Internal Revenue Bulletin 2000-4 (PDF rendition): IRS Revenue Procedures

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

INCOME TAX
Rev. Rul. 2000–4, page 331.
Business expenses; capital expenditures; ISO 9000
costs. Cost incurred by a taxpayer to obtain, maintain,
and renew ISO 9000 certification are deductible as ordi-
nary and necessary business expenses under section 162
of the Code, except to the extent they result in the cre-
ation or acquisition of an asset having a useful life sub-
stantially beyond the taxable year (e.g., a quality manual).
Rev. Proc. 99–49 modified and amplified.
T.D. 8853, page 377.
Final regulations under section 7701(l) of the Code rechar-
acterize fast-pay stock arrangements. The regulations
also impose reporting requirements on certain partici-
pants in fast-pay stock arrangements.
T.D. 8857, page 365.
Final regulations under section 832(b) of the Code relate to the
determination of underwriting income by insurance companies
other than life insurance companies by providing guidance for
purposes of determining the amount of unearned premiums
that are subject to the 20 percent reduction rule.
T.D. 8858, page 332.
Temporary regulations revise the rules governing allocation of
purchase price in deemed and actual asset acquisitions, and
other rules, under sections 338 and 1060 of the Code.
EMPLOYEE PLANS
Notice 2000–3, page 413.
This notice provides additional guidance on the safe harbor
methods contained in sections 401(k)(12) and 401(m)(11) of
the Code for satisfying the nondiscrimination tests contained
in section 401(k) and 401(m). The notice also requests pub-
lic comments on certain issues affecting cash or deferred
arrangements. Notice 98–52 modified.
Notice 2000–8, page 420.
Weighted average interest rate update. The weighted
average interest rate for January 2000 and the resulting per-
missible range of interest rates used to calculate current lia-
bility for purposes of the full funding limitation of section
412(c)(7) of the Code are set forth.
EXCISE TAX
T.D. 8855, page 374.
Final regulations under section 4251 of the Code relate to
prepaid telephone cards.
Announcement 2000–5, page 427.
Comments are requested on proposed regulations relating
to requirements for excise tax returns and deposits.
Internal Revenue
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Bulletin No. 2000–4
January 24, 2000
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page ii.
(Continued on the page following the Introduction)
IRB 2000-4 1/28/00 10:26 AM Page 1

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents are consolidated semiannually into
Cumulative Bulletins, which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
lished rulings and procedures, the effect of subsequent leg-
islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a semiannual basis,
and are published in the first Bulletin of the succeeding semi-
annual period, respectively.
The IRS Mission
Provide America’s taxpayers top quality service by help-
ing them understand and meet their tax responsibilities
and by applying the tax law with integrity and fairness to
all.
Introduction
The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.
IRB 2000-4 1/28/00 10:26 AM Page 2

ADMINISTRATIVE
Rev. Proc. 2000–12, page 387.
This procedure contains the qualified intermediary (QI)
withholding agreement as well as guidance for entering
into the agreement. The objective of the QI withholding
agreement is to simplify withholding and reporting obliga-
tions for payments of income (including interest, divi-
dends, royalties, and gross proceeds) made to an account
holder through one or more foreign intermediaries. Rev.
Proc. 98–27 superseded and Notice 99–8 obsoleted.
REG–105606–99, page 421.
Proposed regulations under section 41(f) of the Code relate
to the computation and allocation of the credit for increasing
research activities for members of a controlled group of tax-
payers. A public hearing is scheduled for April 26, 2000.
Notice 2000–7, page 419.
Section 1504(d) elections; deferral of termination.
This notice provides guidance regarding the effect of the re-
peal of certain Canadian banking legislation on elections
under section 1504(d) of the Code.
Announcement 2000–6, page 428.
This announcement corrects final regulations T.D. 8845,
1999–51 I.R.B. 684, under section 6501 of the Code relat-
ing to the valuation of prior gifts in determining estate and
gift tax liability, and to the period of assesing and collecting
gift tax.
2000–4 I.R.B.January 24, 2000
IRB 2000-4 1/28/00 10:26 AM Page 3

2000–4 I.R.B.331January 24, 2000
Section 162.–Trade or Business
Expenses
26 CFR 1.162-1: Business expenses.
(Also §§ 263, 263A; §§ 1.263(a)-1, 1.263(a)–2,
1.263A–1)
Business expenses; capital expendi-
tures; ISO 9000 costs. Costs incurred by
a taxpayer to obtain, maintain, and renew
ISO 9000 certification are deductible as
ordinary and necessary business expenses
under section 162 of the Code, except to
the extent they result in the creation or ac-
quisition of an asset having a useful life
substantially beyond the taxable year
(e.g., a quality manual). Rev. Proc. 99–49
modified and amplified.
Rev. Rul. 2000–4
ISSUE
Are costs incurred by a taxpayer to ob-
tain, maintain, and renew ISO 9000 certi-
fication deductible as ordinary and neces-
sary business expenses under § 162 of the
Internal Revenue Code, or must they be
capitalized under §§ 263 or 263A?
FACTS
ISO 9000 is a series of international
standards for quality management sys-
tems that was developed by the Interna-
tional Organization for Standardization
(ISO). The ISO 9000 series of standards
is comprised of several specific require-
ments that are intended to ensure a quality
process in providing services or products
to an organization’s customers.
To obtain ISO 9000 certification, an orga-
nization may incur internal and external
costs to assess its current quality processes,
create a quality manual, train its employees,
and implement the new quality system. In
addition, the organization incurs costs to ob-
tain formal certification from an independent
auditor (or “registrar”) that its quality man-
agement system conforms to a specific ISO
9000 standard. This certification generally
lasts from two to four years. After the initial
certification, the organization incurs addi-
tional costs for periodic audits to maintain its
certification and to renew the certification
upon expiration of the initial certification pe-
riod. All these expenditures are referred to
herein as “ISO 9000 costs.”
Although ISO 9000 certification is vol-
untary, it increasingly is a contractual re-
quirement for doing business with many
organizations, both public and private,
worldwide. ISO 9000 certification also is
an alternative to product certification in
some foreign markets, particularly the
European Union.
LAW AND ANALYSIS
Section 162 and § 1.162–1(a) of the In-
come Tax Regulations generally allow a
deduction for all the ordinary and neces-
sary expenses paid or incurred during the
taxable year in carrying on any trade or
business. Courts generally have construed
§ 162 as containing five conditions that an
expenditure must meet to qualify for de-
duction. The expenditure must be (1) an
expense, (2) ordinary, (3) necessary, (4)
paid or incurred during the taxable year,
and (5) made to carry on a trade or busi-
ness. See Commissioner v. Lincoln Sav.
and Loan Ass’n, 403 U.S. 345 (1971).
Section 263(a) and § 1.263(a)–1(a) pro-
vide that no deduction is allowed for any
amount paid out for permanent improve-
ments or betterments made to increase the
value of any property or estate. Section
1.263(a)–2(a) provides that capital expen-
ditures include the cost of acquisition, con-
struction, or erection of buildings, machin-
ery and equipment, furniture and fixtures,
and similar property having a useful life
substantially beyond the taxable year.
Section 263A provides that the direct
and indirect costs properly allocable to real
or tangible personal property produced by
the taxpayer or real or personal property de-
scribed in § 1221(1) that is acquired by the
taxpayer for resale must be capitalized.
Section 1.263A–1(e)(4)(iv)(F) cites quality
control policy as an example of an indirect
cost that generally is not allocated to pro-
duction or resale activities.
Through provisions such as §§ 162(a),
263(a), and 263A, the Code generally en-
deavors to match expenses with the rev-
enues of the taxable period to which the ex-
penses are properly attributable, thereby
resulting in a more accurate calculation of
net income for tax purposes. See, e.g., IN-
DOPCO, Inc. v. Commissioner, 503 U.S.
79, 84 (1992);Commissioner v. Idaho
Power Co., 418 U.S. 1, 16 (1974). More-
over, as the Supreme Court has specifically
recognized, the “decisive distinctions [be-
tween capital and ordinary expenditures]
are those of degree and not of kind,” and a
careful examination of the particular facts
of each case is required. Deputy v. du
Pont, 308 U.S. 488, 496 (1940); Welch v.
Helvering, 290 U.S. 111, 114 (1933).
In determining whether a current deduc-
tion or capitalization is the appropriate tax
treatment for an expenditure, it is important
to consider the extent to which the expendi-
ture will produce future benefits. See IN-
DOPCO, 503 U.S. at 87–88. ISO 9000
certification potentially results in a number
of benefits for a taxpayer. For example, cer-
tification may improve the overall quality of
the taxpayer’s business operations, give the
taxpayer a marketing advantage by differen-
tiating it from non-certified competitors, en-
able the taxpayer to retain customers that
begin requiring their suppliers to be certi-
fied, and enable the taxpayer to expand its
existing business to new markets and new
customers that require their suppliers to be
certified. These benefits generally both re-
late to the current taxable year and extend
beyond the taxable year in which the tax-
payer obtains ISO 9000 certification. Sec-
tion 263(a), however, requires an examina-
tion of not only the duration of the benefits,
but also the extent of the benefits. See IN-
DOPCO, 503 U.S. at 87 (the mere presence
of an incidental future benefit may not war-
rant capitalization). See alsoRev. Rul.
96–62, 1996–2 C.B. 9 (training costs gener-
ally are deductible under § 162 even though
they may have some future benefit); Rev.
Rul. 94–12, 1994–1 C.B. 36 (incidental re-
pair costs generally are deductible under §
162 even though they may have some future
benefit); Rev. Rul. 92–80, 1992–2 C.B. 57
(advertising costs generally are deductible
under § 162 even though they may have
some future effect on business activities).
ISO 9000 certification does not result in
future benefits that are more than incidental.
The benefits derived from ISO 9000 certifi-
cation are akin to the current benefits de-
rived from advertising, training, and similar
expenditures incurred in operating the tax-
payer’s business, retaining existing cus-
tomers, or simply improving the overall
quality or attractiveness of the taxpayer’s
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
IRB 2000-4 1/28/00 10:26 AM Page 331

January 24, 20003322000–4 I.R.B.
business operations. Although the en-
hanced marketability of the taxpayer’s ser-
vices or products resulting from ISO 9000
certification may yield future benefits such
as repeat business or increased market
share, these future benefits are incidental to
the primary benefit of current sales. Expen-
ditures that primarily benefit current opera-
tions generally are deductible. See, e.g., Van
Iderstine Co. v. Commissioner, 261 F.2d
211 (2
nd
Cir. 1958) (payments made to sup-
pliers to ensure a continuing supply of raw
materials were deductible); Snow v. Com-
missioner, 31 T.C. 585 (1958), acq., 1959–2
C.B. 7 (payments made to protect and sup-
plement the taxpayer’s income from its ex-
isting law business were deductible).See
also T.J. Enterprises, Inc. v. Commissioner,
101 T.C. 581 (1993) (expenses incurred to
protect, maintain, or preserve a taxpayer’s
business generally are deductible).
Further, even if ISO 9000 certification
facilitates the expansion of the taxpayer’s
existing business, the mere ability to sell in
new markets and to new customers, with-
out more, does not result in significant fu-
ture benefits.Compare Briarcliff Candy
Corp. v. Commissioner, 475 F.2d 775 (2
nd
Cir. 1973) (expenditures incurred by the
taxpayer to develop a new market for
wholesale customers, which gave the tax-
payer little more than an expectation or
hope of future sales, were deductible under
§ 162); Sun Microsystems v. Commissioner,
T.C. Memo 1993–467 (costs incurred to
promote sales of computer workstations
were not capital expenditures because the
anticipated long-term benefits from the
customer relationship were “softer” and
more speculative than the immediate bene-
fits from the sales) with FMR Corp. v.
Commissioner, 110 T.C. 402 (1998) (costs
to develop and launch mutual funds, which
resulted in new long-term management
contracts, were capital expenditures).
Because ISO 9000 certification yields
only incidental future benefits, ISO 9000
costs are distinguishable from costs incurred
to obtain licenses, stock trading privileges,
state bar certifications, and similar market-
entry requirements that have been held to be
capital expenditures. Unlike ISO 9000 cer-
tification, these requirements are an essen-
tial element to the establishment of the tax-
payer’s business and result either in a
separate and distinct asset or in significant
future benefits. See, e.g., Nachman v. Com-
missioner, 191 F.2d 934 (5
th
Cir. 1951)
(payment to obtain liquor license was a cap-
ital expenditure);Harman v. Commissioner,
72 T.C. 362 (1979) (initiation fees required
to obtain a seat on the New York Stock Ex-
change were capital expenditures); Sharon
v. Commissioner, 66 T.C. 515 (1976), aff ’d,
591 F.2d 1273 (9
th
Cir. 1978) (costs in-
curred by an attorney for admission to vari-
ous bars were capital expenditures).
Accordingly, ISO 9000 certification does
not itself result in the creation of an asset
having a useful life substantially beyond the
taxable year. To the extent the ISO 9000
certification processresults in the creation
of an asset, however, § 263(a) requires cap-
italizing the costs allocable to creating that
asset. For example, the costs of creating a
quality manual must be capitalized, even
though costs of periodic updates to the man-
ual may be deducted. § 263A; §
1.263A–2(a)(2)(ii), Domestic Management
Bureau v. Commissioner, 38 B.T.A. 640
(1938) (costs of preparing and printing a
training manual were capital expenditures);
Rev. Rul. 96–62 (costs of routine updates of
training materials are deductible). In addi-
tion, if the certification process requires the
acquisition of an asset, such as machinery
and equipment, the costs of that asset must
be capitalized under § 263(a).
Further, ISO 9000 costs, other than costs
incurred during the certification process that
are allocable to creating an asset such as a
quality manual, are not costs that are alloca-
ble to production or resale activities for pur-
poses of the uniform capitalization rules of
§ 263A, and thus are not subject to the rules
set forth in that section or the regulations
thereunder. See§ 1.263A–1(e)(4)(iv)(F)
(quality control expenditures generally ex-
cepted from uniform capitalization rules).
HOLDING
Costs incurred by a taxpayer to obtain,
maintain, and renew ISO 9000 certifica-
tion are deductible as ordinary and nec-
essary business expenses under § 162,
except to the extent they result in the cre-
ation or acquisition of an asset having a
useful life substantially beyond the tax-
able year (e.g.,a quality manual).
APPLICATION
Any change in a taxpayer’s method of
accounting to conform with this revenue
ruling is a change in method of account-
ing to which the provisions of §§ 446 and
481 and the regulations thereunder apply.
A taxpayer wanting to change its method
of accounting to conform with the holding
in this revenue ruling must follow the au-
tomatic change in accounting method pro-
visions of Rev. Proc. 99–49, 1999–52
I.R.B. 725, except that the scope limita-
tions in section 4.02 of Rev. Proc. 99-49
do not apply. However, if the taxpayer is
under examination, before an appeals of-
fice, or before a federal court with respect
to any income tax issue, the taxpayer
must provide a copy of the Form 3115,
Application for Change in Accounting
Method, to the examining agent(s), ap-
peals officer, or counsel for the govern-
ment, as appropriate, at the same time that
it files the copy of the Form 3115 with the
national office. The Form 3115 must con-
tain the name(s) and telephone number(s)
of the examining agent(s), appeals officer,
or counsel for the government, as appro-
priate.
EFFECT ON OTHER DOCUMENTS
Rev. Proc. 99–49 is modified and am-
plified to include the prospective change
in accounting method in the APPENDIX.
DRAFTING INFORMATION
The principal author of this revenue
ruling is Kimberly L. Koch of the Office
of Assistant Chief Counsel (Income Tax
and Accounting). For further information
regarding this revenue ruling, contact Ms.
Koch at (202) 622-4950 (not a toll-free
call).
Section 263.—Capital
Expenditures
26 CFR 1.263(a)–1: Capital expenditures; in
general.
Are costs incurred by a taxpayer to obtain, main-
tain, and renew ISO 9000 certification deductible as
ordinary and necessary business expenses under
§162, except to the extent they result in the creation
or acquisition of an asset having a useful life sub-
stantially beyond the taxable year (e.g., a quality
manual)? See Rev. Rul. 2000–4, page 331.
Section 338.—Certain Stock
Purchases Treated As Asset
Acquisitions
26 CFR 1.338–1T: General principles; status of old
target and new target (temporary).
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2000–4 I.R.B.333January 24, 2000
T.D. 8858
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Purchase Price Allocations in
Deemed and Actual Asset
Acquisitions
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations.
SUMMARY: This document contains
temporary regulations relating to the allo-
cation of purchase price in deemed and
actual asset acquisitions. The temporary
regulations determine the amount realized
and the amount of basis allocated to each
asset transferred in a deemed or actual
asset acquisition and affect transactions
reported on either Form 8023 or Form
8594. The intended effect of the tempo-
rary regulations is to remove and replace
many of the current temporary and final
regulations sections under sections 338
and 1060 and renumber others.
DATES: Effective Date:These regula-
tions are effective January 6, 2000.
Applicability Dates: For dates of ap-
plicability of these regulations, see
§1.338(i)–1T and §1.1060–1T(a)(2).
FOR FURTHER INFORMATION CON-
TACT: Richard Starke of the Office of
Assistant Chief Counsel (Corporate),
(202) 622-7790 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information con-
tained in these temporary regulations
have been reviewed and approved by the
Office of Management and Budget in ac-
cordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)) under
the control number 1545-1658.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
The collections of information in these
temporary regulations are in §§1.338–2T(d),
1.338–2T(e)(4), 1.338–5T(d)(3),
1.338–10T(a)(4), 1.338(h)(10)–1T(d)(2),
and 1.1060–1T(e)(ii)(A) and (B). The col-
lections of information are necessary to
make an election to treat a sale of stock as a
sale of assets, to calculate and collect the ap-
propriate amount of tax in a deemed or ac-
tual asset acquisition, and to determine the
bases of assets acquired in a deemed or ac-
tual asset acquisition.
These collections of information are re-
quired to obtain a benefit. The likely re-
spondents and/or recordkeepers are small
businesses or organizations, businesses,
or other for-profit institutions, and farms.
The regulation provides that a section
338 election is made by filing Form 8023.
The burden for this requirement is re-
flected in the burden of Form 8023. The
regulation also provides that both a seller
and a purchaser must each file an asset ac-
quisition statement on Form 8594. The
burden for this requirement is reflected in
the burden of Form 8594.
The burden for the collection of infor-
mation in §1.338–2T(e)(4) is as follows:
Estimated total annual reporting/record-
keeping burden: 25 hours
Estimated average annual burden per re-
spondent/recordkeeper: 0.56 hours
Estimated number of respondents/record-
keepers: 45
Estimated annual frequency of responses:
On occasion
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office
of Management and Budget, Attn: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC 20503.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On August 10, 1999, the IRS and Trea-
sury published in the Federal Register
(REG–107069–97, 64 FR 43461 (1999–36
I.R.B. 346)) a notice of proposed rulemak-
ing. The notice contained proposed regula-
tions under sections 338 and 1060 of the In-
ternal Revenue Code of 1986. The
temporary and final regulations promul-
gated in this Treasury decision are substan-
tively the same as the proposed regulations
published on August 10, 1999. The Ser-
vice and Treasury believe that the com-
ments received on the proposed regulations
warrant further consideration. For instance,
the Service and the Treasury received sev-
eral comments requesting reconsideration
of (1) the provision in §1.338–3(b)(2)(ii) of
the proposed regulations stating that a pur-
chase of target stock occurs only so long as
more than a nominal amount is paid for
such share, and (2) the example in
§1.338–1(a)(2) of the proposed regulations
stating that if target is an insurance com-
pany for which a section 338 election is
made, then the deemed asset sale will be
characterized and taxed as an assumption-
reinsurance transaction. The temporary
regulations reserve the purchase issue ad-
dressed in §1.338–3(b)(2)(ii) of the pro-
posed regulations pending further consider-
ation of the comments. The temporary
regulations retain the assumption-reinsur-
ance example because the example prop-
erly illustrates the principles of the pro-
posed and temporary regulations. The
Service and Treasury will give further con-
sideration to the interaction of section 338
and the assumption-reinsurance rules and
the need for additional guidance on how the
assumption-reinsurance rules should work
in the context of a deemed asset sale.
Notwithstanding such comments, the
proposed regulations generally were favor-
ably received, and the Service and Treasury
are convinced that, in general, the proposed
regulations provide clearer guidance and
better rules than the current final and tem-
porary regulations under sections 338 and
1060. Accordingly, pending further review
of the comments received on the proposed
regulations, the Service and Treasury are
replacing existing temporary and final reg-
ulations with the proposed rules published
on August 10, 1999.
As soon as feasible, final regulations
will be promulgated, replacing these new
temporary regulations. All comments re-
ceived in response to the requests for
comments contained in the notice of Au-
gust 10, 1999, will be considered in the
course of preparing the final regulations.
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January 24, 20003342000–4 I.R.B.
Special Analyses
It has been determined that these tempo-
rary regulations are not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assessment is
not required. It has been determined that a
final regulatory flexibility analysis is re-
quired for the collection of information in
this Treasury decision under 5 U.S.C. 604.
This analysis is set forth below under the
heading “Final Regulatory Flexibility Act
Analysis.” Pursuant to section 7805(f) of
the Internal Revenue Code, these temporary
regulations will be submitted to the Chief
Counsel for Advocacy of the Small Business
Administration for comment on their impact
on small business.
Final Regulatory Flexibility Act
Analysis
This analysis is required under the Reg-
ulatory Flexibility Act (5 U.S.C. chapter
6). This regulatory action is intended to
simplify and clarify the current rules re-
lating to both deemed and actual asset ac-
quisitions. The current rules were devel-
oped over a long period of time and have
been repeatedly amended. The IRS and
Treasury believe these temporary regula-
tions will significantly improve the clarity
of the rules relating to both deemed and
actual asset acquisitions.
The major objective of these temporary
regulations is to modify the rules for allo-
cating purchase price in both deemed and
actual asset acquisitions. In addition,
these temporary regulations replace the
general rules for electing to treat a stock
sale as an asset sale.
These collections of information may af-
fect small businesses if the stock of a cor-
poration which is a small entity is acquired
in a qualified stock purchase or if a trade or
business which is also a small business is
transferred in a taxable transaction. Form
8023 (on which an election to treat a stock
sale as an asset sale is filed) has been sub-
mitted to and approved by the Office of
Management and Budget. With respect to
Form 8023, the IRS estimated that 201
forms would be filed each year and that
each taxpayer would require 12.98 hours to
comply. Form 8594 (on which a sale or ac-
quisition of assets constituting a trade or
business is reported) has also been submit-
ted to and approved by the Office of Man-
agement and Budget. With respect to Form
8594, the IRS estimated that 20,000 forms
would be filed each year and that each tax-
payer would require 12.25 hours to comply.
These estimates have been made available
for public comment and no public com-
ments have been received. The regulations
do not impose new requirements on small
businesses and, in fact, should lessen any
difficulties associated with the existing re-
porting requirements by clarifying the rules
associated with deemed and actual asset ac-
quisitions.
The collections of information require
taxpayers to file an election in order to
treat a stock sale as an asset sale. In addi-
tion, taxpayers must file a statement re-
garding the amount of consideration allo-
cated to each class of assets under the
residual method. The professional skills
that would be necessary to make the elec-
tion or allocate the consideration would
be the same as those required to prepare a
return for the small business.
Consideration was given to limiting the
reporting requirements under section
1060 to trades or businesses meeting a
threshold level of business activity. How-
ever, any threshold derived without fur-
ther information would be arbitrary. In-
stead, these regulations authorize the
Commissioner to exclude certain transac-
tions from the reporting requirements.
Drafting Information
The principal author of these regula-
tions is Richard Starke, Office of the As-
sistant Chief Counsel (Corporate). How-
ever, other personnel from the IRS and
Treasury Department participated exten-
sively in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by removing the entries
for 1.338(b)–1, 1.338(b)–3T, and
1.1060–1T and by adding entries in nu-
merical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.338–6T also issued under 26
U.S.C. 337(d), 338, and 1502.
Section 1.338–7T also issued under 26
U.S.C. 337(d), 338, and 1502.
Section 1.338–8 also issued under 26
U.S.C. 337(d), 338, and 1502.
Section 1.338–9 also issued under 26
U.S.C. 337(d), 338, and 1502.
Section 1.338–10T also issued under 26
U.S.C. 337(d), 338, and 1502.* * *
Section 1.1060–1T also issued under 26
U.S.C. 1060.* * *
Par. 2. In the list below, for each sec-
tion indicated in the left column, remove
the language in the middle column and
add the language in the right column:
SectionRemoveAdd
1.56(g)–1(k)(1)of §1.338(b)–2T(b), of §1.338–6T(b),
if otherwiseif otherwise
1.56(g)–1(k)(1)of §§1.338(b)–2T(c)(1) of §1.338–6T(c)(1)
and (2) alsoand (2) also
1.368–1(a)(k) and 1.338–2(c)(3).(k) and 1.338–3T(c)(3).
1.368–1(e)(6), Example see §1.338–2(c)(3) (whichsee §1.338–3T(c)(3) (which
4, paragraph (ii)
1.597–2(d)(5)(iii)(B)(see §1.338(b)–3T)(see §1.338–7T)
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2000–4 I.R.B.335January 24, 2000
§1.338–0 through 1.338–3 [Removed]
Par. 3. Sections 1.338–0 through
1.338–3 are removed.
Par. 4. Sections 1.338–0T through
1.338–3T are added to read as follows:
§1.338–0T Outline of topics (temporary).
This section lists the captions contained
in the regulations under section 338 as
follows:
§1.338–1T General principles; status of
old target and new target (temporary).
(a) In general.
(1) Deemed transaction.
(2) Application of other rules of law.
(3) Overview.
(b) Treatment of target under other provi-
sions of the Internal Revenue Code.
(1) General rule for subtitle A.
(2) Exceptions for subtitle A.
(3) General rule for other provisions of
the Internal Revenue Code.
(c) Anti-abuse rule.
(1) In general.
(2) Examples.
§1.338–2T Nomenclature and defini-
tions; mechanics of the section 338 elec-
tion (temporary).
(a) Scope.
(b) Nomenclature.
(c) Definitions.
(1) Acquisition date.
(2) Acquisition date assets.
(3) Affiliated group.
(4) Common parent.
(5) Consistency period.
(6) Deemed asset sale.
(7) Deemed sale gain.
(8) Deemed sale return.
(9) Domestic corporation.
(10) Old target’s final return.
(11) Purchasing corporation.
(12) Qualified stock purchase.
(13) Related persons.
(14) Section 338 election.
(15) Section 338(h)(10) election.
(16) Selling group.
(17) Target; old target; new target.
(18) Target affiliate.
(19) 12-month acquisition period.
(d) Time and manner of making election.
(e) Special rules for foreign corporations
or DISCs.
(1) Elections by certain foreign purchas-
ing corporations.
(i) General rule.
(ii) Qualifying foreign purchasing corpo-
ration.
(iii) Qualifying foreign target.
(iv) Triggering event.
(v) Subject to United States tax.
(2) Acquisition period.
(3) Statement of section 338 may be filed
by United States shareholders in cer-
tain cases.
(4) Notice requirement for U.S. persons
holding stock in foreign market.
(i) General rule.
(ii) Limitation.
(iii) Form of notice.
(iv) Timing of notice.
(v) Consequence of failure to comply.
(vi) Good faith effort to comply.
§1.338–3T Qualification for the section
338 election (temporary).
(a) Scope.
(b) Rules relating to qualified stock pur-
chases.
(1) Purchasing corporation requirement.
(2) Purchase.
(i) Definition.
(ii) Purchase of target. [Reserved]
(iii) Purchase of target affiliate.
(3) Acquisitions of stock from related
corporations.
(i) In general.
(ii) Time for testing relationship.
(iii) Cases where section 338(h)(3)(C) ap-
plies—acquisitions treated as pur-
chases.
(iv) Examples.
(4) Acquisition date for tiered targets.
(i) Stock sold in deemed asset sale.
(ii) Examples.
(5) Effect of redemptions.
(i) General rule.
(ii) Redemptions from persons unrelated
to the purchasing corporation.
(iii) Redemptions from the purchasing
corporation or related persons during
12-month acquisition period.
(A) General rule.
(B) Exception for certain redemptions
from related corporations.
(iv) Examples.
(c) Effect of post-acquisition events on el-
igibility for section 338 election.
1.597–5(c)(3)(i)under §§1.338(b)–2T(b), under §1.338–6T(b),
(c)(1) and (2).(c)(1) and (2).
1.597–5(d)(2)(i)under §§1.338(b)–2T(b), under §1.338–6T(b),
(c)(1) and (2).(c)(1) and (2).
1.921–1T(b)(1), A–1and §1.338–1(d).and §1.338–2T(d).
1.1031(d)–1Tsee §1.1060–1T(b), (d), see §1.1060–1T(b), (c),
and (g) Example (3).and (d) Example 1.
1.1031(j)–1(b)(2)(iii)in §1.1060–1T(d).in §1.338–6T(b), to
which reference is made
by §1.1060–1T(c)(2).
1.1502–75(k)See §1.338(h)(10)–See §1.338(h)(10)–
1(e)(6) for1T(d)(7) for
1.1502–76(b)(1)(ii)(A)(1)See §1.338–1(e)(5) See §1.338–10T(a)(5)
(deemed(deemed
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January 24, 20003362000–4 I.R.B.
(1) Post-acquisition elimination of target.
(2) Post-acquisition elimination of the
purchasing corporation.
(3) Consequences of post-acquisition
elimination of target.
(i) Scope.
(ii) Continuity of interest.
(iii) Control requirement.
(iv) Example.
§1.338-4T Aggregate deemed sale price;
various aspects of taxation of the deemed
asset sale (temporary).
(a) Scope.
(b) Determination of ADSP.
(1) General rule.
(2) Time and amount of ADSP.
(i) Original determination.
(ii) Redetermination of ADSP.
(iii) Example.
(c) Grossed-up amount realized on the
sale to the purchasing corporation of
the purchasing corporation’s recently
purchased target stock.
(1) Determination of amount.
(2) Example.
(d) Liabilities of old target.
(1) In general.
(2) Time and amount of liabilities.
(3) Interaction with deemed sale gain.
(e) Calculation of deemed sale gain.
(f) Other rules apply in determining
ADSP.
(g) Examples.
(h) Deemed sale of target affiliate stock.
(1) Scope.
(2) In general.
(3) Deemed sale of foreign target affiliate
by a domestic target.
(4) Deemed sale producing effectively
connected income.
(5) Deemed sale of insurance company
target affiliate electing under section
953(d).
(6) Deemed sale of DISC target affiliate.
(7) Anti-stuffing rule.
(8) Examples.
§1.338–5T Adjusted grossed-up basis
(temporary).
(a) Scope.
(b) Determination of AGUB.
(1) General rule.
(2) Time and amount of AGUB.
(i) Original determination.
(ii) Redetermination of AGUB.
(iii) Examples.
(c) Grossed-up basis of recently pur-
chased stock.
(d) Basis of nonrecently purchased stock;
gain recognition election.
(1) No gain recognition election.
(2) Procedure for making gain recogni-
tion election.
(3) Effect of gain recognition election.
(i) In general.
(ii) Basis amount.
(iii) Losses not recognized.
(iv) Stock subject to election.
(e) Liabilities of new target.
(1) In general.
(2) Time and amount of liabilities.
(3) Interaction with deemed sale gain.
(f) Adjustments by the Internal Revenue
Service.
(g) Examples.
§1.338–6T Allocation of ADSP and
AGUB among target assets(temporary).
(a) Scope.
(1) In general.
(2) Fair market value.
(i) In general.
(ii) Transaction costs.
(iii) Internal Revenue Service authority.
(b) General rule for allocating ADSP and
AGUB.
(1) Reduction in the amount of considera-
tion for Class I assets.
(2) Other assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
(vi) Class VI assets.
(vii) Class VII assets.
(3) Other items designated by the Internal
Revenue Service.
(c) Certain limitations and other rules for
allocation to an asset.
(1) Allocation not to exceed fair market
value.
(2) Allocation subject to other rules.
(3) Special rule for allocating AGUB
when purchasing corporation has non-
recently purchased stock.
(i) Scope.
(ii) Determination of hypothetical pur-
chase price.
(iii) Allocation of AGUB.
(4) Liabilities taken into account in deter-
mining amount realized on subsequent
disposition.
(d) Examples.
§1.338–7T Allocation of redetermined
ADSP and AGUB among target assets
(temporary).
(a) Scope.
(b) Allocation of redetermined ADSP and
AGUB.
(c) Special rules for ADSP.
(1) Increases or decreases in deemed sale
gain taxable notwithstanding old tar-
get ceases to exist.
(2) Procedure for transactions in which
section 338(h)(10) is not elected.
(i) Deemed sale gain included in new tar-
get’s return.
(ii) Carryovers and carrybacks.
(A) Loss carryovers to new target taxable
years.
(B) Loss carrybacks to taxable years of
old target.
(C) Credit carryovers and carrybacks.
(3) Procedure for transactions in which
section 338(h)(10) is elected.
(d) Special rules for AGUB.
(1) Effect of disposition or depreciation of
acquisition date assets.
(2) Section 38 property.
(e) Examples.
§1.338–8 Asset and stock consistency.
(a) Introduction.
(1) Overview.
(2) General application.
(3) Extension of the general rules.
(4) Application where certain dividends
are paid.
(5) Application to foreign target affiliates.
(6) Stock consistency.
(b) Consistency for direct acquisitions.
(1) General rule.
(2) Section 338(h)(10) elections.
(c) Gain from disposition reflected in
basis of target stock.
(1) General rule.
(2) Gain not reflected if section 338 elec-
tion made for target.
(3) Gain reflected by reason of distribu-
tions.
(4) Controlled foreign corporations.
(5) Gain recognized outside the consoli-
dated group.
(d) Basis of acquired assets.
(1) Carryover basis rule.
(2) Exceptions to carryover basis rule for
certain assets.
(3) Exception to carryover basis rule for
de minimis assets.
(4) Mitigation rule.
(i) General rule.
(ii) Time for transfer.
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(e) Examples.
(1) In general.
(2) Direct acquisitions.
(f) Extension of consistency to indirect
acquisitions.
(1) Introduction.
(2) General rule.
(3) Basis of acquired assets.
(4) Examples.
(g) Extension of consistency if dividends
qualifying for 100 percent dividends
received deduction are paid.
(1) General rule for direct acquisitions
from target.
(2) Other direct acquisitions having same
effect.
(3) Indirect acquisitions.
(4) Examples.
(h) Consistency for target affiliates that
are controlled foreign corporations.
(1) In general.
(2) Income or gain resulting from asset
dispositions.
(i) General rule.
(ii) Basis of controlled foreign corpora-
tion stock.
(iii) Operating rule.
(iv) Increase in asset or stock basis.
(3) Stock issued by target affiliate that is a
controlled foreign corporation.
(4) Certain distributions.
(i) General rule.
(ii) Basis of controlled foreign corpora-
tion stock.
(iii) Increase in asset or stock basis.
(5) Examples.
(i) [Reserved]
(j) Anti-avoidance rules.
(1) Extension of consistency rules.
(2) Qualified stock purchase and 12-
month acquisition period.
(3) Acquisitions by conduits.
(i) Asset ownership.
(A) General rule.
(B) Application of carryover basis rule.
(ii) Stock acquisitions.
(A) Purchase by conduit.
(B) Purchase of conduit by corporation.
(C) Purchase of conduit by conduit.
(4) Conduit.
(5) Existence of arrangement.
(6) Predecessor and successor.
(i) Persons.
(ii) Assets.
(7) Examples.
§1.338–9 International aspects of section
338.
(a) Scope.
(b) Application of section 338 to foreign
targets.
(1) In general.
(2) Ownership of FT stock on the acquisi-
tion date.
(3) Carryover FT stock.
(i) Definition.
(ii) Carryover of earnings and profits.
(iii) Cap on carryover of earnings and
profits.
(iv) Post-acquisition date distribution of
old FT earnings and profits.
(v) Old FT earnings and profits unaf-
fected by post-acquisition date
deficits.
(vi) Character of FT stock as carryover
FT stock eliminated upon disposition.
(4) Passive foreign investment company
stock.
(c) Dividend treatment under section
1248(e).
(d) Allocation of foreign taxes.
(e) Operation of section 338(h)(16). [Re-
served]
(f) Examples.
§1.338–10T Filing of returns(tempo-
rary).
(a) Returns including tax liability from
deemed asset sale.
(1) In general.
(2) Old target’s final taxable year other-
wise included in consolidated return
of selling group.
(i) General rule.
(ii) Separate taxable year.
(iii) Carryover and carryback of tax attrib-
utes.
(iv) Old target is a component member of
purchasing corporation’s controlled
group.
(3) Old target is an S corporation.
(4) Combined deemed sale return.
(i) General rule.
(ii) Gain and loss offsets.
(iii) Procedure for filing a combined re-
turn.
(iv) Consequences of filing a combined
return.
(5) Deemed sale excluded from purchas-
ing corporation’s consolidated return.
(6) Due date for old target’s final return.
(i) General rule.
(ii) Application of §1.1502–76(c).
(A) In general.
(B) Deemed extension.
(C) Erroneous filing of deemed sale re-
turn.
(D) Erroneous filing of return for regular
tax year.
(E) Last date for payment of tax.
(7) Examples.
(b) Waiver.
(1) Certain additions to tax.
(2) Notification.
(3) Elections or other actions required to
be specified on a timely filed return.
(i) In general.
(ii) New target in purchasing corpora-
tion’s consolidated return.
(4) Examples.
§1.338(h)(10)–1T Deemed asset sale and
liquidation(temporary).
(a) Scope.
(b) Definitions.
(1) Consolidated target.
(2) Selling consolidated group.
(3) Selling affiliate; affiliated target.
(4) S corporation target
(5) S corporation shareholders.
(6) Liquidation.
(c) Section 338(h)(10) election.
(1) In general.
(2) Simultaneous joint election require-
ment.
(3) Irrevocability.
(4) Effect of invalid election.
(d) Certain consequences of section
338(h)(10) election.
(1) P.
(2) New T.
(3) Old T—deemed sale.
(i) In general.
(ii) Tiered targets.
(4) Old T and selling consolidated group,
selling affiliate, or S corporation
shareholders—deemed liquidation;
tax characterization.
(i) In general.
(ii) Tiered targets.
(5) Selling consolidated group, selling af-
filiate, or S corporation shareholders.
(i) In general.
(ii) Basis and holding period of T stock
not acquired.
(iii) T stock sale.
(6) Nonselling minority shareholders
other than nonselling S corporation
shareholders.
(i) In general.
(ii) T stock sale.
(iii) T stock not acquired.
(7) Consolidated return of selling consoli-
dated group.
2000–4 I.R.B.337January 24, 2000
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(8) Availability of the section 453 install-
ment method.
(i) In deemed asset sale.
(ii) In deemed liquidation.
(9) Treatment consistent with an actual
asset sale.
(e) Examples.
(f) Inapplicability of provisions.
(g) Required information.
§1.338(i)–1T Effective dates (temporary).
§1.338–1T General principles; status of
old target and new target (temporary).
(a) In general—(1) Deemed transac-
tion.Elections are available under sec-
tion 338 when a purchasing corporation
acquires the stock of another corporation
(the target) in a qualified stock purchase.
One type of election, under section
338(g), is available to the purchasing cor-
poration. Another type of election, under
section 338(h)(10), is, in more limited cir-
cumstances, available jointly to the pur-
chasing corporation and the sellers of the
stock. (Rules concerning eligibility for
these elections are contained in §§
1.338–2T, 1.338–3T, and
1.338(h)(10)–1T.) Although target is a
single corporation under corporate law, if
a section 338 election is made, then two
separate corporations, old target and new
target, generally are considered to exist
for purposes of subtitle A of the Internal
Revenue Code. Old target is treated as
transferring all of its assets to an unrelated
person in exchange for consideration that
includes the assumption of, or taking sub-
ject to, liabilities, and new target is treated
as acquiring all of its assets from an unre-
lated person in exchange for considera-
tion that includes the assumption of or
taking subject to liabilities. (Such trans-
action is, without regard to its characteri-
zation for Federal income tax purposes,
referred to as the deemed asset sale and
the income tax consequences thereof as
the deemed sale gain.) If a section
338(h)(10) election is made, old target is
also deemed to liquidate following the
deemed asset sale.
(2) Application of other rules of law.
Other rules of law apply to determine the
tax consequences to the parties as if they
had actually engaged in the transactions
deemed to occur under section 338 and
§§1.338–0T through 1.338–7T, 1.338–8,
1.338–9, 1.338–10T, 1.338(h)(10)–1T,
and 1.338(i)–1T except to the extent oth-
erwise provided in §§1.338–0T through
1.338–7T, 1.338–8, 1.338–9, 1.338–10T,
1.338(h)(10)–1T, and 1.338(i)–1T. See
also §1.338–6T(c)(2). Other rules of law
may characterize the transaction as some-
thing other than or in addition to a sale
and purchase of assets; however, it must
be a taxable transaction. For example, if
target is an insurance company for which
a section 338 election is made, the
deemed asset sale would be characterized
and taxed as an assumption–reinsurance
transaction under applicable Federal in-
come tax law. See §1.817–4(d).
(3) Overview. Definitions and special
nomenclature and rules for making the
section 338 election are provided in
§1.338–2T. Qualification for the section
338 election is addressed in §1.338–3T.
The amount for which old target is treated
as selling all of its assets (the aggregate
deemed sale price, or ADSP) is addressed
in §1.338–4T. The amount for which new
target is deemed to have purchased all its
assets (the adjusted grossed-up basis, or
AGUB) is addressed in §1.338–5T. Sec-
tion 1.338–6T addresses allocation both
of ADSP among the assets old target is
deemed to have sold and of AGUB among
the assets new target is deemed to have
purchased. Section 1.338–7T addresses
allocation of ADSP or AGUB when those
amounts change after the close of new tar-
get’s first taxable year. Asset and stock
consistency are addressed in §1.338–8.
International aspects of section 338 are
covered in §1.338–9. Rules for the filing
of returns are provided in §1.338–10T.
Eligibility for and treatment of section
338(h)(10) elections is addressed in
§1.338(h)(10)–1T.
(b) Treatment of target under other pro-
visions of the Internal Revenue Code—(1)
General rule for subtitle A. Except as
provided in this section, new target is
treated as a new corporation that is unre-
lated to old target for purposes of subtitle
A of the Internal Revenue Code. Thus—
(i) New target is not considered related
to old target for purposes of section 168
and may make new elections under sec-
tion 168 without taking into account the
elections made by old target; and
(ii) New target may adopt, without ob-
taining prior approval from the Commis-
sioner, any taxable year that meets the re-
quirements of section 441 and any
method of accounting that meets the re-
quirements of section 446. Notwithstand-
ing §1.441–1T(b)(2), a new target may
adopt a taxable year on or before the last
day for making the election under section
338 by filing its first return for the desired
taxable year on or before that date.
(2) Exceptions for subtitle A. New tar-
get and old target are treated as the same
corporation for purposes of—
(i) The rules applicable to employee
benefit plans (including those plans de-
scribed in sections 79, 104, 105, 106, 125,
127, 129, 132, 137, and 220), qualified
pension, profit-sharing, stock bonus and
annuity plans (sections 401(a) and
403(a)), simplified employee pensions
(section 408(k)), tax qualified stock op-
tion plans (sections 422 and 423), welfare
benefit funds (sections 419, 419A,
512(a)(3), and 4976), voluntary employee
benefit associations (section 501(c)(9)
and the regulations thereunder);
(ii) Sections 1311 through 1314 (relat-
ing to the mitigation of the effect of limi-
tations) if a section 338(h)(10) election is
not made for target;
(iii) Section 108(e)(5) (relating to the
reduction of purchase money debt);
(iv) Section 45A (relating to the Indian
Employment Credit), section 51 (relating
to the Work Opportunity Credit), section
51A (relating to the Welfare to Work
Credit), and section 1396 (relating to the
Empowerment Zone Act);
(v) Sections 401(h) and 420 (relating to
medical benefits for retirees);
(vi) Section 414 (relating to definitions
and special rules);
and
(vii) Any other provision designated in
the Internal Revenue Bulletin by the In-
ternal Revenue Service. See
§601.601(d)(2)(ii) of this chapter (relat-
ing to the Internal Revenue Bulletin). See
§1.1001–3(e)(4)(F) providing that an
election under section 338 does not result
in the substitution of a new obligor on tar-
get’s debt.
(3) General rule for other provisions of
the Internal Revenue Code. Except as
provided in the regulations under section
338 or in the Internal Revenue Bulletin by
the Internal Revenue Service (see
§601.601(d)(2)(ii) of this chapter), new
target is treated as a continuation of old
target for purposes other than subtitle A of
the Internal Revenue Code. For exam-
ple—
(i) New target is liable for old target’s
January 24, 20003382000–4 I.R.B.
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2000–4 I.R.B.339January 24, 2000
Federal income tax liabilities, including
the tax liability for the deemed sale gain
and those tax liabilities of the other mem-
bers of any consolidated group that in-
cluded old target that are attributable to
taxable years in which those corporations
and old target joined in the same consoli-
dated return (see §1.1502–6(a));
(ii) Wages earned by the employees of
old target are considered wages earned by
such employees from new target for pur-
poses of sections 3101 and 3111 (Federal
Insurance Contributions Act) and section
3301 (Federal Unemployment Tax Act);
and
(iii) Old target and new target must use
the same employer identification number.
(c) Anti-abuse rule—(1) In general.
For purposes of applying the residual
method of §§1.338–0T through 1.338–7T,
1.338–8, 1.338–9, 1.338–10T,
1.338(h)(10)–1T, and 1.338(i)–1T, the
Commissioner is authorized to treat any
property (including cash) transferred by
old target in connection with the transac-
tions resulting in the application of the
residual method as, nonetheless, property
of target at the close of the acquisition
date if the property so transferred, within
24 months after the deemed asset sale, is
owned by new target, or is owned, di-
rectly or indirectly, by a member of the
affiliated group of which new target is a
member and continues after the election
to be held or used to more than an in-
significant extent in connection with one
or more of the activities of new target.
The Commissioner is authorized to treat
any property (including cash) transferred
to old target in connection with the trans-
actions resulting in the application of the
residual method as, nonetheless, not being
property of target at the close of the ac-
quisition date if the property so trans-
ferred by the transferor is, within 24
months after the deemed asset sale, not
owned by new target but owned, directly
or indirectly, by a member of the affiliated
group of which new target is a member or
owned by new target but held or used to
more than an insignificant extent in con-
nection with an activity conducted, di-
rectly or indirectly, by another member of
the affiliated group of which new target is
a member in combination with other
property acquired, directly or indirectly,
from the transferor of the property (or a
member of the same affiliated group) to
old target. For purposes of this para-
graph (c)(1), an interest in an entity is
considered held or used in connection
with an activity if property of the entity is
so held or used. The authority under this
paragraph (c)(1) includes the making of
any necessary correlative adjustments.
(2) Examples.The following examples
illustrate this paragraph (c):
Example 1. Prior to a qualified stock purchase
under section 338, target transfers one of its assets to
a related party. The purchasing corporation then
purchases the target stock and also purchases the
transferred asset from the related party. After its
purchase of target, the purchasing corporation and
target are members of the same affiliated group. A
section 338 election is made. Under an arrangement
with the purchaser, target continues to use the sepa-
rately transferred asset to more than an insignificant
extent in connection with its own activities. Apply-
ing the anti-abuse rule of this paragraph (c), the
Commissioner may consider target to own the trans-
ferred asset for purposes of applying section 338 and
its allocation rules.
Example 2. Target (T) owns all the stock of T1.
T1 leases intellectual property to T, which T uses in
connection with its own activities. P, a purchasing
corporation, wishes to buy the T-T1 chain of corpo-
rations. P, in connection with its planned purchase
of the T stock, contracts to consummate a purchase
of all the stock of T1 on March 1 and of all the stock
of T on March 2. Section 338 elections are there-
after made for both T and T1. Immediately after the
purchases, P, T and T1 are members of the same af-
filiated group. T continues to lease the intellectual
property from T1 and to use the property to more
than an insignificant extent in connection with its
own activities. Thus, an asset of T, the T1 stock,
was removed from T ‘s own assets prior to the quali-
fied stock purchase of the T stock, T1’s own assets
are used after the deemed asset sale in connection
with T’s own activities, and the T1 stock is after the
deemed asset sale owned by P, a member of the
same affiliated group of which T is a member. Ap-
plying the anti-abuse rule of this paragraph (c), the
Commissioner may, for purposes of application of
section 338 both to T and to T1, consider P to have
bought only the stock of T, with T at the time of the
qualified stock purchases of both T and T1 (the qual-
ified stock purchase of T1 being triggered by the
deemed sale under section 338 of T’s assets) owning
T1. The Commissioner would accordingly apply
section 338 first at the T level and then at the T1
level.
§1.338–2T Nomenclature and defini-
tions; mechanics of the section 338 elec-
tion(temporary).
(a) Scope. This section prescribes rules
relating to elections under section 338.
(b) Nomenclature. For purposes of the
regulations under section 338 (except as
otherwise provided):
(1) T is a domestic target corporation
that has only one class of stock outstand-
ing. Old T refers to T for periods ending
on or before the close of T’s acquisition
date; new T refers to T for subsequent pe-
riods.
(2) P is the purchasing corporation.
(3) The P group is an affiliated group of
which P is a member.
(4) P1, P2, etc., are domestic corpora-
tions that are members of the P group.
(5) T1, T2, etc., are domestic corpora-
tions that are target affiliates of T. These
corporations (T1, T2, etc.) have only one
class of stock outstanding and may also
be targets.
(6) S is a domestic corporation (unre-
lated to P and B) that owns T prior to the
purchase of T by P. (S is referred to in
cases in which it is appropriate to con-
sider the effects of having all of the out-
standing stock of T owned by a domestic
corporation.)
(7) A, a U.S. citizen or resident, is an
individual (unrelated to P and B) who
owns T prior to the purchase of T by P.
(A is referred to in cases in which it is ap-
propriate to consider the effects of having
all of the outstanding stock of T owned by
an individual who is a U.S. citizen or resi-
dent. Ownership of T by A and ownership
of T by S are mutually exclusive circum-
stances.)
(8) B, a U.S. citizen or resident, is an
individual (unrelated to T, S, and A) who
owns the stock of P.
(9) F, used as a prefix with the other
terms in this paragraph (b), connotes for-
eign, rather than domestic, status. For ex-
ample, FT is a foreign corporation (as de-
fined in section 7701(a)(5)) and FA is an
individual other than a U.S. citizen or res-
ident.
(10) CFC, used as a prefix with the
other terms in this paragraph (b) referring
to a corporation, connotes a controlled
foreign corporation (as defined in section
957, taking into account section 953(c)).
A corporation identified with the prefix F
may be a controlled foreign corporation.
The prefix CFC is used when the corpora-
tion’s status as a controlled foreign corpo-
ration is significant.
(c) Definitions. For purposes of the
regulations under section 338 (except as
otherwise provided):
(1) Acquisition date.The term acquisi-
tion datehas the same meaning as in sec-
tion 338(h)(2).
(2) Acquisition date assets. Acquisition
date assetsare the assets of the target held
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January 24, 20003402000–4 I.R.B.
at the beginning of the day after the acqui-
sition date (other than assets that were not
assets of old target).
(3) Affiliated group.The term affili-
ated grouphas the same meaning as in
section 338(h)(5). Corporations are affili-
ated on any day they are members of the
same affiliated group.
(4) Common parent. The term common
parenthas the same meaning as in section
1504.
(5) Consistency period.The consis-
tency periodis the period described in
section 338(h)(4)(A) unless extended pur-
suant to §1.338–8(j)(1).
(6) Deemed asset sale. The deemed
asset saleis the transaction described in
§1.338–1T(a)(1) that is deemed to occur
for purposes of subtitle A of the Internal
Revenue Code if a section 338 election is
made.
(7) Deemed sale gain. Deemed sale
gainrefers to, in the aggregate, the Fed-
eral income tax consequences (generally,
the income, gain, deduction, and loss) of
the deemed asset sale. Deemed sale gain
also refers to the Federal income tax con-
sequences of the transfer of a particular
asset in the deemed asset sale.
(8) Deemed sale return. The deemed
sale returnis the return on which target’s
deemed sale gain is reported that does not
include any other items of target. Target
files a deemed sale return when a section
338 election (but not a section 338(h)(10)
election) is filed for target and target is a
member of a selling group (defined in
paragraph (c)(16) of this section) that files
a consolidated return for the period that
includes the acquisition date or is an S
corporation. See §1.338–10T.
(9) Domestic corporation.Adomestic
corporationis a corporation—
(i) That is domestic within the meaning
of section 7701(a)(4) or that is treated as
domestic for purposes of subtitle A of the
Internal Revenue Code (e.g., to which an
election under section 953(d) or 1504(d)
applies); and
(ii) That is not a DISC, a corporation
described in section 1248(e), or a corpo-
ration to which an election under section
936 applies.
(10) Old target’s final return. Old tar-
get’s final returnis the income tax return
of old target for the taxable year ending at
the close of the acquisition date that in-
cludes the deemed sale gain. If the disaf-
filiation rule of §1.338–10T(a)(2)(i) ap-
plies or if target is an S corporation, tar-
get’s deemed sale return is considered old
target’s final return.
(11) Purchasing corporation.The term
purchasing corporationhas the same
meaning as in section 338(d)(1). The pur-
chasing corporation may also be referred
to as purchaser. Unless otherwise pro-
vided, any reference to the purchasing
corporation is a reference to all members
of the affiliated group of which the pur-
chasing corporation is a member. See
sections 338(h)(5) and (8). Also, unless
otherwise provided, any reference to the
purchasing corporation is, with respect to
a deemed purchase of stock under section
338(a)(2), a reference to new target with
respect to its own deemed purchase of
stock in another target.
(12) Qualified stock purchase. The
term qualified stock purchasehas the
same meaning as in section 338(d)(3).
(13) Related persons. Two persons are
related if stock in a corporation owned by
one of the persons would be attributed
under section 318(a) (other than section
318(a)(4)) to the other.
(14) Section 338 election. Asection
338 electionis an election to apply sec-
tion 338(a) to target. A section 338 elec-
tion is made by filing a statement of sec-
tion 338 election pursuant to paragraph
(d) of this section. The form on which
this statement is filed is referred to in the
regulations under section 338 as the Form
8023 Elections Under Section 338 for
Corporations Making Qualified Stock
Purchases.
(15) Section 338(h)(10) election.A
section 338(h)(10) electionis an election
to apply section 338(h)(10) to target. A
section 338(h)(10) election is made by
making a joint election for target under
§1.338(h)(10)–1T.
(16) Selling group. The selling group
is the affiliated group (as defined in sec-
tion 1504) eligible to file a consolidated
return that includes target for the taxable
period in which the acquisition date oc-
curs. However, a selling group is not an
affiliated group of which target is the
common parent on the acquisition date.
(17)Target; old target; new target.
Targetis the target corporation as defined
in section 338(d)(2). Old target refers to
target for periods ending on or before the
close of target’s acquisition date. New
target refers to target for subsequent peri-
ods.
(18) Target affiliate. The term target
affiliatehas the same meaning as in sec-
tion 338(h)(6) (applied without section
338(h)(6)(B)(i)). Thus, a corporation de-
scribed in section 338(h)(6)(B)(i) is con-
sidered a target affiliate for all purposes
of section 338. If a target affiliate is ac-
quired in a qualified stock purchase, it is
also a target.
(19) 12–Month acquisition period. The
12-month acquisition periodis the period
described in section 338(h)(1), unless ex-
tended pursuant to §1.338–8(j)(2).
(d) Time and manner of making elec-
tion. The purchasing corporation makes a
section 338 election for target by filing a
statement of section 338 election on Form
8023 in accordance with the instructions
to the form. The section 338 election
must be made not later than the 15th day
of the 9th month beginning after the
month in which the acquisition date oc-
curs. A section 338 election is irrevoca-
ble. See §1.338(h)(10)–1T(c)(2) for sec-
tion 338(h)(10) elections.
(e) Special rules for foreign corpora-
tions or DISCs—(1) Elections by certain
foreign purchasing corporations—(i)
General rule. A qualifying foreign pur-
chasing corporation is not required to file
a statement of section 338 election for a
qualifying foreign target before the earlier
of 3 years after the acquisition date and
the 180th day after the close of the pur-
chasing corporation’s taxable year within
which a triggering event occurs.
(ii) Qualifying foreign purchasing cor-
poration. A purchasing corporation is a
qualifying foreign purchasing corpora-
tion only if, during the acquisition period
of a qualifying foreign target, all the cor-
porations in the purchasing corporation’s
affiliated group are foreign corporations
that are not subject to United States tax.
(iii) Qualifying foreign target. A target
is a qualifying foreign targetonly if target
and its target affiliates are foreign corpo-
rations that, during target’s acquisition pe-
riod, are not subject to United States tax
(and will not become subject to United
States tax during such period because of a
section 338 election). A target affiliate is
taken into account for purposes of the pre-
ceding sentence only if, during target’s
12-month acquisition period, it is or be-
comes a member of the affiliated group
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2000–4 I.R.B.341January 24, 2000
that includes the purchasing corporation.
(iv) Triggering event. Atriggering
eventoccurs in the taxable year of the
qualifying foreign purchasing corporation
in which either that corporation or any
corporation in its affiliated group be-
comes subject to United States tax.
(v) Subject to United States tax. For
purposes of this paragraph (e)(1), a for-
eign corporation is considered subject to
United States tax—
(A) For the taxable year for which that
corporation is required under §1.6012–2(g)
(other than §1.6012–2(g)(2)(i)(B)(2)) to
file a United States income tax return; or
(B) For the period during which that
corporation is a controlled foreign corpo-
ration, a passive foreign investment com-
pany for which an election under section
1295 is in effect, a foreign investment
company, or a foreign corporation the
stock ownership of which is described in
section 552(a)(2).
(2) Acquisition period. For purposes of
this paragraph (e), the term acquisition
periodmeans the period beginning on the
first day of the 12-month acquisition pe-
riod and ending on the acquisition date.
(3) Statement of section 338 election
may be filed by United States sharehold-
ers in certain cases.The United States
shareholders (as defined in section
951(b)) of a foreign purchasing corpora-
tion that is a controlled foreign corpora-
tion (as defined in section 957 (taking into
account section 953(c))) may file a state-
ment of section 338 election on behalf of
the purchasing corporation if the purchas-
ing corporation is not required under
§1.6012–2(g) (other than
§1.6012–2(g)(2)(i)(B)(2
)) to file a United
States income tax return for its taxable
year that includes the acquisition date.
Form 8023 must be filed as described in
the form and its instructions and also must
be attached to the Form 5471 (informa-
tion return with respect to a foreign cor-
poration) filed with respect to the pur-
chasing corporation by each United States
shareholder for the purchasing corpora-
tion’s taxable year that includes the acqui-
sition date (or, if paragraph (e)(1)(i) of
this section applies to the election, for the
purchasing corporation’s taxable year
within which it becomes a controlled for-
eign corporation). The provisions of
§1.964–1(c) (including §1.964–1(c)(7))
do not apply to an election made by the
United States shareholders.
(4) Notice requirement for U.S. persons
holding stock in foreign market—(i) Gen-
eral rule.If a target subject to a section
338 election was a controlled foreign cor-
poration, a passive foreign investment
company, or a foreign personal holding
company at any time during the portion of
its taxable year that ends on its acquisition
date, the purchasing corporation must de-
liver written notice of the election (and a
copy of Form 8023, its attachments and
instructions) to—
(A) Each U.S. person (other than a
member of the affiliated group of which
the purchasing corporation is a member
(the purchasing group member)) that, on
the acquisition date of the foreign target,
holds stock in the foreign target; and
(B) Each U.S. person (other than a pur-
chasing group member) that sells stock in
the foreign target to a purchasing group
member during the foreign target’s 12-
month acquisition period.
(ii) Limitation. The notice requirement
of this paragraph (e)(4) applies only
where the section 338 election for the for-
eign target affects income, gain, loss, de-
duction, or credit of the U.S. person de-
scribed in paragraph (e)(4)(i) of this
section under section 551, 951, 1248, or
1293.
(iii) Form of notice. The notice to U.S.
persons must be identified prominently as
a notice of section 338 election and
must—
(A) Contain the name, address, and em-
ployer identification number (if any) of,
and the country (and, if relevant, the
lesser political subdivision) under the
laws of which is organized, the purchas-
ing corporation and the relevant target
(i.e., target the stock of which the particu-
lar U.S. person held or sold under the cir-
cumstances described in paragraph
(e)(4)(i) of this section);
(B) Identify those corporations as the
purchasing corporation and the foreign
target, respectively; and
(C) Contain the following declaration
(or a substantially similar declaration):
THIS DOCUMENT SERVES AS NO-
TICE OF AN ELECTION UNDER SEC-
TION 338 FOR THE ABOVE CITED
FOREIGN TARGET THE STOCK OF
WHICH YOU EITHER HELD OR
SOLD UNDER THE CIRCUM-
STANCES DESCRIBED IN TREA-
SURY REGULATIONS SECTION
1.338-2T(e)(4). FOR POSSIBLE
UNITED STATES FEDERAL INCOME
TAX CONSEQUENCES UNDER SEC-
TION 551, 951, 1248, OR 1293 OF THE
INTERNAL REVENUE CODE OF 1986
THAT MAY APPLY TO YOU, SEE
TREASURY REGULATIONS SECTION
1.338-9(b). YOU MAY BE REQUIRED
TO ATTACH THE INFORMATION AT-
TACHED TO THIS NOTICE TO CER-
TAIN RETURNS.
(iv) Timing of notice.The notice re-
quired by this paragraph (e)(4) must be
delivered to the U.S. person on or before
the later of the 120th day after the acquisi-
tion date of the particular target or the day
on which Form 8023 is filed. The notice
is considered delivered on the date it is
mailed to the proper address (or an ad-
dress similar enough to complete deliv-
ery), unless the date it is mailed cannot be
reasonably determined. The date of mail-
ing will be determined under the rules of
section 7502. For example, the date of
mailing is the date of U.S. postmark or the
applicable date recorded or marked by a
designated delivery service.
(v) Consequence of failure to comply.
A statement of section 338 election is not
valid if timely notice is not given to one
or more U.S. persons described in this
paragraph (e)(4). If the form of notice
fails to comply with all requirements of
this paragraph (e)(4), the section 338
election is valid, but the waiver rule of
§1.338-10T(b)(1) does not apply.
(vi)Good faith effort to comply.The
purchasing corporation will be considered
to have complied with this paragraph
(e)(4), even though it failed to provide no-
tice or provide timely notice to each per-
son described in this paragraph (e)(4), if
the Commissioner determines that the
purchasing corporation made a good faith
effort to identify and provide timely no-
tice to those U.S. persons.
§1.338-3T Qualification for the section
338 election(temporary).
(a) Scope.This section provides rules
on whether certain acquisitions of stock
are qualified stock purchases and on other
miscellaneous issues under section 338.
(b) Rules relating to qualified stock
purchases—(1) Purchasing corporation
requirement. An individual cannot make
a qualified stock purchase of target. Sec-
tion 338(d)(3) requires, as a condition of a
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qualified stock purchase, that a corpora-
tion purchase the stock of target. If an in-
dividual forms a corporation (new P) to
acquire target stock, new P can make a
qualified stock purchase of target if new P
is considered for tax purposes to purchase
the target stock. Facts that may indicate
that new P does not purchase the target
stock include new P’s merging down-
stream into target, liquidating, or other-
wise disposing of the target stock follow-
ing the purported qualified stock
purchase.
(2) Purchase—(i) Definition. The term
purchasehas the same meaning as in sec-
tion 338(h)(3).
(ii) Purchase of target.[Reserved]
(iii) Purchase of target affiliate. Stock
in a target affiliate acquired by new target
in the deemed asset sale of target’s assets
is considered purchased if, under general
principles of tax law, new target is consid-
ered to own stock of the target affiliate
meeting the requirements of section
1504(a)(2), notwithstanding that no
amount may be allocated to target’s stock
in the target affiliate.
(3) Acquisitions of stock from related
corporations—(i) In general.Stock ac-
quired by a purchasing corporation from a
related corporation (R) is generally not
considered acquired by purchase. See
section 338(h)(3)(A)(iii).
(ii) Time for testing relationship. For
purposes of section 338(h)(3)(A)(iii), a
purchasing corporation is treated as re-
lated to another person if the relationship
specified in section 338(h)(3)(A)(iii) ex-
ists—
(A) In the case of a single transaction,
immediately after the purchase of Target
stock;
(B) In the case of a series of acquisi-
tions otherwise constituting a qualified
stock purchase within the meaning of sec-
tion 338(d)(3), immediately after the last
acquisition in such series; and
(C) In the case of a series of transac-
tions effected pursuant to an integrated
plan to dispose of Target stock, immedi-
ately after the last transaction in such se-
ries.
(iii) Cases where section
338(h)(3)(C)
applies—acquisitions treated as pur-
chases. If section 338(h)(3)(C) applies
and the purchasing corporation is treated
as acquiring stock by purchase from R,
solely for purposes of determining when
the stock is considered acquired, target
stock acquired from R is considered to
have been acquired by the purchasing cor-
poration on the day on which the purchas-
ing corporation is first considered to own
that stock under section 318(a) (other than
section 318(a)(4)).
(iv) Examples. The following exam-
ples illustrate this paragraph (b)(3):
Example 1. (i) S is the parent of a group of corpo-
rations that are engaged in various businesses. Prior
to January 1, Year 1, S decided to discontinue its in-
volvement in one line of business. To accomplish
this, S forms a new corporation, Newco, with a nom-
inal amount of cash. Shortly thereafter, on January 1,
Year 1, S transfers all the stock of the subsidiary con-
ducting the unwanted business (Target) to Newco in
exchange for 100 shares of Newco common stock
and a Newco promissory note. Prior to January 1,
Year 1, S and Underwriter (U) had entered into a
binding agreement pursuant to which U would pur-
chase 60 shares of Newco common stock from S and
then sell those shares in an Initial Public Offering
(IPO). On January 6, Year 1, the IPO closes.
(ii) Newco’s acquisition of Target stock is one of
a series of transactions undertaken pursuant to one
integrated plan. The series of transactions ends with
the closing of the IPO and the transfer of all the
shares of stock in accordance with the agreements.
Immediately after the last transaction effected pur-
suant to the plan, S owns 40 percent of Newco,
which does not give rise to a relationship described
in section 338(h)(3)(A)(iii). See
§1.338–2T(b)(3)(ii)(C). Accordingly, S and Newco
are not related for purposes of section
338(h)(3)(A)(iii).
(iii) Further, because Newco’s basis in the Target
stock is not determined by reference to S’s basis in
the Target stock and because the transaction is not an
exchange to which section 351, 354, 355, or 356 ap-
plies, Newco’s acquisition of the Target stock is a
purchase within the meaning of section 338(h)(3).
Example 2. (i) On January 1 of Year 1, P pur-
chases 75 percent in value of the R stock. On that
date, R owns 4 of the 100 shares of T stock. On June
1 of Year 1, R acquires an additional 16 shares of T
stock. On December 1 of Year 1, P purchases 70
shares of T stock from an unrelated person and 12 of
the 20 shares of T stock held by R.
(ii) Of the 12 shares of T stock purchased by P
from R on December 1 of Year 1, 3 of those shares
are deemed to have been acquired by P on January 1
of Year 1, the date on which 3 of the 4 shares of T
stock held by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., 4 ( .75).
The remaining 9 shares of T stock purchased by P
from R on December 1 of Year 1, are deemed to
have been acquired by P on June 1 of Year 1, the
date on which an additional 12 of the 20 shares of T
stock owned by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., (20 (
.75) -3). Because stock acquisitions by P sufficient
for a qualified stock purchase of T occur within a
12-month period (i.e., 3 shares constructively on
January 1 of Year 1, 9 shares constructively on June
1 of Year 1, and 70 shares actually on December 1 of
Year 1), a qualified stock purchase is made on De-
cember 1 of Year 1.
Example 3. (i) On February 1 of Year 1, P acquires
25 percent in value of the R stock from B (the sole
shareholder of P). That R stock is not acquired by
purchase. See section 338(h)(3)(A)(iii). On that date,
R owns 4 of the 100 shares of T stock. On June 1 of
Year 1, P purchases an additional 25 percent in value
of the R stock, and on January 1 of Year 2, P pur-
chases another 25 percent in value of the R stock. On
June 1 of Year 2, R acquires an additional 16 shares of
the T stock. On December 1 of Year 2, P purchases
68 shares of the T stock from an unrelated person and
12 of the 20 shares of the T stock held by R.
(ii) Of the 12 shares of the T stock purchased by P
from R on December 1 of Year 2, 2 of those shares
are deemed to have been acquired by P on June 1 of
Year 1, the date on which 2 of the 4 shares of the T
stock held by R on that date were first considered
owned by P under section 318(a)(2)(C) (i.e., 4 ( .5).
For purposes of this attribution, the R stock need not
be acquired by P by purchase. See section 338(h)(1).
(By contrast, the acquisition of the T stock by P from
R does not qualify as a purchase unless P has ac-
quired at least 50 percent in value of the R stock by
purchase. Section 338(h)(3)(C)(i).) Of the remain-
ing 10 shares of the T stock purchased by P from R
on December 1 of Year 2, 1 of those shares is deemed
to have been acquired by P on January 1 of Year 2,
the date on which an additional 1 share of the 4
shares of the T stock held by R on that date was first
considered owned by P under section 318(a)(2)(C)
(i.e., (4 ( .75) –2). The remaining 9 shares of the T
stock purchased by P from R on December 1 of Year
2, are deemed to have been acquired by P on June 1
of Year 2, the date on which an additional 12 shares
of the T stock held by R on that date were first con-
sidered owned by P under section 318(a)(2)(C) (i.e.,
(20 ( .75) –3). Because a qualified stock purchase of
T by P is made on December 1 of Year 2, only if all
12 shares of the T stock purchased by P from R on
that date are considered acquired during a 12-month
period ending on that date (so that, in conjunction
with the 68 shares of the T stock P purchased on that
date from the unrelated person, 80 of T’s 100 shares
are acquired by P during a 12-month period) and be-
cause 2 of those 12 shares are considered to have
been acquired by P more than 12 months before De-
cember 1 of Year 2 (i.e., on June 1 of Year 1), a qual-
ified stock purchase is not made. (Under
§1.338–8(j)(2), for purposes of applying the consis-
tency rules, P is treated as making a qualified stock
purchase of T if, pursuant to an arrangement, P pur-
chases T stock satisfying the requirements of section
1504(a)(2) over a period of more than 12 months.)
Example 4.Assume the same facts as in Example
3, except that on February 1 of Year 1, P acquires 25
percent in value of the R stock by purchase. The re-
sult is the same as in Example 3.
(4) Acquisition date for tiered targets—
(i) Stock sold in deemed asset sale. If an
election under section 338 is made for tar-
get, old target is deemed to sell target’s
assets and new target is deemed to acquire
those assets. Under section 338(h)(3)(B),
new target’s deemed purchase of stock of
another corporation is a purchase for pur-
poses of section 338(d)(3) on the acquisi-
tion date of target. If new target’s deemed
purchase causes a qualified stock pur-
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chase of the other corporation and if a
section 338 election is made for the other
corporation, the acquisition date for the
other corporation is the same as the acqui-
sition date of target. However, the
deemed sale and purchase of the other
corporation’s assets is considered to take
place after the deemed sale and purchase
of target’s assets.
(ii) Examples. The following examples
illustrate this paragraph (b)(4):
Example 1.A owns all of the T stock. T owns 50
of the 100 shares of X stock. The other 50 shares of
X stock are owned by corporation Y, which is unre-
lated to A, T, or P. On January 1 of Year 1, P makes a
qualified stock purchase of T from A and makes a
section 338 election for T. On December 1 of Year 1,
P purchases the 50 shares of X stock held by Y. A
qualified stock purchase of X is made on December 1
of Year 1, because the deemed purchase of 50 shares
of X stock by new T because of the section 338 elec-
tion for T and the actual purchase of 50 shares of X
stock by P are treated as purchases made by one cor-
poration. Section 338(h)(8). For purposes of deter-
mining whether those purchases occur within a 12-
month acquisition period as required by section
338(d)(3), T is deemed to purchase its X stock on T’s
acquisition date, i.e., January 1 of Year 1.
Example 2. On January 1 of Year 1, P makes a
qualified stock purchase of T and makes a section
338 election for T. On that day, T sells all of the
stock of T1 to A. Although T held all of the T1 stock
on T’s acquisition date, T is not considered to have
purchased the T1 stock because of the section 338
election for T. In order for T to be treated as pur-
chasing the T1 stock, T must hold the T1 stock when
T’s deemed asset sale occurs. The deemed asset sale
is considered the last transaction of old T at the close
of T’s acquisition date. Accordingly, the T1 stock
actually disposed of by T on the acquisition date is
not included in the deemed asset sale. Thus, T does
not make a qualified stock purchase of T1.
(5) Effect of redemptions—(i) General
rule. Except as provided in this para-
graph (b)(5), a qualified stock purchase is
made on the first day on which the per-
centage ownership requirements of sec-
tion 338(d)(3) are satisfied by reference to
target stock that is both—
(A) Held on that day by the purchasing
corporation; and
(B) Purchased by the purchasing corpo-
ration during the 12-month period ending
on that day.
(ii) Redemptions from persons unre-
lated to the purchasing corporation. Tar-
get stock redemptions from persons unre-
lated to the purchasing corporation that
occur during the 12-month acquisition pe-
riod are taken into account as reductions
in target’s outstanding stock for purposes
of determining whether target stock pur-
chased by the purchasing corporation in
the 12-month acquisition period satisfies
the percentage ownership requirements of
section 338(d)(3).
(iii) Redemptions from the purchasing
corporation or related persons during 12-
month acquisition period—(A) General
rule. For purposes of the percentage
ownership requirements of section
338(d)(3), a redemption of target stock
during the 12-month acquisition period
from the purchasing corporation or from
any person related to the purchasing cor-
poration is not taken into account as a re-
duction in target’s outstanding stock.
(B) Exception for certain redemptions
from related corporations. A redemption
of target stock during the 12-month acqui-
sition period from a corporation related to
the purchasing corporation is taken into
account as a reduction in target’s out-
standing stock to the extent that the re-
deemed stock would have been consid-
ered purchased by the purchasing
corporation (because of section
338(h)(3)(C)) during the 12-month acqui-
sition period if the redeemed stock had
been acquired by the purchasing corpora-
tion from the related corporation on the
day of the redemption. See paragraph
(b)(3) of this section.
(iv) Examples.The following exam-
ples illustrate this paragraph (b)(5):
Example 1. QSP on stock purchase date; re-
demption from unrelated person during 12-month
period. A owns all 100 shares of T stock. On Janu-
ary 1 of Year 1, P purchases 40 shares of the T stock
from A. On July 1 of Year 1, T redeems 25 shares
from A. On December 1 of Year 1, P purchases 20
shares of the T stock from A. P makes a qualified
stock purchase of T on December 1 of Year 1, be-
cause the 60 shares of T stock purchased by P within
the 12-month period ending on that date satisfy the
80-percent ownership requirements of section
338(d)(3) (i.e., 60/75 shares), determined by taking
into account the redemption of 25 shares.
Example 2. QSP on stock redemption date; re-
demption from unrelated person during 12-month pe-
riod.The facts are the same as in Example 1, except
that P purchases 60 shares of T stock on January 1 of
Year 1 and none on December 1 of Year 1. P makes a
qualified stock purchase of T on July 1 of Year 1, be-
cause that is the first day on which the T stock pur-
chased by P within the preceding 12-month period
satisfies the 80-percent ownership requirements of
section 338(d)(3) (i.e., 60/75 shares), determined by
taking into account the redemption of 25 shares.
Example 3. Redemption from purchasing corpo-
ration not taken into account.On December 15 of
Year 1, T redeems 30 percent of its stock from P.
The redeemed stock was held by P for several years
and constituted P’s total interest in T. On December
1 of Year 2, P purchases the remaining T stock from
A. P does not make a qualified stock purchase of T
on December 1 of Year 2. For purposes of the 80-
percent ownership requirements of section
338(d)(3), the redemption of P’s T stock on Decem-
ber 15 of Year 1 is not taken into account as a reduc-
tion in T’s outstanding stock.
Example 4. Redemption from related person
taken into account.On January 1 of Year 1, P pur-
chases 60 of the 100 shares of X stock. On that date,
X owns 40 of the 100 shares of T stock. On April 1
of Year 1, T redeems X’s T stock and P purchases the
remaining 60 shares of T stock from an unrelated
person. For purposes of the 80-percent ownership
requirements of section 338(d)(3), the redemption of
the T stock from X (a person related to P) is taken
into account as a reduction in T’s outstanding stock.
If P had purchased the 40 redeemed shares from X
on April 1 of Year 1, all 40 of the shares would have
been considered purchased (because of section
338(h)(3)(C)(i)) during the 12-month period ending
on April 1 of Year 1 (24 of the 40 shares would have
been considered purchased by P on January 1 of
Year 1 and the remaining 16 shares would have been
considered purchased by P on April 1 of Year 1).
See paragraph (b)(3) of this section. Accordingly, P
makes a qualified stock purchase of T on April 1 of
Year 1, because the 60 shares of T stock purchased
by P on that date satisfy the 80-percent ownership
requirements of section 338(d)(3) (i.e., 60/60
shares), determined by taking into account the re-
demption of 40 shares.
(c) Effect of post-acquisition events on
eligibility for section 338 election— (1)
Post-acquisition elimination of target. (i)
The purchasing corporation may make an
election under section 338 for target even
though target is liquidated on or after the
acquisition date. If target liquidates on the
acquisition date, the liquidation is consid-
ered to occur on the following day and im-
mediately after new target’s deemed pur-
chase of assets. The purchasing
corporation may also make an election
under section 338 for target even though
target is merged into another corporation,
or otherwise disposed of by the purchasing
corporation provided that, under the facts
and circumstances, the purchasing corpo-
ration is considered for tax purposes as the
purchaser of the target stock.
(ii) The following examples illustrate
this paragraph (c)(1):
Example 1.On January 1 of Year 1, P purchases
100 percent of the outstanding common stock of T.
On June 1 of Year 1, P sells the T stock to an unre-
lated person. Assuming that P is considered for tax
purposes as the purchaser of the T stock, P remains
eligible, after June 1 of Year 1, to make a section 338
election for T that results in a deemed asset sale of
T’s assets on January 1 of Year 1.
Example 2. On January 1 of Year 1, P makes a
qualified stock purchase of T. On that date, T owns
the stock of T1. On March 1 of Year 1, T sells the
T1 stock to an unrelated person. On April 1 of Year
1, P makes a section 338 election for T. Notwith-
standing that the T1 stock was sold on March 1 of
Year 1, the section 338 election for T on April 1 of
Year 1 results in a qualified stock purchase by T of
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T1 on January 1 of Year 1. See paragraph (b)(4)(i)
of this section.
(2) Post-acquisition elimination of the
purchasing corporation. An election
under section 338 may be made for target
after the acquisition of assets of the pur-
chasing corporation by another corpora-
tion in a transaction described in section
381(a), provided that the purchasing cor-
poration is considered for tax purposes as
the purchaser of the target stock. The ac-
quiring corporation in the section 381(a)
transaction may make an election under
section 338 for target.
(3) Consequences of post-acquisition
elimination of target—(i) Scope. The
rules of this paragraph (c)(3) apply to the
transfer of target assets to the purchasing
corporation (or another member of the
same affiliated group as the purchasing
corporation) (the transferee) following a
qualified stock purchase of target stock, if
the purchasing corporation does not make
a section 338 election for target.
Notwithstanding the rules of this para-
graph (c)(3), section 354(a) (and so much
of section 356 as relates to section 354)
cannot apply to any person other than the
purchasing corporation or another mem-
ber of the same affiliated group as the
purchasing corporation unless the transfer
of target assets is pursuant to a reorgani-
zation as determined without regard to
this paragraph (c)(3).
(ii) Continuity of interest. By virtue of
section 338, in determining whether the
continuity of interest requirement of
§1.368-1(b) is satisfied on the transfer of
assets from target to the transferee, the
purchasing corporation’s target stock ac-
quired in the qualified stock purchase rep-
resents an interest on the part of a person
who was an owner of the target’s business
enterprise prior to the transfer that can be
continued in a reorganization.
(iii) Control requirement
. By virtue of
section 338, the acquisition of target stock
in the qualified stock purchase will not
prevent the purchasing corporation from
qualifying as a shareholder of the target
transferor for the purpose of determining
whether, immediately after the transfer of
target assets, a shareholder of the trans-
feror is in control of the corporation to
which the assets are transferred within the
meaning of section 368(a)(1)(D).
(iv) Example. The following example
illustrates this paragraph (c)(3):
Example. (i) Facts.P, T, and X are domestic cor-
porations. T and X each operate a trade or business.
A and K, individuals unrelated to P, own 85 and 15
percent, respectively, of the stock of T. P owns all of
the stock of X. The total adjusted basis of T’s prop-
erty exceeds the sum of T’s liabilities plus the
amount of liabilities to which T’s property is subject.
P purchases all of A’s T stock for cash in a qualified
stock purchase. P does not make an election under
section 338(g) with respect to its acquisition of T
stock. Shortly after the acquisition date, and as part
of the same plan, T merges under applicable state
law into X in a transaction that, but for the question
of continuity of interest, satisfies all the require-
ments of section 368(a)(1)(A). In the merger, all of
T’s assets are transferred to X. P and K receive X
stock in exchange for their T stock. P intends to re-
tain the stock of X indefinitely.
(ii) Status of transfer as a reorganization. By
virtue of section 338, for the purpose of determining
whether the continuity of interest requirement of
§1.368–1(b) is satisfied, P’s T stock acquired in the
qualified stock purchase represents an interest on the
part of a person who was an owner of T’s business
enterprise prior to the transfer that can be continued
in a reorganization through P’s continuing owner-
ship of X. Thus, the continuity of interest require-
ment is satisfied and the merger of T into X is a reor-
ganization within the meaning of section
368(a)(1)(A). Moreover, by virtue of section 338,
the requirement of section 368(a)(1)(D) that a target
shareholder control the transferee immediately after
the transfer is satisfied because P controls X imme-
diately after the transfer. In addition, all of T’s as-
sets are transferred to X in the merger and P and K
receive the X stock exchanged therefor in pursuance
of the plan of reorganization. Thus, the merger of T
into X is also a reorganization within the meaning of
section 368(a)(1)(D).
(iii) Treatment of T and X.Under section 361(a),
T recognizes no gain or loss in the merger. Under
section 362(b), X’s basis in the assets received in the
merger is the same as the basis of the assets in T’s
hands. X succeeds to and takes into account the
items of T as provided in section 381.
(iv) Treatment of P. By virtue of section 338, the
transfer of T assets to X is a reorganization. Pur-
suant to that reorganization, P exchanges its T stock
solely for stock of X, a party to the reorganization.
Because P is the purchasing corporation, section 354
applies to P’s exchange of T stock for X stock in the
merger of T into X. Thus, P recognizes no gain or
loss on the exchange. Under section 358, P’s basis
in the X stock received in the exchange is the same
as the basis of P’s T stock exchanged therefor.
(v) Treatment of K. Because K is not the pur-
chasing corporation (or an affiliate thereof), section
354 cannot apply to K’s exchange of T stock for X
stock in the merger of T into X unless the transfer of
T’s assets is pursuant to a reorganization as deter-
mined without regard to this paragraph (c)(3).
Under general principles of tax law applicable to re-
organizations, the continuity of interest requirement
is not satisfied because P’s stock purchase and the
merger of T into X are pursuant to an integrated
transaction in which A, the owner of 85 percent of
the stock of T, received solely cash in exchange for
A’s T stock. See, e.g., Yoc Heating v. Commissioner,
61 T.C. 168 (1973); Kass v. Commissioner, 60 T.C.
218 (1973), aff’d, 491 F.2d 749 (3d Cir. 1974).
Thus, the requisite continuity of interest under
§1.368–1(b) is lacking and section 354 does not
apply to K’s exchange of T stock for X stock. K rec-
ognizes gain or loss, if any, pursuant to section
1001(c) with respect to its T stock.
§§1.338–4 and 1.338–5 [Redesignated
as §§1.338–8 and 1.338–9]
Par. 5. Sections 1.338–4 and 1.338–5
are redesignated as §§1.338–8 and
1.338–9, respectively.
Par. 6. New §§1.338–4T and 1.338–5T
are added to read as follows:
§1.338–4T Aggregate deemed sale price;
various aspects of taxation of the deemed
asset sale (temporary).
(a) Scope. This section provides rules
under section 338(a)(1) to determine the
aggregate deemed sale price (ADSP) for
target. ADSP is the amount for which old
target is deemed to have sold all of its as-
sets in the deemed asset sale. ADSP is al-
located among target’s assets in accor-
dance with §1.338–6T to determine the
amount for which each asset is deemed to
have been sold. When an increase or de-
crease with respect to an element of ADSP
is required, under general principles of tax
law, after the close of new target’s first
taxable year, redetermined ADSP is allo-
cated among target’s assets in accordance
with §1.338–7T. This section also pro-
vides rules regarding the recognition of
gain or loss on the deemed sale of target
affiliate stock. Notwithstanding section
338(h)(6)(B)(ii), stock held by a target af-
filiate in a foreign corporation or in a cor-
poration that is a DISC or that is described
in section 1248(e) is not excluded from
the operation of section 338.
(b)Determination of ADSP—(1) Gen-
eral rule. ADSP is the sum of—
(i) The grossed-up amount realized on
the sale to the purchasing corporation of
the purchasing corporation’s recently pur-
chased target stock (as defined in section
338(b)(6)(A)); and
(ii) The liabilities of old target.
(2) Time and amount of ADSP—(i)
Original determination.ADSP is initially
determined at the beginning of the day
after the acquisition date of target. Gen-
eral principles of tax law apply in deter-
mining the timing and amount of the ele-
ments of ADSP.
(ii) Redetermination of ADSP. ADSP is
redetermined at such time and in such
amount as an increase or decrease would be
required, under general principles of tax
law, for the elements of ADSP. For exam-
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ple, ADSP is redetermined because of an
increase or decrease in the amount realized
for recently purchased stock or because lia-
bilities not originally taken into account in
determining ADSP are subsequently taken
into account. An increase or decrease to
one element of ADSP may cause an in-
crease or decrease to the other element of
ADSP. For example, if an increase in the
amount realized for recently purchased
stock of target is taken into account after
the acquisition date, any increase in the tax
liability of target for the deemed sale gain is
also taken into account when ADSP is rede-
termined. Increases or decreases with re-
spect to the elements of ADSP that are
taken into account before the close of new
target’s first taxable year are taken into ac-
count for purposes of determining ADSP
and the deemed sale gain as if they had
been taken into account at the beginning of
the day after the acquisition date. Increases
or decreases with respect to the elements of
ADSP that are taken into account after the
close of new target’s first taxable year re-
sult in the reallocation of ADSP among tar-
get’s assets under §1.338–7T.
(iii) Example. The following example
illustrates this paragraph (b)(2):
Example. In Year 1, T, a manufacturer, purchases
a customized delivery truck from X with purchase
money indebtedness having a stated principal
amount of $100,000. P acquires all of the stock of T
in Year 3 for $700,000 and makes a section 338 elec-
tion for T. Assume T has no liabilities other than its
purchase money indebtedness to X. In Year 4, when
T is neither insolvent nor in a title 11 case, T and X
agree to reduce the amount of the purchase money
indebtedness to $80,000. Assume further that the re-
duction would be a purchase price reduction under
section 108(e)(5). T and X’s agreement to reduce
the amount of the purchase money indebtedness
would not, under general principles of tax law that
would apply if the deemed asset sale had actually
occurred, change the amount of liabilities of old tar-
get taken into account in determining its amount re-
alized. Accordingly, ADSP is not redetermined at
the time of the reduction. See §1.338–5T(b)(2)(iii)
Example 1 for the effect on AGUB.
(c) Grossed-up amount realized on the
sale to the purchasing corporation of the
purchasing corporation’s recently pur-
chased target stock—(1) Determination
of amount. The grossed-up amount real-
ized on the sale to the purchasing corpora-
tion of the purchasing corporation’s re-
cently purchased target stock is an
amount equal to—
(i) The amount realized on the sale to
the purchasing corporation of the pur-
chasing corporation’s recently purchased
target stock determined as if old target
were the selling shareholder and the in-
stallment method were not available and
determined without regard to the selling
costs taken into account in paragraph
(c)(1)(iii) of this section;
(ii) Divided by the percentage of target
stock (by value, determined on the acqui-
sition date) attributable to that recently
purchased target stock;
(iii) Less the selling costs incurred by
the selling shareholders in connection
with the sale to the purchasing corpora-
tion of the purchasing corporation’s re-
cently purchased target stock that reduce
their amount realized on the sale of the
stock (e.g., brokerage commissions and
any similar costs to sell the stock).
(2) Example. The following example
illustrates this paragraph (c):
Example. T has two classes of stock outstanding,
voting common stock and preferred stock not taken
into account for purposes of section 1504(a)(2). On
March 1 of Year 1, P purchases 40 percent of the
outstanding T stock from S1 for $500, 20 percent of
the outstanding T stock from S2 for $225, and 20
percent of the outstanding T stock from S3 for $275.
On that date, the fair market value of all the T voting
common stock is $1,250 and the preferred stock
$750. S1, S2, and S3 respectively incur $40, $35,
and $25 of selling costs. S1 continues to own the re-
maining 20 percent of the outstanding T stock. The
grossed-up amount realized on the sale to P of P’s
recently purchased T stock is calculated as follows:
The total amount realized (without regard to selling
costs) is $1,000 (500 + 225 + 275). The percentage
of T stock by value on the acquisition date attribut-
able to the recently purchased T stock is 50%
(1,000/(1,250 + 750)). The selling costs are $100
(40 + 35 + 25). The grossed-up amount realized is
$1,900 (1,000/.5 å100).
(d) Liabilities of old target—(1) In gen-
eral.The liabilities of old target are the li-
abilities of target (and the liabilities to
which target’s assets are subject) as of the
beginning of the day after the acquisition
date (other than liabilities that were neither
liabilities of old target nor liabilities to
which old target’s assets were subject). In
order to be taken into account in ADSP, a
liability must be a liability of target that is
properly taken into account in amount real-
ized under general principles of tax law
that would apply if old target had sold its
assets to an unrelated person for considera-
tion that included that person’s assumption
of, or taking subject to, the liability. Thus,
ADSP takes into account both tax credit re-
capture liability arising because of the
deemed asset sale and the tax liability for
the deemed sale gain unless the tax liability
is borne by some person other than the tar-
get. For example, ADSP would not take
into account the tax liability for the
deemed sale gain when a section
338(h)(10) election is made for a target S
corporation because the S corporation
shareholders bear that liability. However,
if a target S corporation is subject to a tax
under section 1374 or 1375, the liability
for tax imposed by those sections is a lia-
bility of target taken into account in ADSP
(unless the S corporation shareholders ex-
pressly assume that liability).
(2) Time and amount of liabilities. The
time for taking into account liabilities of
old target in determining ADSP and the
amount of the liabilities taken into ac-
count is determined as if old target had
sold its assets to an unrelated person for
consideration that included the unrelated
person’s assumption of or taking subject
to the liabilities. For example, if no
amount of a target liability is properly
taken into account in amount realized as
of the beginning of the day after the ac-
quisition date, the liability is not initially
taken into account in determining ADSP
(although it may be taken into account at
some later date). As a further example, an
increase or decrease in a liability that does
not affect the amount of old target’s basis,
deductions, or noncapital nondeductible
items arising from the incurrence of the li-
ability is not taken into account in redeter-
mining ADSP.
(3) Interaction with deemed sale gain.
Though deemed sale gain increases or de-
creases ADSP by creating or reducing a
tax liability, the amount of the tax liability
itself is a function of the size of the
deemed sale gain. Thus, the determina-
tion of ADSP may require trial and error
computations.
(e) Calculation of deemed sale gain.
Deemed sale gain on each asset is com-
puted by reference to the ADSP allocated
to that asset.
(f) Other rules apply in determining
ADSP.ADSP may not be applied in such
a way as to contravene other applicable
rules. For example, a capital loss cannot
be applied to reduce ordinary income in
calculating the tax liability on the deemed
sale for purposes of determining ADSP.
(g) Examples. The following examples
illustrate this section. For purposes of the
examples in this paragraph (g), unless oth-
erwise stated, T is a calendar year taxpayer
that files separate returns and that has no
loss, tax credit, or other carryovers to Year
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1. Depreciation for Year 1 is not taken into
account. T has no liabilities other than the
Federal income tax liability resulting from
the deemed asset sale, and the T sharehold-
ers have no selling costs. Assume that T’s
tax rate for any ordinary income or net
capital gain resulting from the deemed sale
of assets is 34 percent and that any capital
loss is offset by capital gain. On July 1 of
Year 1, P purchases all of the stock of T
and makes a section 338 election for T.
The examples are as follows:
Example 1. One class. (i) On July 1 of Year 1,
T’s only asset is an item of section 1245 property
with an adjusted basis to T of $50,400, a recomputed
basis of $80,000, and a fair market value of
$100,000. P purchases all of the T stock for
$75,000, which also equals the amount realized for
the stock determined as if old target were the selling
shareholder.
(ii) ADSP is determined as follows (In the fol-
lowing formula, G is the grossed-up amount realized
on the sale to P of P’s recently purchased T stock, L
is T’s liabilities other than T’s tax liability for the
deemed sale gain, T
R
is the applicable tax rate, and
B is the adjusted basis of the asset deemed sold):
ADSP = G + L + T
R
x (ADSP - B)
ADSP = ($75,000/1) + $0 + .34 x (ADSP -
$50,400)
ADSP = $75,000 + .34ADSP - $17,136
.66ADSP = $57,864
ADSP = $87,672.72
(iii) Because ADSP for T ($87,672.72) does not
exceed the fair market value of T’s asset ($100,000),
a Class V asset, T’s entire ADSP is allocated to that
asset. Thus, T has deemed sale gain of $37,272.72
(consisting of $29,600 of ordinary income and
$7,672.72 of capital gain).
(iv) The facts are the same as in paragraph (i) of
this Example 1, except that on July 1 of Year 1, P
purchases only 80 of the 100 shares of T stock for
$60,000. The grossed-up amount realized on the
sale to P of P’s recently purchased T stock (G) is
$75,000 ($60,000/.8). Consequently, ADSP and
deemed sale gain are the same as in paragraphs (ii)
and (iii) of this Example 1.
(v) The facts are the same as in paragraph (i) of
this Example 1, except that T also has goodwill (a
Class VII asset) with an appraised value of $10,000.
The results are the same as in paragraphs (ii) and (iii)
of this Example 1.Because ADSP does not exceed
the fair market value of the Class V asset, no amount
is allocated to the Class VII asset (goodwill).
Example 2. More than one class.(i) P purchases
all of the T stock for $140,000, which also equals the
amount realized for the stock determined as if old
target were the selling shareholder. On July 1 of
Year 1, T has liabilities (not including the tax liabil-
ity for the deemed sale gain) of $50,000, cash (a
Class I asset) of $10,000, actively traded securities
(a Class II asset) with a basis of $4,000 and a fair
market value of $10,000, goodwill (a Class VII
asset) with a basis of $3,000, and the following
Class V assets:
January 24, 20003462000–4 I.R.B.
AssetBasisFMVRatio of
asset fmv
to total
Class V
fmv
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 5,000$ 35,000.14
Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10,00050,000.20
Equipment A (Recomputed basis $80,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5,00090,000.36
Equipment B (Recomputed basis $20,000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10,00075,000.30
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 30,000$ 250,0001.00
(ii) ADSP exceeds $20,000. Thus, $10,000 of
ADSP is allocated to the cash and $10,000 to the ac-
tively traded securities. The amount allocated to an
asset (other than a Class VII asset) cannot exceed its
fair market value (however, the fair market value of
any property subject to nonrecourse indebtedness is
treated as being not less than the amount of such in-
debtedness; see §1.338–6T(a)(2)). See
§1.338–6T(c)(1) (relating to fair market value limi-
tation).
(iii) The portion of ADSP allocable to the Class V
assets is preliminarily determined as follows (in the
formula, the amount allocated to the Class I assets is
referred to as I and the amount allocated to the Class
II assets as II):
ADSP
V
= (G - (I + II)) + L + T
R
( [(II - B
II
) +
(ADSP
V
- B
V
)]
ADSP
V
= ($140,000 - ($10,000 + $10,000)) +
$50,000 + .34 ( [($10,000 - $4,000) + (ADSP
V
-
($5,000 + $10,000 + $5,000 + $10,000))]
ADSP
V
= $161,840 + .34 ADSP
V
.66 ADSP
V
= $161,840
ADSP
V
= $245,212.12
(iv) Because, under the preliminary calculations of
ADSP, the amount to be allocated to the Class I, II, III,
IV, V, and VI assets does not exceed their aggregate
fair market value, no ADSP amount is allocated to
goodwill. Accordingly, the deemed sale of the good-
will results in a capital loss of $3,000. The portion of
ADSP allocable to the Class V assets is finally deter-
mined by taking into account this loss as follows:
ADSP
V
= (G å (I + II)) + L + T
R
( [(II å B
II
) +
(ADSP
V
å B
V
) + (ADSP
VII
å B
VII
)]
ADSP
V
= ($140,000 å ($10,000 + $10,000)) +
$50,000 + .34 ( [($10,000 å $4,000) + (ADSP
V
å
$30,000) + ($0 å $3,000)]
ADSP
V
= $160,820 + .34 ADSP
V
.66 ADSP
V
= $160,820
ADSP
V
= $243,666.67
(v) The allocation of ADSP
V
among the Class V
assets is in proportion to their fair market values, as
follows:
AssetADSPGain
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 34,113.33$ 29,113.33
(capital gain)
Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48,733.3438,733.34
(capital gain)
Equipment A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87,720.0082,720.00
(75,000 ordinary income
7,720 capital gain)
Equipment B . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73,100.0063,100.00
(10,000 ordinary income
53,100 capital gain)
Totals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 243,666.67$ 213,666.67
IRB 2000-4 1/28/00 10:26 AM Page 346

