Recharacterizing Financing Arrangements Involving Fast-Pay Stock

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8853]

RIN 1545-AV07

Recharacterizing Financing Arrangements Involving Fast-Pay Stock

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that recharacterize,

for tax purposes, financing arrangements involving fast-pay stock. The

regulations are necessary to prevent taxpayers from using fast-pay

stock to achieve inappropriate tax avoidance. The regulations affect

corporations that issue fast-pay stock, holders of fast-pay stock, and

other shareholders that may claim tax benefits purported to result from

arrangements involving fast-pay stock.

DATES: Effective Date: February 27, 1997.

Applicability Dates: For dates of applicability, see Secs. 1.1441-

10(e) and 1.7701(l)-3(g) of these regulations.

FOR FURTHER INFORMATION CONTACT: Jonathan Zelnik, (202) 622-3920 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations

has 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(d)) under control number 1545-1642. Responses to this collection

of information are mandatory.

An agency may not conduct or sponsor, and a person is not required

to respond to, a collection of information unless the collection of

information displays a valid control number.

The estimated average annual burden hours per respondent/

recordkeeper: 1 hour.

Comments concerning the accuracy of this burden estimate and

suggestions for reducing this burden should be sent to the Internal

Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and 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.

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 information are confidential, as required by 26 U.S.C. 6103.

Background

On February 27, 1997, the IRS issued Notice 97-21, 1997-1 C.B. 407,

which relates to financing arrangements involving fast-pay stock. Among

other things, the notice informed the public that the IRS and Treasury

Department expected to issue regulations recharacterizing these

arrangements to prevent tax avoidance. No comments were received in

response to Notice 97-21.

On January 6, 1999, the IRS published in the Federal Register a

notice of proposed rulemaking (64 FR 805) providing rules for the

recharacterization of certain fast-pay arrangements under section

7701(l) of the Internal Revenue Code. Because no one requested to speak

at the public hearing, the hearing was canceled. Four written comments

responding to the notice of proposed rulemaking were received. The

comments addressed neither (1) the accuracy of the estimate of the

collection of information burden nor (2) the accuracy of the IRS's

understanding that the total number of entities engaging in

transactions affected by these regulations is not substantial and most

are not small entities within the meaning of the Regulatory Flexibility

Act (5 U.S.C. chapter 6). After considering the comments, the proposed

regulations are adopted as final regulations with some changes.

The preamble to the proposed regulations (64 FR 805) provides a

detailed discussion of fast-pay arrangements and the proposed

regulations.

Summary of Comments and Changes

In General

Two commentators were generally favorable to the proposed

regulations. One considered them a reasonable attempt to address

abusive transactions. The other viewed them as consistent with section

7701(l), but preferred, as a matter of tax policy, a legislative

solution. One of these commentators also recommended narrowing the

scope of the proposed regulations, asserting they might penalize

shareholders who do not benefit from the fast-pay arrangement.

Significantly, neither of these commentators recommended that the final

regulations adopt a different approach, such as the one taken in Notice

97-21.

A third commentator criticized the proposed regulations as

inconsistent with section 7701(l). This commentator viewed them as

addressing not a conduit financing issue, but a tax accounting issue,

namely, that the amount of dividend income under tax principles can

exceed the economic income from the stock. Additionally, this

commentator believed that regulations under section 7701(l) cannot

operate if there is no back-to-back structure or if the corporation

subject to recharacterization holds bona fide assets such as third-

party debt. Finally, the commentator questioned whether the grant of

regulatory authority under section 7701(l) permits recharacterizing

transactions subject to other, comprehensive statutory rules such as

the rules governing the transactions of RICs and REITs.

The IRS and Treasury Department have concluded that section 7701(l)

authorizes recharacterization of any multiple-party financing

transaction, including a fast-pay arrangement. The IRS and Treasury

Department have also concluded (as did the other two commentators) that

recharacterizing a fast-pay arrangement as an arrangement directly

between the fast-pay shareholders and the benefited shareholders is

consistent with the legislative mandate of section 7701(l). Thus, the

final regulations retain the approach of the proposed regulations while

making some changes to address other comments.

Definition of Fast-Pay Stock

Under the proposed regulations, stock is fast-pay stock if it is

structured so that dividends (as defined in section 316) paid by the

corporation with respect to the stock are economically (in whole or in

part) a return of the holder's investment (as opposed to only a return

on the holder's investment). To determine if it is fast-pay stock,

stock is examined when issued, and, for stock that is not fast-pay

stock when issued, when there is a significant modification in the

terms of the stock or the related agreements or a significant change in

the relevant facts and circumstances.

Two commentators expressed concern about the interaction of section

302 with the definition of fast-pay stock and the duty to retest stock.

In particular, the commentators asked whether stock that is not fast-

pay stock when issued can become fast-pay stock solely because a

redemption of the stock is treated as a dividend under section 302.

This conversion is possible because section 302 treats certain

redemptions as distributions of property to which

[[Page 1311]]

section 301 applies rather than as distributions in exchange for stock.

The commentators gave different reasons why stock should not become

fast-pay stock solely because a redemption is treated as a dividend.

One reason was that section 302 and the provisions referring to it (for

example, section 1059(e)) already recharacterize certain redemptions of

stock, which indicates Congress has determined the appropriate tax

treatment of these transactions. Another reason was that applying the

fast-pay regulations to arrangements involving redemptions may have a

chilling effect on common, non-abusive transactions. Finally, it was

suggested that any changes affecting the application of section 302

should be accomplished by issuing new regulations under that statute.

The IRS and Treasury Department agree it is inappropriate to treat

as a fast-pay arrangement every arrangement in which a redemption of

stock produces dividend income under section 302. The IRS and Treasury

Department, however, conclude that eliminating all such arrangements

from the scope of the regulations would render the regulations

meaningless. Little difference exists between a fast-pay arrangement

resulting from redemptions structured to be dividends and a fast-pay

arrangement resulting from dividends structured to be a return of the

holder's investment.

To balance the concerns of the commentators and the concerns of the

IRS and Treasury Department, the final regulations add a new rule

clarifying the effect of section 302 on the determination of whether

stock is fast-pay stock. Under this rule, stock is not fast-pay stock

solely because a redemption is treated as a dividend by section 302

unless there is a principal purpose of achieving the same economic and

tax effect as a fast-pay arrangement. In this way, only those

arrangements in which redemptions are designed to return a

shareholder's economic investment as dividends are recharacterized.

Because the problem of stock redemptions may be common to many

different fast-pay arrangements, regardless of how they are structured,

the rule addressing such problem is placed within the regulations under

section 7701(l) rather than under a different section.

