permit the

substitution.

(b) Effective date. This section applies

to assignments of interest rate swaps,

commodity swaps, and other notional

principal contracts occurring on or after

September 23, 1996.

§1.1001–4T [Removed]

Par. 5. Section 1.1001–4T is removed.

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved January 14, 1998.

Donald C. Lubick,

Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

January 28, 1998, 8:45 a.m., and published in the

issue of the Federal Register for January 29, 1998,

63 F.R. 4396)

Section 471.—General Rule for

Inventories

26 CFR 1.471–2: Valuation of inventories.

Guidance, including a “retail safe harbor

method,” is provided for a taxpayer that wants to

change to a method of accounting for estimating inventory “shrinkage” in computing ending inventory.

See Rev. Proc. 98–29, page 22.

§1.166–3T [Removed]

Par. 3. Section 1.166–3T is removed.

Par. 4. Section 1.1001–4 is added to

read as follows:

Section 472.—Last-in, First-out

Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

§1.1001–4 Modifications of certain

notional principal contracts.

(a) Dealer assignments. For purposes

of §1.1001–1(a), the substitution of a new

LIFO; price indexes; department

stores. The February 1998 Bureau of

Labor Statistics price indexes are accepted for use by department stores em-

April 13, 1998

ploying the retail inventory and last-in,

first-out inventory methods for valuing

inventories for tax years ended on, or with

reference to, February 28, 1998.

Rev. Rul. 98–20

The following Department Store Inventory Price Indexes for February 1998

were issued by the Bureau of Labor Sta-

tistics. The indexes are accepted by the

Internal Revenue Service, under § 1.472–

1(k) of the Income Tax Regulations and

Rev. Proc. 86–46, 1986–2 C.B. 739, for

appropriate application to inventories of

department stores employing the retail inventory and last-in, first-out inventory

methods for tax years ended on, or with

reference to, February 28, 1998.

The Department Store Inventory Price

Indexes are prepared on a national basis

and include (a) 23 major groups of departments, (b) three special combinations

of the major groups - soft goods, durable

goods, and miscellaneous goods, and (c)

a store total, which covers all departments, including some not listed separately, except for the following: candy,

food, liquor, tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE

INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Feb.

1997

Feb.

1998

Percent Change

from Feb. 1997

to Feb. 19981

1. Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 526.4

2. Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650.4

3. Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 640.2

4. Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 897.7

5. Infants’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 617.7

6. Women’s Underwear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 534.2

7. Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296.5

8. Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 546.9

9. Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 417.6

10. Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 615.4

11. Men’s Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 585.1

12. Boys’ Clothing and Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 469.9

13. Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1004.9

14. Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 772.0

15. Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 912.3

16. Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 662.0

17. Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 581.2

18. Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 817.0

19. Major Appliances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246.1

20. Radio and Television . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

78.6

21. Recreation and Education2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111.1

22. Home Improvements2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.3

23. Auto Accessories2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107.9

Groups 1 – 15: Soft Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 598.9

Groups 16 – 20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470.0

Groups 21 – 23: Misc. Goods2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113.3

Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 554.2

535.8

639.3

656.9

886.5

612.6

565.2

308.1

548.2

408.9

624.0

590.4

499.3

1001.0

802.0

926.5

668.3

583.7

810.3

242.0

73.6

107.7

134.0

107.7

601.1

462.4

111.0

552.3

1.8

–1.7

2.6

–1.2

–0.8

5.8

3.9

0.2

–2.1

1.4

0.9

6.3

–0.4

3.9

1.6

1.0

0.4

–0.8

–1.7

–6.4

–3.1

0.5

–0.2

0.4

–1.6

–2.0

–0.3

Groups

1Absence of a minus sign before percentage change in this column signifies price increase.

2Indexes on a January 1986=100 base.

3The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, to-

bacco, and contract departments.

April 13, 1998

1998–15 I.R.B.

DRAFTING INFORMATION

The principal author of this revenue

ruling is Stan Michaels of the Office of

Assistant Chief Counsel (Income Tax and

Accounting). For further information regarding this revenue ruling, contact Mr.

Michaels on (202) 622-4970 (not a tollfree call).

Section 925.—Transfer Pricing

Rules

26 CFR 1.925(a)–1T: Temporary regulations;

transfer pricing rules for FSCs.

T.D. 8764

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

Source and Grouping Rules for

Foreign Sales Corporation

Transfer Pricing

added by the Deficit Reduction Act of

1984, applicable for taxable years of foreign sales corporations beginning after

December 31, 1984. Temporary regulations were published in the Federal Register (52 F.R. 6468) as a Treasury Decision (T.D. 8126 [1987–1 C.B. 184]) on

March 3, 1987. Treasury and IRS believe

that immediate guidance in the form of

these temporary regulations is necessary

for the reasons stated below.

Explanation of Provisions

These regulations set a deadline for an

election to group transactions for purposes of the foreign sales corporation

(FSC) administrative pricing methods and

clarify that the foreign source limit for a

FSC’s related supplier extends to all

transactions giving rise to foreign trading

gross receipts.

I. Grouping Election Deadline.

Background

A. Current temporary regulations.

Current §1.925(a)–1T(c)(8) and

§1.925(b)–1T(b)(3) permit taxpayers annually to group transactions in applying

the administrative pricing (including the

marginal costing) rules to determine FSC

benefits. Current §1.925(a)–1T(c)(8)(i)

requires an election to group to be evidenced on the FSC income tax return for

the taxable year. Current §1.925(a)–

1T(e)(4) authorizes taxpayers to file

amended returns subsequently (within the

statute of limitations period) to redetermine FSC benefits based on a different

grouping of transactions than that originally elected. Pursuant to this provision,

taxpayers may change their grouping

basis, or change from a grouping to a

transaction-by-transaction basis. The IRS

and the Treasury have become increasingly aware of taxpayers who, through the

use of sophisticated computer programs,

substantially revise their transaction

groupings just prior to the expiration of

the statute of limitations and many years

after the original returns were filed.

These revised groupings typically employ

complex estimating techniques. The recent rise in this practice is placing a significant burden on the auditing process

and is creating a potential for abuse.

This document contains amendments to

the Income Tax Regulations (26 CFR part

1) under sections 925 and 927 which were

B. Revised temporary regulations.

Under §1.925(a)–1T(c)(8)(i), the election to group must be made on Schedule P

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains

temporary regulations that provide guidance to taxpayers who have made an election to be treated as a foreign sales corporation (FSC). The regulations provide

rules that clarify the special sourcing rules

under section 927(e)(1) and provide a

deadline for the election to group transactions. The text of the temporary regulations also serves as the text of the proposed

regulations on this subject in REG–

102144–98, page 25 of this Bulletin.

DATES: Effective date: These regulations are effective March 3, 1998.

Applicability: For dates of applicability, see §§1.925(a)–1T(c)(8)(i) and

1.927(e)–1T(c).

FOR FURTHER INFORMATION CONTACT: Elizabeth Beck (202) 622-3880

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

1998–15 I.R.B.

of the FSC’s timely filed U.S. income tax

return (including extensions thereof) for

the taxable year. No untimely or

amended returns will be allowed to elect

to group, to change a grouping basis, or to

change from a grouping basis to a transaction-by-transaction basis for such year.

Conforming changes and cross-references are reflected in §1.925(a)–1T(e)(4)

and §1.925(b)–1T(b)(3).

The regulations apply to taxable years

beginning after December 31, 1997.

There is also a transition rule providing

that the regulations also apply to taxable

years beginning before January 1, 1998.

For these taxable years, the transition rule

allows taxpayers to redetermine their

grouping of transactions with respect to

such years provided such redetermination

is made no later than the due date of the

FSC’s timely filed U.S. income tax return

(including extensions thereof) for its first

taxable year beginning after December

31, 1997.

II. Scope of Related Supplier Foreign

Source Limit.

A. Current temporary regulations and

TRA 97.

Section 927(e)(1) provides that

“[u]nder regulations, the income of a person described in section 482 from a transaction giving rise to foreign trading gross

receipts of a FSC which is treated as from

sources outside the United States shall not

exceed the amount which would be

treated as foreign source income earned

by such person if the pricing rule under

section 994 which corresponds to the rule

used under section 925 with respect to

such transaction applied to such transaction.” Transactions giving rise to foreign

trading gross receipts include qualifying

sales, leases, licenses and services. Current §1.927(e)–1T restates the section

927(e)(1) rule as applicable on “the sale

of export property.” While the statute is

not limited to export sale transactions in

that it applies to any transaction giving

rise to foreign trading gross receipts of a

FSC, the current regulation might be interpreted to apply the special foreign

sourcing limit only to sales of export

property.

Section 1171 of the Taxpayer Relief

Act of 1997 (TRA 97) amended section

927(a)(2)(B) (without any inference intended regarding prior law) to provide

April 13, 1998

that computer software licensed for reproduction abroad is included within the definition of export property for purposes of

the FSC provisions. The amendment applies to gross receipts from computer software licenses attributable to periods after

December 31, 1997, in tax years ending

after such date.

In light of TRA 97, it is important to

clarify the scope of the related supplier’s

foreign source limit under the regulations.

This clarification needs to be implemented immediately in order to provide

clear guidance to taxpayers, including

those utilizing the TRA 97 amendment to

section 927(a)(2)(B).

Drafting Information

Paragraph 1. The authority citation for

part 1 is amended by revising the entries

for sections 1.925(a)–1T and 1.925(b)–1T

to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.925(a)–1T is also issued

under 26 U.S.C. 925(b)(1) and (2) and

927(d)(2)(B).

Section 1.925(b)–1T is also issued

under 26 U.S.C. 925(b)(1) and (2) and

927(d)(2)(B) * * *

Par. 2. Section 1.925(a)–1T is

amended by:

1. Removing the last sentence of paragraph (c)(8)(i) and adding five sentences

in its place.

2. Paragraph (e)(4) is amended by:

a. Removing the language “or grouping of transactions” from the fourth sentence.

b. Adding a sentence to the end of the

paragraph.

The additions read as follows:

Revised temporary regulations.

Under §1.927(e)–1T(a)(1), the related

supplier’s foreign source limit applies to

any transaction, including but not limited

to any sale, lease, license or service, giving rise to foreign trading gross receipts

of a FSC. No inference is intended regarding the scope of application of the

prior regulation.

Conforming changes are reflected in

§1.927(e)–1T(a)(2) and (3). Special rules

are added in §1.927(e)–1T(a)(3)(ii) to

clarify how the corresponding DISC

transfer pricing rules are to be applied for

purposes of the foreign source limit.

Three examples set forth in §1.927(e)–

1T(b) illustrate how the limit is applied

under different transfer pricing methods

and for different types of transactions.

The regulations apply to taxable years

beginning after December 31, 1997.

Special Analyses

It has been determined that this Treasury Decision is not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations, and because the regulation does not

impose a collection of information on

small entities, the Regulatory Flexibility

Act (5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the Internal

Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on their impact on small business.

April 13, 1998

The principal author of these regulations is Elizabeth Beck of the Office of

the Associate Chief Counsel (International). Other personnel from the IRS and

Treasury Department also participated in

the development of these regulations.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR part 1 is amended

as follows:

PART 1—INCOME TAXES

§1.925(a)–1T Temporary Regulations;

Transfer pricing rules for FSCs.

(8) * * * (i) * * * The election to

group transactions shall be evidenced on

Schedule P of the FSC’s timely filed U.S.

income tax return (including extensions

thereof) for the taxable year. No untimely

or amended returns will be allowed to

elect to group, to change a grouping basis,

or to change from a grouping basis to a

transaction-by-transaction basis. The

rules of the previous two sentences of this

paragraph (c)(8)(i) are applicable to taxable years beginning after December 31,

1997. For any taxable year beginning before January 1, 1998, for which a redetermination is otherwise permissible under

paragraph (e)(4) of this section as in effect for taxable years beginning before

January 1, 1998, a redetermination of

grouping of transactions cannot be made

later than the due date of the FSC’s timely

filed U.S. income tax return (including

extensions thereof) for the FSC’s first taxable year beginning after December 31,

1997. The language “or grouping of

transactions” is removed from the fourth

sentence of paragraph (e)(4) of this section, applicable to taxable years beginning after December 31, 1997.

(e) * * *

(4) * * * For the election to group

transactions for purposes of applying the

administrative pricing methods, see paragraph (c)(8)(i) of this section.

Par. 3. In §1.925(b)–1T, paragraph

(b)(3)(i) is amended by adding at the end

of the paragraph the following sentence:

§1.925(b)–1T Temporary regulations;

marginal costing rules.

(b) * * *

(3) * * * (i) * * * For the election to

group transactions for purposes of applying the administrative pricing methods,

see §1.925(a)–1T(c)(8)(i).

Par. 4. Section 1.927(e)–1T is revised

to read as follows:

§1.927(e)–1T Temporary regulations;

special sourcing rule.

(a) Source rules for related persons—

(1) In general. The income of a person

described in section 482 from a transaction giving rise to foreign trading gross

receipts of a FSC which is treated as from

sources outside the United States shall not

exceed the amount which would be

treated as foreign source income earned

by such person if the pricing rule under

section 994 which corresponds to the rule

used under section 925 with respect to

such transaction applied to such transac-

1998–15 I.R.B.

tion. This section applies to any transaction, including but not limited to any sale,

lease, license or service, giving rise to foreign trading gross receipts of a FSC. This

special sourcing rule also applies if the

FSC is acting as a commission agent for

the related supplier with respect to the

transaction described above which gives

rise to foreign trading gross receipts and

the transfer pricing rules of section 925

are used to determine the commission

payable to the FSC. No limitation results

under this section with respect to a transaction to which the section 482 pricing

rule under section 925(a)(3) applies.