Example 3. More than one class.(i) The facts
are the same as in Example 2, except that P pur-
chases the T stock for $150,000, rather than
$140,000. The amount realized for the stock deter-
mined as if old target were the selling shareholder is
also $150,000.
(ii) As in Example 2, ADSP exceeds $20,000.
Thus, $10,000 of ADSP is allocated to the cash and
$10,000 to the actively traded securities.
(iii) The portion of ADSP allocable to the Class V
assets as preliminarily determined under the formula
set forth in paragraph (iii) of Example 2is
$260,363.64. The amount allocated to the Class V
assets cannot exceed their aggregate fair market
value ($250,000). Thus, preliminarily, the ADSP
amount allocated to Class V assets is $250,000.
(iv) Based on the preliminary allocation, the
ADSP is determined as follows (in the formula, the
amount allocated to the Class I assets is referred to
as I, the amount allocated to the Class II assets as II,
and the amount allocated to the Class V assets as V):
ADSP = G + L + T
R
( [(II - B
II
) + (V - B
V
) +
(ADSP - (I + II + V+ B
VII
))]
ADSP = $150,000 + $50,000 + .34 ( [($10,000 -
$4,000) + ($250,000 - $30,000) + (ADSP -
($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP - $15,980
.66ADSP = $184,020
ADSP = $278,818.18
(v) Because ADSP as determined exceeds the ag-
gregate fair market value of the Class I, II, III, IV, V,
and VI assets, the $250,000 amount preliminarily al-
located to the Class V assets is appropriate. Thus,
the amount of ADSP allocated to Class V assets
equals their aggregate fair market value ($250,000),
and the allocated ADSP amount for each Class V
asset is its fair market value. Further, because there
are no Class VI assets, the allocable ADSP amount
for the Class VII asset (goodwill) is $8,818.18 (the
excess of ADSP over the aggregate ADSP amounts
for the Class I, II, III, IV, V and VI assets).
Example 4. Amount allocated to T1 stock. (i)
The facts are the same as in Example 2,except that T
owns all of the T1 stock (instead of the building),
and T1’s only asset is the building. The T1 stock
and the building each have a fair market value of
$50,000, and the building has a basis of $10,000. A
section 338 election is made for T1 (as well as T),
and T1 has no liabilities other than the tax liability
for the deemed sale gain. T is the common parent of
a consolidated group filing a final consolidated re-
turn described in §1.338–10T(a)(1).
(ii) ADSP exceeds $20,000. Thus, $10,000 of
ADSP is allocated to the cash and $10,000 to the ac-
tively traded securities.
(iii) Because T does not recognize any gain on
the deemed sale of the T1 stock under paragraph
(h)(2) of this section, appropriate adjustments must
be made to reflect accurately the fair market value
of the T and T1 assets in determining the allocation
of ADSP among T’s Class V assets (including the
T1 stock). In preliminarily calculating ADSP
V
in
this case, the T1 stock can be disregarded and, be-
cause T owns all of the T1 stock, the T1 asset can
be treated as a T asset. Under this assumption,
ADSP
V
is $243,666.67. See paragraph (iv) of Ex-
ample 2.
(iv) Because the portion of the preliminary ADSP
allocable to Class V assets ($243,666.67) does not ex-
ceed their fair market value ($250,000), no amount is
allocated to Class VII assets for T. Further, this
amount ($243,666.67) is allocated among T’s Class V
assets in proportion to their fair market values. See
paragraph (v) of Example 2. Tentatively, $48,733.34
of this amount is allocated to the T1 stock.
(v) The amount tentatively allocated to the T1
stock, however, reflects the tax incurred on the
deemed sale of the T1 asset equal to $13,169.34 (.34 (
($48,733.34 å $10,000)). Thus, the ADSP allocable to
the Class V assets of T, and the ADSP allocable to the
T1 stock, as preliminarily calculated, each must be re-
duced by $13,169.34. Consequently, these amounts,
respectively, are $230,497.33 and $35,564.00. In de-
termining ADSP for T1, the grossed-up amount real-
ized on the deemed sale to new T of new T’s recently
purchased T1 stock is $35,564.00.
(vi) The facts are the same as in paragraph (i) of
this Example 4, except that the T1 building has a
$12,500 basis and a $62,500 value, all of the out-
standing T1 stock has a $62,500 value, and T owns
80 percent of the T1 stock. In preliminarily calculat-
ing ADSP
V
, the T1 stock can be disregarded but, be-
cause T owns only 80 percent of the T1 stock, only
80 percent of T1 asset basis and value should be
taken into account in calculating T’s ADSP. By tak-
ing into account 80 percent of these amounts, the re-
maining calculations and results are the same as in
paragraphs (ii), (iii), (iv), and (v) of thisExample 4,
except that the grossed-up amount realized on the
sale of the recently purchased T1 stock is
$44,455.00 ($35,564.00/0.8).
(h) Deemed sale of target affiliate stock—
(1) Scope. This paragraph (h) prescribes
rules relating to the treatment of gain or loss
realized on the deemed sale of stock of a tar-
get affiliate when a section 338 election (but
not a section 338(h)(10) election) is made
for the target affiliate. For purposes of this
paragraph (h), the definition of domestic cor-
poration in §1.338–2T(c)(9) is applied with-
out the exclusion therein for DISCs, corpo-
rations described in section 1248(e), and
corporations to which an election under sec-
tion 936 applies.
(2) In general. Except as otherwise
provided in this paragraph (h), if a section
338 election is made for target, target rec-
ognizes no gain or loss on the deemed
sale of stock of a target affiliate having
the same acquisition date and for which a
section 338 election is made if—
(i) Target directly owns stock in the tar-
get affiliate satisfying the requirements of
section 1504(a)(2);
(ii) Target and the target affiliate are
members of a consolidated group filing a
final consolidated return described in
§1.338-10T(a)(1); or
(iii) Target and the target affiliate file a
combined return under §1.338–10T(a)(4).
(3) Deemed sale of foreign target affili-
ate by a domestic target.A domestic tar-
get recognizes gain or loss on the deemed
sale of stock of a foreign target affiliate.
For the proper treatment of such gain or
loss, see, e.g., sections 1246, 1248, 1291
et seq., and 338(h)(16) and §1.338–9.
(4) Deemed sale producing effectively
connected income.A foreign target rec-
ognizes gain or loss on the deemed sale of
stock of a foreign target affiliate to the ex-
tent that such gain or loss is effectively
connected (or treated as effectively con-
nected) with the conduct of a trade or
business in the United States.
(5) Deemed sale of insurance company
target affiliate electing under section
953(d). A domestic target recognizes gain
(but not loss) on the deemed sale of stock
of a target affiliate that has in effect an elec-
tion under section 953(d) in an amount
equal to the lesser of the gain realized or the
earnings and profits described in section
953(d)(4)(B).
(6) Deemed sale of DISC target affiliate.
A foreign or domestic target recognizes
gain (but not loss) on the deemed sale of
stock of a target affiliate that is a DISC or a
former DISC (as defined in section 992(a))
in an amount equal to the lesser of the gain
realized or the amount of accumulated
DISC income determined with respect to
such stock under section 995(c). Such gain
is included in gross income as a dividend as
provided in sections 995(c)(2) and 996(g).
(7) Anti-stuffing rule. If an asset the ad-
justed basis of which exceeds its fair mar-
ket value is contributed or transferred to a
target affiliate as transferred basis property
(within the meaning of section
7701(a)(43)) and a purpose of such transac-
tion is to reduce the gain (or increase the
loss) recognized on the deemed sale of such
target affiliate’s stock, the gain or loss rec-
ognized by target on the deemed sale of
stock of the target affiliate is determined as
if such asset had not been contributed or
transferred.
(8) Examples. The following examples
illustrate this paragraph (h):
Example 1. (i) P makes a qualified stock purchase
of T and makes a section 338 election for T. T’s sole
asset, all of the T1 stock, has a basis of $50 and a fair
market value of $150. T’s deemed purchase of the T1
stock results in a qualified stock purchase of T1 and a
section 338 election is made for T1. T1’s assets have a
basis of $50 and a fair market value of $150.
(ii) T realizes $100 of gain on the deemed sale of
the T1 stock, but the gain is not recognized because
T directly owns stock in T1 satisfying the require-
ments of section 1504(a)(2) and a section 338 elec-
tion is made for T1.
(iii) T1 recognizes gain of $100 on the deemed
sale of its assets.
2000–4 I.R.B.347January 24, 2000
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Example 2.The facts are the same as in Example
1, except that P does not make a section 338 election
for T1. Because a section 338 election is not made
for T1, the $100 gain realized by T on the deemed
sale of the T1 stock is recognized.
Example 3. (i) P makes a qualified stock pur-
chase of T and makes a section 338 election for T. T
owns all of the stock of T1 and T2. T’s deemed pur-
chase of the T1 and T2 stock results in a qualified
stock purchase of T1 and T2 and section 338 elec-
tions are made for T1 and T2. T1 and T2 each own
50 percent of the vote and value of T3 stock. The
deemed purchases by T1 and T2 of the T3 stock re-
sult in a qualified stock purchase of T3 and a section
338 election is made for T3. T is the common parent
of a consolidated group and all of the deemed asset
sales are reported on the T group’s final consolidated
return. See §1.338–10T(a)(1).
(ii) Because T, T1, T2 and T3 are members of a
consolidated group filing a final consolidated return,
no gain or loss is recognized by T, T1 or T2 on their
respective deemed sales of target affiliate stock.
Example 4.(i) T’s sole asset, all of the FT1 stock,
has a basis of $25 and a fair market value of $150.
FT1’s sole asset, all of the FT2 stock, has a basis of
$75 and a fair market value of $150. FT1 and FT2
each have $50 of accumulated earnings and profits for
purposes of section 1248(c) and (d). FT2’s assets
have a basis of $125 and a fair market value of $150,
and their sale would not generate subpart F income
under section 951. The sale of the FT2 stock or assets
would not generate income effectively connected
with the conduct of a trade or business within the
United States. FT1 does not have an election in effect
under section 953(d) and neither FT1 nor FT2 is a
passive foreign investment company.
(ii) P makes a qualified stock purchase of T and
makes a section 338 election for T. T’s deemed pur-
chase of the FT1 stock results in a qualified stock
purchase of FT1 and a section 338 election is made
for FT1. Similarly, FT1’s deemed purchase of the
FT2 stock results in a qualified stock purchase of
FT2 and a section 338 election is made for FT2.
(iii) T recognizes $125 of gain on the deemed
sale of the FT1 stock under paragraph (h)(3) of this
section. FT1 does not recognize $75 of gain on the
deemed sale of the FT2 stock under paragraph (h)(2)
of this section. FT2 recognizes $25 of gain on the
deemed sale of its assets. The $125 gain T recog-
nizes on the deemed sale of the FT1 stock is in-
cluded in T’s income as a dividend under section
1248, because FT1 and FT2 have sufficient earnings
and profits for full recharacterization ($50 of accu-
mulated earnings and profits in FT1, $50 of accumu-
lated earnings and profits in FT2, and $25 of deemed
sale earnings and profits in FT2). §1.338–9(b). For
purposes of sections 901 through 908, the source
and foreign tax credit limitation basket of $25 of the
recharacterized gain on the deemed sale of the FT1
stock is determined under section 338(h)(16).
§1.338–5T Adjusted grossed-up basis
(temporary).
(a) Scope.This section provides rules
under section 338(b) to determine the ad-
justed grossed-up basis (AGUB) for tar-
get. AGUB is the amount for which new
target is deemed to have purchased all of
its assets in the deemed purchase under
section 338(a)(2). AGUB is allocated
among target’s assets in accordance with
§1.338–6T to determine the price at
which the assets are deemed to have been
purchased. When an increase or decrease
with respect to an element of AGUB is re-
quired, under general principles of tax
law, after the close of new target’s first
taxable year, redetermined AGUB is allo-
cated among target’s assets in accordance
with §1.338–7T.
(b) Determination of AGUB—(1) Gen-
eral rule. AGUB is the sum of—
(i) The grossed-up basis in the purchas-
ing corporation’s recently purchased tar-
get stock;
(ii) The purchasing corporation’s basis
in nonrecently purchased target stock; and
(iii) The liabilities of new target.
(2) Time and amount of AGUB—(i)
Original determination.AGUB is ini-
tially determined at the beginning of the
day after the acquisition date of target.
General principles of tax law apply in de-
termining the timing and amount of the
elements of AGUB.
(ii) Redetermination of AGUB. AGUB
is redetermined at such time and in such
amount as an increase or decrease would be
required, under general principles of tax
law, with respect to an element of AGUB.
For example, AGUB is redetermined be-
cause of an increase or decrease in the
amount paid or incurred for recently pur-
chased stock or nonrecently purchased
stock or because liabilities not originally
taken into account in determining AGUB
are subsequently taken into account. An in-
crease or decrease to an element of ADSP
may cause an increase or decrease to an el-
ement of AGUB. For example, if an in-
crease in the amount realized for recently
purchased stock of target is taken into ac-
count after the acquisition date, any in-
crease in tax liability of target for the
deemed sale gain is also taken into account
when AGUB is redetermined. An increase
or decrease to one element of AGUB may
also cause an increase or decrease to an-
other element of AGUB. For example, if
there is an increase in the amount paid or
incurred for recently purchased stock after
the acquisition date, any increase in the
basis of nonrecently purchased stock be-
cause a gain recognition election was made
is also taken into account when AGUB is
redetermined. Increases or decreases with
respect to the elements of AGUB that are
taken into account before the close of new
target’s first taxable year are taken into ac-
count for purposes of determining AGUB
and the basis of target’s assets as if they had
been taken into account at the beginning of
the day after the acquisition date. Increases
or decreases with respect to the elements of
AGUB that are taken into account after the
close of new target’s first taxable year re-
sult in the reallocation of AGUB among
target’s assets under §1.338–7T.
(iii) Examples.The following exam-
ples illustrate this paragraph (b)(2):
Example 1. In Year 1, T, a manufacturer, pur-
chases a customized delivery truck from X with pur-
chase money indebtedness having a stated principal
amount of $100,000 . P acquires all of the stock of T
in Year 3 for $700,000 and makes a section 338 elec-
tion for T. Assume T has no liabilities other than its
purchase money indebtedness to X. In Year 4, when
T is neither insolvent nor in a title 11 case, T and X
agree to reduce the amount of the purchase money
indebtedness to $80,000. Assume that the reduction
would be a purchase price reduction under section
108(e)(5). T and X’s agreement to reduce the
amount of the purchase money indebtedness would,
under general principles of tax law that would apply
if the deemed asset sale had actually occurred,
change the amount of liabilities of old target taken
into account in determining its basis. Accordingly,
AGUB is redetermined at the time of the reduction.
See paragraph (e)(2) of this section. Thus the pur-
chase price reduction affects the basis of the truck
only indirectly, through the mechanism of
§§1.338–6Tand 1.338–7T. See
§1.338–4T(b)(2)(iii) Examplefor the effect on
ADSP.
Example 2.T, an accrual basis taxpayer, is a
chemical manufacturer. In Year 1, T is obligated to
remediate environmental contamination at the site of
one of its plants. Assume that all the events have oc-
curred that establish the fact of the liability and the
amount of the liability can be determined with rea-
sonable accuracy but economic performance has not
occurred with respect to the liability within the
meaning of section 461(h). P acquires all of the
stock of T in Year 1 and makes a section 338 elec-
tion for T. Assume that, if a corporation unrelated to
T had actually purchased T’s assets and assumed T’s
obligation to remediate the contamination, the cor-
poration would not satisfy the economic perfor-
mance requirements until Year 5. Under section
461(h), the assumed liability would not be treated as
incurred and taken into account in basis until that
time. The incurrence of the liability in Year 5 under
the economic performance rules is an increase in the
amount of liabilities properly taken into account in
basis and results in the redetermination of AGUB.
(Respecting ADSP, compare §1.461–4(d)(5), which
provides that economic performance occurs for old
T as the amount of the liability is properly taken into
account in amount realized on the deemed asset sale.
Thus ADSP is not redetermined when new T satis-
fies the economic performance requirements.)
(c) Grossed-up basis of recently pur-
chased stock.The purchasing corpora-
tion’s grossed-up basis of recently pur-
January 24, 20003482000–4 I.R.B.
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chased target stock (as defined in section
338(b)(6)(A)) is an amount equal to—
(1) The purchasing corporation’s basis
in recently purchased target stock at the
beginning of the day after the acquisition
date determined without regard to the ac-
quisition costs taken into account in para-
graph (c)(3) of this section;
(2) Multiplied by a fraction, the numer-
ator of which is 100 percent minus the
percentage of target stock (by value, de-
termined on the acquisition date) attribut-
able to the purchasing corporation’s non-
recently purchased target stock, and the
denominator of which is the percentage of
target stock (by value, determined on the
acquisition date) attributable to the pur-
chasing corporation’s recently purchased
target stock;
(3) Plus the acquisition costs the pur-
chasing corporation incurred in connec-
tion with its purchase of the recently pur-
chased stock that are capitalized in the
basis of such stock (e.g., brokerage com-
missions and any similar costs incurred
by the purchasing corporation to acquire
the stock).
(d) Basis of nonrecently purchased
stock; gain recognition election—(1) No
gain recognition election. In the absence
of a gain recognition election under sec-
tion 338(b)(3) and this section, the pur-
chasing corporation retains its basis in the
nonrecently purchased stock.
(2) Procedure for making gain recogni-
tion election. A gain recognition election
may be made for nonrecently purchased
stock of target (or a target affiliate) only if
a section 338 election is made for target
(or the target affiliate). The gain recogni-
tion election is made by attaching a gain
recognition statement to a timely filed
Form 8023 for target. The gain recogni-
tion statement must contain the informa-
tion specified in the form and its instruc-
tions. The gain recognition election is
irrevocable. If a section 338(h)(10) elec-
tion is made for target, see
§1.338(h)(10)–1T(d)(1) (providing that
the purchasing corporation is automati-
cally deemed to have made a gain recog-
nition election for its nonrecently pur-
chased T stock).
(3) Effect of gain recognition
election—(i) In general. If the purchas-
ing corporation makes a gain recognition
election, then for all purposes of the Inter-
nal Revenue Code—
(A) The purchasing corporation is
treated as if it sold on the acquisition date
the nonrecently purchased target stock for
the basis amount determined under para-
graph (d)(3)(ii) of this section; and
(B) The purchasing corporation’s basis
on the acquisition date in nonrecently pur-
chased target stock immediately follow-
ing the deemed sale in paragraph
(d)(3)(i)(A) of this section is the basis
amount.
(ii) Basis amount. The basis amount is
equal to the amount in paragraph (c)(1) of
this section (the purchasing corporation’s
basis in recently purchased target stock at
the beginning of the day after the acquisi-
tion date determined without regard to the
acquisition costs taken into account in
paragraph (c)(3) of this section) multi-
plied by a fraction the numerator of which
is the percentage of target stock (by value,
determined on the acquisition date) attrib-
utable to the purchasing corporation’s
nonrecently purchased target stock and
the denominator of which is 100 percent
minus the numerator amount. Thus, if
target has a single class of outstanding
stock, the purchasing corporation’s basis
in each share of nonrecently purchased
target stock after the gain recognition
election is equal to the average price per
share of the purchasing corporation’s re-
cently purchased target stock.
(iii) Losses not recognized.Only gains
(unreduced by losses) on the nonrecently
purchased target stock are recognized.
(iv) Stock subject to election. The gain
recognition election applies to—
(A) All nonrecently purchased target
stock; and
(B) Any nonrecently purchased stock in
a target affiliate having the same acquisi-
tion date as target if such target affiliate
stock is held by the purchasing corpora-
tion on such date.
(e) Liabilities of new target—(1) In
general. The liabilities of new target are
the liabilities of target (and the liabilities
to which target’s assets are subject) as of
the beginning of the day after the acquisi-
tion date (other than liabilities that were
neither liabilities of old target nor liabili-
ties to which old target’s assets were sub-
ject). In order to be taken into account in
AGUB, a liability must be a liability of
target that is properly taken into account
in basis under general principles of tax
law that would apply if new target had ac-
quired its assets from an unrelated person
for consideration that included the as-
sumption of, or taking subject to, the lia-
bility. See §1.338–4T(d)(1) for examples
of when tax liabilities are considered lia-
bilities assumed by new target.
(2) Time and amount of liabilities. The
time for taking into account liabilities of
old target in determining AGUB and the
amount of the liabilities taken into ac-
count is determined as if new target had
acquired its assets from an unrelated per-
son for consideration that included the as-
sumption of, or taking subject to, the lia-
bilities. For example, an increase or
decrease in a liability that does not affect
the amount of new target’s basis arising
from the assumption of, or taking subject
to, the liability is not taken into account in
redetermining AGUB.
(3) Interaction with deemed sale gain.
See §1.338–4T(d)(3).
(f) Adjustments by the Internal Revenue
Service. In connection with the examina-
tion of a return, the District Director may
increase (or decrease) AGUB under the
authority of section 338(b)(2) and allocate
such amounts to target’s assets under the
authority of section 338(b)(5) so that
AGUB and the basis of target’s assets
properly reflect the cost to the purchasing
corporation of its interest in target’s as-
sets. Such items may include distribu-
tions from target to the purchasing corpo-
ration, capital contributions from the
purchasing corporation to target during
the 12-month acquisition period, or acqui-
sitions of target stock by the purchasing
corporation after the acquisition date from
minority shareholders.
(g) Examples. The following examples
illustrate this section. For purposes of the
examples in this paragraph (g), T has no
liabilities other than the tax liability for
the deemed sale gain, T shareholders
incur no costs in selling the T stock, and P
incurs no costs in acquiring the T stock.
The examples are as follows:
Example 1.(i) Before July 1 of Year 1, P pur-
chases 10 of the 100 shares of T stock for $5,000.
On July 1 of Year 2, P purchases 80 shares of T stock
for $60,000 and makes a section 338 election for T.
As of July 1 of Year 2, T’s only asset is raw land with
an adjusted basis to T of $50,400 and a fair market
value of $100,000. T has no loss or tax credit carry-
overs to Year 2. T’s marginal tax rate for any ordi-
nary income or net capital gain resulting from the
deemed asset sale is 34 percent. The 10 shares pur-
chased before July 1 of Year 1 constitute nonrecently
purchased T stock with respect to P’s qualified stock
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purchase of T stock on July 1 of Year 2.
(ii) The ADSP formula as applied to these facts is
the same as in §1.338–4T(g) Example 1. Accord-
ingly, the ADSP for T is $87,672.72. The existence
of nonrecently purchased T stock is irrelevant for
purposes of the ADSP formula, because that formula
treats P’s nonrecently purchased T stock in the same
manner as T stock not held by P.
(iii) The total tax liability resulting from T’s
deemed asset sale, as calculated under the ADSP
formula, is $12,672.72.
(iv) If P does not make a gain recognition elec-
tion, the AGUB of new T’s assets is $85,172.72, de-
termined as follows (In the following formula
below, GRP is the grossed-up basis in P’s recently
purchased T stock, BNP is P’s basis in nonrecently
purchased T stock, L is T’s liabilities, and X is P’s
acquisition costs for the recently purchased T stock):
AGUB = GRP + BNP + L + X
AGUB = $60,000 ( [(1 - .1)/.8] + $5,000 +
$12,672.72 + 0
AGUB = $85,172.72
(v) If P makes a gain recognition election, the
AGUB of new T’s assets is $87,672.72, determined
as follows:
AGUB = $60,000 ( [(1 - .1)/.8] + $60,000 ( [(1 -
.1)/.8] ( [.1/(1 - .1)] + $12,672.72
AGUB = $87,672.72
(vi) The calculation of AGUB if P makes a gain
recognition election may be simplified as follows:
AGUB = $60,000/.8 + $12,672.72
AGUB = $87,672.72
(vii) As a result of the gain recognition election,
P’s basis in its nonrecently purchased T stock is in-
creased from $5,000 to $7,500 (i.e., $60,000 ( [(1 å
.1)/.8] ( [.1/(1 å .1)]). Thus, P recognizes a gain in
Year 2 with respect to its nonrecently purchased T
stock of $2,500 (i.e., $7,500 å $5,000).
Example 2. On January 1 of Year 1, P purchases
one-third of the T stock. On March 1 of Year 1, T
distributes a dividend to all of its shareholders. On
April 15 of Year 1, P purchases the remaining T
stock and makes a section 338 election for T. In ap-
propriate circumstances, the District Director may
decrease the AGUB of T to take into account the
payment of the dividend and properly reflect the fair
market value of T’s assets deemed purchased.
Example 3.(i) T’s sole asset is a building worth
$100,000. At this time, T has 100 shares of stock
outstanding. On August 1 of Year 1, P purchases 10
of the 100 shares of T stock for $8,000. On June 1
of Year 2, P purchases 50 shares of T stock for
$50,000. On June 15 of Year 2, P contributes a tract
of land to the capital of T and receives 10 additional
shares of T stock as a result of the contribution.
Both the basis and fair market value of the land at
that time are $10,800. On June 30 of Year 2, P pur-
chases the remaining 40 shares of T stock for
$40,000 and makes a section 338 election for T. The
AGUB of T is $108,800.
(ii) To prevent the shifting of basis from the con-
tributed property to other assets of T, the District Di-
rector may allocate $10,800 of the AGUB to the
land, leaving $98,000 to be allocated to the building.
See paragraph (f) of this section. Otherwise, apply-
ing the allocation rules of §1.338–6T would, on
these facts, result in an allocation to the recently
contributed land of an amount less than its value of
$10,800, with the difference being allocated to the
building already held by T.
Par. 7. Sections 1.338–6T and
1.338–7T are added to read as follows:
§1.338–6T Allocation of ADSP and
AGUB among target assets(temporary).
(a) Scope—(1) In general. This section
prescribes rules for allocating ADSP and
AGUB among the acquisition date assets
of a target for which a section 338 elec-
tion is made.
(2) Fair market value—(i)In general.
Generally, the fair market value of an asset is
its gross fair market value (i.e., fair market
value determined without regard to mort-
gages, liens, pledges, or other liabilities).
However, for purposes of determining the
amount of old target’s deemed sale gain, the
fair market value of any property subject to a
nonrecourse indebtedness will be treated as
being not less than the amount of such in-
debtedness. (For purposes of the preceding
sentence, a liability that was incurred be-
cause of the acquisition of the property is
disregarded to the extent that such liability
was not taken into account in determining
old target’s basis in such property.)
(ii) Transaction costs.Transaction
costs are not taken into account in allocat-
ing ADSP or AGUB to assets in the
deemed sale (except indirectly through
their effect on the total ADSP or AGUB to
be allocated).
(iii) Internal Revenue Service author-
ity.In connection with the examination of
a return, the Internal Revenue Service
may challenge the taxpayer’s determina-
tion of the fair market value of any asset
by any appropriate method and take into
account all factors, including any lack of
adverse tax interests between the parties.
For example, in certain cases the Internal
Revenue Service may make an indepen-
dent showing of the value of goodwill and
going concern value as a means of calling
into question the validity of the taxpayer’s
valuation of other assets.
(b) General rule for allocating ADSP
and AGUB—(1) Reduction in the amount
of consideration for Class I assets. Both
ADSP and AGUB, in the respective allo-
cation of each, are first reduced by the
amount of Class I acquisition date assets.
Class I assets are cash and general deposit
accounts (including savings and checking
accounts) other than certificates of de-
posit held in banks, savings and loan as-
sociations, and other depository institu-
tions. If the amount of Class I assets
exceeds AGUB, new target will immedi-
ately realize ordinary income in an
amount equal to such excess. The amount
of ADSP or AGUB remaining after the re-
duction is to be allocated to the remaining
acquisition date assets.
(2) Other assets—(i) In general. Sub-
ject to the limitations and other rules of
paragraph (c) of this section, ADSP and
AGUB (as reduced by the amount of
Class I assets) are allocated among Class
II acquisition date assets of target in pro-
portion to the fair market values of such
Class II assets at such time, then among
Class III assets so held in such proportion,
then among Class IV assets so held in
such proportion, then among Class V as-
sets so held in such proportion, then
among Class VI assets so held in such
proportion, and finally to Class VII assets.
(ii) Class II assets.Class II assets are ac-
tively traded personal property within the
meaning of section 1092(d)(1) and
§1.1092(d)–1 (determined without regard
to section 1092(d)(3)). In addition, Class II
assets include certificates of deposit and
foreign currency even if they are not ac-
tively traded personal property. Examples
of Class II assets include U.S. government
securities and publicly traded stock.
(iii) Class III assets. Class III assets are
accounts receivable, mortgages, and credit
card receivables from customers which
arise in the ordinary course of business.
(iv) Class IV assets. Class IV assets are
stock in trade of the taxpayer or other
property of a kind which would properly
be included in the inventory of taxpayer if
on hand at the close of the taxable year, or
property held by the taxpayer primarily
for sale to customers in the ordinary
course of its trade or business.
(v) Class V assets. Class V assets are
all assets other than Class I, II, III, IV, VI,
and VII assets.
(vi) Class VI assets. Class VI assets
are all section 197 intangibles, as defined
in section 197, except goodwill and going
concern value.
(vii) Class VII assets. Class VII assets
are goodwill and going concern value
(whether or not the goodwill or going
concern value qualifies as a section 197
intangible).
(3) Other items designated by the Inter-
nal Revenue Service.Similar items may be
added to any class described in this para-
graph (b) by designation in the Internal Rev-
enue Bulletin by the Internal Revenue Ser-
January 24, 20003502000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 350