Characterization of the Financing Instruments

Under the proposed regulations, the fast-pay shareholders are

treated as holding financing instruments issued by the benefited

shareholders rather than as holding the fast-pay stock. The character

of financing instruments (for example, stock or debt) is determined

under general tax principles and depends on all the facts and

circumstances.

All three commentators were concerned by the failure of the

proposed regulations to classify the financing instruments as debt. If

the financing instruments are classified as stock, the benefited

shareholders are subject to substantially greater tax liabilities: they

must include in income all dividends paid by the corporation that

issues the fast-pay stock, but cannot deduct amounts deemed paid with

respect to the financing instruments. According to the commentators,

this result distorts the benefited shareholders' economic income.

Therefore, the regulations should classify the financing instruments as

debt in all cases.

After careful consideration of the comments, the IRS and Treasury

Department have decided against characterizing the financing

instruments in the final regulations. Although debt characterization

may be appropriate in some cases, in other cases it will be more

appropriate to characterize the financing instruments as equity or

something else. Thus, the rule in the proposed regulations is retained.

(As explained below, however, the final regulations permit taxpayers,

for a limited period, to determine their taxable income attributable to

a recharacterized fast-pay arrangement by treating the financing

instruments as debt.)

Election to Limit Taxable Income Attributable to a Recharacterized

Fast-Pay Arrangement for Periods Before April 1, 2000

Because the regulations are effective February 27, 1997 (the date

Notice 97-21 was issued to the public), the proposed regulations permit

a shareholder of a recharacterized fast-pay arrangement to limit, for

certain taxable years, its income from the arrangement. Specifically, a

shareholder may limit its taxable income attributable to a

recharacterized fast-pay arrangement to the taxable income that results

if the fast-pay arrangement is recharacterized under Notice 97-21. This

limit is available under the proposed regulations for taxable years

ending after the effective date of the regulations and before the

regulations are finalized. Any amount excluded under this limit must be

included as an adjustment to taxable income in the shareholder's first

taxable year that includes the date the regulations are finalized.

Thus, the sole benefit of limiting taxable income under the proposed

regulations is a timing benefit. The preamble to the proposed

regulations found this appropriate on the assumption that over the life

of a fast-pay arrangement a shareholder has the same amount of taxable

income whether the fast-pay arrangement is recharacterized under Notice

97-21 or under the regulations.

One commentator criticized this assumption, and, therefore, the

limit and later adjustment. In particular, the commentator pointed out

that if the financing instruments are treated as equity under the

regulations, a benefited shareholder would have had less taxable income

over the life of the fast-pay arrangement under the recharacterization

of Notice 97-21 (that is, a shareholder would have a permanent

reduction to taxable income). Thus, the limit is without any

substantive effect because any non-timing reduction in taxable income

due to the limit is included in the year the regulations are finalized.

To rectify this problem, the commentator asked that, if the final

regulations do not classify the financing instruments as debt in all

cases, they should at least classify the financing instruments as debt

for the period starting after the effective date of the final

regulations and ending before the final regulations are published.

To address these concerns, the final regulations adopt a different

rule from the one in the proposed regulations. As with the proposed

regulations, a shareholder may limit its taxable income to either the

amount determined under Notice 97-21 or the amount determined under the

regulations. For purposes of this limit, a shareholder may assume the

financing instruments are debt under the final regulations. A

shareholder may also make this assumption to determine the amount of

any later adjustment to income because of the limit. Thus, the later

adjustment will not include any permanent reduction to taxable income a

shareholder realizes by limiting its taxable income to the amount

determined under Notice 97-21.

The final regulations also adopt a longer period during which

shareholders may limit their taxable income. Under the proposed

regulation, a shareholder may limit its taxable income for taxable

years ending after February 26, 1997, and before the date these

regulations are published as final regulations in the Federal Register.

The final regulations permit a shareholder to limit its taxable income

for all periods before April 1, 2000. Thus, for all taxable years

ending after February 26, 1997 and before April 1, 2000, and for that

part of a shareholder's taxable year before April 1, 2000, a

shareholder may

[[Page 1312]]

limit its taxable income attributable to the fast-pay arrangement.

In permitting shareholders to determine their taxable income under

the regulations by assuming that the financing instruments are debt for

periods before April 1, 2000, the IRS and Treasury Department intend no

implication regarding the proper characterization of the financing

instruments under general tax principles. Rather, the rule regarding

the financing instruments is intended solely for the purpose of giving

shareholders the benefit of the recharacterization described in Notice

97-21 for periods before April 1, 2000.

Use of Derivatives To Avoid the Regulations

One commentator recommended adding an explicit rule to prevent

parties from using derivative contracts to create a fast-pay

arrangement that escapes either the regulations or the effect of the

recharacterization rules. To illustrate this point, the commentator

posited a simplified transaction in which a corporation issues fast-pay

stock to one tax-exempt entity and benefited stock to another tax-

exempt entity. The tax-exempt entity holding the benefited stock enters

into a prepaid forward contract with a taxable person. Under the

prepaid forward contract, the taxable person must buy the benefited

stock in the future for an amount substantially below its expected

value. According to the commentator, unless the taxable person is

treated as owning the benefited stock, the parties have created a fast-

pay arrangement in which the recharacterization of the regulations

fails to prevent tax avoidance. Without making a recommendation, the

commentator offered a number of rules to correct this situation. (The

commentator did not discuss whether the benefited holder would be

subject to the ``debt-financing'' rules in section 514).

The IRS and Treasury Department have concluded that there is no

present need to modify the regulations to address this problem. First,

the tax treatment of derivatives in general is outside of the scope of

these regulations. Therefore, a rule specific to these regulations

would only increase the complexity regarding the tax treatment of

derivatives. Second, and more importantly, the IRS and Treasury

Department have concluded that under existing law the party entitled to

purchase the benefited stock under a prepaid forward contract such as

the one described above is the owner of the benefited stock for federal

income tax purposes. See Rev. Rul. 82-150, 1982-2 C.B. 110 (concluding

that the holder of a deep-in-the-money option is the owner of the

reference property). Finally, the regulations state they are to be

interpreted in a manner consistent with preventing the avoidance of

tax. Mechanically applying the regulations in a manner that does not

prevent tax avoidance is clearly inconsistent with the purpose of the

regulations and the Congressional mandate of section 7701(l).

Fast-Pay Arrangement Defined

The proposed regulations define a fast-pay arrangement as any

arrangement in which a corporation has outstanding for any part of its

taxable year two or more classes of stock, at least one of which is

fast-pay stock. Some taxpayers assert that the regulations can be

avoided by creating a fast-pay arrangement in which a corporation

issues what is nominally a single class of shares, notwithstanding that

some of the shares are subject to a related agreement. These taxpayers

apparently rely on the formal meaning of ``class'' under state

corporate law and ignore the direction in the proposed regulations to

determine whether stock is fast-pay stock based on all the facts and

circumstances.