(2) Grouping of transactions. If, for

purposes of determining the FSC’s profits

under the administrative pricing rules of

sections 925(a)(1) and (2), grouping of

transactions under §1.925(a)–1T(c)(8)

was elected, the same grouping shall be

used for making the determinations under

this special sourcing rule.

(3) Corresponding DISC pricing

rules—(i) In general. For purposes of

this section—

(A) The DISC gross receipts pricing

rule of section 994(a)(1) corresponds to

the gross receipts pricing rule of section

925(a)(1);

(B) The DISC combined taxable income pricing rule of section 994(a)(2)

corresponds to the combined taxable income pricing rule of section 925(a)(2);

and

of section 994(a)(3) corresponds to the

section 482 pricing rule of section

925(a)(3).

(ii) Special rules. For purposes of this

section—

(A) The DISC pricing rules of section

994(a)(1) and (2) shall be determined

without regard to export promotion expenses;

(B) Qualified export receipts under

section 994(a)(1) and (2) shall be deemed

to be an amount equal to the foreign trading gross receipts arising from the transaction; and

to be an amount equal to the combined

taxable income for purposes of section

925(a)(2) arising from the transaction.

1998–15 I.R.B.

(b) Examples. The provisions of this

section may be illustrated by the following examples:

Example 1. (i) R and F are calendar year taxpayers. R, a domestic manufacturing company, owns all

the stock of F, which is a FSC acting as a commission agent for R. For the taxable year, R and F used

the combined taxable income pricing rule of section

925(a)(2). For the taxable year, the combined taxable income of R and F is $100 from the sale of export property, as defined in section 927(a), manufactured by R using production assets located in the

United States. Title to the export property passed

outside of the United States.

(ii) Under section 925(a)(2), 23 percent of the

$100 combined taxable income of R and F, that is

$23, is allocated to F and the remaining $77 is allocated to R. Absent the special sourcing rule, under

section 863(b) the $77 income allocated to R would

be sourced $38.50 U.S. source and $38.50 foreign

source. Under the special sourcing rule, the amount

of foreign source income earned by a related supplier of a FSC shall not exceed the amount that

would result if the corresponding DISC pricing rule

applied. The DISC combined taxable income pricing rule of section 994(a)(2) corresponds to the combined taxable income pricing rule of section

925(a)(2). Under section 994(a)(2), $50 of the combined taxable income ($100 x .50) would be allocated to the DISC and the remaining $50 would be

allocated to the related supplier. Under section

863(b), the $50 income allocated to the DISC’s related supplier would be sourced $25 U.S. source and

$25 foreign source. Accordingly, under the special

sourcing rule, the foreign source income of R shall

not exceed $25.

Example 2. (i) Assume the same facts as in Example 1 except that the combined taxable income

arises from the licensing of the copyright rights in

computer software for use outside of the United

States and that R developed the computer software

in the United States.

(ii) Under section 925(a)(2), 23 percent of the

$100 combined taxable income of R and F, that is

$23, is allocated to F and the remaining $77 is allocated to R. Absent the special sourcing rule, under

section 862(a)(4) the $77 income allocated to R

would be sourced $77 foreign source in its entirety.

Under the special sourcing rule, the amount of foreign source income earned by a related supplier of a

FSC shall not exceed the amount that would result if

the corresponding DISC pricing rule applied. The

DISC combined taxable income pricing rule of section 994(a)(2) corresponds to the combined taxable

income pricing rule of section 925(a)(2). Under section 994(a)(2), $50 of the combined taxable income

($100 x .50) would be allocated to the DISC and the

remaining $50 would be allocated to the related supplier. Under section 862(a)(4), the $50 income allocated to the DISC’s related supplier would be

sourced $50 foreign source in its entirety. Accordingly, under the special sourcing rule, the foreign

source income of R shall not exceed $50.

Example 3. (i) Assume the same facts as in Example 1 except that R and F used the gross receipts

pricing rule of section 925(a)(1). In addition, for the

taxable year foreign trading gross receipts derived

from the sale of the export property are $2,000.

(ii) Under section 925(a)(1), 1.83 percent of the

$2,000 foreign trading gross receipts, that is $36.60,

is allocated to F and the $63.40 remaining combined

taxable income ($100 - $36.60) is allocated to R.

Absent the special sourcing rule, under section

863(b) the $63.40 income allocated to R would be

sourced $31.70 U.S. source and $31.70 foreign

source. Under the special sourcing rule, the amount

of foreign source income earned by a related supplier of a FSC shall not exceed the amount that

would result if the corresponding DISC pricing rule

applied. The DISC gross receipts pricing rule of

section 994(a)(1) corresponds to the gross receipts

pricing rule of section 925(a)(1). Under section

994(a)(1), $80 ($2,000 x .04) would be allocated to

the DISC and the $20 remaining combined taxable

income would be allocated to the related supplier.

Under section 863(b), the $20 income allocated to

the DISC’s related supplier would be sourced $10

U.S. source and $10 foreign source. Accordingly,

under the special sourcing rule, the foreign source

income of R shall not exceed $10.

section are applicable to taxable years beginning after December 31, 1997.

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

Approved February 20, 1998.

Donald C. Lubick,

Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on

March 2, 1998, 8:45 a.m., and published in the issue

of the Federal Register for March 3, 1998, 63 F.R.

10305)

Section 1441.—Withholding of

Tax

This notice announces that the Department of the

Treasury and the Internal Revenue Service will

amend the effective date of the section 1441 withholding regulations to apply to payments made after

December 31, 1999. The transition rules provided

under those regulations will also be amended to be

consistent with the later effective date of those regulations. This Notice also amends the related transition rule of Notice 97–66, 1997–48 I.R.B. 8, to be

consistent with the later effective date of the 1441

regulations. Finally, this Notice announces that the

Internal Revenue Service intends to develop model

withholding agreements for qualified intermediaries

on a country by country basis. See Notice 98–16,

page 12.

April 13, 1998

Part III. Administrative, Procedural, and Miscellaneous

Effective Date of Regulations

Under Section 1441 and

Qualified Intermediary

Procedures

Notice 98–16

Section 1. Scope

This notice announces that the Department of the Treasury (“Treasury”) and the

Internal Revenue Service (the “IRS”) will

extend the effective date of the section

1441 withholding regulations. As extended, those regulations will apply to

certain payments made to foreign persons

after December 31, 1999. This notice

also provides new transition rules for satisfying the withholding certificate or

statement requirements under the withholding regulations. Finally, this notice

describes the general procedure the IRS

will follow in entering into qualified intermediary withholding agreements in

order to expedite the process of making

such agreements as widely available as

possible.

Section 2. Background

On October 14, 1997, final Income Tax

Regulations (the “final withholding regulations”) substantially revising and replacing existing regulations regarding the

withholding of tax under chapter 3 (sections 1441–1464) of the Internal Revenue

Code (the “Code”) were published in the

Federal Register as T.D. 8734. Those regulations also significantly revise existing

information reporting and backup withholding regulations under chapter 61 and

section 3406 of the Code. As promulgated, the final withholding regulations

will apply to all payments made after December 31, 1998.

Section 3. Extended Effective Date

Treasury and the IRS will amend the

final withholding regulations to extend

the date of applicability of those regulations to payments made after December

31, 1999. Treasury and the IRS recognize

that the final withholding regulations contain substantial changes to existing rules

and will likely require significant changes

to business practices and information systems for many U.S. and foreign withhold-

April 13, 1998

ing agents. These changes come at a time

when many of these entities are also attempting to make significant changes to

business practices and information systems to conform to the Year 2000 date

change and the European Monetary

Union currency conversion.

Treasury and the IRS also must ensure

that qualified intermediary withholding

agreements are available to as many financial intermediaries as possible for the

final withholding regulations to be effectively implemented. As described more

fully below, Treasury and the IRS expect

that the process for making qualified intermediary withholding agreements

widely available will take several months

from the date the process begins.

Accordingly, Treasury and the IRS believe it is in the best interest of tax administration to extend the date of applicability

of the final withholding regulations to ensure that both taxpayers and the government can complete the changes necessary

to implement the new withholding

regime. As extended by this notice, the

final withholding regulations will apply to

payments made after December 31, 1999.

In addition, the IRS will regard the

1999 calendar year as a transition period

for the administration of the withholding

tax system. Accordingly, in enforcing

compliance with current withholding

rules for calendar year 1999, the IRS will

take into account the extent to which a

withholding agent makes a good faith effort during that period to transform its

business practices and information systems to comply with the final withholding

regulations. For example, the IRS will

take into account whether a U.S. withholding agent makes reasonable efforts

during 1999 to modify its account opening practices to conform to the new documentation requirements, obtain new documentation on existing accounts when

new withholding certificates become

available, and make appropriate systems

changes to comply with the final withholding regulations and, if appropriate,

Rev. Proc. 98–27 (relating to qualified intermediary withholding agreements). For

foreign withholding agents, the IRS will

also take into account whether or not the

withholding agent makes an effort to seek

qualified intermediary status. The IRS

will also take into account whether or not

a withholding agent (whether U.S. or foreign) effectively implements the final

withholding regulations beginning on

January 1, 2000.

Section 4. Modified Transition Rules

The final withholding regulations provide transition rules for obtaining new

withholding certificates and statements

containing the necessary information and

representations required by those regulations. The IRS released and requested

public comments on draft new withholding certificates in Announcement 98–15,

published in 1998–10 I.R.B. 36. The new

withholding certificates would replace

current Forms W–8, 1001, 4224, 8709,

and 1078, and statements described in

§1.1441–5 of the regulations in effect before January 1, 1999 (the “existing certificates or statements”).

Generally, under the transition rules

contained in the final withholding regulations, a withholding agent holding a valid

existing certificate or statement on December 31, 1998, may treat that certificate

or statement as valid until the earlier of its

expiration or December 31, 1999. In addition, the transition rules provide that

any existing withholding certificate or

statement that is valid on January 1, 1998,

and that expires during 1998, remains

valid until December 31, 1998. (These

rules cannot operate together, however, to

extend beyond December 31, 1998, the

validity of a certificate that, without the

transition rule, would expire in 1998.)

The IRS intends to modify the withholding certificate and statement transition rules of the final withholding regulations to provide that a withholding agent

holding a valid existing certificate or

statement on December 31, 1999, may

treat that certificate or statement as valid

until the earlier of its expiration or December 31, 2000. No existing certificates

or statements will be effective after December 31, 2000. As under the final regulations, existing certificates and statements that expire in 1999 will not be

effective after expiration. The existing

transition rule providing that any existing

withholding certificate or statement that is

valid on January 1, 1998, and that expires

during 1998 remains valid until Decem-

1998–15 I.R.B.

ber 31, 1998, will be retained. This rule

should ensure that withholding agents

will be able to replace existing withholding certificates or statements that expire

in 1998 with new certificates that will be

valid under the final withholding regulations when those regulations take effect.

The IRS anticipates that new withholding

certificates will be available before December 31, 1998.

New withholding certificates that are

valid under the final withholding regulations will be deemed to satisfy the requirements under the regulations in effect before January 1, 2000, to obtain Forms

W–8, 1001, 4224, 8709, or a statement

under section 1.1441–5. Therefore, in situations where existing certificates and

statements are not outstanding, or new

certificates or statements must be obtained

because of a change in circumstances, a

withholding agent may obtain new withholding certificates. New withholding

certificates will be valid for the period

specified in section 1.1441–1(e)(4)(ii) of

the final withholding regulations, regardless of when they are obtained.

Notice 97–66 (1997–48 I.R.B. 1) provides a related transition rule that is affected by the extended effective date of

the final withholding regulations. Notice

97–66 relates to final Income Tax Regulations on the source and character of

substitute interest and dividend payments

published in the Federal Register on October 14, 1997 as T.D. 8735 (the “final

substitute payment regulations”). The

notice provides guidance on complying

with the statement requirement of section

871(h)(5) for substitute interest payments

made after November 13, 1997, or, if an

election is made under section 6 of the

notice, for substitute interest payments

made after December 31, 1998. Substitute interest payments made by a foreign

person that are U.S. source interest must

satisfy the statement requirement of section 871(h)(5) to qualify as portfolio

interest.

The final substitute payment regulations referred taxpayers to §1.871–14(c)

of the final withholding regulations for

guidance on the statement requirement of

section 871(h)(5). Because §1.871–14(c)

of the final withholding regulations was

not to be effective before January 1, 1999,

however, Notice 97–66 provides a transition rule providing that the statement re-

1998–15 I.R.B.

quirement of section 871(h)(5) will be

satisfied with respect to substitute interest

payments made after November 13, 1997,

and before January 1, 1999, if any written, electronic, or oral statement that reasonably establishes that the payee is a foreign person is given or made to the payor

before, or within a reasonable period

after, the payment.

Because the IRS intends to make

§1.871–14(c) of the final withholding

regulations effective for payments made

after December 31, 1999, as announced

herein, the transition rule in Notice 97–66

is extended to apply to substitute interest

payments made after November 13, 1997

(or after December 31, 1998, if elected)

and before January 1, 2000. The remainder of Notice 97–66 remains unchanged.