vice (see §601.601(d)(2) of this Chapter).
(c) Certain limitations and other rules
for allocation to an asset—(1) Allocation
not to exceed fair market value. The
amount of ADSP or AGUB allocated to
an asset (other than Class VII assets) can-
not exceed the fair market value of that
asset at the beginning of the day after the
acquisition date.
(2) Allocation subject to other rules.The
amount of ADSP or AGUB allocated to an
asset is subject to other provisions of the In-
ternal Revenue Code or general principles
of tax law in the same manner as if such
asset were transferred to or acquired from
an unrelated person in a sale or exchange.
For example, if the deemed asset sale is a
transaction described in section 1056(a)
(relating to basis limitation for player con-
tracts transferred in connection with the
sale of a franchise), the amount of AGUB
allocated to a contract for the services of an
athlete cannot exceed the limitation im-
posed by that section. As another example,
the amount of AGUB allocated to an amor-
tizable section 197 intangible resulting
from an assumption-reinsurance transac-
tion is determined under section 197(f)(5).
(3) Special rule for allocating AGUB
when purchasing corporation has nonre-
cently purchased stock—(i) Scope. This
paragraph (c)(3) applies if at the beginning
of the day after the acquisition date—
(A) The purchasing corporation holds
nonrecently purchased stock for which a
gain recognition election under section
338(b)(3) and §1.338–5T(d) is not made;
and
(B) The hypothetical purchase price de-
termined under paragraph (c)(3)(ii) of this
section exceeds the AGUB determined
under §1.338–5T(b).
(ii) Determination of hypothetical pur-
chase price. Hypothetical purchase price
is the AGUB that would result if a gain
recognition election were made.
(iii) Allocation of AGUB. Subject to
the limitations in paragraphs (c)(1) and
(2) of this section, the portion of AGUB
(after reduction by the amount of Class I
assets) to be allocated to each Class II, III,
IV, V, VI, and VII asset of target held at
the beginning of the day after the acquisi-
tion date is determined by multiplying—
(A) The amount that would be allo-
cated to such asset under the general rules
of this section were AGUB equal to the
hypothetical purchase price; by
(B) A fraction, the numerator of which
is actual AGUB (after reduction by the
amount of Class I assets) and the denomi-
nator of which is the hypothetical pur-
chase price (after reduction by the amount
of Class I assets).
(4) Liabilities taken into account in de-
termining amount realized on subsequent
disposition. In determining the amount
realized on a subsequent sale or other dis-
position of property deemed purchased by
new target, the entire amount of any lia-
bility taken into account in AGUB is con-
sidered to be an amount taken into ac-
count in determining new target’s basis in
property that secures the liability for pur-
poses of applying §1.1001–2(a). Thus, if
a liability is taken into account in AGUB,
§1.1001–2(a)(3) does not prevent the
amount of such liability from being
treated as discharged within the meaning
of §1.1001–2(a)(4) as a result of new tar-
get’s sale or disposition of the property
which secures such liability.
(d) Examples. The following examples
illustrate §§1.338–4T, 1.338–5T, and this
section:
Example 1. (i) T owns 90 percent of the outstanding
T1 stock. P purchases 100 percent of the outstanding T
stock for $2,000. There are no acquisition costs. P
makes a section 338 election for T and, as a result, T1 is
considered acquired in a qualified stock purchase. A
section 338 election is made for T1. The grossed-up
basis of the T stock is $2,000 (i.e., $2,000 ( 1/1).
(ii) The liabilities of T as of the beginning of the
day after the acquisition date (including the tax lia-
bility for the deemed sale gain) that would, under
general principles of tax law, be properly taken into
account before the close of new T’s first taxable
year, are as follows:
2000–4 I.R.B.351January 24, 2000
Liabilities (nonrecourse mortgage plus unsecured liabilities) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 700
Taxes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 1,000
(iii) The AGUB of T is determined as follows:
Grossed-up basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$2,000
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1,000
AGUB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 3,000
(iv) Assume that ADSP is also $3,000.
(v) Assume that, at the beginning of the day after the acquisition date, T’s cash and the fair market values of T’s Class II, III, IV, and V assets
are as follows:
AssetAssetFair
Classmarket
value
ICash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 200*
IIPortfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300
IIIAccounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .600
IVInventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300
VBuilding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .800
VLand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200
VInvestment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .450
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 2,850
*Amount.
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(vi) Under paragraph (b)(1) of this section, the
amount of ADSP and AGUB allocable to T’s Class
II, III, IV, and V assets is reduced by the amount of
cash to $2,800, i.e., $3,000 å $200. $300 of ADSP
and of AGUB is then allocated to actively traded se-
curities. $600 of ADSP and of AGUB is then allo-
cated to accounts receivable. $300 of ADSP and of
AGUB is then allocated to the inventory. Since the
remaining amount of ADSP and of AGUB is $1,600
(i.e., $3,000 å ($200 + $300 + $600 + $300)), an
amount which exceeds the sum of the fair market
values of T’s Class V assets, the amount of ADSP
and of AGUB allocated to each Class V asset is its
fair market value:
Building . . . . . . . . . . . . . . . . . .800
Land . . . . . . . . . . . . . . . . . . . . .200
Investment in T1 . . . . . . . . . . . .450
Total . . . . . . . . . . . . . . . . . . . . .$ 1,450
(vii) T has no Class VI assets. The amount of
ADSP and of AGUB allocated to T’s Class VII as-
sets (goodwill and going concern value) is $150, i.e.,
$1,600 - $1,450.
(viii) The grossed-up basis of the T1 stock is
$500, i.e., $450 ( 1/.9.
(ix) The liabilities of T as of the beginning of the
day after the acquisition date (including the tax lia-
bility for the deemed sale gain) that would, under
general principles of tax law, be properly taken into
account before the close of new T’s first taxable
year, are as follows:
General Liabilities . . . . . . . . . . .$ 100
Taxes Payable . . . . . . . . . . . . . .20
Total . . . . . . . . . . . . . . . . . . .$ 120
(x) The AGUB of T1 is determined as follows:
Grossed-up basis of T1 Stock . .$ 500
Liabilities . . . . . . . . . . . . . . . . .120
AGUB . . . . . . . . . . . . . . . . . . . .$ 620
(xi) Assume that ADSP is also $620.
(xii) Assume that at the beginning of the day after
the acquisition date, T1’s cash and the fair market
values of its Class IV and VI assets are as follows:
AssetAssetFair
ClassMarket
Value
ICash . . . . . . . . . . . . . . $ 50*
IVInventory . . . . . . . . . . 200
VIPatent . . . . . . . . . . . . . 350
Total . . . . . . . . . . . . $ 600
* Amount.
(xiii) The amount of ADSP and of AGUB alloca-
ble to T1’s Class IV and VI assets is first reduced by
the $50 of cash.
(xiv) Because the remaining amount of ADSP
and of AGUB ($570) is an amount which exceeds
the fair market value of T1’s only Class IV asset, the
inventory, the amount allocated to the inventory is
its fair market value ($200). After that, the remain-
ing amount of ADSP and of AGUB ($370) exceeds
the fair market value of T1’s only Class VI asset, the
patent. Thus, the amount of ADSP and of AGUB al-
located to the patent is its fair market value ($350).
(xv) The amount of ADSP and of AGUB allo-
cated to T1’s Class VII assets (goodwill and going
concern value) is $20, i.e., $570 å $550.
Example 2. (i) Assume that the facts are the same
as in Example 1except that P has, for five years,
owned 20 percent of T’s stock, which has a basis in
P’s hands at the beginning of the day after the acqui-
sition date of $100, and P purchases the remaining
80 percent of T’s stock for $1,600. P does not make
a gain recognition election under section 338(b)(3).
(ii) Under §1.338–5T(c), the grossed-up basis of
recently purchased T stock is $1,600, i.e., $1,600 (
(1 - .2)/.8.
(iii) The AGUB of T is determined as follows:
Grossed-up basis of recently
purchased stock as determined
under §1.338–5T(c) ($1,600 x
(1 - .2)/.8) . . . . . . . . . . . . . . . . . . . . .$ 1,600
Basis of nonrecently purchased
stock . . . . . . . . . . . . . . . . . . . . . . . . .100
Liabilities . . . . . . . . . . . . . . . . . . . . .1,000
AGUB . . . . . . . . . . . . . . . . . . . . .$ 2,700
(iv) Since P holds nonrecently purchased stock,
the hypothetical purchase price of the T stock must
be computed and is determined as follows:
Grossed-up basis of recently
purchased stock as
determined under
§1.338–5T(c)
($1,600 ( (1 - .2)/.8) . . . . . . . . . . . .$ 1,600
Basis of nonrecently purchased
stock as if the gain recognition
election under §1.338–5T(d)(2)
had been made ($1,600
( .2/(1 å .2)) . . . . . . . . . . . . . . . . . . .400
Liabilities . . . . . . . . . . . . . . . . . . . . .1,000
Total . . . . . . . . . . . . . . . . . . . . . .$ 3,000
(v) Since the hypothetical purchase price
($3,000) exceeds the AGUB ($2,700) and no gain
recognition election is made under section
338(b)(3), AGUB is allocated under paragraph
(c)(3) of this section.
(vi) First, an AGUB amount equal to the hypo-
thetical purchase price ($3,000) is allocated among
the assets under the general rules of this section.
The allocation is set forth in the column below enti-
tled Original Allocation.Next, the allocation to
each asset in Class II through Class VII is multiplied
by a fraction having a numerator equal to the actual
AGUB reduced by the amount of Class I assets
($2,700 å $200 = $2,500) and a denominator equal
to the hypothetical purchase price reduced by the
amount of Class I assets ($3,000 å $200 = $2,800),
or 2,500/2,800. This produces the Final Allocation:
January 24, 20003522000–4 I.R.B.
ClassAssetOriginalFinal
AllocationAllocation
ICash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 200$ 200
IIPortfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . .300268*
IIIAccounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .600536
IVInventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300268
VBuilding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .800714
VLand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200178
VInvestment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .450402
VIIGoodwill and going concern value . . . . . . . . . . . . . . . . . . . . . . . .150134
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 3,000$ 2,700
* All numbers rounded for convenience.
§1.338–7T Allocation of redetermined
ADSP and AGUB among target assets
(temporary).
(a) Scope.ADSP and AGUB are rede-
termined at such time and in such amount
as an increase or decrease would be re-
quired under general principles of tax law
for the elements of ADSP or AGUB. This
section provides rules for allocating rede-
termined ADSP or AGUB when increases
or decreases with respect to the elements
of ADSP or AGUB are required after the
close of new target’s first taxable year.
For determining and allocating ADSP or
AGUB when increases or decreases are
required with respect to the elements of
ADSP or AGUB before the close of new
target’s first taxable year, see §§1.338–4T,
1.338–5T, and 1.338–6T.
(b) Allocation of redetermined ADSP
and AGUB. When ADSP or AGUB is re-
determined, a new allocation of ADSP or
AGUB is made by allocating the redeter-
mined ADSP or AGUB amount under the
rules of §1.338–6T. If the allocation of
the redetermined ADSP or AGUB amount
under §1.338–6T to a given asset is differ-
ent from the original allocation to it, the
difference is added to or subtracted from
the original allocation to the asset, as ap-
propriate. Amounts allocable to an acqui-
sition date asset (or with respect to a dis-
posed-of acquisition date asset) are
subject to all the asset allocation rules (for
example, the fair market value limitation
in §1.338–6T(c)(1)) as if the redeter-
mined ADSP or AGUB were the ADSP or
AGUB on the acquisition date.
(c) Special rules for ADSP—(1) In-
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creases or decreases in deemed sale gain
taxable notwithstanding old target ceases
to exist. To the extent general principles
of tax law would require a seller in an ac-
tual asset sale to account for events relat-
ing to the sale that occur after the sale
date, target must make such an account-
ing. Target is not precluded from realiz-
ing additional deemed sale gain because
the target is treated as a new corporation
after the acquisition date.
(2) Procedure for transactions in which
section 338(h)(10) is not elected— (i)
Deemed sale gain included in new target’s
return.If an election under section
338(h)(10) is not made, any additional
deemed sale gain of old target resulting
from an increase or decrease in the ADSP
is included in new target’s income tax re-
turn for new target’s taxable year in which
the increase or decrease is taken into ac-
count. For example, if after the acquisi-
tion date there is an increase in the alloca-
ble ADSP of section 1245 property for
which the recomputed basis (but not the
adjusted basis) exceeds the portion of the
ADSP allocable to that particular asset on
the acquisition date, the additional gain is
treated as ordinary income to the extent it
does not exceed such excess amount. See
paragraph (c)(2)(ii) of this section for the
special treatment of old target’s carry-
overs and carrybacks. Although included
in new target’s income tax return, the
deemed sale gain is separately accounted
for as an item of old target and may not be
offset by income, gain, deduction, loss,
credit, or other amount of new target. The
amount of tax on income of old target re-
sulting from an increase or decrease in the
ADSP is determined as if such deemed
sale gain had been recognized in old tar-
get’s taxable year ending at the close of
the acquisition date.
(ii) Carryovers and carrybacks—(A)
Loss carryovers to new target taxable
years.A net operating loss or net capital
loss of old target may be carried forward
to a taxable year of new target, under the
principles of section 172 or 1212, as ap-
plicable, but is allowed as a deduction
only to the extent of any recognized in-
come of old target for such taxable year,
as described in paragraph (c)(2)(i) of this
section. For this purpose, however, tax-
able years of new target are not taken into
account in applying the limitations in sec-
tion 172(b)(1) or 1212(a)(1)(B) (or other
similar limitations). In applying sections
172(b) and 1212(a)(1), only income, gain,
loss, deduction, credit, and other amounts
of old target are taken into account. Thus,
if old target has an unexpired net operat-
ing loss at the close of its taxable year in
which the deemed asset sale occurred that
could be carried forward to a subsequent
taxable year, such loss may be carried for-
ward until it is absorbed by old target’s in-
come.
(B) Loss carrybacks to taxable years of
old target. An ordinary loss or capital
loss accounted for as a separate item of
old target under paragraph (c)(2)(i) of this
section may be carried back to a taxable
year of old target under the principles of
section 172 or 1212, as applicable. For
this purpose, taxable years of new target
are not taken into account in applying the
limitations in section 172(b) or 1212(a)
(or other similar limitations).
(C) Credit carryovers and carrybacks.
The principles described in paragraphs
(c)(2)(ii)(A) and (B) of this section apply
to carryovers and carrybacks of amounts
for purposes of determining the amount of
a credit allowable under part IV, subchap-
ter A, chapter 1 of the Internal Revenue
Code. Thus, for example, credit carry-
overs of old target may offset only in-
come tax attributable to items described
in paragraph (c)(2)(i) of this section.
(3) Procedure for transactions in which
section 338(h)(10) is elected. If an elec-
tion under section 338(h)(10) is made,
any additional deemed sale gain resulting
from an increase or decrease in the ADSP
is accounted for in determining the tax-
able income (or other amount) of the
member of the selling consolidated group,
the selling affiliate, or the S corporation
shareholders to which such income, loss,
or other amount is attributable for the tax-
able year in which such increase or de-
crease is taken into account.
(d) Special rules for AGUB—(1) Effect
of disposition or depreciation of acquisi-
tion date assets.If an acquisition date
asset has been disposed of, depreciated,
amortized, or depleted by new target be-
fore an amount is added to the original al-
location to the asset, the increased amount
otherwise allocable to such asset is taken
into account under general principles of
tax law that apply when part of the cost of
an asset not previously taken into account
in basis is paid or incurred after the asset
has been disposed of, depreciated, amor-
tized, or depleted. A similar rule applies
when an amount is subtracted from the
original allocation to the asset. For pur-
poses of the preceding sentence, an asset
is considered to have been disposed of to
the extent that its allocable portion of the
decrease in AGUB would reduce its basis
below zero.
(2) Section 38 property. Section
1.47–2(c) applies to a reduction in basis
of section 38 property under this section.
(e) Examples. The following examples
illustrate this section. Any amount de-
scribed in the following examples is ex-
clusive of interest. For rules characteriz-
ing deferred contingent payments as
principal or interest, see §§1.483–4,
1.1274–2(g), and 1.1275–4(c). The ex-
amples are as follows:
Example 1. (i)(A) T’s assets other than goodwill
and going concern value, and their fair market val-
ues at the beginning of the day after the acquisition
date, are as follows:
AssetAssetFair
ClassMarket
Value
VBuilding . . . . . . . . . . . . .$ 100
VStock of X (not a target) .200
Total . . . . . . . . . . . . . .$ 300
(B) T has no liabilities other than a contingent li-
ability that would not be taken into account under
general principles of tax law in an asset sale between
unrelated parties when the buyer assumed the liabil-
ity or took property subject to it.
(ii)(A) On September 1, 2000, P purchases all of
the outstanding stock of T for $270 and makes a sec-
tion 338 election for T. The grossed-up basis of the
T stock and T’s AGUB are both $270. The AGUB is
ratably allocated among T’s Class V assets in pro-
portion to their fair market values as follows:
AssetBasis
Building ($270 ( 100/300) . . . . . . . .$ 90
Stock ($270 ( 200/300) . . . . . . . . . . .180
Total . . . . . . . . . . . . . . . . . . . . . . .$270
(B) No amount is allocated to the Class VII as-
sets. New T is a calendar year taxpayer. Assume
that the X stock is a capital asset in the hands of new
T.
(iii) On January 1, 2001, new T sells the X stock
and uses the proceeds to purchase inventory.
(iv) Pursuant to events on June 30, 2002, the
contingent liability of old T is at that time properly
taken into account under general principles of tax
law. The amount of the liability is $60.
(v) T’s AGUB increases by $60 from $270 to
$330. This $60 increase in AGUB is first allocated
among T’s acquisition date assets in accordance with
the provisions of §1.338–6T. Because the redeter-
mined AGUB for T ($330) exceeds the sum of the
fair market values at the beginning of the day after
the acquisition date of the Class V acquisition date
assets ($300), AGUB allocated to those assets is lim-
ited to those fair market values under §1.338-
2000–4 I.R.B.353January 24, 2000
IRB 2000-4 1/28/00 10:26 AM Page 353

6T(c)(1). As there are no Class VI assets, the re-
maining AGUB of $30 is allocated to goodwill and
going concern value (Class VII assets). The amount
of increase in AGUB allocated to each acquisition
date asset is determined as follows:
AssetOriginalRedeterminedIncrease
AGUBAGUB
Building . . . . $ 90$ 100$ 10
X Stock . . . . .18020020
Goodwill and
going concern
value . . . . . . .03030
Total . . . . . . $ 270$ 330$ 60
(vi) Since the X stock was disposed of before the
contingent liability was properly taken into account
for tax purposes, no amount of the increase in
AGUB attributable to such stock may be allocated to
any T asset. Rather, such amount ($20) is allowed
as a capital loss to T for the taxable year 2002 under
the principles of Arrowsmith v. Commissioner, 344
U.S. 6 (1952). In addition, the $10 increase in
AGUB allocated to the building and the $30 in-
crease in AGUB allocated to the goodwill and going
concern value are treated as basis redeterminations
in 2002. See paragraph (d)(1) of this section.
Example 2. (i) On January 1, 2002, P purchases
all of the outstanding stock of T and makes a section
338 election for T. Assume that ADSP and AGUB
of T are both $500 and are allocated among T’s ac-
quisition date assets as follows:
AssetAssetBasis
Class
VMachinery . . . . . . . . . . . . . . $ 150
VLand . . . . . . . . . . . . . . . . . . 250
VIIGoodwill and going. . . . . . .
concern value . . . . . . . . . . . 100
Total . . . . . . . . . . . . . . . $ 500
(ii) On September 30, 2004, P filed a claim
against the selling shareholders of T in a court of ap-
propriate jurisdiction alleging fraud in the sale of the
T stock.
(iii) On January 1, 2007, the former shareholders
refund $140 of the purchase price to P in a settle-
ment of the lawsuit. Assume that, under general
principles of tax law, both the seller and the buyer
properly take into account such refund when paid.
Assume also that the refund has no effect on the tax
liability for the deemed sale gain. This refund re-
sults in a decrease of T’s ADSP and AGUB of $140,
from $500 to $360.
(iv) The redetermined ADSP and AGUB of $360
is allocated among T’s acquisition date assets. Be-
cause ADSP and AGUB do not exceed the fair mar-
ket value of the Class V assets, the ADSP and
AGUB amounts are allocated to the Class V assets
in proportion to their fair market values at the begin-
ning of the day after the acquisition date. Thus,
$135 ($150 ( ($360/($150 + $250))) is allocated to
the machinery and $225 ($250 ( ($360/($150 +
$250))) is allocated to the land. Accordingly, the
basis of the machinery is reduced by $15 ($150 orig-
inal allocation å $135 redetermined allocation) and
the basis of the land is reduced by $25 ($250 origi-
nal allocation å $225 redetermined allocation). No
amount is allocated to the Class VII assets. Accord-
ingly, the basis of the goodwill and going concern
value is reduced by $100 ($100 original allocation å
$0 redetermined allocation).
(v) Assume that, as a result of deductions under
section 168, the adjusted basis of the machinery im-
mediately before the decrease in AGUB is zero. The
machinery is treated as if it were disposed of before
the decrease is taken into account. In 2007, T recog-
nizes income of $15, the character of which is deter-
mined under the principles of Arrowsmith v. Com-
missioner, 344 U.S. 6 (1952), and the tax benefit
rule. No adjustment to the basis of T’s assets is
made for any tax paid on this amount. Assume also
that, as a result of amortization deductions, the ad-
justed basis of the goodwill and going concern value
immediately before the decrease in AGUB is $40. A
similar adjustment to income is made in 2007 with
respect to the $60 of previously amortized goodwill
and going concern value.
(vi) In summary, the basis of T’s acquisition date
assets, as of January 1, 2007, is as follows:
AssetBasis
Machinery . . . . . . . . . . . . . . . . . . . . $ 0
Land . . . . . . . . . . . . . . . . . . . . . . . . . 225
Goodwill and going
concern value . . . . . . . . . . . . . . . . . . 0
Example 3. (i) Assume that the facts are the same
as §1.338–6T(d) Example 2except that the recently
purchased stock is acquired for $1,600 plus addi-
tional payments that are contingent upon T’s future
earnings. Assume that, under general principles of
tax law, such later payments are properly taken into
account when paid. Thus, T’s AGUB, determined as
of the beginning of the day after the acquisition date
(after reduction by T’s cash of $200), is $2,500 and
is allocated among T’s acquisition date assets under
§1.338–6T(c)(3)(iii) as follows:
ClassAssetFinal
Allocation
ICash . . . . . . . . . . . . . . .$ 200
IIPortfolio of actively
traded securities . . . . . .268*
IIIAccounts receivable . .536
IVInventory . . . . . . . . . . .268
VBuilding . . . . . . . . . . . .714
VLand . . . . . . . . . . . . . . .178
VInvestment in T1 . . . . .402
VIIGoodwill and going
concern value . . . . . . . .134
Total . . . . . . . . . . . . .$ 2,700
* All numbers rounded for convenience.
(ii) After the close of new target’s first taxable
year, P pays an additional $200 for its recently pur-
chased T stock. Assume that the additional consid-
eration paid would not increase T’s tax liability for
the deemed sale gain.
(iii) T’s AGUB increases by $200, from $2,700 to
$2,900. This $200 increase in AGUB is accounted
for in accordance with the provisions of
§1.338–6T(c)(3)(iii).
(iv) The hypothetical purchase price of the T
stock is redetermined as follows:
Grossed-up basis of recently
purchased stock as determined
under §1.338–5T(c) ($1,800
( (1 - .2)/.8) . . . . . . . . . . . . . . . . . .$ 1,800
Basis of nonrecently purchased
stock as if the gain recognition
election under §1.338–5T(d)(2)
had been made ($1,800
( .2/(1 å .2)) . . . . . . . . . . . . . . . . . .450
Liabilities . . . . . . . . . . . . . . . . . . . .1,000
Total . . . . . . . . . . . . . . . . . . . . . . . .$ 3,250
(v) Since the redetermined hypothetical purchase
price ($3,250) exceeds the redetermined AGUB
($2,900) and no gain recognition election was made
under section 338(b)(3), the rules of
§1.338–6T(c)(3)(iii) are reapplied using the redeter-
mined hypothetical purchase price and the redeter-
mined AGUB.
(vi) First, an AGUB amount equal to the redeter-
mined hypothetical purchase price ($3,250) is allo-
cated among the assets under the general rules of
§1.338–6T. The allocation is set forth in the column
below entitled Hypothetical Allocation. Next, the
allocation to each asset in Class II through Class VII
is multiplied by a fraction with a numerator equal to
the actual redetermined AGUB reduced by the
amount of Class I assets ($2,900 å $200 = $2,700)
and a denominator equal to the redetermined hypo-
thetical purchase price reduced by the amount of
Class I assets ($3,250 å $200 = $3,050), or
2,700/3,050. This produces the Final Allocation:
January 24, 20003542000–4 I.R.B.
ClassAssetHypotheticalFinal
AllocationAllocation
ICash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 200$ 200
IIPortfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300266*
IIIAccounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .600531
IVInventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .300266
VBuilding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .800708
VLand . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200177
VInvestment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .450398
VIIGoodwill and going concern value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .400354
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 3,250$ 2900
* All numbers rounded for convenience.
IRB 2000-4 1/28/00 10:26 AM Page 354

(vii) As illustrated by this example, reapplying
§1.338–6T(c)(3) results in a basis increase for
some assets and a basis decrease for other assets.
The amount of redetermined AGUB allocated to
each acquisition date asset is determined as fol-
lows:
2000–4 I.R.B.355January 24, 2000
AssetOriginalRedeterminedIncrease
(c)(3) (c)(3)(decrease)
allocationallocation
Portfolio of actively traded securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 268$ 266$ (2)
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .536531(5)
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .268266(2)
Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .714708(6)
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .178177(1)
Investment in T1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .402398(4)
Goodwill and going concern value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .134354220
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 2,500$ 2,700$ 200
Example 4. (i) On January 1, 2001, P purchases
all of the outstanding T stock and makes a section
338 election for T. P pays $700 of cash and
promises also to pay a maximum $300 of contingent
consideration at various times in the future. Assume
that, under general principles of tax law, such later
payments are properly taken into account by P when
paid. Assume also, however, that the current fair
market value of the contingent payments is reason-
ably ascertainable. The fair market value of T’s as-
sets (other than goodwill and going concern value)
as of the beginning of the following day is as fol-
lows:
AssetAssetsFair
Classmarket
value
VEquipment . . . . . . . . . . . . . $ 200
VNon-actively traded
securities . . . . . . . . . . . . . . 100
VBuilding. . . . . . . . . . . . . . . 500
Total . . . . . . . . . . . . . . . 800
(ii) T has no liabilities. The AGUB is $700. In
calculating ADSP, assume that, under §1.1001–1,
the current amount realized attributable to the con-
tingent consideration is $200. ADSP is therefore
$900 ($700 cash plus $200).
(iii) (A) The AGUB of $700 is ratably allocated
among T’s Class V acquisition date assets in propor-
tion to their fair market values as follows:
AssetBasis
Equipment ($700 ( 200/800) . . . . . . .$175.00
Non-actively traded securities
($700 ( 100/800) . . . . . . . . . . . . . . . . .87.50
Building ($700 ( 500/800) . . . . . . . . .437.50
Total . . . . . . . . . . . . . . . . . . . . . . . .$700.00
(B) No amount is allocated to goodwill or going
concern value.
(iv) (A) The ADSP of $900 is ratably allocated
among T’s Class V acquisition date assets in propor-
tion to their fair market values as follows:
AssetBasis
Equipment . . . . . . . . . . . . . . . . . . . . .$200
Non-actively traded securities . . . . . .100
Building . . . . . . . . . . . . . . . . . . . . . . .500
Total . . . . . . . . . . . . . . . . . . . . . . . . . .$800
(B) The remaining ADSP, $100, is allocated to
goodwill and going concern value (Class VII).
(v) P and T file a consolidated return for 2001
and each following year with P as the common par-
ent of the affiliated group.
(vi) In 2004, a contingent amount of $120 is paid
by P. Assume that, under general principles of tax
law, the payment is properly taken into account by P
at the time made. In 2004, there is an increase in T’s
AGUB of $120. The amount of the increase allo-
cated to each acquisition date asset is determined as
follows:
AssetOriginalRedeterminedIncrease
AGUBAGUB
Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 175.00$ 200.00$ 25.00
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87.50100.0012.50
Building . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .437.50500.0062.50
Goodwill and going concern value . . . . . . . . . . . . . . . . . . . . . . . . . . .0.0020.0020.00
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 700.00$ 820.00$ 120.00
Par. 8. Section 1.338–10T is added to
read as follows:
§1.338–10T Filing of returns (tempo-
rary).
(a)Returns including tax liability from
deemed asset sale—(1) In general.Ex-
cept as provided in paragraphs (a)(2) and
(3) of this section, any deemed sale gain
is reported on the final return of old target
filed for old target’s taxable year that ends
at the close of the acquisition date. If old
target is the common parent of an affili-
ated group, the final return may be a con-
solidated return (any such consolidated
return must also include any deemed sale
gain of any members of the consolidated
group that are acquired by the purchasing
corporation on the same acquisition date
as old target).
(2) Old target’s final taxable year oth-
erwise included in consolidated return of
selling group—(i) General rule. If the
selling group files a consolidated return
for the period that includes the acquisition
date, old target is disaffiliated from that
group immediately before the deemed
asset sale and must file a deemed sale re-
turn separate from the group that includes
only the deemed sale gain and the carry-
over items specified in paragraph
(a)(2)(iii) of this section. The deemed
asset sale occurs at the close of the acqui-
sition date and is the last transaction of
old target. Any transactions of old target
occurring on the acquisition date other
than the deemed asset sale are included in
the selling group’s consolidated return. A
deemed sale return includes a combined
deemed sale return as defined in para-
graph (a)(4) of this section.
(ii) Separate taxable year. The deemed
asset sale included in the deemed sale re-
turn under this paragraph (a)(2) occurs in
a separate taxable year, except that old
target’s taxable year of the sale and the
consolidated year of the selling group that
includes the acquisition date are treated as
the same year for purposes of determining
the number of years in a carryover or car-
ryback period.
(iii) Carryover and carryback of tax at-
tributes. Target’s attributes may be car-
ried over to, and carried back from, the
deemed sale return under the rules applic-
able to a corporation that ceases to be a
member of a consolidated group.
(iv) Old target is a component member
of purchasing corporation’s controlled
group. For purposes of its deemed sale
return, target is a component member of
the controlled group of corporations in-
cluding the purchasing corporation unless
target is treated as an excluded member
IRB 2000-4 1/28/00 10:26 AM Page 355

under section 1563(b)(2).
(3) Old target is an S corporation. If
target is an S corporation for the period
that ends on the day before the acquisition
date, old target must file a deemed sale re-
turn as a C corporation. For this purpose,
the principles of paragraph (a)(2) of this
section apply. This paragraph (a)(3) does
not apply if an election under section
338(h)(10) is made for the S corporation.
(4) Combined deemed sale return—(i)
General rule. Under section 338(h)(15),
a combined deemed sale return (com-
bined return) may be filed for all targets
from a single selling consolidated group
(as defined in §1.338(h)(10)–1T(b)(3))
that are acquired by the purchasing corpo-
ration on the same acquisition date and
that otherwise would be required to file
separate deemed sale returns. The com-
bined return must include all such targets.
For example, T and T1 may be included
in a combined return if—
(A) T and T1 are directly owned sub-
sidiaries of S;
(B) S is the common parent of a consol-
idated group; and
(C) P makes qualified stock purchases
of T and T1 on the same acquisition date.
(ii) Gain and loss offsets. Gains and
losses recognized on the deemed asset
sales by targets included in a combined
return are treated as the gains and losses
of a single target. In addition, loss carry-
overs of a target that were not subject to
the separate return limitation year restric-
tions (SRLY restrictions) of the consoli-
dated return regulations while that target
was a member of the selling consolidated
group may be applied without limitation
to the gains of other targets included in
the combined return. If, however, a target
has loss carryovers that were subject to
the SRLY restrictions while that target
was a member of the selling consolidated
group, the use of those losses in the com-
bined return continues to be subject to
those restrictions, applied in the same
manner as if the combined return were a
consolidated return. A similar rule ap-
plies, when appropriate, to other tax at-
tributes.
(iii) Procedure for filing a combined re-
turn. A combined return is made by filing
a single corporation income tax return in
lieu of separate deemed sale returns for all
targets required to be included in the com-
bined return. The combined return re-
flects the deemed asset sales of all targets
required to be included in the combined
return. If the targets included in the com-
bined return constitute a single affiliated
group within the meaning of section
1504(a), the income tax return is signed
by an officer of the common parent of that
group. Otherwise, the return must be
signed by an officer of each target in-
cluded in the combined return. Rules
similar to the rules in §1.1502–75(j) apply
for purposes of preparing the combined
return. The combined return must include
an attachment prominently identified as
an “ELECTION TO FILE A COMBINED
RETURN UNDER SECTION
338(h)(15).” The attachment must—
(A) Contain the name, address, and em-
ployer identification number of each tar-
get required to be included in the com-
bined return;
(B) Contain the following declaration
(or a substantially similar declaration):
EACH TARGET IDENTIFIED IN THIS
ELECTION TO FILE A COMBINED
RETURN CONSENTS TO THE FILING
OF A COMBINED RETURN;
(C) For each target, be signed by a per-
son who states under penalties of perjury
that he or she is authorized to act on be-
half of such target.
(iv)Consequences of filing a combined
return. Each target included in a com-
bined return is severally liable for any tax
associated with the combined return. See
§1.338–1T(b)(3).
(5)Deemed sale excluded from pur-
chasing corporation’s consolidated re-
turn. Old target may not be considered a
member of any affiliated group that in-
cludes the purchasing corporation with re-
spect to its deemed asset sale.
(6) Due date for old target’s final re-
turn—(i) General rule.Old target’s final
return is generally due on the 15th day of
the third calendar month following the
month in which the acquisition date oc-
curs. See section 6072 (time for filing in-
come tax returns).
(ii) Application of §1.1502–76(c)—(A)
In general. Section 1.1502–76(c) applies
to old target’s final return if old target was
a member of a selling group that did not
file consolidated returns for the taxable
year of the common parent that precedes
the year that includes old target’s acquisi-
tion date. If the selling group has not
filed a consolidated return that includes
old target’s taxable period that ends on the
acquisition date, target may, on or before
the final return due date (including exten-
sions), either—
(1) File a deemed sale return on the as-
sumption that the selling group will file
the consolidated return; or
(2) File a return for so much of old tar-
get’s taxable period as ends at the close of
the acquisition date on the assumption
that the consolidated return will not be
filed.
(B)Deemed extension. For purposes of
applying §1.1502–76(c)(2), an extension
of time to file old target’s final return is
considered to be in effect until the last
date for making the election under section
338.
(C) Erroneous filing of deemed sale re-
turn. If, under this paragraph (a)(6)(ii),
target files a deemed sale return but the
selling group does not file a consolidated
return, target must file a substituted return
for old target not later than the due date
(including extensions) for the return of
the common parent with which old target
would have been included in the consoli-
dated return. The substituted return is for
so much of old target’s taxable year as
ends at the close of the acquisition date.
Under §1.1502–76(c)(2), the deemed sale
return is not considered a return for pur-
poses of section 6011 (relating to the gen-
eral requirement of filing a return) if a
substituted return must be filed.
(D) Erroneous filing of return for regu-
lar tax year. If, under this paragraph
(a)(6)(ii), target files a return for so much
of old target’s regular taxable year as ends
at the close of the acquisition date but the
selling group files a consolidated return,
target must file an amended return for old
target not later than the due date (includ-
ing extensions) for the selling group’s
consolidated return. (The amended return
is a deemed sale return.)
(E) Last date for payment of tax.If ei-
ther a substituted or amended final return
of old target is filed under this paragraph
(a)(6)(ii), the last date prescribed for pay-
ment of tax is the final return due date (as
defined in paragraph (a)(6)(i) of this sec-
tion).
(7) Examples.The following examples
illustrate this paragraph (a):
Example 1. (i) S is the common parent of a con-
solidated group that includes T. The S group files
calendar year consolidated returns. At the close of
June 30 of Year 1, P makes a qualified stock pur-
chase of T from S. P makes a section 338 election
for T, and T’s deemed asset sale occurs as of the
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close of T’s acquisition date (June 30).
(ii) T is considered disaffiliated for purposes of
reporting the deemed sale gain. Accordingly, T is
included in the S group’s consolidated return
through T’s acquisition date except that the tax lia-
bility for the deemed sale gain is reported in a sepa-
rate deemed sale return of T. Provided that T is not
treated as an excluded member under section
1563(b)(2), T is a component member of P’s con-
trolled group for the taxable year of the deemed
asset sale, and the taxable income bracket amounts
available in calculating tax on the deemed sale re-
turn must be limited accordingly.
(iii) If P purchased the stock of T at 10 a.m. on
June 30 of Year 1, the results would be the same.
See paragraph (a)(2)(i) of this section.
Example 2.The facts are the same as in Example
1, except that the S group does not file consolidated
returns. T must file a separate return for its taxable
year ending on June 30 of Year 1, which return in-
cludes the deemed asset sale.
(b)Waiver—(1) Certain additions to
tax.An addition to tax or additional
amount (addition) under subchapter A of
chapter 68 of the Internal Revenue Code
arising on or before the last day for mak-
ing the election under section 338 because
of circumstances that would not exist but
for an election under section 338, is
waived if—
(i) Under the particular statute the addi-
tion is excusable upon a showing of rea-
sonable cause; and
(ii) Corrective action is taken on or be-
fore the last day.
(2) Notification. The Internal Revenue
Service should be notified at the time of
correction (e.g., by attaching a statement
to a return that constitutes corrective ac-
tion) that the waiver rule of this paragraph
(b) is being asserted.
(3) Elections or other actions required
to be specified on a timely filed return—
(i)In general. If paragraph (b)(1) of this
section applies or would apply if there
were an underpayment, any election or
other action that must be specified on a
timely filed return for the taxable period
covered by the late filed return described
in paragraph (b)(1) of this section is con-
sidered timely if specified on a late-filed
return filed on or before the last day for
making the election under section 338.
(ii) New target in purchasing corpora-
tion’s consolidated return. If new target
is includible for its first taxable year in a
consolidated return filed by the affiliated
group of which the purchasing corpora-
tion is a member on or before the last day
for making the election under section 338,
any election or other action that must be
specified in a timely filed return for new
target’s first taxable year (but which is not
specified in the consolidated return) is
considered timely if specified in an
amended return filed on or before such
last day, at the place where the consoli-
dated return was filed.
(4) Examples. The following examples
illustrate this paragraph (b):
Example 1. T is an unaffiliated corporation with
a tax year ending March 31. At the close of Septem-
ber 20 of Year 1, P makes a qualified stock purchase
of T. P does not join in filing a consolidated return.
P makes a section 338 election for T on or before
June 15 of Year 2, which causes T’s taxable year to
end as of the close of September 20 of Year 1. An
income tax return for T’s taxable period ending on
September 20 of Year 1 was due on December 15 of
Year 1. Additions to tax for failure to file a return
and to pay tax shown on a return will not be imposed
if T’s return is filed and the tax paid on or before
June 15 of Year 2. (This waiver applies even if the
acquisition date coincides with the last day of T’s
former taxable year, i.e., March 31 of Year 2.) Inter-
est on any underpayment of tax for old T’s short tax-
able year ending September 20 of Year 1 runs from
December 15 of Year 1. A statement indicating that
the waiver rule of this paragraph is being asserted
should be attached to T’s return.
Example 2.Assume the same facts as in Example
1. Assume further that new T adopts the calendar
year by filing, on or before June 15 of Year 2, its first
return (for the period beginning on September 21 of
Year 1 and ending on December 31 of Year 1) indicat-
ing that a calendar year is chosen. See §1.338-
1T(b)(1). Any additions to tax or amounts described
in this paragraph (b) that arise because of the late fil-
ing of a return for the period ending on December 31
of Year 1 are waived, because they are based on cir-
cumstances that would not exist but for the section
338 election. Notwithstanding this waiver, however,
the return is still considered due March 15 of Year 2,
and interest on any underpayment runs from that date.
Example 3. Assume the same facts as in Example
2, except that T’s former taxable year ends on Octo-
ber 31. Although prior to the election old T had a re-
turn due on January 15 of Year 2 for its year ending
October 31 of Year 1, that return need not be filed
because a timely election under section 338 was
made. Instead, old T must file a final return for the
period ending on September 20 of Year 1, which is
due on December 15 of Year 1.
§§1.338(b)–1, 1.338(b)–2T,
1.338(b)–3T, and 1.338(h)(10)–1
[Removed]
Par. 9. Sections 1.338(b)–1,
1.338(b)–2T, and 1.338(b)–3T, and
1.338(h)(10)–1 are removed.
Par. 10. Section 1.338(h)(10)–1T is
added to read as follows:
§1.338(h)(10)–1T Deemed asset sale and
liquidation(temporary).
(a) Scope. This section prescribes rules
for qualification for a section 338(h)(10)
election and for making a section
338(h)(10) election. This section also pre-
scribes the consequences of such election.
The rules of this section are in addition to
the rules of §§1.338–0T through
1.338–7T, 1.338–8, 1.338–9, 1.338–10T,
and 1.338(i)–1T and, in appropriate cases,
apply instead of the rules of §§1.338–0T
through 1.338–7T, 1.338–8, 1.338–9,
1.338–10T, and 1.338(i)–1T.
(b) Definitions—(1) Consolidated tar-
get. Aconsolidated targetis a target that
is a member of a consolidated group
within the meaning of §1.1502–1(h) on
the acquisition date and is not the com-
mon parent of the group on that date.
(2) Selling consolidated group.Asell-
ing consolidated groupis the consoli-
dated group of which the consolidated tar-
get is a member on the acquisition date.
(3) Selling affiliate; affiliated target. A
selling affiliateis a domestic corporation
that owns on the acquisition date an
amount of stock in a domestic target,
which amount of stock is described in
section 1504(a)(2), and does not join in
filing a consolidated return with the tar-
get. In such case, the target is an affili-
ated target.
(4) S corporation target. An S corpo-
ration targetis a target that is an S corpo-
ration immediately before the acquisition
date.
(5) S corporation shareholders. S cor-
poration shareholdersare the S corpora-
tion target’s shareholders. Unless other-
wise indicated, a reference to S
corporation shareholders refers both to S
corporation shareholders who do and
those who do not sell their target stock.
(6) Liquidation. Any reference in this
section to a liquidationis treated as a ref-
erence to the transfer described in para-
graph (d)(4) of this section notwithstand-
ing its ultimate characterization for
Federal income tax purposes.
(c) Section 338(h)(10) election—(1) In
general
. A section 338(h)(10) election
may be made for T if P acquires stock
meeting the requirements of section
1504(a)(2) from a selling consolidated
group, a selling affiliate, or the S corpora-
tion shareholders in a qualified stock pur-
chase.
(2) Simultaneous joint election require-
ment. A section 338(h)(10) election is
made jointly by P and the selling consoli-
dated group (or the selling affiliate or the
S corporation shareholders) on Form
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8023 in accordance with the instructions
to the form. S corporation shareholders
who do not sell their stock must also con-
sent to the election. The section
338(h)(10) election must be made not
later than the 15th day of the 9th month
beginning after the month in which the
acquisition date occurs.
(3) Irrevocability. A section 338(h)(10)
election is irrevocable. If a section
338(h)(10) election is made for T, a sec-
tion 338 election is deemed made for T.
(4) Effect of invalid election. If a sec-
tion 338(h)(10) election for T is not valid,
the section 338 election for T is also not
valid.
(d) Certain consequences of section
338(h)(10) election. For purposes of sub-
title A of the Internal Revenue Code (ex-
cept as provided in §1.338–1T(b)(2)), the
consequences to the parties of making a
section 338(h)(10) election for T are as
follows:
(1) P. P is automatically deemed to
have made a gain recognition election for
its nonrecently purchased T stock, if any.
The effect of a gain recognition election
includes a taxable deemed sale by P on
the acquisition date of any nonrecently
purchased target stock. See
§1.338–5T(d).
(2) New T. The AGUB for new T’s as-
sets is determined under §1.338–5T and is
allocated among the acquisition date as-
sets under §§1.338–6T and 1.338–7T.
Notwithstanding paragraph (d)(4) of this
section (deemed liquidation of old T),
new T remains liable for the tax liabilities
of old T (including the tax liability for the
deemed sale gain). For example, new T
remains liable for the tax liabilities of the
members of any consolidated group that
are attributable to taxable years in which
those corporations and old T joined in the
same consolidated return. See
§1.1502–6(a).
(3) Old T—deemed sale—(i) In gen-
eral.Old T is treated as transferring all of
its assets to an unrelated person in ex-
change for consideration that includes the
assumption of or taking subject to liabili-
ties in a single transaction at the close of
the acquisition date (but before the
deemed liquidation). See §1.338–1T(a)
regarding the tax characterization of the
deemed asset sale. ADSP for old T is de-
termined under §1.338–4T and allocated
among the acquisition date assets under
§§1.338–6T and 1.338–7T. Old T real-
izes the deemed sale gain from the
deemed asset sale before the close of the
acquisition date while old T is a member
of the selling consolidated group (or
owned by the selling affiliate or owned by
the S corporation shareholders). If T is an
affiliated target, or an S corporation tar-
get, the principles of §§1.338–2T(c)(10)
and 1.338–10T(a)(1), (5), and (6)(i) apply
to the return on which the deemed sale
gain is reported. When T is an S corpora-
tion target, T’s S election continues in ef-
fect through the close of the acquisition
date (including the time of the deemed
asset sale and the deemed liquidation)
notwithstanding section 1362(d)(2)(B).
Also, when T is an S corporation target,
any direct and indirect subsidiaries of T
which T has elected to treat as qualified
subchapter S subsidiaries under section
1361(b)(3) remain qualified subchapter S
subsidiaries through the close of the ac-
quisition date. No similar rule applies
when a qualified subchapter S subsidiary,
as opposed to the S corporation that is its
owner, is the target the stock of which is
actually purchased.
(ii) Tiered targets. In the case of par-
ent-subsidiary chains of corporations
making elections under section
338(h)(10), the deemed asset sale of a
parent corporation is considered to pre-
cede that of its subsidiary. See
§1.338–3T(4)(i).
(4) Old T and selling consolidated
group, selling affiliate, or S corporation
shareholders—deemed liquidation; tax
characterization—(i) In general. Old T is
treated as if, before the close of the acqui-
sition date, after the deemed asset sale in
paragraph (d)(3) of this section, and while
old T is a member of the selling consoli-
dated group (or owned by the selling affil-
iate or owned by the S corporation share-
holders), it transferred all of its assets to
members of the selling consolidated
group, the selling affiliate, or S corpora-
tion shareholders and ceased to exist. The
transfer from old T is characterized for
Federal income tax purposes in the same
manner as if the parties had actually en-
gaged in the transactions deemed to occur
because of this section and taking into ac-
count other transactions that actually oc-
curred or are deemed to occur. For exam-
ple, the transfer may be treated as a
distribution in pursuance of a plan of reor-
ganization, a distribution in complete can-
cellation or redemption of all its stock,
one of a series of distributions in com-
plete cancellation or redemption of all its
stock in accordance with a plan of liqui-
dation, or part of a circular flow of cash.
In most cases, the transfer will be treated
as a distribution in complete liquidation to
which section 336 or 337 applies.
(ii) Tiered targets. In the case of par-
ent-subsidiary chains of corporations
making elections under section
338(h)(10), the deemed liquidation of a
subsidiary corporation is considered to
precede the deemed liquidation of its par-
ent.
(5) Selling consolidated group, selling
affiliate, or S corporation shareholders—
(i)In general. If T is an S corporation tar-
get, S corporation shareholders (whether
or not they sell their stock) take their pro
rata share of the deemed sale gain into ac-
count under section 1366 and increase or
decrease their basis in T stock under sec-
tion 1367. Members of the selling con-
solidated group, the selling affiliate, or S
corporation shareholders are treated as if,
after the deemed asset sale in paragraph
(d)(3) of this section and before the close
of the acquisition date, they received the
assets transferred by old T in the transac-
tion described in paragraph (d)(4)(i) of
this section. In most cases, the transfer
will be treated as a distribution in com-
plete liquidation to which section 331 or
332 applies.
(ii) Basis and holding period of T stock
not acquired. A member of the selling
consolidated group (or the selling affiliate
or an S corporation shareholder) retaining
T stock is treated as acquiring the stock so
retained on the day after the acquisition
date for its fair market value. The holding
period for the retained stock starts on the
day after the acquisition date. For pur-
poses of this paragraph, the fair market
value of all of the T stock equals the
grossed-up amount realized on the sale to
P of P’s recently purchased target stock.
See §1.338–4T(c).
(iii) T stock sale. Members of the sell-
ing consolidated group (or the selling af-
filiate or S corporation shareholders) rec-
ognize no gain or loss on the sale or
exchange of T stock included in the quali-
fied stock purchase (although they may
recognize gain or loss on the T stock in
the deemed liquidation).
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(6) Nonselling minority shareholders
other than nonselling S corporation
shareholders—(i) In general. This para-
graph (d)(6) describes the treatment of
shareholders of old T other than the fol-
lowing: members of the selling consoli-
dated group, the selling affiliate, S corpo-
ration shareholders (whether or not they
sell their stock), and P. For a description
of the treatment of S corporation share-
holders, see paragraph (d)(5) of this sec-
tion. A shareholder to which this para-
graph (d)(6) applies is called a minority
shareholder.
(ii) T stock sale. A minority share-
holder recognizes gain or loss on the
shareholder’s sale or exchange of T stock
included in the qualified stock purchase.
(iii) T stock not acquired. A minority
shareholder does not recognize gain or
loss under this section with respect to
shares of T stock retained by the share-
holder. The shareholder’s basis and hold-
ing period for that T stock is not affected
by the section 338(h)(10) election.
(7) Consolidated return of selling con-
solidated group.If P acquires T in a qual-
ified stock purchase from a selling con-
solidated group—
(i) The selling consolidated group must
file a consolidated return for the taxable
period that includes the acquisition date;
(ii) A consolidated return for the selling
consolidated group for that period may
not be withdrawn on or after the day that a
section 338(h)(10) election is made for T;
and
(iii) Permission to discontinue filing
consolidated returns cannot be granted
for, and cannot apply to, that period or
any of the immediately preceding taxable
periods during which consolidated returns
continuously have been filed.
(8) Availability of the section 453 in-
stallment method. Solely for purposes of
applying sections 453, 453A, and 453B,
and the regulations thereunder (the in-
stallment method) to determine the conse-
quences to old T in the deemed asset sale
and to old T (and its shareholders, if rele-
vant) in the deemed liquidation, the rules
in paragraphs (d)(1) through (7) of this
section are modified as follows:
(i) In deemed asset sale. Old T is
treated as receiving in the deemed asset
sale new T installment obligations, the
terms of which are identical (except as to
the obligor) to P installment obligations
issued in exchange for recently purchased
stock of T. Old T is treated as receiving in
cash all other consideration in the deemed
asset sale other than the assumption of, or
taking subject to, old T liabilities. For ex-
ample, old T is treated as receiving in
cash any amounts attributable to the
grossing-up of amount realized under
§1.338–4T(c). The amount realized for
recently purchased stock taken into ac-
count in determining ADSP is adjusted
(and, thus, ADSP is redetermined) to re-
flect the amounts paid under an install-
ment obligation for the stock when the
total payments under the installment
obligation are greater or less than the
amount realized.
(ii)In deemed liquidation. Old T is
treated as distributing in the deemed liqui-
dation the new T installment obligations
that it is treated as receiving in the
deemed asset sale. The members of the
selling consolidated group, the selling af-
filiate, or the S corporation shareholders
are treated as receiving in the deemed liq-
uidation the new T installment obligations
that correspond to the P installment oblig-
ations they actually received individually
in exchange for their recently purchased
stock. The new T installment obligations
may be recharacterized under other rules.
See for example §1.453–11(a)(2) which,
in certain circumstances, treats the new T
installment obligations deemed distrib-
uted by old T as if they were issued by
new T in exchange for the members’ of
the selling consolidated group, the selling
affiliate’s, or the S corporation sharehold-
ers’ stock in old T. The members of the
selling consolidated group, the selling af-
filiate, or the S corporation shareholders
are treated as receiving all other consider-
ation in the deemed liquidation in cash.
(9) Treatment consistent with an actual
asset sale. Old T may not assert any pro-
vision in section 338(h)(10) or this sec-
tion to obtain a tax result that would not
be obtained if the parties had actually en-
gaged in the transactions deemed to occur
because of this section and taking into ac-
count other transactions that actually oc-
curred or are deemed to occur.
(e) Examples. The following examples
illustrate this section:
Example 1. (i) S1 owns all of the T stock and T
owns all of the stock of T1 and T2. S1 is the com-
mon parent of a consolidated group that includes T,
T1, and T2. P makes a qualified stock purchase of
all of the T stock from S1. S1 joins with P in making
a section 338(h)(10) election for T and for the
deemed purchase of T1. A section 338 election is
not made for T2.
(ii) S1 does not recognize gain or loss on the sale
of the T stock and T does not recognize gain or loss
on the sale of the T1 stock because section
338(h)(10) elections are made for T and T1. Thus,
for example, gain or loss realized on the sale of the T
or T1 stock is not taken into account in earnings and
profits. However, because a section 338 election is
not made for T2, T must recognize any gain or loss
realized on the deemed sale of the T2 stock. See
§1.338–4T(h).
(iii) The results would be the same if S1, T, T1,
and T2 are not members of any consolidated group,
because S1 and T are selling affiliates.
Example 2.(i) S and T are solvent corporations.
S owns all of the outstanding stock of T. S and P
agree to undertake the following transaction: T will
distribute half its assets to S, and S will assume half
of T’s liabilities. Then, P will purchase the stock of T
from S. S and P will jointly make a section
338(h)(10) election with respect to the sale of T. The
corporations then complete the transaction as agreed.
(ii) Under section 338(a), the assets present in T
at the close of the acquisition date are deemed sold
by old T to new T. Under paragraph (d)(4) of this
section, the transactions described in paragraph (d)
of this section are treated in the same manner as if
they had actually occurred. Because S and P had
agreed that, after T’s actual distribution to S of part
of its assets, S would sell T to P pursuant to an elec-
tion under section 338(h)(10), and because para-
graph (d)(4) of this section deems T subsequently to
have transferred all its assets to its shareholder, T is
deemed to have adopted a plan of complete liquida-
tion under section 332. T’s actual transfer of assets
to S is treated as a distribution pursuant to that plan
of complete liquidation.
Example 3. (i) S1 owns all of the outstanding
stock of both T and S2. All three are corporations.
S1 and P agree to undertake the following transac-
tion. T will transfer substantially all of its assets and
liabilities to S2, with S2 issuing no stock in ex-
change therefor, and retaining its other assets and li-
abilities. Then, P will purchase the stock of T from
S1. S1 and P will jointly make a section 338(h)(10)
election with respect to the sale of T. The corpora-
tions then complete the transaction as agreed.
(ii) Under section 338(a), the assets present in T
at the close of the acquisition date are deemed sold
by old T to new T. Under paragraph (d)(4) of this
section, the transactions described in this section are
treated in the same manner as if they had actually
occurred. Because old T transferred substantially all
of its assets to S2, and is deemed to have distributed
all its remaining assets and gone out of existence,
the transfer of assets to S2, taking into account the
related transfers, deemed and actual, qualifies as a
reorganization under section 368(a)(1)(D). Section
361(c)(1) and not section 332 applies to T’s deemed
liquidation.
Example 4. (i) T owns two assets: an actively
traded security (Class II) with a fair market value of
$100 and an adjusted basis of $100, and inventory
(Class IV) with a fair market value of $100 and an
adjusted basis of $100. T has no liabilities. S is ne-
gotiating to sell all the stock in T to P for $100 cash
and contingent consideration. Assume that under
generally applicable tax accounting rules, P’s ad-
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justed basis in the T stock immediately after the pur-
chase would be $100, because the contingent con-
sideration is not taken into account. Thus, under the
rules of §1.338–5T, AGUB would be $100. Under
the allocation rules of §1.338–6T, the entire $100
would be allocated to the Class II asset, the actively
traded security, and no amount would be allocated to
the inventory. P, however, plans immediately to
cause T to sell the inventory, but not the actively
traded security, so it requests that, prior to the stock
sale, S cause T to create a new subsidiary, Newco,
and contribute the actively traded security to the
capital of Newco. Because the stock in Newco,
which would not be actively traded, is a Class V
asset, under the rules of §1.338–6T $100 of AGUB
would be allocated to the inventory and no amount
of AGUB would be allocated to the Newco stock.
Newco’s own AGUB, $0 under the rules of
§1.338–5T, would be allocated to the actively traded
security. When P subsequently causes T to sell the
inventory, T would realize no gain or loss instead of
realizing gain of $100.
(ii) Assume that, if the T stock had not itself been
sold but T had instead sold both its inventory and the
Newco stock to P, T would for tax purposes be
deemed instead to have sold both its inventory and
actively traded security directly to P, with P deemed
then to have created Newco and contributed the ac-
tively traded security to the capital of Newco. Sec-
tion 338, if elected, generally recharacterizes a stock
sale as a deemed sale of assets. The tax results of
the deemed sale of assets should, where possible, be
like those of an actual asset sale. Hence, the deemed
sale of assets under section 338(h)(10) should be
treated as one of the inventory and actively traded
security themselves, not of the inventory and Newco
stock. That is the substance of the transaction. The
anti-abuse rule of §1.338–1T(c) does not apply, be-
cause the substance of the deemed sale of assets is a
sale of the inventory and the actively traded security
themselves, not of the inventory and the Newco
stock. Otherwise, the anti-abuse rule might apply.
Example 5. (i) T, a member of a selling consoli-
dated group, has only one class of stock, all of which
is owned by S1. On March 1 of Year 2, S1 sells its T
stock to P for $80,000, and joins with P in making a
section 338(h)(10) election for T. There are no sell-
ing costs or acquisition costs. On March 1 of Year 2,
T owns land with a $50,000 basis and $75,000 fair
market value and equipment with a $30,000 adjusted
basis, $70,000 recomputed basis, and $60,000 fair
market value. T also has a $40,000 liability. S1
pays old T’s allocable share of the selling group’s
consolidated tax liability for Year 2 including the tax
liability for the deemed sale gain (a total of
$13,600).
(ii) ADSP of $120,000 ($80,000 + $40,000 + 0)
January 24, 20003602000–4 I.R.B.
is allocated to each asset as follows:
AssetsBasisFMVFractionAllocable
ADSP
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 50,000$ 75,0005/9$ 66,667
Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30,00060,0004/953,333
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 80,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 135,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$ 120,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
(iii) Under paragraph (d)(3) of this section, old T
has gain on the deemed sale of $40,000 (consisting
of $16,667 of capital gain and $23,333 of ordinary
income).
(iv) Under paragraph (d)(5)(iii) of this section,
S1 recognizes no gain or loss upon its sale of the old
T stock to P. S1 also recognizes no gain or loss upon
the deemed liquidation of T. See paragraph (d)(4) of
this section and section 332.
(v) P’s basis in new T stock is P’s cost for the
stock, $80,000. See section 1012.
(vi) Under §1.338–5T, the AGUB for new T is
$120,000, i.e., P’s cost for the old T stock ($80,000)
plus T’s liability ($40,000). This AGUB is allocated
as basis among the new T assets under §§1.338–6T
and 1.338–7T.
Example 6. (i) The facts are the same as in Ex-
ample 5, except that S1 sells 80 percent of the old T
stock to P for $64,000, rather than 100 percent of the
old T stock for $80,000.
(ii) The consequences to P, T, and S1 are the same
as in Example 5, except that:
(A) P’s basis for its 80-percent interest in the new
T stock is P’s $64,000 cost for the stock. See section
1012.
(B) Under §1.338–5T, the AGUB for new T is
$120,000 (i.e., $64,000/.8 + $40,000 + $0).
(C) Under paragraph (d)(4) of this section, S1
recognizes no gain or loss with respect to the re-
tained stock in T. See section 332.
(D) Under paragraph (d)(5)(ii) of this section, the
basis of the T stock retained by S1 is $16,000 (i.e.,
$120,000 å $40,000 (the ADSP amount for the old T
assets over the sum of new T’s liabilities immedi-
ately after the acquisition date) ( .20 (the proportion
of T stock retained by S1)).
Example 7. (i) The facts are the same as in Ex-
ample 6, except that K, a shareholder unrelated to T
or P, owns the 20 percent of the T stock that is not
acquired by P in the qualified stock purchase. K’s
basis in its T stock is $5,000.
(ii) The consequences to P, T, and S1 are the same
as in Example 6.
(iii) Under paragraph (d)(6)(iii) of this section, K
recognizes no gain or loss, and K’s basis in its T
stock remains at $5,000.
Example 8. (i) The facts are the same as in Ex-
ample 5, except that the equipment is held by T1, a
wholly–owned subsidiary of T, and a section
338(h)(10) election is also made for T1. The T1
stock has a fair market value of $60,000. T1 has no
assets other than the equipment and no liabilities.
S1 pays old T’s and old T1’s allocable shares of the
selling group’s consolidated tax liability for Year 2
including the tax liability for T and T1’s deemed sale
gain.
(ii) ADSP for T is $120,000, allocated $66,667 to
the land and $53,333 to the stock. Old T’s deemed
sale gain is $16,667 (the capital gain on its deemed
sale of the land). Under paragraph (d)(5)(iii) of this
section, old T does not recognize gain or loss on its
deemed sale of the T1 stock. See section 332.
(iii) ADSP for T1 is $53,333 (i.e., $53,333 + $0 +
$0). On the deemed sale of the equipment, T1 rec-
ognizes ordinary income of $23,333.
(iv) Under paragraph (d)(5)(iii) of this section,
S1 does not recognize gain or loss upon its sale of
the old T stock to P.
Example 9. (i) The facts are the same as in Ex-
ample 8, except that P already owns 20 percent of
the T stock, which is nonrecently purchased stock
with a basis of $6,000, and that P purchases the re-
maining 80 percent of the T stock from S1 for
$64,000.
(ii) The results are the same as in Example 8, ex-
cept that under paragraph (d)(1) of this section and
§1.338-5T(d), P is deemed to have made a gain
recognition election for its nonrecently purchased T
stock. As a result, P recognizes gain of $10,000 and
its basis in the nonrecently purchased T stock is in-
creased from $6,000 to $16,000. P’s basis in all the
T stock is $80,000 (i.e., $64,000 + $16,000). The
computations are as follows:
(A) P’s grossed-up basis for the recently pur-
chased T stock is $64,000 (i.e., $64,000 (the basis of
the recently purchased T stock) ( (1 å .2)/(.8) (the
fraction in section 338(b)(4))).
(B) P’s basis amount for the nonrecently pur-
chased T stock is $16,000 (i.e., $64,000 (the
grossed-up basis in the recently purchased T stock) (
(.2)/(1.0 å .2) (the fraction in section 338(b)(3)(B))).
(C) The gain recognized on the nonrecently pur-
chased stock is $10,000 (i.e., $16,000 å $6,000).
Example 10. (i) T is an S corporation whose sole
class of stock is owned 40 percent each by A and B
and 20 percent by C. T, A, B, and C all use the cash
method of accounting. A and B each has an adjusted
basis of $10,000 in the stock. C has an adjusted
basis of $5,000 in the stock. A, B, and C hold no in-
stallment obligations to which section 453A applies.
On March 1 of Year 1, A sells its stock to P for
$40,000 in cash and B sells its stock to P for a
$25,000 note issued by P and real estate having a
fair market value of $15,000. The $25,000 note, due
in full in Year 7, is not publicly traded and bears ad-
equate stated interest. A and B have no selling ex-
penses. T’s sole asset is real estate, which has a
value of $110,000 and an adjusted basis of $35,000.
Also, T’s real estate is encumbered by long-out-
standing purchase-money indebtedness of $10,000.
The real estate does not have built-in gain subject to
section 1374. A, B, and C join with P in making a
section 338(h)(10) election for T.
(ii) Solely for purposes of application of sections
453, 453A, and 453B, old T is considered in its
deemed asset sale to receive back from new T the
$25,000 note (considered issued by new T) and
$75,000 of cash (total consideration of $80,000 paid
for all the stock sold, which is then divided by .80 in
the grossing-up, with the resulting figure of
$100,000 then reduced by the amount of the install-
ment note). Absent an election under section
453(d), gain is reported by old T under the install-
ment method.
(iii) In applying the installment method to old T’s
deemed asset sale, the contract price for old T’s as-
IRB 2000-4 1/28/00 10:26 AM Page 360

