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## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

Bulletin No. 2000–8
February 22, 2000

Internal Revenue

bulletin
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
Rev. Rul. 2000–10, page 643.
LIFO; price indexes; department stores. The December
1999 Bureau of Labor Statistics price indexes are accepted for
use by department stores employing the retail inventory and
last-in, first-out inventory methods for valuing inventories for tax
years ended on, or with reference to, December 31, 1999.

T.D. 8870, page 647.
Final regulations under section 1295 of the Code relate to making and maintaining qualified electing fund (QEF) elections. Notices 88–125 and 98–22 obsoleted.

T.D. 8872, page 639.
REG–209135–88, page 681.
Temporary and proposed regulations under section 337(d) of
the Code provide guidance with respect to the built-in gain of C
corporation assets that become assets of a Regulated Investment Company (RIC) or a Real Estate Investment Trust (REIT) by
(1) the qualification of the corporation as RIC or REIT or (2) the
transfer of assets to a RIC or REIT in a carryover basis transaction. A public hearing on the proposed regulations is scheduled
for May 10, 2000.

EMPLOYEE PLANS
T.D. 8871, page 641.
Final regulations under section 401(b) of the Code relate to
the remedial amendment period during which an employer
that maintains, or a sponsor of, a qualified retirement plan
can make retroactive amendments to the plan to eliminate
certain qualification defects for the entire period.

EXEMPT ORGANIZATIONS
T.D. 8874, page 644.
Final regulations under section 513 of the Code relate to
travel and tour activities of tax-exempt organizations.

ADMINISTRATIVE
REG–208280–86, page 654.
Proposed regulations under section 883 of the Code provide guidance for excluding from a foreign corporation’s

(Continued on the next page)

Finding Lists begin on page ii.

Department of the Treasury
Internal Revenue Service

ADMINISTRATIVE—continued
gross income the income from international operations of
ships or aircraft if the corporation is a qualified foreign
corporation and the income is qualified income. A public
hearing is scheduled for April 27, 2000.

REG–100276–97, page 682.
Proposed regulations under sections 860H-860L of the
Code provide guidance concerning financial asset securitization investment trusts (FASITs). A public hearing is
scheduled for May 15, 2000.

February 22, 2000

REG–103882–99, page 706.
Proposed regulations under section 263A of the Code provide guidance for the payor of a delay rental in deducting
the delay rental as an expense or charging it to depletable
capital account under section 266. A public hearing is
scheduled for May 26, 2000.

REG–105279–99, page 707.
Proposed regulations under section 6071(b) of the Code extend
the due date to March 31 for those electronically filed information returns having a due date of February 28. They also provide
that under section 6651(h) failure to pay penalties will be reduced from 0.5% to 0.25% per month for certain individuals
who enter into an installment agreement under section 6159.

2000–8 I.R.B.

The IRS Mission
Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

and by applying the tax law with integrity and fairness to
all.

Introduction
The Internal Revenue Bulletin is the authoritative instrument
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 are consolidated semiannually into
Cumulative Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all 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.
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.
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-

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.
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).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis,
and are published in the first Bulletin of the succeeding semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

2000–8 I.R.B.

February 22, 2000

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 337.—Nonrecognition
for Property Distributed to
Parent in Complete Liquidation
of Subsidiary

TACT: Christopher W. Schoen, (202)
622-7750 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

26 CFR 1.337(d)–5T: Tax on C assets becoming
RIC or REIT assets (temporary).

T.D. 8872
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Certain Asset Transfers to
Regulated Investment Companies
(RICs) and Real Estate Investment
Trusts (REITs)
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains
temporary regulations that apply with respect to the net built-in gain of C corporation assets that become assets of a Regulated Investment Company [RIC] or Real
Estate Investment Trust [REIT] by the
qualification of a C corporation as a RIC
or REIT or by the transfer of assets of a C
corporation to a RIC or REIT in a carryover basis transaction. The regulations
generally require the corporation to recognize gain as if it had sold the assets
transferred or converted to RIC or REIT
assets at fair market value and immediately liquidated. The regulations permit
the transferee RIC or REIT to elect, in
lieu of liquidation treatment, to be subject
to the rules of section 1374 of the Internal
Revenue Code and the regulations thereunder. The text of the temporary regulations also serves as the text of the proposed regulations set forth in the notice of
proposed rulemaking REG–209135–88
on page 681.
DATES: Effective Date: These regulations are effective February 4, 2000.
Applicability Dates: For dates of applicability, see the Effective Dates portion
of the preamble under SUPPLEMENTARY INFORMATION.
FOR FURTHER INFORMATION CON-

2000–8 I.R.B.

These regulations are being issued
without prior notice and public procedure
pursuant to the Administrative Procedure
Act (5 U.S.C. section 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and
evaluation of public comments, approved
by the Office of Management and Budget
under control number 1545-1672. Responses to this collection of information
are required to obtain a benefit, i.e., to
elect to be subject to section 1374 of the
Internal Revenue Code (Code) and the
regulations thereunder.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the collection of information displays a valid
OMB control number.
For further information concerning
this collection of information, and
where to submit comments on the collection of information and the accuracy
of the estimated burden, and suggestions
as to reducing this burden, please refer
to the preamble to the cross-referencing
notice of proposed rulemaking,
REG–209135–88, on page 681.
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. section 6103.
Background
Sections 631 and 633 of the Tax Reform Act of 1986 (the 1986 Act) (Public
Law 99-514), as amended by sections
1006(e) and (g) of the Technical and
Miscellaneous Revenue Act of 1988 (the
1988 Act) (Public Law 100-647),
amended the Code to repeal the General
Utilities doctrine. The 1986 Act
amended sections 336 and 337 of the
Code, generally requiring corporations
to recognize gain when appreciated
property is distributed in connection

639

with a complete liquidation. Section
337(d) directs the Secretary to prescribe
regulations as may be necessary to carry
out the purposes of General Utilities repeal, including rules to “ensure that such
purposes shall not be circumvented ...
through the use of a regulated investment company [RIC], a real estate investment trust [REIT], or a tax exempt
entity....” The transfer of the assets of a
C corporation to a RIC or REIT could
result in permanently removing the
built-in gain inherent in those assets
from the reach of the corporate income
tax because RIC and REIT income is not
subject to a corporate-level income tax
if such income is distributed to the RIC
or REIT shareholders.
Accordingly, on February 4, 1988, the
IRS issued Notice 88–19 (1988–1 C.B.
486). Notice 88–19 announced that the
IRS intended to promulgate regulations
under the authority of section 337(d) with
respect to transactions or events that result
in the ownership of C corporation assets
by a RIC or REIT with a basis determined
by reference to the corporation’s basis (a
carryover basis). Notice 88–19 served as
an “administrative pronouncement,” and
could be relied upon to the same extent as
a revenue ruling or revenue procedure.
Notice 88–19 also indicated that the regulations would be applicable retroactively
to June 10, 1987. See also Notice 88–96
(1988–2 C.B. 420).
As a result of the issuance of Notice
88–19, many taxpayers have become uncertain about the current law applicable to
their transactions, as well as the proper
method of making a valid election to be
subject to the rules of section 1374 and
the regulations thereunder. In order to resolve this uncertainty and to provide taxpayers with guidance, the IRS and Treasury are issuing these temporary
regulations.
Explanation of Provisions
These regulations implement Notice
88–19 by providing that when a C corporation (1) qualifies to be taxed as a RIC or
REIT, or (2) transfers assets to a RIC or
REIT in a carryover basis transaction, the
C corporation is treated as if it sold all of
its assets at their respective fair market

February 22, 2000

values and immediately liquidated, unless
the RIC or REIT elects to be subject to tax
under section 1374. Any resulting net
built-in gain is recognized by the C corporation and the bases of the assets in the
hands of the RIC or REIT are generally
adjusted to their fair market values to reflect the recognized net built-in gain. The
regulations do not permit a C corporation
to recognize a net built-in loss, and, in this
case, the carryover bases of the assets in
the hands of the RIC or REIT are preserved.
If the RIC or REIT elects to be subject
to treatment under section 1374, its builtin gain, and the corporate-level tax imposed on that gain, is subject to rules similar to the rules applying to the net income
of foreclosure property of REITs.
Effective Dates
In the case of carryover basis transactions involving the transfer of property of
a C corporation to a RIC or REIT, the regulations apply to transactions occurring
on or after June 10, 1987. In the case of a
C corporation that qualifies to be taxed as
a RIC or REIT, the regulations apply to
such qualifications that are effective for
taxable years beginning on or after June
10, 1987.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations and because the regulations do not
impose a collection of information on
small entities, 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 Code, these temporary
regulations will be submitted to the Chief
Counsel of Advocacy of the Small Business Administration for comment on their
impact on small business.
Drafting Information
The principal author of these regulations is Christopher W. Schoen of the Office of Assistant Chief Counsel (Corpo-

February 22, 2000

rate). Other personnel from the IRS and
Treasury participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART I–INCOME TAXES
Paragraph 1. The authority citation for
26 CFR part 1 is amended by adding an
entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.337(d)–5T also issued under
26 U.S.C. 337. * * *
Par. 2. Section 1.337(d)–5T is added to
read as follows:
§1.337(d)–5T Tax on C assets becoming
RIC or REIT assets (temporary).
(a) Treatment of C corporations--(1)
Scope. This section applies to the net
built-in gain of C corporation assets that
become assets of a RIC or REIT by—
(i) The qualification of a C corporation
as a RIC or REIT; or
(ii) The transfer of assets of a C corporation to a RIC or REIT in a transaction in
which the basis of such assets are determined by reference to the C corporation’s
basis (a carryover basis).
(2) Net built-in gain. Net built-in gain
is the excess of aggregate gains (including
items of income) over aggregate losses.
(3) General rule. Unless an election is
made pursuant to paragraph (b) of this
section, the C corporation will be treated,
for all purposes including recognition of
net built-in gain, as if it had sold all of its
assets at their respective fair market values on the deemed liquidation date described in paragraph (a)(7) of this section
and immediately liquidated.
(4) Loss. Paragraph(a)(3) of this section shall not apply if its application
would result in the recognition of net
built-in loss.
(5) Basis adjustment. If a corporation
is subject to corporate-level tax under
paragraph (a)(3) of this section, the bases
of the assets in the hands of the RIC or
REIT will be adjusted to reflect the recognized net built-in gain. This adjustment is
made by taking the C corporation’s basis
in each asset, and, as appropriate, increasing it by the amount of any built-in gain

640

attributable to that asset, or decreasing it
by the amount of any built-in loss attributable to that asset.
(6) Exception—(i) In general. Paragraph (a)(3) of this section does not apply
to any C corporation that—
(A) Immediately prior to qualifying to
be taxed as a RIC was subject to tax as a
C corporation for a period not exceeding
one taxable year; and
(B) Immediately prior to being subject
to tax as a C corporation was subject to
the RIC tax provisions for a period of at
least one taxable year.
(ii) Additional requirement. The exception described in paragraph (a)(6)(i)
of this section applies only to assets acquired by the corporation during the year
when it was subject to tax as a C corporation in a transaction that does not result in
its basis in the asset being determined by
reference to a corporate transferor’s basis.
(7) Deemed liquidation date—(i) Conversions. In the case of a C corporation
that qualifies to be taxed as a RIC or
REIT, the deemed liquidation date is the
last day of its last taxable year before the
taxable year in which it qualifies to be
taxed as a RIC or REIT.
(ii) Carryover basis transfers. In the
case of a C corporation that transfers property to a RIC or REIT in a carryover basis
transaction, the deemed liquidation date is
the day before the date of the transfer.
(b) Section 1374 treatment—(1) In
general. Paragraph (a) of this section will
not apply if the transferee RIC or REIT
elects (as described in paragraph (b)(3) of
this section) to be subject to the rules of
section 1374, and the regulations thereunder. The electing RIC or REIT will be
subject to corporate-level taxation on the
built-in gain recognized during the 10year period on assets formerly held by the
transferor C corporation. The built-in
gains of electing RICs and REITs, and the
corporate-level tax imposed on such
gains, are subject to rules similar to the
rules relating to net income from foreclosure property of REITs. See sections
857(a)(1)(A)(ii), and 857(b)(2)(B), (D),
and (E). An election made under this
paragraph (b) shall be irrevocable.
(2) Ten-year recognition period. In the
case of a C corporation that qualifies to be
taxed as a RIC or REIT, the 10-year recognition period described in section
1374(d)(7) begins on the first day of the

2000–8 I.R.B.