On January 26, 1998, a notice of proposed rulemaking (REG–209322–82) was

published in the Federal Register that

would amend regulations under sections

6031 and 6063 regarding the filing of returns of partnership income (a “partnership return”). Under §1.6031(a)–1(b)(2)

of the proposed regulations, a partnership

return is not required of a foreign partnership if it meets certain conditions and

Forms 1042 and 1042–S are filed under

§1.1461–1(b) and (c), as amended by the

final withholding regulations, either by

the partnership or by another withholding

agent (or agents). The proposed date of

applicability for the exception is taxable

years of a partnership that begin on or

after January 1, 1999. If §1.6031(a)–

1(b)(2) is finalized, Treasury and IRS intend to amend the date of applicability for

that section to reflect the extended date of

applicability of §1.1461–1(b) and (c) of

the final withholding regulations.

Section 5. Qualified Intermediary

Procedures

As indicated above, for the final withholding regulations to be most effectively

implemented, it is desirable for qualified

intermediary withholding agreements to

be available to as many foreign financial

intermediaries as possible. A qualified intermediary is a foreign person, or a foreign branch of a U.S. person, that agrees

with the IRS in a qualified intermediary

withholding agreement to collect information regarding its account holders and

to make that information available as may

be required under the agreement. It is an-

ticipated that the qualified intermediary

regime will reduce the collection of information and reporting required of withholding agents under the current rules.

Simultaneously with this notice, Treasury and the IRS are releasing Revenue

Procedure 98–27, which provides guidance on entering into a qualified intermediary withholding agreement with the

IRS. Although the revenue procedure is

designed to provide specific guidance on

the application process for persons described in §1.1441–1(e)(5)(ii)(A) and (B)

(i.e., foreign financial institutions, foreign

clearing organizations, and foreign

branches of U.S. financial institutions and

U.S. clearing organizations), any person

desiring a qualified intermediary withholding agreement may submit a draft

agreement in the general manner described in the revenue procedure.

This notice announces that, although

any person is permitted to apply for and

negotiate an individual qualified intermediary withholding agreement with the

IRS, the IRS intends to issue a series of

model agreements of broad applicability

to make qualified withholding agreements

as widely available as possible. It is contemplated that, upon release of one of

these model agreements, any person

falling within the class of persons covered

by the model agreement would be able to

accept, sign, and submit the agreement to

the IRS, without the need for individual

negotiations. The IRS currently contemplates that each model agreement will be

specific to a particular country, or group

of countries with similar laws and practices, and will be specific to a class of persons conducting similar intermediary

businesses in a similar manner. Such an

approach enables each model agreement

to cover as broad a class of persons as

possible, while allowing uniform application of all material provisions among all

persons in the identified class.

Because of its intent to issue a series of

model agreements of broad applicability,

the IRS invites submissions of proposed

model agreements by groups or associations of potential qualified intermediaries.

As part of the submission, the IRS requests a description of the class of persons the proposed model agreement is intended to cover and why that class of

persons could operate under a single

model agreement.

April 13, 1998

In the interest of ensuring that as many

financial intermediaries as possible can

become qualified intermediaries well in

advance of the effective date of the final

withholding regulations, the IRS intends

to give submissions of proposed model

agreements of broad applicability first

consideration. Consequently, except in

unusual circumstances, proposed agreements by individual intermediaries, while

also invited, will not likely lead to negotiations with the IRS until sufficient

progress has been made in the process of

issuing model agreements. Moreover,

persons who are clearly within a class of

persons covered by an existing model

agreement will not be permitted to negotiate an individual agreement absent unusual circumstances.

The IRS currently contemplates releasing a group of model agreements simultaneously, rather than issuing them one-byone, and expects that this release will

occur before December 31, 1998. Additional model agreements and individual

agreements may be issued after that first

release of model agreements. Due to time

constraints, however, groups or associations of intermediaries desiring to submit

a proposed model agreement on behalf of

a class of persons should make such a

submission on or before July 3, 1998, to

ensure that such model agreement can be

released and individual agreements can be

concluded prior to December 31, 1998.

Persons submitting proposed model

agreements are advised that these submissions will be made available to the public.

Section 6. Contact Information

The principal author of this Notice is

Carl Cooper of the Office of the Associate

Chief Counsel (International) within the

Office of the Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue,

N.W., Washington, D.C. 20224. For further information regarding this Notice

contact Mr. Cooper at 202-622-3840 (not

a toll-free call).

Extension of the Effective Date

of the Classification Settlement

Program

Notice 98–21

The Internal Revenue Service is extending the Classification Settlement Pro-

April 13, 1998

gram or “CSP” until further notice. The

CSP is an optional settlement program that

allows businesses and tax examiners to resolve worker classification cases as early

in the administrative process as possible,

thereby reducing taxpayer burden. In the

CSP, examiners can offer a business under

audit a worker classification settlement

using a standard closing agreement developed for this purpose. The CSP procedures also ensure that the taxpayer relief

provisions under section 530 of the Revenue Act of 1978 are properly applied.

The Service implemented the CSP in

March 1996 on a two-year trial basis. Review of the program and feedback from

the public have indicated that the program

is successful in facilitating early resolution of cases.

Taxpayer participation in the CSP is entirely voluntary. A taxpayer declining to

accept a settlement offer retains all rights

to administrative appeal that exist under

the Service’s current IRS procedures and

all existing rights to judicial review.

DRAFTING INFORMATION

The principal author of this notice is

Greg Christensen of the Office of Employment Tax Administration and Compliance. For further information regarding this notice, please contact Mr.

Christensen at 202-622-3650 (not a tollfree number).

26 CFR 601.201: Rulings and determination

letters.

(Also Part I, Sections 25, 103, 143; 1.25–4T,

1.103–1, 6a.103A–2.)

Rev. Proc. 98–28

SECTION 1. PURPOSE

This revenue procedure provides guidance concerning the United States and

area median gross income figures that are

to be used by issuers of qualified mortgage bonds, as defined in § 143(a) of the

Internal Revenue Code, and issuers of

mortgage credit certificates, as defined in

§ 25(c), in computing the housing cost/income ratio described in § 143(f)(5).

SECTION 2. BACKGROUND

.01 Section 103(a) provides that, except

as provided in § 103(b), gross income

does not include interest on any state or

local bond. Section 103(b)(1) provides

that § 103(a) shall not apply to any private

activity bond that is not a “qualified

bond” within the meaning of § 141. Section 141(e) provides that the term “qualified bond” includes any private activity

bond that (1) is a qualified mortgage

bond, (2) meets the volume cap requirements under § 146, and (3) meets the applicable requirements under § 147.

.02 Section 143(a)(1) provides that the

term “qualified mortgage bond” means a

bond that is issued as part of a “qualified

mortgage issue”. Section 143(a)(2)(A)

provides that the term “qualified mortgage issue” means an issue of one or more

bonds by a state or political subdivision

thereof, but only if (i) all proceeds of the

issue (exclusive of issuance costs and a

reasonably required reserve) are to be

used to finance owner-occupied residences; (ii) the issue meets the requirements of subsections (c),(d),(e),(f),(g),

(h),(i), and (m)(7) of § 143; (iii) the issue

does not meet the private business tests of

paragraphs (1) and (2) of § 141(b); and

(iv) with respect to amounts received

more than 10 years after the date of issuance, repayments of $250,000 or more

of principal on financing provided by the

issue are used not later than the close of

the first semi-annual period beginning

after the date the prepayment (or complete repayment) is received to redeem

bonds that are part of the issue.

.03 Section 143(f) imposes eligibility

requirements concerning the maximum

income of mortgagors for whom financing may be provided by qualified mortgage bonds. Section 25(c)(2)(A)(iii)(IV)

provides that recipients of mortgage

credit certificates must meet the income

requirements of § 143(f). Generally,

under §§ 143(f)(1) and 25(c)(2)(A)(iii)(IV), these income requirements are met

only if all owner-financing under a qualified mortgage bond and all certified indebtedness amounts under a mortgage

credit certificate program are provided to

mortgagors whose family income is 115

percent or less of the applicable median

family income. Under § 143(f)(6), the income limitation is reduced to 100 percent

of the applicable median family income if

there are fewer than three individuals in

the family of the mortgagor.

.04 Section 143(f)(4) provides that the

term “applicable median family income”

1998–15 I.R.B.

means the greater of (A) the area median

gross income for the area in which the

residence is located or (B) the statewide

median gross income for the state in

which the residence is located.

.05 Section 143(f)(5) provides for an

upward adjustment of the income limitations in certain high housing cost areas.

Under § 143(f)(5)(C), a high housing cost

area is a statistical area for which the

housing cost/income ratio is greater than

1.2. The housing cost/income ratio is determined under § 143(f)(5)(D) by dividing (a) the applicable housing price ratio

by (b) the ratio that the area median gross

income bears to the median gross income

for the United States. The applicable

housing price ratio is the new housing

price ratio (new housing average purchase

price for the area divided by the new

housing average purchase price for the

United States) or the existing housing

price ratio (existing housing average area

purchase price divided by the existing

housing average purchase price for the

United States), whichever results in the

housing cost/income ratio being closer to

1. This income adjustment applies only

to bonds issued and nonissued bond

amounts elected after December 31, 1988.

.06 The Department of Housing and

Urban Development (HUD) has computed the median gross income for the

United States, the states, and statistical

areas within the states. The income information was released to the HUD regional

offices on January 7, 1998, and may be

obtained by calling the HUD reference

service at 1-800-245-2691, or, in the

Washington, D.C., area, at 301-251-5154.

The Internal Revenue Service annually

publishes only the median gross income

for the United States.

.07 The most recent nationwide average purchase prices and average area purchase price safe harbor limitations were

published on September 6, 1994, in Rev.

Proc. 94–55, 1994–2 C.B. 716.

.02 When computing the housing

cost/income ratio under § 143(f)(5), issuers of qualified mortgage bonds and

mortgage credit certificates must use the

area median gross income figures released by HUD on January 7, 1998. See

section 2.06 of this revenue procedure.

SECTION 3. APPLICATION

DRAFTING INFORMATION

.01 When computing the housing

cost/income ratio under § 143(f)(5), issuers of qualified mortgage bonds and

mortgage credit certificates must use

$45,300 as the median gross income for

the United States. See section 2.06 of this

revenue procedure.

The principal author of this revenue

procedure is Patricia M. Monahan of the

Office of Assistant Chief Counsel (Financial Institutions and Products). For further information regarding this revenue

procedure contact Ms. Monahan at (202)

622-4122 (not a toll-free call).

1998–15 I.R.B.

Rev. Proc. 98–27

CONTENTS

SECTION 1.

SECTION 2.

SECTION 3.

SECTION 4.

SECTION 4. EFFECT ON OTHER

REVENUE PROCEDURES

.01 Rev. Proc. 97–26, 1997–17 I.R.B.

17, is obsolete except as provided in section 5.02 of this revenue procedure.

.02 This revenue procedure does not affect the effective date provisions of Rev.

Rul. 86–124, 1986–2 C.B. 27. Those effective date provisions will remain operative at least until the Service publishes a

new revenue ruling that conforms the approach to effective dates set forth in Rev.

Rul. 86–124 to the general approach

taken in this revenue procedure.

SECTION 5. EFFECTIVE DATES

.01 Issuers must use the United States

and area median gross income figures

specified in section 3 of this revenue procedure for commitments to provide financing that are made, or (if the purchase

precedes the financing commitment) for

residences that are purchased, in the period that begins on January 7, 1998, the

date HUD released the income figures,

and ends on the date when these United

States and area median gross income figures are rendered obsolete by a new revenue procedure.

.02 Notwithstanding section 5.01 of

this revenue procedure, issuers may continue to rely on the United States and area

median gross income figures specified in

Rev. Proc. 97–26 with respect to bonds

originally sold and nonissued bond

amounts elected not later than May 13,

1998, if the commitments or purchases

described in section 5.01 are made not

later than July 13, 1998.

SECTION 5.

SECTION 6.

SECTION 7.

SECTION 8.

PURPOSE AND SCOPE

BACKGROUND

DEFINITIONS

APPLICATION PROCEDURES FOR QI STATUS AND WITHHOLDING AGREEMENT

QI WITHHOLDING

AGREEMENT

EFFECTIVE DATE

PAPERWORK REDUCTION ACT

FURTHER INFORMATION

SECTION 1. PURPOSE AND SCOPE

.01 Purpose. This revenue procedure

gives guidance for entering into a withholding agreement with the Internal Revenue Service (IRS) to be treated as a

Qualified Intermediary (QI) under

§1.1441–1(e)(5) of the Income Tax Regulations. It describes the application procedures for becoming a QI and the terms

that the IRS will ordinarily require in a QI

withholding agreement. The objective of

a QI withholding agreement is to simplify

withholding and reporting obligations

with respect to payments of income (including interest, dividends, royalties, and

gross proceeds) made to an account

holder through one or more foreign intermediaries.

.02 Scope. This revenue procedure applies to persons described in §1.1441–

1(e)(5)(ii)(A) and (B)—foreign financial

institutions, foreign clearing organizations, and foreign branches of U.S. financial institutions and U.S. clearing organizations. It does not apply to foreign

corporations seeking to become a QI to

present claims of benefits under an income tax treaty on behalf of shareholders.

See §§1.1441–1(e)(5)(ii)(C) and 1.1441–

6(b)(4)(ii)(B). It does not apply to a foreign partnership seeking to qualify as a

withholding foreign partnership. See

§1.1441–5(c)(2)(ii). It also does not

apply to other persons that the IRS may

accept to be qualified intermediaries as

authorized under §1.1441–1(e)(5)(ii)(D).