To remove any doubt that the regulations cover fast-pay

arrangements no matter how contrived, the IRS and Treasury Department

have simplified the definition of ``fast-pay arrangement'' in the final

regulations. Under this definition, a fast-pay arrangement is any

arrangement in which a corporation has fast-pay stock outstanding for

any part of its taxable year. The regulations illustrate this point

with an example.

Effective Date

These regulations apply to taxable years ending after February 26,

1997.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in Executive Order 12866.

Therefore, a regulatory assessment is not required. It is hereby

certified that these regulations will not have a significant economic

impact on a substantial number of small entities. This certification is

based on the understanding of the IRS and Treasury Department that the

total number of fast-pay arrangements is fewer than 100, that the

number of entities engaging in transactions affected by these

regulations is not substantial and, of those entities, few or none are

small entities within the meaning of the Regulatory Flexibility Act (5

U.S.C. chapter 6). 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 comments on its impact on small businesses.

Drafting Information

The principal authors of these regulations are Jonathan Zelnik and

Marshall Feiring of the Office of the Assistant Chief Counsel

(Financial Institutions & Products). However, other personnel from the

IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding

an entry in numerical order to read in part as follows:

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

Section 1.7701(l)-3 also issued under 26 U.S.C. 7701(l). * * *

Par. 2. Section 1.1441-10, is added to read as follows:

Sec. 1.1441-10 Withholding agents with respect to fast-pay

arrangements.

(a) In general. A corporation that issues fast-pay stock in a fast-

pay arrangement described in Sec. 1.7701(l)-3(b)(1) is a withholding

agent with respect to payments made on the fast-pay stock and payments

deemed made under the recharacterization rules of Sec. 1.7701(l)-3.

Except as provided in this paragraph (a) or in paragraph (b) of this

section, the withholding tax rules under section 1441 and section 1442

apply with respect to a fast-pay arrangement described in

Sec. 1.7701(l)-3(c)(1)(i) in accordance with the recharacterization

rules provided in Sec. 1.7701(l)-3(c). In all cases, notwithstanding

paragraph (b) of this section, if at any time the withholding agent

knows or has reason to know that the Commissioner has exercised the

discretion under either Sec. 1.7701(l)-3(c)(1)(ii) to apply the

recharacterization rules of Sec. 1.7701(l)-

[[Page 1313]]

3(c), or Sec. 1.7701(l)-3(d) to depart from the recharacterization

rules of Sec. 1.7701(l)-3(c) for a taxpayer, the withholding agent must

withhold on payments made (or deemed made) to that taxpayer in

accordance with the characterization of the fast-pay arrangement

imposed by the Commissioner under Sec. 1.7701(l)-3.

(b) Exception. If at any time the withholding agent knows or has

reason to know that any taxpayer entered into a fast-pay arrangement

with a principal purpose of applying the recharacterization rules of

Sec. 1.7701(l)-3(c) to avoid tax under section 871(a) or section 881,

then for each payment made or deemed made to such taxpayer under the

arrangement, the withholding agent must withhold, under section 1441 or

section 1442, the higher of--

(1) The amount of withholding that would apply to such payment

determined under the form of the arrangement; or

(2) The amount of withholding that would apply to deemed payments

determined under the recharacterization rules of Sec. 1.7701(l)-3(c).

(c) Liability. Any person required to deduct and withhold tax under

this section is made liable for that tax by section 1461, and is also

liable for applicable penalties and interest for failing to comply with

section 1461.

(d) Examples. The following examples illustrate the rules of this

section:

Example 1. REIT W issues shares of fast-pay stock to foreign

individual A, a resident of Country C. United States source

dividends paid to residents of C are subject to a 30 percent

withholding tax. W issues all shares of benefited stock to foreign

individuals who are residents of Country D. D's income tax

convention with the United States reduces the United States

withholding tax on dividends to 15 percent. Under Sec. 1.7701(l)-

3(c), the dividends paid by W to A are deemed to be paid by W to the

benefited shareholders. W has reason to know that A entered into the

fast-pay arrangement with a principal purpose of using the

recharacterization rules of Sec. 1.7701(l)-3(c) to reduce United

States withholding tax. W must withhold at the 30 percent rate

because the amount of withholding that applies to the payments

determined under the form of the arrangement is higher than the

amount of withholding that applies to the payments determined under

Sec. 1.7701(l)-3(c).

Example 2. The facts are the same as in Example 1 of this

paragraph (d) except that W does not know, or have reason to know,

that A entered into the arrangement with a principal purpose of

using the recharacterization rules of Sec. 1.7701(l)-3(c) to reduce

United States withholding tax. Further, the Commissioner has not

exercised the discretion under Sec. 1.7701(l)-3(d) to depart from

the recharacterization rules of Sec. 1.7701(l)-3(c). Accordingly, W

must withhold tax at a 15 percent rate on the dividends deemed paid

to the benefited shareholders.

(e) Effective date. This section applies to payments made (or

deemed made) on or after January 6, 1999.

Par. 3. Section 1.7701(l)-0 is added to read as follows:

Sec. 1.7701(l)-0 Table of contents.

This section lists captions that appear in Secs. 1.7701(l)-1 and

1.7701(l)-3:

Sec. 1.7701(l)-1 Conduit financing arrangements.

Sec. 1.7701(l)-3 Recharacterizing financing arrangements involving

fast-pay stock.

(a) Purpose and scope.

(b) Definitions.

(1) Fast-pay arrangement.

(2) Fast-pay stock.

(i) Defined.

(ii) Determination.

(3) Benefited stock.

(c) Recharacterization of certain fast-pay arrangements.

(1) Scope.

(2) Recharacterization.

(i) Relationship between benefited shareholders and fast-pay

shareholders.

(ii) Relationship between benefited shareholders and

corporation.

(iii) Relationship between fast-pay shareholders and

corporation.

(3) Other rules.

(i) Character of the financing instruments.

(ii) Multiple types of benefited stock.

(iii) Transactions affecting benefited stock.

(A) Sale of benefited stock.

(B) Transactions other than sales.

(iv) Adjustment to basis for amounts accrued or paid in taxable

years ending before February 27, 1997.

(d) Prohibition against affirmative use of recharacterization by

taxpayers.

(e) Examples.

(f) Reporting requirement.

(1) Filing requirements.

(i) In general.

(ii) Controlled foreign corporation.

(iii) Foreign personal holding company.

