Conduit Arrangements Regulations

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[INTL-0064-93]

RIN 1545-AS40

Conduit Arrangements Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This document contains proposed regulations relating to

conduit financing arrangements issued under the authority granted by

section 7701(l). The proposed regulations apply to persons engaging in

multiple-party financing arrangements and are necessary in order to

determine which of those arrangements should be recharacterized under

section 7701(l). This document also provides notice of a public hearing

on these proposed regulations.

DATES: Written comments, requests to speak and outlines of topics to be

discussed at the public hearing scheduled for December 16, 1994, must

be received by December 13, 1994.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (INTL-0064-93), room

5228, Internal Revenue Service, POB 7604, Ben Franklin Station,

Washington, DC 20044. In the alternative, submissions may be hand

delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R

(INTL-0064-93), Courier's Desk, Internal Revenue Service, 1111

Constitution Ave. NW, Washington, DC. The public hearing will be held

in the IRS Auditorium, Internal Revenue Building, 1111 Constitution

Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations Richard L.

Chewning, Ramon Camacho, or Elissa Shendalman (202) 622-3870,

concerning submissions and the hearing, Christina Vasquez, (202) 622-

7782 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed

rulemaking have been submitted to the Office of Management and Budget

for review in accordance with the Paperwork Reduction Act (44 U.S.C.

3504(h)). Comments on the collections of information should be sent to

the Office of Management and Budget, Attn: Desk Officer for the

Department of Treasury, Office of Information and Regulatory Affairs,

Washington, DC 20503, with copies to the Internal Revenue Service,

Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC 20224.

The collections of information are in Secs. 1.881-4(c), 1.6038-2,

1.6038A-2, and 1.6038A-3. The information is required by the IRS so

that a district director can determine whether a financing arrangement

is subject to recharacterization under Sec. 1.881-3. The data will be

used by the IRS and taxpayers to verify that the proper amount of tax

is withheld. The likely respondents are withholding agents and foreign

investors.

Estimated total annual recordkeeping burden: 10,000 hours.

Estimated average annual burden per taxpayer: 10 hours.

Estimated number of recordkeepers: 1,000.

Estimated total annual reporting burden: 3,000 hours.

Estimated average burden per respondent: 3 hours.

Estimated number of respondents: 1,000.

Estimated frequency of responses: Annually.

Background

This document contains proposed amendments to the Income Tax

Regulations (26 CFR part 1) under Secs. 1.871-1, 1.881-0, 1.881-3,

1.881-4, 1.1441-3, 1.1441-7, 1.6038-2, 1.6038A-2, 1.6038A-3 and

1.7701(l)-1 that are issued under the authority granted by section

7701(l). Section 7701(l) was enacted as part of the Omnibus Budget

Reconciliation Act of 1993 (Pub.L. 103-66). These proposed regulations

provide guidance with regard to conduit financing arrangements.

Explanation of Provisions

Section 7701(l) authorizes the Secretary to ``prescribe regulations

recharacterizing any multiple-party financing transaction as a

transaction directly among any 2 or more of such parties where the

Secretary determines that such recharacterization is appropriate to

prevent avoidance of any tax imposed by this title.'' Pursuant to this

authority, these regulations provide rules that permit the district

director to disregard, for purposes of sections 871, 881, 1441 and

1442, the participation of one or more persons in a conduit financing

arrangement.

Section 1.881-3

1. Definitions

Section 1.881-3(a)(2) provides definitions of certain terms used

throughout the regulations. A ``financing arrangement'' generally means

two or more financing transactions pursuant to which one person (the

financing entity) advances money or other property to another person

(the intermediate entity) and the intermediate entity advances money or

other property to a third person (the financed entity). The term also

includes two or more financing transactions that achieve substantially

the same result through any other series of steps (e.g., a loan from a

foreign person to a U.S. person, followed by an assignment of the loan

by the foreign person to another person in exchange for a note issued

by the assignee).

A ``financing transaction'' generally means any advance of money or

other property in exchange for debt; any advance of money or other

property in exchange for certain types of stock or a similar interest

in a partnership or trust; any lease or license; any other advance of

money or other property pursuant to which the transferee is obligated

to repay or return a substantial portion of the money or other property

advanced (or the equivalent in value); and any transaction by which a

person becomes a party to an existing financing transaction. An advance

of money or other property in exchange for stock will be considered a

financing transaction only if the issuer or holder of the stock has

rights, or there are arrangements in place, that are intended to ensure

that payments on the instrument will be made as contemplated.

Therefore, an exchange for common stock or ordinary perpetual preferred

stock will not be included. However, an exchange for certain

instruments, such as dividend-linked notes or other perpetual

subordinated debt (which, though denominated as debt, are treated as

equity under U.S. tax principles), will be included if those

instruments provide for normal creditors' rights, such as the right,

arising upon a default on a payment, to enforce the payment through a

legal proceeding or to cause the liquidation of the issuer. The IRS

solicits comments on the definition of a financing transaction.

A ``conduit entity'' means an intermediate entity whose

participation in a financing arrangement is disregarded pursuant to

Sec. 1.881-3.

The regulations also define the terms ``guarantee'' and

``related,'' which are discussed elsewhere in this preamble.

The IRS and the Treasury recognize the potential overlap of these

regulations with the proposed regulations governing securities lending

issued under sections 861, 871, 881, 894 and 1441, published in the

issue of the Federal Register for January 9, 1992, 57 F.R. 860. In

connection with the finalization of the proposed regulations concerning

securities lending and these regulations, guidance will be provided

coordinating the two sets of regulations.

2. Authority of District Director

Section 1.881-3(a)(3) authorizes the district director to treat an

intermediate entity as a conduit entity if the financing arrangement

satisfies the standard for conduit treatment set forth in Sec. 1.881-

3(a)(4). The district director's exercise of this authority will be

subject to judicial review under an ``abuse of discretion'' standard.

In applying the standard for conduit treatment, the district

director has the authority to determine which financing transactions

comprise the financing arrangement and which persons are parties to the

financing arrangement. For example, if an intermediate entity borrows

$100 from a related person and $100 from an unrelated person, and in

turn lends $100 to a U.S. person, the district director may determine

based on the facts, whether the financing arrangement is among the U.S.

borrower, the intermediate entity and the related person or the U.S.

borrower, the intermediate entity and the unrelated person.

3. Standard for Conduit Treatment

Section 1.881-3(a)(4) provides the standard to be applied by the

district director in determining whether an intermediate entity is

disregarded for purposes of section 881. The standard depends upon the

relationship of the parties in the financing arrangement. If the

intermediate entity is related to the financing entity or the financed

entity, the financing arrangement will be subject to recharacterization

if two conditions are satisfied: (i) The participation of the

intermediate entity in the financing arrangement reduces the tax

imposed by section 881; and (ii) the participation of the intermediate

entity in the financing arrangement is pursuant to a tax avoidance

plan, which is defined in Sec. 1.881-3(c)(1) as a plan one of the

principal purposes of which is the avoidance of tax imposed by section

881. The definition of the term ``related'' contained in Sec. 1.881-

3(a)(2)(v), with certain exceptions, is consistent with the definition

of related party (and the related attribution rules) in Sec. 1.6038A-1

(d) and (e).

If the intermediate entity is unrelated to both the financing

entity and the financed entity, the financing arrangement will be

subject to recharacterization if the two conditions described above are

satisfied and, in addition, the intermediate entity would not have

participated in the financing arrangement on substantially the same

terms but for the fact that the financing entity engaged in the

financing transaction with the intermediate entity. Section 1.881-3(b)

provides that, if the financing entity guarantees the liability of the

financed entity to the intermediate entity, it will be presumed that

the intermediate entity would not have participated in the financing

arrangement on substantially the same terms but for the fact that the

financing entity engaged in the financing transaction with the

intermediate entity. A taxpayer may rebut this presumption by producing

clear and convincing evidence to the contrary.

Section 1.881-3(a)(2)(iv) defines a ``guarantee'' as any

arrangement under which a person, directly or indirectly, assures, on a

conditional or unconditional basis, the payment of another person's

obligation with respect to a financing transaction. The regulations

further provide that the term is to be interpreted in accordance with

the definition of guarantee in section 163(j)(6)(D)(iii).

Section 1.881-3(a)(4)(ii)(A) provides that the district director

may apply principles consistent with the general recharacterization

standard described above in cases involving multiple intermediate

entities. Section 1.881-3(a)(4)(ii)(B) contains a special rule that

applies if two (or more) financing transactions involving two (or more)

related persons would form part of a financing arrangement but for the

absence of a financing transaction between the related persons. In such

a case, the district director may treat the related persons as a single

intermediate entity if he or she determines based upon all the facts

and circumstances that the avoidance of the application of Sec. 1.881-3

is one of the principal purposes for the structuring of the financing

transactions. That paragraph also permits the district director to

apply similar principles if a financing transaction exists between

related persons, but one of the principal purposes for the existence of

the financing transaction is to prevent the district director from

treating the related persons as a single intermediate entity.

4. Determination of Existence of Tax Avoidance Plan

Section 1.881-3(c) contains rules for determining whether the

participation of the intermediate entity in the financing arrangement

is pursuant to a plan one of the principal purposes of which is the

avoidance of tax imposed by section 881 (tax avoidance plan). This

determination is to be based upon all of the facts and circumstances.

In this regard, the only relevant purposes are those pertaining to the

participation of the intermediate entity in the financing arrangement,

not those pertaining to the existence of the financing arrangement in

general. Moreover, the fact that an intermediate entity is a resident

of a country that has a treaty with the United States that

significantly reduces the tax that otherwise would have been imposed

under section 881 is not sufficient, by itself, to establish the

existence of a tax avoidance plan. The application of these regulations

only to an intermediate entity whose participation is pursuant to a

plan ensures that these regulations apply only to transactions that are

related to each other through the taxpayer's intention to secure, in an

artificial manner, exemptions or reductions of withholding tax that

would not otherwise be available given the economic substance of its

transactions.