A person that is not within the scope of

this revenue procedure but may seek QI

April 13, 1998

status under §1.1441–1(e)(5)(ii)(C) or

(D), or §1.1441–5(c)(2)(ii) should contact

the Office of the Assistant Commissioner

(International) at the address or telephone

number in section 4.01 of this revenue

procedure.

SECTION 2. BACKGROUND

.01 Withholding and reporting on payments to foreign persons. Under sections

1441 and 1442 of the Internal Revenue

Code (Code), a person that makes a payment of U.S. source interest, dividends,

royalties, and certain other types of income to a foreign person must generally

deduct and withhold 30 percent from the

payment. A lower rate of withholding

may apply under the Code (e.g., section

1443), the regulations, or an income tax

treaty. Generally, a payor of these types

of income must also report the payments

on Form 1042–S. See §1.1461–1(c).

Under sections 6042, 6045, 6049, and

6050N of the Code (the Form 1099 reporting provisions), payors of dividends,

gross proceeds, interest, and royalties

must report the payments on Form 1099

unless an exception applies. If a payor

must report a payment on Form 1099, it

must obtain a Form W–9 from the payee.

If the payor does not receive the Form

W–9, it must backup withhold at a 31percent rate under section 3406 of the

Code. One exception to the Form 1099

reporting provisions applies if the payee

is a foreign person. A payor can treat a

person as foreign if the payor can reliably

associate the payment with documentation that establishes that the person is a

foreign beneficial owner of the income or

a foreign payee. See §§1.6042–3(b)(1)(iii), 1.6045–1(g)(1)(i), 1.6049–5(b)(12),

and 1.6050N–1(c)(1)(i). Moreover, a

payor does not have to backup withhold

on payments to foreign beneficial owners

or foreign payees because backup withholding applies only to amounts that the

payor must report on Form 1099.

.02 Proof of foreign status. The regulations under section 1441 and the Form

1099 reporting provisions of the Code

prescribe the manner in which a beneficial owner or payee certifies to a payor

that it is a foreign or U.S. person and, if

foreign, whether a reduced rate of withholding applies. For proof of foreign status, a payor or a withholding agent may

rely on a Form W–8 or on documentary

April 13, 1998

evidence for payments made outside the

United States to an offshore account or, in

the case of broker proceeds, a sale effected outside the United States.

In addition, a payor or withholding

agent may rely on a QI’s certifications (as

described in §1.1441–1(e)(3)(ii) and section 5.02 of this revenue procedure) to determine whether a beneficial owner or

payee is foreign, and to determine the applicable rate of withholding and the appropriate type of reporting. The QI provides its certifications on a Form W–8.

By furnishing its own Form W–8 to a

payor or withholding agent, a QI may, for

example, act on behalf of its foreign account holders to claim a reduction of the

30-percent withholding rate without having to document or identify to the withholding agent each foreign account holder

individually.

SECTION 3. DEFINITIONS

For purposes of this revenue procedure,

the terms listed below are defined as follows.

.01 A “QI” is an eligible person as described in §1.1441–1(e)(5)(ii)(A) or (B)

(and paragraph .10 of this section) that

enters into a withholding agreement (described in section 5 of this revenue procedure) with the IRS. A person acting in its

capacity as a QI does not act as an agent

of the IRS, nor does it have the authority

to hold itself out as an agent of the IRS.

.02 A “QI-Form W–8” means a withholding certificate described in §1.1441–

1(e)(3)(ii).

.03 An “account holder” means any

person that has an account with a QI. It

includes a person that is the beneficial

owner of the account or a person that

holds the account as an intermediary (e.g.,

custodian, nominee or agent).

.04 An “exempt recipient” means, for

interest, dividends, and royalties, a person

described in §1.6049–4(c)(1)(ii). For broker proceeds, it is a person described in

§5f.6045–1(c)(3)(i)(B) or in §1.6045–

2(b)(2)(i).

.05 A “non-exempt recipient” or “nonexempt payee” means a person that is not

an exempt recipient under the definition

in paragraph .04 of this section.

.06 Any reference to “chapter 3 of the

Code” means sections 1441, 1442, and

1443 of the Code, and shall not include

references to sections 1445 and 1446 of

the Code, unless specifically indicated

otherwise.

.07 Any reference to “chapter 61 of the

Code” means sections 6041, 6041A,

6042, 6044, 6045, 6049, and 6050N of the

Code.

.08 A “reportable amount” means an

amount subject to withholding under

chapter 3 of the Code (within the meaning

of §1.1441–2(a)), U.S. source deposit interest (including original issue discount)

described in section 871(i)(2)(A) of the

Code, and U.S. source interest or original

issue discount on short-term obligations

described in section 871(g)(1)(B) of the

Code. The term does not include payments on deposits with banks and other financial institutions that remain on deposit

for two weeks or less. It also does not include amounts of original issue discount

arising from a sale and repurchase transaction completed within a period of two

weeks or less, or amounts described in

§1.6049–5(b)(7), (10), or (11) (relating to

certain obligations issued in bearer form).

See §1.1441–1(e)(3)(vi).

.09 A “withholding agent” has the same

meaning as set forth in §1.1441–7(a) and

includes a payor, as defined in

§1.6049–4(a)(2). As used in this revenue

procedure, the term generally refers to the

person making a payment to a QI.

.10 An “eligible person” means, as described in §1.1441–1(e)(5)(ii)(A) or (B),

any foreign financial institution, foreign

clearing organization, or foreign branch

of a U.S. financial institution or U.S.

clearing organization.

.11 A “branch” includes an office.

.12 A “financial institution” means a

person described in §1.165–12(c)(1)(iv)

(not including a person providing pension

or other similar benefits or a regulated investment company or other mutual fund,

unless otherwise indicated).

.13 A “clearing organization” means a

person described in §1.163–5(c)(2)(i)(D)(8).

.14 “Class of assets” and “withholding

pool,” have the meanings given to the

terms in section 5.02(4)(c) of this revenue

procedure.

.15 Any reference to “payments to a QI

or an account holder” includes crediting

an amount to the account of the QI or account holder.

.16 An “acceptance agent” is a person,

as described in §301.6109–1(d)(3)(iv)(B),

1998–15 I.R.B.

that is authorized to assist persons in obtaining individual taxpayer identification

numbers or employer identification numbers from the IRS. See Rev. Proc. 96–52,

1996–2 C.B. 372.

SECTION 4. APPLICATION FOR QI

STATUS AND WITHHOLDING

AGREEMENT

.01 Where to Apply and Pre-submission

Conferences. To apply for QI status and a

withholding agreement, an eligible person

must submit a written request to:

Assistant Commissioner (International), CP:IN:OO:WT 950 L’Enfant

Plaza South, SW

Washington DC 20024

FAX: (202) 874-1797

An eligible person may request one or

more pre-submission conferences by contacting the Office of the Assistant Commissioner (International) at (202) 8741800 (not a toll-free number).

.02 Content of Application. The application must establish to the satisfaction of

the IRS that the applicant has adequate resources and procedures to comply with

the terms of a withholding agreement. An

application must include the information

specified in this section 4.02, and any additional information and documentation

requested by the IRS.

(1) A statement that the applicant is an

eligible person and that it requests a QI

withholding agreement with the IRS.

(2) The applicant’s name, address, and

employer identification number (EIN), if

any.

(3) The country in which the applicant

was created or organized and a description of the applicant’s business.

(4) A list of the applicant’s officers and

directors and a list of the employees who

are responsible parties for performance

under the agreement.

(5) A list of the branches that the

agreement will cover and their location.

(6) An explanation and sample of the

account opening agreements and other

documents used to open and maintain the

accounts at each location covered by the

agreement.

(7) The type of account holders (e.g.,

U.S., foreign, treaty benefit claimant, or

intermediary), the approximate number of

account holders within each type, and the

estimated value of U.S. investments that

the QI-Form W–8 will cover.

1998–15 I.R.B.

(8) An explanation of the applicant’s

“know-your-customer” practices and procedures (under its local money-laundering

laws) for opening accounts, and identifying and communicating with customers at

each location covered by the agreement.

The explanation should include whether

local law mandates the “know-your-customer” procedures and the manner in

which local authorities verify compliance.

The applicant should also describe the

governmental or other supervisory authorities that regulate the “know-your-customer” procedures, and the sanctions that

apply under local law for failing to comply with the procedures. The applicant

must include supporting documentation.

(9) A list of assets in the United States

from which amounts owed to the IRS can

be collected, if necessary.

(10) A completed Form SS–4 (Application for Employer Identification Number) to apply for a QI Employer Identification Number (QI-EIN) to be used solely

for QI reporting and filing purposes. An

applicant must apply for a QI-EIN even if

it already has another EIN.

(11) A proposed QI withholding agreement drafted in accordance with section 5

of this revenue procedure.

SECTION 5. QI WITHHOLDING

AGREEMENT

.01 Scope of the agreement. An agreement may not cover U.S. branches of an

eligible person. An eligible person is not

required to include all of its foreign

branches in the agreement. The IRS may

require, however, that an eligible person

agree to include certain of its branches to

insure the disclosure of certain U.S. account holders. See §1.1441–1(e)(5)(iii)

and section 5.02(3), below. In appropriate cases, an eligible person may request

that the agreement cover its related nonU.S. affiliates or unrelated account holders that act as nominees, custodians, or

agents of beneficial owners. If the IRS

grants the request, each related non-U.S.

affiliate or unrelated account holder must

agree to be a signatory to the agreement.

.02 Terms and procedures regarding intermediary withholding certificate. (1)

Submission of QI-Form W–8. The agreement must specify that a QI will furnish

its QI-Form W–8, with its QI-EIN, to

withholding agents for reportable

amounts in lieu of furnishing a Form W-8

or Form W–9 from each of its account

holders to such withholding agents.

(2) Designation of primary withholding

responsibility. A QI is a withholding agent

under chapter 3 of the Code and a payor

under chapter 61 and section 3406 of the

Code for reportable amounts that it pays to

its account holders. Generally, a withholding agent that makes a payment to the

QI, however, will be responsible for actually withholding under chapter 3 and section 3406 of the Code. Thus, if the withholding agent has withheld and reported

on the reportable amounts paid to the QI,

the QI is not required to withhold except

to the extent required to correct any underwithholding. See §1.1441–1(b)(6). The

QI may, however, agree in its withholding

agreement to assume primary withholding

responsibility for payments to foreign account holders. See §1.1441–1(e)(5)(iv).

Generally, the IRS will not allow a QI to

assume primary withholding or reporting

responsibility for payments to U.S. persons unless the QI is a foreign branch of a

U.S. financial institution, or the QI has a

branch in the United States and establishes

that its U.S. branch can adequately comply with the provisions under chapter 61

and section 3406 of the Code.

(3) Disclosure of identity of beneficial

owner or payee by QI. Except as otherwise provided in this subparagraph (3), a

QI is not required to disclose the identity

of its account holders covered by a QIForm W–8 to a withholding agent. Further, the documentation given by an account holder to a QI supporting the

account holder’s claim of foreign status

and, if applicable, entitlement to a reduced rate of withholding does not need

to be attached to the QI-Form W–8. The

QI must, however, furnish a Form W–9

(or an acceptable substitute form) for each

of its account holders (or those of another

intermediary or of a foreign partnership)

that is a U.S. payee that is not an exempt

recipient. The identity of U.S. payees

who are exempt recipients is not required

to be disclosed to the withholding agent.

If the QI does not hold a Form W–9 for a

non-exempt U.S. payee, it must furnish to

the withholding agent any information the

QI has regarding the payee’s name, address, and taxpayer identifying number.

The requirement to disclose the identity

of non-exempt U.S. payees will apply despite local bank secrecy laws.

April 13, 1998

(4) Information to withholding agent.

(a) In general. A QI must agree to identify the classes of assets covered by the

QI-Form W–8 by following §1.1441–

1(e)(5)(v) and subparagraph (4)(c) of this

section. In addition, the QI must state the

rate of withholding for each class.

(b) Application of presumptions. To

identify the relevant classes of assets, a

QI may determine the status of its, or another intermediary’s, account holders by

following the presumptions in §§1.1441–

1(b)(3), 1.1441–5(d) and (e), and 1.6049–

5(d)(2) through (d)(5).

pool. (i) Definition. Generally, a class of

assets is a group of assets that produces

the same type of income (e.g., interest or

dividends), is subject to the same rate of

withholding, and is associated with the

same type of payee or beneficial owner

(e.g., foreign, U.S., or undocumented

(i.e., a payee for whom the QI holds no or

unreliable documentation)). Notwithstanding the general rule that a class of

asset should produce the same type of income, a QI-Form W–8 may state that all

assets held in a particular account are

within a single class of assets if all the income from the assets in such account is

subject to the same rate of withholding

and the same type of information reporting. See, for example, subparagraph

(4)(c)(ii)(C) of this section. The QI withholding agreement must require the QI to

identify classes of assets on a country-bycountry basis. The income from each

class of assets is a separate “withholding

pool.” See section 5.07(3) for more information on withholding pools.

(ii) Application. (A) Foreign payees.

Assets that are associated with foreign

payees, that produce a specific type of income, and are subject to a particular withholding rate are a class of assets. Thus,

there may be numerous classes of assets

for the same type of income paid to foreign payees because of different withholding rates under the Code or an applicable treaty.

(B) U.S. payees. Assets associated

with each U.S. payee that is a non-exempt recipient are a separate class. Assets associated with all U.S. payees that

are exempt recipients are a single separate class.

