Bulletin No. 1997–48

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Internal Revenue

bulletin

Bulletin No. 1997–48

December 1, 1997

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

EMPLOYEE PLANS

Rev. Rul. 97–49, page 4.

Notice 97–69, page 12.

1997 base period T-bill rate. The “base period T-bill rate”

for the period ending September 30, 1997, is published, as

required by section 995(f)(4) of the Code.

REG–105162–97, page 13.

Proposed regulations under section 7701 of the Code describe how elective changes in entity classification will be

treated for Federal tax purposes. A public hearing will be

held on February 24, 1998.

REG–251985–96, page 18.

Weighted average interest rate update. Guidelines are

set forth for determining for November 1997 the weighted

average interest rate and the resulting permissible range of

interest rates used to calculate current liability for purposes

of the full funding limitation of section 412(c)(7) of the Code

as amended by the Omnibus Budget Reconciliation Act of

1987 and by the Uruguay Round Agreements Act (GATT).

EXEMPT ORGANIZATIONS

Proposed regulations under section 863 of the Code relate

to the source of income from sales of inventory produced in

the United States and sold in a U.S. possession or produced

in a U.S. possession and sold in the United States. A public

hearing will be held on January 29, 1998.

Announcement 97–116, page 25.

Notice 97–66, page 8.

Notice 97–61, page 8.

Securities lending transaction notice. Guidance is provided to payors of substitute interest payments made after

November 13, 1997, and before January 1, 1999, to comply with the statement requirement of section 871(h)(5) of

the Code in order to qualify the payments as portfolio interest payments for purposes of the tax imposed under sections 871 and 881 of the Code. Guidance is also provided to

determine the amount of tax imposed and withheld on substitute dividend payments made by one foreign person to another foreign person.

This notice informs the public of the Service’s Year 2000

Date Standard Policy.

Notice 97–68, page 11.

This notice informs taxpayers that the rules in sections

1.664–2(a)(1)(i) and 1.664–3(a)(1)(i)(e) of the proposed Income Tax regulations, published in REG–209823–96,

1997–18 I.R.B. 47, will not be effective for certain charitable remainder trusts for the 1997 tax year.

Finding Lists begin on page 28.

Index for July–November begins on page 30.

Department of the Treasury

Internal Revenue Service

A list is provided of organizations now classified as private

foundations.

ADMINISTRATIVE

Notice 97–67, page 10.

Accounting method requests for grace period interest.

This notice informs taxpayers that the Service will issue

guidance that provides the procedures for a taxpayer to

automatically change its method of accounting to comply

with section 1004 of the Taxpayer Relief Act of 1997 for the

taxpayer’s first taxable year beginning after August 5, 1997.

The notice provides that the Service will not grant any

requests filed on or after August 5, 1997, to change to a

method of accounting for grace period interest other than

the method required by section 1004 of the Act.

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 quarterly and

semiannual basis, and are published in the first Bulletin of the

succeeding quarterly and 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.

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

Section 861.—Income From

Sources Within the United

States

26 CFR 1.861–2: Interest.

Guidance is provided to the payors of U.S. source

substitute interest payments made after November

13, 1997, and before January 1, 1999, for complying

with the statement requirement of § 871(h)(5) in

order to qualify as portfolio interest. See Notice

97–66, page 8.

26 CFR 1.861–3: Dividends.

Guidance is provided on the determination of the

amount of tax imposed under §§ 871 and 881 on

U.S. source substitute dividend payments which are

made by a foreign person to another foreign person

(“foreign-to-foreign” payments).

Section 864.—Definitions and

Special Rules

26 CFR 1.864–5: General provisions relating to

withholding agent.

A general election to defer the effective date of

final securities lending regulations (published October 14, 1997, TD 8735, 62 FR 53498) for substitute

payments made after November 13, 1997, to January 1, 1999, does not apply for substitute interest

and substitute dividend payments received that are

foreign source effectively connected income under

§ 1.864–5(b)(2) of the final regulations. Notice

97–66, page 8.

Section 871.—Tax on

Nonresident Alien Individuals

26 CFR 1.871–7: Taxation of nonresident alien individuals not engaged in U.S. business.

Guidance is provided as to the amount of tax to

be imposed under § 1.871–7(b)(2) with respect to

substitute interest or substitute dividend payments

made by one foreign person to another foreign person. See Notice 97–66, page 8.

26 CFR 1.871–14: Rules relating to repeal of tax on

interest of nonresident alien individuals and foreign

corporations received from certain portfolio debt investments.

Guidance is provided to payors of substitute interest payments made after November 13, 1997, and

before January 1, 1999, i.e., prior to the effective

date of §1.871–14, for complying with the statement

requirement of § 871(h)(5) in order to qualify the

payments as portfolio interest payments for purposes of the tax imposed under §§ 871 and 881. See

Notice 97–66, page 8.

Section 881.—Tax on Income

of Foreign Corporations Not

December 1, 1997

Connected With United States

Business

26 CFR 1.881–2: Income of foreign corporations

treated as effectively connected with U.S. business.

Guidance is provided as to the amount of tax to

be imposed under § 1.881–2(b)(2) with respect to

substitute interest or substitute dividend payments

made by one foreign person to another foreign person. See Notice 97–66, page 8.

Section 995.—Taxation of DISC

Income to Shareholders

1997 base period T-bill rate. The

“base period T-bill rate” for the period

ending September 30, 1997, is published,

as required by section 995(f)(4) of the

Code.

Rev. Rul. 97–49

Section 995(f)(l) of the Internal Revenue Code provides that a shareholder of

a DISC shall pay interest each taxable

year in an amount equal to the product of

the shareholder’s DISC-related deferred

tax liability for the year and the “base period T-bill rate.” Under section 995(f)(4),

the base period T-bill rate is the annual

rate of interest determined by the Secretary to be equivalent to the average investment yield of United States Treasury

bills with maturities of 52 weeks which

were auctioned during the one-year period ending on September 30 of the calendar year ending with (or of the most recent calendar year ending before) the

close of the taxable year of the shareholder. The base period T-bill rate for the

period ending September 30, 1997, is

5.68 percent.

Pursuant to section 6622 of the Code,

interest must be compounded daily. The

table below provides factors for compounding the base period T-bill rate daily

for any number of days in the shareholder’s taxable year (including a 52–53

week accounting period) for the 1997

base period T-bill rate. To compute the

amount of the interest charge for the

shareholder’s taxable year, multiply the

amount of the shareholder’s DISC-related

deferred tax liability (as defined in section

995(f)(2)) for that year by the base period

T-bill rate factor corresponding to the

number of days in the shareholder’s tax-

able year for which the interest charge is

being computed. Generally, one would

use the factor for 365 days. One would

use a different factor only if the shareholder’s taxable year for which the interest charge being determined is a short taxable year, if the shareholder uses the

52-53 week taxable year, or if the shareholder’s taxable year is a leap year.

For the base period T-bill rates for the

periods ending in prior years, see: Rev.

Rul. 86–132, 1986–2 C.B. 137; Rev. Rul.

87–129, 1987–2 C.B. 196; Rev. Rul.

88–94, 1988–2 C.B. 301; Rev. Rul.

89–116, 1989–2 C.B. 197; Rev. Rul.

90–96, 1990–2 C.B. 188; Rev. Rul.

91–59, 1991–2 C.B. 347; Rev. Rul.

92–98, 1992–2 C.B. 201; Rev. Rul.

93–77, 1993–2 C.B. 253; Rev. Rul.

94–68, 1994–2 C.B. 177; Rev. Rul.

95–77, 1995–2 C.B. 122; and Rev. Rul.

96–55, 1996–2 C.B. 57.

DRAFTING INFORMATION

The principal author of this revenue

ruling is David Bergkuist of the Office of

the Associate Chief Counsel (International). For further information about this

revenue ruling, contact Mr. Bergkuist on

(202) 622-3850 (not a toll-free call).

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

.000155616

.000311257

.000466922

.000622611

.000778324

.000934062

.001089824

.001245610

.001401420

.001557255

.001713113

.001868996

.002024904

.002180835

.002336791

.002492771

.002648775

.002804804

1997–48 I.R.B.

1997 ANNUAL RATE,

COMPOUNDED DAILY

1997 ANNUAL RATE,

COMPOUNDED DAILY

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

DAYS

5.68 PERCENT

FACTOR

DAYS

5.68 PERCENT

FACTOR

.002960857

.003116934

.010008430

.010165604

109

110

.017105524

.017263803

.003273036

.003429161

.003585312

.003741486

.003897685

.010322802

.010480025

.010637272

.010794544

.010951840

111

112

113

114

115

.017422106

.017580433

.017738786

.017897162

.018055564

.004053908

.004210155

.004366426

.004522722

.004679043

.011109161

.011266506

.011423876

.011581270

.011738689

116

117

118

119

120

.018213990

.018372441

.018530916

.018689417

.018847941

.004835387

.004991756

.005148149

.005304567

.005461009

.011896132

.012053600

.012211092

.012368608

.012526150

121

122

123

124

125

.019006491

.019165065

.019323664

.019482287

.019640936

.005617475

.005773966

.005930481

.006087020

.006243584

.012683715

.012841306

.012998920

.013156560

.013314223

126

127

128

129

130

.019799609

.019958306

.020117028

.020275775

.020434547

.006400172

.006556784

.006713421

.006870082

.007026768

.013471912

.013629625

.013787362

.013945124

.014102911

131

132

133

134

135

.020593343

.020752165

.020911010

.021069881

.021228776

.007183478

.007340212

.007496971

.007653754

.007810561

.014260722

.014418557

.014576418

.014734302

.014892212

136

137

138

139

140

.021387696

.021546641

.021705610

.021864604

.022023623

.007967393

.008124249

.008281130

.008438035

.008594965

100

.015050146

.015208104

.015366087

.015524095

.015682127

141

142

143

144

145

.022182667

.022341736

.022500829

.022659947

.022819089

.008751919

.008908897

.009065900

.009222927

.009379979

101

102

103

104

105

.015840184

.015998265

.016156371

.016314502

.016472657

146

147

148

149

150

.022978257

.023137449

.023296666

.023455908

.023615174

.009537055

.009694155

.009851280

106

107

108

.016630837

.016789042

.016947271

151

152

153

.023774466

.023933782

.024093123

1997–48 I.R.B.

December 1, 1997

1997 ANNUAL RATE,

COMPOUNDED DAILY

1997 ANNUAL RATE,

COMPOUNDED DAILY

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

DAYS

5.68 PERCENT

FACTOR

DAYS

5.68 PERCENT

FACTOR

154

155

.024252489

.024411879

199

200

.031449673

.031610183

244

245

.038697430

.038859068

156

157

158

159

160

.024571294

.024730734

.024890199

.025049689

.025209204

201

202

203

204

205

.031770719

.031931279

.032091865

.032252475

.032413111

246

247

248

249

250

.039020732

.039182420

.039344134

.039505873

.039667638

161

162

163

164

165

.025368743

.025528307

.025687896

.025847510

.026007149

206

207

208

209

210

.032573771

.032734457

.032895167

.033055902

.033216663

251

252

253

254

255

.039829427

.039991242

.040153081

.040314946

.040476836

166

167

168

169

170

.026166813

.026326501

.026486214

.026645953

.026805716

211

212

213

214

215

.033377448

.033538259

.033699094

.033859955

.034020841

256

257

258

259

260

.040638752

.040800692

.040962658

.041124649

.041286665

171

172

173

174

175

.026965503

.027125316

.027285154

.027445016

.027604903

216

217

218

219

220

.034181751

.034342687

.034503648

.034664633

.034825644

261

262

263

264

265

.041448706

.041610773

.041772864

.041934981

.042097124

176

177

178

179

180

.027764816

.027924753

.028084715

.028244702

.028404713

221

222

223

224

225

.034986680

.035147741

.035308827

.035469938

.035631074

266

267

268

269

270

.042259291

.042421484

.042583702

.042745945

.042908213

181

182

183

184

185

.028564750

.028724812

.028884898

.029045010

.029205146

226

227

228

229

230

.035792236

.035953422

.036114633

.036275870

.036437131

271

272

273

274

275

.043070507

.043232826

.043395170

.043557539

.043719934

186

187

188

189

190

.029365307

.029525493

.029685704

.029845940

.030006201

231

232

233

234

235

.036598418

.036759730

.036921067

.037082428

.037243816

276

277

278

279

280

.043882354

.044044799

.044207270

.044369766

.044532287

191

192

193

194

195

.030166487

.030326798

.030487134

.030647495

.030807880

236

237

238

239

240

.037405228

.037566665

.037728127

.037889615

.038051128

281

282

283

284

285

.044694833

.044857405

.045020002

.045182624

.045345272

196

197

198

.030968291

.031128727

.031289187

241

242

243

.038212666

.038374229

.038535817

286

287

288

.045507945

.045670643

.045833366

December 1, 1997

1997–48 I.R.B.

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

289

290

.045996115

.046158889

291

292

293

294

295

.046321689

.046484514

.046647364

.046810240

.046973140

296

297

298

299

300

.047136067

.047299018

.047461995

.047624998

.047788025

301

302

303

304

305

.047951078

.048114157

.048277260

.048440390

.048603544

306

307

308

309

310

.048766724

.048929929

.049093160

.049256416

.049419698

311

312

313

314

315

.049583005

.049746337

.049909695

.050073078

.050236487

316

.050399921

Section 1441.—Withholding of

Tax on Nonresident Aliens

26 CFR 1.1441–7: Requirement for the deduction

and withholding of tax on payments to foreign

persons.

Guidance is provided to payors of substitute interest and dividend concerning their obligations as

withholding agents on payments made to foreign

beneficial owners that are individuals. See Notice

97–66, page 8.

1997–48 I.R.B.

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

317

318

319

320

.050563380

.050726865

.050890376

.051053912

321

322

323

324

325

.051217473

.051381060

.051544672

.051708309

.051871972

326

327

328

329

330

.052035661

.052199375

.052363115

.052526880

.052690670

331

332

333

334

335

.052854486

.053018327

.053182194

.053346087

.053510005

336

337

338

339

340

.053673948

.053837917

.054001912

.054165932

.054329977

341

342

343

344

345

.054494048

.054658145

.054822267

.054986415

.055150588

Section 1442.—Withholding of

Tax on Nonresident

Corporations

1997 ANNUAL RATE,

COMPOUNDED DAILY

DAYS

5.68 PERCENT

FACTOR

346

347

348

349

350

.055314787

.055479011

.055643261

.055807537

.055971838

351

352

353

354

355

.056136164

.056300516

.056464894

.056629297

.056793726

356

357

358

359

360

.056958181

.057122661

.057287166

.057451698

.057616255

361

362

363

364

365

.057780837

.057945445

.058110079

.058274738

.058439423

366

367

368

369

370

.058604134

.058768870

.058933632

.059098419

.059263232

371

.059428071

beneficial owners that are corporations. See Notice

97–66, page 8.

26 CFR 1.1441–7: Requirement for the deduction

and withholding of tax on payments to foreign persons.

Guidance is provided to payors of substitute interest and dividend concerning their obligations as

withholding agents on payments made to foreign

December 1, 1997

Part III. Administrative, Procedural, and Miscellaneous

Notice 97–61

The Internal Revenue Service has undertaken a large-scale effort to address

the year 2000 issue. The Year 2000 Conversion Project’s primary goal is to make

all current and future IRS information

systems year 2000 compliant. That is,

ensure that all computer systems function correctly before and after January 1,

2000.

The Internal Revenue Service has

adopted a standard for the year representation and date representation. This standard will be used in all data exchanges

with external trading partners (ETPs),

Federal, state and local governments as

well as the private sector. The standard

is:

—

an 8-position year when using

the Gregorian data format; the 8 characters (YYYYMMDD) must be contiguous

and the 4-position year field must be at

the beginning of the date field;

—

a four-position year when using

the Julian date format; the date field

would be represented as YYYYDDD;

—

a four-position year when using

the Epock/Offset date format where the

Epoch (year field) contains four characters and the Offset is a time element determined by the system owner; and,

—

a four-position year will be used

in conjunction with all other date formats and the other elements of the date

field.