RIC’s or REIT’s taxable year for which the
corporation qualifies to be taxed as a RIC
or REIT. In the case of a C corporation
that transfers property to a RIC or REIT in
a carryover basis transaction, the 10-year
recognition period begins on the day the
assets are acquired by the RIC or REIT.
(3) Making the election. A RIC or REIT
validly makes a section 1374 election with
the following statement: “[Insert name and
employer identification number of electing
RIC
or
REIT]
elects
under
§1.337(d)–5T(b) to be subject to the rules
of section 1374 and the regulations thereunder with respect to its assets which formerly were held by a C corporation, [insert
name and employer identification number
of the C corporation, if different from
name and employer identification number
of RIC or REIT].” This statement must be
signed by an official authorized to sign the
income tax return of the RIC or REIT and
attached to the RIC’s or REIT’s Federal income tax return for the first taxable year in
which the assets of the C corporation become assets of the RIC or REIT.
(c) Special rule. In cases where the first
taxable year in which the assets of the C
corporation become assets of the RIC or

REIT ends after June 10, 1987 but before
March 8, 2000, the section 1374 election
may be filed with the first Federal income
tax return filed by the RIC or REIT after
March 8, 2000.
(d) Effective date. In the case of carryover basis transactions involving the
transfer of property of a C corporation to
a RIC or REIT, the regulations apply to
transactions occurring on or after June 10,
1987. In the case of a C corporation that
qualifies to be taxed as a RIC or REIT, the
regulations apply to such qualifications
that are effective for taxable years beginning on or after June 10, 1987.
Par. 3. In §1.852–12, paragraph (d) is
added to read as follows:
§1.852–12 Non-RIC earnings and profits.
*****
(d) For treatment of net built-in gain assets of a C corporation that become assets
of a RIC, see §1.337(d)–5T.
Par. 4. In §1.857–11, paragraph (e) is
added to read as follows:
§1.857–11 Non-REIT earnings and profits.
*****
(e) For treatment of net built-in gain assets of a C corporation that become assets

of a REIT, see §1.337(d)–5T.
PART 602–OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 3. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 4. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:
§602.101––OMB Control numbers.
*****
(b) ***
Robert E. Wenzel,
Deputy Commissioner of
Internal Revenue.
Approved January 21, 2000.
Jonathan Talisman,
Acting Assistant Secretary
for Tax Policy.
(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue
of the Federal Register for February 7, 2000, 65 F.R.
5775)

CFR part or section where
identified and described

Current OMB
control No.

*****
1.337(d)–5T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1672
*****

Section 401.—Qualified
Pensions, Profit-sharing, and
Stock Bonus Plans
26 CFR 1.401(b)–1: Certain retroactive changes in
plan.

T.D. 8871
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Remedial Amendment Period
AGENCY: Internal Revenue Service
(IRS), Treasury.

2000–8 I.R.B.

ACTION: Final and temporary regulations.
SUMMARY: This document contains
regulations relating to the remedial
amendment period, during which a sponsor of a qualified retirement plan or an
employer that maintains a qualified retirement plan can make retroactive amendments to the plan to eliminate certain
qualification defects for the entire period.
These final regulations clarify the scope
of the Commissioner’s authority to provide relief from plan disqualification
under the regulations. These clarifications confirm the Commissioner’s authority to provide appropriate relief for plan
amendments relating to changes to the
plan qualification rules made in recent
legislation. These final regulations affect

641

sponsors of qualified retirement plans,
employers that maintain qualified retirement plans, and qualified retirement plan
participants.
EFFECTIVE DATES: These regulations
are effective February 4, 2000.
FOR FURTHER INFORMATION CONTACT: Linda S.F. Marshall at (202)6226030 or Lisa A. Tavares at (202) 6226090 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 401(b). These regulations provide guidance to clarify the

February 22, 2000

scope of the Commissioner’s authority to
provide relief from plan disqualification
under section 401(b) and the regulations.
On August 1, 1997, temporary regulations
(T.D. 8727, 1997–2 C.B. 47) under section 401(b) were published in the Federal
Register (62 F.R. 41272). A notice of
proposed rulemaking (REG–106043–97,
1997–2 C.B. 654) cross-referencing the
temporary regulations, was published in
the Federal Register (62 F.R. 41322) on
the same day. The temporary regulations
enabled the Commissioner to provide appropriate relief concerning the timing of
plan amendments relating to changes to
the plan qualification rules made in recent
legislation, as well as for other plan
amendments that may be needed as a result of future changes to the Internal Revenue Code (Code).
No written comments responding to the
notice of proposed rulemaking were received. No public hearing was requested
or held. The proposed regulations under
section 401(b) are adopted by this Treasury decision, and the corresponding temporary regulations are removed.
Explanation of Provisions
Section 401(b) provides that a plan is
considered to satisfy the qualification requirements of section 401(a) for the period beginning with the date on which it
was put into effect, or for the period beginning with the earlier of the date on
which any amendment that caused the
plan to fail to satisfy those requirements
was adopted or put into effect, and ending
with the time prescribed by law for filing
the employer’s return for the taxable year
in which that plan or amendment was
adopted (including extensions) or such
later time as the Secretary may designate,
if all provisions of the plan needed to satisfy the qualification requirements are in
effect by the end of the specified period
and have been made effective for all purposes for the entire period.
Section 1.401(b)–1(b) lists the plan provisions that may be amended retroactively
pursuant to the rules of section 401(b).
These plan provisions, termed disqualifying provisions, include the plan provisions
described in section 401(b), as well as
plan provisions that result in failure of a
plan to satisfy the qualification requirements of the Code by reason of a change

February 22, 2000

in those requirements effected by the legislation listed in §1.401(b)–1(b)(2)(i) and
(ii). Under §1.401(b)–1(b)(2)(ii), a disqualifying provision also includes a plan
provision that is integral to a qualification
requirement changed by specified legislation. As in effect prior to the previously
issued final and temporary regulations,
§1.401(b)–1(b)(2)(iii) provided that a disqualifying provision includes a plan provision that results in failure of the plan to
satisfy the Code’s qualification requirements by reason of a change in those requirements effected by amendments to the
Code, that is designated by the Commissioner, at the Commissioner’s discretion,
as a disqualifying provision.
Section 1.401(b)–1(d) provides rules
for determining the period for which the
relief provided under section 401(b) applies (the “remedial amendment period”). Section 1.401(b)–1(d)(1) defines
the beginning of the remedial amendment period for the disqualifying provisions listed in §§1.401(b)–(1)(b)(1) and
1.401(b)–1(b)(2)(i) and (ii).
The final regulations retain the rules set
forth in the temporary regulations to clarify the scope of the Commissioner’s authority to provide relief from plan disqualification under section 401(b). These
changes are needed to clarify the rules relating to the plan provisions that may be
designated by the Commissioner as disqualifying provisions based on amendments to the plan qualification requirements of the Internal Revenue Code.
Section 1.401(b)–1(b)(3) retains the rule
set forth in the temporary regulations to
provide that a disqualifying provision includes a plan provision designated by the
Commissioner, at the Commissioner’s
discretion, as a disqualifying provision
that either (1) results in the failure of the
plan to satisfy the qualification requirements of the Code by reason of a change
in those requirements; or (2) is integral to
a qualification requirement of the Code
that has been changed.
Section
1.401(b)–1(c)(2) retains the rule set forth
in the temporary regulations to provide
the Commissioner with explicit authority
to impose limits and provide additional
rules regarding the amendments that may
be made with respect to disqualifying provisions during the remedial amendment
period. Section 1.401(b)–1(d)(1)(iv) and
(v) provide conforming rules, as previ-

642

ously provided in the temporary regulations, regarding the beginning of the remedial amendment period for disqualifying
provisions
described
in
§1.401(b)–1(b)(3).
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and because the regulation does not
impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Small Business Administration for comment on its impact on
small businesses.
Drafting Information
The principal authors of these regulations are Linda S. F. Marshall and Lisa A.
Tavares, Office of the Associate Chief
Counsel (Employee Benefits and Exempt
Organizations). However, other personnel from the IRS and Treasury Department participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.401(b)–1 is amended
by:
1. Revising paragraphs (b)(3), (c), and
(d)(1)(iv).
2. Adding paragraph (d)(1)(v).
The addition and revisions read as follows:
§1.401(b)–1 Certain retroactive changes
in plan.
*****
(b) * * *

2000–8 I.R.B.

(3) A plan provision designated by the
Commissioner, at the Commissioner’s
discretion, as a disqualifying provision
that either—
(i) Results in the failure of the plan to
satisfy the qualification requirements of
the Internal Revenue Code by reason of a
change in those requirements; or
(ii) Is integral to a qualification requirement of the Internal Revenue Code that
has been changed.
(c) Special rules applicable to disqualifying provisions– – (1) Absence of plan
provision. For purposes of paragraphs
(b)(2) and (3) of this section, a disqualifying provision includes the absence from a
plan of a provision required by, or, if applicable, integral to the applicable change
to the qualification requirements of the
Internal Revenue Code, if the plan was in
effect on the date the change became effective with respect to the plan.
(2) Method of designating disqualifying
provisions. The Commissioner may designate a plan provision as a disqualifying
provision pursuant to paragraph (b)(3) of
this section only in revenue rulings, notices, and other guidance published in the
Internal Revenue Bulletin.
See
§601.601(d)(2) of this chapter.
(3) Authority to impose limitations. In
the case of a provision that has been designated as a disqualifying provision by
the Commissioner pursuant to paragraph
(b)(3) of this section, the Commissioner
may impose limits and provide additional
rules regarding the amendments that may
be made with respect to that disqualifying
provision during the remedial amendment
period. The Commissioner may provide

guidance in revenue rulings, notices, and
other guidance published in the Internal
Revenue Bulletin. See §601.601(d)(2) of
this chapter.
(d) ***
(1) ***
(iv) In the case of a disqualifying provision described in paragraph (b)(3)(i) of
this section, the date on which the change
effected by an amendment to the Internal
Revenue Code became effective with respect to the plan; or
(v) In the case of a disqualifying provision described in paragraph (b)(3)(ii) of
this section, the first day on which the
plan was operated in accordance with
such provision, as amended, unless another time is specified by the Commissioner in revenue rulings, notices, and
other guidance published in the Internal
Revenue Bulletin. See §601.601(d)(2) of
this chapter.
*****
§1.401(b)–1T [Removed]
Par. 3. Section 1.401(b)–1T is removed.
John M. Dalrymple,
Acting Deputy Commissioner
of Internal Revenue.
Approved January 19, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on February 3, 2000, 8:45 a.m., and published in the issue
of the Federal Register for February 4, 2000, 65 F.R.
5432)

Section 472.—Last-in, First-out
Inventories
26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department
stores. The December 1999 Bureau of
Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in,
first-out inventory methods for valuing
inventories for tax years ended on, or with
reference to, December 31, 1999.