(iv) Passive foreign investment company.

(2) Statement.

(g) Effective date.

(1) In general.

(2) Election to limit taxable income attributable to a

recharacterized fast-pay arrangement for periods before April 1,

2000.

(i) Limit.

(ii) Adjustment and statement.

(iii) Examples.

(3) Rule to comply with this section.

(4) Reporting requirements.

Par. 4. Section 1.7701(l)-3 is added to read as follows:

Sec. 1.7701(l)-3 Recharacterizing financing arrangements involving

fast-pay stock.

(a) Purpose and scope. This section is intended to prevent the

avoidance of tax by persons participating in fast-pay arrangements (as

defined in paragraph (b)(1) of this section) and should be interpreted

in a manner consistent with this purpose. This section applies to all

fast-pay arrangements. Paragraph (c) of this section recharacterizes

certain fast-pay arrangements to ensure the participants are taxed in a

manner reflecting the economic substance of the arrangements. Paragraph

(f) of this section imposes reporting requirements on certain

participants.

(b) Definitions--(1) Fast-pay arrangement. A fast-pay arrangement

is any arrangement in which a corporation has fast-pay stock

outstanding for any part of its taxable year.

(2) Fast-pay stock--(i) Defined. Stock is fast-pay stock if it is

structured so that dividends (as defined in section 316) paid by the

corporation with respect to the stock are economically (in whole or in

part) a return of the holder's investment (as opposed to only a return

on the holder's investment). Unless clearly demonstrated otherwise,

stock is presumed to be fast-pay stock if--

(A) It is structured to have a dividend rate that is reasonably

expected to decline (as opposed to a dividend rate that is reasonably

expected to fluctuate or remain constant); or

(B) It is issued for an amount that exceeds (by more than a de

minimis amount, as determined under the principles of Sec. 1.1273-1(d))

the amount at which the holder can be compelled to dispose of the

stock.

(ii) Determination. The determination of whether stock is fast-pay

stock is based on all the facts and circumstances, including any

related agreements such as options or forward contracts. A related

agreement includes any direct or indirect agreement or understanding,

oral or written, between the holder of the stock and the issuing

corporation, or between the holder of the stock and one or more other

shareholders in the corporation. To determine if it is fast-pay stock,

stock is examined when issued, and, for stock that is not fast-pay

stock when issued, when there is a significant modification in the

terms of the stock or the related agreements or a significant change in

the relevant facts and circumstances. Stock is not fast-pay stock

solely because a redemption is treated as a dividend as a result of

section 302(d) unless there is a principal purpose of achieving the

same economic and tax effect as a fast-pay arrangement.

(3) Benefited stock. With respect to any fast-pay stock, all other

stock in the corporation (including other fast-pay stock having any

significantly different characteristics) is benefited stock.

(c) Recharacterization of certain fast-pay arrangements--(1) Scope.

This paragraph (c) applies to any fast-pay arrangement--

[[Page 1314]]

(i) In which the corporation that has outstanding fast-pay stock is

a regulated investment company (RIC) (as defined in section 851) or a

real estate investment trust (REIT) (as defined in section 856); or

(ii) If the Commissioner determines that a principal purpose for

the structure of the fast-pay arrangement is the avoidance of any tax

imposed by the Internal Revenue Code. Application of this paragraph

(c)(1)(ii) is at the Commissioner's discretion, and a determination

under this paragraph (c)(1)(ii) applies to all parties to the fast-pay

arrangement, including transferees.

(2) Recharacterization. A fast-pay arrangement described in

paragraph (c)(1) of this section is recharacterized as an arrangement

directly between the benefited shareholders and the fast-pay

shareholders. The inception and resulting relationships of the

recharacterized arrangement are deemed to be as follows:

(i) Relationship between benefited shareholders and fast-pay

shareholders. The benefited shareholders issue financial instruments

(the financing instruments) directly to the fast-pay shareholders in

exchange for cash equal to the fair market value of the fast-pay stock

at the time of issuance (taking into account any related agreements).

The financing instruments have the same terms (other than issuer) as

the fast-pay stock. Thus, for example, the timing and amount of the

payments made with respect to the financing instruments always match

the timing and amount of the distributions made with respect to the

fast-pay stock.

(ii) Relationship between benefited shareholders and corporation.

The benefited shareholders contribute to the corporation the cash they

receive for issuing the financing instruments. Distributions made with

respect to the fast-pay stock are distributions made by the corporation

with respect to the benefited shareholders' benefited stock.

(iii) Relationship between fast-pay shareholders and corporation.

For purposes of determining the relationship between the fast-pay

shareholders and the corporation, the fast-pay stock is ignored. The

corporation is the paying agent of the benefited shareholders with

respect to the financing instruments.

(3) Other rules--(i) Character of the financing instruments. The

character of a financing instrument (for example, stock or debt) is

determined under general tax principles and depends on all the facts

and circumstances.

(ii) Multiple types of benefited stock. If any benefited stock has

any significantly different characteristics from any other benefited

stock, the recharacterization rules of this paragraph (c) apply among

the different types of benefited stock as appropriate to match the

economic substance of the fast-pay arrangement.

(iii) Transactions affecting benefited stock--(A) Sale of benefited

stock. If one person sells benefited stock to another--

(1) In addition to any consideration actually paid and received for

the benefited stock, the buyer is deemed to pay and the seller is

deemed to receive the amount necessary to terminate the seller's

position in the financing instruments at fair market value; and

(2) The buyer is deemed to issue financing instruments to the fast-

pay shareholders in exchange for the amount necessary to terminate the

seller's position in the financing instruments.

(B) Transactions other than sales. Except for transactions subject

to paragraph (c)(3)(iii)(A) of this section, in the case of any

transaction affecting benefited stock, the parties to the transaction

must make appropriate adjustments to properly take into account the

fast-pay arrangement as characterized under paragraph (c)(2) of this

section.

(iv) Adjustment to basis for amounts accrued or paid in taxable

years ending before February 27, 1997. In the case of a fast-pay

arrangement involving amounts accrued or paid in taxable years ending

before February 27, 1997, and recharacterized under this paragraph (c),

a benefited shareholder must decrease its basis in any benefited stock

(as determined under paragraph (c)(2)(ii) of this section) by the

amount (if any) that--

(A) Its income attributable to the benefited stock (reduced by

deductions attributable to the financing instruments) for taxable years

ending before February 27, 1997, computed by recharacterizing the fast-

pay arrangement under this paragraph (c) and by treating the financing

instruments as debt; exceeds

(B) Its income attributable to such stock for taxable years ending

before February 27, 1997, computed without applying the rules of this

paragraph (c).