sets deemed sold is $100,000, the $110,000 selling
price reduced by the indebtedness of $10,000 to
which the assets are subject. (The $110,000 selling
price is itself the sum of the $80,000 grossed-up in
paragraph (ii) above to $100,000 and the $10,000 li-
ability.) Gross profit is $75,000 ($110,000 selling
price å old T’s basis of $35,000). Old T’s gross
profit ratio is 0.75 (gross profit of $75,000 â
$100,000 contract price). Thus, $56,250 (0.75 ( the
$75,000 cash old T is deemed to receive in Year 1) is
Year 1 gain attributable to the sale, and $18,750
($75,000 å $56,250) is recovery of basis.
(iv) In its liquidation, old T is deemed to distrib-
ute the $25,000 note to B, since B actually sold the
stock partly for that consideration. To the extent of
the remaining liquidating distribution to B, it is
deemed to receive, along with A and C, the balance
of old T’s liquidating assets in the form of cash.
Under section 453(h), B, unless it makes an election
under section 453(d), is not required to treat the re-
ceipt of the note as a payment for the T stock; P’s
payment of the $25,000 note in Year 7 to B is a pay-
ment for the T stock. Because section 453(h) ap-
plies to B, old T’s deemed liquidating distribution of
the note is, under section 453B(h), not treated as a
taxable disposition by old T.
(v) Under section 1366, A reports 40 percent, or
$22,500, of old T’s $56,250 gain recognized in Year
1. Under section 1367, this increases A’s $10,000
adjusted basis in the T stock to $32,500. Next, in
old T’s deemed liquidation, A is considered to re-
ceive $40,000 for its old T shares, causing it to rec-
ognize an additional $7,500 gain in Year 1.
(vi) Under section 1366, B reports 40 percent, or
$22,500, of old T’s $56,250 gain recognized in Year
1. Under section 1367, this increases B’s $10,000
adjusted basis in its T stock to $32,500. Next, in old
T’s deemed liquidation, B is considered to receive
the $25,000 note and $15,000 of other consideration.
Applying section 453, including section 453(h), to
the deemed liquidation, B’s selling price and con-
tract price are both $40,000. Gross profit is $7,500
($40,000 selling price å B’s basis of $32,500). B’s
gross profit ratio is 0.1875 (gross profit of $7,500 â
$40,000 contract price). Thus, $2,812.50 (0.1875 (
$15,000) is Year 1 gain attributable to the deemed
liquidation. In Year 7, when the $25,000 note is
paid, B has $4,687.50 (0.1875 ( $25,000) of addi-
tional gain.
(vii) Under section 1366, C reports 20 percent, or
$11,250, of old T’s $56,250 gain recognized in Year
1. Under section 1367, this increases C’s $5,000 ad-
justed basis in its T stock to $16,250. Next, in old
T’s deemed liquidation, C is considered to receive
$20,000 for its old T shares, causing it to recognize
an additional $3,750 gain in Year 1. Finally, under
paragraph (d)(5)(ii) of this section, C is considered
to acquire its stock in T on the day after the acquisi-
tion date for $20,000 (fair market value = grossed-
up amount realized of $100,000 ( 20%). C’s holding
period in the stock deemed received in new T begins
at that time.
(f) Inapplicability of provisions.The
provisions of section 6043, §1.331– 1(d),
and §1.332–6 (relating to information re-
turns and recordkeeping requirements for
corporate liquidations) do not apply to the
deemed liquidation of old T under para-
graph (d)(4) of this section.
(g) Required information. The Com-
missioner may exercise the authority
granted in section 338(h)(10)(C)(iii) to re-
quire provision of any information
deemed necessary to carry out the provi-
sions of section 338(h)(10) by requiring
submission of information on any tax re-
porting form.
§1.338(i)–1 [Removed]
Par. 11. Section 1.338(i)–1 is removed.
Par. 12. Section 1.338(i)–1T is added
to read as follows:
§1.338(i)–1T Effective dates (temporary).
The provisions of §§1.338–0T through
1.338–7T, 1.338–10Tand
1.338(h)(10)–1T apply to any qualified
stock purchase occurring after January 5,
2000. For rules applicable to qualified
stock purchases on or before January 5,
2000, see §§1.338–0 through 1.338–5,
1.338(b)–1, 1.338(b)–2T, 1.338(b)–3T,
1.338(h)(10)–1, and 1.338(i)–1 in effect
prior to January 6, 2000 (see 26 CFR part
1 revised April 1, 1999).
Par. 13. Section 1.1060–1T is revised
to read as follows:
§1.1060–1T Special allocation rules for
certain asset acquisitions(temporary).
(a) Scope—(1) In general. This section
prescribes rules relating to the require-
ments of section 1060, which, in the case
of an applicable asset acquisition, re-
quires the transferor (the seller) and the
transferee (the purchaser) each to allocate
the consideration paid or received in the
transaction among the assets transferred
in the same manner as amounts are allo-
cated under section 338(b)(5) (relating to
the allocation of adjusted grossed-up
basis among the assets of the target corpo-
ration when a section 338 election is
made). In the case of an applicable asset
acquisition described in paragraph (b)(1)
of this section, sellers and purchasers
must allocate the consideration under the
residual method as described in
§§1.338–6T and 1.338–7T in order to de-
termine, respectively, the amount realized
from, and the basis in, each of the trans-
ferred assets. For rules relating to distrib-
utions of partnership property or transfers
of partnership interests which are subject
to section 1060(d), see §1.755–2T.
(2) Effective date. The provisions of
this section apply to any asset acquisition
occurring after January 5, 2000. For rules
applicable to asset acquisitions on or be-
fore January 5, 2000, see §1.1060–1T in
effect prior to January 6, 2000 (see 26
CFR part 1 revised April 1, 1999).
(3) Outline of topics. In order to facili-
tate the use of this section, this paragraph
(a)(3) lists the major paragraphs in this
section as follows:
(a) Scope.
(1) In general.
(2) Effective date.
(3) Outline of topics.
(b) Applicable asset acquisition.
(1) In general.
(2) Assets constituting a trade or business.
(i) In general.
(ii) Goodwill or going concern value.
(iii) Factors indicating goodwill or going
concern value.
(3) Examples.
(4) Asymmetrical transfers of assets.
(5) Related transactions.
(6) More than a single trade or business.
(7) Covenant entered into by the seller.
(8) Partial non-recognition exchanges.
(c) Allocation of consideration among as-
sets under the residual method.
(1) Consideration.
(2) Allocation of consideration among as-
sets.
(3) Certain costs.
(4) Effect of agreement between parties.
(d) Examples.
(e) Reporting requirements.
(1) Applicable asset acquisitions.
(i) In general.
(ii) Time and manner of reporting.
(A) In general.
(B) Additional reporting requirement.
(2) Transfers of interests in partnerships.
(b) Applicable asset acquisition—(1)
In general.An applicable asset acquisi-
tion is any transfer, whether direct or indi-
rect, of a group of assets if the assets
transferred constitute a trade or business
in the hands of either the seller or the pur-
chaser and, except as provided in para-
graph (b)(8) of this section, the pur-
chaser’s basis in the transferred assets is
determined wholly by reference to the
purchaser’s consideration.
(2) Assets constituting a trade or busi-
ness—(i) In general. For purposes of this
section, a group of assets constitutes a
trade or business if—
(A) The use of such assets would con-
stitute an active trade or business under
section 355; or
(B) Its character is such that goodwill
2000–4 I.R.B.361January 24, 2000
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or going concern value could under any
circumstances attach to such group.
(ii) Goodwill or going concern value.
Goodwill is the value of a trade or busi-
ness attributable to the expectancy of con-
tinued customer patronage. This ex-
pectancy may be due to the name or
reputation of a trade or business or any
other factor. Going concern value is the
additional value that attaches to property
because of its existence as an integral part
of an ongoing business activity. Going
concern value includes the value attribut-
able to the ability of a trade or business
(or a part of a trade or business) to con-
tinue functioning or generating income
without interruption notwithstanding a
change in ownership. It also includes the
value that is attributable to the immediate
use or availability of an acquired trade or
business, such as, for example, the use of
the revenues or net earnings that other-
wise would not be received during any
period if the acquired trade or business
were not available or operational.
(iii)Factors indicating goodwill or
going concern value.In making the de-
termination in this paragraph (b)(2), all
the facts and circumstances surrounding
the transaction are taken into account.
Whether sufficient consideration is avail-
able to allocate to goodwill or going con-
cern value after the residual method is ap-
plied is not relevant in determining
whether goodwill or going concern value
could attach to a group of assets. Factors
to be considered include—
(A) The presence of any intangible as-
sets (whether or not those assets are sec-
tion 197 intangibles), provided, however,
that the transfer of such an asset in the ab-
sence of other assets will not be a trade or
business for purposes of section 1060;
(B) The existence of an excess of the
total consideration over the aggregate
book value of the tangible and intangi-
ble assets purchased (other than good-
will and going concern value) as shown
in the financial accounting books and
records of the purchaser; and
(C) Related transactions, including
lease agreements, licenses, or other sim-
ilar agreements between the purchaser
and seller (or managers, directors, own-
ers, or employees of the seller) in con-
nection with the transfer.
(3) Examples. The following exam-
ples illustrate paragraphs (b)(1) and (2)
of this section:
Example 1. S is a high grade machine shop that
manufactures microwave connectors in limited
quantities. It is a successful company with a reputa-
tion within the industry and among its customers for
manufacturing unique, high quality products. Its
tangible assets consist primarily of ordinary machin-
ery for working metal and plating. It has no secret
formulas or patented drawings of value. P is a com-
pany that designs, manufactures, and markets elec-
tronic components. It wants to establish an immedi-
ate presence in the microwave industry, an area in
which it previously has not been engaged. P is ac-
quiring assets of a number of smaller companies and
hopes that these assets will collectively allow it to
offer a broad product mix. P acquires the assets of S
in order to augment its product mix and to promote
its presence in the microwave industry. P will not
use the assets acquired from S to manufacture mi-
crowave connectors. The assets transferred are as-
sets that constitute a trade or business in the hands of
the seller. Thus, P’s purchase of S’s assets is an ap-
plicable asset acquisition. The fact that P will not
use the assets acquired from S to continue the busi-
ness of S does not affect this conclusion.
Example 2. S, a sole proprietor who operates a
car wash, both leases the building housing the car
wash and sells all of the car wash equipment to P. S’s
use of the building and the car wash equipment con-
stitute a trade or business. P begins operating a car
wash in the building it leases from S. Because the
assets transferred together with the asset leased are
assets which constitute a trade or business, P’s pur-
chase of S’s assets is an applicable asset acquisition.
Example 3. S, a corporation, owns a retail store
business in State X and conducts activities in con-
nection with that business enterprise that meet the
active trade or business requirement of section 355.
P is a minority shareholder of S. S distributes to P
all the assets of S used in S’s retail business in State
X in complete redemption of P’s stock in S held by
P. The distribution of S’s assets in redemption of P’s
stock is treated as a sale or exchange under sections
302(a) and 302(b)(3), and P’s basis in the assets dis-
tributed to it is determined wholly by reference to
the consideration paid, the S stock. Thus, S’s distri-
bution of assets constituting a trade or business to P
is an applicable asset acquisition.
Example 4. S is a manufacturing company with
an internal financial bookkeeping department. P is
in the business of providing a financial bookkeeping
service on a contract basis. As part of an agreement
for P to begin providing financial bookkeeping ser-
vices to S, P agrees to buy all of the assets associated
with S’s internal bookkeeping operations and pro-
vide employment to any of S’s bookkeeping depart-
ment employees who choose to accept a position
with P. In addition to selling P the assets associated
with its bookkeeping operation, S will enter into a
long term contract with P for bookkeeping services.
Because assets transferred from S to P, along with
the related contract for bookkeeping services, are a
trade or business in the hands of P, the sale of the
bookkeeping assets from S to P is an applicable asset
acquisition.
(4) Asymmetrical transfers of assets.
If, under general principles of tax law, a
seller is not treated as transferring the
same assets as the purchaser is treated as
acquiring, the assets acquired by the
purchaser constitute a trade or business,
and, except as provided in paragraph
(b)(8) of this section, the purchaser’s
basis in the transferred assets is deter-
mined wholly by reference to the pur-
chaser’s consideration, then the pur-
chaser is subject to section 1060.
(5) Related transactions.Whether the
assets transferred constitute a trade or
business is determined by aggregating
all transfers from the seller to the pur-
chaser in a series of related transactions.
Except as provided in paragraph (b)(8)
of this section, all assets transferred
from the seller to the purchaser in a se-
ries of related transactions are included
in the group of assets among which the
consideration paid or received in such
series is allocated under the residual
method. The principles of §1.338–1T(c)
are also applied in determining which
assets are included in the group of assets
among which the consideration paid or
received is allocated under the residual
method.
(6) More than a single trade or busi-
ness.If the assets transferred from a
seller to a purchaser include more than
one trade or business, then, in applying
this section, all of the assets transferred
(whether or not transferred in one trans-
action or a series of related transactions
and whether or not part of a trade or
business) are treated as a single trade or
business.
(7) Covenant entered into by the
seller. If, in connection with an applica-
ble asset acquisition, the seller enters
into a covenant (e.g., a covenant not to
compete) with the purchaser, that
covenant is treated as an asset trans-
ferred as part of a trade or business.
(8) Partial non-recognition exchanges.
A transfer may constitute an applicable
asset acquisition notwithstanding the fact
that no gain or loss is recognized with re-
spect to a portion of the group of assets
transferred. All of the assets transferred,
including the non-recognition assets, are
taken into account in determining whether
the group of assets constitutes a trade or
business. The allocation of consideration
under paragraph (c) of this section is done
without taking into account either the
non-recognition assets or the amount of
money or other property that is treated as
transferred in exchange for the non-recog
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nition assets (together, the non-recogni-
tion exchange property). The basis in and
gain or loss recognized with respect to the
non-recognition exchange property are
determined under such rules as would
otherwise apply to an exchange of such
property. The amount of the money and
other property treated as exchanged for
non-recognition assets is the amount by
which the fair market value of the non-
recognition assets transferred by one
party exceeds the fair market value of the
non-recognition assets transferred by the
other (to the extent of the money and the
fair market value of property transferred
in the exchange). The money and other
property that are treated as transferred in
exchange for the non-recognition assets
(and which are not included among the
assets to which section 1060 applies) are
considered to come from the following
assets in the following order: first from
Class I assets, then from Class II assets,
then from Class III assets, then from
Class IV assets, then from Class V assets,
then from Class VI assets, and then from
Class VII assets. For this purpose, liabili-
ties assumed (or to which a non-recogni-
tion exchange property is subject) are
treated as Class I assets. See Example 1
in paragraph (d) of this section for an ex-
ample of the application of section 1060
to a single transaction which is, in part, a
non-recognition exchange.
(c) Allocation of consideration among
assets under the residual method — (1)
Consideration.The seller’s consideration
is the amount, in the aggregate, realized
from selling the assets in the applicable
asset acquisition under section 1001(b).
The purchaser’s consideration is the
amount, in the aggregate, of its cost of
purchasing the assets in the applicable
asset acquisition that is properly taken
into account in basis.
(2) Allocation of consideration among
assets. For purposes of determining the
seller’s amount realized for each of the
assets sold in an applicable asset acquisi-
tion, the seller allocates consideration to
all the assets sold by using the residual
method under §§1.338–6T and 1.338–7T,
substituting consideration for ADSP. For
purposes of determining the purchaser’s
basis in each of the assets purchased in an
applicable asset acquisition, the purchaser
allocates consideration to all the assets
purchased by using the residual method
under §§1.338–6T and 1.338–7T, substi-
tuting consideration for AGUB. In allo-
cating consideration, the rules set forth in
paragraphs (c)(3) and (4) of this section
apply in addition to the rules in
§§1.338–6T and 1.338–7T.
(3) Certain costs.The seller and pur-
chaser each adjusts the amount allocated
to an individual asset to take into account
the specific identifiable costs incurred in
transferring that asset in connection with
the applicable asset acquisition (e.g., real
estate transfer costs or security interest
perfection costs). Costs so allocated in-
crease, or decrease, as appropriate, the
total consideration that is allocated under
the residual method. No adjustment is
made to the amount allocated to an indi-
vidual asset for general costs associated
with the applicable asset acquisition as a
whole or with groups of assets included
therein (e.g., non-specific appraisal fees
or accounting fees). These latter amounts
are taken into account only indirectly
through their effect on the total considera-
tion to be allocated.
(4) Effect of agreement between
parties. If, in connection with an applica-
ble asset acquisition, the seller and pur-
chaser agree in writing as to the allocation
of any amount of consideration to, or as to
the fair market value of, any of the assets,
such agreement is binding on them to the
extent provided in this paragraph (c)(4).
Nothing in this paragraph (c)(4) restricts
the Commissioner’s authority to chal-
lenge the allocations or values arrived at
in an allocation agreement. This para-
graph (c)(4) does not apply if the parties
are able to refute the allocation or valua-
tion under the standards set forth in Com-
missioner v. Danielson, 378 F.2d 771 (3d
Cir.), cert. denied, 389 U.S. 858 (1967) (a
party wishing to challenge the tax conse-
quences of an agreement as construed by
the Commissioner must offer proof that,
in an action between the parties to the
agreement, would be admissible to alter
that construction or show its unenforce-
ability because of mistake, undue influ-
ence, fraud, duress, etc.).
(d) Examples.The following examples
illustrate this section:
Example 1. (i) On January 1, 2001, A transfers
assets X, Y, and Z to B in exchange for assets D, E,
and F plus $1,000 cash.
(ii) Assume the exchange of assets constitutes an
exchange of like-kind property to which section
1031 applies. Assume also that goodwill or going
concern value could under any circumstances attach
to each of the DEF and XYZ groups of assets and,
therefore, each group constitutes a trade or business
under section 1060.
(iii) Assume the fair market values of the assets
and the amount of money transferred are as follows:
2000–4 I.R.B.363January 24, 2000
By ABy B
AssetFair Market ValueAssetFair Market Value
X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 400D . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40
Y . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .400E . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Z . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200F . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
Cash (amount) . . . . . . . . . . . . . . . . .1,000
Total . . . . . . . . . . . . . . . . . . . . . . . . . . .$ 1,000Total. . . . . . . . . . . . . . . . . . . . . . . $ 1,100
(iv) Under paragraph (b)(8) of this section, for
purposes of allocating consideration under para-
graph (c) of this section, the like-kind assets ex-
changed and any money or other property that are
treated as transferred in exchange for the like-kind
property are excluded from the application of sec-
tion 1060.
(v) Since assets X, Y, and Z are like-kind prop-
erty, they are excluded from the application of the
section 1060 allocation rules.
(vi) Since assets D, E, and F are like-kind prop-
erty, they are excluded from the application of the
section 1060 allocation rules. In addition, $900 of
the $1,000 cash B gave to A for A’s like-kind assets
is treated as transferred in exchange for the like-kind
property in order to equalize the fair market values
of the like-kind assets. Therefore, $900 of the cash
is excluded from the application of the section 1060
allocation rules.
(vii) $100 of the cash is allocated under section
1060 and paragraph (c) of this section.
(viii) A, as transferor of assets X, Y, and Z, re-
ceived $100 that must be allocated under section
1060 and paragraph (c) of this section. Since A
transferred no Class I, II, III, IV, V, or VI assets to
which section 1060 applies, in determining its
amount realized for the part of the exchange to
which section 1031 does not apply, the $100 is allo-
cated to Class VII assets (goodwill and going con-
cern value).
IRB 2000-4 1/28/00 10:26 AM Page 363

(ix) A, as transferee of assets D, E, and F, gave
consideration only for assets to which section 1031
applies. Therefore, the allocation rules of section
1060 and paragraph (c) of this section are not ap-
plied to determine the bases of the assets A received.
(x) B, as transferor of assets D, E, and F, received
consideration only for assets to which section 1031
applies. Therefore, the allocation rules of section
1060 do not apply in determining B’s gain or loss.
(xi) B, as transferee of assets X, Y, and Z, gave A
$100 that must be allocated under section 1060 and
paragraph (c) of this section. Since B received from
A no Class I, II, III, IV, V, or VI assets to which sec-
tion 1060 applies, the $100 consideration is allo-
cated by B to Class VII assets (goodwill and going
concern value).
Example 2.(i) On January 1, 2001, S, a sole pro-
prietor, sells to P, a corporation, a group of assets
that constitutes a trade or business under paragraph
(b)(2) of this section. S, who plans to retire immedi-
ately, also executes in P’s favor a covenant not to
compete. P pays S $3,000 in cash and assumes
$1,000 in liabilities. Thus, the total consideration is
$4,000.
(ii) On the purchase date, P and S also execute a
separate agreement that states that the fair market
values of the Class II, Class III, Class V, and Class
VI assets S sold to P are as follows:
Asset AssetFair
ClassMarket
Value
IIActively traded securities . . . . .$ 500
Total Class II . . . . . . . . . . .500
IIIAccounts receivable . . . . . . . . .200
Total Class III . . . . . . . . . . .200
VFurniture and fixtures . . . . . . . .800
Building . . . . . . . . . . . . . . . . . .800
Land . . . . . . . . . . . . . . . . . . . . .200
Equipment . . . . . . . . . . . . . . . . .400
Total Class V . . . . . . . . . . .2,200
VICovenant not to compete . . . . .900
Total Class VI . . . . . . . . . .900
(iii) P and S each allocate the consideration in the
transaction among the assets transferred under para-
graph (c) of this section in accordance with the
agreed upon fair market values of the assets, so that
$500 is allocated to Class II assets, $200 is allocated
to the Class III asset, $2,200 is allocated to Class V
assets, $900 is allocated to Class VI assets, and $200
($4,000 total consideration less $3,800 allocated to
assets in Classes II, III, V, and VI) is allocated to the
Class VII assets (goodwill and going concern value).
(iv) In connection with the examination of P’s re-
turn, the District Director, in determining the fair
market values of the assets transferred, may disre-
gard the parties’ agreement. Assume that the Dis-
trict Director correctly determines that the fair mar-
ket value of the covenant not to compete was $500.
Since the allocation of consideration among Class II,
III, V, and VI assets results in allocation up to the
fair market value limitation, the $600 of unallocated
consideration resulting from the District Director’s
redetermination of the value of the covenant not to
compete is allocated to Class VII assets (goodwill
and going concern value).
(e) Reporting requirements—(1) Applic-
able asset acquisitions—(i) In general.
Unless otherwise excluded from this re-
quirement by the Commissioner, the seller
and the purchaser in an applicable asset ac-
quisition each must report information con-
cerning the amount of consideration in the
transaction and its allocation among the as-
sets transferred. They also must report in-
formation concerning subsequent adjust-
ments to consideration.
(ii) Time and manner of reporting—(A)
In general. The seller and the purchaser
each must file asset acquisition statements
on Form 8594 with their income tax returns
or returns of income for the taxable year
that includes the first date assets are sold
pursuant to an applicable asset acquisition.
This reporting requirement applies to all
asset acquisitions described in this section.
For reporting requirements relating to asset
acquisitions occurring before January 6,
2000, as described in paragraph (a)(2) of
this section, see the temporary regulations
under section 1060 in effect prior to Janu-
ary 6, 2000 (§1.1060–1T as contained in 26
CFR part 1 revised April 1, 1999).
(B) Additional reporting requirement.
When an increase or decrease in considera-
tion is taken into account after the close of
the first taxable year that includes the first
date assets are sold in an applicable asset
acquisition, the seller and the purchaser
each must file a supplemental asset acquisi-
tion statement on Form 8594 with the in-
come tax return or return of income for the
taxable year in which the increase (or de-
crease) is properly taken into account.
(2) Transfers of interests in partner-
ships.For reporting requirements relating
to the transfer of a partnership interest,
see §1.755–2T(c).
PART 602—OMB CONTROL
NUMBERS UNDER PAPERWORK
REDUCTION ACT
Par. 14. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 15. In §602.101, paragraph (b) is
amended by removing the entries for
§§1.338–1, 1.338(b)–1, 1.338(h)(10)–1,
and 1.1060–1T from the tables and adding
new entries to the table in numerical order
to read as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 22, 1999.
Jonathan Talisman,
Acting Assistant Secretary of the
Treasury.
(Filed by the Office of the Federal Register on Janu-
ary 5, 2000, 8:45 a.m., and published in the issue of
the Federal Register for January 7, 2000, 65 F.R.
1235)
January 24, 20003642000–4 I.R.B.
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
1.338–2T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1658
1.338–5T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1658
1.338–10T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1658
1.338–(h)(10)–1T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1658
* * * * *
IRB 2000-4 1/28/00 10:26 AM Page 364

Section 832.—Insurance
Company Taxable Income
26 CFR 1.832–4: Gross Income.
T.D. 8857
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Determination of Underwriting
Income
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the determina-
tion of underwriting income by insurance
companies other than life insurance com-
panies. In computing underwriting in-
come, non-life insurance companies are
required to reduce by 20 percent their de-
ductions for increases in unearned premi-
ums. This requirement was enacted as
part of the Tax Reform Act of 1986.
These regulations provide guidance to
non-life insurance companies for pur-
poses of determining the amount of un-
earned premiums that are subject to the 20
percent reduction rule.
DATES: The regulations are effective
January 5, 2000.
FOR FURTHER INFORMATION CON-
TACT: Gary Geisler, (202) 622-3970
(not a toll-free number)
SUPPLEMENTARY INFORMATION:
Background
On January 2, 1997, the IRS published
in the Federal Registera notice of pro-
posed rulemaking (REG–209839–96,
1997–1 C.B. 780 [62 F.R. 72]) proposing
amendments to the Income Tax Regula-
tions (26 CFR part 1) under section
832(b) of the Internal Revenue Code.
The IRS received a number of written
comments on the proposed regulations.
On April 30, 1997, the IRS held a public
hearing on the proposed regulations.
After consideration of all written and oral
comments regarding the proposed regula-
tions, those regulations are adopted as re-
vised by this Treasury decision.
Explanation of Revisions and
Summary of Comments
Underwriting income
A non-life insurance company’s under-
writing income equals its premiums
earned on insurance contracts during the
taxable year less its losses incurred on in-
surance contracts and its expenses in-
curred.
1
Seesection 832(b)(3). To com-
pute premiums earned, the company starts
with the gross premiums written on insur-
ance contracts during the taxable year,
subtracts return premiums and premiums
paid for reinsurance, and makes an adjust-
ment to reflect the change in its unearned
premiums over the course of the taxable
year. Seesection 832(b)(4). This compu-
tation results in premiums being recog-
nized in underwriting income over the
term of the insurance contract, rather than
in the taxable year in which the premiums
are billed or received from the policy-
holder.
Prior to 1987, 100 percent of the
change in unearned premiums during the
taxable year was taken into account as an
increase or decrease to written premiums
in computing premiums earned. This
treatment “generally reflect[ed]” the ac-
counting conventions (often referred to
as “statutory accounting principles”)
used to prepare a non-life insurance
company’s annual statement for state in-
surance regulatory purposes. See2 H.R.
Conf. Rep. No. 841, 99th Cong., 2d Sess.
II-354 (1986), 1986–3 C.B. (Vol. 4) 354;
S. Rep. No. 313, 99th Cong., 2d Sess.
495 (1986), 1986–3 C.B. (Vol. 3) 495,
H.R. Rep. No. 426, 99th Cong., 1st Sess.
668 (1985), 1986–3 C.B. (Vol. 2) 668.
Because unearned premiums are com-
puted on the basis of the gross premiums
for an insurance contract, the amount of
unearned premiums reflects not only the
portion of the gross premium allocable
to future insurance claims but also the
portion allocable to the insurance com-
pany’s expenses and profit on the insur-
ance contract.
In 1986, Congress determined that de-
ferring unearned premium income and
currently deducting premium acquisition
expenses attributable to unearned premi-
ums resulted in a mismatch of an insur-
ance company’s net income and expense.
Congress decided to require a better
measurement of net income for Federal
income tax purposes. SeeH.R. Rep. No.
426, 1986–3 C.B. (Vol. 2) at 669; S. Rep.
No. 313, 1986–3 C.B. (Vol. 3) at 496.
Rather than defer the deduction for pre-
mium acquisition expenses attributable
to unearned premiums, Congress re-
duced by 20 percent the adjustment for
unearned premiums. For taxable years
beginning on or after January 1, 1993, a
non-life insurance company’s premiums
earned is an amount equal to: (1) its
gross premiums written, less both return
premiums and premiums paid for rein-
surance; plus (2) 80 percent of unearned
premiums at the end of the prior taxable
year, less 80 percent of unearned premi-
ums at the end of the current taxable
year. Section 832(b)(4). The accelera-
tion of income that is typically generated
by the 20 percent reduction of unearned
premiums is intended to be roughly
equivalent to denying current deductibil-
ity for the portion of the insurance com-
pany’s premium acquisition expenses al-
locable to the unearned premiums. See2
H.R. Conf. Rep. No. 841, 1986–3 C.B.
(Vol. 4) at 354–55; S. Rep. No. 313,
1986–3 C.B. (Vol. 3) at 495–98; H.R.
Rep. No. 426, 1986–3 C.B. (Vol. 2) at
668–70.
Role of the annual statement
The proposed regulations provide defi-
nitions of the items used to determine pre-
miums earned under section 832(b)(4)
and timing rules for taking these items
into account for Federal income tax pur-
poses. The treatment provided in the pro-
posed regulations would apply regardless
of the classification or method of report-
ing the items used on an insurance com-
pany’s annual statement.
Several comments questioned whether
there is legal authority to require an in-
surance company to use a method to cal-
2000–4 I.R.B.365January 24, 2000
1
For this purpose, expenses incurred generally refers
to the expenses reported on the company’s annual
statement approved by the National Association of
Insurance Commissioners (NAIC) and filed for state
insurance regulatory purposes, less expenses
incurred which are not allowed as deductions under
section 832(c). Seesection 832(b)(6). Expenses
incurred generally include premium acquisition
expenses attributable to unearned premiums on
insurance contracts.
IRB 2000-4 1/28/00 10:26 AM Page 365

culate premiums earned for Federal in-
come tax purposes that differs from the
method that the company is permitted to
use to calculate premiums earned on its
annual statement. As noted in the pre-
amble to the proposed regulations, the
existing regulations under
§1.832–4(a)(2) state that the annual
statement “. . . insofar as it is not incon-
sistent with the provisions of the Code . .
.” will be recognized and used as a basis
for computing the net income of a non-
life insurance company. Also, if statu-
tory accounting principles permit alter-
native practices, one or more of which
do not clearly reflect income as defined
by the Code, the company is required for
Federal income tax purposes to use a
method that clearly reflects income.
Section 446(b) and §1.446–1(a)(2).
Gross premiums written
The proposed regulations generally de-
fine gross premiums written as the total
amounts payable for insurance coverage
under insurance or reinsurance contracts
issued or renewed during the taxable year.
The proposed regulations, however, do
not address situations where the amounts
charged for insurance coverage may
change due to increases or decreases in
coverage limits, additions or deletions in
property or risks covered, changes in lo-
cation or status of insureds, or other simi-
lar factors.
The final regulations define an insur-
ance company’s “gross premiums writ-
ten” on insurance contracts (which in-
cludes premiums attributable to
reinsurance contracts) as amounts
payable for insurance coverage for the
effective periods of the contracts. The
label placed on a payment in a contract
does not determine whether an amount
is a gross premiums written. The effec-
tive period of a contract is the period
over which one or more rates for insur-
ance coverage are guaranteed in the con-
tract. If a new rate for insurance cover-
age is guaranteed after the effective date
of an insurance contract, the making of
the guarantee generally is treated as the
issuance of a new insurance contract
with an effective period equal to the du-
ration of the new guaranteed rate for in-
surance coverage.
Under the final regulations, gross pre-
miums written include: (1) additional
premiums resulting from increases in
risk exposure during the effective period
of an insurance contract; (2) amounts
subtracted from a premium stabilization
reserve that are used to pay premiums;
and (3) consideration for assuming in-
surance liabilities under contracts not is-
sued by the insurance company (that is,
a payment or transfer of property in an
assumption reinsurance transaction).
Gross premiums written, however, do
not include other items of gross income
described in section 832(b)(1)(C). To
the extent that amounts paid or payable
to an insurance company with respect to
an arrangement are not gross premiums
written, the insurance company may not
treat amounts payable to customers with
respect to the applicable portion of such
arrangements as losses incurred de-
scribed in section 832(b)(5).
Method of reporting gross premiums
written
The proposed regulations provide that a
non-life insurance company reports the
full amount of gross premiums written for
an insurance contract for the earlier of the
taxable year which includes the effective
date of the contract or the year in which
all or a portion of the premium for the
contract is received. A variety of com-
ments were received with respect to the
application of this timing rule to insur-
ance contracts with installment premi-
ums. In response to comments, the final
regulations provide a number of excep-
tions from the general rule with respect to
when an insurance company reports gross
premiums written.
Advance premiums
Under the proposed regulations, a non-
life insurance company that receives a
portion of the premium for an insurance
contract prior to the effective date of the
contract includes the full amount of the
premium in gross premiums written for
the taxable year during which the portion
of the premium was received.
Several comments addressed the treat-
ment of advance premiums in the pro-
posed regulations. One comment en-
dorsed the proposed treatment of advance
premiums, noting that it is proper under
statutory accounting principles to record
the full amount of gross premiums written
and expenses incurred with respect to a
casualty insurance policy for the year in
which an advance premium is received.
2
Other comments argued that since the
policyholder may demand a refund of an
advance premium prior to the policy’s ef-
fective date, the company should be per-
mitted to treat an advance premium as a
nontaxable deposit until such time as cov-
erage begins under the contract. Alterna-
tively, these comments urged that the
company be permitted to report only the
advance premium (rather than the entire
gross premium for the contract) in gross
premiums written for the taxable year of
receipt, and to report the remainder of the
gross premium for the taxable year that
includes the contract’s effective date.
These comments also indicated that com-
panies generally do not deduct the full
amount of premium acquisition expenses
for the contract in the taxable year in
which they receive advance premiums.
In response to comments, the final
regulations permit an insurance company
that receives part of the gross premium
for an insurance contract prior to the ef-
fective date of the contract to report only
the advance premium (rather than the
full amount of the gross premium written
for the contract) in gross premiums writ-
ten for the taxable year of receipt. The
remainder of the gross premium for the
insurance contract is included in gross
premiums written for the taxable year
which includes the effective date of the
contract. This method of reporting gross
premiums written is available only if the
company’s deduction for premium ac-
quisition expenses attributable to the
contract does not exceed a limitation
specified in the regulations, which is in-
tended to ensure that a company does not
deduct premium acquisition expenses at-
tributable to an insurance contract more
rapidly than the company includes pre-
miums for the insurance contract in its
gross premiums written. Companies that
adopt this method of reporting gross pre-
January 24, 20003662000–4 I.R.B.
2
Prior to 1989, advance premiums were required to
be reported in written premiums and unearned pre-
miums on a non-life insurance company’s annual
statement. However, statutory accounting principles
were later modified to permit advance premiums to
be accumulated in a suspense account and reported
as a write-in liability on the annual statement. A
company electing to use this alternative treatment
would not report advance premiums in either written
premiums or unearned premiums on its annual state-
ment until the effective date of the underlying cov-
erage.
IRB 2000-4 1/28/00 10:26 AM Page 366

miums written must use this method for
all insurance contracts with advance pre-
miums.
Accident and health insurance
contracts
The proposed regulations have no spe-
cial rules for determining gross premiums
written with respect to accident and health
insurance contracts. Several comments
indicated that the longstanding practice of
insurance companies that issue accident
and health insurance contracts with in-
stallment premiums is to include amounts
in gross premiums written for the taxable
year in which the installment premiums
become due under the contracts. These
comments also stated that companies gen-
erally do not deduct premium acquisition
expenses allocable to installment premi-
ums not yet due or received with respect
to accident and health insurance con-
tracts.
In response to comments, the final reg-
ulations permit a non- life insurance com-
pany that either issues or proportionally
reinsures cancellable accident and health
insurance contracts with installment pre-
miums to report the installment premiums
in gross premiums written for the earlier
of the taxable year in which the install-
ment premiums become due under the
terms of the contract or the taxable year in
which the installment premiums are re-
ceived. This method of reporting gross
premiums written for cancellable accident
and health insurance contracts with in-
stallment premiums is available only if
the company’s deduction for premium ac-
quisition expenses attributable to those
contracts does not exceed the matching
limitation specified in the regulations.
Companies that adopt this method of re-
porting gross premiums written must use
it for all cancellable accident and health
insurance contracts with installment pre-
miums.
Multi-year contracts with installment
premiums
The final regulations also provide an
exception with respect to the reporting
of gross premiums written for a multi-
year insurance contract for which the
gross premium is payable in install-
ments over the effective period of the
contract. Under the final regulations, a
company may treat this type of multi-
year insurance contract as a series of
separate insurance contracts. The first
insurance contract in the series will be
treated as having an effective period of
12 months. Subsequent insurance con-
tracts in the series will be treated as hav-
ing an effective period equal to the
lesser of 12 months or the remainder of
the period for which the rates for insur-
ance coverage are guaranteed in the
multi-year insurance contract.
This method of reporting gross pre-
mium written for a multi-year insurance
contract with installment premiums is
available only if the company’s deduc-
tion for premium acquisition expenses
attributable to the contract does not ex-
ceed the matching limitation specified in
the regulations. Companies that adopt
this method of reporting gross premiums
written for a multi-year insurance con-
tract must use it for all multi-year con-
tracts with installment premiums.
Contracts that give rise to life
insurance reserves
Some insurance companies that are tax-
able under Part II of Subchapter L issue or
reinsure risks relating to guaranteed re-
newable accident and health insurance
contracts or other contracts that give rise
to “life insurance reserves” (as defined in
section 816(b)). For these companies,
section 832(b)(4) provides that unearned
premiums includes the amount of the
company’s life insurance reserves, as de-
termined under section 807. However,
under section 832(b)(7), the unearned
premiums for contracts giving rise to life
insurance reserves are not reduced by 20
percent. Instead, an amount of otherwise
deductible expenses equal to a percentage
of the net premiums for the contracts must
be capitalized and amortized as specified
policy acquisition expenses under section
848.
3
For purposes of determining the
amount of specified policy acquisition ex-
penses under section 848, a non-life in-
surance company computes net premiums
for the contracts in accordance with sec-
tion 811(a). Seesection 848(d)(2). Thus,
with respect to contracts described in sec-
tion 832(b)(7), a non-life insurance com-
pany does not take into account unpaid
premiums attributable to insurance cover-
age not yet provided (such as deferred and
uncollected premium installments) in de-
termining the amount of specified policy
acquisition expenses required to be amor-
tized under section 848. The proposed
regulations do not provide special rules
for determining gross premiums written
with respect to contracts described in sec-
tion 832(b)(7). Under the final regula-
tions, a non-life insurance company that
issues or reinsures the risks related to a
contract described in section 832(b)(7)
may report gross premiums written for the
contract in the manner required for life in-
surance companies under sections 803
and 811. This method of reporting gross
premiums written for contracts described
in section 832(b)(7) is available only if
the company also determines its deduc-
tion for premium acquisition expenses for
the contracts in accordance with section
811(a), as adjusted by the amount re-
quired to be amortized under section 848
based on the net premiums of the con-
tracts. Thus, the final regulations ensure
that the rules for determining premium in-
come and amortizing premium acquisi-
tion expenses for contracts described in
section 832(b)(7) operate consistently,
whether the issuing company is a non-life
insurance company or a life insurance
company.
Fluctuating risk contracts
The method of reporting gross premi-
ums written for certain insurance con-
tracts covering fluctuating risks is re-
served in the proposed regulations. Some
comments requested that the final regula-
tions not address the method of reporting
gross premiums written for insurance
contracts covering fluctuating risks, not-
ing that the method of recording gross
written premiums for these policies for
annual statement reporting purposes was
being considered by the NAIC as part of
its project to codify statutory accounting
principles. Subsequently, the NAIC is-
sued guidance permitting an insurance
company for annual statement purposes to
report written premiums on workers’
compensation policies (but not on other
casualty contracts involving “fluctuating
risks,” such as commercial automobile li-
ability and product liability policies) ei-
ther on the effective date of the insurance
contract or based on installment billings
to the policyholder. By contrast, with re-
2000–4 I.R.B.367January 24, 2000
3
Under section 848(e)(5), a contract that reinsures a
contract subject to section 848 is treated in the same
manner as the reinsured contract.
IRB 2000-4 1/28/00 10:26 AM Page 367

spect to other types of casualty insurance
policies, the NAIC reaffirmed the general
rule that gross premiums with respect to
these policies must be recorded on the an-
nual statement on the effective date of the
insurance contract.
The final regulations do not permit a
non-life insurance company to report
gross premiums written for a fluctuating
risk contract based on installment billings
to the policyholder. Rather, the final reg-
ulations require a company generally to
report the gross premiums written for the
contract for the earlier of the taxable year
which includes the effective date of the
contract or the year in which all or a por-
tion of the premium for the contract is re-
ceived, with special rules for advance pre-
miums, cancellable accident and health
contracts, multi-year insurance contracts,
and contracts described in section
832(b)(7). The company reports any ad-
ditional premiums resulting from an in-
crease in risk exposure in gross premiums
written for the taxable year in which the
change in risk exposure occurs. Unless
the increase in risk exposure is of tempo-
rary duration, the company determines
the additional premium resulting from a
change in risk exposure based on the re-
mainder of the effective period of the con-
tract.
Return premiums
The proposed regulations define return
premiums as amounts (other than policy-
holder dividends or claims and benefit
payments) paid or credited to the policy-
holder in accordance with the terms of an
insurance contract. Under the final regu-
lations, return premiums are amounts pre-
viously included in an insurance com-
pany’s gross premiums written, which are
refundable to the policyholder (or the ced-
ing company with respect of a reinsurance
agreement) if the amounts are fixed by the
insurance contract and do not depend on
the experience of the insurance company
or the discretion of its management. This
rule incorporates a specific definition of
policyholder dividends.
The final regulations list a number of
items which are included in return premi-
ums, to the extent they have previously
been included in gross premiums written.
These items include: (1) amounts that are
refundable due to policy cancellations or
decreases in risk exposure during the ef-
fective period of an insurance contract;
(2) the unearned portion of unpaid premi-
ums for an insurance contract that is can-
celed or for which there is a decrease in
risk exposure during its effective period;
and (3) amounts that are either refundable
or that reflect the unearned portion of un-
paid premiums for an insurance contract,
arising from the redetermination of the
premium due to correction of posting or
other similar errors.
In addition, the final regulation pro-
vides timing rules for the deduction of re-
turn premiums. If a contract is canceled,
the return premium arising from that can-
cellation is deducted in the taxable year in
which the contract is canceled. If there is
a reduction in risk exposure under an in-
surance contract that gives rise to a return
premium, such return premium is de-
ductible in the taxable year in which the
reduction in risk exposure occurs.
Retrospectively rated insurance
contracts
The proposed regulations provide that
gross written premiums include an insur-
ance company’s estimate of additional
premiums (retro debits) to be received
with regard to the expired portion of a ret-
rospectively rated insurance or reinsur-
ance contract. The proposed regulations
also provide that return premiums include
an insurance company’s estimate of
amounts to be refunded to policyholders
(retro credits) with regard to the expired
portion of a retrospectively rated insur-
ance or reinsurance contract. The pro-
posed regulations, therefore, would mod-
ify the treatment of retro credits under
§1.832–4(a)(3)(ii) of the existing regula-
tions, which treat retro credits as un-
earned premiums. At the option of the
taxpayer, however, the proposed regula-
tions permit a company to continue to in-
clude gross retro credits (but not gross
retro debits) in the amount of unearned
premiums subject to the 20 percent reduc-
tion under section 832(b)(4)(B).
A variety of comments were received
with respect to the treatment of retro deb-
its and retro credits in the proposed regu-
lations. Most comments approved of the
proposed rule to modify the treatment of
retro credits in §1.832–4(a)(3)(ii) and, in-
stead, to permit retro credits to be ac-
counted for as part of return premiums.
Some comments contended, however, that
the method of netting retro debits and
retro credits as an adjustment to unearned
premiums was required under NAIC ac-
counting rules, prior case law, and the
Service’s published rulings interpreting
§1.832–4(a)(3)(ii). These comments ar-
gued that the enactment of the 20 percent
reduction rule in 1986 did not authorize
the Service to change the items included
in unearned premiums, including the his-
torical treatment of retro debits and retro
credits as part of unearned premiums.
Other comments contended that retro deb-
its (but not retro credits) should be dis-
counted using the applicable discount fac-
tors for unpaid losses under section 846.
These comments argued that there is a di-
rect correlation between amounts reported
by an insurance company as retro debits
and the company’s related liabilities for
unpaid losses and unpaid loss adjustment
expenses. Therefore, the comments urged
that, to achieve proper matching of these
items, a non-life insurance company
should be permitted either to report retro
debits as a subtraction from unearned pre-
miums or to discount the retro debits
using the applicable discount factors
under section 846 for the related line of
business.
The treatment of retro debits and retro
credits in the proposed regulations was
premised on the assumptions that retro-
spectively rated arrangements could qual-
ify as insurance contracts for tax pur-
poses, and that all amounts payable under
such arrangements could be considered to
have been paid for insurance coverage.
The final regulations provide that gross
premiums are amounts paid for insurance
coverage. Similarly, unearned premiums
and return premiums only include
amounts included in gross written premi-
ums. The final regulations also provide
that retro credits are not included in un-
earned premiums, and retro debits cannot
be subtracted from unearned premiums.
The final regulations do not permit
amounts includable in gross premiums
written to be discounted, regardless of
when such amounts are paid to the insur-
ance company.
The final regulations do not provide
any inference as to whether some or all of
a retrospective arrangement can qualify as
an insurance contract, or as to whether or
the extent to which amounts paid or
payable to an insurance company with re-
January 24, 20003682000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 368

spect to a retrospective arrangement are
for insurance coverage.
Premium stabilization reserves
Several comments asked for clarifica-
tion of the treatment of premium stabi-
lization reserves.
4
As noted below, the
final regulations provide that retro credits
are not unearned premiums for Federal in-
come tax purposes. Thus, retro credits
added to premium stabilization reserves
are not unearned premiums for Federal in-
come tax purposes. The final regulations
also provide that amounts withdrawn
from a premium stabilization reserve to
pay premiums are included in gross pre-
miums written for the taxable year in
which these amounts are withdrawn from
the stabilization reserve for that purpose.
Unearned premiums
The proposed regulations define un-
earned premiums as the portion of the
gross premiums written that is attributable
to future insurance coverage to be pro-
vided under an insurance or reinsurance
contract. The final regulations generally
retain the rules relating to unearned pre-
miums. Consistent with the existing reg-
ulations under §1.801–4(a), the final reg-
ulations provide that an insurance
company must exclude from unearned
premiums amounts attributable to the net
value of risks reinsured with, or retro-
ceded to, another insurance company.
The final regulations also provide that un-
earned premiums do not include a liability
established by an insurance company on
its annual statement to cover premium de-
ficiencies.
The proposed regulations provide that
an insurance company may consider the
incidence or pattern of the insured risks in
determining the portion of the gross pre-
mium written that is attributable to the un-
expired portion of the insurance coverage.
The final regulations clarify that, if the
risk of loss under an insurance contract
does not vary significantly over the effec-
tive period of the contract, the unearned
premium attributable to the unexpired
portion of the effective period of the con-
tract is determined on a pro rata basis.
However, if the risk of loss under an in-
surance contract varies significantly over
the effective period of the contract, the in-
surance company may consider the pat-
tern and incidence of the risk in determin-
ing the portion of gross premium which
are attributable to the unexpired portion
of the effective period of the contract,
provided that the company maintains suf-
ficient information to demonstrate that its
method of computing unearned premiums
accurately reflects the pattern and inci-
dence of the risk for the insurance con-
tract.
Effective date and transition rules
Under the proposed regulations, the
new rules apply to the determination of
premiums earned for insurance contracts
issued or renewed during taxable years
beginning after January 6, 2000. Several
comments requested that the regulations
permit an insurance company to adopt the
new rules for determining premiums
earned as a change in method of account-
ing deemed made with the Commission-
ers’ consent, with audit protection for
prior years. These comments also urged
that the insurance company be given the
option of either implementing the change
in method of accounting on a cut-off basis
or spreading the section 481(a) adjust-
ments resulting from the change over a
number of years consistent with the Com-
missioner’s general administrative proce-
dures when a taxpayer files a request to
change a method of accounting under sec-
tion 446(e).
In response to these comments, the final
regulations permit taxpayers to change
their method of accounting for determin-
ing premiums earned to comply with the
final regulations under the automatic
change in method of accounting provi-
sions of Rev. Proc. 99–49, 1999–52 I.R.B.
725, subject to certain limitations. A tax-
payer makes the automatic change in
method of accounting on its Federal in-
come tax return for the first taxable year
beginning after December 31, 1999. The
scope limitations in section 4.02 of Rev.
Proc. 99–49 do not apply to a taxpayer’s
automatic change in method of accounting
pursuant to this regulation. The timely du-
plicate filing requirement in section 6.02
of Rev. Proc. 99–49 also does not apply to
this change. If the taxpayer’s method of
computing earned premiums was an issue
under consideration (within the meaning
of section 3.09 of Rev. Proc. 99–49) on
January 5, 2000, however, then the audit
protection rule in section 7.01 of Rev.
Proc. 99–49 does not apply to the tax-
payer’s change in method of accounting.
Special Analyses
It has been determined that this Treasury
Decision is not a significant regulatory ac-
tion as defined in Executive Order 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Pro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and, because
these regulations do not impose on small
entities a collection of information require-
ment, the Regulatory Flexibility Act (5
U.S.C. chapter 6) does not apply. There-
fore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f)
of the Internal Revenue Code, the notice of
proposed rulemaking preceding these reg-
ulations was submitted to the Chief Coun-
sel for Advocacy of the Small Business
Administration for comment on its impact
on small business.
Drafting Information
The principal author of these regula-
tions is Gary Geisler, Office of the Assis-
tant Chief Counsel (Financial Institutions
and Products), IRS. However, other per-
sonnel from the IRS and Treasury Depart-
ment participated in their development.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR part 1 is amended
as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.832–4 is amended as
follows:
1. Paragraph (a)(3) is revised.
2. Paragraphs (a)(4) and (a)(5) are re-
designated as paragraphs (a)(13) and
(a)(14).
2000–4 I.R.B.369January 24, 2000
4
In Rev. Rul. 97–5, 1997–1 C.B. 136, the Service
revoked Rev. Rul. 70–480, 1970–2 C.B. 142, which
had held that amounts held by a non-life insurance
company in a premium stabilization reserve funded
by retro credits are not unearned premiums under
section 832(b)(4). Rev. Rul. 97–5 reasoned that the
assumption in Rev. Rul. 70–480 that stabilization
reserves are part of the insurance company’s surplus
was erroneous.
IRB 2000-4 1/28/00 10:26 AM Page 369

3. New paragraphs (a)(4) through
(a)(12) are added.
The additions and revisions read as fol-
lows:
§1.832–4 Gross income.
(a) * * *
(3) Premiums earned. The determina-
tion of premiums earned on insurance
contracts during the taxable year begins
with the insurance company’s gross pre-
miums written on insurance contracts dur-
ing the taxable year, reduced by return
premiums and premiums paid for reinsur-
ance. Subject to the exceptions in sec-
tions 832(b)(7), 832(b)(8), and 833(a)(3),
this amount is increased by 80 percent of
the unearned premiums on insurance con-
tracts at the end of the preceding taxable
year, and is decreased by 80 percent of the
unearned premiums on insurance con-
tracts at the end of the current taxable
year.
(4) Gross premiums written—(i) In
general. Gross premiums written are
amounts payable for insurance coverage.
The label placed on a payment in a con-
tract does not determine whether an
amount is a gross premium written.
Gross premiums written do not include
other items of income described in sec-
tion 832(b)(1)(C) (for example, charges
for providing loss adjustment or claims
processing services under administrative
services or cost-plus arrangements).
Gross premiums written on an insurance
contract include all amounts payable for
the effective period of the insurance con-
tract. To the extent that amounts paid or
payable with respect to an arrangement
are not gross premiums written, the in-
surance company may not treat amounts
payable to customers under the applica-
ble portion of such arrangements as
losses incurred described in section
832(b)(5).
(ii) Items included.Gross premiums
written include—
(A) Any additional premiums resulting
from increases in risk exposure during the
effective` period of an insurance contract;
(B) Amounts subtracted from a pre-
mium stabilization reserve to pay for in-
surance coverage; and
(C) Consideration in respect of assum-
ing insurance liabilities under insurance
contracts not issued by the taxpayer (such
as a payment or transfer of property in an
assumption reinsurance transaction).
(5) Method of reporting gross premi-
ums written—(i) In general. Except as
otherwise provided under this paragraph
(a)(5), an insurance company reports
gross premiums written for the earlier of
the taxable year that includes the effective
date of the insurance contract or the year
in which the company receives all or a
portion of the gross premium for the in-
surance contract. The effective date of
the insurance contract is the date on
which the insurance coverage provided by
the contract commences. The effective
period of an insurance contract is the pe-
riod over which one or more rates for in-
surance coverage are guaranteed in the
contract. If a new rate for insurance cov-
erage is guaranteed after the effective date
of an insurance contract, the making of
such a guarantee generally is treated as
the issuance of a new insurance contract
with an effective period equal to the dura-
tion of the new guaranteed rate for insur-
ance coverage.
(ii) Special rule for additional premi-
ums resulting from an increase in risk
exposure. An insurance company reports
additional premiums that result from an
increase in risk exposure during the ef-
fective period of an insurance contract in
gross premiums written for the taxable
year in which the change in risk expo-
sure occurs. Unless the increase in risk
exposure is of temporary duration (for
example, an increase in risk exposure
under a workers’ compensation policy
due to seasonal variations in the policy-
holder’s payroll), the company reports
additional premiums resulting from an
increase in risk exposure based on the re-
mainder of the effective period of the in-
surance contract.
(iii) Exception for certain advance
premiums. If an insurance company re-
ceives a portion of the gross premium for
an insurance contract prior to the first day
of the taxable year that includes the effec-
tive date of the contract, the company
may report the advance premium (rather
than the full amount of the gross premium
for the contract) in gross premiums writ-
ten for the taxable year in which the ad-
vance premium is received. An insurance
company may adopt this method of re-
porting advance premiums only if the
company’s deduction for premium acqui-
sition expenses for the taxable year in
which the company receives the advance
premium does not exceed the limitation of
paragraph (a)(5)(vii) of this section. A
company that reports an advance pre-
mium in gross premiums written under
this paragraph (a)(5)(iii) takes into ac-
count the remainder of the gross premium
written and premium acquisition expenses
for the contract in the taxable year that in-
cludes the effective date of the contract.
A company that adopts this method of re-
porting advance premiums must use the
method for all contracts with advance pre-
miums.
(iv) Exception for certain cancellable
accident and health insurance contracts
with installment premiums. If an insur-
ance company issues or proportionally
reinsures a cancellable accident and
health insurance contract (other than a
contract with an effective period that ex-
ceeds 12 months) for which the gross pre-
mium is payable in installments over the
effective period of the contract, the com-
pany may report the installment premi-
ums (rather than the total gross premium
for the contract) in gross premiums writ-
ten for the earlier of the taxable year in
which the installment premiums are due
under the terms of the contract or the year
in which the installment premiums are re-
ceived. An insurance company may
adopt this method of reporting installment
premiums for a cancellable accident and
health insurance contract only if the com-
pany’s deduction for premium acquisition
expenses for the first taxable year in
which an installment premium is due or
received under the contract does not ex-
ceed the limitation of paragraph
(a)(5)(vii) of this section. A company that
adopts this method of reporting install-
ment premiums for a cancellable accident
and health contract must use the method
for all of its cancellable accident and
health insurance contracts with install-
ment premiums.
(v) Exception for certain multi-year in-
surance contracts. If an insurance com-
pany issues or proportionally reinsures an
insurance contract, other than a contract
described in paragraph (a)(5)(vi) of this
section, with an effective period that ex-
ceeds 12 months, for which the gross pre-
mium is payable in installments over the
effective period of the contract, the com-
pany may treat the insurance coverage
provided under the multi-year contract as
a series of separate insurance contracts.
January 24, 20003702000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 370