Rev. Rul. 2000–10
The following Department Store Inventory Price Indexes for December 1999
were issued by the Bureau of Labor Statistics. The indexes are accepted by the
Internal Revenue Service, under
§ 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46, 1986–2 C.B.
739, for appropriate application to inventories of department stores employing the
retail inventory and last-in, first-out inventory methods for tax years ended on,
or with reference to, December 31, 1999.
The Department Store Inventory Price
Indexes are prepared on a national basis
and include (a) 23 major groups of departments, (b) three special combinations of
the major groups - soft goods, durable
goods, and miscellaneous goods, and (c) a
store total, which covers all departments,
including some not listed separately, except for the following: candy, food, liquor,
tobacco, and contract departments.

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)
Groups
1. Piece Goods - - - - - - - - - - - - - - - - - - - - - - - - 2. Domestics and Draperies - - - - - - - - - - - - - - - - 3. Women’s and Children’s Shoes - - - - - - - - - - - - 4. Men’s Shoes - - - - - - - - - - - - - - - - - - - - - - - - 5. Infants’ Wear - - - - - - - - - - - - - - - - - - - - - - - - 6. Women’s Underwear - - - - - - - - - - - - - - - - - - - 7. Women’s Hosiery - - - - - - - - - - - - - - - - - - - - - 8. Women’s and Girls’ Accessories - - - - - - - - - - - 9. Women’s Outerwear and Girls’ Wear - - - - - - - - 10. Men’s Clothing - - - - - - - - - - - - - - - - - - - - - - -

2000–8 I.R.B.

Dec.
1998
546.8
631.2
660.9
905.3
628.7
559.6
304.1
536.4
401.0
603.3

643

Dec.
1999
512.9
619.5
631.0
887.4
650.0
561.6
325.0
526.2
393.5
610.1

Percent Change
from Dec. 1998
to Dec. 19991
-6.2
-1.9
-4.5
-2.0
3.4
0.4
6.9
-1.9
-1.9
1.1

February 22, 2000

11. Men’s Furnishings - - - - - - - - - - - - - - - - - - - - 12. Boys’ Clothing and Furnishings - - - - - - - - - - - - 13. Jewelry - - - - - - - - - - - - - - - - - - - - - - - - - - - - 14. Notions - - - - - - - - - - - - - - - - - - - - - - - - - - - - 15. Toilet Articles and Drugs - - - - - - - - - - - - - - - - 16. Furniture and Bedding - - - - - - - - - - - - - - - - - - 17. Floor Coverings - - - - - - - - - - - - - - - - - - - - - - 18. Housewares - - - - - - - - - - - - - - - - - - - - - - - - - 19. Major Appliances - - - - - - - - - - - - - - - - - - - - - 20. Radio and Television - - - - - - - - - - - - - - - - - - - 21. Recreation and Education2 - - - - - - - - - - - - - - - 22. Home Improvements2 - - - - - - - - - - - - - - - - - - 23. Auto Accessories2 - - - - - - - - - - - - - - - - - - - - - -

591.9
493.7
953.0
771.9
939.4
691.1
602.5
806.5
236.0
69.6
101.6
130.6
107.7

626.0
506.4
924.8
768.3
981.7
688.5
602.7
786.9
234.9
63.2
95.3
129.3
107.3

5.8
2.6
-3.0
-0.5
4.5
-0.4
0.0
-2.4
-0.5
-9.2
-6.2
-1.0
-0.4

Groups 1 - 15: Soft Goods - - - - - - - - - - - - - - - - - -

595.0

596.7

0.3

Groups 16 - 20: Durable Goods - - - - - - - - - - - - - - - -

458.0

445.6

-2.7

Misc. Goods2 - - - - - - - - - - - - - - - - -

106.6

102.1

-4.2

Store Total3 - - - - - - - - - - - - - - - - - - - - - - - - -

544.8

540.2

-0.8

Groups 21 - 23:

1 Absence of a minus sign before the percentage change in this column signifies a price increase.
2 Indexes on a January 1986=100 base.
3 The store total index covers all departments, including some not listed separately, except for the following:

candy, food, liquor, tobacco, and contract depart-

ments.

DRAFTING INFORMATION
The principal author of this revenue ruling
is Alan J. Tomsic of the Office of Assistant
Chief Counsel (Income Tax and Accounting). For further information regarding this
revenue ruling, contact Mr. Tomsic on (202)
622-4970 (not a toll-free call).

Section 513.—Unrelated Trade
or Business
26 CFR 1.513–7: Travel and tour activities of tax
exempt organizations.

T.D. 8874

guidance for tax-exempt organizations
concerning when travel tour activities
may be subject to tax as an unrelated trade
or business. This action affects tax-exempt organizations that engage in travel
tour activities.
DATES: Effective Date: These regulations are effective on February 7, 2000.
Applicability Date: These regulations
are applicable for taxable years beginning
after February 7, 2000.
FOR FURTHER INFORMATION CONTACT: Robin Ehrenberg, (202) 622-6080
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Travel and Tour Activities of
Tax-Exempt Organizations
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations clarifying when the
travel and tour activities of tax-exempt organizations are substantially related to the
purposes for which exemption was
granted. This action provides needed

February 22, 2000

On April 23, 1998, the IRS published in
the Federal Register (63 F.R. 20156) a
notice of proposed rulemaking
(REG–121268–97, 1998–20 I.R.B. 12)
under section 513 to clarify when the
travel and tour activities of tax-exempt organizations are substantially related to the
purposes for which exemption was
granted. The notice of proposed rulemaking added Treas. Reg. §1.513–7, which
provides that whether travel tour activities
are substantially related to an organization’s exempt purposes is determined by
examining all the relevant facts and circumstances. The proposed regulations
also contain examples applying the facts
and circumstances test.

644

The notice of proposed rulemaking solicited comments from the public. Nineteen commentators submitted written comments. A public hearing was held on
February 10, 1999, at which eight speakers
presented testimony. After consideration
of all the comments, the proposed regulations under section 513 are adopted as revised by this Treasury Decision. The comments and revisions are discussed below.
Explanation of Provisions and
Summary of Comments
Many of the commentators welcomed
the proposed regulationsas workable guidance that will promote tax compliance.
Commentators differed on the approach
that the IRS should adopt in final regulations. Some commentators suggested that
the final regulations should adopt specific,
weighted standards to be used in evaluating relatedness to exempt purpose. Other
commentators recommended against
adopting specific standards, arguing that
no single set of standards would be appropriate given the broad range of tax-exempt
organizations. One commentator suggested that the final regulations adopt a set
of specific standards that would apply to
test relatedness of tours in the educational
context and a more general consistency
standard that would evaluate whether the
marketing, location, and execution of a
tour are consistent with the organization’s
core exempt activities.

2000–8 I.R.B.

Section 513(a) generally defines an unrelated trade or business as any trade or
business the conduct of which is not substantially related to the exercise or performance by the organization of its charitable, educational, or other purpose or
function constituting the basis for its exemption under section 501(a). See also
United States v. American Bar Endowment, 477 U.S. 105, 109-110 (1986).
Treas Reg. § 1.513–1(d)(2) provides that,
for the conduct of a trade or business to be
substantially related to the purposes for
which exemption was granted, the production or distribution of the goods or the
performance of services must contribute
importantly to the accomplishment of
those purposes. Whether activities generating gross income contribute importantly
to accomplishing any purpose for which
an organization was granted exemption
depends in each case upon the particular
facts and circumstances. Id. This rule applies to travel tours.
Organizations exempt from tax under
section 501(a) have diverse exempt purposes (for example: charities; social welfare organizations; labor, agricultural and
horticultural organizations; business
leagues; fraternal beneficiary societies).
Accordingly, no one set of factors could
be sufficiently comprehensive as to define
relatedness for the variety of exempt organizations to which these travel tour regulations apply. Even among exempt organizations that share a common exempt
purpose, such as education, the methods
of accomplishing that purpose vary considerably. For this reason, the final regulations do not enumerate any specific factors that determine relatedness of travel
tour activities to exempt purposes. The
final regulations adopt the general facts
and circumstances approach of the proposed regulations. See e.g, Hi-Plains
Hospital v. United States, 670 F.2d 528
(5 th Cir. 1982) (need for case-by-case
analysis identifying exempt purpose and
analysis of how activity in each case contributes to exempt purpose); Louisiana
Credit Union League v. United States, 693
F.2d 525, 534 (5th Cir. 1982) (resolution
of the substantial relationship test requires
“an examination of the relationship between the business activities that generate
the income in question ... and the accomplishment of the organization’s exempt
purposes”). However, as discussed

2000–8 I.R.B.

below, the final regulations include new
examples that provide additional guidance regarding the application of this
facts and circumstances approach in both
educational and noneducational contexts.
Another commentator suggested that
the final regulations should clarify that
the manner in which an organization develops and promotes a tour is relevant to
determining whether the tour activity is
substantially related to exempt purposes.
The development, promotion and operation of a tour are all indicators of whether
an organization’s offering of a tour is related or unrelated to its exempt purpose.
See International Postgraduate Medical
Found. v. Commissioner, 1989-36 T.C.
Memo., 56 T.C.M. (CCH) 1140 (1989)
(brochures promoting the trips emphasized recreational sightseeing activity and
omitted educational course descriptions).
Language has been added to the final regulations stating that relevant facts and circumstances include (but are not limited
to) how a travel tour is developed, promoted and operated.
Examples in the
final regulations also illustrate the relevance of these factors.
Many commentators requested more examples addressing specific areas. As noted
above, examples have been added that further illustrate the application of the facts
and circumstances rule. Some commentators raised concerns regarding the number
of hours of related activities a travel tour
must offer. Examples in the final regulation clarify that the number of hours spent
on any related travel tour activity is only
one factor in determining relatedness of
the tour as a whole to exempt purposes and
is not by itself determinative. Examples in
the final regulation clarify that the nature
of the related activities, and the practicalities of engaging in such activities (for example, the hours during which the activity
normally would be conducted), must also
be taken into account.
One commentator suggested adding an
example addressing whether income from
travel tour activity is a royalty under section 512(b)(2) where the exempt organization does not operate the tour, but provides
member names to a for-profit tour operator. Section 512(b)(2) excludes royalties
from the computation of unrelated business taxable income. The question of
what constitutes a royalty is beyond the
scope of these regulations. For guidance

645

as to whether income received by a taxexempt organization from travel tour activities is excludable from unrelated business taxable income as a royalty, see
generally Treas. Reg. §1.512(b)–1(b) and
Sierra Club v. Commissioner, 86 F.3d
1526 (9th Cir. 1996).
Some commentators suggested that the
final regulations should contain provisions
that prevent tax-exempt organizations
from competing unfairly with taxable travel
businesses. However, the test under section
513 is substantial relatedness to exempt
purposes, not the presence or absence of
unfair competition. Section 513 was enacted to prevent unfair competition between exempt organizations and taxable
businesses. H.R. Rep. No. 2319, 81st
Cong., 2d Sess. (1950), reprinted in 1950-2
C.B. 380, 409; S. Rep. No. 2375, 81 st
Cong., 2d Sess. (1950), reprinted in 1950-2
C.B. 483, 504; Portland Golf Club v. Commissioner, 497 U.S. 154, 161-162, fn. 12
(1990); Treas. Reg. §1.513–1(b). Nevertheless, “Congress did not force exempt organizations to abandon all commercial ventures”, but rather imposed a tax on ventures
that are not substantially related to an organization’s exempt purposes. United States
v. American College of Physicians, 475
U.S. 834, 838 (1986). See also Louisiana
Credit Union League v. United States, 693
F.2d 525, 541 (5th Cir. 1982). Following
this approach, the section 513(a) regulations, published in 1967, state that “any activity of a section 511 organization which is
carried on for the production of income and
which otherwise possesses the characteristics required to constitute ‘trade or business’ within the meaning of section 162–
and which, in addition, is not substantially
related to the performance of exempt functions— presents sufficient likelihood of unfair competition to be within the policy of
the tax [imposed by section 511(a)].”
Treas. Reg. §1.513–1(b). In expanding the
categories of organizations subject to unrelated business income tax in 1969, Congress revisited the unfair competition issue.
“[A] business competing with taxpaying
organizations should not be granted an unfair competitive advantage by operating tax
free unless the business contributes importantly to the exempt function.” H.R. Rep.
No. 413 (Part 1), 91st Cong., 1st Sess., 44,
50 (1969), reprinted in 1969 U.S.C.C.A.N.
1645, 1689, 1695 (emphasis added). If an
organization’s trade or business is substan-