April 13, 1998

stitute a separate class. A QI paying reportable amounts (other than U.S. source

bank deposit interest or short-term OID)

must presume that undocumented payees

of those amounts are foreign unless the QI

has actual knowledge that the payee is a

U.S. non-exempt recipient. For reportable amounts that are bank deposit interest from a U.S. branch of a U.S. bank

or similar financial institution or shortterm original issue discount, the QI must

presume that the undocumented payee is a

U.S. non-exempt recipient.

(D) QI assuming primary withholding

responsibility. Assets for which a QI assumes primary withholding responsibility

are a separate class. The QI does not have

to identify separate classes of assets within that class if the assumption of withholding responsibility makes such a disclosure unnecessary. The QI withholding

agreement may, however, require a QI to

identify the assets with respect to which it

assumes primary withholding responsibility on a country-by-country basis.

(iii) Example. (A) Facts. A QI

(“QI1”) has foreign account holders. The

QI1 also has account holders that are U.S.

non-exempt recipients. Another account

holder is a QI (“QI2”) that has assumed

primary withholding responsibility. Finally, QI1 has some account holders for

whom it does not have the required documentation. QI1 has not assumed primary

withholding responsibility for any assets.

All account holders earn U.S. source

interest that would qualify as portfolio interest if they gave the documentation required by §1.871–14(c)(2). They also

earn U.S. source dividends. Some of the

foreign account holders can benefit from

a 15-percent reduced withholding rate

under a tax treaty on dividend income

while others cannot.

(B) Analysis. QI1 has the following

classes of U.S. source assets and withholding pools:

(1) assets producing interest earned by

foreign account holders claiming the portfolio interest exemption at source (a withholding pool of interest - zero rate);

(2) assets producing dividend income

earned by foreign account holders claiming the 15-percent reduced rate at source

under an income tax treaty (a withholding

pool of dividends - 15% rate);

(3) assets producing dividend income

earned by foreign account holders resid-

ing in a non-treaty country (a withholding

pool of dividends - 30% rate);

(4) assets producing interest income

earned by each U.S. account holder (a

withholding pool per account holder of

interest reportable on a Form 1099 - zero

rate);

(5) assets producing dividends earned

by each U.S. account holder (a withholding pool per account holder for dividends

reportable on a Form 1099 - zero rate);

(6) assets producing dividends and interest income earned by account holders

for whom the QI1 does not hold all of the

required documentation as specified

under the agreement (a withholding pool

for undocumented payees - 30% rate (presumed foreign)—Note: QI1 could divide

this class of assets into one for dividends

and another for interest income); and

(7) assets producing dividends and interest payable to QI2 for its foreign account holders (a withholding pool for

which QI2 assumes withholding).

.03 Documentation requirements. (1)

In general. The agreement must contain

provisions covering the type of documentation a QI will obtain from its account

holders. Generally, the QI must agree to

the same documentation requirements

that apply to withholding agents under

chapters 3 and 61 of the Code. The QI

may use any substitute form for a Form

W–8 or Form W–9 that is acceptable to

the IRS. The QI may include a substitute

form in an account opening form. If a QI

relies on documentary evidence in place

of a Form W–8, the agreement must specify the type of documentary evidence

upon which the QI may rely.

(2) Documentary evidence from beneficial owners. Beneficial owner documentary evidence is acceptable if the QI

complies with the provisions of §1.6049–

5(c)(1). Generally, a QI will be permitted

to rely on the “know-your-customer” procedures (as submitted for review pursuant to section 4.02(8) of this revenue

procedure) if such procedures are acceptable to the IRS.

(3) Documentation supporting claim of

reduced rate. A QI may not reduce the

rate of withholding, or instruct a withholding agent to reduce the rate, unless it

can associate the payment with valid documentation described in the section 1441

regulations or in the QI withholding

agreement. If an account holder is not an

1998–15 I.R.B.

individual, the QI must obtain a certification that the account holder meets the

Limitations on Benefits article contained

in any treaty the account holder invokes.

See §1.1441–6(c)(5). If an account

holder, other than an individual, is acting

for its own account, the QI must also obtain a representation that the account

holder is not a partnership for U.S. tax

purposes. If the account holder is a partnership for U.S. tax purposes, then the QI

must obtain a Form W–9 as described in

§1.1441–1(d)(2) (if the partnership is a

domestic partnership) or a Form W–8 as

described in §1.1441–5(c) (if the partnership is a foreign partnership). In addition,

if an account holder, other than an individual, claims the benefit of a reduced rate of

withholding under a tax treaty, the QI

must obtain the representations set forth in

§§1.1441–6(b)(4)(i) and 1.894–1T(d).

(4) Documentation from intermediaries. When the QI receives a payment of

a reportable amount for an account holder

that is an intermediary (e.g., nominee,

custodian, or agent), the QI must obtain

beneficial owner documentation in the

following manner:

(a) Intermediary that is not a QI. If the

intermediary is not a QI, then the intermediary must give the QI a Form W–8 according to §1.1441–1(e)(3)(iii), including

a statement described in §1.1441–

1(e)(3)(iv) regarding the allocation of

payments. A QI that receives a non-QI intermediary Form W–8 may either give the

non-QI intermediary Form W–8, with all

the accompanying documentation, to the

withholding agent or may use the non-QI

intermediary Form W–8 as the basis for

the certifications that the QI includes in

its own QI-Form W–8 regarding the status of, and entitlement to benefits by, the

non-QI intermediary’s account holders.

(b) Intermediary that is a QI. If the

intermediary is a QI (i.e., a second tier

QI), the second tier QI must give the first

tier QI a QI-Form W–8. The first tier QI

may give the second tier QI’s QI-Form

W–8, and accompanying documentation,

to the withholding agent. Alternatively,

the first tier QI may use the second tier’s

QI-Form W–8 as the basis for the certifications that the first tier QI includes in its

own QI-Form W–8 regarding the status

of, and entitlement to benefits by, the second tier QI’s account holders. If the first

tier QI relies on the second tier QI’s QI-

1998–15 I.R.B.

Form W–8 to certify to the withholding

agent the withholding status of the second

tier QI’s account holders, then the first

tier QI must agree to allocate the assets

associated with the second tier QI’s QIForm W–8 to the classes that the first tier

QI has established for its own account

holders as if the account holders of the

second tier QI were the first tier QI’s own

account holders.

responsibility. If a QI has assumed primary withholding responsibility, it must

generally assume that responsibility for

all other intermediaries, whether or not

they are QIs, that are before it in the chain

of payment. If a second tier QI has

agreed to assume primary withholding responsibility, then a first tier QI that has

also assumed primary withholding responsibility does not have to withhold on

income paid to the second tier QI. If the

second tier QI has assumed primary withholding responsibility but the first tier QI

has not, the first tier QI must agree to

identify for the withholding agent those

assets associated with the second tier QI’s

QI-Form W–8 and on which there should

be no withholding (other than under section 3406 of the Code, if applicable). See

example under paragraph .02(4)(c)(iii),

above.

(5) Standards of reliability and due

diligence. A QI must agree to follow the

due diligence obligations of §1.1441–

7(b)(2)(ii). The reliability of any documentation will be evaluated by the type of

information contained in the documents,

the procedures under which the documents are issued, and the ease with which

the documents could be falsified.

(6) Renewal of documentation. Unless

specified otherwise in the agreement, a QI

must agree to follow the provisions of

§1.1441–1(e)(4)(ii) regarding the renewal

of the Forms W–8 and documentary evidence provided by its account holders.

.04 Assistance regarding taxpayer

identification numbers. (1) Acceptance

agents. A QI may agree to act as an acceptance agent, including a certifying acceptance agent, for purposes of section

6109 of the Code and the regulations

thereunder. See Rev. Proc. 96–52, 1996–

2 C.B. 372, for the duties and obligations

of an acceptance agent.

(2) TIN certifications. A QI may agree

to assist its account holders in complying

with the requirements for a certified TIN

under §1.1441–6(b). Only account holders claiming a reduced rate under an income tax treaty for certain payments (e.g.,

income from non-publicly traded securities) are required to obtain a certified TIN.

See §1.1441–6(b)(1) and (2)(i).

.05 Recordkeeping obligations. The

agreement must provide that the QI will

maintain a record of the documentation

obtained and reviewed under the agreement. The QI must maintain the documentation for any account holder for a period of three years after its validity

expires. The documentation must also be

available for inspection by the IRS or, if

applicable, an approved external auditor.

.06 Withholding obligations. (1) QI

assumes primary withholding responsibility. A QI that assumes primary withholding responsibility must agree to withhold

any amount due under section 1441,

1442, or 1443 of the Code in accordance

with §1.1441–1(b)(1) and §1.1443–1(b).

If applicable, the QI must also agree to

withhold any amount due under section

3406 of the Code. In addition, the QI

must agree to deposit the withheld

amounts following §1.1461–1(a) and all

other relevant deposit obligations. Under

the agreement, the IRS may agree to special deposit procedures to facilitate remittances from a foreign country.

(2) QI that does not assume primary

withholding responsibility. A QI that does

not assume primary withholding responsibility nevertheless must agree to withhold

if it knows that an amount should have

been withheld from the payment and the

full amount was not withheld. The QI

must also agree to comply with withholding and deposit procedures in the same

manner as described in paragraph .06(1)

of this section for amounts that it withholds.

.07 Reporting obligations. (1) In general. The regulations under section 1461

of the Code require a QI to make returns

on a Form 1042 and to provide information to the IRS and beneficial owners or

payees on a Form 1042–S on a calendar

year basis under the provisions of

§1.1461–1(b), subject to the following

modifications to which the IRS may agree.

(2) Form 1042 reporting. Generally,

every QI shall file an annual Form 1042

and the form must include the following

additional information:

April 13, 1998

(a) A schedule providing information

on reportable amounts of income subject

to withholding under chapter 3 of the

Code that the QI received during the calendar year. The schedule should list the

name, address, and EIN of each withholding agent from whom the reportable

amounts were received and the income

type and rate of withholding;

(b) Information regarding overpayments or balances due, adjustments under

§1.1461–2 and an explanation for the

over- or underwithholding;

conducted by the QI’s internal auditors

under the audit guidelines specified in the

agreement (i.e., that the QI is complying

with the agreement in all material respects

or a description of the irregularities uncovered by the internal auditors and the

actions undertaken to correct such irregularities); and

(d) A statement that an approved external auditor conducted an audit, when required, with a copy of the report of audit

findings (see paragraph .09 of this section

regarding verification procedures).

(3) Form 1042–S reporting. The

agreement may waive the obligation for a

QI to report beneficial owner information

to the IRS on Forms 1042–S in appropriate cases. In place of beneficial owner information, the IRS may require the QI to

report by country and withholding pools.

An appropriate case may exist if beneficial owner information is otherwise available to the IRS, for example, pursuant to

treaty exchange of information provisions, or the IRS decides that access to

beneficial owner information is not necessary for compliance. Similarly, reporting

by withholding pools may be sufficient

for compliance purposes if the QI has

agreed to adequate verification procedures as described in paragraph .09 of this

section. The QI may provide the information on a Form 1042–S, as modified by

the IRS to adapt to the withholding pool

reporting requirements, on magnetic

media, by electronic means, or on any

form to which the IRS and the QI agree.

The information must include the number

of account holders in each pool. The type

of withholding pool subdivisions the IRS

may require for the payment of reportable

amounts under chapter 3 of the Code

(within the meaning of §1.1441–2(a)) includes the following:

April 13, 1998

(a) Type of income;

(b) Withholding rate;

holder; and

(d) Type of recipients (e.g., undocumented payees, U.S. payees).

(4) Furnishing a Form 1042–S to the

beneficial owner or payee. The agreement

may modify or waive the obligation under

§1.1461–1(c)(1)(i) that the QI furnish a

statement to a beneficial owner or payee

on a Form 1042–S and provide for alternative reporting procedures.

(5) Reports related to claims of a reduced rate under a tax treaty. The QI

must agree to give the IRS, on request or

on an annual basis, the names and addresses of its account holders that received a reduced rate of withholding

under a tax treaty and that have certified

that they meet the Limitation on Benefits

provision and that they derive, within the

meaning of §1.894–1T(d), the income receiving the benefit. The QI must also

agree to disclose the names and addresses

of account holders of any non-QI intermediary that has given the QI a Form W–8 or

other documentation if the account holders have certified that they meet the Limitation on Benefits provision of a treaty

and derive the income receiving the benefit. Generally, the IRS will agree to limit

disclosure to account holders that receive

more than an agreed upon amount (not

less than $100,000) of treaty-benefited income in their QI account.

.08 Adjustments for under- and overwithholding, refund procedures, and underwithholding determined after the filing

of Form 1042. (1) Adjustments. If a QI

has not assumed primary withholding responsibility, it must agree that it will provide sufficient information to a withholding agent so that the withholding agent

can make the adjustments for over- and

under-withholding described in §1.1461–

2(a) and (b). If a QI has assumed primary

withholding responsibility, it may make

the adjustments itself in the manner described under §1.1461–2(a) and (b).

(2) Refunds. A QI withholding agreement may allow any net amount of overwithholding for a calendar year on a QI’s

account holders which remains outstanding after the due date for filing the QI’s

Form 1042 (not including extensions) to

be refunded to the QI for its account holders (under procedures as the IRS may pre-

scribe) if an adjustment under §1.1461–

2(a) cannot be made.

(3) Underwithholding determined after

filing a QI’s Form 1042. A QI, including a

QI that does not assume primary withholding responsibility, must agree to file an

amended Form 1042 to report any underwithheld tax which is determined after the

filing of the QI’s Form 1042 for the calendar year in which the tax was underwithheld. In addition, the QI must agree to pay

the tax due (including interest and penalties). This includes, but is not limited to,

instances where the underwithholding is

determined as a result of an audit by the

QI’s internal or external auditors.