The first contract in the series is treated as
having been written for an effective pe-
riod of twelve months. Each subsequent
contract in the series is treated as having
been written for an effective period equal
to the lesser of 12 months or the remain-
der of the period for which the rates for
insurance coverage are guaranteed in the
multi-year insurance contract. An insur-
ance company may adopt this method of
reporting premiums on a multi-year con-
tract only if the company’s deduction for
premium acquisition expenses for each
year of the multi-year contract does not
exceed the limitation of paragraph
(a)(5)(vii) of this section. A company that
adopts this method of reporting premiums
for a multi-year contract must use the
method for all multi-year contracts with
installment premiums.
(vi) Exception for insurance contracts
described in section 832(b)(7). If an in-
surance company issues or reinsures the
risks related to a contract described in
section 832(b)(7), the company may re-
port gross premiums written for the con-
tract in the manner required by sections
803 and 811(a) for life insurance compa-
nies. An insurance company may adopt
this method of reporting premiums on
contracts described in section 832(b)(7)
only if the company also determines the
deduction for premium acquisition costs
for the contract in accordance with sec-
tion 811(a), as adjusted by the amount re-
quired to be taken into account under sec-
tion 848 in connection with the net
premiums of the contract. A company
that adopts this method of reporting pre-
miums for a contract described in section
832(b)(7) must use the method for all of
its contracts described in that section.
(vii) Limitation on deduction of pre-
mium acquisition expenses. An insurance
company’s deduction for premium acqui-
sition expenses (for example, commis-
sions, state premium taxes, overhead re-
imbursements to agents or brokers, and
other similar amounts) related to an insur-
ance contract is within the limitation of
this paragraph (a)(5)(vii) if–
(A) The ratio obtained by dividing the
sum of the company’s deduction for pre-
mium acquisition expenses related to the
insurance contract for the taxable year
and previous taxable years by the total
premium acquisition expenses attribut-
able to the insurance contract; does not
exceed
(B) The ratio obtained by dividing the
sum of the amounts included in gross pre-
miums written with regard to the insur-
ance contract for the taxable year and pre-
vious taxable years by the total gross
premium written for the insurance con-
tract.
(viii) Change in method of reporting
gross premiums. An insurance company
that adopts a method of accounting for
gross premiums written and premium ac-
quisition expenses described in paragraph
(a)(5)(iii), (iv), (v), or (vi) of this section
must continue to use the method to report
gross premiums written and premium ac-
quisition expenses unless the company
obtains the consent of the Commissioner
to change to a different method under sec-
tion 446(e) and §1.446–1(e).
(6) Return premiums—(i) In general.
An insurance company’s liability for re-
turn premiums includes amounts previ-
ously included in an insurance company’s
gross premiums written, which are re-
fundable to a policyholder or ceding com-
pany, provided that the amounts are fixed
by the insurance contract and do not de-
pend on the experience of the insurance
company or the discretion of its manage-
ment.
(ii) Items included. Return premiums
include amounts–
(A)Which were previously paid and
become refundable due to policy cancel-
lations or decreases in risk exposure dur-
ing the effective period of an insurance
contract;
(B) Which reflect the unearned portion
of unpaid premiums for an insurance con-
tract that is canceled or for which there is
a decrease in risk exposure during its ef-
fective period; or
(C) Which are either previously paid
and refundable or which reflect the un-
earned portion of unpaid premiums for an
insurance contract, arising from the rede-
termination of a premium due to correc-
tion of posting or other similar errors.
(7) Method of reporting return premi-
ums. An insurance company reports the
liability for a return premium resulting
from the cancellation of an insurance con-
tract for the taxable year in which the con-
tract is canceled. An insurance company
reports the liability for a return premium
attributable to a reduction in risk exposure
under an insurance contract for the tax-
able year in which the reduction in risk
exposure occurs.
(8) Unearned premiums—(i) In gen-
eral. The unearned premium for a con-
tract, other than a contract described in
section 816(b)(1)(B), generally is the por-
tion of the gross premium written that is
attributable to future insurance coverage
during the effective period of the insur-
ance contract. However, unearned premi-
ums held by an insurance company with
regard to the net value of risks reinsured
with other solvent companies (whether or
not authorized to conduct business under
state law) are subtracted from the com-
pany’s unearned premiums. Unearned
premiums also do not include any addi-
tional liability established by the insur-
ance company on its annual statement to
cover premium deficiencies. Unearned
premiums do not include an insurance
company’s estimate of its liability for
amounts to be paid or credited to a cus-
tomer with regard to the expired portion
of a retrospectively rated contract (retro
credits). An insurance company’s esti-
mate of additional amounts payable by its
customers with regard to the expired por-
tion of a retrospectively rated contract
(retro debits) cannot be subtracted from
unearned premiums.
(ii) Special rules for unearned premi-
ums. For purposes of computing “premi-
ums earned on insurance contracts during
the taxable year” under section 832(b)(4),
the amount of unearned premiums in-
cludes—
(A) Life insurance reserves (as defined
in section 816(b), but computed in accor-
dance with section 807(d) and sections
811(c) and (d));
(B) In the case of a mutual flood or fire
insurance company described in section
832(b)(1)(D) (with respect to contracts
described in that section), the amount of
unabsorbed premium deposits that the
company would be obligated to return to
its policyholders at the close of the tax-
able year if all its insurance contracts
were terminated at that time;
(C) In the case of an interinsurer or
reciprocal underwriter that reports un-
earned premiums on its annual statement
net of premium acquisition expenses, the
unearned premiums on the company’s an-
nual statement increased by the portion of
premium acquisition expenses allocable
to those unearned premiums; and
2000–4 I.R.B.371January 24, 2000
IRB 2000-4 1/28/00 10:26 AM Page 371

(D) In the case of a title insurance
company, its discounted unearned premi-
ums (computed in accordance with sec-
tion 832(b)(8)).
(9) Method of determining unearned
premiums. If the risk of loss under an in-
surance contract does not vary signifi-
cantly over the effective period of the
contract, the unearned premium attribut-
able to the unexpired portion of the effec-
tive period of the contract is determined
on a pro rata basis. If the risk of loss
varies significantly over the effective pe-
riod of the contract, the insurance com-
pany may consider the pattern and inci-
dence of the risk in determining the
portion of the gross premium that is at-
tributable to the unexpired portion of the
effective period of the contract. An insur-
ance company that uses a method of com-
puting unearned premiums other than the
pro rata method must maintain sufficient
information to demonstrate that its
method of computing unearned premiums
accurately reflects the pattern and inci-
dence of the risk for the insurance con-
tract.
(10) Examples. The provisions of
paragraphs (a)(4) through (a)(9) of this
section are illustrated by the following ex-
amples:
Example 1. (i) IC is a non-life insurance com-
pany which, pursuant to section 843, files its returns
on a calendar year basis. IC writes a casualty insur-
ance contract that provides insurance coverage for a
one-year period beginning on July 1, 2000 and end-
ing on June 30, 2001. IC charges a $500 premium
for the insurance contract, which may be paid either
in full by the effective date of the contract or in
quarterly installments over the contract’s one year
term. The policyholder selects the installment pay-
ment option. As of December 31, 2000, IC collected
$250 of installment premiums for the contract.
(ii) The effective period of the insurance contract
begins on July 1, 2000 and ends on June 30, 2001.
For the taxable year ending December 31, 2000, IC
includes the $500 gross premium, based on the ef-
fective period of the contract, in gross premiums
written under section 832(b)(4)(A). IC’s unearned
premium with respect to the contract was $250 as of
December 31, 2000. Pursuant to section
832(b)(4)(B), to determine its premiums earned, IC
deducts $200 ($250 x .8) for the insurance contract
at the end of the taxable year.
Example 2. (i) The facts are the same as Exam-
ple 1, except that the insurance contract has a stated
term of 5 years. On each contract anniversary date,
IC may adjust the rate charged for the insurance cov-
erage for the succeeding 12 month period. The
amount of the adjustment in the charge for insurance
coverage is not substantially limited under the insur-
ance contract.
(ii) Under paragraph (a)(5)(i) of this section, IC
is required to report gross premiums written for the
insurance contract based on the effective period for
the contract. The effective period of the insurance
contract is the period for which a rate for insurance
coverage is guaranteed in the contract. Although the
insurance contract issued by IC has a stated term of
5 years, a rate for insurance coverage is guaranteed
only for a period of 12 months beginning with the
contract’s effective date and each anniversary date
thereafter. Thus, for the taxable year ending Decem-
ber 31, 2000, IC includes the $500 gross premium
for the 12 month period beginning with the con-
tract’s effective date in gross premiums written.
IC’s unearned premium with respect to the contract
was $250 as of December 31, 2000. Pursuant to sec-
tion 832(b)(4)(B), to determine its premiums earned,
IC deducts $200 ($250 x .8) for the insurance con-
tract at the end of the taxable year.
Example 3. (i) The facts are the same as Exam-
ple 1, except that coverage under the insurance con-
tract begins on January 1, 2001 and ends on Decem-
ber 31, 2001. On December 15, 2000, IC collects
the first $125 premium installment on the insurance
contract. For the taxable year ended December 31,
2000, IC deducts $20 of premium acquisition ex-
penses related to the insurance contract. IC’s total
premium acquisition expenses, based on the insur-
ance contract’s $500 gross premium, are $80.
(ii) Under paragraph (a)(5)(iii) of this section, IC
may elect to report only the $125 advance pre-
mium (rather than the contract’s $500 gross pre-
mium) in gross premiums written for the taxable
year ended December 31, 2000, provided that IC’s
deduction for the premium acquisition expenses re-
lated to the insurance contract does not exceed the
limitation in paragraph (a)(5)(vii). IC’s deduction
for premium acquisition expenses is within this limi-
tation only if the ratio of the insurance contract’s
premium acquisition expenses deducted for the tax-
able year and any previous taxable year to the insur-
ance contract’s total premium acquisition expenses
does not exceed the ratio of the amounts included in
gross premiums written for the taxable year and any
previous taxable year for the contract to the total
gross premium written for the contract.
(iii) For the taxable year ended December 31,
2000, IC deducts $20 of premium acquisition ex-
penses related to the insurance contract. This deduc-
tion represents 25% of the total premium acquisition
expenses for the insurance contract ($20/$80 =
25%). This ratio does not exceed the ratio of the
$125 advance premium to the insurance contract’s
$500 gross premium ($125/$500 = 25%). There-
fore, under paragraph (a)(5)(iii) of this section, IC
may elect to report only the $125 advance premium
(rather than the $500 gross premium) in gross pre-
miums written for the taxable year ending December
31, 2000. IC reports the balance of the gross pre-
mium for the insurance contract ($375) and deducts
the remaining premium acquisition expenses ($60)
for the insurance contract in the taxable year ending
December 31, 2001.
Example 4. (i) The facts are the same as Exam-
ple 3, except that for the taxable year ending Decem-
ber 31, 2000, IC deducts $60 of premium acquisition
expenses related to the insurance contract.
(ii)For the taxable year ended December 31,
2000, IC deducted 75% of total premium acquisition
expenses for the insurance contract ($60/$80 =
75%). This ratio exceeds the ratio of the $125 ad-
vance premium to the $500 gross premium
($125/$500 = 25%). Because IC’s deduction for
premium acquisition expenses allocable to the con-
tract exceeds the limitation in paragraph (a)(5)(vii)
of this section, paragraph (a)(5)(i) of this section re-
quires IC to report the $500 gross premium in gross
premiums written for the taxable year ending De-
cember 31, 2000. IC’s unearned premium with re-
spect to the contract was $500 as of December 31,
2000. Pursuant to section 832(b)(4)(B), to deter-
mine its premiums earned, IC deducts $400 ($500 x
.8) for the insurance contract at the end of the tax-
able year.
Example 5. (i) IC is a non-life insurance com-
pany which, pursuant to section 843, files its returns
on a calendar year basis. On August 1, 2000, IC is-
sues a one-year cancellable accident and health in-
surance policy to X, a corporation with 80 covered
employees. The gross premium written for the in-
surance contract is $320,000. Premiums are payable
in monthly installments. As of December 31, 2000,
IC has collected $150,000 of installment premiums
from X. For the taxable year ended December 31,
2000, IC has paid or incurred $21,000 of premium
acquisition expenses related to the insurance con-
tract. IC’s total premium acquisition expenses for
the insurance contract, based on the $320,000 gross
premium, are $48,000.
(ii) Under paragraph (a)(5)(iv) of this section, IC
may elect to report only the $150,000 of install-
ment premiums (rather than the $320,000 estimated
gross premium) in gross premiums written for the
taxable year ended December 31, 2000, provided
that its deduction for premium acquisition expenses
allocable to the insurance contract does not exceed
the limitation in paragraph (a)(5)(vii). For the tax-
able year ended December 31, 2000, IC deducts
$21,000 of premium acquisition expenses related to
the insurance contract, or 43.75% of total premium
acquisition expenses for the insurance contract
($21,000/$48,000 = 43.75%). This ratio does not
exceed the ratio of installment premiums to the
gross premium for the contract ($150,000/$320,000
= 46.9%). Therefore, under paragraph (a)(5)(iv) of
this section, IC may elect to report only $150,000 of
installment premiums for the insurance contract
(rather than $320,000 of gross premium) in gross
premiums written for the taxable year ending De-
cember 31, 2000.
Example 6. (i) IC is a non-life insurance com-
pany which, pursuant to section 843, files its returns
on a calendar year basis. On July 1, 2000, IC issues
a one-year workers’ compensation policy to X, an
employer. The gross premium for the policy is de-
termined by applying a monthly rate of $25 to each
of X’s employees. This rate is guaranteed for a pe-
riod of 12 months, beginning with the effective date
of the contract. On July 1, 2000, X has 1,050 em-
ployees. Based on the assumption that X’s payroll
would remain constant during the effective period of
the contract, IC determines an estimated gross pre-
mium for the contract of $315,000 (1,050 x $25 x 12
= $315,000). The estimated gross premium is
payable by X in equal monthly installments. At the
end of each calendar quarter, the premiums payable
under the contract are adjusted based on an audit of
X’s actual payroll during the preceding three months
of coverage.
(ii) Due to an expansion of X’s business in 2000,
the actual number of employees covered under the
contract during each month of the period between
January 24, 20003722000–4 I.R.B.
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July 1, 2000 and December 31, 2000 is 1,050 (July),
1,050 (August), 1,050 (September), 1,200 (Octo-
ber), 1,200 (November), and 1,200 (December).
The increase in the number of employees during the
year is not attributable to a temporary or seasonal
variation in X’s business activities and is expected to
continue for the remainder of the effective period of
the contract.
(iii) Under paragraph(a)(5)(i) of this section,
IC is required to report gross premiums written for
the insurance contract based the effective period of
the contract. The effective period of X’s contract
is based on the 12 month period for which IC has
guaranteed rates for insurance coverage. Under
paragraph (a)(5)(ii), IC must also report the addi-
tional premiums resulting from the change in risk
exposure under the contract for the taxable year in
which the change in such exposure occurs. Unless
the change in risk exposure is of temporary dura-
tion, the additional gross premiums are included in
gross premiums written for the remainder of the
effective period of the contract. Thus, for the tax-
able year ending December 31, 2000, IC reports
gross premiums written of $348,750 with respect
to the workers’ compensation contract issued to X,
consisting of the sum of the initial gross premium
for the contract ($315,000) plus the additional
gross premium attributable to the 150 employees
added to X’s payroll who will be covered during
the last nine months of the contract’s effective pe-
riod (150 x $25 (monthly premium) x 9 =
$33,750). IC’s unearned premium with respect to
the contract was $180,000 as of December 31,
2000, which consists of the sum of the remaining
portion of the original gross premium ($315,000 x
6/12 = $157,500), plus the additional premiums re-
sulting from the change in risk exposure ($33,750
x 6/9 = $22,500) that are allocable to the remain-
ing six months of the contract’s effective period.
Pursuant to section 832(b)(4)(B), to determine its
premiums earned, IC deducts $144,000 ($180,000
x .8) for the insurance contract at the end of the
taxable year.
Example 7. (i) The facts are the same as Exam-
ple 6, except that the increase in the number of X’s
employees for the period ending December 31,
2000 is attributable to a seasonal variation in X’s
business activity.
(ii) Under paragraph (a)(5)(ii) of this section,
for the taxable year ending December 31, 2000, IC
reports gross premiums written of $326,500, con-
sisting of the sum of the initial gross premium for
the contract ($315,000) plus the additional pre-
mium attributable to the temporary increase in risk
exposure during the taxable year (150 x $25 x 3 =
$11,250). The unearned premium that is allocable
to the remaining six months of the effective period
of the contract is $157,500. Pursuant to section
832(b)(4)(B), to determine its premiums earned,
IC deducts $126,000 ($157,500 x .8) for the insur-
ance contract at the end of the taxable year.
Example 8. (i) IC, a non-life insurance com-
pany, issues a noncancellable accident and health
insurance contract (other than a qualified long-
term care insurance contract, as defined in section
7702B(b)) to A, an individual, on July 1, 2000.
The contract has an entry-age annual premium of
$2,400, which is payable by A in equal monthly in-
stallments of $200 on the first day of each month
of coverage. IC incurs agents’ commissions, pre-
mium taxes, and other premium acquisition ex-
penses equal to 10% of the gross premiums re-
ceived for the contract. As of December 31, 2000,
IC has collected $1,200 of installment premiums
for the contract.
(ii) A noncancellable accident and health insur-
ance contract is a contract described in section
832(b)(7). Thus, under paragraph (a)(5)(vi) of this
section, IC may report gross premiums written in
the manner required for life insurance companies
under sections 803 and 811. Accordingly, for the
taxable year ending December 31, 2000, IC may
report gross premiums written of $1,200, based on
the premiums actually received on the contract.
Pursuant to section (a)(5)(vi) of this section, IC
deducts a total of $28 of premium acquisition costs
for the contract, based on the difference between
the acquisition costs actually paid or incurred
under section 811(a) ($1,200 x .10 = $120) and the
amount required to taken into account under sec-
tion 848 in connection with the net premiums for
the contract ($1,200 x .077 = $92).
(iii) Under paragraph (a)(8)(ii)(A) of this sec-
tion, IC includes the amount of life insurance re-
serves (as defined in section 816(b), but computed
in accordance with section 807(d) and sections
811(c) and (d)) in unearned premiums under sec-
tion 832(b)(4)(B). Section 807(d)(3)(A)(iii) re-
quires IC to use a two-year preliminary term
method to compute the amount of life insurance
reserves for a noncancellable accident and health
insurance contract (other than a qualified long-
term care contract). Under this tax reserve
method, no portion of the $1,200 gross premium
received by IC for A’s contract is allocable to fu-
ture insurance coverage. Accordingly, for the tax-
able year ending December 31, 2000, no life insur-
ance reserves are included in IC’s unearned
premiums under section 832(b)(4)(B) with respect
to the contract.
Example 9. (i) IC, a non-life insurance com-
pany, issues an insurance contract with a twelve
month effective period for $1,200 on December 1,
2000. Immediately thereafter, IC reinsures 90% of
its liability under the insurance contract for $900
with IC-2, an unrelated and solvent insurance
company. On December 31, 2000, IC-2 has an
$825 unearned premium with respect to the rein-
surance contract it issued to IC. In computing its
earned premiums, pursuant to section
832(b)(4)(B), IC-2 deducts $660 of unearned pre-
miums ($825 x .8) with respect to the reinsurance
contract.
(ii) Under paragraph (a)(8)(i) of this section,
unearned premiums held by an insurance company
with regard to the net value of the risks reinsured
in other solvent companies are deducted from the
ceding company’s unearned premiums taken into
account for purposes of section 832(b)(4)(B). If
IC had not reinsured 90% of its risks, IC’s un-
earned premium for the insurance contract would
have been $1,100 ($1,200 x 11/12) and IC would
have deducted $880 ($1,100 x .8) of unearned pre-
miums with respect to such contract. However,
because IC reinsured 90% of its risks under the
contract with IC-2, as of December 31, 2000, the
net value of the risks retained by IC for the re-
maining 11 months of the effective period of the
contract is $110 ($1,100 - $990). For the taxable
year ending December 31, 2000, IC includes the
$1,200 gross premium in its gross premiums writ-
ten and deducts the $900 reinsurance premium
paid to IC-2 under section 832(b)(4)(A). Pursuant
to section 832(b)(4)(B), to determine its premiums
earned, IC deducts $88 ($110 x .8) for the insur-
ance contract at the end of the taxable year.
(11) Change in method of
accounting—(i) In general. A change
in the method of determining premiums
earned to comply with the provisions of
paragraphs (a)(3) through (a)(10) of this
section is a change in method of ac-
counting for which the consent of the
Commissioner is required under section
446(e) and §1.446–1(e).
(ii) Application. For the first taxable
year beginning after December 31, 1999,
a taxpayer is granted consent of the Com-
missioner to change its method of deter-
mining premiums earned to comply with
the provisions of paragraphs (a)(3)
through (a)(10) of this section. A tax-
payer changing its method of accounting
in accordance with this section must fol-
low the automatic change in accounting
provisions of Rev. Proc. 99–49, 1999–52
I.R.B. 725 (see §601.601(d)(2) of this
chapter), except that–
(A) The scope limitations in section
4.02 of Rev.
Proc. 99–49 shall not apply;
(B) The timely duplicate filing require-
ment in section 6.02(2) of Rev. Proc.
99–49 shall not apply; and
(C) If the method of accounting for de-
termining premiums earned is an issue
under consideration within the meaning
of section 3.09 of Rev. Proc. 99–49 as of
January 5, 2000, then section 7.01 of Rev.
Proc. 99–49 shall not apply.
(12) Effective date. Paragraphs (a)(3)
through (a)(11) of this section are applica-
ble with respect to the determination of
premiums earned for taxable years begin-
ning after December 31, 1999.
* * * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved December 23, 1999.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on Janu-
ary 5, 2000, 8:45 a.m., and published in the issue of
the Federal Register for January 6, 2000, 65 F.R.
701)
2000–4 I.R.B.373January 24, 2000
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Section 1441.—Withholding of
Tax on Nonresident Aliens
26 CFR 1.1441–10: Recharacterizing financing
arrangements involving fast-pay stock.
See T.D. 8853 on page 377
Section 4251.—Imposition of
Ta x
26 CFR 49.4251–4: Prepaid telephone cards.
T.D. 8855
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 49 and 602
Communications Excise Tax;
Prepaid Telephone Cards
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations relating to the applica-
tion of the communications excise tax to
prepaid telephone cards (PTCs). The reg-
ulations implement certain changes made
by the Taxpayer Relief Act of 1997. They
affect certain telecommunications carri-
ers, resellers, and purchasers of PTCs.
DATES: Effective Dates: These regula-
tions are effective January 7, 2000.
Applicability Dates: For the date of ap-
plicability, see §49.4251–4(f).
FOR FURTHER INFORMATION CON-
TACT: Bernard H. Weberman (202) 622-
3130 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
approved by the Office of Management
and Budget in accordance with the Paper-
work Reduction Act (44 U.S.C. 3507)
under control number 1545-1628. Re-
sponses to this collection of information
are required to obtain a tax benefit.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.
The estimated average burden per re-
spondent is 0.25 hour. The estimated av-
erage annual burden per recordkeeper is
1.2 hours.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224, and to the Office
of Management and Budget, Attn: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC 20503.
Books or records relating to this collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
On December 17, 1998, a notice of pro-
posed rulemaking (REG–118620–97,
1999–9 I.R.B. 46) was published in the Fed-
eral Register(63 FR 69585). Three written
comments were received but no hearing was
held because no requests to speak were re-
ceived. The proposed regulations are
adopted as revised by this Treasury decision.
The principal concerns of the com-
menters related to the rules for determining
the face amount of an untariffed unit card
transferred to a transferee reseller. The pro-
posed regulations provide that the face
amount can be determined by reference to
actual retail sales by the carrier, by reference
to the price at which the PTC is sold to the
transferee reseller, or by reference to the
minutes of domestic communications ser-
vice provided by the PTC. One commenter
requested additional explanation of the basis
for these rules. Another suggested that in
many situations, particularly in the case of
high-denomination (for example, multi-
hour) PTCs, none of the proposed methods
for determining the face amount will accu-
rately reflect the true retail value of the
PTC. This commenter also suggested that if
a carrier can substantiate the actual retail
price of a PTC it should have the option of
treating that price as the face amount.
The final regulations modify the rules re-
lating to untariffed unit cards in three re-
spects. First, they clarify that when the face
amount is determined by reference to actual
retail sales by the carrier, the retail sales
taken into account are sales of PTCs that
provide the same type and amount of com-
munications service. The final regulations
also modify the markup percentage used
when the face amount is determined by ref-
erence to the price at which the carrier sells
the PTC to the transferee reseller. The pro-
posed regulations apply a markup of 65
percent. Under the final regulations, the
markup is reduced to 35 percent to corre-
spond more closely to markups in the retail
sector generally. Lastly, the final regula-
tions modify the rule for determining the
face amount by reference to the minutes of
domestic communications service provided
by the PTC. The proposed regulations pro-
vide that the face amount may be deter-
mined by multiplying the number of min-
utes by a flat $0.30 per-minute rate. As
noted in the comments, however, a high-de-
nomination PTC generally provides lower
cost service on a per-minute basis than an
otherwise equivalent low- denomination
PTC. Accordingly, the final regulations
provide that the per-minute rate used to de-
termine face amount is reduced from $0.30
per minute to $0.20 per minute as the
amount of domestic communications ser-
vice provided by a PTC increases from 40
to 240 minutes.
For sales to transferee resellers, the final
regulations do not permit carriers that can
substantiate the actual retail price of a PTC
to use that price as the face amount. The
IRS and Treasury Department believe that
the modifications to the methods for deter-
mining face amount address concerns that
the prescribed methods may overstate the
face amount. Moreover, a system based on
the actual retail sale price when the retail
sale is made by a person other than the car-
rier could prove very difficult for the IRS to
administer because of the difficulty of veri-
fying the prices at which PTCs are sold by
large numbers of small retailers that may
have acquired the PTCs indirectly through
one or more transferee resellers.
Commenters also suggested that state
and local taxes should be excluded from the
face amount even if they are not separately
stated. In general, the comments propose
an exclusion based on the average amount
of state and local taxes imposed on the car-
rier’s PTCs. These suggestions were not
adopted. Section 4254(c) excludes from
the section 4251 tax base only those state
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and local taxes that are imposed on the sale
or furnishing of communications services
and that are separately stated in the bill. A
tax that is not separately stated (because,
for example, it is imposed after the taxable
sale of the PTC and its amount is not
known at the time of the sale) does not
qualify for this exclusion.
The regulations apply to PTCs trans-
ferred by carriers in calendar quarters be-
ginning after January 7, 2000. Carriers
and transferees may, however, rely on the
regulations in determining the tax treat-
ment of PTCs transferred in quarters be-
ginning on or before that date.
Special Analyses
It has been determined that this Treasury
decision is not a significant regulatory ac-
tion as defined in Executive Order 12866.
Therefore, a regulatory assessment is not
required. It also has been determined that
section 553(b) of the Administrative Proce-
dure Act (5 U.S.C. chapter 5) does not
apply to these regulations. It is hereby cer-
tified that the collection of information in
these regulations will not have a significant
economic impact on a substantial number
of small entities. This certification is based
on the fact that the time required to prepare
or retain the notification is minimal and
will not have a significant impact on those
small entities that are required to provide
notification. Furthermore, notification is
provided only once to each seller. Accord-
ingly, a Regulatory Flexibility Analysis
under the Regulatory Flexibility Act (5
U.S.C. chapter 6) is not required. Pursuant
to section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Drafting Information
The principal author of these regulations
is Bernard H. Weberman, Office of Assis-
tant Chief Counsel (Passthroughs and Spe-
cial Industries). However, other personnel
from the IRS and Treasury Department par-
ticipated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 49 and 602
are amended as follows:
PART 49—FACILITIES AND
SERVICES EXCISE TAXES
Paragraph 1. The authority citation for
part 49 is revised to read as follows:
Authority: 26 U.S.C. 7805.
Section 49.4251–4 also issued under 26
U.S.C. 4251(d).
Par. 2. Section 49.4251–4 is added to
read as follows:
§49.4251–4 Prepaid telephone cards.
(a)In general. In the case of communi-
cations services acquired by means of a
prepaid telephone card (PTC), the face
amount of the PTC is treated as an
amount paid for communications services
and that amount is treated as paid when
the PTC is transferred by any carrier to
any person that is not a carrier. This sec-
tion provides rules for the application of
the section 4251 tax to PTCs.
(b) Definitions. The following defini-
tions apply to this section:
Carriermeans a telecommunications
carrier as defined in 47 U.S.C. 153.
Comparable PTCmeans a currently
available dollar card or tariffed unit card
(other than a PTC transferred in bulk or
under special circumstances, such as for
promotional purposes) that provides the
same type and amount of communications
services as the PTC to which it is being
compared.
Dollar cardmeans a PTC the value of
which is designated by the carrier in dol-
lars (even if also designated in units of
service), provided that the designated
value is not less than the amount for
which the PTC is expected to be sold to a
holder.
Holdermeans a person that purchases
other than for resale.
Prepaid telephone card (PTC) means a
card or similar arrangement that permits
its holder to obtain a fixed amount of
communications services by means of a
code (such as a personal identification
number (PIN)) or other access device pro-
vided by the carrier and to pay for those
services in advance.
Tariffmeans a schedule of rates and
regulations filed by a carrier with the Fed-
eral Communications Commission.
Tariffed unit card means a unit card
that is transferred by a carrier—
(1) To a holder at a price that does not
exceed the designated number of units on
the PTC multiplied by the carrier’s tar-
iffed price per unit; or
(2) To a transferee reseller subject to a
contractual or other arrangement under
which the price at which the PTC is sold
to a holder will not exceed the designated
number of units on the PTC multiplied by
the carrier’s tariffed price per unit.
Transfereemeans the first person that
is not a carrier to whom a PTC is trans-
ferred by a carrier.
Transferee resellermeans a transferee
that purchases a PTC for resale.
Unit cardmeans a PTC other than a
dollar card.
Untariffed unit cardmeans a unit card
other than a tariffed unit card.
(c)Determination of face amount—(1)
Dollar card.The face amount of a dollar
card is the designated dollar value.
(2) Tariffed unit card. The face amount
of a tariffed unit card is the designated
number of units on the PTC multiplied by
the tariffed price per unit.
(3) Untariffed unit card—(i) Transfer
to holder. The face amount of an untar-
iffed unit card transferred by a carrier to a
holder is the amount for which the carrier
sells the PTC to the holder.
(ii) Transfer to transferee reseller—(A)
In general. The face amount of an untar-
iffed unit card transferred by a carrier to a
transferee reseller is at the option of the
carrier—
(1) The highest amount for which the
carrier sells a PTC that provides the same
type and amount of communications ser-
vices to a holder that ordinarily would not
be expected to buy more than one such
PTC at a time (if the carrier makes such
sales on a regular and arm’s-length basis)
or the face amount of a comparable PTC
(if the carrier does not make such sales on
a regular and arm’s-length basis);
(2) 135 percent of the amount for
which the carrier sells the PTC to the
transferee reseller (including in that
amount, in addition to any sum certain
fixed at the time of the sale, any contin-
gent amount per unit multiplied by the
designated number of units on the PTC);
or
(3) If the PTC is of a type that ordinar-
ily is used entirely for domestic commu-
nications service, the maximum number
of minutes of domestic communications
service on the PTC multiplied by the ap-
plicable rate.
(B)Applicable rate. The applicable
rate under paragraph (c)(3)(ii)(A)(3) of
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this section with respect to a PTC is $0.30
reduced (but not below $0.20) by $0.01
for each full 20 minutes by which the
maximum number of minutes of domestic
communications service on the PTC ex-
ceeds 40 minutes.
(C) Sales not at arm’s length. In the
case of a transfer of an untariffed unit
card by a carrier to a transferee reseller
otherwise than through an arm’s-length
transaction, the fair market retail value of
the PTC shall be substituted for the
amount determined in paragraph
(c)(3)(ii)(A)(2) of this section.
(4) Exclusion.The amount of any state
or local tax imposed on the furnishing or
sale of communications services that is
separately stated in the bill or on the face
of the PTC and the amount of any section
4251 tax separately stated in the bill or on
the face of the PTC are disregarded in de-
termining, for purposes of this paragraph
(c), the amount for which a PTC is sold.
(d) Liability for tax—(1) In general.
Under section 4251(d), the section
4251(a) tax is imposed on the transfer of a
PTC by a carrier to a transferee. The per-
son liable for the tax is the transferee. Ex-
cept as provided in paragraph (d)(2) of
this section, the person responsible for
collecting the tax is the carrier transfer-
ring the PTC to the transferee. If a holder
purchases a PTC from a transferee re-
seller, the amount the holder pays for the
PTC is not treated as an amount paid for
communications services and thus tax is
not imposed on that payment.
(2) Effect of statement that purchaser is a
carrier—(i) On transferor. A carrier that
transfers a PTC to a purchaser is not re-
sponsible for collecting the tax if, at the
time of transfer, the transferor carrier has
received written notification from the pur-
chaser that the purchaser is a carrier, and
the transferor has no reason to believe oth-
erwise. The notification to be provided by
the purchaser is a statement, signed under
penalties of perjury by a person with au-
thority to bind the purchaser, that the pur-
chaser is a carrier (as defined in paragraph
(b) of this section). The statement is not re-
quired to take any particular form.
(ii) On purchaser. If a purchaser that is
not a carrier provides the notification de-
scribed in paragraph (d)(2)(i) of this sec-
tion to the carrier that transfers a PTC, the
purchaser remains liable for the tax im-
posed on the transfer of the PTC.
(3) Exemptions. Any exemptions avail-
able under section 4253 apply to the
transfer of a PTC from a carrier to a
holder. Section 4253 does not apply to
the transfer of a PTC from a carrier to a
transferee reseller.
(e) Examples.The following examples
illustrate the provisions of this section:
Example 1. Unit card; sold to individual.(i) On
May 1, 2000, A, a carrier, sells a card it calls a pre-
paid telephone card at A’s retail store to P, an indi-
vidual, for P’s use in making telephone calls. A pro-
vides P with a PIN. The value of the card is not
denominated in dollars, but the face of the card is
marked 30 minutes. The sales price is $9. A tariff
has not been filed for the minutes on the card. The
toll telephone service acquired by purchasing the
card will be obtained by entering the PIN and the
telephone number to be called.
(ii) Because P purchased from a carrier other than
for resale, P is a holder. The card provides its
holder, P, with a fixed amount of communications
services (30 minutes of toll telephone service) to be
obtained by means of a PIN, for which P pays in ad-
vance of obtaining service; therefore, the card is a
PTC. Because the value of the PTC is not desig-
nated in dollars and a tariff has not been filed for the
minutes on the PTC, the PTC is an untariffed unit
card. Because it is transferred by the carrier to the
holder, the face amount is the sales price ($9).
(iii) The card is a PTC; thus, under section
4251(d), the face amount is treated as an amount
paid for communications services and that amount is
treated as paid when the PTC is transferred from A
to P. Accordingly, at the time of transfer, P is liable
for the 3 percent tax imposed by section 4251(a).
The amount of the tax is $0.27 (3% x the $9 face
amount). Thus, the total paid by P is $9.27, the $9
sales price plus $0.27 tax. A is responsible for col-
lecting the tax from P.
Example 2. Unit card; given to individual. (i) The
facts are the same as in Example 1, except that instead
of selling a card, A gives a 30 minute card to P.
(ii) Although the card provides P with a fixed
amount of communications services (30 minutes of
toll telephone service) to be obtained by means of a
PIN, P does not pay for the service. Therefore, the
card is not a PTC, even though it is called a prepaid
telephone card by A.
(iii) Because the card is not a PTC, section
4251(d) does not apply. Furthermore, no tax is im-
posed by section 4251(a) because no amount is paid
for the communications services.
Example 3. Unit card; adding value.(i) After
using the card described inExample 2, P arranges
with A by telephone to have 30 minutes of toll tele-
phone service added to the card. The sales price is
$9. P is told to continue using the PIN provided
with the card.
(ii) Because P purchased from a carrier other than
for resale, P is a holder. The arrangement provides
its holder, P, with a fixed amount of communications
services (30 minutes of toll telephone service) to be
obtained by means of a PIN, for which P pays in ad-
vance of obtaining service; therefore, the arrange-
ment is a PTC. Because the value of the PTC is not
designated in dollars and a tariff has not been filed
for the minutes on the PTC, the PTC is an untariffed
unit card. Because it is transferred by the carrier to
the holder, the face amount is the sales price ($9).
(iii) The arrangement is a PTC; thus, under sec-
tion 4251(d), the face amount is treated as an
amount paid for communications services and that
amount is treated as paid when the PTC is trans-
ferred from A to P. Accordingly, at the time of trans-
fer, P is liable for the 3 percent tax imposed by sec-
tion 4251(a). The amount of the tax is $0.27 (3% x
the $9 face amount). Thus, the total paid by P is
$9.27, the $9 sales price plus $0.27 tax. A is respon-
sible for collecting the tax from P.
Example 4. Dollar card; sold other than for re-
sale. (i) On May 1, 2000, B, a carrier, sells 100,000
cards it calls prepaid telephone cards to Q, an auto
dealer, for $50,000. Q will give away a card to each
person that visits Q’s dealership. B provides Q with
a PIN for each card. The face of each card is marked
$3. The toll telephone service acquired by purchas-
ing the card will be obtained by entering the PIN and
the telephone number to be called.
(ii) Because Q purchased from a carrier other
than for resale, Q is a holder. Each card provides its
holder, Q, with a fixed amount of communications
services ($3 of toll telephone service) to be obtained
by means of a PIN, for which Q pays in advance of
obtaining service; therefore, each card is a PTC even
though Q’s visitors do not pay for the cards. The
value of each PTC is designated in dollars; there-
fore, each PTC is a dollar card. Because the PTC is
a dollar card, the face amount is the designated dol-
lar value ($3).
(iii) The cards are PTCs; thus, under section
4251(d), the face amount is treated as an amount paid
for communications services and that amount is
treated as paid when the PTCs are transferred from B
to Q. Accordingly, at the time of transfer, Q is liable
for the 3 percent tax imposed by section 4251(a).
The amount of the tax is $9,000 (3% x the $3 face
amount x 100,000 PTCs). Thus, the total paid by Q
is $59,000, the $50,000 sales price plus $9,000 tax.
B is responsible for collecting the tax from Q.
Example 5. Tariffed unit card; sold to transferee
reseller.(i) On May 1, 2000, C, a carrier, sells 1,000
cards it calls prepaid telephone cards to R, a conve-
nience store owner, for $7,000. C provides R with a
PIN for each card. The value of the cards is not de-
nominated in dollars, but the face of each card is
marked 30 minutes and a tariff of $0.33 per minute
has been filed for the minutes on each card. R
agrees that it will sell the cards to individuals for
their own use and at a price that does not exceed
$0.33 per minute. R actually sells the cards for $9
each (that is, at a price equivalent to $0.30 per
minute). The toll telephone service acquired by pur-
chasing the card will be obtained by entering the
PIN and the telephone number to be called.
(ii) Because R purchased from a carrier for re-
sale, R is a transferee reseller. Because R’s cus-
tomers will purchase other than for resale, they will
be holders. Each card sold by R provides its holder,
R’s customer, with a fixed amount of communica-
tions services (30 minutes of toll telephone service)
to be obtained by means of a PIN provided by the
carrier, for which R’s customer pays in advance of
obtaining service; therefore, each card is a PTC. Be-
cause the value of each PTC is not designated in dol-
lars and C sells the PTCs to R subject to an arrange-
ment under which the price at which the PTCs are
sold to holders will not exceed the designated num-
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ber of minutes on the PTC multiplied by C’s tariffed
price per minute, each PTC is a tariffed unit card.
Because the PTCs are tariffed unit cards, the face
amount of each PTC is $9.90, the designated num-
ber of minutes on the PTC multiplied by the tariffed
price per minute (30 x $0.33), even though the retail
sale price of each card is $9.
(iii) The cards are PTCs; thus, under section
4251(d), the face amount is treated as an amount
paid for communications services and that amount is
treated as paid when the PTC is transferred from C
to R. Accordingly, at the time of transfer, R is liable
for the 3 percent tax imposed by section 4251(a).
The amount of the tax is $297 (3% x the $9.90 face
amount x 1,000 PTCs). Thus, the total paid by R is
$7,297, the $7,000 sales price plus $297 tax. C is re-
sponsible for collecting the tax from R.
Example 6. Unit card; sold to transferee reseller.
(i) On May 1, 2000, D, a carrier, sells 10,000 cards it
calls prepaid telephone cards to S, a convenience
store owner, for $60,000. D provides S with a PIN
for each card. The value of the cards is not denomi-
nated in dollars, but the face of each card is marked
30 minutes. A tariff has not been filed for the min-
utes on each card. S will sell the cards to individuals
for their own use for $9 each. D also sells a card that
provides 30 minutes of the same type of communi-
cations service at its retail store for $9. The toll tele-
phone service acquired by purchasing the card will
be obtained by entering the PIN and the telephone
number to be called.
(ii) Because S purchased from a carrier for resale,
S is a transferee reseller. Because S’s customers will
purchase other than for resale, they will be holders.
Each card sold by S provides its holder, S’s cus-
tomer, with a fixed amount of communications ser-
vices (30 minutes of toll telephone service) to be ob-
tained by means of a PIN provided by the carrier, for
which S’s customer pays in advance of obtaining
service; therefore, each card is a PTC. Because the
value of each PTC is not designated in dollars and a
tariff has not been filed for the minutes on the PTC,
each PTC is an untariffed unit card.
(iii) The PTCs are untariffed unit cards trans-
ferred by the carrier to a transferee reseller. Thus,
the face amount is determined under paragraph
(c)(3)(ii) of this section, which permits D to choose
from three alternative methods. Under paragraph
(c)(3)(ii)(A)(1
) of this section, the face amount of
each PTC would be $9, the highest amount for
which D sells to holders purchasing a single PTC.
Alternatively, under paragraph (c)(3)(ii)(A)(2) of
this section, the face amount of each PTC would be
$8.10, computed as follows: 135% x the $60,000
sales price â 10,000 PTCs. Finally, under paragraph
(c)(3)(ii)(A)(3) of this section (assuming the PTCs
are of a type that ordinarily is used entirely for do-
mestic communications services), the face amount
of each PTC would be $9 ($0.30 x 30 minutes).
(iv) The cards are PTCs; thus, under section
4251(d), the face amount is treated as an amount
paid for communications services and that amount is
treated as paid when the PTCs are transferred from
D to S. Accordingly, at the time of transfer, S is li-
able for the 3 percent tax imposed by section
4251(a). Assuming that D chooses to determine the
face amount as provided in paragraph
(c)(3)(ii)(A)(2
) of this section, the amount of the tax
is $2,430 (3% x the $8.10 face amount x 10,000
PTCs). Thus, the total paid by S is $62,430, the
$60,000 sales price plus $2,430 tax. D is responsi-
ble for collecting the tax from S.
Example 7. Transfer of card that is not a PTC.
(i) On May 1, 2000, E, a carrier, provides a tele-
phone card to T, an individual, for T’s use in making
telephone calls. E provides T with a PIN. The card
provides access to an unlimited amount of commu-
nications services. E charges T $0.25 per minute of
service, and bills T monthly for services used. The
communications services acquired by using the card
will be obtained by entering the PIN and the tele-
phone number to be called.
(ii) Although the communications services will
be obtained by means of a PIN, T does not receive a
fixed amount of communications services. Also, T
cannot pay in advance since the amount of T’s pay-
ment obligation depends upon the number of min-
utes used. Therefore, the card is not a PTC.
(iii) Because the card is not a PTC, section
4251(d) does not apply. However, the 3 percent tax
imposed by section 4251(a) applies to the amounts
paid by T to E for the communications services. Ac-
cordingly, at the time an amount is paid for commu-
nications services, T is liable for tax. E is responsi-
ble for collecting the tax from T.
(f) Effective date. This section is ap-
plicable with respect to PTCs transferred
by a carrier on or after the first day of the
first calendar quarter beginning after Jan-
uary 7, 2000.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 3. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 4. In §602.101, paragraph (b) is
amended by adding an entry in numerical
order to the table to read as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
John M. Dalrymple,
Acting Deputy Commissioner
of Internal Revenue.
Approved December 13, 1999.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on Janu-
ary 6, 2000, 8:45 a.m., and published in the issue of
the Federal Register for January 7, 2000, 65 F.R.
1056)
2000–4 I.R.B.377January 24, 2000
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
49.4251–4(d)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1628
* * * * *
Section 7701.—Definitions
26 CFR 1.7701(l)–3: Recharacterizing financing
arrangements involving fast-pay stock.
T.D. 8853
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Recharacterizing Financing
Arrangements Involving Fast-
pay Stock
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations that recharacterize, for
tax purposes, financing arrangements in-
volving fast-pay stock. The regulations
are necessary to prevent taxpayers from
using fast-pay stock to achieve inappro-
priate tax avoidance. The regulations af-
fect corporations that issue fast-pay stock,
holders of fast-pay stock, and other share-
holders that may claim tax benefits pur-
ported to result from arrangements in-
volving fast-pay stock.
DATES: Effective Date: February 27,
1997.
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Applicability Dates:For dates of ap-
plicability, see sections 1.1441–10(e) and
1.7701(l)–3(g) of these regulations.
FOR FURTHER INFORMATION CON-
TACT: Jonathan Zelnik, (202) 622-3920
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in these final regulations has been
reviewed and approved by the Office of
Management and Budget in accordance
with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)) under control
number 1545-1642. Responses to this
collection of information are mandatory.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.
The estimated average annual burden
hours per respondent/recordkeeper: 1
hour.
Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to the
Internal Revenue Service, Attn: IRS Re-
ports Clearance Officer, OP:FS:FP, Wash-
ington, DC 20224, and to the Office of
Management and Budget, Attn: Desk
Officer for the Department of the Trea-
sury, Office of Information and Regula-
tory Affairs, Washington, DC 20503.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax information are confidential, as re-
quired by 26 U.S.C. 6103.
Background
On February 27, 1997, the IRS issued
Notice 97–21, 1997–1 C.B. 407, which
relates to financing arrangements involv-
ing fast-pay stock. Among other things,
the notice informed the public that the
IRS and Treasury Department expected to
issue regulations recharacterizing these
arrangements to prevent tax avoidance.
No comments were received in response
to Notice 97–21.
On January 6, 1999, the IRS published
in the Federal Registera notice of pro-
posed rulemaking (REG–104072–97,
1999–11 I.R.B. 12 [64 F.R. 805]) provid-
ing rules for the recharacterization of cer-
tain fast-pay arrangements under section
7701(l) of the Internal Revenue Code.
Because no one requested to speak at the
public hearing, the hearing was canceled.
Four written comments responding to the
notice of proposed rulemaking were re-
ceived. The comments addressed neither
(1) the accuracy of the estimate of the col-
lection of information burden nor (2) the
accuracy of the IRS’s understanding that
the total number of entities engaging in
transactions affected by these regulations
is not substantial and most are not small
entities within the meaning of the Regula-
tory Flexibility Act (5 U.S.C. chapter 6).
After considering the comments, the pro-
posed regulations are adopted as final reg-
ulations with some changes.
The preamble to the proposed regula-
tions (64 FR 805) provides a detailed dis-
cussion of fast-pay arrangements and the
proposed regulations.
SUMMARY OF COMMENTS AND
CHANGES
In General
Two commentators were generally fa-
vorable to the proposed regulations. One
considered them a reasonable attempt to
address abusive transactions. The other
viewed them as consistent with section
7701(l), but preferred, as a matter of tax
policy, a legislative solution. One of these
commentators also recommended narrow-
ing the scope of the proposed regulations,
asserting they might penalize shareholders
who do not benefit from the fast-pay
arrangement. Significantly, neither of these
commentators recommended that the final
regulations adopt a different approach, such
as the one taken in Notice 97–21.
A third commentator criticized the pro-
posed regulations as inconsistent with
section 7701(l). This commentator
viewed them as addressing not a conduit
financing issue, but a tax accounting
issue, namely, that the amount of dividend
income under tax principles can exceed
the economic income from the stock. Ad-
ditionally, this commentator believed that
regulations under section 7701(l) cannot
operate if there is no back-to-back struc-
ture or if the corporation subject to
recharacterization holds bona fide assets
such as third-party debt. Finally, the com-
mentator questioned whether the grant of
regulatory authority under section 7701(l)
permits recharacterizing transactions sub-
ject to other, comprehensive statutory
rules such as the rules governing the
transactions of RICs and REITs.
The IRS and Treasury Department have
concluded that section 7701(l) authorizes
recharacterization of any multiple-party
financing transaction, including a fast-pay
arrangement. The IRS and Treasury De-
partment have also concluded (as did the
other two commentators) that recharacter-
izing a fast-pay arrangement as an
arrangement directly between the fast-pay
shareholders and the benefited sharehold-
ers is consistent with the legislative man-
date of section 7701(l). Thus, the final
regulations retain the approach of the pro-
posed regulations while making some
changes to address other comments.
Definition of Fast-pay Stock
Under the proposed regulations, stock is
fast-pay stock if it is structured so that div-
idends (as defined in section 316) paid by
the corporation with respect to the stock
are economically (in whole or in part) a re-
turn of the holder’s investment (as opposed
to only a return on the holder’s invest-
ment). To determine if it is fast-pay stock,
stock is examined when issued, and, for
stock that is not fast-pay stock when is-
sued, when there is a significant modifica-
tion in the terms of the stock or the related
agreements or a significant change in the
relevant facts and circumstances.
Two commentators expressed concern
about the interaction of section 302 with
the definition of fast-pay stock and the
duty to retest stock. In particular, the
commentators asked whether stock that is
not fast-pay stock when issued can be-
come fast-pay stock solely because a re-
demption of the stock is treated as a divi-
dend under section 302. This conversion
is possible because section 302 treats cer-
tain redemptions as distributions of prop-
erty to which section 301 applies rather
than as distributions in exchange for
stock.
The commentators gave different rea-
sons why stock should not become fast-
pay stock solely because a redemption is
treated as a dividend. One reason was
that section 302 and the provisions refer-
ring to it (for example, section 1059(e))
already recharacterize certain redemp-
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tions of stock, which indicates Congress
has determined the appropriate tax treat-
ment of these transactions. Another rea-
son was that applying the fast-pay regula-
tions to arrangements involving
redemptions may have a chilling effect on
common, non-abusive transactions. Fi-
nally, it was suggested that any changes
affecting the application of section 302
should be accomplished by issuing new
regulations under that statute.
The IRS and Treasury Department
agree it is inappropriate to treat as a fast-
pay arrangement every arrangement in
which a redemption of stock produces
dividend income under section 302. The
IRS and Treasury Department, however,
conclude that eliminating all such
arrangements from the scope of the regu-
lations would render the regulations
meaningless. Little difference exists be-
tween a fast-pay arrangement resulting
from redemptions structured to be divi-
dends and a fast-pay arrangement result-
ing from dividends structured to be a re-
turn of the holder’s investment.
To balance the concerns of the com-
mentators and the concerns of the IRS and
Treasury Department, the final regula-
tions add a new rule clarifying the effect
of section 302 on the determination of
whether stock is fast-pay stock. Under
this rule, stock is not fast-pay stock solely
because a redemption is treated as a divi-
dend by section 302 unless there is a prin-
cipal purpose of achieving the same eco-
nomic and tax effect as a fast-pay
arrangement. In this way, only those
arrangements in which redemptions are
designed to return a shareholder’s eco-
nomic investment as dividends are rechar-
acterized. Because the problem of stock
redemptions may be common to many
different fast-pay arrangements, regard-
less of how they are structured, the rule
addressing such problem is placed within
the regulations under section 7701(l)
rather than under a different section.
Characterization of the Financing
Instruments
Under the proposed regulations, the
fast-pay shareholders are treated as hold-
ing financing instruments issued by the
benefited shareholders rather than as
holding the fast-pay stock. The character
of financing instruments (for example,
stock or debt) is determined under general
tax principles and depends on all the facts
and circumstances.
All three commentators were con-
cerned by the failure of the proposed reg-
ulations to classify the financing instru-
ments as debt. If the financing
instruments are classified as stock, the
benefited shareholders are subject to sub-
stantially greater tax liabilities: they must
include in income all dividends paid by
the corporation that issues the fast-pay
stock, but cannot deduct amounts deemed
paid with respect to the financing instru-
ments. According to the commentators,
this result distorts the benefited share-
holders’ economic income. Therefore,
the regulations should classify the financ-
ing instruments as debt in all cases.
After careful consideration of the com-
ments, the IRS and Treasury Department
have decided against characterizing the fi-
nancing instruments in the final regula-
tions. Although debt characterization
may be appropriate in some cases, in
other cases it will be more appropriate to
characterize the financing instruments as
equity or something else. Thus, the rule
in the proposed regulations is retained.
(As explained below, however, the final
regulations permit taxpayers, for a limited
period, to determine their taxable income
attributable to a recharacterized fast-pay
arrangement by treating the financing in-
struments as debt.)
Election to Limit Taxable Income
Attributable to a Recharacterized Fast-
pay Arrangement for Periods Before
April 1, 2000
Because the regulations are effective
February 27, 1997 (the date Notice
97–21 was issued to the public), the pro-
posed regulations permit a shareholder
of a recharacterized fast-pay arrange-
ment to limit, for certain taxable years,
its income from the arrangement.
Specifically, a shareholder may limit its
taxable income attributable to a rechar-
acterized fast-pay arrangement to the
taxable income that results if the fast-pay
arrangement is recharacterized under
Notice 97–21. This limit is available
under the proposed regulations for tax-
able years ending after the effective date
of the regulations and before the regula-
tions are finalized. Any amount ex-
cluded under this limit must be included
as an adjustment to taxable income in the
shareholder’s first taxable year that in-
cludes the date the regulations are final-
ized. Thus, the sole benefit of limiting
taxable income under the proposed regu-
lations is a timing benefit. The preamble
to the proposed regulations found this
appropriate on the assumption that over
the life of a fast-pay arrangement a
shareholder has the same amount of tax-
able income whether the fast-pay
arrangement is recharacterized under
Notice 97–21 or under the regulations.
One commentator criticized this as-
sumption, and, therefore, the limit and
later adjustment. In particular, the com-
mentator pointed out that if the financing
instruments are treated as equity under
the regulations, a benefited shareholder
would have had less taxable income over
the life of the fast-pay arrangement
under the recharacterization of Notice
97–21 (that is, a shareholder would have
a permanent reduction to taxable in-
come). Thus, the limit is without any
substantive effect because any non-tim-
ing reduction in taxable income due to
the limit is included in the year the regu-
lations are finalized. To rectify this
problem, the commentator asked that, if
the final regulations do not classify the
financing instruments as debt in all
cases, they should at least classify the fi-
nancing instruments as debt for the pe-
riod starting after the effective date of
the final regulations and ending before
the final regulations are published.
To address these concerns, the final
regulations adopt a different rule from the
one in the proposed regulations. As with
the proposed regulations, a shareholder
may limit its taxable income to either the
amount determined under Notice 97–21
or the amount determined under the regu-
lations. For purposes of this limit, a
shareholder may assume the financing in-
struments are debt under the final regula-
tions. A shareholder may also make this
assumption to determine the amount of
any later adjustment to income because of
the limit. Thus, the later adjustment will
not include any permanent reduction to
taxable income a shareholder realizes by
limiting its taxable income to the amount
determined under Notice 97–21.
The final regulations also adopt a
longer period during which shareholders
may limit their taxable income. Under
the proposed regulation, a shareholder
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may limit its taxable income for taxable
years ending after February 26, 1997, and
before the date these regulations are pub-
lished as final regulations in the Federal
Register. The final regulations permit a
shareholder to limit its taxable income for
all periods before April 1, 2000. Thus, for
all taxable years ending after February 26,
1997 and before April 1, 2000, and for
that part of a shareholder’s taxable year
before April 1, 2000, a shareholder may
limit its taxable income attributable to the
fast-pay arrangement.
In permitting shareholders to determine
their taxable income under the regulations
by assuming that the financing instru-
ments are debt for periods before April 1,
2000, the IRS and Treasury Department
intend no implication regarding the
proper characterization of the financing
instruments under general tax principles.
Rather, the rule regarding the financing
instruments is intended solely for the pur-
pose of giving shareholders the benefit of
the recharacterization described in Notice
97–21 for periods before April 1, 2000.
Use of Derivatives to Avoid the
Regulations
One commentator recommended
adding an explicit rule to prevent parties
from using derivative contracts to create a
fast-pay arrangement that escapes either
the regulations or the effect of the rechar-
acterization rules. To illustrate this point,
the commentator posited a simplified
transaction in which a corporation issues
fast-pay stock to one tax-exempt entity
and benefited stock to another tax-exempt
entity. The tax-exempt entity holding the
benefited stock enters into a prepaid for-
ward contract with a taxable person.
Under the prepaid forward contract, the
taxable person must buy the benefited
stock in the future for an amount substan-
tially below its expected value. Accord-
ing to the commentator, unless the taxable
person is treated as owning the benefited
stock, the parties have created a fast-pay
arrangement in which the recharacteriza-
tion of the regulations fails to prevent tax
avoidance. Without making a recommen-
dation, the commentator offered a number
of rules to correct this situation. (The
commentator did not discuss whether the
benefited holder would be subject to the
“debt-financing” rules in section 514).
The IRS and Treasury Department have
concluded that there is no present need to
modify the regulations to address this
problem. First, the tax treatment of deriv-
atives in general is outside of the scope of
these regulations. Therefore, a rule spe-
cific to these regulations would only in-
crease the complexity regarding the tax
treatment of derivatives. Second, and
more importantly, the IRS and Treasury
Department have concluded that under
existing law the party entitled to purchase
the benefited stock under a prepaid for-
ward contract such as the one described
above is the owner of the benefited stock
for federal income tax purposes. SeeRev.
Rul. 82–150, 1982–2 C.B. 110 (conclud-
ing that the holder of a deep-in-the-
money option is the owner of the refer-
ence property). Finally, the regulations
state they are to be interpreted in a man-
ner consistent with preventing the avoid-
ance of tax. Mechanically applying the
regulations in a manner that does not pre-
vent tax avoidance is clearly inconsistent
with the purpose of the regulations and
the Congressional mandate of section
7701(l).
Fast-pay Arrangement Defined
The proposed regulations define a fast-
pay arrangement as any arrangement in
which a corporation has outstanding for
any part of its taxable year two or more
classes of stock, at least one of which is
fast-pay stock. Some taxpayers assert
that the regulations can be avoided by cre-
ating a fast-pay arrangement in which a
corporation issues what is nominally a
single class of shares, notwithstanding
that some of the shares are subject to a re-
lated agreement. These taxpayers appar-
ently rely on the formal meaning of
“class” under state corporate law and ig-
nore the direction in the proposed regula-
tions to determine whether stock is fast-
pay stock based on all the facts and
circumstances.
To remove any doubt that the regula-
tions cover fast-pay arrangements no mat-
ter how contrived, the IRS and Treasury
Department have simplified the definition
of “fast-pay arrangement” in the final reg-
ulations. Under this definition, a fast-pay
arrangement is any arrangement in which
a corporation has fast-pay stock outstand-
ing for any part of its taxable year. The
regulations illustrate this point with an ex-
ample.
Effective Date
These regulations apply to taxable
years ending after February 26, 1997.
Special Analyses
It has been determined that this Trea-
sury decision is not a significant regula-
tory action as defined in Executive Order
12866. Therefore, a regulatory assess-
ment is not required. It is hereby certified
that these regulations will not have a sig-
nificant economic impact on a substantial
number of small entities. This certifica-
tion is based on the understanding of the
IRS and Treasury Department that the
total number of fast-pay arrangements is
fewer than 100, that the number of enti-
ties engaging in transactions affected by
these regulations is not substantial and, of
those entities, few or none are small enti-
ties within the meaning of the Regulatory
Flexibility Act (5 U.S.C. chapter 6).
Therefore, a Regulatory Flexibility
Analysis is not required. Pursuant to sec-
tion 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was submit-
ted to the Chief Counsel for Advocacy of
the Small Business Administration for
comments on its impact on small busi-
nesses.
Drafting Information
The principal authors of these regula-
tions are Jonathan Zelnik and Marshall
Feiring of the Office of the Assistant
Chief Counsel (Financial Institutions &
Products). However, other personnel
from the IRS and Treasury Department
participated in their development.
* * * * *
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by adding an entry in
numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.7701(l)–3 also issued under
26 U.S.C. 7701(l). * * *
Par. 2. Section 1.1441–10, is added to
read as follows:
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§1.1441–10 Withholding agents with re-
spect to fast-pay arrangements.
(a) In general. A corporation that is-
sues fast-pay stock in a fast-pay arrange-
ment described in §1.7701(l)–3(b)(1) is a
withholding agent with respect to pay-
ments made on the fast-pay stock and
payments deemed made under the rechar-
acterization rules of §1.7701(l)–3. Except
as provided in this paragraph (a) or in
paragraph (b) of this section, the with-
holding tax rules under section 1441 and
section 1442 apply with respect to a fast-
pay arrangement described in
§1.7701(l)–3(c)(1)(i) in accordance with
the recharacterization rules provided in
§1.7701(l)–3(c). In all cases, notwith-
standing paragraph (b) of this section, if
at any time the withholding agent knows
or has reason to know that the Commis-
sioner has exercised the discretion under
either §1.7701(l)–3(c)(1)(ii) to apply the
recharacterization rules of
§1.7701(l)–3(c), or §1.7701(l)–3(d) to de-
part from the recharacterization rules of
§1.7701(l)–3(c) for a taxpayer, the with-
holding agent must withhold on payments
made (or deemed made) to that taxpayer
in accordance with the characterization of
the fast-pay arrangement imposed by the
Commissioner under §1.7701(l)–3.
(b) Exception.If at any time the with-
holding agent knows or has reason to
know that any taxpayer entered into a
fast-pay arrangement with a principal pur-
pose of applying the recharacterization
rules of §1.7701(l)–3(c) to avoid tax
under section 871(a) or section 881, then
for each payment made or deemed made
to such taxpayer under the arrangement,
the withholding agent must withhold,
under section 1441 or section 1442, the
higher of—
(1) The amount of withholding that
would apply to such payment determined
under the form of the arrangement; or
(2) The amount of withholding that
would apply to deemed payments deter-
mined under the recharacterization rules
of §1.7701(l)–3(c).
(c) Liability. Any person required to
deduct and withhold tax under this section
is made liable for that tax by section
1461, and is also liable for applicable
penalties and interest for failing to com-
ply with section 1461.
(d) Examples. The following examples
illustrate the rules of this section:
Example 1. REIT W issues shares of fast-pay
stock to foreign individual A, a resident of Country
C. United States source dividends paid to residents
of C are subject to a 30 percent withholding tax. W
issues all shares of benefited stock to foreign indi-
viduals who are residents of Country D. D’s income
tax convention with the United States reduces the
United States withholding tax on dividends to 15
percent. Under §1.7701(l)–3(c), the dividends paid
by W to A are deemed to be paid by W to the bene-
fited shareholders. W has reason to know that A en-
tered into the fast-pay arrangement with a principal
purpose of using the recharacterization rules of
§1.7701(l)–3(c) to reduce United States withholding
tax. W must withhold at the 30 percent rate because
the amount of withholding that applies to the pay-
ments determined under the form of the arrangement
is higher than the amount of withholding that applies
to the payments determined under §1.7701(l)–3(c).
Example 2. The facts are the same as in Example
1of this paragraph (d) except that W does not know,
or have reason to know, that A entered into the
arrangement with a principal purpose of using the
recharacterization rules of §1.7701(l)–3(c) to reduce
United States withholding tax. Further, the Com-
missioner has not exercised the discretion under
§1.7701(l)–3(d) to depart from the recharacteriza-
tion rules of §1.7701(l)–3(c). Accordingly, W must
withhold tax at a 15 percent rate on the dividends
deemed paid to the benefited shareholders.
(e) Effective date. This section applies
to payments made (or deemed made) on
or after January 6, 1999.
Par. 3. Section 1.7701(l)–0 is added to
read as follows:
§1.7701(l)–0 Table of contents.
This section lists captions that appear
in §§1.7701(l)–1 and 1.7701(l)–3:
§1.7701(l)–1 Conduit financing arrange-
ments.
§1.7701(l)–3 Recharacterizing financing
arrangements involving fast-pay stock.
(a) Purpose and scope.
(b) Definitions.
(1) Fast-pay arrangement.
(2) Fast-pay stock.
(i) Defined.
(ii) Determination.
(3) Benefited stock.
(c) Recharacterization of certain fast-pay
arrangements.
(1) Scope.
(2) Recharacterization.
(i) Relationship between benefited share-
holders and fast-pay shareholders.
(ii) Relationship between benefited share-
holders and corporation.
(iii) Relationship between fast-pay share-
holders and corporation.
(3) Other rules.
(i) Character of the financing instruments.
(ii) Multiple types of benefited stock.
(iii) Transactions affecting benefited
stock.
(A) Sale of benefited stock.
(B) Transactions other than sales.
(iv) Adjustment to basis for amounts ac-
crued or paid in taxable years ending be-
fore February 27, 1997.
(d) Prohibition against affirmative use of
recharacterization by taxpayers.
(e) Examples.
(f) Reporting requirement.
(1) Filing requirements.
(i) In general.
(ii) Controlled foreign corporation.
(iii) Foreign personal holding company.
(iv) Passive foreign investment company.
(2) Statement.
(g) Effective date.
(1) In general.
(2) Election to limit taxable income attrib-
utable to a recharacterized fast-pay
arrangement for periods before April 1,
2000.
(i) Limit.
(ii) Adjustment and statement.
(iii) Examples.
(3) Rule to comply with this section.
(4) Reporting requirements.
Par. 4. Section 1.7701(l)–3 is added to
read as follows:
§1.7701(l)–3 Recharacterizing financing
arrangements involving fast-pay stock.
(a) Purpose and scope. This section is
intended to prevent the avoidance of tax
by persons participating in fast-pay
arrangements (as defined in paragraph
(b)(1) of this section) and should be inter-
preted in a manner consistent with this
purpose. This section applies to all fast-
pay arrangements. Paragraph (c) of this
section recharacterizes certain fast-pay
arrangements to ensure the participants
are taxed in a manner reflecting the eco-
nomic substance of the arrangements.
Paragraph (f) of this section imposes re-
porting requirements on certain partici-
pants.
(b) Definitions—(1) Fast-pay arrange-
ment. A fast-pay arrangement is any
arrangement in which a corporation has
fast-pay stock outstanding for any part of
its taxable year.
(2) Fast-pay stock—(i) Defined. Stock
is fast-pay stock if it is structured so that
dividends (as defined in section 316) paid
by the corporation with respect to the
stock are economically (in whole or in
part) a return of the holder’s investment
(as opposed to only a return on the
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holder’s investment). Unless clearly
demonstrated otherwise, stock is pre-
sumed to be fast-pay stock if—
(A) It is structured to have a dividend
rate that is reasonably expected to decline
(as opposed to a dividend rate that is rea-
sonably expected to fluctuate or remain
constant); or
(B) It is issued for an amount that ex-
ceeds (by more than a de minimis
amount, as determined under the princi-
ples of §1.1273–1(d)) the amount at
which the holder can be compelled to dis-
pose of the stock.
(ii) Determination. The determination
of whether stock is fast-pay stock is based
on all the facts and circumstances, includ-
ing any related agreements such as op-
tions or forward contracts. A related
agreement includes any direct or indirect
agreement or understanding, oral or writ-
ten, between the holder of the stock and
the issuing corporation, or between the
holder of the stock and one or more other
shareholders in the corporation. To deter-
mine if it is fast-pay stock, stock is exam-
ined when issued, and, for stock that is
not fast-pay stock when issued, when
there is a significant modification in the
terms of the stock or the related agree-
ments or a significant change in the rele-
vant facts and circumstances. Stock is not
fast-pay stock solely because a redemp-
tion is treated as a dividend as a result of
section 302(d) unless there is a principal
purpose of achieving the same economic
and tax effect as a fast-pay arrangement.
(3) Benefited stock. With respect to
any fast-pay stock, all other stock in the
corporation (including other fast-pay
stock having any significantly different
characteristics) is benefited stock.
(c) Recharacterization of certain fast-
pay arrangements— (1) Scope. This
paragraph (c) applies to any fast-pay
arrangement—
(i) In which the corporation that has
outstanding fast-pay stock is a regulated
investment company (RIC) (as defined in
section 851) or a real estate investment
trust (REIT) (as defined in section 856);
or
(ii) If the Commissioner determines
that a principal purpose for the structure
of the fast-pay arrangement is the avoid-
ance of any tax imposed by the Internal
Revenue Code. Application of this para-
graph (c)(1)(ii) is at the Commissioner’s
discretion, and a determination under this
paragraph (c)(1)(ii) applies to all parties
to the fast-pay arrangement, including
transferees.
(2) Recharacterization. A fast-pay
arrangement described in paragraph (c)(1)
of this section is recharacterized as an
arrangement directly between the bene-
fited shareholders and the fast-pay share-
holders. The inception and resulting rela-
tionships of the recharacterized
arrangement are deemed to be as follows:
(i) Relationship between benefited
shareholders and fast-pay shareholders.
The benefited shareholders issue financial
instruments (the financing instruments)
directly to the fast-pay shareholders in ex-
change for cash equal to the fair market
value of the fast-pay stock at the time of
issuance (taking into account any related
agreements). The financing instruments
have the same terms (other than issuer) as
the fast-pay stock. Thus, for example, the
timing and amount of the payments made
with respect to the financing instruments
always match the timing and amount of
the distributions made with respect to the
fast-pay stock.
(ii) Relationship between benefited
shareholders and corporation. The bene-
fited shareholders contribute to the corpo-
ration the cash they receive for issuing the
financing instruments. Distributions
made with respect to the fast-pay stock
are distributions made by the corporation
with respect to the benefited sharehold-
ers’ benefited stock.
(iii) Relationship between fast-pay
shareholders and corporation. For pur-
poses of determining the relationship be-
tween the fast-pay shareholders and the
corporation, the fast-pay stock is ignored.
The corporation is the paying agent of the
benefited shareholders with respect to the
financing instruments.
(3) Other rules—(i) Character of the fi-
nancing instruments. The character of a
financing instrument (for example, stock
or debt) is determined under general tax
principles and depends on all the facts and
circumstances.
(ii) Multiple types of benefited stock. If
any benefited stock has any significantly
different characteristics from any other
benefited stock, the recharacterization
rules of this paragraph (c) apply among
the different types of benefited stock as
appropriate to match the economic sub-
stance of the fast-pay arrangement.
(iii) Transactions affecting benefited
stock—(A) Sale of benefited stock. If one
person sells benefited stock to another—
(1) In addition to any consideration ac-
tually paid and received for the benefited
stock, the buyer is deemed to pay and the
seller is deemed to receive the amount
necessary to terminate the seller’s posi-
tion in the financing instruments at fair
market value; and
(2) The buyer is deemed to issue fi-
nancing instruments to the fast-pay share-
holders in exchange for the amount neces-
sary to terminate the seller’s position in
the financing instruments.
(B) Transactions other than sales. Ex-
cept for transactions subject to paragraph
(c)(3)(iii)(A) of this section, in the case of
any transaction affecting benefited stock,
the parties to the transaction must make
appropriate adjustments to properly take
into account the fast-pay arrangement as
characterized under paragraph (c)(2) of
this section.
(iv) Adjustment to basis for amounts
accrued or paid in taxable years ending
before February 27, 1997. In the case of
a fast-pay arrangement involving amounts
accrued or paid in taxable years ending
before February 27, 1997, and recharac-
terized under this paragraph (c), a bene-
fited shareholder must decrease its basis
in any benefited stock (as determined
under paragraph (c)(2)(ii) of this section)
by the amount (if any) that—
(A) Its income attributable to the bene-
fited stock (reduced by deductions attrib-
utable to the financing instruments) for
taxable years ending before February 27,
1997, computed by recharacterizing the
fast-pay arrangement under this para-
graph (c) and by treating the financing in-
struments as debt; exceeds
(B) Its income attributable to such
stock for taxable years ending before Feb-
ruary 27, 1997, computed without apply-
ing the rules of this paragraph (c).
(d) Prohibition against affirmative use
of recharacterization by taxpayers. A tax-
payer may not use the rules of paragraph
(c) of this section if a principal purpose
for using such rules is the avoidance of
any tax imposed by the Internal Revenue
Code. Thus, with respect to such tax-
payer, the Commissioner may depart from
the rules of this section and recharacterize
(for all purposes of the Internal Revenue
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Code) the fast-pay arrangement in accor-
dance with its form or its economic sub-
stance. For example, if a foreign person
acquires fast-pay stock in a REIT and a
principal purpose for acquiring such stock
is to reduce United States withholding
taxes by applying the rules of paragraph
(c) of this section, the Commissioner may,
for purposes of determining the foreign
person’s United States tax consequences
(including withholding tax), depart from
the rules of paragraph (c) of this section
and treat the foreign person as holding
fast-pay stock in the REIT.
(e) Examples. The following examples
illustrate the rules of paragraph (c) of this
section:
Example 1. Decline in dividend rate—(i) Facts.
Corporation X issues 100 shares of A Stock and 100
shares of B Stock for $1,000 per share. By its terms,
a share of B Stock is reasonably expected to pay a
$110 dividend in years 1 through 10 and a $30 divi-
dend each year thereafter. If X liquidates, the holder
of a share of B Stock is entitled to a preference equal
to the share’s issue price. Otherwise, the B Stock
cannot be redeemed at either X’s or the share-
holder’s option.
(ii) Analysis. When issued, the B Stock has a
dividend rate that is reasonably expected to decline
from an annual rate of 11 percent of its issue price to
an annual rate of 3 percent of its issue price. Since
the B Stock is structured to have a declining divi-
dend rate, the B Stock is fast-pay stock, and the A
Stock is benefited stock.
Example 2. Issued at a premium—(i) Facts. The
facts are the same as in Example 1of this paragraph
(e) except that a share of B Stock is reasonably ex-
pected to pay an annual $110 dividend as long as it
is outstanding, and Corporation X has the right to re-
deem the B Stock for $400 a share at the end of year
10.
(ii) Analysis. The B Stock is structured so that
the issue price of the B Stock ($1,000) exceeds (by
more than a de minimis amount) the price at which
the holder can be compelled to dispose of the stock
($400). Thus, the B Stock is fast-pay stock, and the
A Stock is benefited stock.
Example 3. Planned section 302(d)
redemptions—(i) Facts. Corporation L, a subchap-
ter C corporation, issues 220 shares of common
stock for $1,000 per share. No other stock is autho-
rized, but L can issue warrants entitling the holder to
acquire L common stock for $3,000 per share until
such time as L adopts a plan of liquidation. L can
adopt a plan of liquidation if approved by 90 percent
of its shareholders. Half of L’s stock is purchased by
Corporation M, and half by Organization N, which
is tax exempt. At the time of purchase, M and N
agree that for a period of ten years L will annually
redeem (and N will tender) ten shares of stock in ex-
change for $12,100 and ten warrants. It is antici-
pated that, under sections 302 and 301, the annual
payment to N will be a distribution of property that
is a dividend.
(ii) Analysis. Considering all the facts and cir-
cumstances, including the agreement between M
and N, L’s redemption of N’s stock is undertaken
with a principal purpose of achieving the same eco-
nomic and tax effect as a fast-pay arrangement.
Thus, N’s stock is fast-pay stock, M’s stock is bene-
fited stock, and the parties have entered into a fast-
pay arrangement. Because L is neither a RIC nor a
REIT, whether this fast-pay arrangement is rechar-
acterized under paragraph (c) of this section depends
on whether the Commissioner determines, under
paragraph (c)(1)(ii) of this section, that a principal
purpose for the structure of the fast-pay arrangement
is the avoidance of any tax imposed by the Internal
Revenue Code.
Example 4. Recharacterization illustrated—(i)
Facts. On formation, REIT Y issues 100 shares of C
Stock and 100 shares of D Stock for $1,000 per
share. By its terms, a share of D Stock is reasonably
expected to pay a $110 dividend in years 1 through
10 and a $30 dividend each year thereafter. In years
1 through 10, persons holding a majority of the D
Stock must consent before Y may take any action
that would result in Y liquidating or dissolving,
merging or consolidating, losing its REIT status, or
selling substantially all of its assets. Thereafter, Y
may take these actions without consent so long as
the D Stock shareholders receive $400 in exchange
for their D Stock.
(ii) Analysis. When issued, the D Stock has a
dividend rate that is reasonably expected to decline
from an annual rate of 11 percent of its issue price to
an annual rate of 3 percent of its issue price. In addi-
tion, the $1,000 issue price of a share of D Stock ex-
ceeds the price at which the shareholder can be com-
pelled to dispose of the stock ($400). Thus, the D
Stock is fast-pay stock, and the C Stock is benefited
stock. Because Y is a REIT, the fast-pay arrange-
ment is recharacterized under paragraph (c) of this
section.
(iii) Recharacterization. The fast-pay arrange-
ment is recharacterized as follows:
(A) Under paragraph (c)(2)(i) of this section, the
C Stock shareholders are treated as issuing financing
instruments to the D Stock shareholders in exchange
for $100,000 ($1,000, the fair market value of each
share of D Stock, multiplied by 100, the number of
shares).
(B) Under paragraph (c)(2)(ii) of this section, the
C Stock shareholders are treated as contributing
$200,000 to Y (the $100,000 received for the financ-
ing instruments, plus the $100,000 actually paid for
the C Stock) in exchange for the C Stock.
(C) Under paragraph (c)(2)(ii) of this section,
each distribution with respect to the D Stock is
treated as a distribution with respect to the C Stock.
(D) Under paragraph (c)(2)(iii) of this section,
the C Stock shareholders are treated as making pay-
ments with respect to the financing instruments, and
Y is treated as the paying agent of the financing in-
struments for the C Stock shareholders.
Example 5. Transfer of benefited stock illus-
trated— (i) Facts. The facts are the same as in Ex-
ample 4of this paragraph (e). Near the end of year
5, a person holding one share of C Stock sells it for
$1,300. The buyer is unrelated to REIT Y or to any
of the D Stock shareholders. At the time of the sale,
the amount needed to terminate the seller’s position
in the financing instruments at fair market value is
$747.
(ii) Benefited shareholder’s treatment on sale.
Under paragraph (c)(3)(iii)(A) of this section, the
seller’s amount realized is $2,047 ($1,300, the
amount actually received, plus $747, the amount
necessary to terminate the seller’s position in the fi-
nancing instruments at fair market value). The
seller’s gain on the sale of the common stock is $47
($2,047, the amount realized, minus $2,000, the
seller’s basis in the common stock). The seller has
no income or deduction with respect to terminating
its position in the financing instruments.
(iii) Buyer’s treatment on purchase. Under para-
graph (c)(3)(iii)(A) of this section, the buyer’s basis
in the share of D Stock is $2,047 ($1,300, the
amount actually paid, plus $747, the amount needed
to terminate the seller’s position in the financing in-
struments at fair market value). Under paragraph
(c)(3)(iii)(B) of this section, simultaneous with the
sale, the buyer is treated as issuing financing instru-
ments to the fast-pay shareholders in exchange for
$747, the amount necessary to terminate the seller’s
position in the financing instruments at fair market
value.
Example 6. Fast-pay arrangement involving
amounts accrued or paid in a taxable year ending
before February 27, 1997— (i) Facts. Y is a calen-
dar year taxpayer. In June 1996, Y acquires shares
of REIT T benefited stock for $15,000. In Decem-
ber 1996, Y receives dividends of $100. Under the
recharacterization rules of paragraph (c)(2) of this
section, Y’s 1996 income attributable to the bene-
fited stock is $1,200, Y’s 1996 deduction attribut-
able to the financing instruments is $500, and Y’s
basis in the benefited stock is $25,000.
(ii) Analysis. Under paragraph (c)(3)(iv) of this
section, Y’s basis in the benefited stock is reduced
by $600. This is the amount by which Y’s 1996 in-
come from the fast-pay arrangement as recharacter-
ized under this section ($1,200 of income attribut-
able to the benefited stock less $500 of deductions
attributable to the financing instruments), exceeds
Y’s 1996 income from the fast-pay arrangement as
not recharacterized under this section ($100 of in-
come attributable to the benefited stock). Thus, in
1997 when the fast-pay arrangement is recharacter-
ized, Y’s basis in the benefited stock is $24,400.
(f) Reporting requirement—(1) Filing
requirements—(i) In general. A corpora-
tion that has fast-pay stock outstanding at
any time during the taxable year must at-
tach the statement described in paragraph
(f)(2) of this section to its federal income
tax return for such taxable year. This
paragraph (f)(1)(i) does not apply to a
corporation described in paragraphs
(f)(1)(ii), (iii), or (iv) of this section.
(ii) Controlled foreign corporation. In
the case of a controlled foreign corpora-
tion (CFC), as defined in section 957, that
has fast-pay stock outstanding at any time
during its taxable year (during which time
it was a CFC), each controlling United
States shareholder (within the meaning of
§1.964-1(c)(5)) must attach the statement
described in paragraph (f)(2) of this sec-
tion to the shareholder’s Form 5471 for
the CFC’s taxable year. The provisions of
section 6038 and the regulations under
2000–4 I.R.B.383January 24, 2000
IRB 2000-4 1/28/00 10:26 AM Page 383