The IRS said it will be contacting its

external trading partners to inform them

of the date by which data exchanges will

be converted. The trading partners will

be expected to certify that they will be

ready to receive the data and that they

will provide any related exchanges to the

IRS as specified in the standard.

External Trading Partners who provide data in accord with specifications

generally issued in Revenue Procedures

will continue to be informed of the date

requirements through Revenue Procedures. Others, with whom IRS has

agreements for specific exchanges, such

as with state revenue departments involved in tax administration, will be contacted individually by the IRS.

December 1, 1997

Certain Payments Made

Pursuant to a Securities

Lending Transaction

ments. The Treasury and the Service request comments on the treatment of foreign-to-foreign payments provided in this

Notice.

Notice 97–66

SECTION 2. SUBSTITUTE INTEREST

PAYMENTS

SECTION 1. SUMMARY

On October 14, 1997, final regulations

were published in the Federal Register

[T.D. 8735], RIN 1545-AP71, (the “final

regulations”) which source substitute interest and substitute dividend payments

that are made pursuant to a securities

lending or sale-repurchase transaction by

reference to the income that would be

earned with respect to the underlying

transferred debt security or stock. The

final regulations also provide that substitute interest and dividend payments that

are U.S. source under the regulations are

also characterized as interest and dividends for purposes of determining the

fixed or determinable annual or periodical

income of foreign resident individuals

and corporations subject to tax under sections 871, 881, 4948(a) and Chapter 3 of

the Internal Revenue Code and for purposes of granting tax treaty benefits with

respect to interest and dividends. As promulgated, the final regulations were made

applicable in all respects for substitute interest (as defined in § 1.861–2(a)(7) of

the income tax regulations) and substitute

dividend payments (as defined in §

1.861–3(a)(6)) made after November 13,

1997.

This Notice provides guidance on complying with the statement requirement of

section 871(h)(5) for substitute interest

payments made after November 13, 1997,

and before January 1, 1999. In addition,

the Treasury and the Service intend to

propose new regulations to provide specific guidance on how substitute dividend

payments made by one foreign person to

another foreign person (“foreign-to-foreign payments”) are to be treated. Until

the proposed regulations are promulgated,

this Notice clarifies how the amount of

the tax imposed under §§ 1.871–7(b)(2)

and 1.881–2(b)(2) will be determined

with respect to foreign-to-foreign pay-

Substitute interest payments made by a

foreign person that are U.S. source interest under the final regulations must satisfy

the statement requirement of section

871(h)(5) to qualify as portfolio interest.

The final regulations refer taxpayers to §

1.871–14(c) for this purpose, but those

regulations are not generally applicable

until January 1, 1999. Under this Notice,

the statement requirement 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 prior to, or within a

reasonable period of time after, the payment. The statement requirement of the

preceding sentence is deemed to be satisfied if the payor is subject to, and satisfies

with respect to the payee, the regulatory

rules in the jurisdiction in which the payor

is operating regarding establishing the

identity of a customer (i.e., “know your

customer” rules). Also, if a taxpayer

makes an election under § 1.14411(f)(2)(ii), such election will be effective,

pursuant to this Notice, to allow a withholding agent to apply retroactively

the documentation requirements of

§ 1.871–14(c) with respect to one or more

substitute interest payments made

after November 13, 1997. Treas. Reg.

§ 1.871–14(c)(3) allows a withholding

agent to collect a certificate or documentary evidence at any time until the expiration of the beneficial owner’s period of

limitation for claiming a refund of tax

with respect to portfolio interest.

SECTION 3. SUBSTITUTE DIVIDEND

PAYMENTS

The final regulations were adopted to

eliminate unjustifiable differences between the taxation of similar economic investments. It has been brought to the at-

1997–48 I.R.B.

tention of the Treasury and the Service,

however, that, in certain circumstances,

the total U.S. withholding tax paid with

respect to a securities loan or sale-repurchase transaction, or series of such transactions, could be excessive due to the application of the final regulations. The

Treasury and the Service believe that taxpayers can avoid such excessive withholding taxes in the vast majority of cases

by structuring their transactions appropriately. In some circumstances, however,

such structuring may be difficult or impossible.

To address these concerns, under this

Notice, the amount of U.S. withholding tax

to be imposed under §§ 1.871–7(b)(2) and

1.881–2(b)(2) with respect to a foreign-toforeign payment will be the amount of the

underlying dividend multiplied by a rate

equal to the excess of the rate of U.S. withholding tax that would be applicable to

U.S. source dividends paid by a U.S. person directly to the recipient of the substitute

payment over the rate of U.S. withholding

tax that would be applicable to U.S. source

dividends paid by a U.S. person directly to

the payor of the substitute payment. This

amount may be reduced or eliminated to

the extent that the total U.S. tax actually

withheld on the underlying dividend and

any previous substitute payments is greater

than the amount of U.S. withholding tax

that would be imposed on U.S. source dividends paid by a U.S. person directly to the

payor of the substitute payment. The recipient of a substitute payment may not, however, disregard the form of its transaction in

order to reduce the U.S. withholding tax.

Therefore, a recipient of a foreign-to-foreign payment will not be entitled to a refund or tax credit against any other U.S. tax

liability to reflect the fact that the rate of

U.S. withholding tax that would be applicable to a U.S. source dividend paid by a U.S.

person directly to such recipient is less than

the rate of U.S. withholding tax that would

be applicable to a U.S. source dividend

paid by a U.S. person directly to the payor

of the substitute payment (or any payor of a

previous substitute payment or the underlying dividend).

As a result of this formula, substitute

payments with respect to foreign-to-foreign securities loans and sale-repurchase

transactions that do not reduce the overall U.S. withholding tax generally will

not be subject to withholding tax. For

1997–48 I.R.B.

example, no withholding tax is required

in situations where transactions are entered into between residents of the same

country. The Treasury and the Service

believe that this Notice adequately addresses the concerns of those foreign

persons who are required by their local

regulators to enter into transactions only

with residents of the same country.

Conversely, to the extent a foreign-toforeign securities loan or sale-repurchase

transaction would reduce the overall

U.S. withholding tax, an incremental

amount of U.S. withholding tax is imposed on the substitute payment.

SECTION 4. LIABILITY OF

WITHHOLDING AGENTS

Each person who makes a foreign-toforeign payment shall be treated as a

withholding agent under section 1.1441–7

with respect to such payment. If a U.S.

withholding agent withholds the highest

rate of tax which would be imposed on all

foreign recipients of dividends and substitute payments in a chain of such payments, each foreign withholding agent

will be treated as having satisfied its withholding obligation under §1.1441–7.

SECTION 5. EXAMPLES

The following examples illustrate the

principles of this Notice:

Example 1. Same Country Securities Loan. FP, a

pension fund resident in Country X, owns stock issued by USCo, a corporation resident in the United

States. An income tax treaty between Country X

and the United States limits the U.S. withholding tax

on gross dividends to 15 percent. USBroker, a U.S.

broker-dealer, needs to borrow the stock owned by

FP. Under Country X rules intended to safeguard

the interests of workers, however, FP is required to

deal only with Country X residents in connection

with its investment activities. Accordingly, FP enters into a securities loan with FBroker, a brokerdealer also resident in Country X. FBroker then enters into a securities loan with USBroker. USCo

pays a dividend of $100 on March 15, 1998. USBroker is the shareholder of record with respect to

the dividend. Since USBroker is a U.S. person,

USCo does not withhold on the dividend. USBroker

makes a substitute payment of $100 to FBroker from

which USBroker withholds $15. The rate of withholding tax that would be applicable to a U.S. source

dividend payment made by a U.S. person directly to

FP is the same as the rate of withholding tax that

would be applicable to a U.S. source dividend payment made by a U.S. person directly to FBroker.

Accordingly, no U.S. withholding tax is imposed

under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the

substitute payments made by FBroker to FP.

Example 2. Non-Same Country Securities Loan.

A, a resident of Country X, owns shares of USCo, a

U.S. resident corporation. Country X has a treaty

with the United States which limits the United States

tax on gross dividends to 15 percent. A enters into a

securities loan with B, a resident of Country Y,

whose treaty with the United States also limits the

United States tax on gross dividends to 15 percent.

USCo pays a dividend of $100 on March 15, 1998.

B is the shareholder of record with respect to the

dividend. USCo withholds $15 and pays B a net

dividend of $85. B makes a substitute payment of

$85 to A. The rate of withholding tax that would be

applicable to a U.S. source dividend payment made

by a U.S. person directly to A is the same as the rate

of withholding tax that would be applicable to a U.S.

source dividend payment made by a U.S. person directly to B. Accordingly, no U.S. withholding tax is

imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)

on the substitute payments made by B to A.

Example 3. Increased Treaty Benefits. The facts

are the same as in example 2, except that Country X

has no treaty with the United States. Since a dividend payment made by a U.S. person directly to A

would have been subject to a 30-percent withholding tax, B must withhold an additional $15 ((30 percent - 15 percent) x $100) on the substitute payment

it makes to A. Alternatively, USCo could have withheld 30 percent from the dividend payment made to

B, thereby satisfying B’s withholding liability under

§ 1.1441–7.

Example 4. Multiple Country Securities Loans.

A, a resident of Country W, owns shares of USCo, a

U.S. resident corporation. Country W has an income tax treaty with the United States that limits the

United States tax on gross dividends to 15 percent.

B, a resident of Country X, enters into a securities

loan with A. Country X does not have an income tax

treaty with the United States. C, a resident of Country Y, enters into a securities loan with B. Country Y

has an income tax treaty with the United States

which limits the United States tax on gross dividends to 10 percent. D, a resident of country Z, enters into a securities loan with C. Country Z has an

income tax treaty with the United States which limits the United States tax on gross dividends to 15

percent.

USCo pays a dividend of $100 on March 15,

1998. D is the shareholder of record with respect to

the dividend. USCo withholds $15 and pays D a net

dividend of $85. D makes a substitute payment of

$85 to C. The rate of withholding tax that would be

applicable to a U.S. source dividend payment made

by a U.S. person directly to C is less than the rate of

withholding tax that would be applicable to a U.S.

source dividend payment made by a U.S. person directly to D. Accordingly, no U.S. withholding tax is

imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)

on the substitute payments received by C. However,

C is not entitled to a refund or tax credit against any

other U.S. tax liability for the additional 5-percent

tax reflected in its substitute payment from D over

the amount to which C would have been subject had

C received a dividend directly from USCo.

C makes a substitute payment of $85 to B from

which C withholds $15. Since a dividend payment

made by a U.S. person directly to B would have

been subject to a 30-percent withholding tax, C generally would be required to withhold an additional

$20 ((30 percent - 10 percent) x $100) on the substitute payment it makes to B. However, because $15

December 1, 1997

actually was withheld with respect to a $100 gross

dividend paid to D, C may reduce by $5 ((15 percent

- 10 percent) x $100) the $20 withholding obligation

on its substitute payment to B.

B makes a substitute payment of $70 to A. The

rate of withholding tax that would be applicable to a

U.S. source dividend payment made by a U.S. person directly to A is less than the rate of withholding

tax that would be applicable to a U.S. source dividend payment made by a U.S. person directly to B.

Accordingly, no U.S. withholding tax is imposed

under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the

substitute payment received by A. However, A is

not entitled to a refund or tax credit against any

other U.S. tax liability for the additional 15-percent

tax reflected in its substitute payment from B over

the amount to which A would have been subject had

A received a dividend directly from USCo.

Alternatively, USCo could have withheld 30 percent from the dividend payment made to D, thereby

satisfying C’s withholding obligation under §

1.1441–7.

SECTION 6. EFFECTIVE DATE OF

REGULATIONS

The provisions of this Notice are effective for purposes of applying the final

regulations as of November 14, 1997, the

effective date of those regulations. Because some withholding agents may require additional time to adjust their business practices to implement the

provisions of the final regulations and

this Notice, a withholding agent can

elect to defer the application of the final

regulations, other than Treas. Reg. §

1.864–5(b)(2)(ii), and this Notice until

January 1, 1998. A withholding agent

makes such an election by attaching a

statement to such effect to a timely filed

tax return (Form 1042) for the period

that includes November 14, 1997, or if

no such return is otherwise required for

the period including that date, on a

timely filed return (Form 1042) for the

period that includes January 1, 1998.

Withholding agents making this election

must apply the provisions of the final

regulations and this Notice for substitute

payments made after December 31,

1997.

SECTION 7. REQUEST FOR

COMMENTS

Treasury and the Service invite

comments on the guidance provided

by this Notice. Written comments should

be submitted by January 12, 1998,

to the Internal Revenue Service, P.O.

Box 7604 Ben Franklin Station, Atten-

December 1, 1997

tion: CC:CORP:T:R: (Notice 97-66)

Room 5228, Washington, DC 20044. Alternatively, comments may be

submitted via the internet at:

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

comments.html. The comments submitted

will be available for public inspection and

copying.

SECTION 8. PAPERWORK

REDUCTION ACT

The collections of information contained in this Notice 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 1545–1566.

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

control number.

The collections of information contained in this Notice are in Sections 2 and

6. The information is required to qualify

substitute interest payments as portfolio

interest and to defer, on election by the

taxpayer, the effective date of this Notice

and the final securities lending regulations (T.D. 8735, 62 FR 53498) for substitute payments made after December 31,

1997. The information will be used for

the same purpose described in the preceding sentence. The collections of information are required to obtain a benefit. The

likely respondents are businesses or other

for-profit institutions.

The estimated total annual reporting

and/or recordkeeping burden is 61,750

hours.

The estimated annual burden per respondent/recordkeeper varies from 1

minute to 15 minutes, depending on individual circumstances, with an estimated

average of 10 minutes. The estimated

number of respondents and/or recordkeepers is 377,500.

The estimated frequency of responses

(used for reporting requirements only) is

once.

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 9. CONTACT

INFORMATION

The principal author of this Notice is

Paul Epstein of the Office of the Associate Chief Counsel (International) within

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

NW, Washington, DC 20224. For further

information regarding this Notice contact

Milton Cahn or Paul Epstein at 202-6223870 (not a toll-free call).

Grace Period Interest

Notice 97–67

Many credit card agreements provide

for a grace period during which the credit

card issuer does not charge interest for a

billing cycle if the credit card holder pays

off its account balance by a specified date.

Under section 1004 of the Taxpayer Relief

Act of 1997 (the “Act”), Pub. L. No.

105–34, 111 Stat. 788, 911, if a taxpayer

holds a pool of credit card receivables, the

taxpayer must accrue interest and original

issue discount on the receivables based on

a reasonable assumption regarding the

timing of the payments by the obligors of

the receivables in the pool. Thus, the taxpayer is not permitted to assume that all of

its credit card holders will pay their balances by the date specified in the grace period provision of the credit card agreement

and, based on this assumption, defer the

inclusion of grace period interest. Section

1004 of the Act is effective for taxable

years beginning after August 5, 1997. The

Internal Revenue Service will issue guidance that provides the procedures for a

taxpayer to automatically change its

method of accounting to comply with section 1004 for the taxpayer’s first taxable

year beginning after August 5, 1997.

The Service will process requests by

taxpayers to change their methods of accounting for grace period interest that

were pending with the Service on August

4, 1997. For any requests filed on or

after August 5, 1997 (the date of enactment of the Act), the Service will exercise its discretion to deny requests to

change to a method of accounting for

grace period interest other than the

method required by section 1004 of the

Act. See § 446(e) of the Internal Revenue Code. See also H.R. Conf. Rep. No.

1997–48 I.R.B.

220, 105th Cong., 1st Sess. 523 (1997);

H.R. Rep. No. 148, 105th Cong., 1st

Sess. 457 (1997).

For further information about this notice, contact William E. Blanchard of the

Office of Assistant Chief Counsel (Financial Institutions and Products) at (202)

622-3950, or Wendy MacDonald of the

Office of Assistant Chief Counsel (Income Tax and Accounting), at (202) 6226299 (not toll-free numbers).