.09 Verification procedures. (1) In

general. Unless the QI agreement allows

for verification by an external auditor, a

QI must agree to make records and account information specified in the QI

withholding agreement available to the

IRS for audit, and must agree to procedures for carrying out an audit of those

records and information. The IRS must

be able to verify that the QI has adequate

systems and control procedures in effect

to comply with the agreement. In addition, the IRS may require specific procedures to allow it to verify compliance

with the QI withholding agreement for

specific accounts.

(2) Verification of specific account information. If a QI is not subject to audit

under the approved external auditor procedure, described in paragraph .10(3) of

this section, then the QI withholding

agreement will contain procedures for

IRS audits of account information. Generally, a QI that complies with the filing

requirements on Forms 1042 and 1042–S

(or otherwise makes account holder information available to the IRS) may be

exempted from IRS audits or be subject

to abbreviated IRS audits. If a QI has

agreed to certify tax residence to the IRS

under §1.1441–6(c)(2)(iii) based upon

documentation the QI has obtained and

reviewed, it must also agree to give the

documentation to the IRS upon written

request in the manner agreed. To conduct

periodic compliance checks, the IRS may

rely on sampling techniques to assure reliability of the examination without

undue disruption to the QI. The agreement will specify the manner in which

IRS compliance checks will take place.

In appropriate cases, assistance may be

1998–15 I.R.B.

obtained from the tax authorities of the

countries where the QI activities are

located.

(3) Approved external auditors. If,

given local enforcement of know-yourcustomer procedures and local oversight

and controls over the QI and its external

auditors, the IRS determines it is appropriate, the following procedures will generally apply under the agreement.

(a) The QI must establish that it has implemented adequate internal procedures

and accounting systems to comply with

the QI withholding agreement and to verify its compliance with those procedures.

Internal auditors must review those procedures and accounting systems on an annual basis as a regular part of their audit

program. Their conclusions must be included in their annual audit report. A

statement certifying that the annual review has taken place and the results of

that review (including a notation of all irregularities observed and actions taken to

address those irregularities) must be attached to the QI’s annual Form 1042 filed

with the IRS.

(b) Verification must also be performed by external auditors. The QI must

agree to an external auditor’s review after

the first year of operation as a QI. Thereafter, the frequency and scope of compliance checks by external auditors will

occur only at the request of the IRS, generally based upon a review of the QI’s

Form 1042 or indicators that the QI may

have compliance problems (e.g., large refund requests, large pool of undocumented payees). The scope of review by

external auditors may be limited based on

the scope of annual internal audits. In

order for the external auditors to perform

their audit effectively, the QI must agree

to allow external auditors to have access

to all of its relevant records for purposes

of performing the audits.

QI withholding agreement. Subsequent

changes of external auditors must also be

approved by the IRS. To be approved, an

auditor must be subject to regulatory supervision under the laws of the country or

countries in which the QI’s activities

under the agreement are expected to

occur. The external auditor’s procedures

must require it to verify that the QI complies with the terms of the agreement and

1998–15 I.R.B.

to report non-compliance findings under

the agreement.

(d) Upon completion of the audit, the

external auditors must issue a report of

audit findings (or incorporate their audit

findings as a separate part of a larger audit

report) and provide the report to the IRS

in English (and using U.S. dollars). The

report must explain the scope and objectives of the audit, state the methodology

used, and certify that the audit was conducted in accordance with applicable laws

and regulatory requirements. The report

must express the auditor’s opinion on the

QI’s compliance with the terms of the

agreement. The QI and the approved external auditor must agree to allow the IRS

to communicate with the external auditors

and review their workpapers, if necessary.

If the external auditor’s report identifies

compliance issues or if, based on a review

of the external auditor’s report, the IRS

determines that further checks are necessary, then the IRS may request that the external auditor perform additional audit

procedures.

(4) Special rules for foreign branches

of U.S. financial institutions. Generally, a

QI that is a foreign branch of a U.S. financial institution will be subject to the same

IRS audit procedures that apply to any

U.S. taxpayer.

.10 Guarantee of payment. To insure

collection of payments for underwithheld

amounts, the agreement may require a

guarantee to be furnished by the QI to the

IRS. The guarantee may include a letter

of credit, bond, or other surety in an

amount to which the QI and the IRS

agree. The amount of the bond or letter of

credit must be commensurate with the approximate risk of underwithholding. Factors to be considered in this regard include the amount of U.S. investments

made through the QI, the number of beneficial owners making U.S. investments,

the type of investment and the characteristics of the beneficial owners, and the degree of reporting by the QI to the IRS.

Generally, a QI that has substantial assets

in the United States will be considered to

have adequately guaranteed its withholding obligations.

.11 Approval and Execution. An agreement must be signed by the authorized

representative of the QI and by the IRS.

The Assistant Commissioner (International) will sign on behalf of the IRS upon

approval by the Associate Chief Counsel

(International). To the extent an agreement covers a QI’s related non-U.S. affiliate or unrelated account holder, that affiliate or account holder must be a signatory

to the agreement.

.12 Expiration, Termination and Default. (1) Term and events of termination.

The period of the agreement will be between three and six years. The agreement

may be renewed for further periods as

specified in paragraph .13 of this section.

Either the IRS or the QI may terminate

the agreement prior to its term by delivering a 30-day notice of termination to the

other party. The IRS will not give notice

of termination until thirty days after it has

delivered a notice of default to the QI.

The IRS may deliver a notice of default at

any time after an event of default under

the agreement has occurred or after a significant change in the circumstances of

the QI has occurred such as a merger,

changes in the business or operations of

the QI, or bankruptcy.

(2) Events of default. Events of default

include the determination upon audit or

otherwise that the QI has failed to comply

with the procedures required by the agreement in a way that (1) causes, or may

cause, significant underwithholding, excessive refunds, or an excessive number of

undocumented payees, or (2) impedes, or

may impede, the disclosure of the identity

of persons who are required to be disclosed under the agreement. An event of

default also includes the lack of cooperation by the QI or an approved external auditor in connection with an audit of the QI

or with inquiries by the IRS related to verifying compliance by the QI. The agreement will define when underwithholding

or inadequate reporting is deemed to be

significant. A QI will also be in default if

it makes material misrepresentations on its

Form W–8; it has actual knowledge at the

time a payment is made that documentation regarding a significant number of account holders is lacking, incorrect, or unreliable; or it fails to perform any other

material duty or obligation required of it

under the agreement. The QI may respond

to the notice of default by making an offer

to cure within thirty days. The IRS will

accept or reject the offer to cure, or make a

counter-proposal, within ten days.

.13 Renewal. A QI may renew a QI

withholding agreement by submitting an

April 13, 1998

application for renewal to the IRS no earlier than one year and no later than six

months prior to the expiration of the

agreement. In the application for renewal, the QI will update the information

it provided in the original application.

Before approval of any renewal of the

agreement, the IRS will require an audit

of the QI.

.14 Effective date of agreements. The

agreements entered into under §1.1441–

1(e)(5) will be effective for all accounts

opened on or after the date specified in

the agreement. For accounts existing on

the effective date of the agreement, the

requirements to obtain documentation

generally will not apply until the expiration of the one-year period beginning on

the agreement’s effective date. Until the

documentation is obtained for these accounts, the QI generally will be permitted

to rely on any documentation or information in an existing account file. In the absence of any documentation or indication, or actual knowledge, the QI will be

allowed to presume that an account

holder is a foreign person based on the

indicia of foreign status described in

§1.1441–1(b)(3)(iii)(A). The presumption shall not be effective for purposes of

obtaining the benefit of the portfolio interest exemption under section 871(h) or

881(c) of the Code or the benefit of a tax

treaty.

SECTION 6. EFFECTIVE DATE

This revenue procedure is effective on

the date of its publication in the Internal

Revenue Bulletin. The IRS may conclude

agreements under this revenue procedure

at any time after that date, but such agreements will not have effect before the date

specified in the agreement.

SECTION 7. PAPERWORK

REDUCTION ACT

The collections of information contained in this revenue procedure have

been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act

(44 U.S.C. 3507) under control number

1545–1597.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the collection of information displays a valid

OMB control number.

April 13, 1998

The collections of information are contained in sections 4 and 5 of this revenue

procedure regarding (1) the application

procedures for QI status and withholding

agreements, and (2) the provisions of the

QI withholding agreement requiring

record retention or maintenance, and any

communication or contact with the IRS or

the account holders. This information

will be used to enable the IRS to determine whether to enter into a withholding

agreement with the QI applicant and, if

accepted, to verify the QI’s compliance

with the agreement. The collection of information is required to obtain a QI withholding agreement. The likely respondents are business or other for-profit

institutions.

The estimated total annual reporting

and/or recordkeeping burden is 301,393

hours.

The estimated average annual burden is

30 minutes for a QI account holder, and

2,093 hours for a QI, depending on individual circumstances. The estimated

number of respondents and/or recordkeepers is 88,504.

The estimated annual frequency of responses is on occasion.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

SECTION 8. FURTHER

INFORMATION

For further information regarding this

revenue procedure, telephone the Office

of Assistant Commissioner (International)

at (202) 874-1800 (not a toll-free number).

26 CFR 601.204: Changes in accounting periods

and in methods of accounting.

(Also Part I, Sections 471; 1.471–2.)

Rev. Proc. 98–29

SECTION 1. PURPOSE

This revenue procedure provides guidance for a taxpayer that wants to change

to a method of accounting for estimating

inventory “shrinkage” in computing ending inventory. “Shrinkage” refers collectively to such items as undetected theft,

breakage, and bookkeeping errors. In addition, section 4 of this revenue procedure

provides interim guidance that describes

the “retail safe harbor method” for a taxpayer that wants to change to the retail

safe harbor method for estimating inventory shrinkage. The procedures for a taxpayer within the scope of this revenue

procedure to automatically change to a

method of accounting for estimating inventory shrinkage are provided in Rev.

Proc. 97–37, 1997–33 I.R.B. 18, as modified by section 5.02 of this revenue procedure. This revenue procedure also requests comments on issues that should be

addressed in forthcoming regulations

under § 471 regarding proper methods of

estimating inventory shrinkage for taxable years ending after August 5, 1997.

SECTION 2. BACKGROUND

.01 Section 471(a) of the Internal Revenue Code provides that whenever, in the

opinion of the Secretary, the use of inventories is necessary in order to clearly determine the income of any taxpayer, inventories must be taken by such taxpayer

on such basis as the Secretary may prescribe as conforming as nearly as may be

to the best accounting practice in the trade

or business and as most clearly reflecting

income.

.02 Section 1.471–2(d) of the Income

Tax Regulations provides that when a taxpayer maintains book inventories in accordance with a sound accounting system,

the net value of the inventory will be

deemed to be the cost basis of the inventory, provided that such book inventories

are verified by physical inventories at reasonable intervals and adjusted to conform

therewith. Physical inventories are used

to determine and adjust book inventories

for shrinkage.

.03 Section 961 of the Taxpayer Relief

Act of 1997 (Act) amended § 471(b) to

permit, under certain circumstances, adjustments to ending inventory for estimates of inventory shrinkage. Section

961(b) of the Act provides that, in the

case of any taxpayer permitted by

§ 471(b) to change its method of accounting to a permissible method for any taxable year, the change is treated as made

with the consent of the Secretary and the

period for taking into account the adjustments under § 481 by reason of such

change is four years.

1998–15 I.R.B.

.04 The legislative history (Conference

Report and House Report) accompanying

the Act provides that a taxpayer is permitted by § 471(b) to change its method of

accounting if the taxpayer is currently

using a method that does not utilize estimates of inventory shrinkage and wants to

change to a method that includes inventory shrinkage estimates based on physical

inventories taken at other than year-end.

H.R. Rep. No. 220 (Conference Report),

105th Cong., 1st Sess. 466, at 467–68

(1997); H.R. Rep No. 2014 (House Report), 105th Cong., 1st Sess. 408, at 410

(1997). In addition, the Conference Report provides a safe harbor method applicable to taxpayers primarily engaged in retail trade (the “retail safe harbor method”).

The Conference Report further provides

that the conferees expect that the Secretary

will provide procedures allowing a taxpayer to automatically change to the retail

safe harbor method. Pursuant to the Conference Report, use of the retail safe harbor method will be deemed to result in a

clear reflection of income, provided such

safe harbor method is consistently applied

and the taxpayer’s inventory methods otherwise satisfy the clear reflection of income standard.

SECTION 3. SCOPE

.01 Applicability. This revenue procedure applies to a taxpayer requesting the

Commissioner’s consent to change to a

method of accounting for estimating inventory shrinkage in computing ending

inventory, using:

(1) the retail safe harbor method, regardless of whether the taxpayer’s present

method of accounting estimates inventory

shrinkage; or

(2) a method other than the retail

safe harbor method, provided (a) the taxpayer’s present method of accounting does

not estimate inventory shrinkage, and (b)

the taxpayer’s new method of accounting

(that estimates inventory shrinkage)

clearly reflects income under § 446(b).

.02 Inapplicability. This revenue procedure does not apply to a taxpayer requesting to change to a method other than

the retail safe harbor method of accounting for estimating inventory shrinkage in

computing ending inventory, if the taxpayer’s present method of accounting estimates inventory shrinkage. A taxpayer

requesting such a change must file a Form

1998–15 I.R.B.