(d) Prohibition against affirmative use of recharacterization by

taxpayers. A taxpayer may not use the rules of paragraph (c) of this

section if a principal purpose for using such rules is the avoidance of

any tax imposed by the Internal Revenue Code. Thus, with respect to

such taxpayer, the Commissioner may depart from the rules of this

section and recharacterize (for all purposes of the Internal Revenue

Code) the fast-pay arrangement in accordance with its form or its

economic substance. For example, if a foreign person acquires fast-pay

stock in a REIT and a principal purpose for acquiring such stock is to

reduce United States withholding taxes by applying the rules of

paragraph (c) of this section, the Commissioner may, for purposes of

determining the foreign person's United States tax consequences

(including withholding tax), depart from the rules of paragraph (c) of

this section and treat the foreign person as holding fast-pay stock in

the REIT.

(e) Examples. The following examples illustrate the rules of

paragraph (c) of this section:

Example 1. Decline in dividend rate--(i) Facts. Corporation X

issues 100 shares of A Stock and 100 shares of B Stock for $1,000

per share. By its terms, a share of B Stock is reasonably expected

to pay a $110 dividend in years 1 through 10 and a $30 dividend each

year thereafter. If X liquidates, the holder of a share of B Stock

is entitled to a preference equal to the share's issue price.

Otherwise, the B Stock cannot be redeemed at either X's or the

shareholder's option.

(ii) Analysis. When issued, the B Stock has a dividend rate that

is reasonably expected to decline from an annual rate of 11 percent

of its issue price to an annual rate of 3 percent of its issue

price. Since the B Stock is structured to have a declining dividend

rate, the B Stock is fast-pay stock, and the A Stock is benefited

stock.

Example 2. Issued at a premium--(i) Facts. The facts are the

same as in Example 1 of this paragraph (e) except that a share of B

Stock is reasonably expected to pay an annual $110 dividend as long

as it is outstanding, and Corporation X has the right to redeem the

B Stock for $400 a share at the end of year 10.

(ii) Analysis. The B Stock is structured so that the issue price

of the B Stock ($1,000) exceeds (by more than a de minimis amount)

the price at which the holder can be compelled to dispose of the

stock ($400). Thus, the B Stock is fast-pay stock, and the A Stock

is benefited stock.

Example 3. Planned section 302(d) redemptions--(i) Facts.

Corporation L, a subchapter C corporation, issues 220 shares of

common stock for $1,000 per share. No other stock is authorized, but

L can issue warrants entitling the holder to acquire L common stock

for $3,000 per share until such time as L adopts a plan of

liquidation. L can adopt a plan of liquidation if approved by 90

percent of its shareholders. Half of L's stock is purchased by

Corporation M, and half by Organization N, which is tax exempt. At

the time of purchase, M and N agree that for a period of ten years L

will annually redeem (and N will tender) ten shares of stock in

exchange for $12,100 and ten warrants. It is anticipated that, under

sections 302 and 301, the annual payment to N will be a distribution

of property that is a dividend.

(ii) Analysis. Considering all the facts and circumstances,

including the agreement between M and N, L's redemption of N's stock

is undertaken with a principal purpose of achieving the same

economic and tax

[[Page 1315]]

effect as a fast-pay arrangement. Thus, N's stock is fast-pay stock,

M's stock is benefited stock, and the parties have entered into a

fast-pay arrangement. Because L is neither a RIC nor a REIT, whether

this fast-pay arrangement is recharacterized under paragraph (c) of

this section depends on whether the Commissioner determines, under

paragraph (c)(1)(ii) of this section, that a principal purpose for

the structure of the fast-pay arrangement is the avoidance of any

tax imposed by the Internal Revenue Code.

Example 4. Recharacterization illustrated--(i) Facts. On

formation, REIT Y issues 100 shares of C Stock and 100 shares of D

Stock for $1,000 per share. By its terms, a share of D Stock is

reasonably expected to pay a $110 dividend in years 1 through 10 and

a $30 dividend each year thereafter. In years 1 through 10, persons

holding a majority of the D Stock must consent before Y may take any

action that would result in Y liquidating or dissolving, merging or

consolidating, losing its REIT status, or selling substantially all

of its assets. Thereafter, Y may take these actions without consent

so long as the D Stock shareholders receive $400 in exchange for

their D Stock.

(ii) Analysis. When issued, the D Stock has a dividend rate that

is reasonably expected to decline from an annual rate of 11 percent

of its issue price to an annual rate of 3 percent of its issue

price. In addition, the $1,000 issue price of a share of D Stock

exceeds the price at which the shareholder can be compelled to

dispose of the stock ($400). Thus, the D Stock is fast-pay stock,

and the C Stock is benefited stock. Because Y is a REIT, the fast-

pay arrangement is recharacterized under paragraph (c) of this

section.

(iii) Recharacterization. The fast-pay arrangement is

recharacterized as follows:

(A) Under paragraph (c)(2)(i) of this section, the C Stock

shareholders are treated as issuing financing instruments to the D

Stock shareholders in exchange for $100,000 ($1,000, the fair market

value of each share of D Stock, multiplied by 100, the number of

shares).

(B) Under paragraph (c)(2)(ii) of this section, the C Stock

shareholders are treated as contributing $200,000 to Y (the $100,000

received for the financing instruments, plus the $100,000 actually

paid for the C Stock) in exchange for the C Stock.

(C) Under paragraph (c)(2)(ii) of this section, each

distribution with respect to the D Stock is treated as a

distribution with respect to the C Stock.

(D) Under paragraph (c)(2)(iii) of this section, the C Stock

shareholders are treated as making payments with respect to the

financing instruments, and Y is treated as the paying agent of the

financing instruments for the C Stock shareholders.

Example 5. Transfer of benefited stock illustrated--(i) Facts.

The facts are the same as in Example 4 of this paragraph (e). Near

the end of year 5, a person holding one share of C Stock sells it

for $1,300. The buyer is unrelated to REIT Y or to any of the D

Stock shareholders. At the time of the sale, the amount needed to

terminate the seller's position in the financing instruments at fair

market value is $747.

(ii) Benefited shareholder's treatment on sale. Under paragraph

(c)(3)(iii)(A) of this section, the seller's amount realized is

$2,047 ($1,300, the amount actually received, plus $747, the amount

necessary to terminate the seller's position in the financing

instruments at fair market value). The seller's gain on the sale of

the common stock is $47 ($2,047, the amount realized, minus $2,000,

the seller's basis in the common stock). The seller has no income or

deduction with respect to terminating its position in the financing

instruments.