February 22, 2000

tially related to its exempt purposes, the tax
under section 511 is not imposed, regardless of the existence of competition with
taxable entities. Accordingly, the final regulations continue to focus on relatedness to
exempt purposes, as required by section
513.
The preamble to the proposed regulations requested comments on whether the
final regulations should include documentation and recordkeeping requirements specific to travel tours. Commentators split on
the preferred approach. Some commentators requested general guidance as to the
types of records that an organization should
keep to establish a tour’s purpose, but did
not want the IRS to mandate specific
recordkeeping requirements. Other commentators asked that the IRS specify what
documentation is required. Section 6001
authorizes the Secretary to prescribe regulations that require taxpayers to keep
records sufficient to establish whether a
taxpayer is liable for any tax imposed under
the Code. Currently, any person subject to
tax under subtitle A of the Code, including
the tax imposed under section 511, or required to file a return of information with
respect to income, must keep permanent
books or records sufficient to establish the
amount of gross income, deductions, credits or other matters required to be shown by
such person in any return of tax or information. See Treas. Reg. §1.6001–1(a). In addition, every organization exempt from tax
under section 501(a) must keep permanent
books of account or records sufficient to
show specifically items of gross income,
receipts and disbursements, and to substantiate the information required by section
6033. See Treas. Reg. §1.6001– 1(c).
The IRS and Treasury Department believe that, with respect to travel tours, it is
unnecessary to supplement the existing
recordkeeping requirements under sections 6001 and 6033. Therefore, the final
regulations do not impose additional
recordkeeping requirements. However,
in response to commentators’ suggestions, examples in the final regulations illustrate that contemporaneous documentation showing how an organization
develops, promotes and operates the
travel tour is relevant to the facts and circumstances analysis.
Special Analyses
It has been determined that these final

February 22, 2000

regulations are not a significant regulatory action as defined in Executive Order
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) and the Regulatory Flexibility
Act (5 U.S.C. chapter 6) do not apply to
these regulations, and, therefore, a Regulatory Flexibility Analysis is not required.
Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed
rulemaking preceding these regulations
was submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact on
small business.
Drafting Information
The principal author of these regulations is Robin Ehrenberg, Office of Associate Chief Counsel (Employee Benefits
and Exempt Organizations). However,
other personnel from the IRS and the
Treasury Department participated in their
development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805. * * *
Par. 2. Section 1.513–7 is added to
read as follows:
§1.513–7 Travel and tour activities of tax
exempt organizations.
(a) Travel tour activities that constitute a
trade or business, as defined in
§1.513–1(b), and that are not substantially
related to the purposes for which exemption has been granted to the organization
constitute an unrelated trade or business
with respect to that organization. Whether
travel tour activities conducted by an organization are substantially related to the organization’s exempt purpose is determined
by looking at all relevant facts and circumstances, including, but not limited to, how
a travel tour is developed, promoted and
operated. Section 513(c) and §1.513–1(b)
also apply to travel tour activity. Application of the rules of section 513(c) and

646

§1.513–1(b) may result in different treatment for individual tours within an organization’s travel tour program.
(b) Examples. The provisions of this
section are illustrated by the following examples. In all of these examples, the
travel tours are priced to produce a profit
for the exempt organization. The examples are as follows:
Example 1. O, a university alumni association, is
exempt from federal income tax under section
501(a) as an educational organization described in
section 501(c)(3). As part of its activities, O operates a travel tour program. The program is open to
all current members of O and their guests. O works
with travel agencies to schedule approximately 10
tours annually to various destinations around the
world. Members of O pay $x to the organizing
travel agency to participate in a tour. The travel
agency pays O a per person fee for each participant.
Although the literature advertising the tours encourages O’s members to continue their lifelong learning
by joining the tours, and a faculty member of O’s related university frequently joins the tour as a guest
of the alumni association, none of the tours includes
any scheduled instruction or curriculum related to
the destinations being visited. The travel tours made
available to O’s members do not contribute importantly to the accomplishment of O’s educational purpose. Rather, O’s program is designed to generate
revenues for O by regularly offering its members
travel services. Accordingly, O’s tour program is an
unrelated trade or business within the meaning of
section 513(a).
Example 2. N is an organization formed for the
purpose of educating individuals about the geography and culture of the United States. It is exempt
from federal income tax under section 501(a) as an
educational and cultural organization described in
section 501(c)(3). N engages in a number of activities to accomplish its purposes, including offering
courses and publishing periodicals and books. As
one of its activities, N conducts study tours to national parks and other locations within the United
States. The study tours are conducted by teachers
and other personnel certified by the Board of Education of the State of P. The tours are directed toward
students enrolled in degree programs at educational
institutions in P, as reflected in the promotional materials, but are open to all who agree to participate in
the required study program. Each tour’s study program consists of instruction on subjects related to
the location being visited on the tour. During the
tour, five or six hours per day are devoted to organized study, preparation of reports, lectures, instruction and recitation by the students. Each tour group
brings along a library of material related to the subject being studied on the tour. Examinations are
given at the end of each tour and the P State Board
of Education awards academic credit for tour participation. Because the tours offered by N include a
substantial amount of required study, lectures, report
preparation, examinations and qualify for academic
credit, the tours are substantially related to N’s educational purpose. Accordingly, N’s tour program is
not an unrelated trade or business within the meaning of section 513(a).
Example 3. R is a section 501(c)(4) social welfare organization devoted to advocacy on a particu-

2000–8 I.R.B.

lar issue. On a regular basis throughout the year, R
organizes travel tours for its members to Washington, DC. While in Washington, the members follow
a schedule according to which they spend substantially all of their time during normal business hours
over several days attending meetings with legislators and government officials and receiving briefings on policy developments related to the issue that
is R’s focus. Members do have some time on their
own in the evenings to engage in recreational or social activities of their own choosing. Bringing
members to Washington to participate in advocacy
on behalf of the organization and learn about developments relating to the organization’s principal
focus is substantially related to R’s social welfare
purpose. Therefore, R’s operation of the travel tours
does not constitute an unrelated trade or business
within the meaning of section 513(a).
Example 4. S is a membership organization
formed to foster cultural unity and to educate X
Americans about X, their country of origin. It is exempt from federal income tax under section 501(a)
and is described in section 501(c)(3) as an educational and cultural organization. Membership in S is
open to all Americans interested in the X heritage.
As part of its activities, S sponsors a program of
travel tours to X. The tours are divided into two categories. Category A tours are trips to X that are designed to immerse participants in the X history, culture and language. Substantially all of the daily
itinerary includes scheduled instruction on the X
language, history and cultural heritage, and visits to
destinations selected because of their historical or
cultural significance or because of instructional resources they offer. Category B tours are also trips to
X, but rather than offering scheduled instruction,
participants are given the option of taking guided
tours of various X locations included in their itinerary. Other than the optional guided tours, Category
B tours offer no instruction or curriculum. Destinations of principally recreational interest, rather than
historical or cultural interest, are regularly included
on Category B tour itineraries. Based on the facts
and circumstances, sponsoring Category A tours is
an activity substantially related to S’s exempt purposes, and does not constitute an unrelated trade or
business within the meaning of section 513(a).
However, sponsoring Category B tours does not
contribute importantly to S’s accomplishment of its
exempt purposes and, thus, constitutes an unrelated
trade or business within the meaning of section
513(a).
Example 5. T is a scientific organization engaged
in environmental research. T is exempt from federal
income tax under section 501(a) as an organization
described in section 501(c)(3). T is engaged in a
long-term study of how agricultural pesticide and
fertilizer use affects the populations of various bird
species. T collects data at several bases located in
an important agricultural region of country U. The
minutes of a meeting of T’s Board of Directors state
that, after study, the Board has determined that nonscientists can reliably perform needed data collection in the field, under supervision of T’s biologists.
The Board minutes reflect that the Board approved
offering one-week trips to T’s bases in U, where participants will assist T’s biologists in collecting data
for the study. Tour participants collect data during
the same hours as T’s biologists. Normally, data collection occurs during the early morning and evening

2000–8 I.R.B.

hours, although the work schedule varies by season.
Each base has rustic accommodations and few
amenities, but country U is renowned for its beautiful scenery and abundant wildlife. T promotes the
trips in its newsletter and on its Internet site and
through various conservation organizations. The
promotional materials describe the work schedule
and emphasize the valuable contribution made by
trip participants to T’s research activities. Based on
the facts and circumstances, sponsoring trips to T’s
bases in country U is an activity substantially related
to T’s exempt purpose, and, thus, does not constitute
an unrelated trade or business within the meaning of
section 513(a).
Example 6. V is an educational organization devoted to the study of ancient history and cultures and
is exempt from federal income tax under section
501(a) as an organization described in section
501(c)(3). In connection with its educational activities, V conducts archaeological expeditions around
the world, including in the Y region of country Z. In
cooperation with the National Museum of Z, V recently presented an exhibit on ancient civilizations
of the Y region of Z, including artifacts from the collection of the Z National Museum. V instituted a
program of travel tours to V’s archaeological sites
located in the Y region. The tours were initially proposed by V staff members as a means of educating
the public about ongoing field research conducted
by V. V engaged a travel agency to handle logistics
such as accommodations and transportation arrangements. In preparation for the tours, V developed educational materials relating to each archaeological
site to be visited on the tour, describing in detail the
layout of the site, the methods used by V’s researchers in exploring the site, the discoveries made
at the site, and their historical significance. V also
arranged special guided tours of its exhibit on the Y
region for individuals registered for the travel tours.
Two archaeologists from V (both of whom had participated in prior archaeological expeditions in the Y
region) accompanied the tours. These experts led
guided tours of each site and explained the significance of the sites to tour participants. At several of
the sites, tour participants also met with a working
team of archaeologists from V and the National Museum of Z, who shared their experiences. V prepared promotional materials describing the educational nature of the tours, including the daily trips to
V’s archaeological sites and the educational background of the tour leaders, and providing a recommended reading list. The promotional materials do
not refer to any particular recreational or sightseeing
activities. Based on the facts and circumstances,
sponsoring trips to the Y region is an activity substantially related to V’s exempt purposes. The
scheduled activities, which include tours of archaeological sites led by experts, are part of a coordinated
educational program designed to educate tour participants about the ancient history of the Y region of Z
and V’s ongoing field research. Therefore, V’s tour
program does not constitute an unrelated trade or
business within the meaning of section 513(a).
Example 7. W is an educational organization devoted to the study of the performing arts and is exempt from federal income tax under section 501(a)
as an organization described in section 501(c)(3). In
connection with its educational activities, W presents public performances of musical and theatrical
works. Individuals become members of W by mak-

647

ing an annual contribution to W of $q. Each year, W
offers members an opportunity to travel as a group
to one or more major cities in the United States or
abroad. In each city, tour participants are provided
tickets to attend a public performance of a play, concert or dance program each evening. W also
arranges a sightseeing tour of each city and provides
evening receptions for tour participants. W views its
tour program as an important means to develop and
strengthen bonds between W and its members, and
to increase their financial and volunteer support of
W. W engaged a travel agency to handle logistics
such as accommodations and transportation arrangements. No educational materials are prepared by W
or provided to tour participants in connection with
the tours. Apart from attendance at the evening cultural events, the tours offer no scheduled instruction,
organized study or group discussion. Although several members of W’s administrative staff accompany
each tour group, their role is to facilitate member interaction. The staff members have no special expertise in the performing arts and play no educational
role in the tours. W prepared promotional materials
describing the sightseeing opportunities on the tours
and emphasizing the opportunity for members to socialize informally and interact with one another and
with W staff members, while pursuing shared interests. Although W’s tour program may foster goodwill among W members, it does not contribute importantly to W’s educational purposes. W’s tour
program is primarily social and recreational in nature. The scheduled activities, which include sightseeing and attendance at various cultural events, are
not part of a coordinated educational program.
Therefore, W’s tour program is an unrelated trade or
business within the meaning of section 513(a).