Guidance on Making Payments

for Charitable Remainder Trusts

Notice 97–68

This notice informs taxpayers that the

rules in §§ 1.664–2(a)(1)(i) and

1.664–3(a)(1)(i)(e) of the proposed Income Tax Regulations, published in a Notice of Proposed Rulemaking on April 18,

1997 (62 Fed. Reg. 19072), will not be effective for certain charitable remainder

trusts (CRTs) for the 1997 taxable year.

BACKGROUND

Generally, a CRT is a trust that provides for a specified distribution at least

annually over a specified period to one or

more noncharitable beneficiaries and

holds an irrevocable remainder interest in

the trust for a charitable organization.

Section 664 of the Internal Revenue Code

provides for two types of CRTs: a charitable remainder annuity trust (CRAT) and a

charitable remainder unitrust (CRUT). A

CRAT pays a fixed annuity amount at

least annually to the noncharitable beneficiary or beneficiaries. A CRUT pays a

fixed percentage of the fair market value

of the assets held by the trust as of the annual valuation date (the unitrust amount)

at least annually to the noncharitable beneficiary or beneficiaries.

Section 664(d) provides that to qualify

as a CRT, the trust must pay the annuity

or unitrust amount at least annually to the

noncharitable beneficiaries. As an administrative convenience, §§ 1.664–2(a)(1)

and 1.664–3(a)(1) of the Income Tax Regulations have allowed CRTs to pay the annuity or unitrust amount within a reasonable time after the close of the tax year in

which it is due without the timing of the

payment causing the trust to fail to function exclusively as a CRT.

1997–48 I.R.B.

PROPOSED REGULATIONS

REGARDING PAYING ANNUITY

OR UNITRUST AMOUNT

The proposed amendments to

§§ 1.664–2(a)(1)(i) and 1.664–3(a)(1)(i)(e) of the proposed regulations (the

proposed timing amendments) would require a CRT to pay the annuity amount or

the unitrust amount under the fixed percentage method of § 664(d)(2) by the

close of the tax year in which the payment

is due in order to function exclusively as a

CRT. Under the effective date in the proposed regulations, once final, the proposed timing amendments would apply to

taxable years ending after April 18, 1997,

the date the proposed regulations were

published in the Federal Register.

The Service and Treasury issued the

proposed timing amendments in response

to abuses associated with the use of accelerated CRTs described in Notice 94–78,

1994–2 C.B. 555. Taxpayers using accelerated CRTs characterize the payment of

the annuity or unitrust amount as a distribution of trust corpus that is not subject to

tax by delaying the required payment

until after the end of the tax year in which

it is due.

Since publishing the proposed regulations, the Service and Treasury have received a significant number of comments

expressing concern that the proposed

timing amendments will place a significant burden on many trusts that are not

engaging in abuses. Some commentators

observed that for many CRTs the character of the annuity or unitrust amount is

not affected by the time at which the payment is made. Because these trusts have

accumulated sufficient income in the ordinary, capital gains, and other income

categories of § 664(b)(1), (2), and (3), no

portion of the annuity or unitrust amount

distributed will be characterized as trust

corpus under § 664(b)(4) irrespective of

whether the amount is paid before or

after the close of the tax year for which it

is due. The commentators add that being

required to pay the annuity or unitrust

amount by the close of the calendar year

would create a hardship if the trustee is

relying on end-of-the-year dividends and

similar income, which may not arrive

until January of the following year, to

make the annuity or unitrust payment.

The commentators also argue that the

proposed timing amendments would create a hardship for trustees of CRUTs that

have a December 31 valuation date because such a trustee would be forced to

value the assets in the trust and make a

payment of the unitrust amount after the

close of business and before midnight on

that date.

In light of the enactment of the Taxpayer Relief Act of 1997 (the Act) on August 5, 1997, other commentators have argued that the proposed timing

amendments are no longer necessary to

stop the abuses created by accelerated

CRTs. The Act amended the definition of

a CRT to include a maximum allowable

percentage of 50 percent for calculating

the annuity amount or unitrust amount

and a minimum 10 percent present value

for the charitable remainder interest. Taxpayer Relief Act of 1997, Pub. L. No.

105–34, § 1089, 111 Stat. 960, 961. We

note that the Senate Finance Committee

explicitly stated that it did not intend for

the Act to “limit or alter the validity of the

regulations proposed by the Treasury Department on April 18, 1997, or the Treasury Department’s authority to address

this or other abuses of the rules governing

the taxation of charitable remainder trusts

or their beneficiaries.” S. Rep. No. 33,

105th Cong., 1st Sess. 201 (1997).

Several commentators have asked for

relief from the effective date for the proposed timing amendments while their

comments are considered and before the

regulations are finalized.

APPLICATION OF PROPOSED

TIMING AMENDMENTS

The Service and Treasury recognize

that complying with the proposed timing

amendments in 1997 may create an unnecessary burden on those trusts for

which the potential for abuse is minimal.

Therefore, when the proposed regulations

are adopted as final regulations under a

Treasury Decision, the Service and Treasury intend to provide that for the taxable

year 1997 a CRT created before January

1, 1998, will not be made subject to the

rules stated in §§ 1.664–2(a)(1)(i) and

1.664–3(a)(1)(i)(e) of the proposed regulations if in 1997 the trust is:

(1) A CRAT under which the sum certain to be paid each year to one or more

persons is 15 percent or less of the initial

December 1, 1997

net fair market value of all property

placed in the trust, or

(2) A CRUT under which the fixed percentage of the net fair market value of the

unitrust’s assets to be paid each year to one

or more persons is 15 percent or less, or

(3) A CRAT or CRUT from which all

of the annuity amounts or unitrust

amounts paid for 1997 are characterized

in the hands of the beneficiary as income

from the categories described in §

664(b)(1), (2), and (3), and not as trust

corpus. Thus, a CRT created before January 1, 1998, that meets any one of these

three exceptions may pay its annuity

amount or unitrust amount for the taxable

year 1997 within a reasonable period of

time after the close of the tax year under

§§ 1.664–2(a)(1)(i) and 1.664–3(a)(1)(i)

of the Income Tax Regulations.

The Service and Treasury will continue

to consider the comments submitted on

the proposed regulations before deciding

whether to adopt an amended version of

the proposed regulations as final regulations.

For further information regarding this

notice, please call Mary Beth Collins or

Jeff Erickson of the Office of the Assistant Chief Counsel (Passthroughs and

Special Industries) on (202) 622-3070

(not a toll-free call).

Weighted Average Interest Rate

Update

Notice 88–73 provides guidelines for

determining the weighted average interest

Month

Year

November

1997

6.81

vision. For further information regarding

this notice, call (202) 622-6076 between

December 1, 1997

DRAFTING INFORMATION

Notice 97–69

Weighted

Average

rate and the resulting permissible range of

interest rates used to calculate current liability for the purpose of the full funding

limitation of § 412(c)(7) of the Internal

Revenue Code as amended by the Omnibus Budget Reconciliation Act of 1987

and as further amended by the Uruguay

Round Agreements Act, Pub. L. 103–465

(GATT).

The average yield on the 30-year Treasury Constant Maturities for October

1997 is 6.33 percent.

The following rates were determined

for the plan years beginning in the month

shown below.

90% to 107%

Permissible

Range

90% to 110%

Permissible

Range

6.13 to 7.29

6.13 to 7.49

2:30 and 3:30 p.m. Eastern time (not a

toll-free number). Ms. Prestia’s number

The principal author of this notice is

Donna Prestia of the Employee Plans Di-

is (202) 622-7377 (also not a toll-free

number).

1997–48 I.R.B.

Part IV. Items of General Interest

Notice of Proposed Rulemaking

and Notice of Public Hearing

Treatment of Changes in

Elective Entity Classification

sues, Philip Tretiak or Ronald M.

Gootzeit, (202) 622-3860 (not a toll free

number); concerning submissions and the

hearing, Evangelista Lee, (202) 622-7190

(not a toll-free number).

REG–105162–97

SUPPLEMENTARY INFORMATION:

AGENCY: Internal Revenue Service

(IRS), Treasury.

Background

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains

proposed regulations addressing elective

changes in entity classification. The proposed regulations describe how elective

changes in classification will be treated

for federal tax purposes. The proposed

regulations would affect business entities

and their members. This document also

contains a notice of public hearing on

these proposed regulations.

DATES: Written comments must be received by January 26, 1998. Requests to

speak (with outlines of oral comments) at

the public hearing scheduled for February

24, 1998, must be submitted by January

26, 1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (REG-105162–97),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. In the alternative, submissions may be hand delivered between

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

CC:DOM:CORP:R (REG–105162–97),

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 room

2615, Internal Revenue Building, 1111

Constitution Avenue, NW, Washington,

DC.

FOR FURTHER INFORMATION

CONTACT: Concerning the regulations,

Jeff Erickson, (202) 622-3070 (not a tollfree number); concerning international is-

1997–48 I.R.B.

This document proposes to amend the

current Income Tax Regulations (26 CFR

Parts 1 and 301) relating to the classification of entities for federal tax purposes.

On December 18, 1996, the IRS and Treasury published final regulations under

section 7701 (final regulations), replacing

the former classification rules with an

elective regime. See T.D. 8697 (1997–2

I.R.B. 11).

Under the final regulations, a business

entity that is not specifically classified as

a corporation in the final regulations (an

eligible entity) can elect its classification

for federal tax purposes under certain circumstances. An eligible entity with at

least two members can elect to be classified as a partnership or as an association

taxable as a corporation. An eligible entity with a single member can elect to be

classified as an association or as an entity

that is disregarded as an entity separate

from its owner. An eligible entity may

also elect to change its classification, except that an election may not be made

more than once in any sixty month period.

An eligible entity that does not make an

election is classified under certain default

provisions.

Explanation of Provisions

Characterization of Elective Changes in

Classification

The proposed regulations describe how

elective changes in an entity’s classification will be treated for federal tax purposes. Under the final regulations, there

are four possible changes in classification

by election: (i) a partnership elects to be

an association; (ii) an association elects to

be a partnership; (iii) an association elects

to be a disregarded entity; and (iv) a disregarded entity elects to be an association.

There are two other possible ways in

which an entity’s classification could

change (a partnership converts to a disre-

garded entity or a disregarded entity converts to a partnership) but these changes

occur only as a result of a change in the

number of members, not as the result of

an elective change. The proposed regulations do not address the form of these two

possible types of changes.

The proposed regulations provide a

specific characterization for each of the

four possible elective changes. In each

case, the characterization provided in the

proposed regulations attempts to minimize the tax consequences of the change

in classification and achieve administrative simplicity. The proposed regulations

provide that if an association elects to be

classified as a partnership, the association

is deemed to liquidate by distributing its

assets and liabilities to its shareholders.

Then, the shareholders are deemed to

contribute all of the distributed assets and

liabilities to the partnership. This characterization of an elective change from an

association to a partnership is consistent

with Rev. Rul. 63–107 (1963–1 C.B. 71).

If a partnership elects to be classified as

an association, the partnership is deemed

to contribute all of its assets and liabilities

to the association in exchange for stock in

the association. Then, the partnership is

deemed to liquidate by distributing stock

in the association to its partners. The proposed regulations do not affect the holdings in Rev. Rul. 84–111 (1984–2 C.B.

88), in which the IRS ruled that it would

respect the particular form undertaken by

the taxpayers when a partnership converts

to a corporation.

If an association elects to be disregarded as an entity separate from its

owner, the association is deemed to liquidate by distributing its assets and liabilities to its sole owner. Conversely, if an eligible entity that is disregarded as an

entity separate from its owner elects to be

classified as an association, the owner of

the eligible entity is deemed to contribute

all of the assets and liabilities of that entity to the association in exchange for

stock of the association.

The proposed regulations also provide

that the tax treatment of an elective

change in classification is determined

under all relevant provisions of the Internal Revenue Code and general principles

of tax law, including the step transaction

December 1, 1997

doctrine. This provision in the proposed

regulations is intended to ensure that the

tax consequences of an elective change

will be identical to the consequences that

would have occurred if the taxpayer had

actually taken the steps described in the

proposed regulations. The IRS and Treasury request comments on the application

of general principles of tax law to the

transactions that are deemed to occur on

an elective change in classification.

Change in Number of Members of Entity

The proposed regulations address the

effect of a change in the number of members on the classification of an entity.

Under the proposed regulations, if there

is a change in the number of members of

an association, the classification of the

entity is not affected. If an eligible entity classified as a partnership subsequently has only one member (and is still

treated as an entity under local law), the

entity will be disregarded as an entity

separate from its owner. If a single

member entity that is disregarded as an

entity separate from its owner subsequently has more than one member, the

entity is classified as a partnership as of

the date the entity has more than one

member. The classifications provided in

the proposed regulations can be changed

by election, assuming that the entity is

not subject to the sixty month limitation

on elections.

Timing of Elective Changes in

Classification

The proposed regulations provide that

an election to change the classification of

an entity is treated as occurring at the start

of the day for which the election is effective. Any transactions that are deemed to

occur as a result of the change in classification are treated as occurring immediately before the close of the day before

the effective date of the election. For example, if an election is made to convert

from an association to a partnership effective on January 1, the entity is treated as a

partnership on January 1, and the deemed

transactions specified in the proposed regulations are treated as occurring immediately before the close of December 31.

As a result, the last day of the association’s taxable year will be December 31

and the first day of the partnership’s taxable year will be January 1.

December 1, 1997

Treatment of Foreign Eligible Entities

Any eligible entity, including a foreign

eligible entity whose classification is not

relevant for federal tax purposes, may

elect to change its classification. The IRS

and Treasury request comments on the appropriateness of allowing such a foreign

eligible entity to make a classification

election, and comments on what the federal tax consequences of such an election

should be (e.g., with respect to the basis

of property held by the entity).

Foreign Per Se Entities

The final regulations provide a list of

the names of certain foreign business entities that are treated as corporations for

federal tax purposes. In most cases, the

name by which an entity will be known is

provided by the statutory corporate law of

the relevant jurisdiction. In certain cases,

however, the corporate law does not provide a statutory name. In these jurisdictions, taxpayers and practitioners often

fill the statutory void with a name derived

from a number of the statutory characteristics of the entity. In an effort to make

the list of foreign per se corporations

more accessible, the final regulations use

the commonly used non-statutory term in

certain cases where the statute does not

provide a defined name. To minimize any

uncertainty, however, the provisions of

§301.7701–2(b)(8)(iii) and (iv) were included in the final regulations to address

this issue. In response to comments from

taxpayers, these subsections of the final

regulations are clarified to provide guidance on the terms used in the final regulations. Furthermore, the regulations clarify that the term Berhad used with regard

to Malaysia does not include a “Sendirian

Berhad” (the equivalent of a private limited company). The regulations also clarify that, in relation to Mexico, the term

Sociedad Anonima includes a Sociedad

Anonima that chooses to apply the variable capital provision of Mexican corporate law (Sociedad Anonima de Capital

Variable). The fact that capital may be

varied does not make this a different type

of entity from a Sociedad Anonima that

does not choose to apply the variable capital provision. These clarifications are not

intended to change the interpretation of

the final regulations.

The proposed regulations also clarify

the treatment of the Finnish, Maltese, and

Norwegian entities specified in the final

regulations. Effective January 1, 1996,

Maltese and Norwegian corporate law

recognized a distinction between public

and private companies, and the proposed

regulations reflect this change. The proposed regulations also provide that the

rules of the final regulations with regard

to the Maltese and Norwegian entities

may be applied (when these proposed regulations are finalized) as though the entities specified in the proposed regulations

had been included in the final regulations

issued on December 18, 1996. Thus, a

Maltese or Norwegian entity that is no

longer treated as a per se corporation

under the regulations would be able to

make an election within 75 days of the

date these proposed regulations are finalized, and such election could be effective

as of January 1, 1997. Finnish law, since

September 1, 1997, has recognized a similar distinction between public and private

companies. It is proposed that a Finnish

entity that is no longer treated as a per se

corporation under the regulations would

be able to make an election within 75

days of the date these proposed regulations are finalized, and such election

could be effective as of September 1,

1997.