Section 1.881-3(c)(2) lists several nonexclusive factors that are

relevant to the determination of whether the intermediate entity's

participation is pursuant to a tax avoidance plan. Avoidance of the tax

imposed by section 881 may be one of the principal purposes for such a

plan even though it is outweighed by other purposes (taken together or

separately).

Section 1.881-3(c)(3) provides that it shall be presumed that the

participation of an intermediate entity (or entities) in a financing

arrangement is not pursuant to a tax avoidance plan if the intermediate

entity is related to the financing entity or the financed entity and

the intermediate entity performs significant financing activities, as

defined, with respect to the financing transactions forming part of the

financing arrangement to which it is a party. The district director may

rebut the presumption by establishing that the participation of the

intermediate entity in the financing arrangement is pursuant to a tax

avoidance plan. The IRS solicits comments on the significant financing

activity presumption.

Section 1.881-3(c)(4) provides a set of special rules applicable in

cases where the financing entity is unrelated to the intermediate

entity (or entities) and the financed entity. Section 1.881-3(c)(4)(i)

provides that, in such cases, if the intermediate entity (or, in the

case of multiple intermediate entities, the intermediate entity that

has engaged in a financing transaction with the financed entity) is

actively engaged in a substantial trade or business (other than the

business of making or managing investments, except pursuant to a

banking, insurance, financing or similar trade or business, the income

from which is earned predominantly in transactions with unrelated

persons), it will be presumed that the participation of the

intermediate entity in the financing arrangement is not pursuant to a

tax avoidance plan. This presumption may be rebutted if the district

director establishes that the participation of the intermediate entity

in the financing arrangement is pursuant to such a plan.

Section 1.881-3(c)(4)(ii) provides that, in any case where a

financing entity is unrelated to the financed entity and the

intermediate entity (or entities), the financing entity will not be

liable for tax under section 881 pursuant to these regulations unless

the financing entity knows or has reason to know that the financing

arrangement is subject to recharacterization under Sec. 1.881-3(a)(3).

Section 1.881-3(c)(4)(ii) does not relieve the section 881 liability

for purposes of determining whether any person is liable for

withholding tax pursuant to Sec. 1.1441-3(j) or whether any party to a

financing arrangement is entitled to a refund of tax actually withheld

by a withholding agent pursuant to section 1441. Accordingly, if the

requirements of Sec. 1.881-3(a)(4) are satisfied, the financed entity

is required to pay withholding tax without regard to the knowledge of

the financing entity and no party to the financing arrangement is

entitled to a refund (except to the extent the amount withheld exceeds

the amount determined under section 881).

A person is not considered to have reason to know that the

financing arrangement is subject to recharacterization if the person

knows of the financing transactions that comprise the financing

arrangement but does not know or have reason to know of facts

sufficient to establish that the intermediate entity's participation

was pursuant to a tax avoidance plan. The IRS solicits comments on the

treatment of unrelated financing entities.

5. Determination of Amount of Tax Liability

Section 1.881-3(d) provides rules for determining the portion of

each payment made by a financed entity that is recharacterized under

Sec. 1.881-3(a)(3). The recharacterized portion is proportionate to a

ratio of the principal amounts of the financing transactions that

comprise the financing arrangement. This ratio measures the proportion

of money or other property advanced by the financing entity to the

intermediate entity that is considered to flow through to the financed

entity.

If a financing arrangement involves multiple conduit entities, the

ratio is based upon a comparison of the smallest financing transaction

between a conduit entity and a party other than the financed entity,

and the financing transaction involving the financed entity. Thus, if

pursuant to a financing arrangement, A lends $500 to B, B lends $300 to

C, and C lends $350 to D, and B and C are conduit entities, the ratio

equals $300/$350 (assuming at the time of the payment from the financed

entity to the conduit entity the principal amounts have not changed).

This rule does not apply, however, in a case where the district

director treats related persons as a single intermediate entity under

Sec. 1.881-3(a)(4)(ii)(B).

Section 1.881-3(d)(1)(iii) provides that the principal amount of a

financing transaction will be determined on the basis of all of the

facts and circumstances. The principal amount generally will equal the

amount of money, or the fair market value of other property (determined

as of the time that the financing transaction is entered into),

advanced in the financing transaction. In the case of a debt instrument

or stock, the fair market value of the property advanced will be

considered to equal the issue price unless the fair market value

differs materially from the issue price. The principal amount of a

financing transaction will be subject to adjustments, as appropriate.

The IRS solicits comments on the definition of principal amount.

Section 1.881-3(d)(2) provides that payments made by a financed

entity pursuant to a financing arrangement that is recharacterized

under Sec. 1.881-3(a)(3) are subject to tax at the rate applicable to

payments made directly to the financing entity. Thus, the rate of tax

will be affected by whether an income tax treaty is in existence

between the United States and the country in which the financing entity

is a resident. However, special withholding rules apply under

Sec. 1.1441-3(j).

6. Interaction With Treaties

These regulations are intended to provide anti-abuse rules that

supplement, but do not conflict with, the limitation on benefits

articles in U.S. income tax treaties. Treaty limitation on benefits

articles commonly limit the tax benefits of the treaty to those

residents of the other contracting state that have a substantial

business nexus with, or otherwise have a significant business purpose

for residing in, the other contracting state. These articles generally

provide objective, bright-line rules for determining whether an entity

has a sufficient nexus to the contracting state to be treated as a

resident for treaty purposes. It has been recognized that contracting

states may supplement these rules by transactionally-based domestic

anti-abuse rules, including rules under which a particular transaction

may be recast, in accordance with the substance of the transaction.

These regulations, which reflect common law substance over form

principles as applied to conduit financing arrangements, complement the

limitation on benefits provisions of income tax treaties and are not

precluded by the inclusion of such provisions, just as those provisions

have not overridden the applicability of existing anti-conduit rulings

such as Rev. Rul. 84-152, 1984-2 C.B. 381, Rev. Rul. 84-153, 1984-2

C.B. 383, and Rev. Rul. 87-89, 1987-1 C.B. 195.

Accordingly, Sec. 1.881-3(d)(3) provides that a financing

arrangement may be recharacterized under Sec. 1.881-3 regardless of

whether the conduit entity is a resident of a country that has an

income tax treaty with the United States. Thus, the treaty applicable

to determine the amount of tax due under section 881, if any, will be

based upon the substance of the financing arrangement.

7. Alternative Approach Not Adopted

In formulating these regulations, the IRS and the Treasury

considered several alternative standards for recharacterizing a

financing arrangement. For example, consideration was given to a test

that would measure the similarity of the cash flows of the financing

transactions that comprise the financing arrangement, with respect to

both the advance and repayment of funds. This test was rejected

principally for the following reasons. First, the delineation of cash

flows considered characteristic of a conduit arrangement would be

inherently arbitrary. In a substantial number of cases, the application

of the test would produce results that were either overinclusive or

underinclusive. Second, such a test could be circumvented, particularly

with respect to cash flows on repayment. Related parties have

particular flexibility to structure the terms of their financing

transactions to satisfy a bright-line test. Unrelated parties may have

less flexibility. However, in either case, parties could alter the

financial consequences of holding an asset or liability with particular

cash flows through the use of derivative financial instruments.

Although the regulations do not adopt a bright-line cash flow test,

Sec. 1.881-3(c)(2) (i)(C) and (ii)(B) provides that the timing of the

advances of money or other property to the intermediate entity and the

financed entity pursuant to the financing arrangement is a factor

relevant to whether the intermediate entity's participation is pursuant

to a tax avoidance plan. The regulations do not set forth as a factor

the similarity of the repayment terms of the financing transactions.

This is because of concerns about the extent to which the similarity of

repayment terms is a useful indication of a tax avoidance plan. The IRS

solicits comments on this point.

8. Equity Investments

The legislative history to section 7701(l) authorizes the issuance

of regulations that apply to financing arrangements involving equity

investments. These regulations, however, generally do not include

investments in common stock (or investments in ordinary perpetual

preferred stock) in the definition of financing transaction principally

for the following reasons. First, because a corporation has no legal

obligation to make distributions with respect to its common stock,

inclusion of ordinary common stock in the definition of financing

transaction could add significant uncertainty and complexity to the

application of the regulations. Second, there are substantial questions

about the extent to which common stock and ordinary perpetual preferred

stock can be used in a conduit financing arrangement to avoid U.S.

withholding tax. Nevertheless, the IRS and the Treasury remain

concerned about the potential for abuse with respect to such equity

investments and will monitor developments in this area. If the IRS and

the Treasury determine that taxpayers are structuring conduit financing

arrangements with such stock to avoid U.S. withholding tax, these

regulations may be extended to cover such stock.

9. Guarantees

The legislative history to section 7701(l) authorizes the issuance

of regulations that apply to financing arrangements involving debt

guarantees. These regulations, however, generally do not treat debt

guarantees as a financing transaction as defined in Sec. 1.881-

3(a)(2)(ii). Nevertheless, the IRS and the Treasury remain concerned

about the potential for abuse with respect to debt guarantees and will

monitor developments in this area. If the IRS and the Treasury

determine that taxpayers are structuring conduit financing arrangements

with debt guarantees to avoid U.S. withholding tax, these regulations

may be extended to cover debt guarantees.