section 6038 apply to any statement re-
quired by this paragraph (f)(1)(ii).
(iii) Foreign personal holding com-
pany. In the case of a foreign personal
holding company (FPHC), as defined in
section 552, that has fast-pay stock out-
standing at any time during its taxable
year (during which time it was a FPHC),
each United States citizen or resident who
is an officer, director, or 10-percent share-
holder (within the meaning of section
6035(e)(1)) of such FPHC must attach the
statement described in paragraph (f)(2) of
this section to his or her Form 5471 for
the FPHC’s taxable year. The provisions
of sections 6035 and 6679 and the regula-
tions under sections 6035 and 6679 apply
to any statement required by this para-
graph (f)(1)(iii).
(iv) Passive foreign investment com-
pany.In the case of a passive foreign in-
vestment company (PFIC), as defined in
section 1297, that has fast-pay stock out-
standing at any time during its taxable
year (during which time it was a PFIC),
each shareholder that has elected (under
section 1295) to treat the PFIC as a quali-
fied electing fund and knows or has rea-
son to know that the PFIC has outstanding
fast-pay stock must attach the statement
described in paragraph (f)(2) of this sec-
tion to the shareholder’s Form 8621 for
the PFIC’s taxable year. Each share-
holder owning 10 percent or more of the
shares of the PFIC (by vote or value) is
presumed to know that the PFIC has is-
sued fast-pay stock. The provisions of
sections 1295(a)(2) and 1298(f) and the
regulations under those sections (includ-
ing §1.1295–1T(f)(2)) apply to any state-
ment required by this paragraph (f)(1)(iv).
(2) Statement. The statement required
under this paragraph (f) must say, “This
fast-pay stock disclosure statement is re-
quired by §1.7701(l)–3(f) of the income
tax regulations.” The statement must also
identify the corporation that has outstand-
ing fast-pay stock and must contain the
date on which the fast-pay stock was is-
sued, the terms of the fast-pay stock, and
(to the extent the filing person knows or
has reason to know such information) the
names and taxpayer identification num-
bers of the shareholders of any stock that
is not traded on an established securities
market (as described in §1.7704–1(b)).
(g) Effective date—(1) In general. Ex-
cept as provided in paragraph (g)(4) of
this section (relating to reporting require-
ments), this section applies to taxable
years ending after February 26, 1997.
Thus, all amounts accrued or paid during
the first taxable year ending after Febru-
ary 26, 1997, are subject to this section.
(2) Election to limit taxable income at-
tributable to a recharacterized fast-pay
arrangement for periods before April 1,
2000—(i) Limit. For periods before April
1, 2000, provided the shareholder rechar-
acterizes the fast-pay arrangement consis-
tently for all such periods, a shareholder
may limit its taxable income attributable
to a fast-pay arrangement recharacterized
under paragraph (c) of this section to the
taxable income that results if the fast-pay
arrangement is recharacterized under ei-
ther—
(A) Notice 97–21, 1997–1 C.B. 407,
see §601.601(d)(2) of this chapter; or
(B) Paragraph (c) of this section, com-
puted by assuming the financing instru-
ments are debt.
(ii) Adjustment and statement. A
shareholder that limits its taxable income
to the amount determined under para-
graph (g)(2)(i)(A) of this section must in-
clude as an adjustment to taxable income
the excess, if any, of the amount deter-
mined under paragraph (g)(2)(i)(B) of this
section, over the amount determined
under paragraph (g)(2)(i)(A) of this sec-
tion. This adjustment to taxable income
must be made in the shareholder’s first
taxable year that includes April 1, 2000.
A shareholder to which this paragraph
(g)(2)(ii) applies must include a statement
in its books and records identifying each
fast-pay arrangement for which an adjust-
ment must be made and providing the
amount of the adjustment for each such
fast-pay arrangement.
(iii) Examples. The following exam-
ples illustrate the rules of this paragraph
(g)(2). For purposes of these examples,
assume that a shareholder may limit its
taxable income under this paragraph
(g)(2) for periods before January 1,
2000.
Example 1. Fast-pay arrangement recharacter-
ized under Notice 97–21; REIT holds third-party
debt—(i) Facts. (A) REIT Y is formed on January
1, 1997, at which time it issues 1,000 shares of fast-
pay stock and 1,000 shares of benefited stock for
$100 per share. Y and all of its shareholders are
U.S. persons and have calendar taxable years. All
shareholders of Y have elected to accrue market dis-
count based on a constant interest rate, to include the
market discount in income as it accrues, and to
amortize bond premium.
(B) For years 1 through 5, the fast-pay stock has
an annual dividend rate of $17 per share ($17,000
for all fast-pay stock); in later years, the fast-pay
stock has an annual dividend rate of $1 per share
($1,000 for all fast-pay stock). At the end of year 5,
and thereafter, a share of fast-pay stock can be ac-
quired by Y in exchange for $50 ($50,000 for all
fast-pay stock).
(C) On the day Y is formed, it acquires a five-
year mortgage note (the note) issued by an unrelated
third party for $200,000. The note provides for an-
nual interest payments on December 31 of $18,000
(a coupon interest rate of 9.00 percent, compounded
annually), and one payment of principal at the end of
5 years. The note can be prepaid, in whole or in
part, at any time.
(ii) Recharacterization under Notice 97–21—(A)
In general. One way to recharacterize the fast-pay
arrangement under Notice 97–21 is to treat the fast-
pay shareholders and the benefited shareholders as if
they jointly purchased the note from the issuer with
the understanding that over the five-year term of the
note the benefited shareholders would use their
share of the interest to buy (on a dollar-for-dollar
basis) the fast-pay shareholders’ portion of the note.
The benefited shareholders’ and the fast-pay share-
holders’ yearly taxable income under Notice 97–21
can then be calculated after determining their initial
portions of the note and whether those initial por-
tions are purchased at a discount or premium.
(B) Determining initial portions of the debt in-
strument. The fast-pay shareholders’ and the bene-
fited shareholders’ initial portions of the note can be
determined by comparing the present values of their
expected cash flows. As a group, the fast-pay share-
holders expect to receive cash flows of $135,000
(five annual payments of $17,000, plus a final pay-
ment of $50,000). As a group, the benefited share-
holders expect to receive cash flows of $155,000
(five annual payments of $1,000, plus a final pay-
ment of $150,000). Using a discount rate equal to
the yield to maturity (as determined under
§1.1272–1(b)(1)(i)) of the mortgage note (9.00 per-
cent, compounded annually), the present value of
the fast-pay shareholders’ cash flows is $98,620, and
the present value of the benefited shareholders’ cash
flows is $101,380. Thus, the fast-pay shareholders
initially acquire 49 percent of the note at a $1,380
premium (that is, they paid $100,000 for $98,620 of
principal in the note). The benefited shareholders
initially acquire 51 percent of the note at a $1,380
discount (that is, they paid $100,000 for $101,380 of
principal in the note). Under section 171, the fast-
pay shareholders’ premium is amortizable based on
their yield in their initial portion of the note (8.574
percent, compounded annually). The benefited
shareholders’ discount accrues based on the yield in
their initial portion of the note (9.353 percent, com-
pounded annually).
(C) Taxable income under Notice 97–21—(1
)
Fast-pay shareholders. Under Notice 97–21, the
fast-pay shareholders compute their taxable income
attributable to the fast-pay arrangement for periods
before January 1, 2000, by subtracting the amortiz-
able premium from the accrued interest on the fast-
pay shareholders’ portion of the note. For purposes
of paragraph (g)(2)(i)(A) of this section, the fast-pay
shareholders’ taxable income as a group is as fol-
lows:
January 24, 20003842000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 384

(2) Benefited shareholders. Under Notice
97–21, the benefited shareholders compute their
taxable income attributable to the fast-pay
arrangement for periods before January 1, 2000,
by adding the accrued discount to the accrued in-
terest on the benefited shareholders’ portion of the
note. For purposes of paragraph (g)(2)(i)(A) of
this section, the benefited shareholders’ taxable in-
come as a group is as follows:
2000–4 I.R.B.385January 24, 2000
InterestAmortizableTaxable
Taxable PeriodIncomePremiumIncome
1/1/97 - 12/31/97$ 8,876($302)$ 8,574
1/1/98 - 12/31/98$ 8,145($293)$ 7,852
1/1/99 - 12/31/99$ 7,348($281)$ 7,067
$24,369($876)$23,493
InterestAccruedTaxable
Taxable PeriodIncomeDiscountIncome
1/1/97 - 12/31/97$ 9,124$229$ 9,353
1/1/98 - 12/31/98$ 9,855$251$10,106
1/1/99 - 12/31/99$10,652
$274$10,926
$29,631$754$30,385
(iii) Taxable income under the recharacteriza-
tion of this section—(A) Fast-pay shareholders.
Under paragraphs (c) and (g)(2)(i)(B) of this sec-
tion, the fast-pay shareholders’ taxable income
attributable to the fast-pay arrangement for peri-
ods before January 1, 2000, is the interest
deemed paid on the financing instruments. For
purposes of paragraph (g)(2)(i)(B) of this section,
the fast-pay shareholders’ taxable income as a
group is as follows:
Taxable
Taxable PeriodIncome
1/1/97 - 12/31/97$ 8,574
1/1/98 - 12/31/98$ 7,852
1/1/99 - 12/31/99$ 7,067
$23,493
(B) Benefited shareholders. Under paragraphs (c)
and (g)(2)(i)(B) of this section, the benefited share-
holders compute their taxable income attributable to
the fast-pay arrangement for periods before January
1, 2000, by subtracting the interest deemed paid on
the financing instruments from the dividends actu-
ally and deemed paid on the benefited stock. For
purposes of paragraph (g)(2)(i)(B) of this section,
the benefited shareholders’ taxable income as a
group is as follows:
DividendsInterest Paid
Paid OnOn FinancingTaxable
Taxable PeriodBenefited StockInstrumentsIncome
1/1/97 - 12/31/97$18,000($ 8,574)$ 9,426
1/1/98 - 12/31/98$18,000($ 7,852)$10,148
1/1/99 - 12/31/99$18,000
($ 7,067)$10,933
$54,000($23,493)$30,507
(iv) Limit on taxable income under paragraph
(g)(2)(i) of this section—(A) Fast-pay sharehold-
ers. For periods before January 1, 2000, the fast-
pay shareholders have the same taxable income
under the recharacterization of Notice 97–21 and
paragraph (g)(2)(i)(A) of this section ($23,493) as
they have under the recharacterization of para-
graphs (c) and (g)(2)(i)(B) of this section
($23,493). Thus, under paragraph (g)(2)(i) of this
section, the fast-pay shareholders may limit their
taxable income attributable to the fast-pay arrange-
ment for periods before January 1, 2000, to
$23,493 (as a group).
(B) Benefited shareholders. For periods before
January 1, 2000, the benefited shareholders have
taxable income attributable to the fast-pay arrange-
ment of $30,385 under the recharacterization of
Notice 97–21 and paragraph (g)(2)(i)(A) of this
section, and taxable income of $30,507 under the
recharacterization of paragraphs (c) and
(g)(2)(i)(B) of this section. Thus, under paragraph
(g)(2)(i) of this section, the benefited shareholders
may limit their taxable income attributable to the
fast-pay arrangement for periods before January 1,
2000, to either $30,385 (as a group) or $30,507 (as
a group).
(v) Adjustment to taxable income under para-
graph (g)(2)(ii) of this section. Under paragraph
(g)(2)(ii) of this section, any benefited shareholder
that limited its taxable income to the amount deter-
mined under paragraph (g)(2)(i)(A) of this section
must include as an adjustment to taxable income
the excess, if any, of the amount determined under
paragraph (g)(2)(i)(B) of this section, over the
amount determined under paragraph (g)(2)(i)(A) of
this section. If all benefited shareholders limited
their taxable income to the amount determined
under paragraph (g)(2)(i)(A) of this section, then as
a group their adjustment to income is $122
($30,507, minus $30,385). Each shareholder must
include its adjustment in income for the taxable
year that includes January 1, 2000.
Example 2. REIT holds debt issued by a bene-
fited shareholder—(i) Facts. The facts are the
same as in Example 1of this paragraph (g)(2) ex-
cept that corporation Z holds 800 shares (80 per-
cent) of the benefited stock, and Z, instead of a
third party, issues the mortgage note acquired by Y.
(ii) Recharacterization under Notice 97–21.
Because Y holds a debt instrument issued by Z, the
fast-pay arrangement is recharacterized under No-
tice 97–21 as an arrangement in which Z issued
one or more instruments directly to the fast-pay
shareholders and the other benefited shareholders.
(A) Fast-pay shareholders. Consistent with this
recharacterization, Z is treated as issuing a debt in-
strument to the fast-pay shareholders for $100,000.
The debt instrument provides for five annual pay-
ments of $17,000 and an additional payment of
$50,000 in year five. Thus, the debt instrument’s
yield to maturity is 8.574 percent per annum, com-
pounded annually.
(B) Benefited shareholders. Z
is also treated as issuing a debt instrument to the
other benefited shareholders for $20,000 (200
shares multiplied by $100, or 20 percent of the
$100,000 paid to Y by the benefited shareholders
as a group). This debt instrument provides for five
annual payments of $200 and an additional pay-
ment of $30,000 in year five. The debt instru-
ment’s yield to maturity is 9.304 percent per
annum, compounded annually.
(C) Issuer’s interest expense under Notice
97–21. Under Notice 97-21, Z’s interest expense
attributable to the fast-pay arrangement for periods
before January 1, 2000, equals the interest accrued
on the debt instrument held by the fast-pay share-
holders, plus the interest accrued on the debt in-
strument held by the benefited shareholders other
than Z. For purposes of paragraph (g)(2)(i)(A) of
this section, Z’s interest expense is as follows:
IRB 2000-4 1/28/00 10:26 AM Page 385

AccruedAccrued
InterestInterestTotal
Fast-payOther BenefitedInterest
Taxable PeriodShareholdersShareholdersExpense
1/1/97 - 12/31/97($ 8,574) ($1,861)($10,435)
1/1/98 - 12/31/98($ 7,852) ($2,015)($ 9,867)
1/1/99 - 12/31/99($ 7,067)($2,184)($ 9,251)
($23,493)($6,060)($29,553)
January 24, 20003862000–4 I.R.B.
(iii) Recharacterization under this section.
Under paragraphs (c) and (g)(2)(i)(B) of this section,
Z’s taxable income attributable to the fast-pay
arrangement for periods before January 1, 2000,
equals Z’s share of the dividends actually and
deemed paid on the benefited stock (80 percent of
the outstanding benefited stock), reduced by the sum
of the interest accrued on the note held by Y and the
interest accrued on the financing instruments
deemed to have been issued by Z. For purposes of
paragraph (g)(2)(i)(B) of this section, Z’s taxable in-
come is as follows:
AccruedAccrued
DividendsInterestInterest
BenefitedOn DebtFinancingTaxable
Taxable PeriodStockHeld By YInstrumentsExpense
1/1/97 - 12/31/97$14,400($18,000)($ 6,859)($10,459)
1/1/98 - 12/31/98$14,400($18,000)($ 6,281)($ 9,881)
1/1/99 - 12/31/99$14,400($18,000)($ 5,654)($ 9,254)
$43,200($54,000)($18,794)($29,594)
(iv) Limit on taxable income under this paragraph
(g)(2). For periods before January 1, 2000, Z has a
taxable loss attributable to the fast-pay arrangement of
$29,553 under the recharacterization of Notice 97-21
and paragraph (g)(2)(i)(A) of this section, and a tax-
able loss of $29,594 under the recharacterization of
paragraphs (c) and (g)(2)(i)(B) of this section. Thus,
under paragraph (g)(2)(i) of this section, Z may report
a taxable loss attributable to the fast-pay arrangement
for periods before January 1, 2000, of either $29,553
or $29,594. Under paragraph (g)(2)(ii), Z has no ad-
justment to its taxable income for its taxable year that
includes January 1, 2000.
(3) Rule to comply with this section. To
comply with this section for each taxable
year in which it failed to do so, a taxpayer
should file an amended return. For tax-
able years ending before January 10,
2000, a taxpayer that has complied with
Notice 97–21, 1997–1 C.B. 407 (see
§601.601(d)(2) of this chapter), for all
such taxable years is considered to have
complied with this section and limited its
taxable income under paragraph
(g)(2)(i)(A) of this section.
(4) Reporting requirements. The re-
porting requirements of paragraph (f) of
this section apply to taxable years (of the
person required to file the statement) end-
ing after January 10, 2000.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 5. The authority citation for part
602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 6. Section 602.101(b) is amended
by adding an entry in numerical order to
the table to read as follows:
§602.101 OMB Control numbers.
* * * * *
(b) * * *
Robert E. Wenzel,
Deputy Commissioner
of Internal Revenue.
Approved January 7, 2000.
Jonathan Talisman,
Acting Assistant Secretary
of the Treasury.
(Filed by the Office of the Federal Register on Janu-
ary 7, 2000, 8:45 a.m., and published in the issue of
the Federal Register for January 10, 2000, 65 F.R.
1310)
CFR part or section whereCurrent OMB
identified and describedcontrol No.
* * * * *
49.4251–4(d)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1545-1628
* * * * *
IRB 2000-4 1/28/00 10:26 AM Page 386