Special Basis Adjustments Under

Section 743

Section 743 provides that the basis of

partnership property is not adjusted as the

result of a transfer of an interest in the

partnership by sale or exchange unless the

partnership has made an election under

section 754. If a section 754 election is

made, the transferee partner is treated as

having a special basis adjustment with respect to partnership property. This adjustment constitutes an adjustment to the

basis of partnership property with respect

to the transferee partner only. Some uncertainty has remained as to the treatment

of this special basis adjustment upon the

contribution of the partnership property to

a corporation in a section 351 exchange,

and because the proposed regulations provide for a deemed contribution by the

partnership to a corporation in an elective

conversion to an association, the proposed regulations address this uncertainty.

The proposed regulations provide that a

1997–48 I.R.B.

corporate transferee’s basis in property

transferred by a partnership in a transfer

described in section 351 includes any special basis adjustment under section 743.

The special basis adjustment is also taken

into account in determining the partner’s

basis in the stock received in the exchange. For example, assume a partnership owns Property X, which has a common basis of $100 for the partnership and

in which Partner A has a $5 special basis

adjustment under section 743(b). Subsequently, the partnership validly elects to

be classified as an association. The partnership is deemed to contribute all of its

assets and liabilities to the association in

exchange for stock in the association, and

immediately thereafter, the partnership

liquidates by distributing the stock of the

association to its partners. If the transfer

of the assets to the association would be a

transfer described in section 351, then

under the proposed regulations, the association’s basis in Property X includes

Partner A’s $5 special basis adjustment.

Thus, the association has a $105 basis in

Property X (Partner A’s $5 special basis

adjustment plus the partnership’s $100

common basis). Partner A’s basis in the

association’s stock will reflect the $5 special basis adjustment previously on Property X.

The proposed regulations also provide,

however, that the amount of gain, if any,

recognized by the partnership on the

transfer is determined without reference

to any special basis adjustment. The partner with the special basis adjustment can

then use the special basis adjustment to

reduce its share of any gain recognized by

the partnership. This approach of determining gain at the partnership level and

allowing the partner to use the special

basis adjustment as an offset is similar to

the treatment of a sale of property with a

special basis adjustment.

Proposed Effective Date

Except as otherwise specified, these

regulations are proposed to apply as of the

date the final regulations are published in

the Federal Register.

Special Analyses

It has been determined that this notice

of proposed rulemaking is not a signifi-

1997–48 I.R.B.

cant 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 these regulations do

not impose on small entities a collection

of information requirement, the Regulatory Flexibility Act (5 U.S.C. chapter 6)

does not apply. Therefore, a Regulatory

Flexibility Analysis is not required. 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 February 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 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 timely

written comments and an outline of the

topics to be discussed and the time to be

devoted to each topic by (preferably a

signed original and eight (8) copies) January 26, 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 Ann M. Veninga, Office of Chief

Counsel (Passthroughs and Special Indus-

tries) and Philip Tretiak, Office of Associate Chief Counsel (International). However, other personnel from the IRS and

Treasury Department participated in their

development.

Proposed Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 301

are proposed to be 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 * * *

Par. 2. Section 1.743-2 is added under

the undesignated centerheading “Transfer

of Interests in a Partnership” to read as

follows:

§1.743-2 Transfer of property

to a corporation.

(a) Basis in transferred property. A

corporation’s adjusted tax basis in property transferred to the corporation by a

partnership in a transfer described in section 351 is determined with reference to

any special basis adjustment to the property under section 743(b) (other than any

special basis adjustment that reduces a

partner’s gain under paragraph (b) of this

section).

(b) Partnership gain. The amount of

gain, if any, recognized by a partnership

on a transfer of property by the partnership to a corporation in a transfer described in section 351 is determined without reference to any special basis

adjustment to the transferred property

under section 743(b). The amount of

gain, if any, recognized by the partnership

on the transfer that is allocated to a partner with a special basis adjustment in the

transferred property is adjusted to reflect

the partner’s special basis adjustment in

the transferred property.

adjusted tax basis in stock received from a

corporation in a transfer described in section 351 is determined without reference

to the special basis adjustment in property

transferred to the corporation in the section 351 exchange. A partner with a special basis adjustment in property transferred to the corporation, however, has a

special basis adjustment in the stock re-

December 1, 1997

ceived by the partnership in the section

351 exchange in an amount equal to the

partner’s special basis adjustment in the

transferred property, reduced by any special basis adjustment that reduced the

partner’s gain under paragraph (b) of this

section.

(d) Effective date. This section applies

to transfers that occur on or after the date

final regulations are published in the Federal Register.

PART 301—PROCEDURE AND

ADMINISTRATION

Par. 3. The authority citation for part

301 continues to read in part as follows:

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

Par. 4. Section 301.6109-1 is amended

as follows:

1. Paragraph (d)(2)(ii) is removed and

reserved.

2. Paragraph (h) is redesignated as

paragraph (i) and the first sentence of

newly designated paragraph (i)(1) is

amended by removing the language

“paragraph (h)” and adding “paragraph

(i)” in its place.

3. A new paragraph (h) is added.

The addition reads as follows:

§301.6109-1 Identifying numbers.

(h) Special rules for certain entities

under §301.7701–3—(1) General rule.

Any entity that has an employer identification number (EIN) will retain that EIN

if its federal tax classification changes

under §301.7701–3.

(2) Special rules for entities that are

disregarded as entities separate from

their owners—(i) When an entity becomes

disregarded as an entity separate from its

owner. Except as otherwise provided in

regulations or other guidance, a single

owner entity that is disregarded as an entity separate from its owner under

§301.7701–3, must use its owner’s taxpayer identifying number (TIN) for federal tax purposes.

(ii) When an entity that was disregarded as an entity separate from its

owner becomes recognized as a separate

entity. If a single owner entity’s classification changes so that it is recognized as a

separate entity for federal tax purposes,

and that entity had an EIN, then the entity

must use that EIN and not the TIN of the

December 1, 1997

single owner. If the entity did not already

have its own EIN, then the entity must acquire an EIN and not use the TIN of the

single owner.

(3) Effective date. This paragraph (h)

applies to changes in classification that

occur on or after the date on which these

regulations are published as final regulations in the Federal Register.

Par. 5. Section 301.7701–2 is amended

as follows:

1. Paragraph (b)(8)(i) is amended by

revising the entries for Finland, Malta,

and Norway.

2. Paragraph (b)(8)(ii)(A) is redesignated as paragraph (b)(8)(ii)(A)(1) and

the language “and” at the end of the paragraph is removed.

3. Paragraph (b)(8)(ii)(B) is redesignated as paragraph (b)(8)(ii)(A)(2) and

the period at the end of the paragraph is

removed and the language “; and “ is

added in its place.

4. Paragraph (b)(8)(ii) heading and introductory text are redesignated as paragraph (b)(8)(ii)(A) heading and introductory text, and a new paragraph heading is

added for paragraph (b)(8)(ii).

5. Paragraphs (b)(8)(ii)(A)(3) and

(b)(8)(ii)(B) are added.

6. Paragraphs (b)(8)(iii), (b)(8)(iv),

and (e) are revised.

The revisions and additions read as follows:

§301.7701-2 Business entities;

definitions.

(b) * * *

(8) * * *

(i) * * *

Finland, Julkinen Osakeyhtio/Publikt Aktiebolag

Malta, Public Limited Company

Norway, Allment Aksjeselskap

(ii) Clarification of list of corporations

in paragraph (b)(8)(i) of this section—

(A) Exceptions in certain cases. * * *

(3) With regard to Malaysia, a

Sendirian Berhad.

(B) Inclusions in certain cases. With

regard to Mexico, the term Sociedad

Anonima includes a Sociedad Anonima

that chooses to apply the variable capital

provision of Mexican corporate law (Sociedad Anonima de Capital Variable).

(iii) Public companies. For purposes of

paragraph (b)(8)(i) of this section, with

regard to Cyprus, Hong Kong, Jamaica,

and Trinidad and Tobago, the term Public

Limited Company includes any Limited

Company that is not defined as a private

company under the corporate laws of

those jurisdictions. In all other cases,

where the term Public Limited Company

is not defined, that term shall include any

Limited Company defined as a public

company under the corporate laws of the

relevant jurisdiction.

(iv) Limited companies. For purposes

of this paragraph (b)(8), any reference to

a Limited Company includes, as the case

may be, companies limited by shares and

companies limited by guarantee.

(e) Effective date. Except as otherwise

provided in this paragraph (e), the rules of

this section apply as of January 1, 1997.

The reference to the Finnish, Maltese, and

Norwegian entities in paragraph (b)(8)(i)

of this section is applicable on the date the

final regulations are published in the Federal Register. Any Maltese or Norwegian entity that becomes an eligible entity

as a result of paragraph (b)(8)(i) of this

section in effect on the date final regulations are published in the Federal Register may elect (within 75 days of the date

final regulations are published in the Federal Register) to be classified for federal

tax purposes as an entity other than a corporation retroactive to any period from

and including January 1, 1997. Any

Finnish entity that becomes an eligible

entity as a result of paragraph (b)(8)(i) of

this section in effect on the date final regulations are published in the Federal

date final regulations are published in the

Federal Register) to be classified for federal tax purposes as an entity other than a

corporation retroactive to any period from

and including September 1, 1997.

Par. 6. Section 301.7701–3 is amended

as follows:

1. A sentence is added at the end of

paragraph (c)(1)(iv).

1997–48 I.R.B.

2. Paragraph (c)(2)(iii) is added.

3. A heading is added to paragraph

(d)(1).

4. Paragraph (f) is redesignated as

paragraph (h) and newly designated paragraph (h)(1) is revised.

5. Paragraphs (f) and (g) are added.

The revision and additions read as follows:

§301.7701–3 Classification of certain

business entities.

(1) * * *

(iv) Limitation. * * * An election by a

newly-formed eligible entity that is effective on the date of formation is not considered a change for purposes of this paragraph (c)(1)(iv).

(2) * * *

(iii) Changes in classification. For purposes of paragraph (c)(2)(i) of this section, if an election under paragraph

(c)(1)(i) of this section is made to change

the classification of an entity, each person

who was an owner on the date that any

transactions under paragraph (g) of this

section are deemed to occur, and who is

not an owner at the time the election is

filed, must also sign the election. This

paragraph (c)(2)(iii) applies to elections

filed on or after the date final regulations

are published in the Federal Register.

(d) Special rules for foreign eligible entities—(1) Definition of relevance. * * *

(f) Changes in number of members of

an entity—(1) Associations. The classification of an eligible entity as an association is not affected by any change in the

number of members of the entity.

(2) Partnerships and single member

entities. An eligible entity classified as a

partnership is disregarded as an entity

separate from its owner as of the date the

entity has only one member. A single

member entity disregarded as an entity

separate from its owner is classified as a

partnership as of the date the entity has

more than one member.

(3) Effect on sixty month limitation. A

change in the number of members of an

entity does not result in the creation of a

1997–48 I.R.B.

new entity for purposes of the sixty month

limitation on elections under paragraph

(c)(1)(iv) of this section.

(4) Examples. The following examples

illustrate the application of this paragraph

(f):

Example 1. (i) On April 1, 1998, A and B, U.S.

persons, form X, a foreign eligible entity. X is

treated as an association under the default provisions

of paragraph (b)(2)(i) of this section, and X does not

make an election to be classified as a partnership. A

subsequently purchases all of B’s interest in X.

(ii) Under paragraph (f)(1) of this section, X continues to be classified as an association. X, however, can subsequently elect to be disregarded as an

entity separate from A. The sixty month limitation

of paragraph (c)(1)(iv) of this section does not prevent X from making an election because X has not

made a prior election under paragraph (c)(1)(i) of

this section.

Example 2. (i) On April 1, 1998, A and B, U.S.

persons, form X, a foreign eligible entity. X is

treated as an association under the default provisions

of paragraph (b)(2)(i) of this section, and X does not

make an election to be classified as a partnership.

On January 1, 1999, X elects to be classified as a

partnership effective on that date. Under the sixty

month limitation of paragraph (c)(1)(iv) of this section, X cannot elect to be classified as an association

until January 1, 2004 (i.e., sixty months after the effective date of the election to be classified as a partnership).

(ii) On June 1, 1999, A purchases all of B’s interest in X. After A’s purchase of B’s interest, X can no

longer be classified as a partnership because X has

only one member. Under paragraph (f)(2) of this

section, X is disregarded as a separate entity as of

the date A becomes the only member of X. X, however, is not treated as a new entity for purposes of

paragraph (c)(1)(iv) of this section. As a result, the

sixty month limitation of paragraph (c)(1)(iv) of this

section continues to apply to X and X cannot elect to

be classified as an association until January 1, 2004

(i.e., sixty months after January 1, 1999, the effective date of the election by X to be classified as a

partnership).

(5) Effective date. This paragraph (f)

applies as of the date the final regulations

are published in the Federal Register.

(g) Elective changes in classification—

(1) Deemed treatment of elective

change—(i) Partnership to association. If

an eligible entity classified as a partnership elects under paragraph (c)(1)(i) of

this section to be classified as an association, the following is deemed to occur:

The partnership contributes all of its assets and liabilities to the association in exchange for stock in the association, and

immediately thereafter, the partnership

liquidates by distributing the stock of the

association to its partners.

(ii) Association to partnership. If an

eligible entity classified as an association

elects under paragraph (c)(1)(i) of this

section to be classified as a partnership,

the following is deemed to occur: The association distributes all of its assets and liabilities to its shareholders in liquidation

of the association, and immediately thereafter, the shareholders contribute all of the

distributed assets and liabilities to a newly

formed partnership.

(iii) Association to disregarded entity.

If an eligible entity classified as an association elects under paragraph (c)(1)(i) of

this section to be disregarded as an entity

separate from its owner, the following is

deemed to occur: The association distributes all of its assets and liabilities to its

single owner in liquidation of the association.

(iv) Disregarded entity to an association. If an eligible entity that is disregarded as an entity separate from its

owner elects under paragraph (c)(1)(i) of

this section to be classified as an association, the following is deemed to occur:

The owner of the eligible entity contributes all of the assets and liabilities of

the entity to the association in exchange

for stock of the association.

(2) Effect of elective changes. The tax

treatment of a change in the classification

of an entity for federal tax purposes by

election under paragraph (c)(1)(i) of this

section is determined under all relevant

provisions of the Internal Revenue Code

and general principles of tax law, including the step transaction doctrine.

(3) Timing of election. An election

under paragraph (c)(1)(i) of this section

that changes the classification of an eligible entity for federal tax purposes is

treated as occurring at the start of the day

for which the election is effective. Any

transactions that are deemed to occur

under this paragraph (g) as a result of a

change in classification are treated as occurring immediately before the close of

the day before the election is effective.

For example, if an election is made to

change the classification of an entity from

an association to a partnership effective

on January 1, the deemed transactions

specified in paragraph (g)(1)(ii) of this

section (including the liquidation of the

association) are treated as occurring immediately before the close of December

31 and must be reported by the owners of

the entity on December 31. As a result,

the last day of the association’s taxable

year will be December 31 and the first

December 1, 1997

day of the partnership’s taxable year will

be January 1.

(4) Effective date. This paragraph (g)

applies to elections that are filed on or

after the date the final regulations are

published in the Federal Register.

(h) Effective date—(1) In general. Except as otherwise provided in this section,

the rules of this section are applicable as

of January 1, 1997.

Michael P. Dolan,

Acting Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on October 27, 1997, 8:45 a.m., and published in the issue of

the Federal Register for October 28, 1997, 62 F.R.

55768)

Notice of Proposed Rulemaking

and Notice Of Public Hearing

Source of Income From Sales of

Inventory Partly From Sources

Within a Possession of the United

States; Also, Source of Income

Derived From Certain Purchases

From a Corporation Electing

Section 936

REG–251985–96

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains

proposed regulations under section 863

governing the source of income from

sales of inventory produced in the United

States and sold in a possession of the

United States or produced in a possession

of the United States and sold in the

United States. It also contains proposed

regulations under section 863 governing

the source of income from sales of inventory purchased in a possession of the

United States and sold in the United

States. This document affects persons

who produce (in whole or in part) inventory in the United States and sell in a possession, or produce (in whole or in part)

December 1, 1997

inventory in a possession and sell in the

United States, as well as persons who

purchase inventory in a possession and

sell in the United States. This document

also contains proposed regulations under

section 936 governing the source of income of a taxpayer from the sale in the

United States of property purchased from

a corporation that has an election under

section 936 in effect. This document also

provides notice of a public hearing on

these proposed regulations.