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved January 21, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue
of the Federal Register for February 7, 2000, 65 F.R.
5772)

Section 1295.—Qualified
Electing Fund
26 CFR 1.1295–1: Qualified electing funds.

T.D. 8870
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602

February 22, 2000

General Rules for Making and
Maintaining Qualified Electing
Fund Elections
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations that provide guidance to
a passive foreign investment company
(PFIC) shareholder that makes the election under section 1295 (section 1295
election) to treat the PFIC as a qualified
electing fund (QEF), and for PFIC shareholders that wish to make a section 1295
election that will apply on a retroactive
basis (retroactive election). In addition,
this document contains a final regulation
that provides guidance under section 1291
to a PFIC shareholder that is a tax-exempt
organization. Lastly, this document contains final regulations under section 1293
for calculating and reporting net capital
gain by a QEF, and also clarifies the application of the current income inclusion
rules of section 1293 to interest in a QEF
held through a domestic pass through entity.
DATES: Effective Date. These regulations are effective February 7, 2000.
Applicability Date. In general, these
regulations are applicable as of January 2,
1998. For special dates of applicability
see §1.1295–1(k).
FOR FURTHER INFORMATION CONTACT: Margaret A. Fung, (202) 6223840 (not a toll free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information in these
final regulations have been reviewed and
approved by the Office of Management
and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507) under control number 1545 - 1555.
Responses to these collections of information are mandatory for PFIC shareholders that wish to make the section
1295 election to treat the PFIC as a QEF.
Comments on the collections of information should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with

February 22, 2000

copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
OP:FS:FP, Washington, DC 20224.
The estimated average annual burden
per respondent and/or recordkeeper varies
from fifteen minutes to three hours, depending on individual circumstances,
with an estimated average of twenty-nine
minutes.
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.
Books or records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On January 2, 1998, the Treasury and
the IRS published temporary regulations
regarding the section 1295 election and
rules applicable to a PFIC shareholder
under sections 1291, 1293, 1295 and 1297
(redesignated as section 1298 by the Taxpayer Relief Act of 1997, and hereafter
referred to as section 1298) (T.D. 8750,
1998–8 I.R.B. 4 [63 F.R. 6]). On that
same date, the Treasury and the IRS published a proposed rulemaking
(REG–115795–97, 1998–8 I.R.B. 33) in
the Federal Register (63 F.R. 35). The
text of the temporary regulations served
as the text of the proposed regulations.
Sections 1291, 1293, 1295 and 1298
were added by the Tax Reform Act of
1986, effective for taxable years of foreign
corporations beginning after December 31,
1986. As originally enacted, the section
1295 election was an election made by the
PFIC. The Technical and Miscellaneous
Revenue Act of 1988 (TAMRA) amended
section 1295, effective for taxable years of
foreign corporations beginning after December 31, 1986, to change the section
1295 election to a shareholder-by-shareholder election. Sections 1291, 1293 and
1298 were also amended by TAMRA, and
sections 1293 and 1298 were further
amended by the Omnibus Budget Reconciliation Act of 1993. Section 1298 also
was amended by the Revenue Reconciliation Act of 1989 and the Small Business

648

Job Protection Act of 1996. In addition,
the Taxpayer Relief Act of 1997 (1997
TRA) amended section 1 to provide categories of long-term capital gain and the
maximum rates of tax to which the categories are subject. In certain cases, this
amendment affects the calculation of net
capital gain for purposes of section 1293.
No written comments were received on
the proposed regulations, and no public
hearing was requested or held. The proposed regulations are adopted as final regulations as revised by this Treasury Decision. The revisions are summarized in the
explanations below.
Explanation of Revisions
A foreign corporation is a PFIC for a
taxable year if the foreign corporation satisfies either the income or asset test of
section 1297(a) for that year. A foreign
corporation is a PFIC under the income
test if 75 percent or more of its gross income for its taxable year is passive, or investment-type, income. Alternatively,
under the asset test, a foreign corporation
is a PFIC if 50 percent or more of the average fair market value of its assets during
its taxable year are assets that produce or
are held for the production of passive income. A shareholder of a foreign corporation that qualifies as a PFIC is subject to
the interest charge regime of section 1291
with respect to certain distributions by the
PFIC and certain dispositions of its stock.
Generally, a shareholder of a PFIC may
avoid the interest charge regime by making a timely election under section 1295
to treat a PFIC as a QEF, in which case
the shareholder will be taxed annually
pursuant to section 1293 on its pro rata
share of the ordinary earnings and net
capital gain of the PFIC. Under section
1295(a), a section 1295 election will
apply with respect to the PFIC if the PFIC
complies with requirements prescribed by
the Secretary for purposes of determining
the ordinary earnings and net capital gain
of the PFIC and otherwise carrying out
the purposes of the PFIC provisions.
Section 1295(b)(1), as enacted by
TAMRA, provides that a shareholder may
make a section 1295 election with respect
to a PFIC for any taxable year of the
shareholder (shareholder election year).
Once made, the election will apply to that
year and to all subsequent years of the
shareholder unless revoked by the share-

2000–8 I.R.B.

holder with the consent of the Secretary.
Section 1295(b)(2) prescribes the time for
making the election. In general, for the
section 1295 election to be applicable to a
taxable year, the shareholder must make
the election by the due date, as extended
under section 6081, for the shareholder’s
return for that taxable year. However, to
the extent provided in the regulations, a
section 1295 election may be made for a
taxable year after the prescribed due date
if the shareholder failed to make a timely
election because the shareholder reasonably believed that the foreign corporation
was not a PFIC.
Under
temporary
regulations
§1.1295–1T(d)(1) and (f)(1), the shareholder, as defined in §1.1291–9(j)(3), of a
PFIC makes the section 1295 election by
filing a Form 8621 with the shareholder’s
Federal income tax return by the election
due date for the shareholder election year,
and by filing a copy of that form with the
Philadelphia Service Center. In addition,
under
temporary
regulation
§1.1295–1T(f)(2), the shareholder must
file an annual Form 8621 with its Federal
income tax return to report the shareholder’s pro rata share of the ordinary
earnings and net capital gain of the QEF.
Temporary regulation §1.1295–1T(f)(2)
also required that a copy of the annual
Form 8621 be filed with the Philadelphia
Service Center. To reduce taxpayer burden, this final regulation eliminates the
requirement for filing a copy of Form
8621 with the Philadelphia Service Center
when the shareholder makes the section
1295 election or reports the shareholder’s
annual pro rata share of the ordinary earnings and net capital gain of the QEF.
In addition, this final regulation clarifies the rule in temporary regulation
§1.1295–1T(c)(2)(ii) for income inclusion by the shareholder of a QEF under
section 1293 for any taxable year that the
foreign corporation is not a PFIC under
section 1297(a) and is not treated as a
PFIC under section 1298(b)(1). This final
regulation clarifies that in such case, the
shareholder is not required to include pursuant to section 1293 the shareholder’s
pro rata share of ordinary earnings and net
capital gain for such year, and the shareholder shall not be required to satisfy the
section 1295 annual reporting requirement for such year. Cessation of a foreign
corporation’s status as a PFIC will not,

2000–8 I.R.B.

however, terminate a section 1295 election. Thus, if the foreign corporation is a
PFIC in any taxable year after a year in
which it is not treated as a PFIC, the
shareholder’s original election under section 1295 continues to apply and the
shareholder must take into account its pro
rata share of ordinary earnings and net
capital gain for such year and comply
with the section 1295 annual reporting requirement.
The Taxpayer Relief Act of 1997 added
section 1296 to provide PFIC shareholders with an alternative method for current
income inclusion by making a mark-tomarket election with respect to their PFIC
stock that qualifies as marketable stock.
The election is available to shareholders
whose taxable years begin after December 31, 1997 for stock in a foreign corporation whose taxable year ends with or
within the shareholder’s taxable year.
The effect of a mark-to-market election
on a section 1295 election will be addressed in subsequent regulations under
section 1296. In addition, temporary regulation §1.1297–3T(c) governing the
deemed dividend election by a United
States person that is a shareholder of a
PFIC will be finalized in a future regulation project.
Notice 98–22 (1998–17 I.R.B. 5) provides that taxpayers will be permitted to
apply the rules of the temporary regulations under §1.1295–1T(b)(4) (section
1295 election by shareholders who file a
joint return) and §1.1295–1T(f) and (g)
(procedures for making a section 1295
election and annual information requirements by the PFIC or intermediary) to
taxable years beginning before January 1,
1998, for which the statute of limitations
on the assessment of tax has not expired
and, with respect to § 1.1295–1T(b)(4), if
certain consistency requirements are met.
The rule of Notice 98–22 has been incorporated into §1.1295–1(k) of this regulation. Final regulation §1.1295–1(k) is
changed to reflect the special effective
dates for §1.1295–1(b)(4), (f) and (g) as
provided by Notice 98–22. Accordingly,
Notice 98–22 is obsoleted since the effective date provisions are contained in this
final regulation.
Notice 88–125 described the requirements a shareholder must satisfy to make
and maintain a section 1295 election for
taxable years beginning before January 1,

649

1998. As a result of the procedures and
requirements set forth first in the temporary regulations published on January 2,
1998, and now in these final regulations,
Notice 88–125 is obsoleted effective February 7, 2000.
Effect On Other Documents
Notice 88–125 and Notice 98–22 are
obsoleted as of February 7, 2000.
Special Analyses
It has been determined that the final regulations are not a significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not
required. It has also been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not
apply to these regulations. Further, it is
hereby certified, pursuant to sections
603(a) and 605(b) of the Regulatory Flexibility Act (5 U.S.C. chapter 6), that the collection of information contained in these
regulations will not have a significant economic impact on substantial number of
small entities. The cost of collection of information to small entities is insignificant
because the primary reporting burden is on
individual PFIC shareholders who make
the section 1295 election. Therefore, the
collection of information will not have a
substantial economic impact. Therefore, a
regulatory flexibility analysis under the
Regulatory Flexibility Act is not required.
Pursuant to section 7805(f) of the Internal
Revenue Code, the notice of proposed rulemaking preceding these regulations was
submitted to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal author of the final regulations is Margaret A. Fung, Office of Associate Chief Counsel (International).
However, other personnel from the IRS
and Treasury Department participated in
their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:

February 22, 2000

PART 1–INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Sec. 1.1291–1 also issued under 26
U.S.C. 1291. * * *
Sec. 1.1293–1 also issued under 26
U.S.C. 1293. * * *
Sec. 1.1295–3 also issued under 26
U.S.C. 1295. * * *
§1.1291–1T [Redesignated as
§1.1291–1]
Par. 2. Section 1.1291–1T is redesignated as §1.1291–1 and the section heading is revised to read as follows:
§1.1291–1 Taxation of U.S. persons that
are shareholders of PFICs that are not
pedigreed QEFs.
*****
Par. 3. Section 1.1293–1T is redesignated as §1.1293–1 and the newly designated section is amended by revising the
section heading and the first sentence of
paragraph (c)(1) to read as follows:
§1.1293–1 Current taxation of income
from qualified electing funds.
*****
(c) Application of rules of inclusion
with respect to stock held by a pass
through entity — (1) In general. If a domestic pass through entity makes a section 1295 election, as provided in paragraph (d)(2) of this section, with respect
to the PFIC shares that it owns, directly or
indirectly, the domestic pass through entity takes into account its pro rata share of
the ordinary earnings and net capital gain
attributable to the QEF shares held by the
pass through entity. * * *
*****
Par. 4. Section 1.1295–0 is amended
by:
1. Revising the introductory text of the
section.
2. Removing the entry for the heading
of §1.1295–1T and adding an entry for
the heading of §1.1295–1 in its place.
3. Revising the entries for
§1.1295–1(d)(3) through (d)(5).
4. Adding entries for §1.1295–1(d)(6)
and (e)(1) and (e)(2).
5. Removing the entry for the heading
of §1.1295–3T and adding an entry for
the heading of §1.1295–3 in its place.
The revisions and additions read as fol-

February 22, 2000

lows:
§1.1295–0 Table of contents.
This section contains a listing of the
headings for §§1.1295–1 and 1.1295–3.
§1.1295–1 Qualified electing funds.
*****
(d) * * *
(3) Indirect ownership of a PFIC
through other PFICs.
(4) Member of consolidated return
group as shareholder.
(5) Option holder.
(6) Exempt organization.
(e) * * *
(1) General rule.
(2) Examples.
*****
§1.1295–3 Retroactive elections.
*****
§1.1295–1T [Redesignated as
§1.1295–1]
Par. 5. Section §1.1295–1T is redesignated as §1.1295–1 and the newly designated section is amended by:
1. Revising the section heading.
2. Revising paragraph (b)(3)(iv)(B).
3. Adding paragraph (b)(3)(v).
4. Adding a sentence to the end of paragraph (b)(4).
5.
Revising paragraphs (c)(2)(ii)
and (iii).
6.
Revising the third sentence in
paragraph (c)(2)(v) Example 3.
7. Redesignating paragraphs (d)(3),
(d)(4) and (d)(5) as paragraphs (d)(4),
(d)(5) and (d)(6), respectively.
8. Adding a new paragraph (d)(3).
9. Revising paragraph (e).
10. In the last sentence of paragraph
(f)(1)(iii), the language “capital gain;
and” is removed and the language “capital
gain.” is added in its place.
11. Adding the word “and” at the end of
paragraph (f)(1)(ii).
12. Removing paragraph (f)(1)(iv).
13. Adding the word “and” at the end
of paragraph (f)(2)(i)(B).
14. In the last sentence of paragraph
(f)(2)(i)(C), the language “capital gain;
and” is removed and the language “capital
gain.” is added in its place.
15. Removing paragraph (f)(2)(i)(D).
16. Adding a new paragraph (f)(3).
17. Revising the introductory language
of paragraph (g)(3).
18. Adding paragraph (g)(5).
19. Revising the first sentence of para-

650

graph (h).
20. Revising paragraph (k).
The revisions and additions read as follows:
§1.1295–1 Qualified electing funds.
*****
(b) * * *
(3) * * *
(iv) * * *
(B) In the case of PFIC stock transferred by an interest holder or beneficiary
to a pass through entity in a transaction in
which gain is not fully recognized (including pursuant to regulations under section 1291(f)), the pass through entity
makes the section 1295 election with respect to the PFIC stock transferred for the
taxable year in which the transfer was
made. The PFIC stock transferred will be
treated as stock of a pedigreed QEF by the
pass through entity, however, only if that
stock was treated as stock of a pedigreed
QEF with respect to the interest holder or
beneficiary at the time of the transfer, and
the PFIC has been a QEF with respect to
the pass through entity for all taxable
years of the PFIC that are included wholly
or partly in the pass through entity’s holding period of the PFIC stock during which
the foreign corporation was a PFIC within
the meaning of §1.1291–9(j).
(v) Characterization of stock distributed by a partnership. In the case of
PFIC stock distributed by a partnership to
a partner in a transaction in which gain is
not fully recognized, the PFIC stock will
be treated as stock of a pedigreed QEF by
the partners only if that stock was treated
as stock of a pedigreed QEF with respect
to the partnership for all taxable years of
the PFIC that are included wholly or
partly in the partnership’s holding period
of the PFIC stock during which the foreign corporation was a PFIC within the
meaning of §1.1291–9(j), and the partner
has a section 1295 election in effect with
respect to the distributed PFIC stock for
the partner’s taxable year in which the
distribution was made. If the partner does
not have a section 1295 election in effect,
the stock shall be treated as stock in a section 1291 fund. See paragraph (k) of this
section for special applicability date of
paragraph (b)(3)(v) of this section.
(4) * * * See paragraph (k) of this section for special applicability date of paragraph (b)(4) of this section.
(c) * * *

2000–8 I.R.B.

(2) * * *
(ii) Effect of PFIC status on election.
A foreign corporation will not be treated
as a QEF for any taxable year of the foreign corporation that the foreign corporation is not a PFIC under section 1297(a)
and is not treated as a PFIC under section
1298(b)(1). Therefore, a shareholder
shall not be required to include pursuant
to section 1293 the shareholder’s pro rata
share of ordinary earnings and net capital
gain for such year and shall not be required to satisfy the section 1295 annual
reporting requirement of paragraph (f)(2)
of this section for such year. Cessation of
a foreign corporation’s status as a PFIC
will not, however, terminate a section
1295 election. Thus, if the foreign corporation is a PFIC in any taxable year after a
year in which it is not treated as a PFIC,
the shareholder’s original election under
section 1295 continues to apply and the
shareholder must take into account its pro
rata share of ordinary earnings and net
capital gain for such year and comply
with the section 1295 annual reporting requirement.
(iii) Effect on election of complete termination of a shareholder’s interest in the
PFIC. Complete termination of a shareholder’s direct and indirect interest in
stock of a foreign corporation will not terminate a shareholder’s section 1295 election with respect to the foreign corporation. Therefore, if a shareholder
reacquires a direct or indirect interest in
any stock of the foreign corporation, that
stock is considered to be stock for which
an election under section 1295 has been
made and the shareholder is subject to the
income inclusion and reporting rules required of a shareholder of a QEF.
*****
(v) * * *
Example 3. * * * If P does not make the section
1295 election with respect to the FC stock, C will
continue to be subject, in C’s capacity as an indirect
shareholder of FC, to the income inclusion and reporting rules required of shareholders of QEFs in
1999 and subsequent years for that portion of the FC
stock C is treated as owning indirectly through the
partnership. * * *

(d) * * *
(3) Indirect ownership of a PFIC
through other PFICs — (i) In general.
An election under section 1295 shall
apply only to the foreign corporation for
which an election is made. Therefore, if a
shareholder makes an election under section 1295 to treat a PFIC as a QEF, that

2000–8 I.R.B.

election applies only to stock in that foreign corporation and not to the stock in
any other corporation which the shareholder is treated as owning by virtue of its
ownership of stock in the QEF.
(ii) Example. The following example
illustrates the rules of paragraph (d)(3)(i)
of this section:
Example. In 1988, T, a U.S. person, purchased
stock of FC, a foreign corporation that is a PFIC.
FC also owns the stock of SC, a foreign corporation
that is a PFIC. T makes an election under section
1295 to treat FC as a QEF. T’s section 1295 election
applies only to the stock T owns in FC, and does not
apply to the stock T indirectly owns in SC.

*****
(e) Time for making a section 1295
election — (1) In general. Except as provided in §1.1295–3, a shareholder making
the section 1295 election must make the
election on or before the due date, as extended under section 6081 (election due
date), for filing the shareholder’s income
tax return for the first taxable year to
which the election will apply. The section
1295 election must be made in the original return for that year, or in an amended
return, provided the amended return is
filed on or before the election due date.
(2) Examples. The following examples illustrate the rules of paragraph (e)(1)
of this section:
Example 1. In 1998, C, a domestic corporation,
purchased stock of FC, a foreign corporation that is
a PFIC. Both C and FC are calendar year taxpayers.
C wishes to make the section 1295 election for its
taxable year ended December 31, 1998. The section
1295 election must be made on or before March 15,
1999, the due date of C’s 1998 income tax return as
provided by section 6072(b). On March 14, 1999, C
files a request for a three-month extension of time to
file its 1998 income tax return under section
6081(b). C’s time to file its 1998 income tax return
and to make the section 1295 election is thereby extended to June 15, 1999.
Example 2. The facts are the same as in Example
1 except that on May 1, 1999, C filed its 1998 income tax return and failed to include the section
1295 election. C may file an amended income tax
return for 1998 to make the section 1295 election
provided the amended return is filed on or before the
extended due date of June 15, 1999.

*****
(f) * * *
(3) Effective date. See paragraph (k)
of this section for special applicability
date of paragraph (f) of this section.
(g) * * *
(3) Annual Intermediary Statement. In
the case of a U.S. person that is an indirect shareholder of a PFIC that is owned
through an intermediary, as defined in
paragraph (j) of this section, an Annual

651

Intermediary Statement issued by an intermediary containing the information described in paragraph (g)(1) of this section
and reporting the indirect shareholder’s
pro rata share of the ordinary earnings and
net capital gain of the QEF as described in
paragraph (g)(1)(ii)(A) of this section,
may be provided to the indirect shareholder in lieu of the PFIC Annual Information Statement if the following conditions are satisfied —
*****
(5) Effective date. See paragraph (k)
of this section for special applicability
date of paragraph (g) of this section.
(h) Transition rules. Taxpayers may
rely on Notice 88–125 (1988–2 C.B. 535)
(see §601.601(d)(2) of this chapter), for
rules on making and maintaining elections for shareholder election years (as
defined in paragraph (j) of this section)
beginning after December 31, 1986, and
before January 1, 1998. * * *
*****
(k) Effective dates. Paragraphs
(b)(2)(iii), (b)(3), (b)(4) and (c) through
(j) of this section are applicable to taxable
years of shareholders beginning after December 31, 1997. However, taxpayers
may apply the rules under paragraphs
(b)(4), (f) and (g) of this section to a taxable year beginning before January 1,
1998, provided the statute of limitations
on the assessment of tax has not expired
as of April 27, 1998 and, in the case of
paragraph (b)(4) of this section, the taxpayers who filed the joint return have
consistently applied the rules of that section to all taxable years following the year
the election was made. Paragraph
(b)(3)(v) of this section is applicable as of
February 7, 2000, however a taxpayer
may apply the rules to a taxable year prior
to the applicable date provided the statute
of limitations on the assessment of tax for
that taxable year has not expired.
§1.1295–3T [Redesignated as
§1.1295–3]
Par. 6. Section §1.1295–3T is redesignated as §1.1295–3 and the newly designated section is amended by revising the
section heading and paragraphs (b)(1) and
(c)(5)(i) to read as follows:
§1.1295–3 Retroactive elections.
*****
(b) * * *
(1) Reasonably believed, within the

February 22, 2000

meaning of paragraph (d) of this section,
that as of the election due date, as defined
in § 1.1295–1(e), the foreign corporation
was not a PFIC for its taxable year that
ended during the retroactive election year;
*****
(c) * * *
(5) Time of and manner for filing a

Protective Statement—(i) In general.
Except as provided in paragraph (c)(5)(ii)
of this section, a Protective Statement
must be attached to the shareholder’s federal income tax return for the shareholder’s first taxable year to which the
Protective Statement will apply. The
shareholder must file its return and the

copy of the Protective Statement by the
due date, as extended under section 6081,
for the return.
*****
Par. 7. In the list below, for each section
indicated in the left column, remove the
language in the middle column and add
the language in the right column.