3115, Application for Change in Accounting Method, with the Commissioner in

accordance with the requirements of

§1.446–1(e)(3)(i) and Rev. Proc. 97–27,

1997–21 I.R.B. 10.

SECTION 4. RETAIL SAFE HARBOR

METHOD

.01 The retail safe harbor method of

estimating inventory shrinkage, as described in sections 4.02 through 4.07 of

this revenue procedure, may be used in

computing ending store inventory by taxpayers that are primarily engaged in retail

trade (the resale of personal property to

the general public), where physical inventories are normally taken at each location

at least annually.

.02 The retail safe harbor method uses

a historical ratio of shrinkage to sales to

estimate the inventory shrinkage that occurred between the date of the last physical inventory and the end of the taxable

year. This historical ratio is based on the

actual shrinkage established by all physical inventories taken during the most recent three taxable years and the sales for

related periods. The most recent three

taxable years include the taxable year for

which the shrinkage estimate is to be

made and the two prior taxable years.

The historical ratio, or estimated shrinkage determined using the historical ratio,

cannot be adjusted by judgmental or other

factors (for example, floors or caps).

.03 For stores with departments, a taxpayer must determine the historical ratio

separately for each store or each department in a store. This determination must

be done in the same manner for all stores

with departments that are in the same

trade or business of the taxpayer. For

stores without departments, a taxpayer

must determine the historical ratio separately for each store. If a taxpayer has a

new store (or a new department in a store)

for which the taxpayer has not verified

shrinkage by a physical inventory in each

of the most recent three taxable years, the

historical ratio is the average of the historical ratios of the taxpayer’s other stores

(or other departments in the store where

the taxpayer computes the historical ratio

on a department basis) during the most recent three taxable years.

.04 The estimated inventory shrinkage

permitted by the retail safe harbor method

is determined by multiplying the histori-

cal ratio for each store or each department

in a store by its sales for the period between the date of the last physical inventory and the end of the taxable year.

.05 Taxpayers using the last-in first-out

(LIFO) inventory method must allocate

shrinkage among their various LIFO inventory pools in a reasonable and consistent manner.

.06 Estimated shrinkage determined in

accordance with consistent application of

the retail safe harbor method may not be

recalculated, through a look-back adjustment or otherwise, to reflect the results of

physical inventories taken after year-end.

.07 A taxpayer that changes to the retail safe harbor method must use the retail

safe harbor method consistently to determine the ending inventory for all stores

that comprise a separate trade or business

of the taxpayer. Use of the retail safe harbor method for estimating inventory

shrinkage results in the clear reflection of

income, provided this method is used

consistently and the taxpayer’s inventory

methods otherwise satisfy the clear reflection of income standard.

SECTION 5. CHANGING TO THE

RETAIL SAFE HARBOR METHOD OR

OTHER METHOD OF ESTIMATING

INVENTORY SHRINKAGE

.01 In general. Any change in a taxpayer’s computation of ending inventory

to estimate inventory shrinkage, or any

change in the computation of such estimate, is a change in method of accounting

to which the provisions of §§ 446 and 481

and the regulations thereunder apply.

.02 Automatic change. A taxpayer

within the scope of this revenue procedure that wants to change to a method of

accounting for estimating inventory

shrinkage in computing ending inventory

must follow the automatic change in accounting method provisions of Rev. Proc.

97–37, with the following modifications:

(1) The scope limitations in section

4.02 of Rev. Proc. 97–37, as well as the

application procedures in sections 6.03,

6.04, and 6.05 of Rev. Proc. 97–37, do not

apply. However, if the taxpayer is under

examination, before an appeals office, or

before a federal court with respect to any

income tax issue, the taxpayer must provide a copy of the Form 3115 to the examining agent(s), appeals officer, or

counsel for the government, as appropri-

April 13, 1998

ate, at the same time that it files the copy

of the Form 3115 with the national office.

The Form 3115 must contain the name(s)

and telephone number(s) of the examining agent(s), appeals officer, or counsel

for the government, as appropriate.

(2) A taxpayer that, on or before

June 12, 1998, files its original federal income tax return for its first taxable year

ending on or after August 5, 1997, is not

subject to the filing requirement in section

6.02(2)(a) of Rev. Proc. 97–37, provided

the taxpayer complies with the following

filing requirement. The taxpayer must

complete and file a Form 3115 in duplicate. The original must be attached to the

taxpayer’s amended federal income tax

return for the taxpayer’s first taxable year

ending on or after August 5, 1997. This

amended return must be filed no later than

August 11, 1998. A copy of the Form

3115 must be filed with the national office

(see section 6.02(6) of Rev. Proc. 97–37

for the address) no later than when the

taxpayer’s amended return is filed.

(3) A taxpayer, whose present

method of accounting estimates inventory shrinkage, does not receive audit protection under section 7 of Rev. Proc. 97–

37 in connection with a change to the retail safe harbor method if, on the date the

taxpayer files a copy of the Form 3115

with the national office, the taxpayer’s

present method of estimating inventory

shrinkage is an issue under consideration

within the meaning of section 3.09 of

Rev. Proc. 97–37.

(4) In addition to all the requirements and procedures in Rev. Proc. 97-37,

as modified by this revenue procedure, the

following rules apply to a taxpayer within

the scope of this revenue procedure that

changes to a method other than the retail

safe harbor method of accounting for estimating inventory shrinkage. The taxpayer

must provide a detailed description of all

aspects of the new method of estimating

inventory shrinkage (including, for LIFO

April 13, 1998

taxpayers, the method of determining inventory shrinkage for, or allocating inventory shrinkage to, each LIFO pool) in the

Form 3115 filed by the taxpayer for such a

change. The District Director or national

office subsequently may review whether

the new method clearly reflects the taxpayer’s income under § 446(b). If the District Director or the national office determines that the new method of accounting

does not clearly reflect the taxpayer’s income, the taxpayer will be treated as having made a change in method of accounting without obtaining the consent of the

Commissioner as required by § 446(e).

See section 6.06 of Rev. Proc. 97–37.

(5) For a change in method of accounting within the scope of this revenue

procedure, the provisions of Rev. Proc.

97–37 are effective for taxable years ending after August 5, 1997.

(6) The transition rules in section

13.02 of Rev. Proc. 97–37 do not apply to

any change in method of accounting

within the scope of this revenue procedure. The Service will return any Form

3115 if it is filed with the national office

pursuant to the Code, regulations, or administrative guidance other than Rev.

Proc. 97–37 and the change in method of

accounting is within the scope of this revenue procedure.

.03 Future change. A taxpayer that

changes to the retail safe harbor method

described in this revenue procedure will

not be precluded, solely by reason of such

change, from changing to another safe

harbor method for estimating inventory

shrinkage in computing ending inventory

in the first year that such other safe harbor

method is available.

SECTION 6. REGULATIONS AND

REQUEST FOR PUBLIC COMMENT

The Service intends to issue regulations

under § 471 regarding proper methods for

estimating inventory shrinkage in com-

puting ending inventory for taxable years

ending after August 5, 1997. Comments

are requested regarding safe harbor methods for estimating inventory shrinkage

(including the retail safe harbor method),

and any other issues that these regulations

should address. Written comments

should be submitted by August 11, 1998,

to: Internal Revenue Service, P.O. Box

7604, Ben Franklin Station, Washington,

DC 20044, Attn: CC:DOM:CORP:R

(IT&A BRANCH 7, Room 5226). Submissions may be hand-delivered between

the hours of 8 a.m. and 5 p.m. to:

Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW,

Washington DC, Attn: CC:DOM:CORP:

R (IT&A Branch 7, Room 5226). Alternatively, taxpayers may submit comments

electronically at

http://www.irs.ustreas.gov/prod/tax_re

gs/comments.html

(the Service’s internet site). All comments submitted will be available for public inspection and copying.

SECTION 7. EFFECTIVE DATE

This revenue procedure is effective for

taxable years ending after August 5, 1997.

SECTION 8. EFFECT ON OTHER

DOCUMENTS

Rev. Proc. 97–37 is modified and amplified to include this automatic accounting method change in the Appendix.

DRAFTING INFORMATION

The principal author of this revenue

procedure is Jan L. Skelton of the Office

of Assistant Chief Counsel (Income Tax

and Accounting). For further information

regarding this revenue procedure, contact

Ms. Skelton at (202) 622-4970 (not a tollfree call).

1998–15 I.R.B.

Part IV. Items of General Interest

Notice of Proposed Rulemaking

and Notice of Public Hearing

Constitution Avenue, NW., Washington,

DC.

Source and Grouping Rules for

Foreign Sales Corporation

Transfer Pricing

FOR FURTHER INFORMATION CONTACT: Concerning the regulations,

Elizabeth Beck (202) 622-3880; concerning submissions and the hearing, Michael

Slaughter, (202) 622-7190 (not toll-free

numbers).

REG–102144–98

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking by cross-reference to

temporary regulations and notice of public hearing.

SUMMARY: In T.D. 8764, page 9 of this

Bulletin, the IRS is issuing temporary

regulations that provide guidance to taxpayers who have made an election to be

treated as a foreign sales corporation

(FSC). The regulations provide rules

clarifying the special sourcing rules under

section 927(e)(1) and provide a deadline

for the election to group transactions.

This document also provides notice of a

public hearing on these proposed regulations. The text of the temporary regulations also serves as the text of the proposed regulations.

DATES: Written comments must be received by June 1, 1998. Requests to

speak (with outlines of oral comments) to

be discussed at the public hearing scheduled for June 24, 1998, at 10 a.m., must

be received by June 3, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–102144–98),

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:DOM:CORP:R

(REG-102144-98), Courier’s Desk, Internal Revenue Service, 1111 Constitution

Avenue, NW, Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting

the “Tax Regs” option on the IRS Home

Page, or by submitting comments directly

to the IRS Internet site at http://www.irs.

ustreas.gov/prod/tax_regs/comments.html.

The public hearing will be held in Room

2615, Internal Revenue Service, 1111

1998–15 I.R.B.

SUPPLEMENTARY INFORMATION:

Background

Temporary regulations in T.D. 8764

amend the Income Tax Regulations (26

CFR part 1) relating to sections 925 and

927. The temporary regulations contain

rules relating to the grouping of transactions under the FSC transfer pricing rules

and the special source rules under section

927(e)(1). The preamble to the temporary

regulations explains the temporary regulations.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has

also been determined that section 553(b)

of the Administrative Procedure Act (5

U.S.C. chapter 5) does not apply to these

regulations, and because the regulation

does not impose a collection of information on small entities, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, this notice of

proposed rulemaking will be submitted to

the Chief Counsel for Advocacy of the

Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (preferably a signed original and

eight (8) copies) that are submitted timely

to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled

for June 24, 1998, at 10 a.m., in room

2615, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington,

DC. Because of access restrictions, visitors will not be admitted beyond the Internal Revenue lobby more than 15 minutes

before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written

comments by June 1, 1998, and submit an

outline of the topics to be discussed and

the time to be devoted to each topic

(preferably a signed original and eight (8)

copies) by June 3, 1998.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the schedule of

speakers will be prepared after the deadline for receiving outlines has passed.

Copies of the agenda will be available

free of charge at the hearing.

Drafting Information

The principal author of the proposed

regulations is Elizabeth Beck, of the Office of the Associate Chief Counsel (International). Other personnel from the IRS

and Treasury Department also participated in the development of these regulations.

Proposed Amendments to the Regulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding the following

entries to the table in numerical order to

read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.925(a)–1 is also issued under

26 U.S.C. 925(b)(1) and (2) and

927(d)(2)(B).

Section 1.925(b)–1 is also issued under

26 U.S.C. 925(b)(1) and (2) and

927(d)(2)(B). * * *

Par. 2. Section 1.925(a)–1 is added as

follows:

[The text of proposed §1.925(a)–1 consisting of paragraphs (c)(8)(i) and (e)(4) is

the same as the text of §1.925(a)– 1T(c)(8)(i) and (e)(4) as amended in T.D. 8764.]

April 13, 1998

Par. 3. Section 1.925(b)–1 is added as

follows:

[The text of proposed §1.925(b)–1 consisting of paragraph (b)(3)(i) is the same

as the text of §1.925(b)–1T(b)(3)(i) as

amended in T.D. 8764.]

Par. 4. Section 1.927(e)–1 is amended

as follows:

[The text of proposed §1.927(e)-1 is

the same as the text of §1.927(e)-1T published in T.D. 8764.]

Michael P. Dolan,

Deputy Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on

March 2, 1998, 8:45 a.m., and published in the issue

of the Federal Register for March 3, 1998, 63 F.R.

10351)

Notice of Proposed Rulemaking

and Notice of Public Hearing

Return of Partnership Income

REG–209322–82

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Withdrawal of notice of proposed rulemaking; notice of proposed

rulemaking and notice of public hearing.

SUMMARY: This document withdraws

the notice of proposed rulemaking relating to partnership returns. The proposed

regulations were published in the Federal

198–82, 1986–1 C.B. 778]. These regulations revise the partnership filing requirement to reflect changes to the law made

by the Taxpayer Relief Act of 1997

(TRA). All partnerships required to file

partnership returns, including certain foreign partnerships, are affected by these

regulations. This document also contains

a notice of a public hearing on the proposed regulations.

DATES: Written comments must be received by April 27, 1998. Requests to

speak and outlines of oral comments to be

discussed at the public hearing scheduled

for May 19, 1998, at 10 a.m., must be received by April 28, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG–209322–82),

April 13, 1998

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:DOM:CORP:R

(REG–209322–82), Courier’s Desk, Internal Revenue Service, 1111 Constitution

Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments

electronically via the Internet by selecting

the “Tax Regs” option of the IRS Home

Page, or by submitting comments directly

to the IRS Internet site at: http://www.irs.

ustreas.gov/prod/tax_regs/comments.html.