DATES: Comments and outlines of oral

comments to be presented at the public

hearing scheduled for January 29, 1998,

at 10 a.m. must be received by January 8,

1998.

ADDRESSES: Send submissions to:

CC:DOM:CORP:R (INTL–0003–95),

room 5228, Internal Revenue Service,

POB 7604, Ben Franklin Station, Washington, DC 20044. In the alternative, submissions may be hand delivered between

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

CC:DOM:CORP:R (REG–251985–96),

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

Washington, DC, or electronically, via 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 Building, 1111

Constitution Avenue, NW, Washington,

DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Anne

Shelburne, (202) 622-3880; concerning

submissions and the hearing, Ms. Evangelista Lee, (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 (OMB) 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 Treasury,

Office of Information and Regulatory Af-

fairs, 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

should be received by December 9, 1998.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the proper performance of the functions of the IRS, 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 capital or start-up costs and

costs of operation, maintenance, and purchase of services to provide information.

The collection of information requirements are in proposed §1.863–3(f)(6).

This information is required by the IRS

to monitor compliance with the federal

tax rules for determining the source of

income from the sale of inventory produced in the United States and sold in a

possession of the United States or produced in a possession of the United

States and sold in the United States, or

from the sale of inventory purchased in a

possession of the United States and sold

in the United States. The likely respondents are taxpayers who produce inventory in the United States and sell in a

possession, or who produce inventory in

a possession and sell in the United

States, or who purchase inventory in a

possession and sell in the United States.

Responses to this collection of information are required to properly determine

the source of a taxpayer’s income from

such sales.

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.

1997–48 I.R.B.

Estimated total annual reporting burden:

500 hours. The estimated annual burden

per respondent varies from 1 hour to 5

hours, depending on individual circumstances, with an estimated average of 2.5

hours.

Estimated number of respondents: 200

Estimated annual frequency of responses:

One time per year.

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

control number assigned by the Office of

Management and Budget.

vember 29, 1996 (61 F.R. 60540), and the

prior regulations were renumbered

§§1.863–3A and 1.863–3AT. The new

regulations retain the prior rules for Section 863 Possession Sales by providing in

paragraph §1.863–3(f) that taxpayers

must apply the rules of §1.863–3A(c) in

allocating and apportioning income derived from sources partly within the

United States and partly within a possession of the United States. These proposed

regulations would modify the existing

rules for allocating and apportioning income between the United States and a

possession.

Background

1. Property produced and sold

These proposed regulations contain

rules under section 863 relating to the

source of income from cross-border sales

of certain property. These regulations

also contain rules under section 936 relating to the source of income of a taxpayer

from the sale in the United States of property purchased from a corporation that has

an election under section 936 in effect.

These regulations are proposed to be effective for taxable years beginning 30

days after publication of final regulations.

Currently, income derived from sales

of inventory produced in the United

States and sold in a possession of the

United States or produced in a possession

of the United States and sold in the United

States (Possession Production Sales), is

allocated or apportioned between the

United States and a possession according

to one of three methods. Such income is

allocated under the independent factory

price method, apportioned under an apportionment method, or, with permission

of the District Director, allocated or apportioned on the basis of the taxpayer’s

books and records.

Under the current regulations, if an independent factory or production price

(IFP) exists for Possession Production

Sales, taxpayers must use the IFP method

to determine the income attributable to

production activities in both the sale establishing the IFP and in sales of similar

products.

If an IFP does not exist, the current

possessions regulations provide that the

taxable income from Possession Production Sales is first computed and then apportioned between the United States and

the possession. One-half of the taxable

income is apportioned on the basis of the

taxpayer’s property within the United

States and within the possession. In applying the property fraction, the taxpayer’s property includes property held or

used to produce income derived from

Possession Production Sales. The other

half of the taxpayer’s taxable income is

apportioned between U.S. and possession

sources on the basis of the business of the

taxpayer within the United States and

within the possession. Currently, busi-

Explanation of Provisions

I. Income Partly From Sources Within a

Possession

A. Current Regulations

Section 863 authorizes the Secretary to

promulgate regulations allocating or apportioning to sources within or without

the United States all items of gross income, expenses, losses, and deductions

other than those items specified in sections 861(a) and 862(a).

Guidance to determine the source of

possession income is divided into two

types of transactions: transactions described in section 863(b)(2) for property

produced in the United States and sold in

a possession (or vice versa), and transactions described in section 863(b)(3) for

property purchased in a possession and

sold in the United States (collectively,

Section 863 Possession Sales).

Section 1.863–3 of the income tax regulations contains rules for determining the

source of income derived from sales of

certain property. These regulations were

published in the Federal Register on No-

1997–48 I.R.B.

ness of the taxpayer is measured by the

sum of certain expenses, including

amounts paid for labor, and the purchase

of certain supplies, plus receipts from

Possession Production Sales. Finally, as a

third method, the existing regulations

allow a taxpayer to request permission

from the District Director to use the taxpayer’s books and records to allocate or

apportion income to sources within or

without the United States if those books

reflect more clearly than the other methods the taxable income derived from

sources within the United States.

2. Property purchased and sold

The second type of possession transaction governed by the existing regulations

is the sale of inventory purchased in a

possession and sold in the United States

(Possession Purchase Sales) as described

in section 863(b)(3). Under the current

regulations, the income from such sales is

divided between the United States and

possession sources under one of two

methods. The income can be apportioned, or, with permission of the District

Director, allocated or apportioned on the

basis of the taxpayer’s books and records.

Under the apportionment method, taxable income is first determined, and then

apportioned by a fraction, the numerator

being the business of the taxpayer in the

United States, the denominator being the

total business of the taxpayer in the

United States and in the possession. The

fraction is computed in the same manner

as the business fraction discussed previously, except that such expenses, purchases, and sales are limited to those attributable to Possession Purchase Sales.

B. Issues Under Current Regulations

The IRS and Treasury believe the rules

for allocating and apportioning income

between the United States and the possessions of the United States should be

amended to reflect certain changes made

to the regulations under §1.863–3 governing cross-border sales of inventory involving the United States and a foreign

country (other than those involving possessions). Thus, for example, under the

apportionment method provided in the

proposed regulations, the property and

business activity fractions apportioning

income between the United States and a

possession are modified to apportion

December 1, 1997

gross income attributable to an activity,

rather than to apportion net income.

The IRS and Treasury also believe certain ambiguities exist in the current regulations. The possessions rules were originally promulgated in 1926, and may not

reflect current business practices. The

current regulations use examples to illustrate methods for allocating or apportioning income between the United States and

a possession, and should be modified to

state rules.

Further, although the apportionment

method for allocating Possession Production Sales income under the existing possessions regulations treats half of the income as production income, the

production formula is not necessarily limited to production assets. The current inclusion of sales assets in the formula apportioning production income results in

excessive income being allocated to sales

activities. The production income formula should only take into account assets

directly involved in production of inventory. In addition, the IRS and Treasury

have reexamined the business activity

fraction, and have concluded it should be

revised to more clearly reflect the taxpayer’s business other than production.

The current fraction, for example, omits

certain investments or expenses, such as

marketing and advertising expenses, although income attributable in part to such

expenses or investments is then included

in the income apportioned by the fraction.

The current regulations also take into account production expenses in the business

activity fraction apportioning income

from Possession Production Sales. The

Service and Treasury believe that this is

inappropriate in the context of Possession

Production Sales because the business activity fraction is not intended to determine

the source of income attributable to production activity. In the proposed regulations, the fraction apportioning Possession Production Sales is renamed the

business sales activity fraction and excludes factors reflecting production activity.

The current regulations also do not address issues in attributing to the United

States or to the possession, the activities

reflected in the business activity fraction.

For example, the current regulations provide no guidance on whether a particular

expense should be represented in the frac-

December 1, 1997

tion as attributable to the United States or

to a possession.

Accordingly, the IRS and Treasury are

issuing proposed regulations under section 863 to make the possessions rules

more consistent with the other regulations

governing the source of income from

cross-border sales of inventory, and to address certain ambiguities and problems in

the existing regulations.

C. Proposed Regulations

Section 1.863-3(f) generally retains the

methods of the current regulations for dividing income between the United States

and a possession of the United States,

with several modifications.

1. Methods to allocate gross income to

activities of the taxpayer

a. Property produced and sold

i. The possession 50/50 method

Consistent with the final regulations

under §1.863–3, paragraph (f)(2)(i)(A) of

the proposed regulations makes the 50/50

method the general rule to allocate gross

income from Possession Production Sales

between production and business sales activity, so that the income from each type

of activity can then be apportioned between U. S. and foreign sources. The taxpayer, however, may elect to apply the

IFP method (described in paragraph

(f)(2)(i)(B)), or, with the consent of the

District Director, the books and records

method (described in paragraph

(f)(2)(i)(C)).

Under the possession 50/50 method,

the proposed regulations allocate half of

the taxpayer’s gross income from Possession Production Sales to production activity and half to business sales activity. The

income is then apportioned between U.S.

and possession sources based on a property fraction and a business sales activity

fraction. As described below, the proposed regulations make certain changes to

the existing property fraction and to the

existing business activity fraction.

The proposed regulations apply the

property fraction in §1.863–3(c) to apportion the half of a taxpayer’s income allocated to production activity. Thus, income is apportioned to the United States

or to a possession based on the location of

the taxpayer’s production assets. In a

change from the current regulations, and

consistent with the changes made to the

regulations under §1.863–3(c), produc-

tion assets are defined as tangible and intangible assets owned directly by the taxpayer that are directly used by the taxpayer to produce inventory sold in

Possession Production Sales, instead of

all its assets that produce income from

Possession Production Sales. Production

assets are included in the fraction at their

adjusted tax basis.

The other half of the taxpayer’s gross

income is apportioned according to a

business sales activity fraction. The portion of this income that is possession

source income is determined by multiplying the income by a fraction, the numerator being the business sales activity of the

taxpayer in the possession, and the denominator being the business sales activity of the taxpayer within the possession

and outside the possession. The remaining income is sourced in the United

States. Although some of the business

sales activity factors not incurred in a possession may be incurred in a foreign

country, Treasury and the Internal Revenue Service believe that the business

sales activity fraction is only intended to

source the business sales activity portion

of Possession Production Sales outside

the United States to the extent of business

sales activity located in a possession.

The proposed regulations make some

modifications to the factors in the fraction

representing the business sales activity of

the taxpayer. Business sales activity is

measured by the sum of certain expenses,

including amounts paid for labor, materials, advertising, and marketing (but excluding any expenses or other amounts

that are nondeductible under section

263A, interest, and research and development), plus receipts for the sale of goods.

This formula is intended to reflect better

the business sales activity producing the

income by including more of the factors

responsible for producing that income.

Cost of goods sold is also excluded from

the business sales activity fraction apportioning income from Possession Production Sales, because such costs generally

reflect production activity. Production

activity is already represented in the formula by the one-half of the taxpayer’s income apportioned according to the location of production assets.

Finally, the proposed regulations provide more explicit guidance for attributing business sales activity between the

1997–48 I.R.B.

United States and a possession. Expenses

are allocated and apportioned between the

United States and a possession based on

the rules in §§1.861–8 through

1.861–14T. Gross sales are allocated to

the United States or a possession based on

the place of sale.

ii. The IFP method

The proposed regulations make the IFP

method elective, and thus eliminate any

bias against taxpayers choosing to export

through independent distributors. The

regulations rely upon the revised regulations under §1.863–3 for rules in applying

the IFP method.

iii. Books and records method

The proposed regulations retain the

books and records method of the existing

regulations, permitting taxpayers to request permission from the District Director to use their books and records to determine the source of their income. The

proposed regulations refer to revised

§1.863–3(b)(3) in applying the method to

Possession Production Sales.

b. Property purchased and sold

i. The business activity method

Paragraph (f)(3)(i)(A) makes the business activity method the general rule to

apportion income from Possession Purchase Sales between the United States and

a possession. The taxpayer may, however, elect to apply, with consent of the

District Director, the books and records

method.

The proposed regulations retain the

structure of the existing regulations by apportioning the taxpayer’s income from

Possession Purchase Sales on the basis of

a business activity fraction. The portion

of this income that is possession source

income is determined by multiplying the

income by a fraction, the numerator being

the business of the taxpayer in the possession, and the denominator being the business of the taxpayer within the possession

and outside the possession. The remaining income is sourced in the United

States.

The business activity fraction is similar

to that discussed previously, used to apportion the taxpayer’s income in Possession Production Sales, except that the

fraction applies only to expenses, cost of

goods sold, and sales attributable to Possession Purchase Sales. In addition, the

business activity fraction apportioning

Possession Purchase Sales includes

1997–48 I.R.B.

amounts paid for cost of goods sold.

Such costs are attributed to the possession, however, only to the extent the property purchased is manufactured, produced, grown, or extracted in the

possession. Treasury and the Internal

Revenue Service anticipate that if a taxpayer acts in the reasonable belief that the

products were manufactured in the possession, the taxpayer could act on that

basis in preparing its tax return. As modified, the business activity fraction reflects

the view of Treasury and the Internal Revenue Service that section 863(b)(3)’s purchase rule was intended to apply only to

purchase and resale transactions, where

the goods purchased are created or derived from the possession.

ii. Books and records method

The proposed regulations retain the

books and records method of the existing

regulations, permitting taxpayers to request permission from the District Director to use their books and records to determine the source of their income. The

proposed regulations refer to revised

§1.863–3(b)(3) in applying the method to

Possession Purchase Sales.

2. Determination of source of gross

income

Unlike the current regulations which

provide specific rules for determining the

source of income attributable to production activity and business activity only for

purposes of the 50/50 method, the proposed regulations adopt rules applicable

to each of the methods. Under the proposed regulations, once gross income attributable to production activity, business

activity, or sales activity has been determined under one of the prescribed methods, the source of the gross income is determined separately for each type of

income. The source of gross income attributable to production activity (when

applying the possession 50/50 method) is

determined under paragraph (c)(1), based

on the location of production assets. The

source of gross income attributable to

sales activity (when applying the IFP

method or the books and records method)

is determined under paragraph (c)(2),

based generally on the location of the

sale. The source of gross income attributable to business sales activity (when applying the possession 50/50 method) is

determined under paragraph (f)(2)(ii)(B),

based on expenses, and gross sales attributable to Possession Production Sales.

The source of gross income attributable to

business activity (when applying the business activity method) is determined under

paragraph (f)(3)(ii), based on expenses,

cost of goods sold, and gross sales attributable to Possession Purchase Sales.

3. Determination of source of

taxable income

Once the source of gross income is determined under paragraph (f)(2) or (3),

taxpayers then determine the source of

taxable income. Under proposed paragraph (f)(4), taxpayers must allocate or

apportion under §§1.861–8 through

1.861–14T the amounts of expenses,

losses and other deductions to gross income determined under each of the prescribed methods. In the case of amounts

of expenses, losses and other deductions

allocated or apportioned to gross income

determined under the IFP method or the

books and records method, the taxpayer

must apply the rules of §§1.861–8

through 1.861–14T to allocate or apportion these amounts between gross income

from sources within the United States and

within a possession. For expenses, losses

and other deductions allocated or apportioned to gross income determined under

the possessions 50/50 method, taxpayers

must apportion expenses and other deductions pro rata based on the relative

amounts of U.S. and possession source

gross income. The research and experimental (R&E) expense allocation rules in

§1.861–17 apply to taxpayers using the

50/50 method, so that the R&E set aside

(described in §1.861–17) remains available to such taxpayers.

4. Treatment of gross income derived

from certain purchases from a

corporation that has an election

in effect under section 936

The proposed regulations clarify that

section 863 does not apply to determine

the source of a taxpayer’s gross income

derived from a purchase of inventory

from a corporation that has an election in

effect under section 936, if the taxpayer’s

income from sales of that inventory is

taken into account to determine benefits

under section 936(h)(5)(C) for the section

936 corporation.