2000–4 I.R.B.387January 24, 2000
Application Procedures for
Qualified Intermediary Status
Under Section 1441; Final
Qualified Intermediary
Withholding Agreement
Rev. Proc. 2000–12
SECTION 1. PURPOSE AND SCOPE
.01 Purpose. This revenue procedure
provides guidance for entering into a
qualified intermediary (QI) withholding
agreement with the Internal Revenue
Service (IRS) under §1.1441–1(e)(5) of
the income tax regulations.
1
Section 3
of this revenue procedure provides the
application procedures for becoming a
QI and Section 4 provides the final qual-
ified intermediary withholding agree-
ment (“QI withholding agreement”).
The objective of the QI withholding
agreement is to simplify withholding
and reporting obligations for payments
of income (including interest, dividends,
royalties, and gross proceeds) made to
an account holder through one or more
foreign intermediaries.
.02 Scope. This revenue procedure ap-
plies to persons described in §1.1441–
1(e)(5)(ii)(A) and (B)–foreign financial
institutions, foreign clearing organiza-
tions, and foreign branches of U.S. finan-
cial institutions and U.S. clearing organi-
zations. The principles of this agreement
may, however, be used to conclude QI
withholding agreements with foreign cor-
porations described in
§1.1441–1(e)(5)(ii)(C) seeking to become
a QI to present claims of benefits under an
income tax treaty on behalf of sharehold-
ers and to other persons that the IRS may
accept to be qualified intermediaries as
authorized under §1.1441–1(e)(5)(ii)(D).
This revenue procedure does not apply to
a foreign partnership seeking to qualify as
a withholding foreign partnership. See
§1.1441–5(c)(2)(ii). The IRS and Trea-
sury will, however, consider applying the
principles of the QI withholding agree-
ment provided in this revenue procedure
to a foreign partnership acting on behalf
of its partners in appropriate circum-
stances. A person that is not within the
scope of this revenue procedure may seek
QI status by contacting the Office of the
Assistant Commissioner (International) at
the address or telephone number in Sec-
tion 3.01 of this revenue procedure.
SECTION 2. BACKGROUND
.01 Withholding and reporting on pay-
ments to foreign persons.Under sections
1441 and 1442 of the Internal Revenue
Code (Code), a person that makes a pay-
ment of U.S. source interest, dividends,
royalties, and certain other types of in-
come to a foreign person must generally
deduct and withhold 30 percent from the
payment. A lower rate of withholding
may apply under the Code (e.g., section
1443), the regulations, or an income tax
treaty. Generally, a payor of these types
of income must also report the payments
on Forms 1042–S. See §1.1461–1(c).
Under sections 6041, 6042, 6045, 6049,
and 6050N of the Code (the Form 1099 re-
porting provisions), payors of interest, div-
idends, royalties, gross proceeds from the
sales of securities, and other fixed or deter-
minable income must report payments on
Form 1099 unless an exception applies. If
a payment is reportable on Form 1099, a
payor must generally obtain a Form W-9
from the payee. If the payor does not re-
ceive the Form W-9, it must generally
backup withhold at a 31 percent rate under
section 3406 of the Code and report the
payment on Form 1099. An exception to
the Form 1099 reporting provisions applies
if the payee is a foreign person. A payor
can treat a person as foreign if the payor
can reliably associate the payment with
documentation that establishes that the per-
son is the beneficial owner of the income
or a foreign payee. See §§1.6041–4(a),
1.6042–3(b)(1)(iii); 1.6045–1(g)(1)(i);
1.6049–5(b)(12); and 1.6050N–1(c)(1)(i).
Moreover, a payor does not have to backup
withhold on payments to foreign beneficial
owners or foreign payees because backup
withholding applies only to amounts that
the payor must report on Form 1099.
.02 Responsibilities of intermediaries
that enter into the QI withholding agree-
ment.When the IRS enters into a QI
withholding agreement with a foreign
person, that foreign person becomes a QI.
A QI is a withholding agent under chapter
3 of the Code and a payor under chapter
61 and section 3406 of the Code for
amounts that it pays to its account hold-
ers. Except as otherwise provided in the
Agreement, a QI’s obligations with re-
spect to amounts it pays to account hold-
ers are governed by chapter 3, chapter 61,
and section 3406 of the Code and the reg-
ulations thereunder. A QI shall act in its
capacity as a QI pursuant to the Agree-
ment only for those accounts the QI has
with a withholding agent that the QI has
designated as accounts for which it acts as
a QI. A QI is not required to act as a QI
for all accounts that it has with a with-
holding agent. However, if QI designates
an account as one for which it will act as a
QI, it must act as a QI for all payments
made to that account.
SECTION 3. APPLICATION FOR QI
STATUS
.01 Where to Apply. To apply for QI
status, an eligible person must submit the
information required by this Section 3 to:
Assistant Commissioner (International)
Foreign Payments Division
OP:IN:I:FP
950 L’Enfant Plaza South, SW
Washington, DC 20024
Telephone: (202) 874-1800
Fax: (202) 874-1797
.02 Contents of the Application. A
prospective QI must submit an applica-
tion to become a QI. The application
must establish to the satisfaction of the
IRS that the applicant has adequate re-
sources and procedures to comply with
the terms of the QI withholding agree-
ment. An application must include the in-
formation specified in this section 3.02,
and any additional information and docu-
mentation requested by the IRS:
(1) A statement that the applicant is an
eligible person and that it requests to enter
into a QI withholding agreement with the
IRS.
(2) The applicant’s name, address, and
employer identification number (EIN), if
any.
(3) The country in which the applicant
was created or organized and a descrip-
tion of the applicant’s business.
Part III. Administrative, Procedural, and Miscellaneous
1
All citations to income tax regulations in this rev-
enue procedure are to the regulations as amended by
T.D. 8734 (62 FR 53387), T.D. 8804 (63 FR 72183),
and T.D. 8856 (64 FR 73408).
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January 24, 20003882000–4 I.R.B.
(4) A list of the position titles of those
persons who will be the responsible par-
ties for performance under the Agreement
and the names, addresses, and telephone
numbers of those persons as of the date
the application is submitted.
(5) An explanation and sample of the
account opening agreements and other
documents used to open and maintain the
accounts at each location covered by the
Agreement.
(6) A list describing the type of account
holders (e.g., U.S., foreign, treaty benefit
claimant, or intermediary), the approxi-
mate number of account holders within
each type, and the estimated value of U.S.
investments that the QI agreement will
cover.
(7) A general description of U.S. assets
by type (e.g., U.S. securities, U.S. real es-
tate), including assets held by U.S. custo-
dians, and their approximate aggregate
value by type. The applicant should pro-
vide separate information for assets bene-
ficially owned by the applicant and for as-
sets it holds for others.
(8) A completed Form SS-4 (Applica-
tion for Employer Identification Number)
to apply for a QI Employer Identification
Number (QI-EIN) to be used solely for QI
reporting and filing purposes. An appli-
cant must apply for a QI-EIN even if it al-
ready has another EIN. Each legal entity
governed by the QI withholding agree-
ment must complete a Form SS-4.
(9) Completed appendices and attach-
ments that appear at the end of the QI
agreement set forth in section 4.
The IRS will not enter into a QI with-
holding agreement that provides for the
use of documentary evidence obtained
under a country’s know-your-customer
rules if it has not received the “know-
your-customer” practices and procedures
for opening accounts and responses to the
18 specific items presented below. If the
information has already been provided to
the IRS, it is not necessary for a particular
prospective QI to submit the information.
The IRS may publish lists of countries for
which it has received know-your-cus-
tomer information and for which the
know-your-customer rules are acceptable.
A prospective QI applicant may also con-
tact the IRS at the address or telephone
number provided in section 3.01 to obtain
information. The 18 items are as follows:
1.An English translation of the laws
and regulations (“know-your-cus-
tomer” rules) governing the require-
ments of a QI to obtain documenta-
tion confirming the identity of QI’s
account holders. The translation
must include the name of the law, and
the appropriate citations to the law
and regulations.
2.The name of the organization
(whether a governmental entity or
private association) responsible for
enforcing the know-your-customer
rules. Specify how those rules are
enforced (e.g., through audit) and the
frequency of compliance checks.
3.The penalties that apply for failure to
obtain, or evaluate, documentation
under the know-your-customer rules.
4.The definition of customer or account
holder that is used under the know-
your- customer rules. Specify
whether the definition encompasses
direct and indirect beneficiaries of an
account if the activity in the account
involves the receipt or disbursal of
funds. Specify whether the definition
of customer or account holder
includes a trust beneficiary, a compa-
ny whose assets are managed by an
asset manager, a controlling share-
holder of a closely held corporation
or the grantor of a trust.
5. A statement regarding whether the
documentation required under the
know-your- customer rules requires a
financial institution to determine if its
account holder is acting as an inter-
mediary for another person.
6. A statement regarding whether the
documentation required under the
know-your- customer rules requires a
financial institution to identify the
account holder as a beneficial owner
of income credited to an account.
7. A list of the specific documentation
required to be used under the know-
your- customer rules, or if those rules
do not require use of specific docu-
mentation, the documentation that is
generally accepted by the authorities
responsible for enforcing those rules.
8. A statement regarding whether the
know-your-customer rules require
that an account holder provide a per-
manent residence address.
9. A summary of the rules that apply if
an account is not opened in person
(e.g., correspondence, telephone,
Internet).
10. Whether an account holder’s identity
may be established, in whole or in
part, by introductions or referrals.
11. The circumstances under which new
documentation must be obtained, or
existing documentation verified,
under the know-your-customer rules.
12. A list of all the exceptions, if any, to
the documentation requirements
under the know-your-customer rules.
13. A statement regarding whether the
know-your-customer rules do not
require documentation from an
account holder if a payment to or
from that account holder is cleared by
another financial institution.
2
14. A statement regarding how long the
documentation remains valid under
the know- your-customer rules.
15. A statement regarding how long the
documentation obtained under the
know-your- customer rules must be
retained and the manner for maintain-
ing that documentation.
16. Specify whether the rules require the
maintenance of wire transfer records,
the form of the wire transfer records
and how long those records must be
maintained. State whether the wire
transfer records require information as
to both the original source of the funds
and the final destination of the funds.
17. A list of any payments or types of
accounts that are not subject to the
know-your- customer rules.
18. Specify whether there are special
rules that apply for purposes of pri-
vate banking activities.
SECTION 4. QUALIFIED
INTERMEDIARY WITHHOLDING
AGREEMENT
The text of the QI agreement is set
forth below. Upon receipt and review of
an application to become a qualified inter-
mediary, the IRS will complete the QI
agreement (e.g., insertion of the QI’s
name, etc.). A prospective QI should en-
sure that it has provided to the IRS all of
the information that is required to com-
plete the agreement. It may be necessary
for the IRS to contact the potential quali-
fied intermediary, or its authorized repre-
2
Generally, the IRS will not permit a QI to
establish the identity of an account holder with-
out obtaining documentation directly from the
account holder.
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2000–4 I.R.B.389January 24, 2000
sentative, to obtain additional informa-
tion. Once the IRS has obtained all the
information required to complete the
agreement, the IRS will send two un-
signed copies of the QI withholding
agreement to the prospective QI for signa-
ture. Both copies of the agreement should
be signed by a person with the authority
to sign the agreement and returned to the
IRS at the address specified in section
3.01. The IRS will sign the QI agreement
and return one of the originals to the qual-
ified intermediary.
The IRS will consider changes to the text
of the QI agreement as set forth below
only in rare and unusual circumstances.
The IRS will not accept, however, any
changes that it determines would provide
a potential QI with a competitive advan-
tage over other similarly situated QIs.
COUNTRY-BY-COUNTRY
REPORTING
The IRS and Treasury have decided that
a QI that has executed a QI withholding
agreement prior to January 1, 2001, will
not be required to provide a country-by-
country break down of reporting pools on
Form 1042-S. See section 8.03 of the QI
withholding agreement for a definition of
reporting pool. It was decided that requir-
ing such information at this time would
impede implementation of the QI system
since it is recognized that financial institu-
tions will be required to commit substan-
tial information technology resources to
address technology issues that have been
delayed by the year 2000 problem. The
IRS and Treasury, however, are continuing
to study whether to require country code
information for reporting pools in the fu-
ture. Therefore, the IRS and Treasury may
require a potential QI that enters into an
agreement after December 31, 2000, or a
QI that enters into an agreement after the
expiration of an agreement’s initial term, to
provide a country-by-country break down
of reporting pools.
SECTION 1. PURPOSE AND SCOPE
Sec. 1.01. General Obligations
Sec. 1.02. Parties to the Agreement
SECTION 2. DEFINITIONS
Sec. 2.01. Account Holder
Sec. 2.02. Agreement
Sec. 2.03. Amounts Subject to NRA
Withholding
Sec. 2.04. Assumption of
Withholding Responsibility
Sec. 2.05. Backup Withholding
Sec. 2.06. Beneficial Owner
Sec. 2.07. Broker Proceeds
Sec. 2.08. Chapter 3 of the Code
Sec. 2.09. Chapter 61 of the Code
Sec. 2.10. Deposit Interest
Sec. 2.11. Designated Broker
Proceeds
Sec. 2.12. Documentary Evidence
Sec. 2.13. Documentation
Sec. 2.14. Documented Account
Holder
Sec. 2.15. Exempt Recipient
Sec. 2.16. External Auditor
Sec. 2.17. Flow -Through Entity
Sec. 2.18. Foreign Person
Sec. 2.19. Form W-8
Sec. 2.20. Form W-9
Sec. 2.21. Form 945
Sec. 2.22. Form 1042
Sec. 2.23. Form 1042-S
Sec. 2.24. Form 1096
Sec. 2.25. Form 1099
Sec. 2.26. Form 1099 Reporting
Sec. 2.27. Intermediary
Sec. 2.28. Know-Your-Customer
Rules
Sec. 2.29. Marketable Securities
Sec. 2.30. Non-Exempt Recipient
Sec. 2.31. Nonqualified Intermediary
Sec. 2.32. NRA Withholding
Sec. 2.33. Overwithholding
Sec. 2.34. Paid Outside the United
States
Sec. 2.35. Payment
Sec. 2.36. Payor
Sec. 2.37. Presume/Presumption
Sec. 2.38. Private Arrangement
Intermediary
Sec. 2.39. Qualified Intermediary
Sec. 2.40. Qualified Intermediary (or
QI) EIN
Sec. 2.41. Reduced Rate of
Withholding
Sec. 2.42. Reliably Associating a
Payment With Documentation
Sec. 2.43. Reportable Amount
Sec. 2.44. Reportable Payment
Sec. 2.45. Reporting Pool
Sec. 2.46. Short-Term Obligation
Sec. 2.47. TIN
Sec. 2.48. Underwithholding
Sec. 2.49. Undocumented Account
Holder
Sec. 2.50. U.S. Payor/Non-U.S.
Payor
Sec. 2.51. U.S. Person
Sec. 2.52. Withholding Agent
Sec. 2.53. Withholding Rate Pool
Sec. 2.54. Withholding Statement
Sec. 2.55. Other Terms
SECTION 3. WITHHOLDING
RESPONSIBILITY
Sec. 3.01. NRA Withholding
Responsibility
Sec. 3.02. Primary NRA Withholding
Responsibility Not Assumed
Sec. 3.03. Assumption of Primary
NRA Withholding Responsibility
Sec. 3.04. Backup Withholding
Responsibility
Sec. 3.05. Primary Form 1099
Reporting and Backup Withholding
Responsibility For Reportable
Payments Other Than Reportable
Amounts
Sec. 3.06. Primary Form 1099
Reporting and Backup Withholding
Responsibility For Reportable
Amounts Not Assumed
Sec. 3.07. Assumption of Primary
Form 1099 Reporting and Backup
Withholding Responsibility
Sec. 3.08. Deposit Requirements
SECTION 4. PRIVATE
ARRANGEMENT
INTERMEDIARIES
Sec. 4.01. In General
Sec. 4.02. Modification of
Obligations for PAI Agreements
Sec. 4.03. Termination of
Arrangement
SECTION 5. DOCUMENTATION
REQUIREMENTS
Sec. 5.01. Documentation
Requirements
Sec. 5.02. Documentation For
Foreign Account Holders
Sec. 5.03. In General.
Sec. 5.04. Documentation for
International Organizations
Sec. 5.05. Documentation for Foreign
Governments and Foreign Central
Banks of Issue
Sec. 5.06. Documentation for Foreign
Tax-Exempt Organizations
Sec. 5.07. Documentation From
Intermediaries or Flow-Through
Entities
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January 24, 20003902000–4 I.R.B.
Sec. 5.08. Documentation For U.S.
Exempt Recipients
Sec. 5.09. Documentation for U.S.
Non-Exempt Recipients
Sec. 5.10. Documentation Validity
Sec. 5.11. Documentation Validity
Period
Sec. 5.12. Maintenance and Retention
of Documentation
Sec. 5.13. Application of
Presumption Rules
SECTION 6. QUALIFIED
INTERMEDIARY WITHHOLDING
CERTIFICATE AND DISCLOSURE
OF ACCOUNT HOLDERS TO
WITHHOLDING AGENT
Sec. 6.01. Qualified Intermediary
Withholding Certificate
Sec. 6.02. Withholding Statement
Sec. 6.03. Withholding Rate Pools
Sec. 6.04. Legal Prohibitions Against
Disclosure of U.S. Non-Exempt
Recipients
SECTION 7. TAX RETURN
OBLIGATIONS
Sec. 7.01. Form 1042 Filing
Requirement
Sec. 7.02. Form 945 Filing
Requirement
Sec. 7.03. Retention of Returns
SECTION 8. INFORMATION
REPORTING OBLIGATIONS
Sec. 8.01. Form 1042-S Reporting
Sec. 8.02. Recipient Specific
Reporting
Sec. 8.03. Reporting Pools for Form
1042-S Reporting
Sec. 8.04. Form 1099 Reporting
Responsibility
SECTION 9. ADJUSTMENTS FOR
OVER- AND UNDER-
WITHHOLDING; REFUNDS
Sec. 9.01. Adjustments for NRA
Overwithholding by Withholding
Agent
Sec. 9.02. Adjustments for NRA
Overwithholding by QI
Sec. 9.03. Repayment of Backup
Withholding
Sec. 9.04. Collective Credit or
Refund Procedures for NRA
Overwithholding
Sec. 9.05. Adjustments for NRA
Underwithholding
Sec. 9.06. NRA Underwithholding
After Form 1042 Filed
Sec. 9.07. Special Rule Regarding
Failure to Deposit Penalties
SECTION 10. EXTERNAL AUDIT
PROCEDURES
Sec. 10.01. In General
Sec. 10.02. Designation of External
Auditor
Sec. 10.03. Timing and Scope of
External Audits
Sec. 10.04. Use of Statistical
Sampling
Sec. 10.05. External Auditor’s Report
Sec. 10.06. Expanding Scope and
Timing of External Audit
SECTION 11. EXPIRATION,
TERMINATION AND DEFAULT
Sec. 11.01. Term of Agreement
Sec. 11.02. Termination of
Agreement
Sec. 11.03. Significant Change in
Circumstances
Sec. 11.04. Events of Default
Sec. 11.05. Notice and Cure
Sec. 11.06. Renewal
SECTION 12. MISCELLANEOUS
PROVISIONS
THIS AGREEMENT is made in dupli-
cate under and in pursuance of section
1441 of the Internal Revenue Code of
1986, as amended, (the “Code”) and Trea-
sury Regulation §1.1441–1(e)(5) by and
between ______________, any affiliated
entities of ____________ designated in
Appendix A of this Agreement that are
signatories to this Agreement (individu-
ally and collectively referred to as “QI”),
and the INTERNAL REVENUE SER-
VICE (the “IRS”):
WHEREAS, QI has submitted an ap-
plication in accordance with Revenue
Procedure 2000–12 to be a qualified inter-
mediary for purposes of Treas. Reg.
§1.1441–1(e)(5);
WHEREAS, QI and the IRS desire to
enter into an agreement to establish QI’s
rights and obligations regarding docu-
mentation, withholding, information re-
porting, tax return filing, deposits, and re-
fund procedures under sections 1441,
1442, 1443, 1461, 3406, 6041, 6042,
6045, 6049, 6050N, 6302, 6402, and 6414
of the Code with respect to certain types
of payments;
NOW, THEREFORE, in considera-
tion of the following terms, representa-
tions, and conditions, the parties agree as
follows:
SECTION 1. PURPOSE AND SCOPE
Sec. 1.01. General Obligations.QI is a
withholding agent under chapter 3 of the
Code and a payor under chapter 61 and sec-
tion 3406 of the Code for amounts that it
pays to its account holders. Except as oth-
erwise provided in this Agreement, QI’s
obligations with respect to amounts it pays
to account holders are governed by chapter
3, chapter 61, and section 3406 of the Code
and the regulations thereunder. QI shall act
in its capacity as a qualified intermediary
pursuant to this Agreement only for those
accounts QI has with a withholding agent
that QI has designated as accounts for
which it acts as a qualified intermediary.
QI is not required to act as a qualified inter-
mediary for all accounts that it has with a
withholding agent. However, if QI desig-
nates an account as one for which it will act
as a qualified intermediary, it must act as a
qualified intermediary for all payments
made to that account.
Sec. 1.02. Parties to the Agreement.
This Agreement applies to:
(A)All offices of QI located in the coun-
tries described in Appendix A of this
Agreement; and
(B)The Internal Revenue Service.
Notwithstanding section 1.02(A) of this
Agreement, an office of QI shall be sub-
ject to the provisions of this Agreement
only to the extent it receives a payment
from a withholding agent with respect to
an account that QI has designated as an
account for which it is acting as a quali-
fied intermediary. See section 6.02 of this
Agreement for the procedure to designate
an account. QI may add any countries not
initially included in Appendix A without
prior IRS approval if the country is one
for which the IRS will enter a model qual-
ified intermediary agreement and QI pro-
vides the IRS an amended Appendix A at
the address described in section 12.06 of
this Agreement. Offices in the additional
countries may begin to operate under this
Agreement immediately after QI satisfies
the notification requirement of this sec-
tion 1.02. Appendix A, as amended, shall
become part of this Agreement.
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2000–4 I.R.B.391January 24, 2000
SECTION 2. DEFINITIONS
For purposes of this Agreement, the terms
listed below are defined as follows:
Sec. 2.01. Account Holder.An “account
holder” means any person that is a direct
account holder or an indirect account
holder and for which QI acts as a quali-
fied intermediary. A direct account holder
is any person who has an account directly
with QI (including an intermediary or
flow-through entity). An indirect account
holder is any person who receives
amounts from a QI but who does not have
a direct account relationship with QI. For
example, a person that has an account
with a foreign intermediary or an interest
in a flow-through entity which, in turn, is
a direct account holder of QI is an indirect
account holder. In addition, the person
that is the sole owner of an entity that is
disregarded under Treas. Reg.
§301.7701–2(c)(2) as an entity separate
from its owner is an indirect account
holder. A person is an indirect account
holder even if there are multiple tiers of
intermediaries or flow-through entities
between the person and the QI.
Sec. 2.02. Agreement.“Agreement”
means this Agreement, all appendices and
attachments to this Agreement, and QI’s
application to become a qualified inter-
mediary. All such appendices, attach-
ments, and QI’s application are incorpo-
rated into this Agreement by reference.
Sec. 2.03. Amounts Subject to NRA
Withholding. An “amount subject to
NRA withholding” is an amount de-
scribed in Treas. Reg. §1.1441–2(a). An
amount subject to NRA withholding shall
not include interest paid as part of the pur-
chase price of an obligation sold between
interest payment dates or original issue
discount paid as part of the purchase price
of an obligation sold in a transaction other
than the redemption of such obligation,
unless the sale is part of a plan the princi-
pal purpose of which is to avoid tax and
QI has actual knowledge or reason to
know of such plan.
Sec. 2.04. Assumption of Withholding
Responsibility.A QI that assumes pri-
mary NRA withholding responsibility, or
assumes primary Form 1099 reporting
and backup withholding responsibility,
assumes the primary responsibility for de-
ducting, withholding, and depositing the
appropriate amount from a payment.
Generally, a qualified intermediary’s as-
sumption of primary NRA withholding
responsibility or the assumption of pri-
mary backup withholding responsibility
relieves the person who makes a payment
to the qualified intermediary from the re-
sponsibility to withhold. Under section
3.05 of this Agreement, QI generally has
primary Form 1099 reporting and backup
withholding responsibility with respect to
certain payments even though it does not
assume such responsibility for payments
not described in that section.
Sec. 2.05. Backup Withholding.
“Backup withholding” means the with-
holding required under section 3406 of
the Code.
Sec. 2.06. Beneficial Owner.A “benefi-
cial owner” has the meaning given to that
term in Treas. Reg. §1.1441–1(c)(6).
Sec. 2.07. Broker Proceeds.“Broker pro-
ceeds” means the gross proceeds from a
sale of an asset to the extent that the gross
proceeds would be subject to Form 1099
reporting if paid to a U.S. non-exempt re-
cipient. For purposes of this Agreement,
broker proceeds also include any proceeds
paid by QI from the sale of assets pursuant
to the provisions of section 6.04 of this
Agreement that are owned by a U.S. non-
exempt recipient and that produce, or could
produce, reportable payments regardless of
whether the sale is effected at an office in-
side or outside the United States and re-
gardless of whether or not the sale is ef-
fected by QI or another person on
instructions from QI. Thus, the exception
in Treas. Reg. §1.6045–1(a), which ex-
cludes from Form 1099 reporting certain
sales effected at an office outside the
United States, shall not apply in the case of
U.S. non-exempt recipients whose identity
is prohibited by law from disclosure. In ad-
dition, the exception from backup with-
holding on certain payments contained in
Treas. Reg. §31.3406(g)–1(e) shall not
apply to such broker proceeds.
Sec. 2.08. Chapter 3 of the Code.Any
reference to “chapter 3 of the Code”
means sections 1441, 1442, 1443, 1461,
1463, and 1464 of the Code.
Sec. 2.09. Chapter 61 of the Code.Any
reference to “chapter 61 of the Code”
means sections 6041, 6042, 6045, 6049,
and 6050N of the Code.
Sec. 2.10. Deposit Interest.“Deposit in-
terest” means interest described in section
871(i)(2)(A) of the Code.
Sec. 2.11. Designated Broker Proceeds.
“Designated broker proceeds” means–
(A)Any broker proceeds from the sale of
assets that produce, or could produce, re-
portable amounts if the sale is effected at
an office inside the United States, as de-
fined in Treas. Reg. §1.6045–1(g)(3), (un-
less an exception to reporting applies
under chapter 61 of the Code); and
(B)Any broker proceeds from the sale of
an asset that produces, or could produce,
reportable amounts that are beneficially
owned by a U.S. non-exempt recipient
whose identity and account information is
prohibited from disclosure as described in
section 6.04 of this Agreement. For this
purpose, it is irrelevant whether the sale is
effected by QI or another person upon in-
structions from QI. It is also irrelevant
whether the sale is effected at an office in-
side or outside the United States. Thus,
the exception in Treas. Reg. §1.6045–1(a)
(which excepts sales effected at an office
outside the United States by a non-U.S.
payor) and the exception in Treas. Reg.
31.3406(g)–1(e) (which excepts certain
payments made outside the United States
from backup withholding) do not apply in
the case of an account holder whose iden-
tity is prohibited by law from disclosure.
Sec. 2.12. Documentary Evidence.
“Documentary evidence” means any doc-
umentation obtained under the appropri-
ate know-your-customer rules (as de-
scribed in the Attachments to this
Agreement), any documentary evidence
described in Treas. Reg. §1.1441–6 suffi-
cient to establish entitlement to a reduced
rate of withholding under an income tax
treaty, or any documentary evidence de-
scribed in Treas. Reg. §1.6049–5(c) suffi-
cient to establish an account holder’s sta-
tus as a foreign person for purposes of
chapter 61 of the Code. Documentary ev-
idence does not include a Form W-8 or
Form W-9 (or an acceptable substitute
Form W-8 or Form W-9).
Sec. 2.13. Documentation.“Documen-
tation” means any valid Form W-8, Form
W-9 (or acceptable substitute Form W-8
or Form W-9) or documentary evidence
as defined in section 2.12 of this Agree-
ment, including all statements or other in-
formation required to be associated with
the form or documentary evidence.
Sec. 2.14. Documented Account
Holder.A “documented account holder”
is an account holder for whom QI holds
valid documentation.
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January 24, 20003922000–4 I.R.B.
Sec. 2.15. Exempt Recipient.For pur-
poses of Form 1099 reporting and backup
withholding, an “exempt recipient”
means a person described in Treas. Reg.
§1.6049– 4(c)(1)(ii) (for interest, divi-
dends, and royalties), a person described
in Treas. Reg. §5f.6045–1(c)(3)(i)(B) and
§1.6045–2(b)(2)(i) (for broker proceeds),
and a person described in Treas. Reg.
§1.6041–3(q) (for rents, amounts paid on
notional principal contracts, and other
fixed or determinable income). Exempt
recipients are not exempt from NRA with-
holding.
Sec. 2.16. External Auditor.An “exter-
nal auditor” is any approved auditor listed
in Appendix B of this Agreement that QI
(or any private arrangement intermediary
of QI) engages to perform the audits re-
quired by section 10 of this Agreement.
Sec. 2.17. Flow -Through Entity. A
flow-through entity is a foreign partner-
ship described in Treas. Reg.
§301.7701–2 or 3 (other than a withhold-
ing foreign partnership), a foreign trust
that is described in section 651(a) of the
Code, or a foreign trust all or a portion of
which is treated as owned by the grantor
or other person under sections 671
through 679 of the Code. For an item of
income for which a treaty benefit is
claimed, an entity is also a flow-through
entity to the extent it is treated as fiscally
transparent under section 894 and the reg-
ulations thereunder.
Sec. 2.18. Foreign Person.A “foreign
person” is any person that is not a “United
States person” and includes a “nonresi-
dent alien individual,” a “foreign corpora-
tion,” a “foreign partnership,” a “foreign
trust,” and a “foreign estate,” as those
terms are defined in section 7701 of the
Code. For purposes of chapter 3 of the
Code, the term foreign person also means,
with respect to a payment by a withhold-
ing agent (including a qualified interme-
diary), a foreign branch of a U.S. person
that provides a valid Form W-8IMY on
which it represents that it is a qualified in-
termediary. A foreign branch of a U.S.
person that is a qualified intermediary is,
however, a U.S. payor for purposes of
chapter 61 and section 3406 of the Code.
Sec. 2.19. Form W-8.“Form W-8”
means IRS Form W-8BEN, Certificate of
Foreign Status of Beneficial Owner for
United States Tax Withholding; IRS Form
W-8ECI, Certificate of Foreign Person’s
Claim for Exemption From Withholding
on Income Effectively Connected With
the Conduct of a Trade or Business in the
United States; IRS Form W-8EXP, Cer-
tificate of Foreign Governments and
Other Foreign Organizations for United
States Tax Withholding; and IRS Form
W-8IMY, Certificate of Foreign Interme-
diary, Foreign Partnership, and Certain
U.S. Branches for United States Tax
Withholding, as appropriate. It also in-
cludes any acceptable substitute form.
Sec. 2.20. Form W-9.“Form W-9”
means IRS Form W-9, Request for Tax-
payer Identification Number and Certifi-
cation, or any acceptable substitute.
Sec. 2.21. Form 945.“Form 945” means
IRS Form 945, Annual Return of With-
held Federal Income Tax.
Sec. 2.22. Form 1042.“Form 1042”
means an IRS Form 1042, Annual With-
holding Tax Return for U.S. Source In-
come of Foreign Persons.
Sec. 2.23. Form 1042-S.“Form 1042-S”
means an IRS Form 1042-S, Foreign Per-
son’s U.S. Source Income Subject to
Withholding.
Sec. 2.24. Form 1096.“Form 1096”
means IRS Form 1096, Annual Summary
and Transmittal of U.S. Information Re-
turns.
Sec. 2.25. Form 1099.“Form 1099”
means IRS Form 1099-B, Proceeds From
Broker and Barter Exchange Transac-
tions; IRS Form 1099-DIV, Dividends
and Distributions; IRS Form 1099-INT,
Interest Income; IRS Form 1099-MISC,
Miscellaneous Income; IRS Form 1099-
OID, Original Issue Discount, and any
other form in the IRS Form 1099 series
appropriate to the type of payment re-
quired to be reported.
Sec. 2.26. Form 1099 Reporting.
“Form 1099 reporting” means the report-
ing required on Form 1099.
Sec. 2.27. Intermediary.An “intermedi-
ary” means any person that acts on behalf
of another person such as a custodian,
broker, nominee, or other agent.
Sec. 2.28. Know-Your-Customer Rules.
The phrase “know-your customer rules”
refers to the applicable laws, regulations,
rules, and administrative practices and
procedures, identified in the Attachments
to this Agreement, governing the require-
ments of QI to obtain documentation con-
firming the identity of QI’s account hold-
ers.
Sec. 2.29. Marketable Securities.For
purposes of this Agreement, the term
“marketable securities” means those secu-
rities described in Treas. Reg. §1.1441–6
for which a TIN is not required to obtain
treaty benefits.
Sec. 2.30. Non-Exempt Recipient.A
“non-exempt recipient” means a person
that is not an exempt recipient under the
definition in section 2.15 of this Agree-
ment.
Sec. 2.31. Nonqualified Intermediary.
A “nonqualified intermediary” is any in-
termediary that is not a qualified interme-
diary. A nonqualified intermediary in-
cludes any custodian, nominee, or other
agent as well as any financial institution
intermediary unless such person enters an
agreement to be a qualified intermediary
and acts in such capacity.
Sec. 2.32. NRA Withholding.“Nonresi-
dent alien (NRA) withholding” is any
withholding required under chapter 3 of
the Code, whether the payment subject to
withholding is made to an individual or to
an entity.
Sec. 2.33. Overwithholding.The term
“overwithholding” means the excess of
the amount actually withheld under chap-
ter 3 or section 3406 of the Code over the
amount required to be withheld.
Sec. 2.34. Paid Outside the United
States.An amount is “paid outside the
United States” if it is paid outside the
United States within the meaning of
Treas. Reg. §1.6049–5(e).
Sec. 2.35. Payment.A “payment” is
considered made to a person if that person
realizes income whether or not such in-
come results from an actual transfer of
cash or other property. See Treas. Reg.
§1.1441–2(e). For example, a payment
includes crediting an amount to an ac-
count.
Sec. 2.36. Payor.A “payor” is defined in
Treas. Reg. §31.3406(a)–2 and
§1.6049–4(a)(2) and generally means any
person required to make an information re-
turn under chapter 61 of the Code. The
term includes any person that makes a pay-
ment, directly or indirectly, to QI and to
whom QI provides information, pursuant
to this Agreement, so that such person can
report a payment on Form 1099 and, if ap-
propriate, backup withhold. See sections
3.05 and 6 of this Agreement. Also see
section 2.50 of this Agreement for the defi-
nition of U.S. payor and non-U.S. payor.
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2000–4 I.R.B.393January 24, 2000
Sec. 2.37. Presume/Presumption.The
terms “presume” or “presumption” refer
to the presumption rules set forth in sec-
tion 5.13(C) of this Agreement.
Sec. 2.38. Private Arrangement Inter-
mediary.A “private arrangement inter-
mediary” or “PAI” is an intermediary de-
scribed in section 4 of this Agreement.
Sec. 2.39. Qualified Intermediary.A
“qualified intermediary” is a person, de-
scribed in Treas. Reg.
§1.1441–1(e)(5)(ii), that enters into a
withholding agreement with the IRS to be
treated as a qualified intermediary and
acts in its capacity as a qualified interme-
diary.
Sec. 2.40. Qualified Intermediary (or
QI) EIN.A “qualified intermediary EIN”
or “QI-EIN” means the employer identifi-
cation number assigned by the IRS to a
qualified intermediary. QI’s QI-EIN is
only to be used when QI is acting as a
qualified intermediary. For example, QI
must give a withholding agent its non-QI
EIN, if any, rather than its QI-EIN if it is
receiving income as a beneficial owner
and a taxpayer identification number is
required. QI must also use its non-QI
EIN, if any, when acting as a nonqualified
intermediary. Each signatory to this
agreement must have its own QI-EIN.
Sec. 2.41. Reduced Rate of Withhold-
ing.A “reduced rate of withholding”
means a rate of withholding under chapter
3 of the Code that is less than 30 percent,
including an exemption from withhold-
ing, or not withholding 31 percent under
section 3406 of the Code.
Sec. 2.42. Reliably Associating a Pay-
ment With Documentation. See section
5.13(B) of this Agreement to determine
whether QI can reliably associate a pay-
ment with documentation.
Sec. 2.43. Reportable Amount.A “re-
portable amount” means an amount sub-
ject to NRA withholding (as defined in
section 2.03 of this Agreement); U.S.
source deposit interest (as defined in sec-
tion 2.10 of this Agreement); and U.S.
source interest or original issue discount
paid on the redemption of short-term
obligations (as defined in section 2.46 of
this Agreement). The term does not in-
clude payments on deposits with banks
and other financial institutions that re-
main on deposit for two weeks or less. It
also does not include amounts of original
issue discount arising from a sale and re-
purchase transaction completed within a
period of two weeks or less, or amounts
described in Treas. Reg. §1.6049–5(b)(7),
(10), or (11) (relating to certain foreign
targeted registered obligations and certain
obligations issued in bearer form).
Sec. 2.44. Reportable Payment.For
purposes of this Agreement, a reportable
payment means amounts described in sec-
tion 2.44(A) of this Agreement, in the
case of a U.S. payor, and amounts de-
scribed in section 2.44(B) of this Agree-
ment, in the case of a non-U.S. payor.
(A) U.S. Payor.If QI is a U.S. payor, a
reportable payment means any reportable
payment as defined in section 3406(b) of
the Code, including any broker proceeds
from the sale of assets beneficially owned
by a U.S. non-exempt recipient account
holder that produce, or could produce, re-
portable payments if the identity and ac-
count information of that account holder
is prohibited by law, including by con-
tract, from disclosure as described in sec-
tion 6.04 of this Agreement. For this pur-
pose, it is irrelevant whether the sale is
effected by QI or QI instructs another per-
son to effect the sale. It is also irrelevant
whether the sale is effected at an office in-
side or outside the United States. Thus,
the exception in Treas. Reg. §1.6045–1(a)
(which excepts sales effected at an office
outside the United States by a non-U.S.
payor) and the exception in Treas. Reg.
31.3406(g)–1(e) (which excepts certain
payments made outside the United States
from backup withholding) do not apply in
the case of an account holder whose iden-
tity is prohibited by law from disclosure.
(B) Non-U.S. Payor. If QI is a non-U.S.
payor a reportable payment means–
(1)Any reportable amount (unless an ex-
ception to reporting applies under chapter
61 of the Code);
(2)Any broker proceeds from the sale of
assets that produce, or could produce, re-
portable amounts if the sale is effected at
an office inside the United States, as de-
fined in Treas. Reg. §1.6045–1(g)(3), (un-
less an exception to reporting applies
under chapter 61 of the Code);
(3)Any broker proceeds from the sale of
an asset that produces, or could produce,
reportable amounts that are beneficially
owned by a U.S. non-exempt recipient
whose identity and account information is
prohibited by law, including by contract,
from disclosure as described in section
6.04 of this Agreement. For this purpose,
it is irrelevant whether the sale is effected
by QI or another person upon instructions
from QI. It is also irrelevant whether the
sale is effected at an office inside or out-
side the United States. Thus, the excep-
tion in Treas. Reg. §1.6045–1(a) (which
excepts sales effected at an office outside
the United States by a non-U.S. payor)
and the exception in Treas. Reg.
31.3406(g)–1(e) (which excepts certain
payments made outside the United States
from backup withholding) do not apply in
the case of an account holder whose iden-
tity is prohibited by law from disclosure;
and
(4)Any foreign source interest, dividends,
rents, royalties, or other fixed and deter-
minable income if such income is paid in
the United States or to an account main-
tained in the United States or any other
amount presumed paid to a U.S. non-ex-
empt recipient under section 5.13(C)(4)
of this Agreement (unless an exception to
reporting applies under chapter 61 of the
Code).
Sec. 2.45. Reporting Pool.A reporting
pool is defined in section 8.03 of this
Agreement.
Sec. 2.46. Short-Term Obligation.A
“short-term obligation” is any obligation
described in section 871(g)(1)(B)(i) of the
Code.
Sec. 2.47. TIN.A “TIN” is a U.S. tax-
payer identification number.
Sec. 2.48. Underwithholding.“Under-
withholding” means the excess of the
amount required to be withheld under
chapter 3 or section 3406 of the Code
over the amount actually withheld.
Sec. 2.49. Undocumented Account
Holder.An “undocumented account
holder” is an account holder for whom QI
does not hold valid documentation.
Sec. 2.50. U.S. Payor/Non-U.S. Payor.
The terms “U.S. payor” and “non-U.S.
payor” have the same meaning as in
Treas. Reg. §1.6049–5(c).
Sec. 2.51. U.S. Person.A “United States
(or U.S.) person” is a person described in
section 7701(a)(30) of the Code, the U.S.
government (including an agency or in-
strumentality thereof), a State of the
United States (including an agency or in-
strumentality thereof), or the District of
Columbia (including an agency or instru-
mentality thereof).
Sec. 2.52. Withholding Agent.A “with-
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January 24, 20003942000–4 I.R.B.
holding agent” has the same meaning as
set forth in Treas. Reg. §1.1441–7(a) and
includes a payor (as defined in section
2.36 of this Agreement). As used in this
Agreement, the term generally refers to
the person making a payment to a quali-
fied intermediary.
Sec. 2.53. Withholding Rate Pool.The
term “withholding rate pool” is defined in
section 6.03 of this Agreement.
Sec. 2.54. Withholding Statement.The
term “withholding statement” is defined
in section 6.02 of this Agreement.
Sec. 2.55. Other Terms.Any term not
defined in this section has the same mean-
ing that it has under the Code, the income
tax regulations under the Code, or any ap-
plicable income tax treaty.
SECTION 3. WITHHOLDING
RESPONSIBILITY
Sec. 3.01. NRA Withholding Responsi-
bility.QI is subject to the withholding
and reporting provisions applicable to
withholding agents under chapter 3 of the
Code. Under chapter 3, a withholding
agent must withhold 30 percent of any
payment of an amount subject to NRA
withholding made to an account holder
that is a foreign person unless the with-
holding agent can reliably associate the
payment with documentation upon which
it can rely to treat the payment as made to
a payee that is a U.S. person or as made to
a beneficial owner that is a foreign person
entitled to a reduced rate of withholding.
See section 5 of this Agreement regarding
documentation requirements.
Sec. 3.02. Primary NRA Withholding
Responsibility Not Assumed.Notwith-
standing sections 1.01 and 3.01 of this
Agreement, QI shall not be required to
withhold under chapter 3 of the Code if it
does not accept primary NRA withhold-
ing responsibility under section 3.03 of
this Agreement and it has provided a valid
withholding certificate and correct with-
holding statements to a withholding agent
from which it receives an amount subject
to NRA withholding in accordance with
section 6 of this Agreement. Notwith-
standing its election not to assume pri-
mary NRA withholding responsibility, QI
shall, however, withhold the difference
between the amount of NRA withholding
required under chapter 3 of the Code and
the amount actually withheld by another
withholding agent if QI–
(A)Actually knows that the appropriate
amount has not been withheld by another
withholding agent; or
(B)Made an error which results in the
withholding agent’s failure to withhold
the correct amount due (e.g., QI fails to
provide an accurate withholding state-
ment with respect to the payment) and QI
has not corrected the underwithholding
under the reimbursement and setoff pro-
cedures of section 9.05 of this Agreement.
QI is not required to withhold under chap-
ter 3 of the Code on an amount subject to
NRA withholding that it pays to another
qualified intermediary that has assumed
primary NRA withholding responsibility
with respect to the payment or to a with-
holding foreign partnership. See section
8 of this Agreement regarding QI’s re-
sponsibility to report amounts subject to
withholding on Form 1042–S.
Sec. 3.03. Assumption of Primary NRA
Withholding Responsibility.QI, upon
notification to a withholding agent, may
assume primary NRA withholding respon-
sibility for an amount subject to NRA
withholding by providing a valid withhold-
ing certificate described in section 6 of this
Agreement to a withholding agent that
makes a payment of an amount subject to
NRA withholding and by designating on
the withholding statement associated with
such certificate the account for which QI
assumes primary NRA withholding re-
sponsibility. QI may assume primary
NRA withholding responsibility without
informing the IRS. QI is not required to
assume primary NRA withholding respon-
sibility for all accounts it has with the with-
holding agent. However, if QI assumes
primary NRA withholding responsibility
for any account, it must assume that re-
sponsibility for all payments of amounts
subject to NRA withholding made by the
withholding agent to that account. To the
extent that QI assumes primary NRA with-
holding responsibility, QI shall withhold
from amounts subject to NRA withholding
the amount required to be withheld under
chapter 3 of the Code. QI is not required,
however, to withhold on amounts it pays to
another qualified intermediary that has cer-
tified to QI on Form W-8IMY that it has
assumed primary withholding responsibil-
ity with respect to the payment or to a
withholding foreign partnership. See sec-
tion 8 of this Agreement regarding QI’s re-
sponsibility to report amounts subject to
withholding on Form 1042-S.
Sec. 3.04. Backup Withholding Re-
sponsibility.QI is a payor under section
3406 of the Code with respect to re-
portable payments. Under section 3406, a
payor is required to deduct and withhold
31 percent from the payment of a re-
portable payment to a U.S. non-exempt
recipient if the U.S. non-exempt recipient
has not provided its TIN in the manner re-
quired under that section; the IRS notifies
the payor that the TIN furnished by the
payee is incorrect; there has been a noti-
fied payee under-reporting described in
section 3406(c); or there has been a payee
certification failure described in section
3406(d). QI represents that there are no
legal restrictions that prohibit it from
complying with the Form 1099 reporting
requirements of this Agreement or impos-
ing backup withholding and depositing
the amounts withheld in accordance with
section 3.08 of this Agreement.
Sec. 3.05. Primary Form 1099 Report-
ing and Backup Withholding Responsi-
bility For Reportable Payments Other
Than Reportable Amounts.Under sec-
tion 6.01 of this Agreement, QI is only re-
quired to provide a withholding agent
with information regarding reportable
amounts. Therefore, QI is primarily re-
sponsible for reporting on Form 1099
and, if required, backup withholding on
the payments described in section 3.05(A)
and (B) of this Agreement whether or not
QI assumes primary Form 1099 reporting
and backup withholding responsibility
with respect to reportable amounts under
section 3.07 of this Agreement. No provi-
sion of this Agreement which requires QI
to provide another withholding agent with
information regarding reportable amounts
shall be construed as relieving QI of its
Form 1099 reporting and backup with-
holding obligations with respect to re-
portable payments that are not reportable
amounts.
(A) U.S. Payor.Except as provided in
section 3.05(C) of this Agreement, if QI is
a U.S. payor, QI has primary Form 1099
reporting and backup withholding respon-
sibility for reportable payments as defined
in section 3406(b) of the Code other than
reportable amounts. For example, if QI is
a U.S. payor, it has primary Form 1099
reporting and backup withholding respon-
sibility for payments of foreign source in-
come as well as all broker proceeds paid
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to account holders that are, or are pre-
sumed to be, U.S. non-exempt recipients,
unless an exception to reporting or
backup withholding applies. QI also has
primary Form 1099 reporting and backup
withholding responsibility for broker pro-
ceeds from the sale of assets beneficially
owned by a U.S. non-exempt recipient ac-
count holder that produce or could pro-
duce, reportable payments if the identity
and account information of that account
holder is prohibited by law from disclo-
sure as described in section 6.04 of this
Agreement. See section 2.44(A) of this
Agreement for the instances in which cer-
tain reporting and withholding exceptions
do not apply.
(B) Non-U.S. Payor.Except as provided
in section 3.05(C) of this Agreement, if
QI is a non-U.S. payor, QI has primary
Form 1099 reporting and backup with-
holding responsibility for broker proceeds
described in section 2.44(B)(2) and (3) of
this Agreement and foreign source in-
come paid in the United States or to an ac-
count maintained in the United States as
described in section 2.44(B)(4) of this
Agreement, if such payments are made, or
presumed made under section 5.13(C)(4)
of this Agreement, to U.S. non-exempt re-
cipients.
(C) Designated Broker Proceeds Proce-
dure. Whether QI is a U.S. payor or non-
U.S. payor, QI may request another payor
to report on Form 1099 and, if required,
backup withhold on designated broker
proceeds (as defined in section 2.11 of
this Agreement), provided the other payor
actually receives the broker proceeds. QI
will not be primarily responsible for Form
1099 reporting and for backup withhold-
ing if the other payor agrees to do the re-
porting and backup withholding and QI
provides all of the information necessary
for the other payor to properly report, and
backup withhold on the designated broker
proceeds. QI, however, remains primarily
responsible for Form 1099 reporting and
backup withholding if the other payor
does not agree to report and backup with-
hold, or QI knows that the other payor
failed to do so.
Sec. 3.06. Primary Form 1099 Report-
ing and Backup Withholding Responsi-
bility For Reportable Amounts Not As-
sumed.Notwithstanding sections 1.01
and 3.04 of this Agreement, QI shall not
be required to backup withhold on a re-
portable amount if QI does not assume
primary Form 1099 reporting and backup
withholding responsibility and it provides
a payor from which it receives a re-
portable amount the Forms W-9 of its
U.S. non- exempt recipient account hold-
ers (or, if a U.S. non-exempt recipient
fails to provide a Form W-9, information
regarding the account holder’s name, ad-
dress, and TIN, if a TIN is available) to-
gether with the withholding rate pools (as
defined in section 6.03 of this Agreement)
attributable to U.S. non-exempt recipient
account holders. Notwithstanding its
election not to assume primary Form
1099 reporting and backup withholding
responsibility, QI shall backup withhold
and report a reportable amount if–
(A)QI actually knows a reportable
amount is subject to backup withholding
and another payor failed to apply backup
or NRA withholding;
(B)Another payor has not applied backup
or NRA withholding to a reportable
amount because of an error made by QI
(e.g., QI failed to provide the other payor
with information regarding the name, ad-
dress, TIN, if available, and withholding
rate pool for a U.S. non-exempt recipient
account holder subject to backup with-
holding);
(C)QI pays a reportable amount to a U.S.
non-exempt recipient whose identity and
other account information are prohibited
by law from disclosure (see section 6.04
of this Agreement) and another payor of
the reportable amount has not backup
withheld.
QI is not required to backup withhold,
however, on a reportable amount it makes
to a withholding foreign partnership or to
another qualified intermediary if the other
qualified intermediary has assumed pri-
mary Form 1099 reporting and backup
withholding responsibility with respect to
the payment. See section 3.05 of this
Agreement for backup withholding re-
sponsibility for reportable payments other
than reportable amounts. See section 8.04
of this Agreement regarding QI’s respon-
sibility to report reportable payments on
Form 1099.
[NOTE: A qualified intermediary that is
not a U.S. payor must obtain IRS approval
to assume primary Form 1099 reporting
and backup withholding responsibility with
respect to reportable amounts. The IRS
will evidence its approval of a non-U.S.
payor’s assumption of primary Form 1099
reporting and backup withholding respon-
sibility by the signature of the Commis-
sioner, or his delegate, in the margin of
section 3.07 of this Agreement. ]
Sec. 3.07. Assumption of Primary
Form 1099 Reporting and Backup
Withholding Responsibility.QI may as-
sume primary Form 1099 reporting re-
sponsibility under chapter 61 of the Code
and primary backup withholding respon-
sibility under section 3406 of the Code
with respect to reportable amounts. See
sections 3.05 and 8.04 of this Agreement
for QI’s obligations regarding reportable
payments other than reportable amounts.
A qualified intermediary that assumes
such responsibility is subject to all of the
obligations imposed by chapter 61 and
section 3406 of the Code and shall be sub-
ject to any applicable penalties for failure
to meet those obligations. The exception
from backup withholding under Treas.
Reg. §31.3406(g)–1(e) shall not apply,
however, to payments of deposit interest,
or interest or original issue discount on re-
demptions of short-term obligations, to
the extent QI must presume that an ac-
count holder is a U.S. non-exempt recipi-
ent under section 5.13(C)(2) of this
Agreement. QI shall inform a withhold-
ing agent from which it receives a re-
portable amount that it has assumed pri-
mary Form 1099 reporting and backup
withholding responsibility by providing
the withholding agent with a valid with-
holding certificate described in section 6
of this Agreement and by designating on
the withholding statement associated with
such certificate the account for which QI
assumes primary Form 1099 reporting
and backup withholding responsibility.
QI may assume primary Form 1099 re-
porting and backup withholding responsi-
bility without informing the IRS, unless
QI is a non-U.S. payor. QI is not required
to assume primary Form 1099 reporting
and backup withholding responsibility for
all accounts it has with a withholding
agent. However, if QI assumes primary
Form 1099 reporting and backup with-
holding responsibility for any account, it
must assume that responsibility for all re-
portable amounts made by a payor to that
account. QI shall not be required to
backup withhold on a reportable amount
it makes to another qualified intermediary
that has assumed primary Form 1099 re-
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porting and backup withholding responsi-
bility with respect to the reportable
amount. See section 8 of this Agreement
regarding QI’s responsibility to report re-
portable payments on Form 1099.
Sec. 3.08. Deposit Requirements.If QI
is a U.S. payor or a non-U.S. payor that
assumes primary NRA withholding re-
sponsibility or primary Form 1099 and
backup withholding responsibility, it must
deposit amounts withheld under chapter 3
or section 3406 of the Code with a Fed-
eral Reserve bank or authorized financial
institution at the time and in the manner
provided under section 6302 of the Code
(see Treas. Reg. §1.6302–2(a) or
§31.6302–1(h)). If QI is a non-U.S. payor
that does not assume primary NRA with-
holding responsibility or primary Form
1099 and backup withholding responsibil-
ity, QI must deposit amounts withheld by
the 15th day following the month in
which the NRA or backup withholding
occurred.
SECTION 4. PRIVATE
ARRANGEMENT
INTERMEDIARIES
Sec. 4.01. In General.QI may enter into
a private arrangement with another inter-
mediary under which the other intermedi-
ary agrees to perform all of the obliga-
tions of QI under this Agreement, except
as provided in section 4.02 of this Agree-
ment. Such agreement shall be between
the QI and all the offices of the other in-
termediary located in a specified country.
The specified country must be one for
which this Agreement is available. Such
an intermediary is referred to in this
Agreement as a private arrangement inter-
mediary (“PAI”). By entering into a PAI
agreement, QI is not assigning its liability
for the performance of any of its obliga-
tions under this Agreement. Therefore,
QI shall remain liable for any tax, penal-
ties, interest, and any other sanction that
may result from the failure of the PAI to
meet any of the obligations imposed by its
agreement with QI. QI agrees not to as-
sert any defenses against the IRS for the
failures of the PAI or any defenses that
the PAI may assert against QI. For pur-
poses of this Agreement, the PAI’s actual
knowledge or reason to know of facts rel-
evant to withholding or reporting shall be
imputed to QI. QI’s liability for the fail-
ures of the PAI shall apply even though
the PAI is itself a withholding agent under
chapter 3 of the Code and a payor under
chapter 61 and section 3406 and is itself
separately liable for its failure to meet its
obligations under the Internal Revenue
Code. Notwithstanding the foregoing, QI
shall not be liable for tax, interest, or
penalties for failure to withhold and re-
port under chapters 3, 61, and section
3406 of the Code unless the underwith-
holding or the failure to report amounts
correctly on Forms 945, 1042, 1042-S or
1099 are due to QI’s or its PAI’s failure to
properly perform its obligations under
this Agreement. The PAI is not required
to enter into an agreement with the IRS.
The IRS may, however, in its sole discre-
tion, refuse to permit an intermediary to
operate as a PAI by providing notice to QI
at the address provided in section 12.06 of
this Agreement. QI may, however, appeal
the IRS’s determination by following the
notice and cure provisions in section
11.05 of this Agreement. For purposes of
this Agreement, an intermediary shall be
considered a PAI only if the following
conditions are met:
(A)The PAI is, pursuant to a written
agreement between QI and the PAI, sub-
ject to all the obligations of QI under this
Agreement, except to the extent modified
by section 4.02 of this Agreement;
(B)QI files a notice with the Commis-
sioner, or his delegate, at the address set
forth in section 12.06 of this Agreement,
before the first payment for which the in-
termediary acts as a PAI giving the name,
address, taxpayer identification number
of the intermediary, if any, and the name
of the country or countries in which the
offices of the intermediary that are subject
to the PAI agreement are located;
(C)The PAI is subject to the identical ex-
ternal audit procedures that apply to QI
under this Agreement and the PAI uses an
external auditor designated in Appendix B
of this Agreement, or another auditor ap-
proved by the IRS for that PAI; and
(D)The PAI furnishes QI with a Form W-
8IMY described in section 6 of this
Agreement as modified by this section
4.01(D). The PAI is required to provide
QI with the Forms W-9 (or, in absence of
the form, the name, address and TIN, if
available) of the PAI’s U.S. non-exempt
recipient account holders and the with-
holding rate pool information for those
account holders as required by section
6.03 of this Agreement. In addition, the
PAI is required to disclose to QI the ac-
count holders of a nonqualified intermedi-
ary, or interest holders in a flow-through
entity, which has an account with the PAI
and all of the information relating to those
account holders that is required for the
QI, or another withholding agent, to re-
port the payments made to those account
holders as required by sections 8.02(B)
and 8.04 of this Agreement. The PAI is
not required to disclose to QI, or another
withholding agent, its direct account
holders that are foreign persons.
Sec. 4.02. Modification of Obligations
for PAI Agreements.The agreement be-
tween QI and a PAI must provide that QI
shall include all reportable payments
made by the PAI in QI’s Forms 945 and
1099 and all payments of amounts subject
to NRA withholding made by the PAI in
QI’s Forms 1042 and 1042-S as if QI had
made the payments directly to the PAI’s
account holders. Therefore, QI shall re-
port payments made to a PAI’s direct for-
eign account holders (other than interme-
diaries, custodians, nominees, agents or
flow-through entities) using the reporting
pools as described in section 8.03 of this
Agreement and shall report payments
made to indirect foreign account holders
of the PAI by reporting the payments as
made to specific recipients under the rules
of section 8.02 of this Agreement. QI
shall also file Forms 1099 and, if re-
quired, backup withhold on reportable
payments made to U.S. non-exempt recip-
ient direct or indirect account holders of a
PAI in accordance with the terms of this
Agreement. QI shall require a PAI to pro-
vide QI with all the information necessary
for QI to meet its obligations under this
Agreement. No provisions shall be con-
tained in the agreement between QI and a
PAI that preclude, and no provisions of
this Agreement shall be construed to pre-
clude, the PAI’s joint and several liability
for tax, penalties, and interest under chap-
ters 3, 61, and section 3406 of the Code to
the extent that underwithholding, penal-
ties, and interest have not been collected
from QI and the underwithholding or fail-
ure to report amounts correctly on Forms
945, 1042, 1042-S or 1099 are due to a
PAI’s failure to properly perform its
obligations under its agreement with QI.
QI’s agreement with a PAI must require
the PAI to disclose information regarding
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U.S. non-exempt recipients to the same
extent that QI is required to disclose such
information to the IRS or another payor
under this Agreement. Nothing in the
agreement between QI and a PAI shall
permit the PAI to assume primary NRA
withholding responsibility or primary
Form 1099 reporting and backup with-
holding responsibility.
Sec. 4.03. Termination of Arrange-
ment.QI shall cease to treat an interme-
diary as a PAI within 90 days from the
day QI knows that the PAI is in default of
its agreement with QI unless the PAI has
cured the event of default prior to the ex-
piration of such 90 day period. QI must
provide the IRS with notice of any PAI
agreement that has been terminated
within 30 days of the termination.
SECTION 5. DOCUMENTATION
REQUIREMENTS
Sec. 5.01. Documentation Require-
ments.QI shall apply the presumption
rules to any account holder that receives a
reportable amount or reportable payment
unless QI can reliably associate the pay-
ment with valid documentation from the
account holder. QI agrees to use its best
efforts to obtain documentation from ac-
count holders. If QI is obtaining docu-
mentary evidence, QI also agrees to ad-
here to the know-your-customer rules that
apply to QI with respect to the account
holder from whom the documentary evi-
dence is obtained. As set forth in section
11.04(F) of this Agreement, failure to ob-
tain documentation from a significant
number of direct account holders consti-
tutes an event of default. QI agrees to re-
view and maintain documentation in ac-
cordance with this section 5 and, in the
case of documentary evidence obtained
from direct account holders, in accordance
with the know-your-customer rules set
forth in the Attachments to this Agree-
ment. QI also agrees to make documenta-
tion (together with any associated with-
holding statements and other documents
or information) available upon request for
inspection by QI’s external auditor. QI
represents that none of the laws to which it
is subject prohibits disclosure of the iden-
tity of any account holder (including ac-
count holders subject to the provisions of
section 6.04 of this Agreement) or account
information to QI’s external auditor. QI
may rely on the documentation it obtains
under this section 5 as the basis for the in-
formation it provides another withholding
agent under section 6 of this Agreement,
as well as to determine its own withhold-
ing and reporting obligations.
Sec. 5.02. Documentation For Foreign
Account Holders. Except as otherwise
provided in section 5 of this Agreement, QI
may treat an account holder (including an
account holder that is a collective invest-
ment vehicle) as a foreign beneficial owner
of an amount if the account holder provides
a valid Form W-8 (other than Form W-
8IMY) or valid documentary evidence, as
described in section 2.12 of this Agreement,
that supports the account holder’s status as a
foreign person. QI may treat a documented
foreign beneficial owner account holder as
entitled to a reduced rate of NRA withhold-
ing if all the requirements to a reduced rate
are met and the documentation provided by
the account holder supports entitlement to a
reduced rate. QI may not, however, reduce
the rate of NRA withholding or backup
withholding required under the presumption
rules of section 5.13(C) of this Agreement if
QI knows that the account holder (including
a collective investment vehicle) is not the
beneficial owner of a reportable amount or
reportable payment. In addition, QI may
not treat an account holder that provides
documentation indicating that it is a bank,
broker, intermediary, or agent (such as an at-
torney) as a beneficial owner unless QI re-
ceives a statement, in writing and signed by
a person with authority to sign such a state-
ment, stating that such account holder is the
beneficial owner of the income. Further, QI
may not reduce the rate of withholding that
applies under the presumption rules of sec-
tion 5.13(C) of this Agreement on the basis
of a collective or global certification that is
made by any person (such as an intermedi-
ary or flow-through entity) on behalf of oth-
ers unless the certification is a valid Form
W-8IMY, and then, only to the extent that
QI can reliably associate the payment with
valid documentation that establishes the ac-
count holder’s entitlement to a reduced rate
of withholding. See section 5.13(B) of this
Agreement for rules regarding reliable asso-
ciation with documentation.
Sec. 5.03. In General.QI may not reduce
the rate of withholding based on a benefi-
cial owner’s claim of treaty benefits unless
QI obtains the documentation required by
section 5.03(A) of this Agreement. In addi-
tion, QI agrees to establish procedures to
inform account holders of the terms of lim-
itation on benefits provisions of a treaty
(whether or not those provisions are con-
tained in a separate article entitled Limita-
tion on Benefits) under which the account
holder is claiming benefits.
(A) Treaty Documentation.The docu-
mentation required by this section
5.03(A) is as follows:
(1)The account holder has provided a
properly completed Form W-8BEN with
part II of the form completed, including
the appropriate limitation on benefits and
section 894 certifications. A TIN shall
not be required, however, if the beneficial
owner is a direct account holder. An indi-
rect account holder is required to have a
TIN to claim treaty benefits unless it is
claiming treaty benefits on income from a
marketable security;
(2)The account holder has provided doc-
umentary evidence that has been obtained
pursuant to the know-your-customer rules
that apply to the account holder and the
account holder has made the treaty state-
ment required by section 5.03(B) of this
Agreement, if applicable; or
(3)The account holder provides the type of
documentary evidence required under
Treas. Reg. §1.1441-6 to establish entitle-
ment to a reduced rate of withholding under
a treaty and the account holder has made
the treaty statement required by section
5.03(B) of this Agreement, if applicable.
(B) Treaty Statement.The treaty state-
ment required by this section 5.03(B) is as
follows:
[Name of account holder] meets all
provisions of the treaty that are neces-
sary to claim a reduced rate of with-
holding, including any limitation on
benefits provisions, and derives the in-
come within the meaning of section
894 of the Code, and the regulations
thereunder, as the beneficial owner.
QI shall not be required to obtain a treaty
statement required by this section 5.03(B)
from an individual who is a resident of an
applicable treaty country or from the gov-
ernment, or its political subdivisions, of a
treaty country.
(C) Transition Rule for Treaty Certifi-
cation.QI may reduce the rate of with-
holding on a payment made to a benefi-
cial owner account holder that is
otherwise entitled to a reduced rate of
withholding under an income tax treaty
without obtaining the treaty statement re-
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quired in sections 5.03(B) of this Agree-
ment provided that the account to which
the payment is made was established be-
fore January 1, 2001, and the payment to
which a reduced rate of withholding
under the income tax treaty is applied is
received on or before December 31, 2002.
Sec. 5.04. Documentation for Interna-
tional Organizations.QI may not treat
an account holder as an international or-
ganization entitled to an exemption from
withholding under section 892 of the
Code unless the name provided on the
documentation (including a Form W-
8EXP) is the name of an entity designated
as an international organization by execu-
tive order pursuant to 22 United States
Code 288 through 288(f) and the docu-
mentation is valid under section 5.10 of
this Agreement. If an international orga-
nization is not claiming benefits under
section 892 of the Code but under another
Code exception, the provisions of sec-
tions 5.02 of this Agreement apply rather
than the provisions of this section 5.04.
Sec. 5.05. Documentation for Foreign
Governments and Foreign Central
Banks of Issue.
(A) Documentation From a Foreign
Government or Foreign Central Bank
of Issue Claiming an Exemption From
Withholding Under Section 892 or Sec-
tion 895. QI may not treat an account
holder as a foreign government or foreign
central bank of issue exempt from with-
holding under section 892 or 895 of the
Code unless–
(1)QI receives from the account holder a
Form W-8EXP or documentary evidence
establishing that the account holder is a
foreign government or foreign central
bank of issue;
(2)The income paid to the account holder
is the type of income that qualifies for an
exemption from withholding under sec-
tion 892 or 895; and
(3)QI does not know, or have reason to
know, that the account holder is a con-
trolled commercial entity, that the income
owned by the foreign government or for-
eign central bank of issue is being re-
ceived from a controlled commercial en-
tity, or that the income is from the
disposition of an interest in a controlled
commercial entity.
(B) Treaty Exemption. QI may treat an
account holder as a foreign government or
foreign central bank of issue entitled to a
reduced rate of withholding under an in-
come tax treaty if it has valid documenta-
tion that, under section 5.03 of this Agree-
ment, is sufficient to obtain a reduced rate
of withholding under a treaty.
(C) Other Code Exception.If a foreign
government or foreign central bank of
issue is not claiming benefits under sec-
tion 892 of the Code but under another
Code exception (e.g., the portfolio inter-
est exception under sections 871(h) or
881(c) of the Code), the provisions of sec-
tions 5.02 of this Agreement apply rather
than the provisions of this section 5.05.
Sec. 5.06. Documentation for Foreign
Tax-Exempt Organizations.
(A) Reduced Rate of Withholding
Under Section 501.QI may not treat an
account holder as a foreign organization
described under section 501(c) of the
Code, and therefore exempt from with-
holding (or, if the account holder is a for-
eign private foundation, subject to with-
holding at a 4-percent rate under section
1443(b) of the Code) unless QI obtains a
valid Form W-8EXP on which Part III of
the form is completed.
(B) Reduced Rate of Withholding
Under Treaty. QI may not treat an ac-
count holder as a foreign organization that
is tax-exempt on an item of income pur-
suant to a treaty unless QI obtains valid
documentation as described under section
5.03 of this Agreement that is sufficient
for obtaining a reduced rate of withhold-
ing under a treaty and the documentation
establishes that the account holder is an
organization exempt from tax under the
treaty on that item of income.
(C) Other Exceptions.If a tax-exempt
entity is not claiming a reduced rate of
withholding because it is an organization
described under section 501(c) of the
Code or under a treaty article that applies
to exempt certain organizations from tax,
but is claiming a reduced rate of with-
holding under another Code or treaty ex-
ception, the provisions of section 5.02 of
this Agreement shall apply rather than the
provisions of this section 5.06.
Sec. 5.07. Documentation From Inter-
mediaries or Flow-Through Entities.
QI shall apply the presumption rules of
section 5.13 of this Agreement to a re-
portable amount or reportable payment
made to a nonqualified intermediary or
flow-through entity except to the extent
QI follows the documentation procedures
set forth below.
(A) Nonqualified Intermediaries and
Flow-Through Entities.QI shall not
apply the presumption rules on a payment
made to a nonqualified intermediary or
flow-through entity to the extent–
(1)QI receives a valid Form W-8IMY
provided by the nonqualified intermedi-
ary or the flow- through entity; and
(2)QI can reliably associate the payment,
within the meaning of section 5.13(B) of
this Agreement, with valid documentation
described in this section 5 provided by ac-
count holders that are not themselves non-
qualified intermediaries or flow through
entities.
(B) Qualified Intermediaries and With-
holding Foreign Partnerships.QI shall
not apply the presumption rules to a pay-
ment made to a qualified intermediary or
withholding foreign partnership to the ex-
tent QI can reliably associate the payment
with a valid Form W-8IMY provided by
the qualified intermediary or withholding
foreign partnership and, for those pay-
ments for which a qualified intermediary
has not assumed primary NRA withhold-
ing responsibility or primary Form 1099
reporting and backup withholding respon-
sibility, QI can reliably associate the pay-
ment with a withholding rate pool, as de-
scribed in section 6.03 of this Agreement.
(C) Private Arrangement Intermedi-
aries.QI shall not apply the presumption
rules of section 5.13 of this Agreement if
QI has an agreement with a PAI, QI ob-
tains from the PAI a Form W-8IMY com-
pleted as if the PAI were a qualified inter-
mediary (with the exception that the PAI
must not provide a QI-EIN on the Form
W-8IMY) and QI can reliably associate
the payment with reporting pools as de-
scribed under section 8 of this Agreement,
or with withholding rate pool information
relating to U.S. non-exempt recipients
and indirect foreign account holders.
Sec. 5.08. Documentation For U.S. Ex-
empt Recipients.QI shall not treat an
account holder as a U.S. exempt recipient
unless QI obtains from the account
holder–
(A)A valid Form W-9 on which the ac-
count holder writes “Exempt” in Part II of
the Form;
(B)Documentary evidence that is sufficient
to establish both the account holder’s U.S.
and exempt recipient status; or
(C)Documentary evidence that is suffi-
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cient to establish the account holder’s sta-
tus as a U.S. person and QI can treat the
person as an exempt recipient under the
rules of Treas. Reg. §§1.6041–3(q),
5f.6045–1(c)(3)(i)(B), 1.6045–2(b)(2)(i),
or 1.6049–4(c)(1)(ii), as appropriate,
without obtaining documentation.
Sec. 5.09. Documentation for U.S. Non-
Exempt Recipients. QI shall not treat an
account holder as a U.S. non-exempt re-
cipient unless QI obtains a valid Form W-
9 from the account holder, QI knows an
account holder is a U.S. non-exempt re-
cipient, or QI must presume a person is a
U.S. non-exempt recipient under sections
5.13(C)(2) or (4) of this Agreement. See
section 6.04 of this Agreement for rules
that apply if the identity of a U.S. non-ex-
empt recipient is prohibited by law from
being disclosed.
Sec. 5.10. Documentation Validity.
(A) In General.QI may not rely on doc-
umentation if QI has actual knowledge, or
reason to know as described in section
5.10(B) and (C) of this Agreement, that
the information or statements contained in
the documentation are unreliable or incor-
rect. Once QI knows, or has reason to
know, that documentation provided by an
account holder is unreliable or incorrect,
it can no longer reliably associate a pay-
ment with valid documentation and,
therefore, shall treat the account holder as
an undocumented account holder and
shall apply the presumption rules of sec-
tion 5.13 of this Agreement until it ob-
tains valid documentation. In addition, if
QI discovers that information contained
in documentation is unreliable or incor-
rect, QI agrees that it will promptly pro-
vide a withholding agent with corrected
information (e.g., corrected withholding
rate pools, corrected Forms W-9, or cor-
rect TINs), if necessary for the withhold-
ing agent to perform its obligations,
within 30 days after QI discovers that the
documentation upon which it has relied is
unreliable or incorrect. If QI receives no-
tification from the IRS that documenta-
tion provided by an account holder is un-
reliable or incorrect (e.g., that the TIN
provided by an account holder is incor-
rect) QI shall follow the procedures set
forth in Treas. Reg. §31.3406(d)–5.
(B) Reason to Know–Direct Account
Holders.QI shall be considered to have
reason to know that documentation pro-
vided by a direct account holder is unreli-
able or incorrect only if one or more of
the circumstances described in this sec-
tion 5.10(B) apply. If an account holder
has provided documentation that is not re-
liable under the rules of this section
5.10(B), QI may require new documenta-
tion. Alternatively, QI may rely on the
documentation originally provided if the
rules of this section 5.10(B) permit such
reliance based on additional statements
and documentation.
(1) General Rules.
(i)To the extent QI has primary Form
1099 and backup withholding responsibil-
ity, QI shall not rely on a Form W-9 if it is
not permitted to do so under the rules of
Treas. Reg. §31.3406(h)–3(e).
(ii)QI shall not treat documentary evi-
dence provided by an account holder as
valid if the documentary evidence does
not reasonably establish the identity of the
person presenting the documentary evi-
dence. For example, documentary evi-
dence is not valid if it is provided in per-
son by an account holder that is a natural
person and the photograph on the docu-
mentary evidence, if any, does not match
the appearance of the person presenting
the document.
(iii) QI may not rely on documentation to
reduce the withholding rate that would
otherwise apply under the presumption
rules if the account holder’s documenta-
tion is incomplete, contains information
that is inconsistent with the account
holder’s claim, QI has other account in-
formation that is inconsistent with the ac-
count holder’s claim, or the documenta-
tion lacks information necessary to
establish entitlement to a reduced rate of
withholding. For example, if an account
holder provides documentary evidence to
claim treaty benefits and the documentary
evidence establishes the account holder’s
status as a foreign person and a resident of
a treaty country, but fails to provide the
treaty statement in section 5.03 of this
Agreement, if required, the documentary
evidence does not establish the account
holder’s entitlement to a reduced rate of
withholding. However, for purposes of
establishing an account holder’s status as
a foreign person or residency under an in-
come tax treaty, documentation shall be
considered inconsistent only if it is not re-
liable under the rules of section
5.10(B)(2) and (3) of this Agreement.
(2) Rules Regarding Establishment of
Foreign Status.
(i)QI shall not treat documentary evi-
dence provided by an account holder after
December 31, 2000, as valid for purposes
of establishing the account holder’s for-
eign status if the only mailing or resi-
dence address that is available to QI is an
address at a financial institution (unless
the financial institution is a beneficial
owner), an in-care-of address, or a P.O.
Box. In this case, QI must obtain addi-
tional documentation that is sufficient to
establish the account holder’s identity as a
foreign person. QI shall not treat docu-
mentary evidence provided by an account
holder before January 1, 2001, as valid for
purposes of establishing an account
holder’s status as a foreign person if it has
actual knowledge that a person is a U.S.
person or if it has a mailing or residence
address for the account holder in the
United States. If QI has an address for the
account holder in the United States, QI
may treat the account holder as a foreign
person if it can so treat the account holder
under the rules of section 5.10(B)(2)(ii) of
this Agreement.
(ii)QI shall not treat documentation as
valid for purposes of establishing an ac-
count holder’s status as a foreign person if
QI has a mailing or residence address
(whether or not on the documentation) for
the account holder in the United States or
if the account holder notifies QI of a new
address in the United States.
If the account holder is a natural person,
QI may nevertheless treat the account
holder as a foreign person if QI–
(a)Has in its possession or obtains addi-
tional documentary evidence (which does
not contain a U.S. address) supporting the
claim of foreign status and a reasonable
explanation in writing supporting the ac-
count holder’s foreign status;
(b)Has in its possession or obtains a valid
Form W-8, if the initial documentation
provided was not a Form W-8, and the
Form W-8 contains a permanent residence
address outside the United States and a
mailing address outside the United States
(or if a mailing address is inside the
United States the account holder provides
a reasonable explanation in writing sup-
porting the account holder’s foreign sta-
tus); or
(c)Is required to report annually a pay-
ment to the account holder on a tax infor-
mation statement in the country in which
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QI, or a branch of QI, is located; QI is re-
quired to file a copy of that statement with
the tax authority of that country; and that
country has an income tax treaty in effect
with the United States.
If the documentation is provided by an
entity (other than a flow-through entity),
QI may nevertheless treat the account
holder as a foreign person if QI–
(d)Has in its possession, or obtains, doc-
umentation that substantiates that the en-
tity is actually organized or created under
the laws of a foreign country;
(e)Obtains a valid Form W-8, if the initial
documentation provided was not a Form
W-8, and the Form W-8 contains a perma-
nent residence outside the United States
and a mailing address outside the United
States (or if a mailing address is inside the
United States the account holder provides
additional documentary evidence suffi-
cient to establish the account holder’s for-
eign status); or
(f)Is required to report annually a pay-
ment to the account holder on a tax infor-
mation statement in the country in which
QI, or a branch of QI, is located; QI is re-
quired to file a copy of that statement with
the tax authority of that country; and that
country has an income tax treaty in effect
with the United States.
(iii)QI shall not treat documentation as
valid for purposes of establishing an ac-
count holder’s status as a foreign person if
the account holder has standing instruc-
tions directing QI to pay amounts from its
account to an address or an account main-
tained in the United States. QI may treat
documentation as valid for establishing
foreign status even though the account
holder has such standing instructions if
the account holder provides a reasonable
explanation in writing that supports its
foreign status.
(3) Rules for Establishing Residency
Under An Income Tax Treaty.
(i)QI shall not treat an account holder
as a resident under an income tax treaty if
the permanent residence address on a
Form W-8 is not in the applicable treaty
country. QI may, however, rely on the
Form W-8 if the account holder provides
a reasonable explanation for the perma-
nent residence address outside the treaty
(e.g., the address is the address of a
branch located outside the treaty country
in which the entity is a resident) or QI has
in its possession, or obtains, documentary
evidence that establishes residency in a
treaty country.
(ii)QI shall not treat an account holder
as a resident under an income tax treaty if
the permanent residence address on a
Form W-8 is in the applicable treaty coun-
try but QI has a mailing or residence ad-
dress for the account holder (whether or
not contained on the Form W-8) outside
the applicable treaty country. A mailing
address that is a P.O. Box, in-care-of ad-
dress, or address at a financial institution
(if the financial institution is not a benefi-
cial owner) shall not preclude QI from
treating the account holder as a resident of
an applicable treaty country if such ad-
dress is in the applicable treaty country.
If QI has a mailing or residence address
for the account holder outside the applica-
ble treaty country, QI may nevertheless
rely on the form if–
(a)QI has in its possession, or obtains,
additional documentation supporting the
account holder’s claim of residence in the
applicable treaty country (and the addi-
tional documentation does not contain an
address outside the treaty country);
(b)QI has in its possession, or obtains,
documentation that establishes that the
account holder is an entity organized in a
treaty country (or an entity managed and
controlled in a treaty country, if the ap-
plicable treaty so requires);
(c)QI knows that the address outside the
applicable treaty country (other than a P.O.
Box, or in-care-of address) is a branch of a
bank or insurance company; or
(d)QI obtains a written statement from
the account holder that reasonably estab-
lishes entitlement to treaty benefits.
(iii)QI shall not treat documentary evi-
dence as valid for purposes of establish-
ing residency in a treaty country if QI has
a mailing or residence address for the ac-
count holder (whether or not on the docu-
mentary evidence) that is outside the ap-
plicable treaty country, or the only
address that QI has (whether in or outside
of the applicable treaty country) is a P.O.
Box, an in-care-of address, or the address
of a financial institution (if the financial
institution is not the beneficial owner).
QI may nevertheless rely on the docu-
mentary evidence if–
(a)QI has in its possession, or obtains,
additional documentary evidence support-
ing the account holder’s claim of resi-
dence in the applicable treaty country
(and the documentary evidence does not
contain an address outside the applicable
treaty country, a P.O. Box, an in-care-of
address, or the address of a financial insti-
tution);
(b)QI has in its possession, or obtains,
documentary evidence that establishes
that the account holder is an entity orga-
nized in a treaty country (or an entity
managed and controlled in a treaty coun-
try, if the applicable treaty so requires); or
(c)QI obtains a valid Form W-8 that
contains a permanent residence address
and a mailing address in the applicable
treaty country.
(iv)QI shall not treat documentation as
valid for purposes of establishing an ac-
count holder’s residence in an applicable
treaty country if the account holder has
standing instructions for QI to pay
amounts from its account to an address or
an account outside the treaty country un-
less the account holder provides a reason-
able explanation, in writing, establishing
the account holder’s residence in the ap-
plicable treaty country.
(C) Reason to know–Indirect Ac-
count Holders.QI shall be considered to
have reason to know that relevant infor-
mation or statements contained in docu-
mentation provided by an indirect account
holder are unreliable or incorrect if a rea-
sonably prudent person in the position of
a qualified intermediary would question
the claims made. QI shall have reason to
know that indirect account holder docu-
mentary evidence provided by a nonquali-
fied intermediary or a flow-through entity
is unreliable or incorrect if a nonqualified
intermediary or flow-through entity does
not provide QI with the names of the indi-
rect account holders, their addresses, allo-
cation information allocating payments to
each indirect account holder, and suffi-
cient information for QI to report pay-
ments on Forms 1042-S and Forms 1099.
In addition, QI shall have reason to be-
lieve that an indirect account holder is not
entitled to a reduced rate of withholding
under an income tax treaty if the nonqual-
ified intermediary or flow-through entity
has not provided sufficient information so
that QI can verify that the indirect account
holder has provided a TIN, if required,
and made the necessary statements re-
garding limitations on benefits provisions
and deriving the income under section
894 of the Code and the regulations there-
January 24, 20004002000–4 I.R.B.
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under.
Sec. 5.11. Documentation Validity Pe-
riod.
(A) Documentation Other than Form
W-9.QI may rely on valid documentary
evidence obtained from account holders
in accordance with applicable know-your-
customer rules as long as the documen-
tary evidence remains valid under those
rules or until QI knows, or has reason to
know, that the information contained in
the documentary evidence is incorrect.
QI may rely on the representations de-
scribed in section 5.03 of this Agreement
obtained in connection with such docu-
mentation for the same period of time as
the documentation. QI may rely on a
Form W-8 until its validity expires under
Treas. Reg. §1.1441–1(e)(4)(ii) and may
rely on documentary evidence (other than
documentary evidence obtained pursuant
to applicable know-your-customer rules)
until its validity expires under Treas. Reg.
§1.6049–5(c)(2).
(B) Form W-9.QI may rely on a valid
Form W-9 as long as it has not been in-
formed by the IRS or another withholding
agent that the form is unreliable. If QI
has primary Form 1099 reporting and
backup withholding responsibility, it may
rely on a Form W-9 unless one of the con-
ditions of Treas. Reg.
§31.3406(h)–3(e)(2)(i) through (v) apply.
Sec. 5.12. Maintenance and Retention
of Documentation.
(A) Maintaining Documentation. QI
shall maintain documentation by retaining
the original documentation, a certified
copy, a photocopy, a microfiche, or by
electronic storage or similar means of
record retention. For accounts opened
prior to January 1, 2001, if QI was not re-
quired under its know-your-customer
rules to maintain originals or copies of
documentation, QI may rely on its ac-
count information if it has complied with
all other aspects of its know-your-cus-
tomer rules regarding establishment of an
account holder’s identity, it has a record
that the documentation required under the
know-your-customer rules was actually
examined by an employee of QI in accor-
dance with the know-your-customer rules,
and it has no information in its possession
that would require QI to treat the docu-
mentation as invalid under the rules of
section 5.10(B) of this Agreement.
(B) Retention Period. QI shall retain an
account holder’s documentation obtained
under this section 5 for as long as docu-
mentation is required to be retained under
know-your-customer rules identified in
the relevant Attachment(s) to this Agree-
ment, whether or not the documentation
was obtained pursuant to those rules.
Sec. 5.13. Application of Presumption
Rules.
(A) In General.QI shall apply the pre-
sumption rules of section 5.13(C) of this
Agreement if QI cannot reliably associate
a payment with valid documentation from
an account holder other than a nonquali-
fied intermediary or a flow-through en-
tity. The presumption rules cannot be
used to grant a reduced rate of withhold-
ing. For example, the portfolio interest
exception of sections 871(h) and 881(c)
of the Code shall not apply to a person
that is presumed to be foreign. Further,
QI must apply the presumption rules
when required and may not rely on its ac-
tual knowledge regarding an account
holder’s status as a U.S. or foreign per-
son. For example, if the account holder is
presumed to be a U.S. non-exempt recipi-
ent, QI must treat the account holder as
subject to 31% backup withholding on a
reportable payment even though QI actu-
ally knows that the account holder is a
foreign person. Notwithstanding the pre-
ceding sentence, QI must rely on its ac-
tual knowledge regarding an account
holder rather than what is presumed under
section 5.13(C) of this Agreement if,
based on such knowledge, it should with-
hold an amount greater than the withhold-
ing rate under the presumption rules or it
should report on Form 1042-S or Form
1099 an amount that would otherwise not
be reported. Thus, if an account holder is
presumed to be a foreign person with re-
spect to an amount subject to withhold-
ing, QI must treat the account holder as
subject to 30 percent withholding and re-
port the payment on Form 1042-S unless
QI has actual knowledge that the account
holder is a U.S. non-exempt recipient, in
which case it must withhold 31 percent
from the gross amount of the payment and
report the payment on Form 1099. Fail-
ure to follow the presumption rules may
result in liability for underwithholding,
penalties, and interest.
(B) Reliably Associating a Payment
With Documentation. A payment can be
reliably associated with documentation if
it is considered reliably associated with
documentation under the rules of Treas.
Reg. §1.1441–1(b)(2)(vii). Generally, QI
can reliably associate a payment with
documentation if, for that payment, it
holds valid documentation, as described
in section 5 of the Agreement, from an ac-
count holder other than a nonqualified in-
termediary or flow-through entity; it can
reliably determine how much of the pay-
ment relates to the valid documentation
provided by such an account holder; and
it has no actual knowledge or reason to
know that any of the information or state-
ments in the documentation are incorrect.
Sections 5.13(B)(1)–(5) of this Agree-
ment describe whether a payment is reli-
ably associated with documentation if the
payment is made to an intermediary or
flow-through entity.
(1) Reliably Associating a Payment
With Documentation Provided by a
Nonqualified Intermediary or a Flow-
Through Entity.Generally, QI can reli-
ably associate a payment with documen-
tation provided by a nonqualified
intermediary or a flow-through entity
only to the extent it can reliably associate
the payment with a valid Form W-8IMY;
it can determine the portion of the pay-
ment that relates to valid documentation,
associated with the Form W-8IMY, from
an account holder other than a nonquali-
fied intermediary or flow-through entity;
and the nonqualified intermediary or
flow-through entity provides sufficient in-
formation for QI to report the payments
on Form 1042-S or Form 1099, if report-
ing is required. Notwithstanding the pre-
ceding sentence, to the extent a payment
is not subject to reporting on Form 1042-
S or Form 1099, QI can reliably associate
the payment with valid documentation
provided it can determine the portion of
the payment allocable to a group of docu-
mented account holders (other than non-
qualified intermediaries or flow-through
entities) for whom withholding and re-
porting is not required. For example, a QI
can treat a payment of deposit interest al-
locable to a group of documented foreign
account holders and documented U.S. ex-
empt recipients as reliably associated with
valid documentation. If the documenta-
tion attached to a nonqualified intermedi-
ary or flow-through entity’s Form W-
8IMY is documentation from another
nonqualified intermediary or flow-
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through entity, then the qualified interme-
diary must apply the rules of this para-
graph to that other nonqualified interme-
diary or flow-through entity.
(2) Reliably Associating a Payment
With a Withholding Certificate Pro-
vided By a Qualified Intermediary.
Generally, QI can reliably associate a
payment with documentation provided by
another qualified intermediary that does
not assume either primary NRA withhold-
ing responsibility or primary Form 1099
reporting and backup withholding respon-
sibility to the extent the other qualified in-
termediary provides a valid Form W-
8IMY and a withholding statement that
allocates the payment among withholding
rate pools for foreign account holders and
withholding rate pools attributable to each
U.S. non-exempt recipient account holder
for which the other qualified intermediary
has provided a valid Form W-9. The pre-
sumption rules shall not apply, however,
even if a payment cannot be allocated to
each U.S. non-exempt recipient account
holder to the extent the alternative proce-
dures of section 6.03(B) of this Agree-
ment apply.
(3) Reliably Associating a Payment
with Documentation Provided by a
Qualified Intermediary That Assumes
Primary NRA Withholding Responsi-
bility. Generally, QI can reliably associ-
ate a payment with valid documentation
provided by another qualified intermedi-
ary that assumes primary NRA withhold-
ing responsibility, but not primary Form
1099 reporting and backup withholding
responsibility, to the extent it can associ-
ate the payment with a valid Form W-
8IMY and the withholding statement as-
sociated with the Form W-8IMY allocates
the payment between a single withholding
rate pool attributable to all foreign per-
sons for which the qualified intermediary
assumes primary NRA withholding re-
sponsibility and to withholding rate pools
attributable to each U.S. non-exempt re-
cipient account holder for which the other
qualified intermediary has provided a
valid Form W-9. The presumption rules
shall not apply, however, even if a pay-
ment cannot be allocated to each U.S.
non-exempt recipient account holder to
the extent the alternative procedures of
section 6.03(B) of this Agreement apply.
(4) Reliably Associating a Payment
With Documentation Provided by a
Qualified Intermediary that Assumes
Primary Form 1099 Reporting and
Backup Withholding Responsibility.
Generally, QI can reliably associate a
payment with valid documentation pro-
vided by another qualified intermediary
that assumes primary Form 1099 report-
ing and backup withholding responsibil-
ity, but not primary NRA withholding re-
sponsibility, to the extent it can associate
the payment with a valid Form W-8IMY
and a withholding statement that allocates
the payment among withholding rate
pools for foreign account holders.
(5) Reliably Associating a Payment
With Documentation Provided by a
Qualified Intermediary that Assumes
Both Primary NRA Withholding Re-
sponsibility and Primary Form 1099
Reporting and Backup Withholding
Responsibility.Generally, QI can reli-
ably associate a payment with valid docu-
mentation provided by another qualified
intermediary that assumes both primary
NRA withholding responsibility and pri-
mary Form 1099 reporting and backup
withholding responsibility if QI can asso-
ciate the payment with a valid Form W-
8IMY and a withholding statement that
designates the accounts for which the
other qualified intermediary is acting as a
qualified intermediary and is assuming
primary NRA withholding and primary
Form 1099 reporting and backup with-
holding responsibility.
(C) Presumption Rules.The presump-
tion rules are as follows:
(1) Payments Made Outside the United
States to an Offshore Account of
Amounts Subject to NRA Withholding.
An amount that is subject to NRA with-
holding that is paid outside the United
States to an account that is maintained
outside the United States is presumed
made to an undocumented foreign ac-
count holder. Therefore, QI must treat the
amount as subject to withholding at a rate
of 30 percent on the gross amount paid
and report the payment to an unknown ac-
count holder on Form 1042-S.
(2) Payments of Deposit Interest and
OID on Short-Term Obligations. An
amount of U.S. source deposit interest
(other than an amount that is part of the
purchase price of a certificate of deposit
sold in a transaction other than a redemp-
tion) or an amount of U.S. source interest
or original issue discount on the redemp-
tion of a short-term obligation that is paid
outside the United States to an offshore
account is presumed made to an undocu-
mented U.S. non-exempt recipient ac-
count holder. QI must backup withhold at
31 percent and report such amounts on
Form 1099 unless it has provided suffi-
cient information for another payor from
which it receives such amounts to backup
withhold and report the payments and QI
does not know that the other payor has
failed to backup withhold or report.
(3) Foreign Source Income, Broker
Proceeds, and Certain Other Amounts.
QI shall presume that the following pay-
ments are made to an exempt recipient
provided that such amounts are paid out-
side the United States to an account main-
tained outside the United States:
(i)Foreign source income;
(ii)Broker proceeds;
(iii)Original issue discount paid in a sale
other than a redemption;
(iv)Interest paid as part of the purchase
price of an obligation when the instru-
ment is sold between interest payment
dates;
(v)Amounts held on deposit with banks
or other financial institutions for two
weeks or less;
(vi)Amounts of original issue discount
arising from a sale and repurchase trans-
action that is completed within two weeks
or less; or
(vii)Amounts described in Treas. Reg.
§§1.6049-5(b)(7), (10), and (11).
Such amounts are not subject to withhold-
ing or reporting.
(4) Other Payments.Any payment not
covered in sections 5.13(C)(1), (2) or (3)
of this Agreement shall be presumed
made to a U.S. non-exempt recipient and
therefore shall be subject to Form 1099
reporting and to backup withholding.
Backup withholding shall not be required,
however, if the exception provided in
Treas. Reg. §31.3406(g)–1(e) applies.
For example, any reportable payment
paid inside the United States or paid to a
U.S. account is presumed made to a U.S.
non-exempt recipient and shall be subject
to backup withholding and reporting on
Form 1099 as paid to an unknown owner.
SECTION 6. QUALIFIED
INTERMEDIARY WITHHOLDING
CERTIFICATE AND DISCLOSURE
OF ACCOUNT HOLDERS TO
WITHHOLDING AGENT
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Sec. 6.01. Qualified Intermediary
Withholding Certificate.QI agrees to
furnish a qualified intermediary withhold-
ing certificate to each withholding agent
from which it receives a reportable
amount as a qualified intermediary. The
qualified intermediary withholding cer-
tificate is a Form W-8IMY (or acceptable
substitute form) that certifies that QI is
acting as a qualified intermediary, con-
tains QI’s QI-EIN, and provides all other
information required by the form. QI also
agrees to furnish each withholding agent
to whom it provides a Form W-8IMY the
withholding statement described in sec-
tion 6.02 of this Agreement. QI is not re-
quired to disclose, as part of its Form W-
8IMY or its withholding statement, any
information regarding the identity of an
account holder that is a foreign person or
a U.S. exempt recipient. However, to
the extent it does not assume primary
Form 1099 reporting and backup with-
holding responsibility, QI must provide to
a withholding agent the Forms W-9 ob-
tained from each U.S. non-exempt recipi-
ent account holder on whose behalf QI re-
ceives a reportable amount. If a U.S.
non-exempt recipient that must be dis-
closed has not provided a Form W-9, QI
must, to the extent it has not assumed pri-
mary Form 1099 reporting and backup
withholding, disclose the name, address,
and TIN (if available) to the withholding
agent. QI is not required, however, to dis-
close the identity of a U.S. non-exempt
recipient if QI is prohibited by law from
making the disclosure and QI follows the
procedures of section 6.04 of this Agree-
ment.
Sec. 6.02. Withholding Statement.
(A) In General.QI agrees to provide to
each withholding agent from which QI re-
ceives reportable amounts as a qualified
intermediary a written statement (the
“withholding statement”) described in
this section 6.02. The statement forms an
integral part of the Form W-8IMY. The
withholding statement may be provided in
any manner, and in any form, to which QI
and the withholding agent mutually agree.
For example, QI and the withholding
agent may agree to establish a procedure
to furnish withholding statement informa-
tion electronically. The procedure must
contain sufficient safeguards to ensure
that the information received by the with-
holding agent is the information sent by
QI and must also document all occasions
of user access that result in the submis-
sion or modification of withholding state-
ment information. In addition, the QI and
the withholding agent must be capable of
providing a hard copy of all withholding
statements provided by the QI. The with-
holding statement shall be updated as
often as necessary for the withholding
agent to meet its reporting and withhold-
ing obligations under this Agreement.
(B) Content of Withholding Statement.
The withholding statement must contain
sufficient information for a withholding
agent to apply the correct rate of with-
holding on payments from the accounts
identified on the statement and to prop-
erly report such payments on Forms
1042-S and Forms 1099, as applicable.
The withholding statement must–
(1)Designate those accounts for which QI
acts as a qualified intermediary;
(2)Designate those accounts for which QI
assumes primary NRA withholding re-
sponsibility and/or primary Form 1099 re-
porting and backup withholding responsi-
bility; and
(3)Provide information regarding with-
holding rate pools, as described in section
6.03 of this Agreement, if necessary.
Sec. 6.03. Withholding Rate Pools.
(A) In General.QI shall provide as part
of its withholding statement withholding
rate pool information in a manner suffi-
cient for the withholding agent to meet its
NRA and backup withholding responsi-
bilities and its Form 1042-S and Form
1099 reporting responsibilities. With-
holding rate pool information is not re-
quired to the extent QI has assumed both
primary NRA withholding responsibility
and primary Form 1099 reporting and
backup withholding responsibility and all
the information required for the withhold-
ing agent to report payments on Form
1042-S (e.g., the type of income) are
within the knowledge of the withholding
agent. A withholding rate pool is a pay-
ment of a single type of income (e.g., in-
terest, dividends) determined in accor-
dance with the categories of income
reported on Form 1042-S or Form 1099,
as applicable, that is subject to a single
rate of withholding (e.g., 0%, 10%, 15%,
or 30%). To the extent QI does not as-
sume primary Form 1099 and backup
withholding responsibility, QI’s withhold-
ing statement must establish a separate
withholding rate pool for each U.S. non-
exempt recipient account holder that QI
has disclosed to the withholding agent un-
less QI uses the alternative procedures in
section 6.03(B) of this Agreement. QI
shall determine withholding rate pools
based on valid documentation obtained
under section 5 of this Agreement, or if a
payment cannot be reliably associated
with valid documentation, on the pre-
sumption rules of section 5.13(C) of this
Agreement. If QI has an account holder
that is another intermediary (whether a
qualified intermediary, a non-qualified in-
termediary, or a private arrangement in-
termediary) or a flow-through entity, QI
may combine the account holder informa-
tion provided by the intermediary or flow-
through entity with QI’s direct account
holder information to determine QI’s
withholding rate pools.
(B) Alternative Procedure for U.S.
Non-Exempt Recipients.QI may, by
mutual agreement with the withholding
agent, establish a single withholding rate
pool (not subject to backup withholding)
for all U.S. non-exempt recipient account
holders for whom QI has provided Forms
W-9 prior to the withholding agent paying
any reportable amounts or, if applicable,
designated broker proceeds. Alterna-
tively, QI may include such U.S. non-ex-
empt recipients in a zero rate withholding
pool that includes U.S. exempt recipients
and foreign persons exempt from NRA
withholding provided that all the condi-
tions of this paragraph 6.03(B) are met.
QI may establish a separate withholding
rate pool (subject to 31% withholding) for
all U.S. non-exempt recipient account
holders for whom QI has not provided
Forms W-9 prior to the withholding agent
paying any reportable amounts or, if ap-
plicable, designated broker proceeds. If
QI chooses the alternative procedure of
this section 6.03(B), QI must provide suf-
ficient information to the withholding
agent no later than January 15 of the year
following the year in which the reportable
amounts and designated broker proceeds,
if applicable, are paid that allocates such
payments to each U.S. non-exempt recipi-
ent account holder. Failure to provide
such information will result in the appli-
cation of penalties to the QI under sec-
tions 6721 and 6722 of the Code and shall
constitute an event of default under sec-
tion 11.04 of this Agreement.
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Sec. 6.04. Legal Prohibitions Against
Disclosure of U.S. Non-Exempt Recipi-
ents.
(A) Accounts Established Prior to Jan-
uary 1, 2001.If QI knows an account
holder is a U.S. non-exempt recipient and
the account holder’s account was estab-
lished with QI prior to January 1, 2001 (a
pre-2001 account), QI agrees to the fol-
lowing procedures:
(1)If QI is prohibited by law, including
by contract, from disclosing to a with-
holding agent or to the IRS on Form 1099
the account holder’s name, address, and
TIN, for reportable payments paid to the
account holder, then QI must–
(i)Request from the account holder the
authority to make such a disclosure;
(ii)Request from the account holder the
authority to sell any assets that generate,
or could generate, reportable payments;
or
(iii)Request that the account holder dis-
close himself by mandating QI to provide
a Form W-9 completed by the account
holder.
(2)QI must make the requests described
in section 6.04(A)(1) at least two times
during each calendar year and in a manner
consistent with QI’s normal communica-
tions with the account holder (e.g., by
mail, telephone, etc.). If QI is not autho-
rized to initiate communications with the
account holder (e.g., QI can only commu-
nicate with the account holder in person),
QI must make the request at the time and
in the manner that QI is authorized to
communicate with the account holder.
(3)Until QI receives a waiver of all prohi-
bitions against disclosure or authorization
to sell all assets that generate, or could
generate, reportable payments, or a man-
date from the account holder to provide a
Form W-9, QI shall backup withhold on
all reportable payments paid to the ac-
count holder and report those payments
on Form 1099 or, in the case of reportable
amounts and designated proceeds, pro-
vide another withholding agent with all
the information required for that with-
holding agent to backup withhold and re-
port the payments on Form 1099. If the
account holder disposes of any assets that
generate, or could generate, reportable
payments prior to providing QI with a
waiver of all prohibitions against disclo-
sure or authorization to sell all such as-
sets, QI shall apply backup withholding
and Form 1099 reporting in accordance
with sections 3 and 8 of this Agreement.
(4)If QI has not assumed primary Form
1099 reporting and backup withholding
responsibility but is authorized, or is man-
dated, to disclose the account holder’s
name, address, TIN and reportable
amounts (and, designated broker proceeds
if section 3.05(C) of this Agreement ap-
plies) to a withholding agent, QI must
provide the account holder’s Form W-9
(or, if a Form W-9 was not obtained, the
account holder’s name, address, and TIN,
if available) to the withholding agent to-
gether with appropriate withholding rate
pool information within 30 days of the
date QI receives such authorization.
(5)If QI is authorized to dispose of the
account holder’s assets that generate, or
could generate, reportable payments, QI
must sell or exchange all such assets
within 60 days of receiving authorization.
In addition, if QI later discovers that an
account contains such assets, QI must sell
such assets within 60 days of the discov-
ery. See sections 3 and 8 of this Agree-
ment for backup withholding and Form
1099 reporting responsibilities.
(6)If QI is not authorized to disclose the
account holder’s identity or to sell or ex-
change all of the account holder’s assets
that generate or could generate reportable
payments, but QI is not prohibited by law,
including by contract, from disposing of
the account holder’s assets even though it
has not obtained specific authorization,
QI must sell or exchange all such assets
on or before December 31, 2002, and
apply backup withholding and Form 1099
reporting in accordance with sections 3
and 8 of this Agreement.
(B) Account Holder Discovered to be
U.S. Non-Exempt Recipient.If QI’s
records indicate that the account holder of
a pre-2001 account is a foreign person
and the QI discovers that the account
holder is a U.S. non-exempt recipient, QI
shall follow the procedures of section
6.04(A) of this Agreement, except that if
QI may legally sell or exchange the ac-
count holder’s assets that generate, or
could generate, reportable payments with-
out authorization, QI must sell or ex-
change all such assets on or before the
date that is 365 days after QI learns that
the account holder is a U.S. non-exempt
recipient, or, if later, December 31, 2002.
(C) Accounts Opened on or After Janu-
ary 1, 2001.QI agrees to the following
procedures for accounts opened by U.S.
non-exempt recipients on or after January
1, 2001 (post-2000 accounts):
(1)If QI is prohibited by law, including
by contract, from disclosing to a with-
holding agent or to the IRS on Form 1099
the account holder’s name, address, and
TIN, for reportable payments paid to the
account holder, then QI must–
(i)Request from the account holder the
authority to make such a disclosure;
(ii)Request from the account holder, prior
to opening the account, the authority to
exclude from the account holder’s ac-
count any assets that generate, or could
generate, reportable payments; or
(iii)Request that the account holder dis-
close himself by mandating QI to transfer
a Form W-9 completed by the account
holder.
(2)If QI is authorized to disclose the ac-
count holder’s name, address, TIN (if
available) and reportable amounts (and
designated broker proceeds, if section
3.05(C) of this Agreement applies), QI
must obtain a valid Form W-9 from the
account holder and, to the extent QI does
not have primary Form 1099 and backup
withholding responsibility, provide the
Form W-9 to the appropriate withholding
agent promptly after obtaining the Form
W-9. If a Form W-9 is not obtained, then
QI must provide the account holder’s
name, address, and TIN, if any, to the
withholding agents from whom QI re-
ceives reportable amounts (and, if applic-
able, designated broker proceeds) on be-
half of the account holder together with
appropriate withholding rate pool infor-
mation relating to the account holder. To
the extent QI has assumed primary Form
1099 reporting and backup withholding, it
must backup withhold on all reportable
payments until it receives a valid Form
W-9.
(3)If QI is not authorized to disclose an
account holder’s name and other required
information but is authorized to exclude
from the account holder’s account any as-
sets that generate, or could generate, re-
portable payments, QI must follow proce-
dures designed to ensure that it will not
hold any assets that generate, or could
generate, reportable payments in the ac-
count holder’s account.
(4)If QI is authorized to exclude from the
account holder’s account any assets that
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generate, or could generate, reportable
payments and QI discovers that the ac-
count contains such assets, QI must sell
such assets within 60 days of discovering
such assets and apply backup withholding
and Form 1099 reporting in accordance
with sections 3 and 8 of this Agreement.
(5)QI agrees that if any account holder in
a post-2000 account is discovered, after
the opening of the account, to be a U.S.
non-exempt recipient then QI will–
(i)Immediately correct the withholding
statement information provided to the
withholding agent, if necessary, and
(ii)Either obtain a Form W-9 within 60
days of discovering that the account holder
is a U.S. non-exempt recipient, and, if QI
has not assumed primary Form 1099 re-
porting and backup withholding responsi-
bility, provide the Form W-9 to the appro-
priate withholding agents together with
appropriate withholding pool information
promptly after obtaining the Form W-9 or,
if QI is not authorized to disclose account
holder information, sell all of the account
holder’s assets that generate or could gen-
erate reportable payments within 60 calen-
dar days from the day that QI discovers the
account holder is a U.S. non-exempt recip-
ient. QI must backup withhold, or instruct
a withholding agent to backup withhold on
any reportable payments made after the
time QI discovers the account holder’s
U.S. non-exempt recipient status and be-
fore obtaining a valid Form W-9 from the
account holder.
SECTION 7. TAX RETURN
OBLIGATIONS
Sec. 7.01. Form 1042 Filing Require-
ment.
(A) In general.QI shall file a return on
Form 1042, whether or not QI withheld
any amounts under chapter 3 of the Code,
on or before March 15 of the year follow-
ing any calendar year in which QI acts as
a qualified intermediary. A separate Form
1042 must be filed by each legal entity
that is a qualified intermediary covered by
this Agreement. Form 1042 shall be filed
at the address indicated on the form or at
any other address at which the IRS noti-
fies QI under the provisions of section
12.06 of this Agreement. In addition to
the information specifically requested on
Form 1042 and the accompanying in-
structions, QI shall attach to the form the
following information:
(1)A statement setting forth the amounts
of any overwithholding or underwithhold-
ing adjustments made under Treas. Reg.
§1.1461-2 and sections 9.02 and 9.05 of
this Agreement, and an explanation of the
circumstances that resulted in the over- or
under- withholding.
(2)A statement that sets forth the aggre-
gate amounts of reportable payments paid
to U.S. non-exempt recipient account
holders, and the number of such account
holders, whose identity is prohibited by
foreign law, including by contract, from
disclosure. QI must separately report
each type of reportable payment (deter-
mined by reference to the types of income
reported on Forms 1099) and the number
of undisclosed account holders receiving
such payments. See section 6.04 of this
Agreement.
(B) Extensions For Filing Returns.QI
may request an extension of the time for
filing Form 1042, or any of the informa-
tion required to be attached to the form,
by submitting Form 2758, Application for
Extension of Time to File Certain Excise,
Income, Information, and Other Returns
on or before the due date of the return.
The application must be in writing, prop-
erly signed by a duly authorized agent of
QI, and shall clearly set forth the follow-
ing:
(1)The calendar year for which the exten-
sion is requested; and
(2)A full explanation of the reasons for
requesting the extension to assist the IRS
in determining the period of extension, if
any, that will be granted.
Sec. 7.02. Form 945 Filing Require-
ment.QI shall file a return on Form 945
on or before January 31 following the cal-
endar year in which QI backup withheld
any amount under section 3406 of the
Code. Separate Forms 945 must be filed
by each legal entity that is a qualified in-
termediary covered by this Agreement.
The form must be filed at the address
specified in the instructions for Form 945
or at any other address at which the IRS
notifies QI under the provisions of section
12.06 of this Agreement.
Sec. 7.03. Retention of Returns.QI
shall retain Forms 945 and 1042 for the
applicable statute of limitations on assess-
ments and collection under section 6501
of the Code.
SECTION 8. INFORMATION
REPORTING OBLIGATIONS
Sec. 8.01. Form 1042-S Reporting.Ex-
cept as otherwise provided in section 8.02
of this Agreement, QI is not required to
file Forms 1042-S for amounts paid to
each separate account holder for whom
such reporting would otherwise be re-
quired. Instead, QI shall file a Form
1042-S reporting the pools of income
(“reporting pools”) as determined in sec-
tion 8.03 of this Agreement. QI must file
its Forms 1042-S in the manner required
by the regulations under chapter 3 of the
Code and the instructions to the form, in-
cluding any requirement to file the forms
magnetically or electronically. Separate
Forms 1042-S must be filed by each legal
entity that is a qualified intermediary cov-
ered by this Agreement. Each qualified
intermediary covered by this Agreement
may, however, allow its individual
branches to file Forms 1042-S provided
that all Forms 1042-S contain the QI-EIN
of the legal entity of which the branch
forms a part. Any Form 1042-S required
by this section 8 shall be filed on or be-
fore March 15 following the calendar year
in which the payment reported on the
form was made. QI may request an ex-
tension of time to file Forms 1042-S by
submitting Form 8809, Request for Ex-
tension of Time to File Information Re-
turns, by the due date of Forms 1042-S in
the manner required by Form 8809.
Sec. 8.02. Recipient Specific Reporting.
QI (whether or not it assumes primary
NRA withholding responsibility) is re-
quired to file separate Forms 1042-S for
amounts paid to each separate account
holder as described in this section 8.02.
QI must file separate Forms 1042-S by in-
come code, exemption code, recipient
code, and withholding rate.
(A) QI must file separate Forms 1042-S
for each qualified intermediary or with-
holding foreign partnership account
holder that receives an amount subject to
NRA withholding from QI (or from a PAI
of QI), whether such account holder is a
direct or indirect account holder.
(B)QI must file separate Forms 1042-S
for each foreign account holder of a non-
qualified intermediary or foreign interest
holder of a flow-through entity receiving
an amount subject to NRA withholding
(whether the nonqualified intermediary or
flow-through entity is a direct or indirect
account holder) to the extent QI can reli-
ably associate such amounts with valid
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documentation from an account holder
that is not itself a nonqualified intermedi-
ary or flow-through entity. In addition,
QI must file separate Forms 1042-S for
each foreign account holder of a nonqual-
ified intermediary or foreign interest
holder of a flow-through entity that is an
account holder of a PAI of QI (whether
the nonqualified intermediary or flow-
through entity is a direct or indirect ac-
count holder of the PAI) to the extent QI
can reliably associate the amounts subject
to NRA withholding with valid documen-
tation from an account holder that is not
itself a nonqualified intermediary or flow-
through entity.
(C)QI must file separate Forms 1042-S
made out to an unknown recipient for
amounts subject to withholding paid to a
nonqualified intermediary or flow-through
entity (whether the nonqualified interme-
diary or flow-through entity is a direct or
indirect account holder), to the extent that
QI cannot reliably associate such amounts
with valid documentation from the ac-
count holders of the nonqualified interme-
diary or the interest holders of the flow-
through entity. In addition, QI must file
separate Forms 1042-S made out to an un-
known recipient for amounts subject to
withholding paid to a nonqualified inter-
mediary or flow-through entity that is a di-
rect or indirect account holder of a PAI of
QI to the extent that QI cannot reliably as-
sociate such amounts with valid documen-
tation from the account holders of such
nonqualified intermediary or the interest
holders of the flow-through entity.
Sec. 8.03. Reporting Pools for Form
1042-S Reporting.Except for amounts
required to be reported under section 8.02
of this Agreement, QI shall report all
amounts subject to NRA withholding by
reporting pools on a Form 1042-S if those
amounts are paid to direct account holders
of QI or to direct account holders of a PAI
of QI that are (or are presumed to be) for-
eign persons. A separate Form 1042-S
shall be filed for each type of reporting
pool. A reporting pool consists of income
that falls within a particular withholding
rate and within a particular income code,
exemption code, and recipient code as de-
termined on Form 1042-S. QI may use a
single recipient code for all reporting
pools except for amounts paid to foreign
tax-exempt recipients, for which a sepa-
rate recipient code must be used. For this
purpose, a foreign tax-exempt recipient
includes any organization that is not sub-
ject to NRA withholding and is not liable
to tax in its country of residence because
it is a charitable organization, a pension
fund, or a foreign government.
Sec. 8.04. Form 1099 Reporting Re-
sponsibility.QI shall file Forms 1099
and, unless filing magnetically, Form
1096, for reportable payments made to
the persons specified in this section 8.04.
Forms 1099 shall be filed on or before the
date prescribed for the particular Form
1099 under chapter 61 of the Code and in
the manner required by regulations under
chapter 61 of the Code and the instruc-
tions to the forms, including any require-
ment to file the forms magnetically or
electronically. Extensions of the time to
file Forms 1099 may be requested by sub-
mitting Form 8809, Request for Exten-
sion of Time to File Information Returns,
in the manner required by the form. If QI
is required to file Forms 1099, it must file
the appropriate form for the type of in-
come paid (e.g., Form 1099-DIV for divi-
dends, Form 1099-INT for interest, Form
1099-B for broker proceeds). QI must
file Forms 1099 in the situations listed in
sections 8.04(A) through (E) of this
Agreement regardless of whether it as-
sumes primary Form 1099 reporting and
backup withholding responsibility unless
otherwise provided in those sections.
(A) QI must file a Form 1099 made out to
an unknown owner for the aggregate
amount of a particular type of reportable
amount paid to account holders that are
U.S. non-exempt recipients (whether di-
rect or indirect account holders) whose
identity and account information are pro-
hibited by law, including by contract,
from being disclosed. However, QI is not
required to file a Form 1099 for, or
backup withhold on, a reportable amount
to the extent QI has provided sufficient
information to another payor for that
payor to report the reportable amount as
paid to an unknown owner and to backup
withhold on the reportable amount and QI
does not know that the other payor has
failed to report or backup withhold.
(B)QI must file a Form 1099 made out to
an unknown owner on the aggregate
amount of a reportable payment that is not
a reportable amount paid to a U.S. non-
exempt recipient (whether a direct or indi-
rect account holder) whose identity and
account information are prohibited by
law, including by contract, from disclo-
sure. Notwithstanding the previous sen-
tence, QI is not required to report on
Form 1099 and backup withhold on des-
ignated broker proceeds to the extent the
designated broker proceeds provisions of
section 3.05 of this Agreement apply and
QI does not know that the other payor has
failed to report or backup withhold.
(C)QI must file a Form 1099 for a re-
portable amount paid to each U.S. non-
exempt recipient account holder (whether
a direct or indirect account holder) whose
identity and account information are not
prohibited by foreign law, including by
contract, from disclosure and for whom
QI has not provided a Form W-9 to a
withholding agent or has not provided the
account holder’s name, address, TIN (if
available) and withholding rate pool in-
formation to a withholding agent.
(D)QI must file a Form 1099 for a re-
portable payment (other than a reportable
amount) paid to each U.S. non-exempt re-
cipient (whether a direct or indirect ac-
count holder), or to any account holder
that is presumed to be a U.S. non-exempt
recipient, whose identity and account in-
formation are not prohibited by foreign
law, including by contract, from disclo-
sure. Notwithstanding the previous sen-
tence, QI is not required to report on
Form 1099 or backup withhold on desig-
nated broker proceeds paid to a U.S. non-
exempt recipient if the procedures of sec-
tion 3.05 of this Agreement apply and QI
does not know that the other payor has
failed to report or backup withhold.
(E)QI must file a Form 1099 for account
holders (whether direct or indirect) that
are, or are presumed to be, U.S. non-ex-
empt recipients that receive reportable
amounts for which QI has assumed pri-
mary Form 1099 reporting and backup
withholding responsibility.
(F)QI must file a Form 1099 for an ac-
count holder (whether direct or indirect)
that is a U.S. person (whether exempt or
non-exempt) if QI has made a reportable
payment to which it applied backup with-
holding and QI has not reported the
amount under section 8.04(A)-(E) of this
Agreement.
SECTION 9. ADJUSTMENTS FOR
OVER- AND UNDER-
WITHHOLDING; REFUNDS
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Sec. 9.01. Adjustments for NRA Over-
withholding by Withholding Agent.QI
may request a withholding agent to make
an adjustment for amounts paid to QI on
which the withholding agent has over-
withheld under chapter 3 of the Code by
applying either the reimbursement proce-
dure described in section 9.01(A) of this
Agreement or the set-off procedure de-
scribed in section 9.01(B) of this Agree-
ment within the time period prescribed for
those procedures. Nothing in this section
shall be interpreted to require a withhold-
ing agent to apply the reimbursement or
set off procedures under sections 9.01(A)
or (B) of this Agreement.
(A) Reimbursement Procedure.QI may
request a withholding agent to repay QI
for any amount overwithheld under chap-
ter 3 of the Code and for the withholding
agent to reimburse itself under the reim-
bursement procedures of Treas. Reg.
§1.1461-2(a)(2)(i) by making the request
to the withholding agent prior to the due
date for filing the Form 1042 and Form
1042-S (without regard to extensions) for
the calendar year of overwithholding.
(B) Set-off Procedure.QI may request a
withholding agent to repay QI by apply-
ing the amount overwithheld against any
amount which otherwise would be re-
quired to be withheld under chapter 3 of
the Code from income paid by the with-
holding agent to QI. QI must make the
request before the earlier of the due date
(without regard to extensions) for the
withholding agent to file Form 1042-S for
the calendar year of overwithholding or
the date that the Form 1042-S is actually
filed with the IRS.
Sec. 9.02. Adjustments for NRA Over-
withholding by QI.QI may make an ad-
justment for amounts paid to its account
holders that it has overwithheld under
chapter 3 of the Code by applying either
the reimbursement or set-off procedures
described in this section within the time
period prescribed for those procedures.
(A) Reimbursement Procedure.QI may
repay its account holders for an amount
overwithheld and reimburse itself by re-
ducing, by the amount of tax actually re-
paid to the account holders, the amount of
any subsequent deposit of tax required to
be made by QI under section 3.08 of this
Agreement. For purposes of this section
9.02(A), an amount that is overwithheld
shall be applied in order of time to each of
the QI’s subsequent deposit periods in the
same calendar year to the extent that the
withholding taxes required to be de-
posited for a subsequent deposit period
exceed the amount actually deposited. An
amount overwithheld in a calendar year
may be applied to deposit periods in the
calendar year following the calendar year
of overwithholding only if:
(1)QI states on a Form 1042-S (issued, if
applicable, to the account holders of the
income or otherwise to a reporting pool),
filed by March 15 of the calendar year
following the calendar year of overwith-
holding, the amount of tax withheld and
the amount of any actual repayments; and
(2)QI states on a Form 1042, filed by
March 15 of the calendar year following
the calendar year of overwithholding, that
the filing of the Form 1042 constitutes a
claim for credit in accordance with Treas.
Reg. §1.6414–1.
(B) Set-Off Procedure.QI may repay its
account holders by applying the amount
overwithheld against any amount which
otherwise would be required under chap-
ter 3 of the Code to be withheld from a
payment made by QI to the account hold-
ers before the earlier of March 15 of the
calendar year following the calendar year
of overwithholding or the date that the
Form 1042-S is actually filed with the
IRS. For purposes of making a return on
Form 1042 or 1042-S for the calendar
year of overwithholding, and for purposes
of making a deposit of the amount with-
held, the reduced amount shall be consid-
ered the amount required to be withheld
from such income under chapter 3 of the
Code.
Sec. 9.03. Repayment of Backup With-
holding.If QI erroneously withholds, as
defined under Treas. Reg. §31.6413(a)–3,
an amount under section 3406 of the Code
from an account holder, QI may refund
the amount erroneously withheld as pro-
vided in Treas. Reg. §31.6413(a)–3.
Sec. 9.04. Collective Credit or Refund
Procedures for NRA Overwithholding.
If there has been overwithholding under
chapter 3 of the Code on amounts subject
to NRA withholding paid to QI’s account
holders during a calendar year and the
amount has not been recovered under the
reimbursement or set-off procedures
under sections 9.01 or 9.02 of this Agree-
ment, QI may request a credit or refund of
the total amount overwithheld by follow-
ing the procedures of this section 9.04.
QI shall not include in its collective re-
fund claim payments made to an indirect
account holder or to a direct account
holder that is a nonqualified intermediary
or flow-through entity. QI shall follow
the procedures set forth under sections
6402 and 6414 of the Code, and the regu-
lations thereunder, to claim the credit or
refund. No credit or refund will be al-
lowed after the expiration of the statutory
period of limitation for refunds under sec-
tion 6511 of the Code. QI may use the
collective refund procedures under this
section 9.04 only if the following condi-
tions are met:
(A)QI must not have issued Forms 1042-
S to the account holders that received the
payment that was subject to overwith-
holding;
(B)QI must submit together with its
amended return on which it claims a
credit or refund a statement of the reason
for the overwithholding;
(C)QI must submit together with its
amended return on which it claims a
credit or refund a statement that it has re-
paid the amount of overwithholding to the
appropriate account holders prior to filing
the claim for credit or refund; and
(D)QI must retain a record showing that
it repaid the account holders the amount
of the overwithholding.
Sec. 9.05. Adjustments for NRA Under-
withholding.If QI knows that an amount
should have been withheld under chapter
3 of the Code from a previous payment to
an account holder but was not withheld,
QI may either withhold from future pay-
ments made to the same account holder or
satisfy the tax from property that it holds
in custody for the account holder or prop-
erty over which it has control. The addi-
tional withholding or satisfaction of the
tax owed may only be made before the
due date of the Form 1042 (not including
extensions) for the calendar year in which
the underwithholding occurred. QI’s re-
sponsibilities will be met if it informs a
withholding agent from which it received
the payment of the underwithholding and
the withholding agent satisfies the under-
withholding.
Sec. 9.06. NRA Underwithholding
After Form 1042 Filed.If, after a Form
1042 has been filed for a calendar year,
QI, QI’s external auditor, or the IRS de-
termines that, due to QI’s failure to carry
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out its obligations under this Agreement,
QI has underwithheld tax for such year,
QI shall file an amended Form 1042 to re-
port and pay the underwithheld tax. QI
shall pay the underwithheld tax, the inter-
est due on the underwithheld tax, and any
applicable penalties, at the time of filing
the amended Form 1042. If QI fails to
file an amended return, the IRS shall
make such return under section 6020 of
the Code. See section 10.04 of this
Agreement for procedures that apply if
underwithholding is discovered as part of
a statistical sampling of accounts.
Sec. 9.07. Special Rule Regarding Fail-
ure to Deposit Penalties.Solely for pur-
poses of applying section 6656 of the
Code (failure to make deposit of taxes),
neither QI nor its withholding agent will
be considered to have made an underpay-
ment of a deposit of NRA withholding
taxes if the conditions of this paragraph
are met. The conditions of this paragraph
are that–
(A)The withholding agent or QI makes
its deposits within the time (deposit pe-
riod) required by section 6302 of the
Code, or if applicable, section 3.08 of this
Agreement;
(B)The deposit is not less than 90 percent
of the aggregate amount of the tax re-
quired to be withheld under chapter 3 of
the Code during the deposit period applic-
able to the withholding agent or QI; and
(C)QI and the withholding agent deter-
mine the difference between the total
amount required to be deposited and the
amount actually deposited as of the end of
the 3rd, 6th, 9th, and 12th months of the
calendar year and the difference is de-
posited no later than the 15th day of the
second following month (i.e., May 15,
August 15, November 15 and February
15, respectively). In determining whether
there has been an underpayment, reim-
bursements and set-offs shall be taken
into account.
SECTION 10. EXTERNAL AUDIT
PROCEDURES
Sec. 10.01. In General.Unless QI re-
quests an IRS audit in lieu of an external
audit, the IRS agrees not to conduct an on-
site audit of QI, or any PAI with which QI
has an agreement, with respect to with-
holding and reporting obligations covered
by this Agreement provided that an exter-
nal auditor designated in Appendix B of
this Agreement conducts an audit of QI,
and any PAI, in accordance with this sec-
tion 10. QI shall permit the external audi-
tor to have access to all relevant records of
QI for purposes of performing the external
audit, including information regarding
specific account holders. QI shall permit
the IRS to communicate directly with the
external auditor and to review the audit
procedures followed by the external audi-
tor. QI represents that there are no legal
prohibitions that prevent the external audi-
tor from examining any information rele-
vant to the external audit to be performed
under this section 10 and that there are no
legal prohibitions that prevent the IRS
from communicating directly with the au-
ditor. QI shall permit the IRS to examine
the external auditor’s work papers and re-
ports. However, the external auditor is not
required to divulge the identity of QI’s ac-
count holders to the IRS.
Sec. 10.02. Designation of External Au-
ditor. QI’s external auditor must be one
of the auditors listed in Appendix B of
this Agreement, unless QI and the IRS
agree, prior to the audit, to substitute an-
other auditor. QI shall not propose an ex-
ternal auditor unless it has a reasonable
belief that the auditor is subject to laws,
regulations, or rules that impose sanctions
for failure to exercise its independence
and to perform the audit competently.
The IRS has the right to reject a proposed
external auditor, or to revoke its accep-
tance of an external auditor, if the IRS, in
its sole discretion, reasonably believes
that the auditor is not independent or can-
not perform an effective audit under this
Agreement.
Sec. 10.03. Timing and Scope of Exter-
nal Audits.QI shall have the external au-
ditor conduct an audit of the second full
calendar year and the fifth full calendar
year that this Agreement is in effect, sub-
ject to section 10.06 of this Agreement.
The external auditor shall verify whether
QI is in compliance with this Agreement
by conducting an audit that meets the re-
quirements of this section 10.03. The ex-
ternal auditor shall verify whether QI is in
compliance with its QI agreement by pro-
viding a report to the IRS. The report
must be received by the IRS, at the ad-
dress set forth in section 12.06 of this
Agreement, no later than June 30 of the
year following the year being audited.
The IRS may, however, upon request by
the external auditor, extend the due date
of the audit report upon good cause. The
report must disclose that the external au-
ditor has, at a minimum, performed the
following checks listed in this paragraph
10.03, and set forth how each of those
checks was performed and the results of
the checks. QI’s (or a PAI’s) external au-
ditor is encouraged to contact the IRS at
the address set forth in section 12.06 of
this Agreement and submit an audit plan
(which includes, if relevant, the extent to
which the external auditor proposes to
rely on QI’s internal audit procedures)
prior to performing the audit so that the
audit may be conducted in the most effi-
cient and least costly manner possible.
(A) Documentation. The external audi-
tor must–
(1)Verify that QI has training materials,
manuals, and directives that instruct the
appropriate QI employees how to request,
collect, review, and maintain documenta-
tion in accordance with this Agreement;
(2)Review QI’s account opening proce-
dures and interview QI’s employees, to
determine if appropriate documentation is
requested from account holders and, if
obtained, that it is reviewed and main-
tained in accordance with this Agreement;
(3)Verify that QI follows procedures de-
signed to inform account holders that
claim a reduced rate of withholding under
an income tax treaty about any applicable
limitation on benefits procedures;
(4)Review QI’s accounts, using a valid
sample of accounts for which treaty bene-
fits are claimed, to ensure that QI is ob-
taining the treaty statements required by
section 5.03(B);
(5)Review information, using a valid
sample, contained in account holder files
to determine if the documentation validity
standards of section 5.10 of this Agree-
ment are being met. For example, the ex-
ternal auditor must verify that changes in
account holder information (e.g., a
change of address to a U.S. address or
change of account holder status from for-
eign to U.S.) are being conveyed to QI’s
withholding agent, or, if QI assumes pri-
mary NRA withholding responsibility or
primary Form 1099 reporting and backup
withholding responsibility, that QI is ap-
plying the appropriate withholding rate;
(6)Review accounts, using a valid sample
of U.S. non-exempt recipient account hold-
ers, to determine if QI is obtaining Forms
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W-9 from those customers whose identity
is not prohibited by law from disclosure,
and that QI is transmitting those forms to a
withholding agent to the extent QI does not
assume primary Form 1099 reporting and
backup withholding responsibility with re-
spect to reportable amounts and, if applica-
ble, designated broker proceeds;
(7)Review accounts, using a valid sample
of U.S. non-exempt recipient account
holders whose identity and account infor-
mation is prohibited by law, including by
contract, from disclosure, to verify that–
(i)Such accounts exist in only rare and
unusual circumstances (and detailing in
the audit report the nature of such circum-
stances); and
(ii)The procedures of section 6.04 have
been, and are being, followed.
(8)Review QI’s agreements with its PAIs
to ensure that the obligations imposed on
the PAIs are identical to the obligations
imposed on QI under this Agreement, ex-
cept as otherwise provided in section
4.02.
(9)State in its external audit report if the
auditor is aware that QI is in material vio-
lation or is under investigation for viola-
tion of any of the know-your-customer
rules, practices, or procedures applicable
to the offices audited.
(10) State in its external audit report if the
auditor is aware that QI removes U.S.
non- exempt recipients from accounts
covered by this Agreement for the pur-
pose of circumventing the Form 1099 re-
porting and backup withholding provi-
sions of this Agreement.
(B) Withholding Rate Pools.The exter-
nal auditor must–
(1)Verify that QI has training materials,
manuals, and directives that instruct the
appropriate QI employees how to deter-
mine withholding rate pools based on
documentation and the presumption rules;
(2)Interview employees responsible for
determining withholding rate pools to as-
certain if they are adequately trained to
determine those pools and that they fol-
low adequate procedures for determining
those pools;
(3)Review QI’s procedures for preparing
the withholding statements associated
with QI’s Forms W-8IMY and verify that
the withholding statements provided to
withholding agents convey complete and
correct information on a timely basis;
(4)Perform test checks, using a valid
sample of account holders assigned to
each withholding rate pool, and cross
check that assignment against the docu-
mentation provided by, or presumption
rules that apply to, the account holder, the
type of income earned, and the withhold-
ing rate applied;
(5)Perform test checks, using a valid
sample of accounts of U.S. non-exempt
recipients, to verify that appropriate with-
holding rate pools are established for U.S.
non-exempt recipients; and
(6)Verify, if QI is using the alternative
procedure for U.S. non-exempt recipients
contained in section 6.03(B) of this
Agreement, that QI is providing sufficient
and timely information to withholding
agents that allocates reportable payments
to U.S. non-exempt recipients.
(C) Withholding Responsibilities.The
external auditor must–
(1)To the extent QI has assumed primary
NRA withholding responsibility, perform
test checks, using a valid sample of for-
eign account holders, to verify that QI is
withholding the proper amounts;
(2)To the extent QI has not assumed pri-
mary NRA withholding responsibility,
verify that QI has fulfilled its responsibili-
ties under section 3.02 of this Agreement;
(3)To the extent QI has assumed primary
Form 1099 reporting and backup with-
holding responsibility, perform test
checks using a valid sample of U.S. non-
exempt recipient account holders to verify
that QI backup withheld when required;
(4)To the extent QI has not assumed pri-
mary Form 1099 reporting and backup
withholding responsibility, perform test
checks using a valid sample of U.S. non-
exempt account holders to verify that QI
has fulfilled its backup withholding re-
sponsibilities under sections 3.04, 3.05
and 3.06 of this Agreement;
(5)Review the accounts of U.S. non-ex-
empt recipient account holders whose
identity is prohibited by law, including by
contract, from disclosure and verify that
QI or another payor is backup withhold-
ing on reportable payments made to such
account holders;
(6)Review a valid sample of accounts of
U.S. non-exempt recipient account hold-
ers and determine if assets that generate
or could generate reportable payments are
held in an account of any U.S. non-ex-
empt recipient account holders whose
identity is prohibited by law, including by
contract, from disclosure, and ascertain
the reason why such assets have not been
disposed of or the account holder dis-
closed; and
(7)Verify that amounts withheld were
timely deposited in accordance with sec-
tion 3.08 of this Agreement.
(D) Return Filing and Information Re-
porting.The external auditor must–
(1)Obtain copies of original and amended
Forms 1042 and Forms 945, and any
schedules, statements, or attachments re-
quired to be filed with those forms, and
determine whether the amounts of in-
come, taxes, and other information re-
ported on those forms are accurate by–
(i)Reviewing work papers;
(ii)Reviewing Forms W-8IMY, together
with the associated withholding state-
ments, that QI has provided to withhold-
ing agents;
(iii)Reviewing copies of Forms 1042-S
that withholding agents have provided QI;
(iv)Reviewing account statements from
withholding agents;
(v)Reviewing correspondence between
QI and withholding agents; and
(vi)Interviewing personnel responsible
for preparing the Forms 1042 and 945 and
the work papers used to prepare those
forms.
(2)Obtain copies of original and cor-
rected Forms 1042-S and Forms 1099 to-
gether with the work papers used to pre-
pare those forms and determine whether
the amounts reported on those forms are
accurate by–
(i)Reviewing the Forms 1042-S received
from withholding agents;
(ii)Reviewing the Forms W-8IMY, and
the associated withholding statements,
that QI has provided withholding agents;
(iii)Reviewing a valid sample of account
statements issued by QI to account hold-
ers; and
(iv)Interviewing QI’s personnel responsi-
ble for preparing the Forms 1042-S and, if
applicable, Forms 1099, and the work pa-
pers used to prepare those forms.
(3)Thoroughly review the statements at-
tached to amended Forms 1042 filed to
claim a refund, ascertain their veracity,
and determine the causes of any overwith-
holding reported and ensure QI did not
issue Forms 1042-S to persons whom it
included as part of its collective credit or
refund.
(4)Determine, in the case of collective
2000–4 I.R.B.409January 24, 2000
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credits or refunds, that QI repaid the ap-
propriate account holders prior to request-
ing a collective refund or credit.
(E) Change in Circumstances.The ex-
ternal auditor must verify that in the
course of the audit it has not discovered
any significant change in circumstances,
as described in section 11.03(A), (D), or
(E) of this Agreement.
Sec. 10.04. Use of Statistical Sampling.
If the external auditor is required to make
a determination based on a valid sample
of accounts, it shall use a statistical sam-
pling whenever an examination of all of
accounts within a particular class of ac-
counts would be prohibitive in terms of
time and expense. If it is reasonable to
examine all accounts in connection with a
particular issue, statistical sampling tech-
niques shall not be used. If statistical
sampling techniques are required, the ex-
ternal auditor must determine a sample
size that provides a 95 percent confidence
level. If statistical sampling has been
used and the auditor determines that un-
derwithholding has occurred with respect
to the sampled accounts, the IRS will de-
termine the total amount of underwithheld
tax by projecting the underwithholding
over the entire population of similar ac-
counts. For this purpose, QI agrees to
provide the IRS with the information
(e.g., number of accounts and amounts)
required to project the underwithholding.
QI shall either report and pay, in accor-
dance with section 9.06 of this Agree-
ment, the underwithheld tax determined
under the IRS projection or propose an-
other amount of underwithholding based
on a more accurate population, a more ac-
curate projection technique, or an exami-
nation of all similar accounts. If the IRS
does not agree with the amount proposed
by QI, the IRS shall assess a tax by mak-
ing a return under section 6020 of the
Code.
Sec. 10.05. External Auditor’s Report.
Upon completion of the audit of QI and
any PAI, the external auditor shall issue a
report, or reports, of audit findings di-
rectly to the IRS by sending the original
report to the IRS at the address set forth in
section 12.06 of this Agreement by June
30 following the calendar year being au-
dited, or if that date falls on a Saturday or
Sunday, the next U.S. business day. The
report must be in writing, in English, and
currency amounts must be stated in U.S.
dollars. The report must fully describe
the scope of the audit, the methodologies
(including sampling techniques) used to
determine whether QI is in compliance
with the provisions of this Agreement,
and the result of each such determination.
The report must also specifically address
each of the items in section 10.03 of this
Agreement.
Sec. 10.06. Expanding Scope and Tim-
ing of External Audit.Upon review of
the external auditor’s report, the IRS may
request, and QI must permit, the external
auditor to perform additional audit proce-
dures, or to expand the external audit to
cover some or all of the calendar years for
which the period of limitations for assess-
ment of taxes has not expired. In addi-
tion, the IRS may request, and QI agrees
to permit, the external auditor to perform
an audit for one or more calendar years
not scheduled for audit under section
10.03 of this Agreement.
SECTION 11. EXPIRATION,
TERMINATION AND DEFAULT
Sec. 11.01. Term of Agreement.This
Agreement shall be in effect on
_________ and shall expire on December
31 of the fifth full calendar year after the
year in which this Agreement first takes
effect. This Agreement may be renewed
as provided in section 11.06 of this Agree-
ment.
Sec. 11.02. Termination of Agreement.
This Agreement may be terminated by ei-
ther the IRS or QI prior to the end of its
term by delivery of a notice of termina-
tion to the other party in accordance with
section 12.06 of this Agreement. The
IRS, however, shall not terminate the
Agreement unless there has been a signif-
icant change in circumstances, as defined
in section 11.03 of this Agreement, or an
event of default has occurred, as defined
in section 11.04 of this Agreement, and
the IRS determines, in its sole discretion,
that the significant change in circum-
stances or the event of default warrants
termination of this Agreement. In addi-
tion, the IRS shall not terminate this
Agreement in the event of default if QI
can establish to the satisfaction of the IRS
that all events of default for which it has
received notice have been cured within
the time period agreed upon. The IRS
shall notify QI, in accordance with sec-
tion 11.05 of this Agreement, that an
event of default has occurred and that the
IRS intends to terminate the Agreement
unless QI cures the default. A notice of
termination sent by either party shall take
effect on the date specified in the notice.
Sec. 11.03. Significant Change in Cir-
cumstances.For purposes of this Agree-
ment, a significant change in circum-
stances includes, but is not limited to–
(A)An acquisition of all, or substantially
all, of QI’s assets in any transaction in
which QI is not the surviving legal entity;
(B)A change in U.S. federal law or pol-
icy, or applicable foreign law or policy,
that affects the validity of any provision
of this Agreement, materially affects the
procedures contained in this Agreement,
or affects QI’s ability to perform its oblig-
ations under this Agreement;
(C)A ruling of any court that affects the
validity of any provision of this Agree-
ment;
(D)A material change in the know-your-
customer rules and procedures set forth in
any Attachment to this Agreement; or
(E)A significant change in QI’s business
practices that affects QI’s ability to meet
its obligations under this Agreement.
Sec. 11.04. Events of Default.For pur-
poses of this Agreement, an event of de-
fault occurs if QI fails to perform any ma-
terial duty or obligation required under
this Agreement, and includes, but is not
limited to, the occurrence of any of the
following:
(A)QI fails to implement adequate proce-
dures, accounting systems, and internal
controls to ensure compliance with this
Agreement;
(B)QI underwithholds an amount that QI
is required to withhold under chapter 3 of
the Code and fails to correct the under-
withholding or to file an amended Form
1042 reporting, and paying, the appropri-
ate tax;
(C)QI underwithholds an amount that QI
is required to backup withhold under sec-
tion 3406 of the Code;
(D)QI makes a misrepresentation on
Forms W-8IMY or the associated with-
holding statement that results in under-
withholding by a withholding agent;
(E)QI makes excessive refund claims;
(F)Documentation described in section 5
of this Agreement is lacking, incorrect, or
unreliable for a significant number of di-
rect account holders;
(G)QI fails to timely file Forms 945,
January 24, 20004102000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 410