The public hearing will be held in the IRS

Auditorium, 7400 Corridor, Internal Revenue Building, 1111 Constitution Avenue

NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Martin

Schäffer or Christopher Kelley, 202-6223080; concerning foreign partnerships,

Ronald Gootzeit, 202-622-3860; concerning submissions and the hearing, Michael

Slaughter, 202-622-7190 (not toll-free

numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of

Management and Budget for review in accordance with the Paperwork Reduction

Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information

should be sent to the Office of Management and Budget, Attn: Desk Officer for

the Department of the Treasury, Office of

Information and Regulatory Affairs,

Washington, DC 20503, with copies to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, T:FP, Washington, DC 20224. Comments on the collection of information must be received

by March 27, 1998. Comments are

specifically requested on:

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal

Revenue Service, including whether the

information will have practical utility;

The accuracy of the estimated burden

associated with the proposed collection of

information (see below);

How the quality, utility, and clarity of

the information to be collected may be enhanced;

How the burden of complying with the

proposed collection of information may

be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of the capital or start-up

costs and costs of operation, maintenance,

and purchase of services to provide information.

The collection of information in this

proposed regulation is in §1.6031(a)-1.

This information is required to enable the

IRS to verify that a taxpayer is reporting

the correct amount of income or gain or

claiming the correct amount of losses, deductions, or credits from that taxpayer’s

interest in the partnership. The collection

of information is mandatory. The likely

respondents are businesses and other forprofit institutions.

The burden is reflected in the burden of

Form 1065.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

This document contains proposed

amendments to the Income Tax Regulations (26 CFR Part 1) under sections 6031

and 6063 of the Internal Revenue Code of

1986 (Code). These amendments are designed, in part, to reflect changes made to

section 6031 by section 1141 of TRA,

Public Law 105–34, 111 Stat. 788 (1997).

Section 6031 contains rules regarding the

filing of returns of partnership income

(partnership returns).

On January 23, 1986, the IRS published in the Federal Register (51 F.R.

3075) proposed regulations under section

6031 of the Internal Revenue Code (existing proposed regulations). Section

1.6031–1 of the existing proposed regulations provides rules that, if finalized,

1998–15 I.R.B.

would implement the partnership filing

requirements of section 404 of the Tax

Equity and Fiscal Responsibility Act of

1982 (TEFRA), Public Law 97–248, 96

Stat. 669 (1982). Because section 1141 of

TRA supersedes the partnership filing requirements of section 404 of TEFRA, the

IRS and Treasury consider it appropriate

to reissue proposed regulations reflecting

recent changes to the law, while giving

taxpayers another opportunity to comment. Accordingly, this document withdraws §1.6031–1 of the existing proposed

regulations published in the Federal Register on January 23, 1986 (51 F.R. 3075).

A partnership that has followed the rules

contained in §1.6031–1 of the existing

final regulations for all taxable years prior

to the taxable year for which these new

regulations will become effective will be

treated as fully complying with the partnership filing requirements with respect

to such taxable years.

Section 6063 provides that a partnership return shall be signed by any one of

the partners. The proposed regulations

clarify who must sign a partnership return

filed solely for the purpose of making certain partnership-level elections.

Explanation of Provisions

Filing Requirement

Section 6031(a) requires every partnership to file a partnership return. New section 6031(e), as added by section 1141 of

TRA, exempts certain foreign partnerships from the filing requirement of section 6031(a). Section 6031(e) provides

that a foreign partnership is not required

to file a return for a tax year unless during

that year it derives gross income from

sources within the United States or has

gross income that is effectively connected

with the conduct of a trade or business

within the United States. Further exceptions to the filing requirement for foreign

partnerships may be provided by regulations.

The proposed regulations separately

describe the filing requirements for domestic and foreign partnerships. In accordance with section 6031(a), the proposed

regulations provide that, except in certain

limited circumstances, every domestic

partnership must file a partnership return.

Under section 6031 and the proposed

regulations, a foreign partnership gener-

1998–15 I.R.B.

ally must file a partnership return only if

it has either United States source income

or income effectively connected (or

treated as effectively connected) with the

conduct of a trade or business within the

United States. However, under the proposed regulations, a foreign partnership

that has no gross income that is effectively connected with the conduct of a

trade or business within the United States,

and that would be required to file a partnership return only because it has gross

income derived from sources within the

United States, will be exempt from the requirement to file a partnership return if (i)

no United States person has a direct or indirect interest in the partnership; (ii) the

gross income derived from sources within

the United States is either fixed or determinable annual or periodical income described in §1.1441–2(b) or other amounts

subject to withholding described in

§1.1441–2(c); (iii) Forms 1042 and 1042–

S are filed with respect to all such gross

income in accordance with §1.1461–1(b)

and (c); and (iv) the tax liability of the

partners with respect to such gross income

has been fully satisfied by the withholding

of tax at the source, if applicable, under

chapter 3. The foreign partnership’s

obligation to file Forms 1042 and 1042–S

is generally eliminated by the regulations

under section 1461 published in the Federal Register on October 14, 1997 (62

F.R. 53387) if those returns are filed by

the withholding agent (or agents) making

the payments of United States source income to the partnership and the partners’

tax liability with respect to United States

source income has been fully satisfied by

withholding. See §1.1461–1(b)(2) and

(c)(4). The IRS and Treasury invite comments addressing other ways to reduce duplicative information filing.

Any domestic or foreign partnership that

elects to be excluded from subchapter K of

Chapter 1 of the Code under section 761(a)

will not be required to file a partnership return, except that where a partnership

makes an election under §1.761–2(b)(2)(i),

the partnership must timely file a partnership return that contains the information

required by §1.761–2(b)(2)(i) for the taxable year for which the election is made.

Failure to Meet Filing Requirement

If a partnership that is not a small partnership under section 6231(a)(1)(B) is re-

quired to file a partnership return under

section 6031 but fails to do so, the period

of limitations on assessment of tax attributable to items of that partnership remains

open indefinitely under section 6229(a).

The failure of a partnership to file a return

required by section 6031 might also result

in disallowance under section 6231(f) of

the deductions, losses, and credits flowing

through to the partners and could subject

the partnership to penalties under section

6698 and/or section 7203.

Information To Be Furnished to Partners

Under section 6031(b), every partnership that is required by section 6031(a) to

file a partnership return must furnish information to its partners as required by

regulations. The rules governing partnership statements to partners and nominees

are in §1.6031(b)–1T.

Partnership Elections

A foreign partnership otherwise exempt

from the filing requirement that wants to

make a partnership-level election under

section 703(b) must file a partnership return for the year of the election. The proposed regulations provide rules similar to

those contained in §1.7701–3(c)(2) of the

entity classification regulations with respect to who has the authority to file such

returns. Generally, the return must be

signed by all partners or by an authorized

partner.

Proposed Effective Dates

These regulations are proposed to be

applicable to partnership tax years ending

on or after the 90th day after final regulations on this subject are published in the

Federal Register. However, the exceptions for certain foreign partnerships contained in §1.6031(a)–1(b)(2) will not be

applicable to any partnership taxable

years beginning before January 1, 1999.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a significant regulatory action as defined in EO

12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these proposed regulations. It is hereby certified

April 13, 1998

that the collection of information contained in these proposed regulations will

not have a significant economic impact on

a substantial number of small entities.

This certification is based on the fact that

the regulations would reduce (rather than

increase) the number of small entities that

are required to file a partnership return.

Specifically, the proposed regulations

would eliminate the filing requirements

for certain foreign partnerships that are

fully subject to withholding in order to

prevent duplicative filing requirements.

In addition to eliminating the filing requirements in these circumstances, for

ease of reference the proposed regulations

update and restate the general requirements to file a partnership return as set

forth in existing regulations. Because the

proposed regulations would not impose

any new reporting requirements that are

not imposed by the existing regulations,

and the only significant modification of

the existing regulations is to eliminate the

filing requirement for certain foreign partnerships, the regulations will not have a

significant economic impact on a substantial number of small entities. Accordingly, a Regulatory Flexibility Analysis

under the Regulatory Flexibility Act (5

U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Code, these

proposed regulations will be submitted to

the Chief Counsel for Advocacy of the

Small Business Administration for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are

adopted as final regulations, consideration will be given to any written comments (preferably a signed original and

eight (8) copies) that are submitted timely

to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled

for Tuesday, May 19, 1998, at 10 a.m., in

the IRS Auditorium, 7400 Corridor, Internal Revenue Building, 1111 Constitution

Avenue NW, Washington, DC. Because

of access restrictions, visitors will not be

admitted beyond the building lobby more

than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3)

apply to the hearing.

Persons that wish to present oral comments at the hearing must submit written

comments by April 27, 1998, and submit

April 13, 1998

an outline of the topics to be discussed

and the time to be devoted to each topic

(signed original and eight (8) copies) by

April 28, 1998.

A period of 10 minutes will be allotted

to each person for making comments.

An agenda showing the scheduling of

the speakers will be prepared after the

deadline for receiving outlines has

passed. Copies of the agenda will be

available free of charge at the hearing.

Drafting Information

The principal authors of these regulations are Martin Schäffer and Christopher

Kelley, Office of Assistant Chief Counsel

(Passthroughs and Special Industries),

and Ronald Gootzeit, Office of the Associate Chief Counsel (International).

However, other personnel from the IRS

and Treasury Department participated in

their development.

Withdrawal of Proposed Amendments to

the Regulations

Accordingly, under the authority of 26

U.S.C. 7805, the notice of proposed rulemaking that was published in the Federal

3075) is withdrawn.

Proposed Amendments to the Regulations

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

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding an entry in

numerical order to read as follows:

Authority: 26 U.S.C. 7805. * * *

Section 1.6031(a)–1 also issued under

26 U.S.C. 6031. * * *

§1.6031–1 [Removed]

Par. 1a. Section 1.6031–1 is removed.

Par. 2. Section 1.6031(a)–1 is added to

read as follows:

§1.6031(a)–1 Return of partnership

income.

(a) Domestic partnerships—(1) Return

required. Except as provided in paragraphs (a)(3) and (c) of this section, every

domestic organization that is a partner-

ship must file a return of partnership income under section 6031 (partnership return) for each taxable year on the form

prescribed for the partnership return. The

partnership return must be filed for the

taxable year of the partnership regardless

of the taxable years of the partners. For

taxable years of a partnership and of a

partner, see section 706 and §1.706–1.

For the rules governing partnership statements to partners and nominees, see

§1.6031(b)–1T.

(2) Content of return. The partnership

return must contain the information required by the prescribed form and the accompanying instructions.

(3) Special rule. A partnership that has

no income, deductions, or credits for federal income tax purposes for a taxable

year is not required to file a partnership

return for that year.

(4) Failure to file. For the consequences of a failure to comply with the requirements of section 6031(a) and this

paragraph (a), see sections 6229(a),

6231(f), 6698, and 7203.

(b) Foreign partnerships—(1) Return

required. A foreign partnership must file

a partnership return for a partnership taxable year only if it has gross income derived from sources within the United

States or it has gross income that is (or is

treated as) effectively connected with the

conduct of a trade or business within the

United States for the taxable year. Certain exceptions to this requirement are

provided in paragraphs (b)(2) and (c) of

this section. A foreign partnership that is

required to file a partnership return must

file the partnership return in accordance

with the rules provided for domestic partnerships in paragraph (a) of this section.

(2) Exception to partnership return requirement for certain foreign partnerships investing in the United States. A

foreign partnership that has no gross income that is effectively connected with

the conduct of a trade or business within

the United States, and that would be required to file a partnership return only because it has gross income derived from

sources within the United States, is not required to file a partnership return under

section 6031 if—

(i) No United States person has a direct

or indirect interest in the partnership;

(ii) The gross income derived from

sources within the United States is either

1998–15 I.R.B.

fixed or determinable annual or periodical

income described in §1.1441–2(b) or

other amounts subject to withholding described in §1.1441–2(c);

(iii) Forms 1042 and 1042–S are filed

with respect to all such gross income in

accordance with §1.1461–1(b) and (c). In

order to satisfy this requirement, Forms

1042 and 1042–S must be filed by the

partnership unless the partnership is not

required to file such returns under

§1.1461–1(b)(2) and (c)(4), in which

case, Forms 1042 and 1042–S must be

filed by another withholding agent (or

agents); and

(iv) The tax liability of the partners

with respect to such gross income has

been fully satisfied by the withholding of

tax at the source, if applicable, under

chapter 3 of the Internal Revenue Code.

(3) Partnership information or returns

required of partners who are United

States persons—(i) In general. If a

United States person is a partner in a partnership that is not required to file a partnership return, the district director or director of the service center may require

that person to render the statements or

provide the information necessary to verify the accuracy of the reporting by that

person of any items of partnership income, gain, loss, deduction, or credit.

(ii) Certain partnership elections. For

a partnership that is not otherwise required to file a partnership return, if an

election that can only be made by the

partnership under section 703 (affecting

the computation of taxable income derived from a partnership) is to be made by

or for the partnership, a return on the form

prescribed for the partnership return must

be filed for the partnership. The return

must be signed by—

(A) Each partner that is a partner in the

partnership at the time the election is

made; or

(B) Any partner of the partnership who

is authorized (under local law or the partnership’s organizational documents) to

make the election and who represents to

having such authorization under penalti

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