(iii) Buyer's treatment on purchase. Under paragraph

(c)(3)(iii)(A) of this section, the buyer's basis in the share of D

Stock is $2,047 ($1,300, the amount actually paid, plus $747, the

amount needed to terminate the seller's position in the financing

instruments at fair market value). Under paragraph (c)(3)(iii)(B) of

this section, simultaneous with the sale, the buyer is treated as

issuing financing instruments to the fast-pay shareholders in

exchange for $747, the amount necessary to terminate the seller's

position in the financing instruments at fair market value.

Example 6. Fast-pay arrangement involving amounts accrued or

paid in a taxable year ending before February 27, 1997--(i) Facts. Y

is a calendar year taxpayer. In June 1996, Y acquires shares of REIT

T benefited stock for $15,000. In December 1996, Y receives

dividends of $100. Under the recharacterization rules of paragraph

(c)(2) of this section, Y's 1996 income attributable to the

benefited stock is $1,200, Y's 1996 deduction attributable to the

financing instruments is $500, and Y's basis in the benefited stock

is $25,000.

(ii) Analysis. Under paragraph (c)(3)(iv) of this section, Y's

basis in the benefited stock is reduced by $600. This is the amount

by which Y's 1996 income from the fast-pay arrangement as

recharacterized under this section ($1,200 of income attributable to

the benefited stock less $500 of deductions attributable to the

financing instruments), exceeds Y's 1996 income from the fast-pay

arrangement as not recharacterized under this section ($100 of

income attributable to the benefited stock). Thus, in 1997 when the

fast-pay arrangement is recharacterized, Y's basis in the benefited

stock is $24,400.

(f) Reporting requirement--(1) Filing requirements--(i) In general.

A corporation that has fast-pay stock outstanding at any time during

the taxable year must attach the statement described in paragraph

(f)(2) of this section to its federal income tax return for such

taxable year. This paragraph (f)(1)(i) does not apply to a corporation

described in paragraphs (f)(1)(ii), (iii), or (iv) of this section.

(ii) Controlled foreign corporation. In the case of a controlled

foreign corporation (CFC), as defined in section 957, that has fast-pay

stock outstanding at any time during its taxable year (during which

time it was a CFC), each controlling United States shareholder (within

the meaning of Sec. 1.964-1(c)(5)) must attach the statement described

in paragraph (f)(2) of this section to the shareholder's Form 5471 for

the CFC's taxable year. The provisions of section 6038 and the

regulations under section 6038 apply to any statement required by this

paragraph (f)(1)(ii).

(iii) Foreign personal holding company. In the case of a foreign

personal holding company (FPHC), as defined in section 552, that has

fast-pay stock outstanding at any time during its taxable year (during

which time it was a FPHC), each United States citizen or resident who

is an officer, director, or 10-percent shareholder (within the meaning

of section 6035(e)(1)) of such FPHC must attach the statement described

in paragraph (f)(2) of this section to his or her Form 5471 for the

FPHC's taxable year. The provisions of sections 6035 and 6679 and the

regulations under sections 6035 and 6679 apply to any statement

required by this paragraph (f)(1)(iii).

(iv) Passive foreign investment company. In the case of a passive

foreign investment company (PFIC), as defined in section 1297, that has

fast-pay stock outstanding at any time during its taxable year (during

which time it was a PFIC), each shareholder that has elected (under

section 1295) to treat the PFIC as a qualified electing fund and knows

or has reason to know that the PFIC has outstanding fast-pay stock must

attach the statement described in paragraph (f)(2) of this section to

the shareholder's Form 8621 for the PFIC's taxable year. Each

shareholder owning 10 percent or more of the shares of the PFIC (by

vote or value) is presumed to know that the PFIC has issued fast-pay

stock. The provisions of sections 1295(a)(2) and 1298(f) and the

regulations under those sections (including Sec. 1.1295-1T(f)(2)) apply

to any statement required by this paragraph (f)(1)(iv).

(2) Statement. The statement required under this paragraph (f) must

say, ``This fast-pay stock disclosure statement is required by

Sec. 1.7701(l)-3(f) of the income tax regulations.'' The statement must

also identify the corporation that has outstanding fast-pay stock and

must contain the date on which the fast-pay stock was issued, the terms

of the fast-pay stock, and (to the extent the filing person knows or

has reason to know such information) the names and taxpayer

identification numbers of the shareholders of any stock that is not

traded on an established securities market (as described in

Sec. 1.7704-1(b)).

(g) Effective date--(1) In general. Except as provided in paragraph

(g)(4) of this section (relating to reporting requirements), this

section applies to taxable years ending after February 26, 1997. Thus,

all amounts accrued or paid

[[Page 1316]]

during the first taxable year ending after February 26, 1997, are

subject to this section.

(2) Election to limit taxable income attributable to a

recharacterized fast-pay arrangement for periods before April 1, 2000--

(i) Limit. For periods before April 1, 2000, provided the shareholder

recharacterizes the fast-pay arrangement consistently for all such

periods, a shareholder may limit its taxable income attributable to a

fast-pay arrangement recharacterized under paragraph (c) of this

section to the taxable income that results if the fast-pay arrangement

is recharacterized under either--

(A) Notice 97-21, 1997-1 C.B. 407, see Sec. 601.601(d)(2) of this

chapter; or

(B) Paragraph (c) of this section, computed by assuming the

financing instruments are debt.

(ii) Adjustment and statement. A shareholder that limits its

taxable income to the amount determined under paragraph (g)(2)(i)(A) of

this section must include as an adjustment to taxable income the

excess, if any, of the amount determined under paragraph (g)(2)(i)(B)

of this section, over the amount determined under paragraph

(g)(2)(i)(A) of this section. This adjustment to taxable income must be

made in the shareholder's first taxable year that includes April 1,

2000. A shareholder to which this paragraph (g)(2)(ii) applies must

include a statement in its books and records identifying each fast-pay

arrangement for which an adjustment must be made and providing the

amount of the adjustment for each such fast-pay arrangement.

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

paragraph (g)(2). For purposes of these examples, assume that a

shareholder may limit its taxable income under this paragraph (g)(2)

for periods before January 1, 2000.

Example 1. Fast-pay arrangement recharacterized under Notice 97-

21; REIT holds third-party debt--(i) Facts. (A) REIT Y is formed on

January 1, 1997, at which time it issues 1,000 shares of fast-pay

stock and 1,000 shares of benefited stock for $100 per share. Y and

all of its shareholders are U.S. persons and have calendar taxable

years. All shareholders of Y have elected to accrue market discount

based on a constant interest rate, to include the market discount in

income as it accrues, and to amortize bond premium.