Affected Section

Remove

Add

1.1293–1(c)(1), last sentence

§1.1295–1T(j).

§1.1295–1(j).

1.1293–1(c)(2)(i), first sentence

§1.1295–1T(D)(2),

§1.1295–1(d)(2),

1.1295–1(b)(3)(iv)(A)

stock), and

stock) and

1.1295–1(c)(2)(ii), first sentence

1296(a)

1297(a)

1.1295–1(c)(2)(ii), first sentence

1297(b)(1).

1298(b)(1).

1.1295–1(c)(2)(iv), last sentence

§1.1293–1T(c).

§1.1293–1(c).

1.1295–1(d)(1), last sentence

(d)(5)

(d)(6)

1.1295–1(d)(2)(i)(A), last sentence

§1.1293–1T(c)(1),

§1.1293–1(c)(1),

1.1295–1(d)(2)(ii), last sentence

§1.1293–1T(c)(1),

§1.1293–1(c)(1),

1.1295–1(d)(2)(iii), last sentence

§1.1293–1T(c)(1),

§1.1293–1(c)(1),

1.1295–1(d)(6), first sentence

§1.1291–1T(e),

§1.1291–1(e),

1.1295–1(f)(1)(iii), last sentence

QEF calculated the QEF’s

PFIC calculated the PFIC’s

1.1295–1(g)(1) introductory text,
second sentence, last word

representation —

representations —

1.1295–1(g)(1)(ii)(A)

§1.1293–1T(a)(2)

§1.1293–1(a)(2)

1.1295–1(h), second sentence

§1.1295–1T

§1.1295–1

1.1295–1(i)(1)(iii), last sentence

never was made.

was never made.

1.1295–1(i)(3)(iii)

through 1297

through 1298

1.1295–3(a), first sentence

§1.1295–1T(j),

§1.1295–1(j),

1.1295–3(a), first sentence

§1.1295–1T(e)

§1.1295–1(e)

1.1295–3(b)(2)

and 1297

and 1298

1.1295–3(c)(3)

§1.1295–1T(d).

§1.1295–1(d).

1.1295–3(c)(4)(i)(A), third sentence

assessment of taxes

assessment of all PFIC related taxes

1.1295–3(c)(6)(i), last sentence

see §1.1295–1T(c)(2)(iii).

see §1.1295–1(c)(2)(iii).

1.1295–3(d)(1), first sentence

section 1296(a)

section 1297(a)

1.1295–3(d)(1), second sentence

section 1296(a)

section 1297(a)

1.1295–3(f)(2)(i) introductory text,
second sentence

PFIC and the availability

PFIC and of the availability

1.1295–3(f)(4)(vi), first sentence

§1.1295–1T(d).

§1.1295–1(d).

1.1295–3(g)(3), first sentence

§1.1295–1T(d).

§1.1295–1(d).

February 22, 2000

652

2000–8 I.R.B.

PART 602- - OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 8. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 9. In § 602.101, paragraph (b) is
amended by removing the entries for
§§1.1295–1T and 1.1295–3T and adding
entries in numerical order to the table to
read as follows:

§ 602.101 OMB Control numbers.
*****
(b) * * *

(Filed by the Office of the Federal Register on February 4, 2000, 8:45 a.m., and published in the issue
of the Federal Register for February 7, 2000, 65 F.R.
5777)

Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved January 14, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.

CFR part or section where
identified and described

Current OMB
control No.

*****
1.1295–1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1555
1.1295–3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545–1555
*****

2000–8 I.R.B.

653

February 22, 2000

Part IV. Items of General Interest
Notice of Proposed Rulemaking
and Notice of Public Hearing
Exclusions From Gross Income
of Foreign Corporations
REG–208280–86
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
SUMMARY: This document contains
proposed rules implementing the portions
of section 883(a) and (c) of the Internal
Revenue Code (Code) that relate to income derived by foreign corporations
from the international operation of a ship
or ships or aircraft. The proposed rules
reflect changes made by the Tax Reform
Act of 1986 and subsequent legislative
amendments. The proposed rules provide, in general, that a foreign corporation
organized in a qualified foreign country
and engaged in the international operation
of ships or aircraft shall exclude qualified
income from gross income for purposes
of United States Federal income taxation,
provided that the corporation can satisfy
certain ownership and related documentation requirements. The proposed rules explain when a foreign country is a qualified
foreign country and what income is considered to be qualified income. The proposed rules specify how a foreign corporation may satisfy the ownership and
related documentation requirements. In
addition, the proposed rules describe the
information that the foreign corporation
must include on its United States income
tax return in order to claim an exemption.
This document provides notice of a public
hearing on these proposed rules.
DATES: Written comments must be received by May 8, 2000. Requests to
speak and outlines of topics to be discussed at the public hearing scheduled for
Thursday, April 27, 2000, at 10 a.m. must
be received by Wednesday, April 5, 2000.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–208280–86),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be

February 22, 2000

hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–208280–86),
Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments electronically
via the Internet by selecting the “Tax
Regs” option on the IRS Home Page, or
by submitting comments directly to the
IRS Internet site at http://www.irs.ustreas.gov/tax_regs/regslist.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 proposed rules,
Patricia A. Bray, (202) 622-3880; concerning submissions, the hearing, and/or
to be placed on the building access list to
attend the hearing, Guy Traynor, (202)
622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of
Management and Budget for review in accordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information
should be sent to the Office of Management and Budget, Attn: Desk Officer for
the Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503, with copies to
the IRS, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 20224.
Comments on the collection of information should be received by April 10, 2000.
Comments are specifically requested concerning:
Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal
Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information (see below);
How the quality, utility and clarity of
the information to be collected may be enhanced;

654

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 in this
proposed regulation is in §§1.883–1,
1.883–2, 1.883–3, 1.883–4, and 1.883–5.
The information required in these sections
will enable a foreign corporation to determine if it is eligible to exclude its income
from the international operation of a ship
or ships or aircraft from gross income on
its U.S. Federal income tax return. The
information required in these sections will
also enable the IRS to monitor compliance with the provisions of the proposed
regulations with respect to the stock ownership requirements of §1.883–1(c)(2),
and to make a preliminary determination
of whether the foreign corporation is eligible to claim such an exemption and is
accurately reporting income as required
under section 6012.
The collection of information and responses to these collections of information are mandatory. The likely respondents are foreign corporations engaged in
the international operation of a ship or
ships or aircraft that wish to claim an exemption from U.S. tax under section 883,
and certain of their shareholders owning
(directly or indirectly) a majority of the
value of the shares of such corporations.
Estimated total annual reporting/recordkeeping burden on corporations: 1,400
hours.
The estimated annual burden per respondent varies from 30 minutes to eight
hours, depending on the circumstances of
the foreign corporation, with an estimated
average of one hour.
Estimated number of respondents:
1,400.
Estimated annual frequency of responses: Once.
Estimated total annual reporting burden on shareholders: 22,500 hours.
The estimated annual burden per respondent varies from 15 minutes to eight
hours, depending on the circumstances of

2000–8 I.R.B.

the shareholder or intermediary, with an
estimated average of 90 minutes.
Estimated number of respondents:
15,000.
Estimated annual frequency of responses: Once.
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.
Books or records relating to a collection of information must be retained as
long as their contents may become material in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
Section 883 provides an exemption
from gross income for earnings of a foreign corporation derived from the international operation of a ship or ships or aircraft (hereinafter ships or aircraft) if an
equivalent exemption from tax is granted
by the applicable foreign country to corporations organized in the United States.
Section 883 has generally been referred to
as the reciprocal exemption provision.
Before 1986, section 883 eliminated U.S.
tax on earnings from the operation of
ships or aircraft derived by foreign persons, including U.S.-controlled foreign
corporations, based on whether the country of documentation of the ship or registry of the aircraft provided an exemption
to U.S. persons. Section 883 did not require a foreign transportation company to
be organized or resident in the country of
registration or documentation. Many
countries offered various incentives, including no taxation, to non-resident shipping companies that registered ships in
that jurisdiction (referred to as flaggingout or documenting ships under flags of
convenience). Thus, foreign corporations
that documented their ships in such flag of
convenience countries could claim a reciprocal exemption from U.S. income tax.
Congress concluded in 1986 that the
reciprocal exemption provisions were not
meeting their original goal of reserving
the right to tax transportation income to
the country of residence of the taxpayer
(and therefore to eliminate double taxation). In cases where residents of a coun-

2000–8 I.R.B.

try with which the United States might
desire a reciprocal exemption used vessels or aircraft documented or registered
under another flag, the unilateral U.S.
concession provided under prior law left
the country of residence little incentive to
exempt U.S. shippers. Congress was concerned that U.S.-based transportation
companies were at a competitive disadvantage because U.S. companies remained potentially subject to tax by the
countries in which their foreign competitors were organized and resident.
Congress amended the reciprocal exemption provisions of section 883 to rectify this situation. Tax Reform Act of
1986, section 1212, Public Law 99-514,
((1986–3 C.B. 1) (the 1986 Act)), as
amended by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA),
Public Law 100–647 (1988–3 C.B. 1), and
by the Omnibus Budget Reconciliation Act
of 1989, Public Law 101–239 (1990–1
C.B. 210), (the 1986 Act, as amended). It
is now irrelevant under section 883 where
a ship is documented or an aircraft is registered. Instead, section 883 provides that a
foreign corporation may qualify for the
reciprocal exemption only if it is organized
in a foreign country that grants corporations organized in the United States an
equivalent exemption with respect to income derived from the international operation of ships or aircraft. In addition, more
than 50 percent of the value of the stock of
the foreign corporation must be owned by
individuals who are residents of a foreign
country that grants corporations organized
in the United States an equivalent exemption. The 50 percent ownership requirement generally does not apply if the corporation is either a qualifying controlled
foreign corporation (CFC) or if its stock is
primarily and regularly traded on an established securities market in a qualified foreign country or the United States.
Since 1986, the United States and more
than 30 foreign countries have entered
into reciprocal exemption agreements incorporating the statutory amendments of
section 883. In addition, more than 60
countries now provide an equivalent exemption through domestic law or an income tax convention. The current regulations under §1.883–1, however, have not
been amended to reflect the statutory
changes enacted since 1986. This document proposes updated rules reflecting

655

the statutory changes.
Explanation of Provisions
General Rule
Section 1.883–1(a) provides the general rule. A foreign corporation engaged
in the international operation of a ship or
aircraft shall exclude from its gross income for U.S. Federal income tax purposes any income it derives from the international operation of ships or aircraft if
such income is qualified income under
paragraph (b) and if the corporation is a
qualified foreign corporation under paragraph (c).
Section 1.883–1(b) provides that qualified income is income that is properly includible in an income category described
in paragraph (h)(2) of this section and that
is the subject of an equivalent exemption
granted by the foreign country in which
the foreign corporation seeking qualified
foreign corporation status is organized.
Section 1.883–1(c)(1) describes the
general requirements that a foreign corporation must satisfy to be considered a
qualified foreign corporation. A qualified
foreign corporation is a corporation, as
defined in §§301.7701–2(b) and
301.7701–3, that is engaged in the international operation of ships or aircraft and
that is organized in a qualified foreign
country. A qualified foreign corporation
must also satisfy one of the three stock
ownership tests described in paragraph
(c)(2) of this section as well as the substantiation and reporting requirements described in paragraph (c)(3) of this section.
Paragraph (c)(2) describes the three
stock ownership tests. Generally, a foreign corporation must be able to demonstrate and document that more than fifty
percent of the value of its stock is owned
by qualified shareholders, as determined
under §1.883–4 (qualified shareholder
stock ownership test). However, a foreign corporation will not be required to
demonstrate that it satisfies the qualified
shareholder stock ownership test if it can
demonstrate either that its stock is primarily and regularly traded on an established
securities market in a qualified foreign
country or in the United States, as determined under §1.883–2 (publicly-traded
test), or that it is a qualifying controlled
foreign corporation as determined under
§1.883–3 (CFC test).