10. Collateral Consequences of Recharacterization

These regulations do not provide that a financing arrangement

recharacterized for purposes of sections 871, 881, 1441 or 1442 is also

recharacterized for purposes of other Code sections. The IRS and the

Treasury are considering, however, the circumstances under which the

recharacterization should be extended to other Code sections. The IRS

solicits comments on this point.

11. Use of Regulations by Taxpayers

Section 1.881-3(a)(3) provides that a taxpayer may not apply

Sec. 1.881-3 to reduce its tax liability. However, a taxpayer may

comply with the provisions of Sec. 1.881-3 in order to avoid the

imposition of interest and penalties.

Section 1.881-4

Section 1.881-4 provides rules for the furnishing of information

and the maintenance of records concerning financing arrangements to

which Sec. 1.881-3 applies.

Section 1.881-4(b) provides that a financed entity that is a

reporting corporation within the meaning of section 6038A(a) and the

regulations under that section, or that is required to report pursuant

to section 6038(a) and the regulations under that section, must comply

with certain reporting requirements with respect to any financing

transaction to which the financed entity is a party that it knows or

has reason to know forms a part of a financing arrangement described in

Sec. 1.881-3(a)(4) (determined without regard to the tax avoidance

purpose rule of Sec. 1.881-3(a)(4)(i)(B)). This rule applies only if a

person with respect to which the financed entity is required to report

under sections 6038 or 6038A is a party to that financing arrangement.

Section 1.881-4(c) provides that a financed entity or any other

person subject to the general recordkeeping requirements of section

6001, or the recordkeeping requirements of Sec. 1.6038A-3, must keep

the permanent books of account or records, as required by section 6001

or Sec. 1.6038A-3, that may be relevant to the determination of whether

the financing arrangement is subject to recharacterization under

Sec. 1.881-3.

Section 1.1441-3(j)

Section 1.1441-3(j) provides that a financed entity or other person

required to withhold tax under section 1441 with respect to a financing

arrangement subject to recharacterization under Sec. 1.871-1(b)(7) or

1.881-3(a)(3), is required to withhold in accordance with the

recharacterization on the portion of each payment subject to

recharacterization, as determined by Sec. 1.881-3(d).

Section 1.1441-7

Section 1.1441-7(d) provides that a person is required to withhold

tax under section 1441 in accordance with the recharacterization of a

financing arrangement under Sec. 1.881-3(a)(3) if the person knows or

has reason to know that the financing arrangement is subject to

recharacterization under those sections and the person otherwise is a

withholding agent with respect to the financing arrangement. The

``knows or has reason to know'' standard is the standard that generally

applies to withholding agents presented with a claim for treaty

benefits. See, e.g., Rev. Rul. 85-4, 1985-1 C.B. 294, 295; Rev. Rul.

76-224, 1976-1 C.B. 268, 269. A person is not considered to have reason

to know that a financing arrangement is subject to recharacterization

under Sec. 1.881-3(a)(3) if the person knows of the financing

transactions that comprise the financing arrangement but does not know

or have reason to know of facts sufficient to establish that the

intermediate entity's participation was pursuant to a tax avoidance

plan. The IRS solicits comments on the standard applicable to

withholding agents.

Proposed Effective Date

Sections 1.881-3, 1.881-4, 1.1441-3(j) and 1.1441-7(d) are proposed

to be effective for payments made after the date which is 30 days after

publication of final regulations in the Federal Register. This

regulation shall not apply with respect to interest payments made by

United States corporations to Netherlands Antilles corporations in

connection with debt obligations issued prior to October 15, 1984 (see

Rev. Rul. 85-163, 1985-2 C.B. 349) and payments of interest covered by

section 127(g)(3) of the Tax Reform Act of 1984.

Special Analyses

It has been determined that this notice of proposed rulemaking is

not a significant regulatory action as defined in EO 12866. Therefore,

a regulatory assessment is not required. It also has been determined

that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) 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, this notice of proposed rulemaking will be

submitted to the Chief Counsel for Advocacy of the Small Business

Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,

consideration will be given to any written comments (a signed original

and eight (8) copies) that are submitted timely to the IRS. All

comments will be available for public inspection and copying.

A public hearing has been scheduled for Friday, December 16, 1994,

at 10 a.m., in the Internal Revenue Service Auditorium, 7400 corridor.

Because of access restrictions, visitors will not be admitted beyond

the Internal Revenue Building lobby more than 15 minutes before the

hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must

submit written comments and submit an outline of the topics to be

discussed and the time to be devoted to each topic (signed original and

eight (8) copies) by December 13, 1994.

A period of 10 minutes will be allotted to each person for making

comments.

An agenda showing the scheduling of the speakers will be prepared

after the deadline for receiving outlines has passed. Copies of the

agenda will be available free of charge at the hearing.

Drafting Information

Several persons from the Office of Chief Counsel and the Treasury

Department participated in developing these regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendment to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

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

removing the entry for Secs. 1.6038A-1 through 1.6038A-7 and adding

entries in numerical order to read as follows:

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

Section 1.871-1 also issued under 26 U.S.C. 7701(l). * * *

Section 1.881-3 also issued under 26 U.S.C. 7701(l). * * *

Section 1.881-4 also issued under 26 U.S.C. 7701(l). * * *

Section 1.1441-3 also issued under 26 U.S.C. 7701(l). * * *

Section 1.1441-7 also issued under 26 U.S.C. 7701(l). * * *

Section 1.6038-2 also issued under 26 U.S.C. 7701(l). * * *

Section 1.6038A-1 also issued under 26 U.S.C. 6038A.

Section 1.6038A-2 also issued under 26 U.S.C. 6038A and 7701(l).

Section 1.6038A-3 also issued under 26 U.S.C. 6038A and 7701(l).

Section 1.6038A-4 also issued under 26 U.S.C. 6038A.

Section 1.6038A-5 also issued under 26 U.S.C. 6038A.

Section 1.6038A-6 also issued under 26 U.S.C. 6038A.

Section 1.6038A-7 also issued under 26 U.S.C. 6038A. * * *

Section 1.7701(l)-1 also issued under 26 U.S.C. 7701(l). * * *

Par. 2. In Sec. 1.871-1, paragraph (b)(7) is added to read as

follows:

Sec. 1.871-1 Classification and manner of taxing alien individuals.

* * * * *

(b) * * *

(7) Conduit financing arrangements. For rules regarding conduit

financing arrangements, see Secs. 1.881-3 and 1.881-4.

* * * * *

Par. 3. Sections 1.881-0, 1.881-3 and 1.881-4 are added to read as

follows:

Sec. 1.881-0 Table of contents.

This section lists the major headings for Secs. 1.881-1 through

1.881-4.

Sec. 1.881-1 Manner of taxing foreign corporations.

(a) Classes of foreign corporations.

(b) Manner of taxing.

(1) Foreign corporations not engaged in U.S. business.

(2) Foreign corporations engaged in U.S. business.

(c) Meaning of terms.

(d) Rules applicable to foreign insurance companies.

(1) Corporations qualifying under subchapter L.

(2) Corporations not qualifying under subchapter L.

(e) Other provisions applicable to foreign corporations.

(1) Accumulated earnings tax.

(2) Personal holding company tax.

(3) Foreign personal holding companies.

(4) Controlled foreign corporations.

(i) Subpart F income and increase of earnings invested in U.S.

property.

(ii) Certain accumulations of earnings and profits.

(5) Changes in tax rate.

(6) Consolidated returns.

(7) Adjustment of tax of certain foreign corporations.

Sec. 1.881-2 Taxation of foreign corporations not engaged in U.S.

business.

(a) Imposition of tax.

(b) Fixed or determinable annual or periodical income.

(c) Other income and gains.

(1) Items subject to tax.

(2) Determination of amount of gain.

(d) Credits against tax.

(e) Effective date.

Sec. 1.881-3 Conduit financing arrangements.

(a) General rules and definitions.

(1) Purpose and scope.

(2) Definitions.

(i) Financing arrangement.

(ii) Financing transaction.

(iii) Conduit entity.

(iv) Guarantee.

(v) Related.

(vi) Tax avoidance plan.

(3) Treatment of intermediate entity as conduit entity.

(i) Authority of district director.

(ii) Taxpayer's use of this section.

(4) Standard for conduit treatment.

(i) In general.

(ii) Multiple intermediate entities.

(A) In general.

(B) Special rule for related persons.

(b) Determination of whether intermediate entity would not have

participated in financing arrangement on substantially same terms.

(c) Determination of whether participation of intermediate

entity is pursuant to a tax avoidance plan.

(1) In general.

(2) Factors taken into account in determining the presence or

absence of a tax avoidance plan.

(3) Presumption if significant financing activities performed by

a related intermediate entity.

(i) General rule.

(ii) Requirements.

(4) Special rules for cases where financing entity is unrelated

to both intermediate entity and financed entity.

(i) Presumption of no tax avoidance.

(ii) Liability of financing entity.

(d) Determination of amount of tax liability.

(1) Amount of payment subject to recharacterization.

(i) In general.

(ii) Multiple conduit entities.

(iii) Determination of principal amount.

(2) Rate of tax.

(3) Effect of income tax treaties.

(4) Withholding tax due.

(e) Coordination with sections 871, 884, 1441 and 1442.

(f) Examples.

(g) Effective date.

Sec. 1.881-4 Reporting and recordkeeping requirements concerning

conduit financing arrangements.

(a) Scope.

(b) Reporting requirements.

(1) Persons required to report.

(2) Reporting requirement.

(3) Additional disclosure.

(c) Recordkeeping requirements.

(d) Application of sections 6038 and 6038A.

(1) In general.

(2) Duplication of reporting requirements.

(e) Effective date.

Sec. 1.881-3 Conduit financing arrangements.