December 1, 1997

5. Treatment of partners and partnerships

The proposed regulations rely on the

rules in §1.863–3(g) for determining the

appropriate treatment in transactions involving partnerships. Under those rules,

the aggregate approach applies to a partnership’s production and sales activity for

two purposes only. First, the aggregate approach applies in determining the character

of a partner’s distributive share of partnership income. Second, the aggregate approach applies in sourcing income from

sales of inventory property that is transferred in-kind from or to a partnership.

source without regard to whether a possession product is a component, endproduct form, or integrated product. No

inference should be drawn from the proposed effective date concerning the treatment of transactions involving sales of

property purchased from a section 936

corporation entered into before the regulations are applicable.

Proposed Effective Dates

These regulations are proposed to be

effective for taxable years beginning on

or after the date that is 30 days after the

date of publication of final regulations.

6. Election and reporting rules

Special Analyses

Under paragraph (f)(6)(i) of the proposed regulations, a taxpayer must use the

50/50 method to determine the source of

income from Possession Production Sales

unless the taxpayer elects to use the IFP

method, or elects the books and records

method. For Possession Purchase Sales, a

taxpayer must use the business activity

method, unless the taxpayer elects the

books and records method. The taxpayer

makes an election by using the method on

its timely filed original tax return. That

method must be used in later taxable

years unless the Commissioner or his delegate consents to a change. Permission to

change methods in later years will not be

withheld unless the change would result

in a substantial distortion of the source of

income.

A taxpayer must fully explain the

methodology used in applying either

paragraph (f)(2) or (3), and the amount of

income allocated or apportioned to U.S.

and foreign sources, in a statement attached to its tax return.

II. Income Derived From Certain

Purchases From a Corporation That Has

an Election in Effect Under Section 936

These proposed regulations clarify that

where a taxpayer purchases a product

from a corporation that has an election in

effect under section 936, the source of the

taxpayer’s gross income derived from

sales of that product (in whatever form

sold) in the United States is U.S. source,

if the taxpayer’s income from sales of

that product is taken into account to determine benefits under section

936(h)(5)(C)(i) for the section 936 corporation. The taxpayer’s income is U.S.

December 1, 1997

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 is hereby certified

that these regulations will not have a significant economic impact on a substantial

number of small entities. This certification is based on the fact that the rules of

this section principally impact large

multinationals who pay foreign taxes on

substantial foreign operations and therefore the rules will impact very few small

entities. Moreover, in those few instances

where the rules of this section impact

small entities, the economic impact on

such entities is not likely to be significant.

Accordingly, a regulatory flexibility

analysis is not required. 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 comments that

are submitted timely (in the manner described under the ADDRESSES caption)

to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled

for January 29, 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 Inter-

nal Revenue 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 comments and an outline of topics to be discussed and the time to be devoted to each

topic (in the manner described under the

ADDRESSES caption of this preamble)

by January 8, 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 author of these regulations is Anne Shelburne, Office of Associate Chief Counsel (International). However, other personnel from the IRS and

Treasury Department participated in their

development.

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 revising the entry for

“Section 1.863-3”, removing the entry for

“Sections 1.936-4 through 1.936-7” and

adding entries in numerical order to read

as follows:

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

Section 1.863-3 also issued under 26

U.S.C. 863(a) and (b), and 26 U.S.C.

936(h).***

Section 1.936-4 also issued under 26

U.S.C. 936(h).

Section 1.936-5 also issued under 26

U.S.C. 936(h).

Section 1.936-6 also issued under 26

U.S.C. 863(a) and (b), and 26 U.S.C.

936(h).

Section 1.936-7 also issued under 26

U.S.C. 936(h).***

Par. 2 Section 1.863-3 is amended as

follows:

1. Paragraph (f) is revised.

2. Paragraph (h) is amended by adding

a sentence at the end of the paragraph.

1997–48 I.R.B.

The revision and addition read as follows:

§1.863-3 Allocation and apportionment

of income from certain sales of inventory.

(f) Income partly from sources within a

possession of the United States—(1) In

general. This paragraph (f) relates to

gains, profits, and income, which are

treated as derived partly from sources

within the United States and partly from

sources within a possession of the United

States (Section 863 Possession Sales).

This paragraph (f) applies to determine

the source of income derived from the

sale of inventory produced (in whole or in

part) by the taxpayer within the United

States and sold within a possession, or

produced (in whole or in part) by a taxpayer in a possession and sold within the

United States (Possession Production

Sales). It also applies to determine the

source of income derived from the purchase of personal property within a possession of the United States and its sale

within the United States (Possession Purchase Sales). A taxpayer subject to this

paragraph (f) must divide gross income

from Section 863 Possession Sales using

one of the methods described in either

paragraph (f)(2)(i) of this section (in the

case of Possession Production Sales) or

paragraph (f)(3)(i) of this section (in the

case of Possession Purchase Sales). Once

a taxpayer has elected a method, the taxpayer must separately apply that method

to the applicable category of Section 863

Possession Sales in the United States and

to those in a possession. The source of

gross income from each type of activity

must then be determined under either

paragraph (f)(2)(ii) or (3)(ii) of this section, as appropriate. The source of taxable

income from Section 863 Possession

Sales is determined under paragraph

(f)(4) of this section. The taxpayer must

apply the rules for computing gross and

taxable income by aggregating all Section

863 Possession Sales to which a method

in this section applies after separately applying that method to Section 863 Possession Sales in the United States and to Section 863 Possession Sales in a possession.

This section does not apply to determine

the source of a taxpayer’s gross income

derived from a sale of inventory purchased from a corporation that has an

1997–48 I.R.B.

election in effect under section 936, if the

taxpayer’s income from sales of that inventory is taken into account to determine

benefits under section 936 for the section

936 corporation. For rules to be applied

to determine the source of such income,

see §1.936-6(a)(5) Q&A 7a and (b)(1)

Q&A 13.

(2) Allocation or apportionment for

Possession Production Sales—(i) Methods for determining the source of gross

income for Possession Production

Sales—(A) Possession 50/50 method.

Under the possession 50/50 method, gross

income from Possession Production Sales

is allocated between production activity

and business sales activity as described in

this paragraph (f)(2)(i)(A). Under the

possession 50/50 method, one-half of the

taxpayer’s gross income will be considered income attributable to production activity and the source of that income will

be determined under the rules of paragraph (f)(2)(ii)(A) of this section. The remaining one-half of such gross income

will be considered income attributable to

business sales activity and the source of

that income will be determined under the

rules of paragraph (f)(2)(ii)(B) of this section.

(B) IFP method. In lieu of the possession 50/50 method, a taxpayer may elect

the independent factory price (IFP)

method. Under the IFP method, gross income from Possession Production Sales is

allocated to production activity or sales

activity using the IFP method, as described in paragraph (b)(2) of this section,

if an IFP is fairly established under the

rules of paragraph (b)(2) of this section.

See paragraphs (f)(2)(ii)(A) and (C) of

this section for rules for determining the

source of gross income attributable to

production activity and sales activity.

taxpayer may elect to allocate gross income using the books and records

method described in paragraph (b)(3) of

this section, if it has received in advance

the permission of the District Director

having audit responsibility over its return. See paragraph (f)(2)(ii) of this section for rules for determining the source

of gross income.

(ii) Determination of source of gross

income from production, business sales,

and sales activity—(A) Gross income attributable to production activity. The

source of gross income from production

activity is determined under the rules of

paragraph (c)(1) of this section, except

that the term possession is substituted for

foreign country wherever it appears.

(B) Gross income attributable to business sales activity—(1) Source of gross

income. Gross income from the taxpayer’s business sales activity is sourced

in the possession in the same proportion

that the amount of the taxpayer’s business

sales activity for the taxable year within

the possession bears to the amount of the

taxpayer’s business sales activity for the

taxable year both within the possession

and outside the possession, with respect

to Possession Production Sales. The remaining income is sourced in the United

States.

(2) Business sales activity. For purposes of this paragraph (f)(2)(ii)(B), the

taxpayer’s business sales activity is equal

to the sum of—

(i) The amounts for the taxable period

paid for wages, salaries, and other compensation of employees, and other expenses attributable to Possession Production Sales (other than amounts that are

nondeductible under section 263A, interest, and research and development); and

(ii) Possession Production Sales for the

taxable period.

(3) Location of business sales activity.

For purposes of determining the location

of the taxpayer’s business activity within

a possession, the following rules apply:

(i) Sales. Receipts from gross sales

will be attributed to a possession under

the provisions of paragraph (c)(2) of this

section.

(ii) Expenses. Expenses will be attributed to a possession under the rules of

§§1.861–8 through 1.861–14T.

activity. The source of the taxpayer’s income that is attributable to sales activity,

as determined under the IFP method or

the books and records method, will be determined under the provisions of paragraph (c)(2) of this section.

(3) Allocation or apportionment for

Possession Purchase Sales—(i) Methods

for determining the source of gross income for Possession Purchase Sales—

(A) Business activity method. Gross income from Possession Purchase Sales is

allocated in its entirety to the taxpayer’s

business activity, and is then apportioned

December 1, 1997

between U.S. and possession sources

under paragraph (f)(3)(ii) of this section.

(B) Books and records method. A

taxpayer may elect to allocate gross income using the books and records method

described in paragraph (b)(3) of this section, subject to the conditions set forth in

paragraph (b)(3) of this section. See paragraph (f)(2)(ii) of this section for rules for

determining the source of gross income.

(ii) Determination of source of gross

income from business activity—(A)

Source of gross income. Gross income

from the taxpayer’s business activity is

sourced in the possession in the same proportion that the amount of the taxpayer’s

business activity for the taxable year

within the possession bears to the amount

of the taxpayer’s business activity for the

taxable year both within the possession

and outside the possession, with respect

to Possession Purchase Sales. The remaining income is sourced in the United

States.

(B) Business activity. For purposes of

this paragraph (f)(3)(ii), the taxpayer’s

business activity is equal to the sum of—

(1) The amounts for the taxable period

paid for wages, salaries, and other compensation of employees, and other expenses attributable to Possession Purchase Sales (other than amounts that are

nondeductible under section 263A, interest, and research and development);

(2) Cost of goods sold attributable to

Possession Purchase Sales during the taxable period; and

(3) Possession Purchase Sales for the

taxable period.

purposes of determining the location of

the taxpayer’s business activity within a

possession, the following rules apply:

(1) Sales. Receipts from gross sales

will be attributed to a possession under

the provisions of paragraph (c)(2) of this

section.

(2) Cost of goods sold. Payments for

cost of goods sold will be properly attributable to gross receipts from sources

within the possession only to the extent

that the property purchased was manufactured, produced, grown, or extracted in

the possession (within the meaning of

section 954(d)(1)(A)).

(3) Expenses. Expenses will be attributed to a possession under the rules of

§§1.861–8 through 1.861–14T.

December 1, 1997

(iii) Examples. The following examples illustrate the rules of paragraph

(f)(3)(ii) relating to the determination of

source of gross income from business activity:

Example 1. (i) U.S. Co. purchases in a possession product X for $80 from A. A manufactures X in

the possession. Without further production, U.S.

Co. sells X in the United States for $100. Assume

U.S. Co. has sales and administrative expenses in

the possession of $10.

(ii) To determine the source of U.S. Co.’s gross

income, the $100 gross income from sales of X is allocated entirely to U.S. Co.’s business activity.

Forty-seven dollars of U.S. Co.’s gross income is

sourced in the possession. [Possession expenses

($10) plus possession purchases ($80) plus possessions sales ($0), divided by total expenses ($10) plus

total purchases ($80) plus total sales ($100).] The

remaining $53 is sourced in the United States.

Example 2. (i) Assume the same facts as in Example 1, except that A manufactures X outside the

possession.

(ii) To determine the source of U.S. Co.’s gross

income, the $100 gross income is allocated entirely

to U.S. Co.’s business activity. Five dollars of U.S.

Co.’s gross income is sourced in the possession.

[Possession expenses ($10) plus possession purchases ($0) plus possession sales ($0), divided by

total expenses ($10) plus total purchases ($80) plus

total sales ($100).] The $80 purchase is not included

in the numerator used to determine U.S. Co.’s business activity in the possession, since product X was

not manufactured in the possession. The remaining

$95 is sourced in the United States.

(4) Determination of source of taxable

income. Once the source of gross income

has been determined under paragraph

(f)(2) or (3) of this section, the taxpayer

must properly allocate and apportion separately under §§1.861–8 through

1.861–14T the amounts of its expenses,

losses, and other deductions to its respective amounts of gross income from Section 863 Possession Sales determined

separately under each method described

in paragraph (f)(2) or (3) of this section.

In addition, if the taxpayer deducts expenses for research and development

under section 174 that may be attributed

to its Section 863 Possession Sales under

§1.861–8(e)(3), the taxpayer must separately allocate or apportion expenses,

losses, and other deductions to its respective amounts of gross income from each

relevant product category that the taxpayer uses in applying the rules of

§1.861–8(e)(3)(i)(A). In the case of

gross income from Section 863 Possession Sales determined under the IFP

method or books and records method, a

taxpayer must apply the rules of

§§1.861–8 through 1.861–14T to prop-

erly allocate or apportion amounts of expenses, losses and other deductions, allocated and apportioned to such gross income, between gross income from

sources within and without the United

States. In the case of gross income from

Possession Production Sales determined

under the possessions 50/50 method or

gross income from Possession Purchase

Sales computed under the business activity method, the amounts of expenses,

losses, and other deductions allocated

and apportioned to such gross income

must be apportioned between sources

within and without the United States pro

rata based on the relative amounts of

gross income from sources within and

without the United States determined

under those methods.

(5) Special rules for partnerships. In

applying the rules of this paragraph (f) to

transactions involving partners and partnerships, the rules of paragraph (g) of this

section apply.

(6) Election and reporting rules—(i)

Elections under paragraph (f)(2) or (3) of

this section. If a taxpayer does not elect

one of the methods specified in paragraph

(f)(2) or (3) of this section, the taxpayer

must apply the possession 50/50 method

in the case of Possession Production Sales

or the business activity method in the case

of Possession Purchase Sales. The taxpayer may elect to apply a method specified in either paragraph (f)(2) or (3) of

this section by using the method on a

timely filed original return (including extensions). Once a method has been used,

that method must be used in later taxable

years unless the Commissioner consents

to a change. Permission to change methods from one year to another year will be

granted unless the change would result in

a substantial distortion of the source of

the taxpayer’s income.

(ii) Disclosure on tax return. A taxpayer who uses one of the methods described in paragraph (f)(2) or (3) of this

section must fully explain in a statement

attached to the tax return the methodology

used, the circumstances justifying use of

that methodology, the extent that sales are

aggregated, and the amount of income so

allocated.

(h) Effective dates. * * * However,

the rules of paragraph (f) of this section

apply to taxable years beginning on or

1997–48 I.R.B.

after the date that is 30 days after the date

of publication of final regulations.

Par. 3. In §1.936-6, paragraph (a)(5)

Q&A 7a is added to read as follows:

§1.936-6 Intangible property income

when an election out is made: Cost

sharing and profit split options; covered

intangibles.

(a) * * *

(5) * * *

Q.7a: What is the source of the taxpayer’s gross income derived from a sale

in the United States of a possession product purchased by the taxpayer (or an affiliate) from a corporation that has an election in effect under section 936, if the

income from such sale is taken into account to determine benefits under cost

sharing for the section 936 corporation?

Is the result different if the taxpayer (or an

affiliate) derives gross income from a sale

in the United States of an integrated product incorporating a possession product

purchased by the taxpayer (or an affiliate)

from the section 936 corporation, if the

taxpayer (or an affiliate) processes the

possession product or an excluded component in the United States?

A.7a: Under either scenario, the income is U.S. source, without regard to

whether the possession product is a component, end-product, or integrated product. Section 863 does not apply in determining the source of the taxpayer ’s

income. This Q&A 7a is applicable for

taxable years beginning on or after the

date that is 30 days after the date of publication of final regulations.