February 22, 2000

To satisfy the substantiation and reporting requirements described in paragraph
(c)(3) of this section, a foreign corporation must include the information set out
in that paragraph in its Form 1120F, “U.S.
Income Tax Return of a Foreign Corporation,” in such form and manner as the
Form 1120F and its accompanying instructions prescribe. The information to
be submitted with the return includes information set out in §§1.883–2(f),
1.883–3(d) and 1.883–4(e), as applicable,
relating to information demonstrating that
the foreign corporation satisfies one of the
three stock ownership tests. Section
1.883–5(c) provides a transition rule that
will require such information to be included in a statement attached to the return until the Form 1120F and its instructions are amended to conform to final
regulations under this section.
Paragraph (c)(3)(ii) provides that if the
Commissioner requests in writing that the
foreign corporation substantiate representations made under paragraph (c)(3)(i) of
this section, or under §1.883–2(f),
1.882–3(d) or 1.883–4(e), the foreign corporation must provide the supporting documentation or substantiation within 60
days following the written request. If the
foreign corporation does not provide all
of the information requested within the 60
day period but demonstrates that the failure was due to reasonable cause and not
willful neglect, the Commissioner may
grant the foreign corporation a 30-day extension to provide the supporting documentation or substantiation. Whether a
failure to obtain the documentation or
substantiation in a timely manner was due
to reasonable cause shall be determined
by the Commissioner after considering all
the facts and circumstances.
Paragraph (c)(4) contains a rule that allows the Commissioner to retain the right
to cure any defects in the documentation
where the Commissioner is satisfied that
the foreign corporation would otherwise
be a qualified foreign corporation.
Paragraph (d) defines a qualified foreign country as a foreign country that
grants an equivalent exemption to corporations organized in the United States for
the relevant category of qualified income
earned by the foreign corporation seeking
qualified foreign corporation status. A
foreign country may be a qualified foreign country with respect to one category

February 22, 2000

of income but not with respect to other
categories of income.
Operation of Ships or Aircraft
Section 1.883–1(e) explains what it
means to be engaged in the operation of
ships or aircraft for purposes of these proposed rules and provides examples of activities that are not treated as the operation of ships or aircraft. Under the
general rule, only a corporation that is an
owner, lessor, or lessee of an entire ship
or aircraft used to carry cargo or persons
for hire can be considered engaged in the
operation of ships or aircraft.
The term operation of ships or aircraft,
which includes the operation of a single
ship or aircraft, means: the carrying of
cargo or passengers for hire; the time or
voyage charter of a ship or the wet lease
of an aircraft, as those terms are defined
in the regulations; and the bareboat charter of a ship or the dry lease of an aircraft,
as those terms are defined in the regulations. The term also includes active participation by a corporation that is otherwise engaged in the operation of ships or
aircraft in a pool, partnership, strategic alliance, joint operating agreement or code
sharing arrangement, or other joint venture that is itself engaged in the operation
of ships or aircraft.
Paragraph (e)(2) provides as examples
that activities of the following will not be
considered operation of ships or aircraft:
a non-vessel operating common carrier
(an NVOCC); a space or slot charterer; a
ship management company; a company
that obtains ships crews; a ship’s agent; a
ship or aircraft broker; a freight forwarder; a travel agent; a tour operator; a
pure container leasing company; a passive
investor in a shipping or aircraft business;
or a concessionaire. The proposed rule
also provides the definitions of a number
of relevant terms.
International Operation of Ships or
Aircraft
Section 1.883–1(f) distinguishes international from domestic operation of ships or
aircraft. In TAMRA, Congress directed
that transportation income derived solely
from sources within the United States
under section 863(c)(1) should not be
granted exemption from U.S. income taxation under section 883. Congress also specified, however, that the reciprocal exemption generally should be available for

656

income from international transport activity
that is treated as 50 percent U.S. source income under section 863(c)(2). This is the
same type of income on which the gross
basis tax of section 887 generally would be
imposed. See, S. Rep. No. 100-445, 100th
Cong., 2d Sess. 241-242 (1988). However,
the reciprocal exemption may not necessarily be available to all types of persons earning that type of income.
To carry out Congress’s intent,
§1.883–1(f)(1) defines the term international operation to mean the operation of
ships or aircraft on voyages or flights that
begin or end in the United States and correspondingly end or begin in a foreign
country, determined on a passenger-bypassenger or cargo-by-cargo basis, as discussed below. The term specifically excludes a “cruise to nowhere” that begins
in a U.S. port, travels out into open waters
beyond the territorial limits of the United
States, and then returns to the U.S. port of
origin without touching a foreign port
during the voyage. The fact that a ship
travels beyond United States territorial
limits does not, in itself, constitute international operation of ships or aircraft if
there is no stop in a foreign country, as
determined under paragraph (f)(2). The
same rules apply for aircraft.
Paragraph (f)(2) provides rules for determining the beginning and ending
points of a voyage for purposes of the definition of the term international operation. Except in the case of a round trip
cruise, the carriage of a passenger will be
treated as ending at the passenger’s final
destination even if, en route to the passenger’s final destination, a stop is made at a
U.S. intermediate point for refueling,
maintenance, or other business reasons,
provided the passenger does not change
aircraft or ships at the U.S. intermediate
point. Similarly, carriage of a passenger
will be treated as beginning at the passenger’s point of origin even if en route to the
passenger’s final destination, a stop is
made at a U.S. intermediate point provided the passenger does not change aircraft or ships at the U.S. intermediate
point. Carriage of a passenger will be
treated as beginning or ending at a U.S.
intermediate point if the passenger
changes aircraft or ships at that location.
See, H.R. Rep No. 432, 98th Cong., 2d
Sess. 1340 (1984); H.R. Rep. No. 861,
98th Cong., 2d Sess. 934 (1984).

2000–8 I.R.B.

The carriage of a passenger on a round
trip cruise that begins in the United States
and stops at one or more foreign ports for
day excursions, maintenance or other
business reasons, and returns to the same
or another U.S. port will be treated as the
international operation of a ship. Pursuant to paragraph (f)(2)(i)(A) such a
round trip cruise may also include one or
more intermediate stops at a U.S. port or
ports for similar purposes.
Carriage of cargo will be treated as
ending at the final destination of the cargo
even if, en route to that final destination, a
stop is made at a U.S. intermediate point,
provided that the cargo is transported to
its ultimate destination on the same ship
or aircraft, or provided the same taxpayer
transports the cargo to and from the U.S.
intermediate point and the cargo does not
pass through customs at the U.S. intermediate point. Similarly, carriage of cargo
will be treated as beginning at the cargo’s
point of origin even if, en route to its final
destination, a stop is made at a U.S. intermediate point, provided that the cargo is
transported to its ultimate destination on
the same ship or aircraft or provided both
that the same taxpayer transports the
cargo on both legs of the trip and that the
cargo does not pass through customs at
the U.S. intermediate point. Repackaging, recontainerization, or any other activity involving the unloading of the cargo at
the U.S. intermediate point will not
change these results. See, H.R. Rep No.
432, 98th Cong., 2d Sess. 1340 (1984);
H.R. Rep. No. 861, 98th Cong., 2d Sess.
934 (1984), reprinted in 1984–3 C.B.
Vol.2., 1, 188.
Whether income is from international
operation is generally to be determined on
a passenger-by-passenger and item of
cargo-by-item of cargo basis. In the case
of income from the bareboat charter of a
ship or the dry lease of an aircraft,
whether the charter income is derived
from international operation is determined by reference to the use of the ship
or aircraft by the lowest-tier lessee-operator in the chain of lessees.
A person that is the lessor of a ship
under a bareboat charter or of an aircraft
under a dry lease will be treated as engaged in the international operation of
such ship or aircraft to the extent that the
lowest-tier lessee-operator in the chain of
ownership uses such ship or aircraft for

2000–8 I.R.B.

the international carriage of passengers or
cargo for hire during the shorter of the period of the charter or the taxable year.
Paragraph (f)(2)(iii) adopts the guidance
in section 5.02 of Rev. Proc. 91–12
(1991–1 C.B. 473), for determining the
amount of income from the bareboat charter of a ship or the dry lease of an aircraft
that is treated as derived from the international operation of the ship or aircraft.
The rule provides that a foreign corporation must use a reasonable method for determining the proportion of the charter income that is attributable to such
international operation.
One reasonable method, described in
§1.883–1(f)(2)(iii)(A), is based on the
proportion of the days in the term of the
charter or the taxable year, whichever is
shorter, that the ship or aircraft is used in
international operation by the lowest tier
lessee-operator in its chain of lessees. For
this purpose, the number of days during
which the ship or aircraft is not generating
transportation income, within the meaning of section 863(c)(2) (for example,
days during which the ship or aircraft is
out of service while being repaired or
maintained) should not be included in the
numerator of the ratio. Another reasonable method described in paragraph
(f)(2)(iii)(B) is based on the proportion of
the gross income of the lowest tier lesseeoperator of the ship or aircraft derived
from the international operation of the
ship or aircraft during the taxable year.
An allocation based on the net income of
such lessee-operator will not be considered reasonable for this purpose due to the
administrative difficulties involved in determining and verifying the proper allocation of the operator’s expenses.
Activities Incidental to International
Operations
Some corporations engaged in the operation of ships or aircraft earn income
from activities that are so closely related
to the primary activity of operation of
ships or aircraft that it is appropriate to
exclude income from these activities from
taxation under section 883 of the Code.
By contrast, in cases where the operator’s
activities are not so closely related to the
primary activity of operation of ships or
aircraft, it is not appropriate to exclude
the income from such activities from taxation.
The purpose of §1.883–1(g) is to pro-

657

vide rules for determining when a closely
related activity is incidental to the business of the international operation of
ships or aircraft. Paragraph (g)(1) provides examples of activities that will be
considered incidental to the international
operation of ships or aircraft. For example, where a ship operator contracts for
the international carriage of cargo or passengers on a second operator’s ship, the
activity may be incidental to the international operation of a ship by the first operator. Other examples are: the temporary
investment of working capital funds; the
sale of tickets for international travel by a
ship operator for another ship operator, or
by an air carrier for another air carrier; the
rental by the operator of a ship or aircraft
of containers and related equipment used
in connection with the international operation of its ship or aircraft; and bareboat
charter of ships or aircraft normally operated on international voyages or flights
but currently not needed by the operator,
and that are used for international voyages or flights by the lessee/charterer.
If an operator enters into a contract that
requires a concessionaire to provide services onboard during the international operation of the operator’s ship or aircraft
and if the operator receives income from
such services, then the income of the operator is appropriately treated as incidental to the operation of the ship or aircraft
by the operator.
Paragraph (g)(2) provides examples of
activities that are not considered incidental to the international operation of ships
or aircraft. These examples include: the
sale of or arranging for train travel, bus
transfers, land tour packages, or port city
hotel accommodations within the United
States or a foreign country; and the sale of
airline tickets by a cruise ship operator or
cruise tickets by an air carrier. Further
examples include the sale or rental of U.S.
real property; treasury activities involving
the investment of excess funds or funds
awaiting repatriation generated by the operation of ships or aircraft; rental of containers for a domestic leg of transportation in connection with international
carriage of cargo; mere passive investment in an enterprise engaged in the international operation of ships or aircraft; services performed by the operator for
parti

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3Abcf07d0853b45aa4. Public record. Not legal advice.