(a) General rules and definitions--(1) Purpose and scope. Pursuant

to the authority of section 7701(l), this section provides rules that

permit the district director to disregard, for purposes of section 881,

the participation of one or more persons in a conduit financing

arrangement. These rules also apply for purposes of sections 871, 1441,

and 1442. See Sec. 1.881-4 for reporting and recordkeeping requirements

concerning conduit financing arrangements. See Secs. 1.1441-3(j) and

1.1441-7(d) for withholding rules applicable to conduit financing

arrangements.

(2) Definitions. The following definitions apply to this section

and to Secs. 1.881-4, 1.1441-3(j) and 1.1441-7(d).

(i) Financing arrangement means two or more financing transactions

pursuant to which one person (the financing entity) advances money or

other property to another person (the intermediate entity) and the

intermediate entity advances money or other property to a third person

(the financed entity), and, if there is more than one intermediate

entity, there is a chain of financing transactions linking each

intermediate entity. For this purpose, a transfer of money or other

property in satisfaction of a repayment obligation is not an advance of

money or other property. The term financing arrangement also includes

two or more financing transactions that achieve substantially the same

result through any other series of steps. A financing arrangement

exists only for the period during which all of the financing

transactions are coexistent. See Example 1 of paragraph (f) of this

section for an illustration of the term financing arrangement.

(ii) Financing transaction means--

(A) Any advance of money or other property in exchange for debt;

(B) Any advance of money or other property in exchange for stock

(or a similar interest in a partnership or trust) if--

(1) As of the issue date, the holder has the right (or, as of the

issue date, it is more likely than not that the holder will receive the

right) to cause the issuer to redeem the stock, or will receive such a

right upon the occurrence of a specified event and such event is more

likely than not to occur, or, as of the issue date, it is more likely

than not that the stock will be redeemed as a result of an issuer's

right to redeem the stock (assuming for all purposes of this paragraph

(a)(2)(ii)(B)(1) that the issuer will have the legally available funds

to redeem the stock);

(2) The holder possesses the right (or, as of the issue date, it is

more likely than not that the holder will obtain the right) to cause,

directly or indirectly, the issuer to make any payment (other than a

payment described in paragraph (a)(2)(ii)(B)(1) of this section) with

respect to the stock (assuming for this purpose that the issuer will

have the legally available funds to make such a payment), including the

right, arising upon a default on a payment (other than rights arising,

in the ordinary course, between the date that a payment is declared and

the date that a payment is made), to enforce the payment through a

legal proceeding, cause the issuer to be liquidated, or elect a

majority of the issuer's board of directors, but not including a right

derived from ownership of a controlling interest in the issuer in cases

where the control does not arise from a default or similar contingency

under the instrument; or

(3) Under circumstances similar to those described in paragraph

(a)(2)(ii)(B)(1) or (2) of this section, the holder has the right to

require a person related to the issuer (or any other person who is

acting pursuant to a plan or arrangement with the issuer) to acquire

the stock or make a payment with respect to the stock;

(C) Any lease or license;

(D) Any advance of money or other property not described in

paragraph (a)(2)(ii)(A), (B) or (C) of this section (including an

advance by any person to a trust described in sections 671 through 679)

pursuant to which the transferee is obligated to repay or return a

substantial portion of the money or other property advanced, or the

equivalent in value. This paragraph (a)(2)(ii)(D) shall not apply to

the posting of collateral unless the intermediate entity is permitted

to reduce such collateral to cash (through a transfer, grant of a

security interest or similar transaction) prior to default on the

financing transaction secured by the collateral; and

(E) Any transaction by which a person becomes a party to an

existing financing transaction.

(iii) Conduit entity means an intermediate entity whose

participation in a financing arrangement is disregarded in whole or in

part pursuant to this section.

(iv) Guarantee means any arrangement under which a person, directly

or indirectly, assures, on a conditional or unconditional basis, the

payment of another person's obligation with respect to a financing

transaction. The term shall be interpreted in accordance with the

definition of the term in section 163(j)(6)(D)(iii). However, a

guarantee that was neither in existence nor contemplated at the time

the financing transaction between the intermediate entity and the

financed entity was entered into is not a guarantee for these purposes.

(v) Related means related within the meaning of sections 267(b) or

707(b)(1), or controlled within the meaning of section 482, and the

regulations under those sections. For purposes of determining whether a

person is related to another person, the constructive ownership rules

of section 318 shall apply, and the attribution rules of section 267(c)

also shall apply to the extent they attribute ownership to persons to

whom section 318 does not attribute ownership.

(vi) Tax avoidance plan is defined in paragraph (c)(1) of this

section.

(3) Treatment of intermediate entity as conduit entity--(i)

Authority of district director. For purposes of section 881, the

district director may determine that an intermediate entity is a

conduit entity under the standard set forth in paragraph (a)(4) of this

section. In applying that paragraph, the district director may

determine the composition of the financing arrangement and the number

of parties to the financing arrangement.

(ii) Taxpayer's use of this section. A taxpayer may not apply this

section to reduce the amount of its Federal income tax liability by

disregarding the form of its financing transactions for Federal income

tax purposes or by compelling the district director to do so.

(4) Standard for conduit treatment--(i) In general. The district

director, in his or her discretion, may treat an intermediate entity in

a financing arrangement as a conduit entity if--

(A) The participation of the intermediate entity in the financing

arrangement reduces the tax imposed by section 881;

(B) The participation of the intermediate entity in the financing

arrangement is pursuant to a tax avoidance plan; and

(C) Either--

(1) The intermediate entity is related to the financing entity or

the financed entity; or

(2) The intermediate entity would not have participated in the

financing arrangement on substantially the same terms but for the fact

that the financing entity engaged in the financing transaction with the

intermediate entity.

(ii) Multiple intermediate entities--(A) In general. If a financing

arrangement involves multiple intermediate entities, the district

director may apply principles consistent with those of paragraph

(a)(4)(i) of this section to the entire financing arrangement so as to

treat two or more intermediate entities as conduit entities. For an

illustration of this rule see Example 2 of paragraph (f) of this

section.

(B) Special rule for related persons. If two (or more) financing

transactions involving two (or more) related persons would form part of

a financing arrangement but for the absence of a financing transaction

between the related persons, the district director may treat the

related persons as a single intermediate entity if he or she determines

that the avoidance of the application of this section is one of the

principal purposes for the structuring of the financing transactions.

This determination shall be based upon all of the facts and

circumstances, including, without limitation, the factors set forth in

paragraph (c)(2) of this section. The district director may apply

similar principles if a financing transaction exists between related

persons, but one of the principal purposes for the existence of the

financing transaction is to prevent the district director from treating

the related persons as a single intermediate entity. For examples

illustrating the special rule of this paragraph, see Examples 3, 4 and

5 of paragraph (f) of this section.

(b) Determination of whether intermediate entity would not have

participated in financing arrangement on substantially same terms. The

determination of whether an intermediate entity would not have

participated in a financing arrangement on substantially the same terms

but for the financing transaction between the financing entity and the

intermediate entity shall be based upon all of the facts and

circumstances. It shall be presumed that the intermediate entity would

not have participated in the financing arrangement on substantially the

same terms if the financing entity guarantees the liability of the

financed entity to the intermediate entity under that financing

transaction. A taxpayer may rebut this presumption by producing clear

and convincing evidence to the contrary.

(c) Determination of whether participation of intermediate entity

is pursuant to a tax avoidance plan--(1) In general. A tax avoidance

plan is a plan one of the principal purposes of which is the avoidance

of tax imposed by section 881. The plan may be formal or informal,

written or oral, and may involve any one or more of the parties to the

financing arrangement. It may be inferred from the facts and

circumstances, but must be in existence no later than the last date

that any of the financing transactions comprising the financing

arrangement are entered into. The determination of whether the

participation of the intermediate entity in the financing arrangement

is pursuant to a tax avoidance plan shall be based upon all of the

facts and circumstances relevant to the existence of a plan and to the

purposes for the participation of the intermediate entity in the

financing arrangement.

(2) Factors taken into account in determining the presence or

absence of a tax avoidance plan. Among the facts and circumstances

taken into account in determining whether the participation of an

intermediate entity in a financing arrangement is pursuant to a tax

avoidance plan are--

(i) Whether the participation of the intermediate entity in the

financing arrangement significantly reduces the tax that otherwise

would have been imposed under section 881 (determined by comparing the

rate of tax imposed on payments made by the financed entity to the

intermediate entity with the rate that would have been imposed had the

payments been made by the financed entity to the financing entity).

However, the fact that an intermediate entity is a resident of a

country that has a treaty with the United States that significantly

reduces the tax that otherwise would have been imposed under section

881 is not sufficient, by itself, to establish the existence of a tax

avoidance plan;

(ii) Whether the intermediate entity would have been able to make

the advance of the money or other property to the financed entity

without the advance of money or other property to it by the financing

entity;

(iii) The length of the period of time that separates the advances

of money or other property by the financing entity to the intermediate

entity and by the intermediate entity to the financed entity. A short

period of time is indicative of a tax avoidance plan while a long

period of time is not; and

(iv) If the intermediate entity is related to the financed entity,

whether the two entities enter into a financing transaction to finance

a trade or business actively engaged in by the financed entity that

forms a part of, or is complementary to, a substantial trade or

business actively engaged in by the intermediate entity (other than the

business of making or managing investments, except pursuant to a

banking, insurance, financing or similar trade or business the income

from which is earned predominantly in transactions with unrelated

persons). A financing transaction described in the preceding sentence

is indicative that no tax avoidance plan exists.