(B) For years 1 through 5, the fast-pay stock has an annual

dividend rate of $17 per share ($17,000 for all fast-pay stock); in

later years, the fast-pay stock has an annual dividend rate of $1

per share ($1,000 for all fast-pay stock). At the end of year 5, and

thereafter, a share of fast-pay stock can be acquired by Y in

exchange for $50 ($50,000 for all fast-pay stock).

(C) On the day Y is formed, it acquires a five-year mortgage

note (the note) issued by an unrelated third party for $200,000. The

note provides for annual interest payments on December 31 of $18,000

(a coupon interest rate of 9.00 percent, compounded annually), and

one payment of principal at the end of 5 years. The note can be

prepaid, in whole or in part, at any time.

(ii) Recharacterization under Notice 97-21--(A) In general. One

way to recharacterize the fast-pay arrangement under Notice 97-21 is

to treat the fast-pay shareholders and the benefited shareholders as

if they jointly purchased the note from the issuer with the

understanding that over the five-year term of the note the benefited

shareholders would use their share of the interest to buy (on a

dollar-for-dollar basis) the fast-pay shareholders' portion of the

note. The benefited shareholders' and the fast-pay shareholders'

yearly taxable income under Notice 97-21 can then be calculated

after determining their initial portions of the note and whether

those initial portions are purchased at a discount or premium.

(B) Determining initial portions of the debt instrument. The

fast-pay shareholders' and the benefited shareholders' initial

portions of the note can be determined by comparing the present

values of their expected cash flows. As a group, the fast-pay

shareholders expect to receive cash flows of $135,000 (five annual

payments of $17,000, plus a final payment of $50,000). As a group,

the benefited shareholders expect to receive cash flows of $155,000

(five annual payments of $1,000, plus a final payment of $150,000).

Using a discount rate equal to the yield to maturity (as determined

under Sec. 1.1272-1(b)(1)(i)) of the mortgage note (9.00 percent,

compounded annually), the present value of the fast-pay

shareholders' cash flows is $98,620, and the present value of the

benefited shareholders' cash flows is $101,380. Thus, the fast-pay

shareholders initially acquire 49 percent of the note at a $1,380

premium (that is, they paid $100,000 for $98,620 of principal in the

note). The benefited shareholders initially acquire 51 percent of

the note at a $1,380 discount (that is, they paid $100,000 for

$101,380 of principal in the note). Under section 171, the fast-pay

shareholders' premium is amortizable based on their yield in their

initial portion of the note (8.574 percent, compounded annually).

The benefited shareholders' discount accrues based on the yield in

their initial portion of the note (9.353 percent, compounded

annually).

(C) Taxable income under Notice 97-21--(1) Fast-pay

shareholders. Under Notice 97-21, the fast-pay shareholders compute

their taxable income attributable to the fast-pay arrangement for

periods before January 1, 2000, by subtracting the amortizable

premium from the accrued interest on the fast-pay shareholders'

portion of the note. For purposes of paragraph (g)(2)(i)(A) of this

section, the fast-pay shareholders' taxable income as a group is as

follows:

----------------------------------------------------------------------------------------------------------------

Interest Amortizable

Taxable period income premium Taxable income

----------------------------------------------------------------------------------------------------------------

1/1/97-12/31/97.............................................. $8,876 ($302) $8,574

1/1/98-12/31/98.............................................. 8,145 (293) 7,852

1/1/99-12/31/99.............................................. 7,348 (281) 7,067

--------------------------------------------------

Total.................................................... 24,369 (876) 23,493

----------------------------------------------------------------------------------------------------------------

(2) Benefited shareholders. Under Notice 97-21, the benefited

shareholders compute their taxable income attributable to the fast-

pay arrangement for periods before January 1, 2000, by adding the

accrued discount to the accrued interest on the benefited

shareholders' portion of the note. For purposes of paragraph

(g)(2)(i)(A) of this section, the benefited shareholders' taxable

income as a group is as follows:

----------------------------------------------------------------------------------------------------------------

Interest Amortizable

Taxable period income premium Taxable income

----------------------------------------------------------------------------------------------------------------

1/1/97-12/31/97.............................................. $9,124 $229 $9,353

1/1/98-12/31/98.............................................. 9,855 251 10,106

1/1/99-12/31/99.............................................. 10,652 274 10,926

--------------------------------------------------

Total.................................................... 29,631 754 30,385

----------------------------------------------------------------------------------------------------------------

[[Page 1317]]

(iii) Taxable income under the recharacterization of this

section--(A) Fast-pay shareholders. Under paragraphs (c) and

(g)(2)(i)(B) of this section, the fast-pay shareholders' taxable

income attributable to the fast-pay arrangement for periods before

January 1, 2000, is the interest deemed paid on the financing

instruments. For purposes of paragraph (g)(2)(i)(B) of this section,

the fast-pay shareholders' taxable income as a group is as follows:

------------------------------------------------------------------------

Taxable

Taxable period income

------------------------------------------------------------------------

1/1/97-12/31/97............................................... $8,574

1/1/98-12/31/98............................................... 7,852

1/1/99-12/31/99............................................... 7,067

Total....................................................... 23,493

------------------------------------------------------------------------

(B) Benefited shareholders. Under paragraphs (c) and

(g)(2)(i)(B) of this section, the benefited shareholders compute

their taxable income attributable to the fast-pay arrangement for

periods before January 1, 2000, by subtracting the interest deemed

paid on the financing instruments from the dividends actually and

deemed paid on the benefited stock. For purposes of paragraph

(g)(2)(i)(B) of this section, the benefited shareholders' taxable

income as a group is as follows:

----------------------------------------------------------------------------------------------------------------

Dividends paid Interest paid

Taxable period on benefited on financing Taxable income

stock instruments

----------------------------------------------------------------------------------------------------------------

1/1/97-12/31/97.............................................. $18,000 ($8,574) $9,426

1/1/98-12/31/98.............................................. 18,000 (7,852) 10,148

1/1/99-12/31/99.............................................. 18,000 (7,067) 10,933

--------------------------------------------------

Total.................................................... 54,000 (23,493) 30,507

----------------------------------------------------------------------------------------------------------------

(iv) Limit on taxable income under paragraph (g)(2)(i) of this

section--(A) Fast-pay shareholders. For periods before January 1,

2000, the fast-pay shareholders have the same taxable income under

the recharacterization of Notice 97-21 and paragraph (g)(2)(i)(A) of

this section ($23,493) as they have under the recharacterization of

paragraphs (c) and (g)(2)(i)(B) of this section ($23,493). Thus,

under paragraph (g)(2)(i) of this section, the fast-pay shareholders

may limit their taxable income attributable to the fast-pay

arrangement for periods before January 1, 2000, to $23,493 (as a

group).