Michael P. Dolan,

Acting Commissioner of

Internal Revenue.

(Filed by the Office of the Federal Register on October 9, 1997, 8:45 a.m., and published in the issue of

the Federal Register for October 10, 1997, 62 F.R.

52953)

1997–48 I.R.B.

Foundations Status of Certain

Organizations

Announcement 97–116

The following organizations have

failed to establish or have been unable to

maintain their status as public charities or

as operating foundations. Accordingly,

grantors and contributors may not, after

this date, rely on previous rulings or designations in the Cumulative List of Organizations (Publication 78), or on the presumption arising from the filing of notices

under section 508(b) of the Code. This

listing does not indicate that the organizations have lost their status as organizations described in section 501(c)(3), eligible to receive deductible contributions.

Former Public Charities. The following

organizations (which have been treated as

organizations that are not private foundations described in section 509(a) of the

Code) are now classified as private foundations:

Babys Exchange, Parker, AZ

Bachman Northwest Highway

Community Association, Dallas, TX

Baillie Players Inc., Columbia, SC

Bainbridge-Decatur County Council for

the Arts, Inc., Bainbridge, GA

Balkan Relief Fund, Inc.,

Fern Park, FL

Bamberg Kiddie Kampus Inc.,

Bamberg, SC

Bandits Football Association,

Ofallon, MO

Bankhead Learning Academy Inc.,

Atlanta, GA

Baptist Hill House Inc., Detroit, MI

Baptist Ministrers Conference of

Cincinnati and Vicinity, Cincinnati, OH

Baptist Village Residents Association,

Phoenix, AZ

Barnabas Ministries, Springfield, OH

Bartow County Coalition for Substance

Abuse Prevention, Cartersville, GA

BASE Camp Childrens Cancer

Foundation, Inc., Windermere, FL

Basic Interdenominational Lackland

Shelter, Incorporated, San Antonio, TX

Bastrop County Crime Stoppers, Inc.,

Bastrop, TX

Baton Rouge Black Alcoholism Council,

Baton Rouge, LA

Battered Women as Survivors Inc.,

Columbus, OH

Bay Area Neighborhood Development

Corporation, Sandusky, OH

Bay Area Raiders Football Inc.,

Tampa, FL

Bay Area Youth Wheelchair Athletic

Association, St. Petersburg, FL

Bay Hope House, Bokeelia, FL

Bayou-River Social Services, Luling, LA

Bayshore Volunteer Fire Department,

Inc., North Ft. Myers, FL

Baytown Youth Development Center,

Inc., Baytown, TX

Beall Society for Sight Preservation, Inc.,

Cleveland, OH

Bear Buddies Educational Resources,

Inc., Hudson, WI

Bedford City Schools Foundation,

Bedford, OH

Beech Economic Development

Association, Philadelphia, PA

Beechwood Resource Center Inc.,

River Rouge, MI

Behavioral Communication Research,

Lexington, KY

Bel Canto Lyric Opera Company,

Philadelphia, PA

Belle Babb Nansfield Foundation,

Des Moines, IA

Belleville Public Library Foundation,

Belleville, KS

Ben Davis Youth Sports Association,

Inc., Indianapolis, IN

Bengali Association of Greater Dallas-Ft.

Worth, Plano, TX

Benjamin House Inc., Cleveland, OH

Benzie Housing Council, Benzonia, MI

Berlitz Gallery Theatre, Chandler, AZ

Berryville Baseball Association, Inc.,

Berryville, AR

Best Southwest Business Center,

Duncanville, TX

Bethel Foundation, Des Moines, IA

Bethlehem Ministries Inc., Paterson, NJ

Better Business Bureau of the Golden

Spread Educational Foundation,

Amarillo, TX

Better Community Relations Inc.,

Toledo, OH

Better Homes for North Carolina Inc.,

Raleigh, NC

Better Life Inc., Birmingham, MI

Better Way of Life, Chicago, IL

December 1, 1997

Bexar Metropolitan Housing Association,

San Antonio, TX

Beyer School Parent Teacher

Organization, Rockford, IL

Beyond the Limits–Childrens Outreach

Services, Jackson, MS

Bhagavat Dharma Samaj Inc.,

Baltimore, MD

Bibleway Community Outreach Projects,

Inc., Annapolis, MD

Biblical Counseling Ministries Inc.,

Merrian, KS

Big Bend People and Goats, Alpine, TX

Big Brothers-Big Sisters of Ford County,

Inc., Dodge City, KS

Big Brothers-Big Sisters of Owensboro,

Inc., Owensboro, KY

Big Brothers-Big Sisters of Morgan

County, Inc., Decatur, AL

Big Horn Basin of Wyoming Resource

Conservation and Developmental

Project, Worland, WY

Billings Senior High Band Parents Inc.,

Billings, MT

Binghampton Fellowship Foundation,

Inc., Memphis, TN

Birmingham Chapter of the American

Association of Energy,

Birmingham, AL

Birmingham Regional Sports Club Inc.,

Birmingham, AL

Birmingham Schools Athletic Foundation,

Birmingham, AL

Birthline of Wellington Inc.,

Wellington, KS

December 1, 1997

Birthright of Sterling, Sterling, CO

BJ Nutritional Service Inc., Houston, TX

Black & White Medical Transportation,

Inc., Pine Bluff, AR

Black Activities at a Glance,

Columbus, OH

Black Bear Awareness, Trufant, MI

Black Belt Improvement Group,

Hope Hull, AL

Black Business Entrepreneurs, Sandy, UT

Black Professional Men Inc.,

Baltimore, MD

Black State Employees Association,

Dallas, TX

Blind Comprehensive Action Network,

St. John, MO

Blind People of America Entertainment

BPOA, Inc., Albuquerque, NM

Blossomland Arts and Cultural Council,

Saint Joseph, MI

Blue Ash Revitalization Inc.,

Blue Ash, OH

Blue Ridge Home for Boys, Greer, SC

Bluebirds Over Georgia Inc., Atlanta, GA

Bluegrass Brass Inc., Lexington, KY

Blues Club Inc., Jonesboro, AR

Blues Society of Indiana Incorporated,

Indianapolis, IN

Bnai Brith Athletic and Achievement

Award Endowment Fund, Roanoke, VA

Bnai Brith Covenant House of Tucson

Arizona Inc., Tucson, AZ

Boardwalk Estates Inc., Garden City, KS

Bob Johnson Ice Hockey Foundation,

Colorado Springs, CO

Bogalusa Humane Society, Bogalusa, LA

Bone Marrow International,

Greensboro, NC

Book Bank Project, Mesa, AZ

Book of Hope Inc., Deerfield, FL

Booksellers for Social Responsibility,

Chicago, IL

Boone County Youth Soccer Association,

Florence, KY

Bootstrap Inc., New Berlin, WI

Boston Township Hall Committee Inc.,

Peninsula, OH

Bowling Green Choral Society Inc.,

Bowling Green, KY

Boys & Girls Club of the Smoky

Mountains, Inc., Sevierville, TN

BRACE Inc., Winston-Salem, NC

BREATHE, Boulder, CO

If an organization listed above submits

information that warrants the renewal of

its classification as a public charity or as a

private operating foundation, the Internal

Revenue Service will issue a ruling or determination letter with the revised classification as to foundation status. Grantors

and contributors may thereafter rely upon

such ruling or determination letter as provided in section 1.509(a)–7 of the Income

Tax Regulations. It is not the practice of

the Service to announce such revised classification of foundation status in the Internal Revenue Bulletin.

1997–48 I.R.B.

Definition of Terms

Revenue rulings and revenue procedures

(hereinafter referred to as “rulings”) that

have an effect on previous rulings use the

following defined terms to describe the

effect:

Amplified describes a situation where

no change is being made in a prior published position, but the prior position is

being extended to apply to a variation of

the fact situation set forth therein. Thus,

if an earlier ruling held that a principle

applied to A, and the new ruling holds

that the same principle also applies to B,

the earlier ruling is amplified. (Compare

with modified, below).

Clarified is used in those instances

where the language in a prior ruling is

being made clear because the language

has caused, or may cause, some confusion. It is not used where a position in a

prior ruling is being changed.

Distinguished describes a situation

where a ruling mentions a previously

published ruling and points out an essential difference between them.

Modified is used where the substance

of a previously published position is

being changed. Thus, if a prior ruling

held that a principle applied to A but not

to B, and the new ruling holds that it ap-

plies to both A and B, the prior ruling is

modified because it corrects a published

position. (Compare with amplified and

clarified, above).

Obsoleted describes a previously published ruling that is not considered determinative with respect to future transactions. This term is most commonly used

in a ruling that lists previously published

rulings that are obsoleted because of

changes in law or regulations. A ruling

may also be obsoleted because the substance has been included in regulations

subsequently adopted.

Revoked describes situations where the

position in the previously published ruling is not correct and the correct position

is being stated in the new ruling.

Superseded describes a situation where

the new ruling does nothing more than

restate the substance and situation of a

previously published ruling (or rulings).

Thus, the term is used to republish under

the 1986 Code and regulations the same

position published under the 1939 Code

and regulations. The term is also used

when it is desired to republish in a single

ruling a series of situations, names, etc.,

that were previously published over a period of time in separate rulings. If the

new ruling does more than restate the

substance of a prior ruling, a combination

of terms is used. For example, modified

and superseded describes a situation

where the substance of a previously published ruling is being changed in part and

is continued without change in part and it

is desired to restate the valid portion of

the previously published ruling in a new

ruling that is self contained. In this case

the previously published ruling is first

modified and then, as modified, is superseded.

Supplemented is used in situations in

which a list, such as a list of the names of

countries, is published in a ruling and

that list is expanded by adding further

names in subsequent rulings. After the

original ruling has been supplemented

several times, a new ruling may be published that includes the list in the original

ruling and the additions, and supersedes

all prior rulings in the series.

Suspended is used in rare situations to

show that the previous published rulings

will not be applied pending some future

action such as the issuance of new or

amended regulations, the outcome of

cases in litigation, or the outcome of a

Service study.

Abbreviations

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contribution Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign Corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statements of Procedral Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

The following abbreviations in current use and formerly used will appear in material published in the

Bulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C.—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

1997–48 I.R.B.

December 1, 1997

Numerical Finding List1

Bulletins 1997–27 through 1997–47

Announcements:

97–61, 1997–29 I.R.B. 13

97–67, 1997–27 I.R.B. 37

97–68, 1997–28 I.R.B. 13

97–69, 1997–28 I.R.B. 13

97–70, 1997–29 I.R.B. 14

97–71, 1997–29 I.R.B. 15

97–72, 1997–29 I.R.B. 15

97–73, 1997–30 I.R.B. 86

97–74, 1997–31 I.R.B. 16

97–75, 1997–32 I.R.B. 28

97–76, 1997–32 I.R.B. 28

97–77, 1997–33 I.R.B. 58

97–78, 1997–34 I.R.B. 11

97–79, 1997–35 I.R.B. 8

97–80, 1997–34 I.R.B. 12

97–81, 1997–34 I.R.B. 12

97–82, 1997–34 I.R.B. 12

97–83, 1997–34 I.R.B. 13

97–84, 1997–34 I.R.B. 13

97–85, 1997–35 I.R.B. 8

97–86, 1997–35 I.R.B. 9

97–87, 1997–35 I.R.B. 9

97–88, 1997–35 I.R.B. 9

97–89, 1997–36 I.R.B. 10

97–90, 1997–36 I.R.B. 10

97–91, 1997–37 I.R.B. 25

97–92, 1997–37 I.R.B. 26

97–93, 1997–36 I.R.B. 11

97–94, 1997–36 I.R.B. 12

97–95, 1997–36 I.R.B. 12

97–96, 1997–39 I.R.B. 15

97–97, 1997–38 I.R.B. 22

97–98, 1997–39 I.R.B. 15

97–99, 1997–40 I.R.B. 7

97–100, 1997–40 I.R.B. 8

97–101, 1997–41 I.R.B. 13

97–102, 1997–41 I.R.B. 15

97–103, 1997–41 I.R.B. 16

97–104, 1997–42 I.R.B. 39

97–105, 1997–42 I.R.B. 40

97–106, 1997–45 I.R.B. 11

97–107, 1997–43 I.R.B. 25

97–108, 1997–43 I.R.B. 25

97–109, 1997–45 I.R.B. 12

97–110, 1997–45 I.R.B. 14

97–111, 1997–47 I.R.B. 15

97–112, 1997–46 I.R.B. 20

97–113, 1997–46 I.R.B. 21

97–114, 1997–46 I.R.B. 21

97–115, 1997–47 I.R.B. 17

Court Decisions:

2061, 1997–31 I.R.B. 5

2062, 1997–32 I.R.B. 8

Delegation Orders:

97 (Rev. 34), 1997–41 I.R.B. 14

172 (Rev. 5), 1997–28 I.R.B. 6

Notices:

97–37, 1997–27 I.R.B. 4

97–38, 1997–27 I.R.B. 8

Notices–Continued

Revenue Rulings:

97–39, 1997–27 I.R.B. 8

97–40, 1997–28 I.R.B. 6

97–41, 1997–28 I.R.B. 6

97–42, 1997–29 I.R.B. 12

97–43, 1997–30 I.R.B. 9

97–44, 1997–31 I.R.B. 15

97–45, 1997–33 I.R.B. 7

97–46, 1997–34 I.R.B. 10

97–47, 1997–35 I.R.B. 5

97–48, 1997–35 I.R.B. 5

97–49, 1997–36 I.R.B. 8

97–50, 1997–37 I.R.B. 21

97–51, 1997–38 I.R.B. 20

97–52, 1997–38 I.R.B. 20

97–53, 1997–40 I.R.B. 6

97–54, 1997–41 I.R.B. 7

97–55, 1997–40 I.R.B. 6

97–56, 1997–43 I.R.B. 19

97–57, 1997–43 I.R.B. 19

97–58, 1997–45 I.R.B. 7

97–59, 1997–45 I.R.B. 7

97–60, 1997–46 I.R.B. 8

97–63, 1997–47 I.R.B. 6

97–64, 1997–47 I.R.B. 7

97–27, 1997–27 I.R.B. 4

97–28, 1997–28 I.R.B. 4

97–29, 1997–28 I.R.B. 4

97–30, 1997–31 I.R.B. 12

97–31, 1997–32 I.R.B. 4

97–32, 1997–33 I.R.B. 4

97–33, 1997–34 I.R.B. 4

97–34, 1997–34 I.R.B. 14

97–35, 1997–35 I.R.B. 4

97–36, 1997–36 I.R.B. 5

97–37, 1997–37 I.R.B. 15

97–38, 1997–38 I.R.B. 14

97–39, 1997–39 I.R.B. 4

97–40, 1997–39 I.R.B. 8

97–41, 1997–40 I.R.B. 4

97–42, 1997–41 I.R.B. 4

97–43, 1997–42 I.R.B. 8

97–44, 1997–45 I.R.B. 5

97–45, 1997–46 I.R.B. 4

97–46, 1997–46 I.R.B. 7

97–47, 1997–47 I.R.B. 4

Railroad Retirement Quarterly Rate:

1997–28 I.R.B. 5

Public Laws

105–35, 1997–43 I.R.B. 13

Proposed Regulations:

REG–104893–97, 1997–29 I.R.B. 13

REG–105160–97, 1997–37 I.R.B. 22

REG–106043–97, 1997–37 I.R.B. 24

REG–107644–97, 1997–32 I.R.B. 24

REG–107872–97, 1997–47 I.R.B. 11

REG–114000–97, 1997–47 I.R.B. 13

REG–208151–91, 1997–38 I.R.B. 21

REG–246250–96, 1997–42 I.R.B. 30

Treasury Decisions:

8722, 1997–29 I.R.B. 4

8723, 1997–30 I.R.B. 4

8724, 1997–36 I.R.B. 4

8725, 1997–37 I.R.B. 16

8726, 1997–34 I.R.B. 7

8727, 1997–34 I.R.B. 5

8728, 1997–37 I.R.B. 4

8729, 1997–38 I.R.B. 4

8730, 1997–38 I.R.B. 16

8731, 1997–42 I.R.B. 6

8732, 1997–42 I.R.B. 4

8733, 1997–43 I.R.B. 8

8734, 1997–44 I.R.B. 5

8735, 1997–43 I.R.B. 4

Revenue Procedures:

97–32, 1997–27 I.R.B. 9

97–32A, 1997–34 I.R.B. 10

97–33, 1997–30 I.R.B. 10

97–34, 1997–30 I.R.B. 14

97–35, 1997–33 I.R.B. 11

97–36, 1997–33 I.R.B. 14

97–37, 1997–33 I.R.B. 18

97–38, 1997–33 I.R.B. 43

97–39, 1997–33 I.R.B. 48

97–40, 1997–33 I.R.B. 50

97–41, 1997–33 I.R.B. 5

97–42, 1997–33 I.R.B. 57

97–43, 1997–39 I.R.B. 12

97–44, 1997–41 I.R.B. 8

97–45, 1997–41 I.R.B. 10

97–46, 1997–42 I.R.B. 10

97–47, 1997–42 I.R.B. 19

97–48, 1997–43 I.R.B. 19

97–49, 1997–43 I.R.B. 22

97–50, 1997–45 I.R.B. 8

97–51, 1997–45 I.R.B. 9

97–52, 1997–46 I.R.B. 17

97–53, 1997–47 I.R.B. 10

1 A cumulative list of all revenue rulings, revenue

procedures, Treasury decisions, etc., published in

Internal Revenue Bulletins 1997–1 through 1997–26

will be found in Internal Revenue Bulletin 1997–27,

dated July 7, 1997.