(3) Presumption if significant financing activities performed by a

related intermediate entity--

(i) General rule. It shall be presumed that the participation of an

intermediate entity (or entities) in a financing arrangement is not

pursuant to a tax avoidance plan if the intermediate entity is related

to either or both the financing entity or the financed entity, and the

intermediate entity performs significant financing activities with

respect to the financing transactions forming part of the financing

arrangement to which it is a party. This presumption may be rebutted if

the district director establishes that the participation of the

intermediate entity in the financing arrangement is pursuant to a tax

avoidance plan. For illustrations of this presumption, see Examples 12,

13 and 14 of paragraph (f) of this section.

(ii) Requirements. For purposes of this paragraph (c)(3), an

intermediate entity performs significant financing activities with

respect to such financing transactions if--

(A) Rents or royalties earned with respect to leases or licenses

constituting such financing transactions are derived in the active

conduct of a trade or business within the meaning of Sec. 1.954-2T(c)

or (d), to be applied by substituting the term intermediate entity for

the term controlled foreign corporation; or

(B) Officers and employees of the intermediate entity, without the

material participation of any officer or employee of a related person,

other than participation in the approval of any guarantee of a

financing transaction--

(1) Participate actively and materially in arranging the

intermediate entity's participation in such financing transactions.

This requirement shall not apply to a financing transaction that is the

advance of property in exchange for a trade receivable that is ordinary

and necessary to carrying on a substantial trade or business of either

the financed entity or the financing entity if officers or employees of

that entity participated actively and materially in arranging the

financing transaction; and

(2) Within the country in which the intermediate entity is

organized (or, if different, within the country with respect to which

the intermediate entity is claiming the benefits of a tax treaty)--

(i) Exercise management and oversight of (and actually carry out)

the intermediate entity's strategic business decision-making process

and of its day-to-day operations, which must consist of a substantial

trade or business, or supervision, administration and financing of a

substantial group of related persons; and

(ii) Actively manage, on an ongoing basis, material business risks

arising from such financing transactions as an integral part of the

management of the intermediate entity's financial and capital

requirements (including management of risks of currency and interest

rate fluctuations) and management of the intermediate entity's short-

term investments of working capital.

(4) Special rules for cases where financing entity is unrelated to

both intermediate entity and financed entity--(i) Presumption of no tax

avoidance. It shall be presumed that the participation of an

intermediate entity (or entities) in a financing arrangement is not

pursuant to a tax avoidance plan if the financing entity is unrelated

to the intermediate entity (or entities) and the financed entity, and

the intermediate entity (or, in the case of multiple intermediate

entities, the intermediate entity that has engaged in a financing

transaction with the financing entity) is actively engaged in a

substantial trade or business (other than the business of making or

managing investments, except pursuant to a banking, insurance,

financing or similar trade or business the income from which is earned

predominantly in transactions with unrelated persons). This presumption

may be rebutted if the district director establishes that the

participation of the intermediate entity in the financing arrangement

is pursuant to a tax avoidance plan. For an illustration of this

special rule see Example 15 of paragraph (f) of this section.

(ii) Liability of financing entity--(A) In general. Notwithstanding

that the district director may treat an intermediate entity in a

financing arrangement as a conduit entity under paragraph (a)(4) of

this section, a financing entity that is unrelated to the financed

entity and the intermediate entity (or entities) shall not be liable

for tax under section 881 pursuant to this section unless the financing

entity knows or has reason to know that the financing arrangement is

subject to recharacterization under paragraph (a)(3) of this section.

This paragraph (c)(4)(ii) shall not apply, however, for purposes of

determining whether any person is liable for withholding tax pursuant

to Sec. 1.1441-3(j) or whether any party to a financing arrangement is

entitled under sections 1461 to 1464 to a refund of tax actually

withheld by a withholding agent pursuant to section 1441. Accordingly,

if the conditions of paragraph (a)(4) of this section are satisfied,

the financed entity shall be required to pay withholding tax without

regard to the knowledge of the financing entity and no party to the

financing arrangement shall be entitled to a refund except to the

extent the amount withheld exceeds the amount determined under section

881 by recharacterizing the transaction and disregarding the conduit

entity pursuant to paragraph (a)(4).

(B) Know or have reason to know standard. The standard described in

paragraph (c)(4)(ii)(A) shall be satisfied if the person knows or has

reason to know those facts relevant to whether the financing

arrangement satisfies the conditions set forth in paragraph (a)(4) of

this section, including whether the participation of the intermediate

entity in the financing arrangement is pursuant to a tax avoidance

plan. A person shall not be considered to have reason to know that the

financing arrangement is subject to recharacterization under paragraph

(a)(3) of this section if the person knows of the financing

transactions that comprise the financing arrangement but does not know

or have reason to know of facts sufficient to establish that the

participation of the intermediate entity in the financing arrangement

was pursuant to such a plan.

(d) Determination of amount of tax liability--(1) Amount of payment

subject to recharacterization--(i) In general. If the district director

treats an intermediate entity as a conduit entity pursuant to paragraph

(a)(3) of this section, a portion of each payment made by the financed

entity with respect to the financing transactions that comprise the

financing arrangement shall be subject to recharacterization as a

transaction directly between the financed entity and the financing

entity. The recharacterized portion shall be the portion of the payment

that is equal to the ratio (not to exceed 1:1) of the average principal

amount of such financing transaction(s) between the conduit entity and

the financing entity to the average principal amount of such financing

transaction(s) between the financed entity and the conduit entity, for

the period to which the payment made by the financed entity relates.

The average may be computed using any method applied consistently that

reflects with reasonable accuracy the amount outstanding for the

period. For an illustration of the calculation of the amount of tax

liability see Example 16 of paragraph (f) of this section.

(ii) Multiple conduit entities. Except in the case of a financing

arrangement described in paragraph (a)(4)(ii)(B) of this section, if a

financing arrangement involves multiple intermediate entities that are

treated as conduit entities, the ratio described in paragraph (d)(1)(i)

of this section shall be based upon a comparison of the financing

transaction between a conduit entity and a party other than the

financed entity that has the lowest average principal amount, and the

financing transaction involving the financed entity.

(iii) Determination of principal amount. The principal amount of a

financing transaction shall be determined on the basis of all of the

facts and circumstances. The principal amount generally will equal the

amount of money, or the fair market value of other property (determined

as of the time that the financing transaction is entered into),

advanced in the financing transaction. In the case of a debt instrument

or stock, the fair market value of the property advanced will be

considered to equal the issue price unless the fair market value

differs materially from the issue price. The principal amount of a

financing transaction shall be subject to adjustments, as appropriate.

For example, in the case of an OID debt instrument that is repaid in

installments and has an issue price equal to the fair market value of

the property advanced, appropriate adjustments will be made for

accruals of original issue discount and repayments of principal

(including accrued original issue discount).

(2) Rate of tax. If a financing arrangement is recharacterized

under paragraph (a)(3) of this section, the payments by the financed

entity described in section 881 shall be subject to tax at the rate

that would have been applicable had payments been made directly to the

financing entity. The applicable rate shall be determined by reference

to the character of the financing transaction (e.g., loan or lease)

between the intermediate entity and the financed entity.

(3) Effect of income tax treaties. A financing arrangement shall be

subject to recharacterization under this section regardless of whether

a conduit entity is a resident of a country that has an income tax

treaty with the United States. Accordingly, if the financing

arrangement is recharacterized as a transaction directly between the

financed entity and a person that is not entitled to claim the benefits

of the income tax treaty, the treaty shall not operate to reduce the

amount of tax due under section 881.

(4) Withholding tax due. For withholding rules applicable to

financing arrangements described in paragraph (a)(4) of this section,

see Secs. 1.1441-3(j) and 1.1441-7(d).

(e) Coordination with sections 871, 884, 1441 and 1442. For

purposes of this section, any reference to tax imposed under section

881 includes, as the context may require, a reference to tax imposed

under sections 871, 884(f)(1)(A), 1441, or 1442.

(f) Examples. The following examples illustrate this section. For

purposes of these examples, unless otherwise indicated, it is assumed

that FP, a corporation organized in country X, owns all of the stock of

FS, a corporation organized in country Y, and DS, a corporation

organized in the United States. Country Y, but not country X, has an

income tax treaty with the United States. The treaty exempts interest,

rents and royalties paid by a resident of one state (the source state)

to a resident of the other state from tax in the source state.

Example 1. Financing arrangement. (i) On January 1, 1995, FP

lends $1,000,000 to DS in exchange for a note issued by DS. On

January 1, 1996, FP assigns the DS note to FS in exchange for a note

issued by FS. After receiving notice of the assignment, DS remits

payments due under its note to FS.

(ii) FP's loan to DS and FP's assignment of the DS note to FS

are financing transactions within the meaning of paragraph

(a)(2)(ii) of this section, and the transactions together constitute

a financing arrangement within the meaning of paragraph (a)(2)(i) of

this section. Therefore, for purposes of section 881, the district

director may treat FS as a conduit entity if the conditions of

paragraph (a)(4)(i) of this section are satisfied.

Example 2. Multiple conduits. (i) On January 1, 1995, FP

deposits $1,000,000 with BK, a bank that is organized in country Y

and is unrelated to FP and its subsidiaries. On January 1, 1996, at

a time when the FP-BK deposit is still outstanding, BK lends

$500,000 to BK2, a bank that is wholly- owned by BK and is organized

in country Y. On the same date, BK2 lends $500,000 to FS. On July 1,

1996, FS lends $500,000 to DS. FP pledges its deposit to BK2 in

support of FS' obligation to repay the BK2 loan. FS', BK's and BK2's

participation in the financing arrangement is pursuant to a tax

avoidance plan.