(B) Benefited shareholders. For periods before January 1, 2000,

the benefited shareholders have taxable income attributable to the

fast-pay arrangement of $30,385 under the recharacterization of

Notice 97-21 and paragraph (g)(2)(i)(A) of this section, and taxable

income of $30,507 under the recharacterization of paragraphs (c) and

(g)(2)(i)(B) of this section. Thus, under paragraph (g)(2)(i) of

this section, the benefited shareholders may limit their taxable

income attributable to the fast-pay arrangement for periods before

January 1, 2000, to either $30,385 (as a group) or $30,507 (as a

group).

(v) Adjustment to taxable income under paragraph (g)(2)(ii) of

this section. Under paragraph (g)(2)(ii) of this section, any

benefited shareholder that limited its taxable income to the amount

determined under paragraph (g)(2)(i)(A) of this section must include

as an adjustment to taxable income the excess, if any, of the amount

determined under paragraph (g)(2)(i)(B) of this section, over the

amount determined under paragraph (g)(2)(i)(A) of this section. If

all benefited shareholders limited their taxable income to the

amount determined under paragraph (g)(2)(i)(A) of this section, then

as a group their adjustment to income is $122 ($30,507, minus

$30,385). Each shareholder must include its adjustment in income for

the taxable year that includes January 1, 2000.

Example 2. REIT holds debt issued by a benefited shareholder--

(i) Facts. The facts are the same as in Example 1 of this paragraph

(g)(2) except that corporation Z holds 800 shares (80 percent) of

the benefited stock, and Z, instead of a third party, issues the

mortgage note acquired by Y.

(ii) Recharacterization under Notice 97-21. Because Y holds a

debt instrument issued by Z, the fast-pay arrangement is

recharacterized under Notice 97-21 as an arrangement in which Z

issued one or more instruments directly to the fast-pay shareholders

and the other benefited shareholders.

(A) Fast-pay shareholders. Consistent with this

recharacterization, Z is treated as issuing a debt instrument to the

fast-pay shareholders for $100,000. The debt instrument provides for

five annual payments of $17,000 and an additional payment of $50,000

in year five. Thus, the debt instrument's yield to maturity is 8.574

percent per annum, compounded annually.

(B) Benefited shareholders. Z is also treated as issuing a debt

instrument to the other benefited shareholders for $20,000 (200

shares multiplied by $100, or 20 percent of the $100,000 paid to Y

by the benefited shareholders as a group). This debt instrument

provides for five annual payments of $200 and an additional payment

of $30,000 in year five. The debt instrument's yield to maturity is

9.304 percent per annum, compounded annually.

(C) Issuer's interest expense under Notice 97-21. Under Notice

97-21, Z's interest expense attributable to the fast-pay arrangement

for periods before January 1, 2000, equals the interest accrued on

the debt instrument held by the fast-pay shareholders, plus the

interest accrued on the debt instrument held by the benefited

shareholders other than Z. For purposes of paragraph (g)(2)(i)(A) of

this section, Z's interest expense is as follows:

----------------------------------------------------------------------------------------------------------------

Accrued Accrued

interest fast- interest other Total interest

Taxable period pay benefited expense

shareholders shareholders

----------------------------------------------------------------------------------------------------------------

1/1/97-12/31/97.............................................. ($8,574) ($1,861) ($10,435)

1/1/98-12/31/98.............................................. (7,852) (2,015) (9,867)

1/1/99-12/31/99.............................................. (7,067) (2,184) (9,251)

--------------------------------------------------

Total.................................................... (23,493) (6,060) (29,553)

----------------------------------------------------------------------------------------------------------------

(iii) Recharacterization under this section. Under paragraphs

(c) and (g)(2)(i)(B) of this section, Z's taxable income

attributable to the fast-pay arrangement for periods before January

1, 2000, equals Z's share of the dividends actually and deemed paid

on the benefited stock (80 percent of the outstanding benefited

stock), reduced by the sum of the interest accrued on the note held

by Y and the interest accrued on the financing instruments deemed to

have been issued by Z. For purposes of paragraph (g)(2)(i)(B) of

this section, Z's taxable income is as follows:

[[Page 1318]]

----------------------------------------------------------------------------------------------------------------

Accrued

Dividends Accrued interest Taxable

Taxable period benefited interest on financing expense

stock debt held by Y instruments

----------------------------------------------------------------------------------------------------------------

1/1/97-12/31/97................................. $14,400 ($18,000) ($6,859) ($10,459)

1/1/98-12/31/98................................. 14,400 (18,000) (6,281) (9,881)

1/1/99-12/31/99................................. 14,400 (18,000) ( 5,654) (9,254)

---------------------------------------------------------------

Total....................................... 43,200 (54,000) (18,794) (29,594)

----------------------------------------------------------------------------------------------------------------

(iv) Limit on taxable income under this paragraph (g)(2). For

periods before January 1, 2000, Z has a taxable loss attributable to

the fast-pay arrangement of $29,553 under the recharacterization of

Notice 97-21 and paragraph (g)(2)(i)(A) of this section, and a

taxable loss of $29,594 under the recharacterization of paragraphs

(c) and (g)(2)(i)(B) of this section. Thus, under paragraph

(g)(2)(i) of this section, Z may report a taxable loss attributable

to the fast-pay arrangement for periods before January 1, 2000, of

either $29,553 or $29,594. Under paragraph (g)(2)(ii), Z has no

adjustment to its taxable income for its taxable year that includes

January 1, 2000.

(3) Rule to comply with this section. To comply with this section

for each taxable year in which it failed to do so, a taxpayer should

file an amended return. For taxable years ending before Janaury 10,

2000, a taxpayer that has complied with Notice 97-21, 1997-1 C.B. 407

(see Sec. 601.601(d)(2) of this chapter), for all such taxable years is

considered to have complied with this section and limited its taxable

income under paragraph (g)(2)(i)(A) of this section.

(4) Reporting requirements. The reporting requirements of paragraph

(f) of this section apply to taxable years (of the person required to

file the statement) ending after Janaury 10, 2000.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 5. The authority citation for part 602 continues to read as

follows:

Authority: 26 U.S.C. 7805.

Par. 6. Section 602.101(b) is amended by adding an entry in

numerical order to the table to read as follows:

Sec. 602.101 OMB Control numbers.

* * * * *

(6) * * *

------------------------------------------------------------------------

Current OMB

CFR part or section where identified and described control No.

------------------------------------------------------------------------

* * * * *

1.7701(l)-3................................................ 1545-1642

* * * * *

------------------------------------------------------------------------

Approved: December 10, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

Robert Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 00-114 Filed 1-7-00; 8:45 am]

BILLING CODE 4830-01-P