December 1, 1997

1997–48 I.R.B.

Finding List of Current Action on

Previously Published Items1

Bulletins 1997–27 through 1997–47

*Denotes entry since last publication

Revenue Procedures:

82–36

Modified and superseded by

97–49, 1997–43 I.R.B. 22

96–36

Superseded by

97–34, 1997–30 I.R.B. 14

96–42

Superseded by

97–27, 1997–27 I.R.B. 9

97–32

Modified and amplified by

97–32A, 1997–34 I.R.B. 10

Revenue Rulings:

73–67

Revoked by

97–46, 1997–46 I.R.B. 7

89–42

Supplemented by

97–31, 1997–32 I.R.B. 4

93–76

Clarified, modified, partially

obsoleted, and superceded by

97–39, 1997–39 I.R.B 4

94–7

Clarified, modified, partially

obsoleted, and superceded by

97–39, 1997–39 I.R.B 4

1 A cumulative finding list for previously published

items mentioned in Internal Revenue Bulletins

1997–1 through 1997–26 will be found in Internal

Revenue Bulletin 1997–27, dated July 7, 1997.

1997–48 I.R.B.

December 1, 1997

Index

Internal Revenue Bulletins

1997–27 Through 1997–47

For the index of items published during

the first six months of 1997, see I.R.B.

1997–27, dated July 7, 1997.

The abbreviation and number in parenthesis following the index entry refer to

the specific item; numbers in roman and

italic type following the parenthesis refer

to the Internal Revenue Bulletin in which

the item may be found and the page

number on which it appears.

Key to Abbreviations:

Revenue Ruling

Revenue Procedure

Treasury Decision

Court Decision

Public Law

Executive Order

Delegation Order

TDO

Treasury Department Order

Tax Convention

SPR

Statement of Procedural

Rules

PTE

Prohibited Transaction

Exemption

EMPLOYMENT TAX

Penalty:

Guidance regarding waiver of failure to

deposit penalty for certain taxpayers

required to begin using electronic

funds transfer on or after July 1,

1997 (Notice 43) 30, 86

Railroad retirement:

Rate determination; quarterly (July 1,

1997) 28, 5

Regulations:

26 CFR 31.0–1(a), 31.0–3(f), amended;

31.6302–1(h), added; 31.6302–1(i),

redesignated; 31.6302–1T, removed;

31.6302(c)–3, amended; 31.6302–3T,

removed; federal tax deposits by electronic funds transfer (TD 8723) 30, 4

26 CFR 31.3401(a)(6)–1, 31.3406–0,

31.3406(d)–3, 31.3406(h)–2, 31.6413(a)–3, amended; 31.3406(g)–1(e),

added; 31.9999–0, added effective

10/14/97; 31.9999–0, removed effective 1/1/99; 35a.9999–0T, removed

effective 10/14/97; 35a.9999–0,

added effective 10/14/97; 35a.9999–0,

–1, –2, –3, –3A, –4T, –5, removed ef-

December 1, 1997

fective 1/1/99; withholding of tax on

certain U.S. source income paid to

foreign persons (TD 8734) 44,5

26 CFR 301.6634–1, 301.6601–1,

301.6651–1,

1.6013–2(b)(1),

amended; 301.6656–3, added;

301.7122–1(e), revised; 301.7430–0,

–1, –2, –4, –5, amended; 301.7430–6,

revised; miscellaneous sections affected by TBOR 2 and PRWORA

1996 (TD 8725) 37, 16

ESTATE TAX

Marital or charitable bequests (CtD 2062)

32, 8

26 CFR 301.6634–1, 301.6601–1,

301.6651–1, 1.6013–2(b)(1), amended;

301.6656–3, added; 301.7122–1(e), revised; 301.7430–0, –1, –2, –4, –5,

amended; 301.7420–6, revised; miscellaneous sections affected by TBOR 2

and PRWORA 1996 (TD 8725) 37, 16

EXCISE TAX

Group health plans; access, portability,

and renewability requirements; correction (Notice 41) 28, 6

Regulations:

26 CFR 40.6302(c)–1, amended;

40.6302(c)–1T, removed; federal tax

deposits by electronic funds transfer

(TD 8723) 30, 4

26 CFR 301.6634–1, 301.6601–1,

301.6651–1, 1.6013–2(b)(1), amended;

301.6656–3, added; 301.7122–1(e), revised; 301.7430–0, –1, –2, –4, –5,

amended; 301.7420– 6, revised; miscellaneous sections affected by TBOR

2 and PRWORA 1996 (TD 8725)

37, 16

Rural airport list (RP 46) 42, 10

GIFT TAX

Regulations:

26 CFR 301.6634–1, 301.6601–1,

301.6651–1, 1.6013–2(b)(1), amended;

301.6656–3, added; 301.7122–1(e), revised; 301.7430–0, –1, –2, –4, –5,

amended; 301.7420–6, revised; miscellaneous sections affected by TBOR 2

and PRWORA 1996 (TD 8725) 37, 16

INCOME TAX

Accuracy-related penalty, TD 8656 correction (Notice 55) 40, 6

Allocation of interest expense among

taxpayer’s expenditures (Notice 46)

34, 10

Automatic relief for S elections (RP 48)

43, 19

Calculation of partner’s limited deficit

restoration obligation (RR 38) 38, 14

Capital gain dividends by RICs or REITs;

designation of classes (Notice 64) 47,

Capital gains and losses; rates (Notice 59)

45, 7

Changes to RP 96–11 (Notice 48) 37, 5

Charitable contributions; business expenses (RP 52) 46, 17

Consent to change accounting method to

comply with section 475 mark-to-market

rules (RP 43) 39, 12

Depreciation:

Retail motor fuels outlet (RR29) 28, 4

Elections into mark-to-market accounting (Notice 37) 27, 8

Education incentives; credits; interest deduction; individual retirement accounts

(Notice 60) 46, 8

Electing Small Business Trust (ESBT)

qualification (Notice 49) 36, 8

Electronic filing of Form 941, Employer’s

Quarterly Federal Tax Return (RP 47)

42, 19

Electronic or magnetic media filing:

Specifications for 1997 Forms 1098,

1099, 5498, and W–2G (RP 34) 30,

Employee plans:

Cost-of-living adjustments, 1998 (Notice 58) 45, 7

Covered compensation tables; 1998

(RR 45) 46, 4

Delegation of authority (DO 97 (Rev.

34)) 41, 14

Highly compensated employee, definition (Notice 45) 33, 7

Individual retirement plans, definition of

academic period (Notice 53) 40, 6

Organizations, functions, and authority

delegations; director, Employee

Plans Division (DO 172(Rev. 5)) 28,

Remedial amendment period extension

(RP 41) 33, 51

Funding:

Full funding limitations, weighted average interest rate, July 1997 (Notice

44) 31, 15; August 1997 (Notice 47)

35, 5; September 1997 (Notice 51)

38, 20; October 1997 (Notice 56) 43,

1997–48 I.R.B.

INCOME TAX—Continued INCOME TAX—Continued INCOME TAX—Continued

Enhanced oil recovery credit for 1997

(Notice 39) 27, 8

Extension of time to file, Form 926 (Notice 42) 29, 12

Forms 1096, 1098, 1099 series, 5498,

W–2G:

Reproduction of forms; RP 97–32, modified and amplified (RP 97–32A) 34,

10; Requirements for reproducing

paper substitutes (RP27) 27, 9

Fringe benefits aircraft valuation formula

(RR 33) 34, 4

Insurance companies; segregated asset accounts (RR 46) 46, 7

Intercompany transactions on separate entity basis (RP 49) 43, 22

Interest:

Investment:

Federal short-term, mid-term, and

long-term rates for July 1997 (RR 27)

27, 4; August 1997 (RR 30) 31, 12;

September 1997 (RR 36) 36, 5;

October 1997 (RR 41) 40, 4; November 1997 (RR 44) 45, 5

Rates:

Underpayments and overpayments for

calendar quarter beginning October 1,

1997 (RR 40) 39, 8

International operation of ships and aircraft; income exempt from tax (RR 31) 32,

Inventories:

LIFO:

Automobile dealers (RR 42) 41, 4;

(RP 44) 41, 8

Price indexes, department stores,

May 1997 (RR 28) 28, 4; June

1997 (RR 32) 33, 4; July 1997

(RR 37) 37, 15; August 1997 (RR

43) 42, 8; September 1997 (RR

47) 47, 4

Late S corporation elections (RP 40) 33, 50

Low-income housing:

Bond factor amounts, July–September

1997 (RR 34) 34, 4

Tax credit (RP 42) 33, 57

Marginal production rates for 1997 (Notice 38) 27, 8

Mark-to-market accounting method for

dealers in securities (RR 39) 39, 4

Material limitation on surviving spouse’s

right to income (Notice 63) 47, 6

Methods of accounting:

Automatic consent to change (RP 37)

33, 18

1997–48 I.R.B.

Last-in, first-out inventory method (RP

36) 33, 14

Original issue discount (RP 39) 33, 48

Package design costs (RP 35) 33, 11

Warranty contracts (RP 38) 33, 43

Mutual life insurance companies; differential earnings rate (RR 35) 35, 4

Optional rules for substantiating certain

travel etc., expenses (RP 45) 41, 10

Private delivery services; timely filing or

payment (Notice 50) 37, 21

Proposed regulations:

26 CFR 1.263A–0, amended; rules for

property produced in a farming business (REG–208151–91) 38, 21

26 CFR 1.401(b)–1; remedial amendment period (REG–106043–97) 37, 24

26 CFR 1.411(d)–4, amended; permitted

elimination of preretirement optional

forms benefit (REG–107644–97)

32, 24

26 CFR 1.465–27, added; qualified

nonrecourse financing under section

465(b)(6) (REG–105160–97) 37, 22

26 CFR 1.894–1(d), added; guidance

regarding claims for certain income

tax convention (REG–104893–97)

29, 13

26 CFR 1.1441–1 (e)(4)(iv), revised;

Form W–8, electronic filing

(REG–107872–97) 47, 11

26 CFR 1.1441–3(b), revised; sales of

obligations between interest payment dates; Withholding on interest

(REG–114000–97) 47, 13

26 CFR 301.6104(e)–0, –1, –2, –3,

added; tax-exempt organizations,

public disclosure requirements,

guidance availability and hearing

(REG–246250–96) 42, 30

Punitive damages for personal injuries

(CtD 2061) 31, 5

Qualified state tuition programs (Notice

52) 38, 20

Regulations:

26 CFR 1.42–15, added; low-income

housing tax credit, available unit rule

(TD 8732) 42, 4

26 CFR 1.42–16, added; 1.42–16T, removed; low-income housing tax

credit, federal grants (TD 8731) 42, 6

26 CFR 1.61–4, 1.162–12(a), 1.263A–

1, 1.471–6, amended; 1.263A–4T, revised; rules for property produced in

a farming business (TD 8729) 38, 4

26 CFR 1.163–5(c)(2)(i)(B)(5),

1.165–12, 1.817–7, 1.1441–8, 1.1445–5,

1.6041–1, –2, –3, 1.6041–7, 1.6042–2,

–4, 1.6043–2, 1.6044–2, 1.6045–1, –2,

1.6049–4, –5, –6, –7, –8(a), 1.6050A,

1.6050H–1, 1.6050N–1, 1.6071–1,

301.6109–1, 301.6114–1, 301.6402–3,

301.6721–0, 1.1441–3, 1.871–14,

1.1441–0, –9, 1.1442–3, 1.6041–8,

1.6041A–1, added; 1.871–6, 1.1441–1,

–2, –5, –6, 1.1442–1, –2, 1.1443–1,

1.1461–1, –2, 1.1462–1, 1.1463–1,

1.6041–4, 1.6044–3, –5, 1.6091–1(b)(15), revised; 1.1441–4T, 1.1461–3,

–4, 1.6045–1T, –2T, removed;

1.1441–8T, redesignated; withholding of tax on certain U.S. source income paid to foreign persons and related collection, refunds, and credits

(TD 8734) 44, 5

26 CFR 1.263A–0, –1, –15, amended;

1.263A, added; 1.263A–7T, removed; procedure for changing a

method of accounting under section

263A (TD 8728) 37, 4

26 CFR 1.302–2, amended; 1.1059(e)(1), added; extraordinary dividends (TD 8724) 36, 4

26 CFR 1.401(b)–1, amended; 1.401(b)–1T, added; remedial amendment

period (TD 8727) 34, 5

26 CFR 1.501(c)(5)–1, amended; taxexempt organizations, requirements

(TD 8726) 34, 7

26 CFR 1.704–3, 1.1245–1, amended;

allocations of depreciation recapture

among partners in a partnership (TD

8730) 38, 16

26 CFR 1.861–2, 1.864–5, 1.871–7,

1.881–2, 1.884–1, 1.7701(1)–1; securities lending transactions, certain

payments made (TD 8735) 43, 4

26 CFR 1.894–1T(a) through (c),

added; guidance regarding claims for

certain income tax convention (TD

8722) 29, 4

26 CFR 1.6038–2, 1.6046–1(g),

301.6114–1, 301.7701(b)–0, –3, –7,

–8; treaty-based return positions (TD

8733) 43, 8

26 CFR 1.6302–1, –2, amended;

1.6302–1T, –2T, –3T, –4T, removed;

1.6302–3(c), revised; 1.6302–4,

added; federal tax deposits by electronic funds transfer (TD 8723) 30, 4

December 1, 1997

INCOME TAX—Continued INCOME TAX—Continued INCOME TAX—Continued

26 CFR 301.6334–1, 301.6601–1,

301.6651–1, 1.6013–2(b)(1), amended;

301.6656–3, added; 301.7122–1(e), revised; 301.7430–0, –1, –2, –4, –5,

amended; 301.7430–6, revised; miscellaneous sections affected by TBOR 2

and PRWORA 1996 (TD 8725) 37, 16

December 1, 1997

Section 911(d)(4) waiver (RP 51) 45,9

Tax forms and instructions:

Electronic Federal Tax Payment System (EFTPS); electronic remittance

system for federal tax deposits and

payments (RP 33) 30, 10

Taxpayer Browsing Protection Act (PL

105–35) 43, 13

Treatment of Hong Kong and China

(Notice 40) 28, 6

Work Opportunity and Welfare-to-Work

tax credits (Notice 54) 41, 7

Year 2000 costs; computer software (RP

50) 45, 8

1997–48 I.R.B.

Notes

1997–48 I.R.B.

December 1, 1997

Notes

December 1, 1997

1997–48 I.R.B.

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