(ii) Since there are multiple intermediate entities, under

paragraph (a)(4)(ii)(A) of this section, principles consistent with

those of paragraph (a)(4)(i) of this section apply to the entire

financing arrangement for purposes of determining whether the

requirements of paragraph (a)(4) of this section are satisfied.

Since BK and BK2 are unrelated to FP, FS and DS, the conditions of

paragraph (a)(4)(i)(C)(2) of this section must be satisfied with

respect to the financing transactions between FP, BK, BK2 and FS.

The conditions of that paragraph are presumed under paragraph (b) of

this section to be satisfied because FP's pledge of an asset in

support of FS' obligation to repay the BK2 loan is a guarantee

within the meaning of paragraph (a)(2)(iv) of this section. Since BK

and BK2 are related, it is not necessary that the conditions of

paragraph (a)(4)(i)(C)(2) of this section be satisfied independently

with respect to the financing transactions between FP, BK and BK2.

In addition, the conditions of paragraphs (a)(4)(i)(A) and (B) of

this section are satisfied because the participation of BK, BK2 and

FS in the financing arrangement reduces the tax imposed by section

881, and FS', BK's and BK2's participation in the financing

arrangement is pursuant to a tax avoidance plan. Accordingly, for

purposes of section 881, the district director may treat FP as a

financing entity and BK, BK2 and FS as conduit entities, and

recharacterize the financing arrangement as a financing transaction

directly between DS and FP.

Example 3. Related persons treated as a single conduit entity.

(i) On January 1, 1995, FP deposits $1,000,000 with BK, a bank that

is organized in country X and is unrelated to FP and its

subsidiaries. M, a corporation also organized in country X, is

wholly-owned by the sole shareholder of BK but is not a bank within

the meaning of section 881(c)(3)(A). On July 1, 1995, M lends

$1,000,000 to DS in exchange for a note maturing on July 1, 2005.

The note is in registered form within the meaning of section

881(c)(2)(B)(i) and DS has received from M the statement required by

section 881(c)(2)(B)(ii). The conditions of paragraph (a)(4)(i) of

this section would be satisfied with respect to the financing

transactions between FP, BK, M and DS but for the absence of a

financing transaction between BK and M. One of the principal

purposes for the absence of a financing transaction between BK and M

is the avoidance of the application of this section.

(ii) Pursuant to paragraph (a)(4)(ii)(B) of this section, the

district director may treat the financing transactions between FP,

BK, M and DS as a financing arrangement for purposes of this section

even though BK and M do not engage in a financing transaction. In

such a case, BK and M would be considered a single intermediate

entity for purposes of this section.

Example 4. Related persons treated as a single conduit entity.

(i) On January 1, 1995, FP lends $10,000,000 to FS in exchange for a

10-year note that pays interest annually at a rate of 8 percent per

annum. On January 2, 1995, FS contributes $10,000,000 to FS2, a

wholly-owned subsidiary of FS organized in country Y, in exchange

for common stock of FS2. On January 1, 1996, FS2 lends $10,000,000

to DS in exchange for an 8-year note that pays interest annually at

a rate of 10 percent per annum.

(ii) FS is a holding company that has no significant assets

other than the stock of FS2. Throughout the period that the FP-FS

loan is outstanding, FS causes FS2 to make distributions to FS, most

of which are used to make interest and principal payments on the FP-

FS loan. Without the distributions from FS2, FS would not have had

the funds with which to make payments on the FP-FS loan.

(iii) The conditions of paragraph (a)(4)(i) of this section

would be satisfied with respect to the financing transactions

between FP, FS, FS2 and DS but for the absence of a financing

transaction between FS and FS2. One of the principal purposes for

the absence of a financing transaction between FS and FS2 is the

avoidance of the application of this section.

(iv) Pursuant to paragraph (a)(4)(ii)(B) of this section, the

district director may treat the financing transactions between FP,

FS, FS2 and DS as a financing arrangement for purposes of this

section even though FS and FS2 do not engage in a financing

transaction. In such a case, FS and FS2 would be considered a single

intermediate entity for purposes of this section.

Example 5. Related persons treated as a single conduit entity.

Assume the same facts as in Example 4 except that FS contributes

$9,900,000 and lends $100,000 to FS2. Pursuant to paragraph

(a)(4)(ii)(B) of this section, the district director may treat the

financing transactions between FP, FS, FS2 and DS as a financing

arrangement for purposes of this section even though FS and FS2

engage in a financing transaction since from the facts and

circumstances the district director may determine that one of the

principal purposes for the existence of the financing transaction is

to prevent the district director from treating the related persons

as a single intermediate entity. In such a case, FS and FS2 would be

considered a single intermediate entity for purposes of this

section.

Example 6. Reduction of tax. (i) On January 1, 1995, FP licenses

to FS the rights to use a patent in the U.S. to manufacture product

A. FS agrees to pay FP a fixed amount in royalties each year under

the license. On January 1, 1996, FS sublicenses to DS the rights to

use the patent in the U.S. Under the sublicense, DS agrees to pay FS

royalties based upon the units of product A manufactured by DS each

year. Although the formula for computing the amount of royalties

paid by DS to FS differs from the formula for computing the amount

of royalties paid by FS to FP, each represents an arm's length rate.

The fair market value of the patent rights do not increase between

January 1, 1995, and January 1, 1996.

(ii) Under the country Y-U.S. income tax treaty, the royalties

paid by DS to FS are exempt from U.S. withholding tax. However,

pursuant to Secs. 1.881-2(b) and 1.1441-2(a), the parties withhold

tax at a 30 percent rate on the royalties paid to FP because the

royalties are paid in consideration for the privilege of using the

patent in the United States, and therefore the royalties constitute

income from U.S. sources under section 861(a)(4).

(iii) Because the principal amount of the license between FS and

DS is equal to or less than the principal amount of the license

between FP and FS, the royalties paid by DS and FS represent an

arm's length rate, and the rate of tax imposed on royalties paid by

FS to FP is the same as the rate that would have been imposed on

royalties paid by DS to FP, the participation of FS in the FP-FS-DS

financing arrangement is not considered to reduce the tax imposed by

section 881 within the meaning of paragraph (a)(4)(i)(A) of this

section.

Example 7. A principal purpose of plan. (i) On January 1, 1995,

FS lends $10,000,000 to DS in exchange for a 10-year note that pays

interest annually at a rate of 8 percent per annum. As was intended

at the time of the loan from FS to DS, on July 1, 1995, FP makes an

interest-free demand loan of $10,000,000 to FS. A principal purpose

for FS' participation in the FP-FS-DS financing arrangement is that

FS generally coordinates the financing for all of FP's subsidiaries

(although FS does not engage in significant financing activities

with respect to such financing transactions). However, another

principal purpose for FS' participation is to allow the parties to

benefit from the lower withholding tax rate provided under the

treaty between country Y and the United States.

(ii) The financing arrangement satisfies the tax avoidance

purpose requirement of paragraph (a)(4)(i)(B) of this section since

FS participated in the financing arrangement pursuant to a plan one

of the principal purposes of which is to allow the parties to

benefit from the country Y-U.S. treaty.

Example 8. Reduction of tax. (i) FX is a wholly-owned subsidiary

of FP and is a resident of country Y. FX owns all of the stock of

FS1, which also is a resident of country Y. FS1 owns all of the

stock of DX, a corporation organized in the United States. On

January 1, 1995, FP contributes $10,000,000 to the capital of FX. On

July 1, 1995, FX lends $10,000,000 to FS1. On January 1, 1996, FS1

lends $10,000,000 to DX. Under the terms of the country Y-U.S.

income tax treaty, a country Y resident is not entitled to the

reduced withholding rate on interest income provided by the treaty

if the resident is entitled to, even if it does not claim, special

tax benefits under country Y law. In order to qualify for the

reduced withholding rate on the interest it receives from DX, FS1

does not claim the special tax benefits under country Y law. FX,

however, obtains the special tax benefits under country Y law, which

substantially reduces the rate of tax imposed on the interest it

receives from FS1. Accordingly, if FX had made a loan directly to

DX, payments of interest by DX to FX would have been subject to tax

under section 881 at a 30 percent rate.

(ii) Pursuant to paragraph (a)(3)(i) of this section, the

district director may determine that the FX-FS1 loan and the FS1-DX

loan comprise a financing arrangement. Pursuant to paragraph

(c)(2)(i)(A) of this section, the significant reduction in tax

resulting from the participation of FS1 in the financing arrangement

is evidence that the participation of FS1 in the financing

arrangement is pursuant to a tax avoidance plan. However, other

facts relevant to the presence of such a plan must also be taken

into account.

Example 9. Time period between financing transactions. (i) On

January 1, 1995, FP lends $10,000,000 to FS in exchange for a 10-

year note that pays no interest annually. When the note matures, FS

is obligated to pay $24,000,000 to FP. On January 1, 1996, FS lends

$10,000,000 to DS in exchange for a 10-year note that pays interest

annually at a rate of 10 percent per annum.

(ii) Pursuant to paragraph (c)(2)(i)(C) of this section, the

twelve-month period between the loan by FP to FS and the loan by FS

to DS is evidence that the participation of FS in the financing

arrangement is pursuant to a tax avoidance plan. However, other

facts relevant to the presence of such a plan must also be taken

into account.

Example 10. Active conduct of a trade or business. (i) FP is a

holding company. FS is actively engaged in country Y in the business

of manufacturing and selling product A. DS manufactures product B,

which is a principal component used by FS in the manufacture of

product A. FS' business activity is substantial. On January 1, 1995,

FP lends $100,000,000 to FS to finance FS' business operations. On

January 1, 1996, FS lends $30,000,000 to DS to finance its

manufacturing business.

(ii) Pursuant to paragraph (c)(2)(ii)(C) of this section, the

fact that FS makes a loan to DS in order to finance a business

actively engaged in by DS that forms a part of, or is complementary

to, a substantial business actively engaged in by FS is evidence

that the participation of FS in the financing arrangement is not

pursuant to a tax avoidance plan. However, other facts relevant to

the presence of such a plan must also be taken into account.

Example 11. Ordinary course deposits of working capital. (i)

Over a period of years, FP has maintained a deposit with BK, a bank

that is organized in country Y and is unrelated to FP and its

subsidiaries. FP has placed funds in the bank account in order to

maintain sufficient liquidity to meet its working capital needs. On

January 1, 1995, BK lends $5,000,000 to DS. FP guarantees to BK that

DS will satisfy its repayment obligation on the loan. Both prior to

and after the loan is made, the balance in FP's bank account remains

within a range appropriate to meet FP's working capital needs.

(ii) The fact that FP has historically maintained an account

with BK to meet its working capital needs and that, prior to and

after BK's loan to DS, the balance within the account remains within

a range appropriate to meet those business needs, is evidence that

the participation of BK in the FP-BK-DS financing arrangement is not

pursuant to a tax avoidance plan. However, other facts relevant to

the presence of such a plan must also be taken into account.

(iii) Assume the same facts, except that on January 1, 2000,

FP's deposit with BK substantially exceeds FP's expected working

capital needs. On January 2, 2000, BK lends additional funds to DS.

FP would have lent the funds to DS directly but for the imposition

of the withholding tax on payments made directly to FP by DS.

(iv) The presence of funds substantially in excess of FP's

working capital needs and FP's willingness to lend funds directly to

DS is evidence that the participation of BK in the FP-BK-FS

financing arrangement is pursuant to a tax avoidance plan. However,

other facts relevant to the presence of such a plan must also be

taken into account.

(v) In either case, the taxpayer may establish, pursuant to

paragraph (b) of this section, that BK would have made the loan to

DS on substantially the same terms in the absence of FP's deposit

with BK.

Example 12. Presumption with respect to significant financing

activities. (i) FS has 100 employees located in country Y who are

responsible for coordinating the financing of all of the

subsidiaries of FP, which are engaged in a substantial trade or

business and are located in both country Y and country X. FS

maintains a centralized cash management accounting system for FP and

its subsidiaries in which it records all intercompany payables and

receivables; these payables and receivables ultimately are reduced

to a single balance either due from or owing to FS and each of FP's

subsidiaries. FS is responsible for disbursing or receiving any cash

payments required by transactions between its affiliates and

unrelated parties. FS must borrow any cash necessary to meet those

external obligations and invests any excess cash for the benefit of

the FP group. FS enters into interest rate and foreign exchange

contracts as necessary to manage the risks arising from mismatches

in incoming and outgoing cash flows. At the request of DS, on

January 1, 1995, FS pays a supplier $1,000,000 for materials

delivered to DS and charges DS an open account receivable for this

amount. On February 3, 1995, FS reverses the account receivable from

DS to FS when DS delivers to FP goods with a value in excess of

$1,000,000.

(ii) The accounts payable from DS to FS and from FS to other

subsidiaries of FP constitute financing transactions within the

meaning of paragraph (a)(2)(ii) of this section, and the

transactions together constitute a financing arrangement within the

meaning of paragraph (a)(2)(i) of this section. FS performs

significant financing activities with respect to the financing

transactions even though FS did not actively and materially

participate in arranging the financing transactions because the

financing transactions consisted of advances of property in exchange

for trade receivables that were ordinary and necessary to carry on

the trades or businesses of DS and the other subsidiaries of FP.

Accordingly, pursuant to paragraph (c)(3)(i) of this section, FS's

participation in the financing arrangement is presumed not to be

pursuant to a tax avoidance plan.

Example 13. Active management of material business risks. (i)

The facts are the same as in Example 12, except that, in addition to

its short-term funding needs, DS needs long-term financing to fund

an acquisition of another U.S. company; the acquisition is scheduled

to close on January 15, 1995. FS has a revolving credit agreement

with a syndicate of banks located in Country X. On January 14, 1995,

FS borrows $10 billion for 10 years under the revolving credit

agreement, paying yen LIBOR plus 50 basis points on a quarterly

basis. FS enters into a currency swap with BK, an unrelated bank

that is not a member of the syndicate, under which FS will pay BK 10

billion and will receive $100 million on January 15, 1994; these

payments will be reversed on January 15, 2004. FS will pay BK U.S.

dollar LIBOR plus 50 basis points on a notional principal amount of

$100 million semiannually and will receive yen LIBOR plus 50 basis

points on a notional principal amount of $10 billion quarterly. Upon

the closing of the acquisition on January 15, 1995, DS borrows $100

million from FS for 10 years, paying U.S. dollar LIBOR plus 50 basis

points semiannually.

(ii) Although FS performs significant financing activities with

respect to certain financing transactions to which it is a party, FS

does not perform significant financing activities with respect to

the financing transactions between FS and the syndicate of banks and

between FS and DS because FS has eliminated all material business

risks arising from those financing transactions through its currency

swap with BK. Accordingly, the financing arrangement does not

benefit from the presumption of paragraph (c)(3)(i) and the district

director must determine whether the participation of FS in the

financing arrangement is pursuant to a tax avoidance plan on the

basis of all the facts and circumstances.

Example 14. A principal purpose of plan. (i) The facts are the

same as in Example 12, except that, on January 1, 1995, FP lends to

FS 20,000,000 deutsche marks (worth $10,000,000) in exchange for a

10-year note that pays interest annually at a rate of 5 percent per

annum. Also, on January 1, 1995, FS lends $10,000,000 to DS in

exchange for a 10-year note that pays interest annually at a rate of

8 percent per annum. FS would not have had sufficient funds to make

the loan to DS without the loan from FP. FS does not enter into any

long-term hedging transaction with respect to these financing

transactions, but manages its currency risk arising from the

transactions on a daily, weekly or quarterly basis by entering into

forward currency contracts.

(ii) Because FS performs significant financing activities with

respect to the financing transactions between FS, DS and FP, the

participation of FS in the financing arrangement is presumed not to

be pursuant to a tax avoidance plan. The district director may rebut

this presumption by establishing that the participation of FS is

pursuant to a tax avoidance plan, based on all the facts and

circumstances. The mere fact that FS is a resident of country Y is

not sufficient to establish the existence of a tax avoidance plan.

However, the existence of a plan can be inferred from other factors

in addition to the fact that FS is a resident of country Y. For

example, the loans are made on the same day and FS would not have

been able to make the loan to DS without the loan from FP.

Example 15. Presumption with respect to unrelated financing

entity. (i) FP is a corporation organized in country Y that is

actively engaged in a substantial manufacturing business. On January

1, 1995, FP obtains a 20-year $100,000,000 loan from BK, a bank that

is organized in country X and is unrelated to FP and its

subsidiaries. On January 1, 1996, FP lends $10,000,000 to DS.

(ii) Pursuant to paragraph (c)(4)(i) of this section, FP's

participation in the financing arrangement with BK and DS is

presumed not to be pursuant to a tax avoidance plan because BK is

unrelated to both FP and DS, and FP is actively engaged in a

substantial manufacturing business.

Example 16. Calculation of amount of tax liability. (i) On

January 1, 1996, FP makes two three-year installment loans of

$250,000 each to FS that pay interest at a rate of 9 percent per

annum. Payments on each loan are $7,950 per month. On the same date,

FS lends $1,000,000 to DS in exchange for a two-year note that pays

interest semi-annually at a rate of 10 percent per annum, beginning

on June 30, 1996. The district director determines that the

financing transactions between FP and FS, and FS and DS, are made

pursuant to a financing arrangement involving FP, FS and DS, that

satisfies the conditions of paragraph (a)(4) of this section.

(ii) Assume that for the period of January 1, 1996 through June

30, 1996, the average principal amount of the financing transactions

between FP and FS that comprise the financing arrangement is

$469,319. Further, assume that for the period of July 1, 1996

through December 31, 1996, the average principal amount of the

financing transactions between FP and FS is $393,632. The average

principal amount of the financing transaction between FS and DS for

the same periods is $1,000,000.

(iii) Pursuant to paragraph (d)(1)(i) of this section, the

portion of the $50,000 interest payment made by DS to FS on June 30,

1996, that is recharacterized as a payment to FP is $23,450 computed

as follows: ($50,000 x $469,319/$1,000,000) = $23,450. The portion

of the interest payment made on December 31, 1996 that is

recharacterized as a payment to FP is $19,650, computed as follows:

($50,000 x $393,632/$1,000,000)=$19,650.

(iv) Under Sec. 1.1441-3(j), DS is liable for withholding tax at

a 30 percent rate on the portion of the $50,000 payment to FS that

is recharacterized as a payment to FP, i.e., $7,035 with respect to

the June 30, 1996 payment and $5,895 with respect to the December

31, 1996 payment.

(g) Effective date. This section is effective for payments made

after the date which is 30 days after publication of final regulations

in the Federal Register. This section shall not apply with respect to

interest payments made by United States corporations to Netherlands

Antilles corporations in connection with debt obligations issued prior

to October 15, 1984 and payments of interest covered by section

127(g)(3) of the Tax Reform Act of 1984.

Sec. 1.881-4 Reporting and recordkeeping requirements concerning

conduit financing arrangements.

(a) Scope. This section provides rules for the furnishing of

information and the maintenance of records concerning certain financing

arrangements to which the provisions of Sec. 1.881-3 apply. This

section also provides rules for coordinating the application of

sections 6038 and 6038A with the application of this section.

(b) Reporting requirements--(1) Persons required to report. A

financed entity that is a reporting corporation within the meaning of

section 6038A(a) and the regulations under that section, or that is

required to report pursuant to section 6038(a) and the regulations

under that section, shall be required to comply with the requirements

of this paragraph (b) with respect to any financing transaction to

which the financed entity is a party, that the financed entity knows or

has reason to know forms a part of a financing arrangement described in

Sec. 1.881-3(a)(4) (determined without regard to Sec. 1.881-

3(a)(4)(i)(B)). For purposes of this paragraph (b), a financed entity

will be considered to know or have reason to know that the conditions

of Sec. 1.881-3(a)(4)(i)(C)(2) are satisfied with respect to a

financing arrangement if the financed entity knows or has reason to

know that the financing entity has guaranteed the liability of the

financed entity under the financing transaction. This paragraph (b)

applies only if a person with respect to which the financed entity is

required to report under sections 6038 or 6038A is a party to the

financing arrangement.

(2) Reporting requirement. A financed entity described in paragraph

(b)(1) of this section shall be required to attach to the Form 5471 or

5472, whichever is applicable, for each year in which it is a party to

a financing transaction described in paragraph (b)(1) of this section,

a statement setting forth the following information (rendered in the

English language and expressed in United States currency, with

disclosure of applicable exchange rates) concerning each financing

transaction--

(i) The character (e.g., loan, stock, lease, license) of the

financing transaction;

(ii) The name of the person that advanced money or other property

to the financed entity in the financing transaction, and the name of

the person (if different) to which the financed entity has made

payments pursuant to the financing arrangement;

(iii) The date and amount of each advance of money or other

property to the financed entity;

(iv) The amount of money or other property paid by the financed

entity pursuant to the financing transaction, and the date on which

each payment was made;

(v) A description of any guarantee provided by the financing entity

in connection with the financing arrangement; and

(vi) With respect to each party to the financing arrangement that

is related to the financed entity within the meaning of Sec. 1.881-

3(a)(2)(v)--

(A) The name, address, taxpayer identification number, if any, and

country of residence of the related person; and

(B) A description of the manner in which the financed entity and

the person are related.

(3) Additional disclosure. A financed entity may be required to

disclose on its Federal income tax return, or on other forms (including

Form 5471 or Form 5472, if otherwise applicable), information

concerning its participation in a financing arrangement described in

paragraph (b)(1) of this section, regardless of whether the financed

entity is required to report pursuant to paragraph (b)(1) of this

section. Information disclosed on the return or other forms need not

also be reported pursuant to paragraph (b)(2) of this section.

(c) Recordkeeping requirements. A financed entity or any other

person subject to the general recordkeeping requirements of section

6001 must keep the permanent books of account or records, as required

by section 6001, that may be relevant to whether that person is a party

to a financing arrangement that is subject to recharacterization under

Sec. 1.881-3. In addition, a financed entity that is a reporting

corporation within the meaning of section 6038A(a) and the regulations

under that section, and any other person that is subject to the

recordkeeping requirements of Sec. 1.6038A-3, must comply with such

recordkeeping requirements with respect to records that may be relevant

to whether the financed entity is a party to a financing arrangement

that is subject to recharacterization under Sec. 1.881-3.

(d) Application of sections 6038 and 6038A--(1) In general. Any

information that a financed entity is required to report pursuant to

paragraph (b) of this section, or any records that any person is

required to maintain pursuant to paragraph (c) of this section, shall

be considered information that is required to be reported, or records

that are required to be maintained, pursuant to sections 6038 or 6038A

if such person is required to report information or maintain records

concerning transactions between the financed entity and any other party

to the financing arrangement under either section 6038 or section

6038A. Accordingly, the provisions of sections 6038 and 6038A

(including, without limitation, the penalty provisions thereof), and

the regulations under those sections, shall apply to any information

required to be reported or records required to be maintained pursuant

to this section.

(2) Duplication of reporting requirements. Information that is

required to be reported on Form 5471 by Sec. 1.6038-2(f) or on Form

5472 by Sec. 1.6038A-2(b) need not be duplicated on the statements

required by paragraph (b)(2) of this section. Information that is

required to be reported about a particular financing transaction on the

statement required by paragraph (b)(2) of this section shall not be

considered to duplicate information required to be reported in the

aggregate on Form 5471 or Form 5472 about more than one financing

transaction.

(e) Effective date. This section is effective for tax years in

which payments described in Sec. 1.881-3 are made. This section shall

not apply with respect to interest payments made by United States

corporations to Netherlands Antilles corporations in connection with

debt obligations issued prior to October 15, 1984 and payments of

interest covered by section 127(g)(3) of the Tax Reform Act of 1984.

Par. 4. In Sec. 1.1441-3, paragraph (j) is added to read as

follows:

Sec. 1.1441-3 Exceptions and rules of special application.

* * * * *

(j) Conduit financing arrangements. A financed entity or other

person required to withhold tax under section 1441 with respect to a

financing arrangement subject to recharacterization under Sec. 1.871-

1(b)(7) or 1.881-3(a)(3), shall be required to withhold in accordance

with the recharacterization on the portion of each payment subject to

recharacterization, as determined by Sec. 1.881-3(c). If the financing

entity is entitled to the benefit of a treaty that provides a reduced

rate of tax on a payment of the type recharacterized, the financed

entity may withhold tax at that reduced rate if the financing entity

complies with the procedures, if any, prescribed in the relevant

treaty, or in regulations under section 1441. See Sec. 1.1441-7(d)

relating to withholding tax liability of the withholding agent in

conduit financing arrangements subject to Sec. 1.881-3. This paragraph

(j) is effective for payments made after the date which is 30 days

after publication of final regulations in the Federal Register. This

section shall not apply with respect to interest payments made by

United States corporations to Netherlands Antilles corporations in

connection with debt obligations issued prior to October 15, 1984 and

payments of interest covered by section 127(g)(3) of the Tax Reform Act

of 1984.

Par. 5. In Sec. 1.1441-7, paragraph (d) is added to read as

follows:

Sec. 1.1441-7 General provisions relating to withholding agents.

* * * * *

(d) Conduit financing arrangements. A person shall be required to

withhold tax under section 1441 in accordance with the

recharacterization of a financing arrangement under Sec. 1.871-1(b)(7)

or 1.881-3(a)(3) if the person knows or has reason to know that the

financing arrangement is subject to recharacterization under those

sections and the person otherwise is a withholding agent with respect

to the financing arrangement. This standard shall be satisfied if the

person knows or has reason to know those facts relevant to whether the

financing arrangement satisfies the conditions set forth in Sec. 1.881-

3(a)(4), including whether the participation of the intermediate entity

is pursuant to a tax avoidance plan. A person shall not be considered

to have reason to know that the financing arrangement is subject to

recharacterization under Sec. 1.871-1(b)(7) or 1.881-3(a)(3) if the

person knows of the financing transactions that comprise the financing

arrangement but does not know or have reason to know facts sufficient

to establish that the participation of the intermediate entity in the

financing arrangement was pursuant to such a plan. This paragraph is

effective for payments made after the date which is 30 days after

publication of final regulations in the Federal Register. This section

shall not apply with respect to interest payments made by United States

corporations to Netherlands Antilles corporations in connection with

debt obligations issued prior to October 15, 1984 and payments of

interest covered by section 127(g)(3) of the Tax Reform Act of 1984.

Par. 6. In Sec. 1.6038-2, paragraph (f)(12) is added to read as

follows:

Sec. 1.6038-2 Reporting requirements for conduit financing

arrangements.

* * * * *

(f) * * *

(12) Conduit financing arrangements. See Sec. 1.881-4 for

additional information that must be reported on (or attached to) Form

5471 relating to conduit financing arrangements.

* * * * *

Par. 7. In Sec. 1.6038A-2, paragraph (b)(9) is added to read as

follows:

Sec. 1.6038A-2 Requirement of return.

* * * * *

(b) * * *

(9) See Sec. 1.881-4 for additional information that must be

reported on (or attached to) Form 5472 relating to conduit financing

arrangements.

* * * * *

Par. 8. In Sec. 1.6038A-3, paragraphs (b)(5) and (c)(2)(vii) are

added to read as follows:

Sec. 1.6038A-3 Record maintenance.

* * * * *

(b) * * *

(5) Records relating to conduit financing arrangements. See

Sec. 1.881-4 relating to conduit financing arrangements.

(c) * * *

(2) * * *

(vii) Records relating to conduit financing arrangements. See

Sec. 1.881-4 relating to conduit financing arrangements.

* * * * *

Par. 9. Section 1.7701(l)-1 is added to read as follows:

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

(a) Scope. Section 7701(l) authorizes the issuance of regulations

that recharacterize any multiple-party financing transaction as a

transaction directly among any two or more of such parties where the

Secretary determines that such recharacterization is appropriate to

prevent avoidance of any tax imposed by title 26 of the United States

Code.

(b) Regulations issued under authority of section 7701(l). The

following regulations are issued under the authority of section

7701(l)--

(1) Sec. 1.871-1(b)(7);

(2) Sec. 1.881-3;

(3) Sec. 1.881-4;

(4) Sec. 1.1441-3(j);

(5) Sec. 1.1441-7(d);

(6) Sec. 1.6038A-2(f)(12);

(7) Sec. 1.6038A-2(b)(9);

(8) Sec. 1.6038A-3(b)(5); and

(9) Sec. 1.6038A-3(c)(2)(vii).

Margaret Milner Richardson,

Commissioner of Internal Revenue.

[FR Doc. 94-25403 Filed 10-11-94; 8:48 am]

BILLING CODE 4830-01-U