1042, 1042-S, or 1099 or files forms that
are materially incorrect or fraudulent or
fails to provide information necessary for
a withholding agent or payor to file Forms
1099 with respect to disclosed U.S. per-
sons;
(H)QI fails to have an external audit per-
formed when required, QI’s external audi-
tor fails to provide its report directly to
the IRS on a timely basis, QI fails to co-
operate with the external auditor, or QI or
its external auditor fails to cooperate with
the IRS;
(I)QI fails to disclose to a withholding
agent, or to the IRS, U.S. nonexempt re-
cipient account holders to the extent the
disclosure is not prohibited by foreign
law, including by contract;
(J)QI fails to inform the IRS of any
change in the know-your-customer rules
described in any Attachment to this
Agreement within 90 days of the change
becoming effective;
(K)QI fails to inform the IRS within 90
days of any significant change in its busi-
ness practices to the extent that change af-
fects QI’s obligations under this Agree-
ment;
(L)QI fails to inform the IRS of any pri-
vate arrangement, as described in section
4 of this Agreement;
(M)QI fails to cure a default identified by
the IRS or by an external auditor;
(N)QI makes any fraudulent statement or a
misrepresentation of material fact with re-
gard to this Agreement to the IRS, a with-
holding agent, or QI’s external auditor;
(O)The IRS determines that QI’s external
auditor is not sufficiently independent to
adequately perform its audit function or
the external auditor fails to provide an
audit report that complies with section 10
of this Agreement;
(P)An intermediary with which QI has a
PAI agreement is in default with that
agreement and QI fails to meet its obliga-
tion to terminate that agreement within
the time period specified in section 4.03
of this Agreement;
(Q) QI has not complied with the proce-
dures of section 6.04 of this Agreement or
has any undisclosed U.S. non-exempt re-
cipients (except in rare and unusual cir-
cumstances) whose accounts contain as-
sets that generate, or could generate,
reportable payments;
(R)QI is prohibited by any law from dis-
closing the identity of an account holder
or account information to QI’s external
auditor;
(S)QI, to the extent it has primary Form
1099 reporting and backup withholding
responsibility, fails to comply with the re-
quirements of chapter 61 and section
3406 of the Code;
(T)QI, to the extent that it elects the alter-
native withholding rate pool procedures
of section 6.03(B) of this Agreement (re-
garding U.S. non-exempt recipient ac-
count holders) fails to provide allocation
information by January 15th as required
by that section;
(U)QI fails to make deposits in the time
and manner required by section 3.08 of
this Agreement or fails to make adequate
deposits, taking into account the proce-
dures of 9.07 of this Agreement;
(V)QI fails to permit the external audi-
tor to perform additional audit proce-
dures, or to expand the external audit to
cover some or all of the calendar years
for which the period of limitations for
assessment of taxes has not expired
under the provisions of section 10.06 of
this Agreement; or
(W)QI removes U.S. non-exempt recip-
ients from accounts covered by this
Agreement for the purpose of circum-
venting the Form 1099 reporting and
backup withholding provisions of this
Agreement.
Sec. 11.05. Notice and Cure.Upon the
occurrence of an event of default, the
IRS may deliver to QI a notice of default
specifying the event of default that has
occurred. QI shall respond to the notice
of default within 60 days (60-day re-
sponse) from the date of the notice of
default. The 60-day response shall con-
tain an offer to cure the event of default
and the time period in which the cure
will be accomplished or shall state the
reasons why QI does not agree that an
event of default has occurred. If QI
does not provide a 60-day response, the
IRS may deliver a notice of termination
as provided in section 11.02 of this
Agreement. If QI provides a 60-day re-
sponse, the IRS shall either accept or re-
ject QI’s statement that no default has
occurred or accept or reject QI’s pro-
posal to cure an event of default. If the
IRS rejects QI’s contention that no de-
fault has occurred or rejects QI’s pro-
posal to cure a default, the IRS will offer
a counter-proposal to cure the event of
default. Within 30 days of receiving the
IRS’s counter-proposal, QI shall notify
the IRS (30-day response) whether it
continues to maintain that no default has
occurred or whether it rejects the IRS’s
counter-proposal to cure an event of de-
fault. If QI’s 30-day response states that
no default has occurred or it rejects the
IRS’s counter-proposal to cure, the par-
ties shall seek to resolve their disagree-
ment within 30 days of the IRS’s receipt
of QI’s 30-day response. If a satisfac-
tory resolution has not been achieved at
the end of this latter 30-day period, or if
QI fails to provide a 30-day response,
the IRS may terminate this Agreement
by providing a notice of termination in
accordance with section 11.02 of this
Agreement. If QI receives a notice of
termination from the IRS, it may appeal
the determination within 30 days of the
date of the notice of termination by
sending a written notice to the address
specified in section 12.06 of this Agree-
ment. If QI appeals the notice of termi-
nation, this Agreement shall not termi-
nate until the appeal has been decided.
If an event of default is discovered in
the course of an external audit, the QI
may cure the default, without following
the procedures of this section 11.05, if
the external auditor’s report describes
the default and the actions that QI took
to cure the default and the IRS deter-
mines that the cure procedures followed
by QI were sufficient. If the IRS deter-
mines that QI’s actions to cure the de-
fault were not sufficient, the IRS shall
issue a notice of default and the proce-
dures described in this section 11.05
shall be followed.
Sec. 11.06. Renewal.If QI intends to
renew this Agreement, it shall submit an
application for renewal to the IRS no ear-
lier than one year and no later than six
months prior to the expiration of this
Agreement. Any such application for re-
newal must contain an update of the infor-
mation provided by QI to the IRS in con-
nection with the application to enter into
this Agreement, and any other informa-
tion the IRS may request in connection
with the renewal process. This Agree-
ment shall be renewed only upon the sig-
natures of both QI and the IRS. Either the
IRS or QI may seek to negotiate a new
qualified intermediary agreement rather
than renew this Agreement.
2000–4 I.R.B.411January 24, 2000
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SECTION 12. MISCELLANEOUS
PROVISIONS
Sec. 12.01.QI’s application to become a
qualified intermediary and all the Appen-
dices and Attachments to this Agreement
are hereby incorporated into and made an
integral part of this Agreement. This
Agreement, QI’s application, and the Ap-
pendices and Attachments to this Agree-
ment constitute the complete agreement
between the parties.
Sec. 12.02.This Agreement may be
amended by the IRS if the IRS determines
that such amendment is needed for the
sound administration of the internal rev-
enue laws or internal revenue regulations.
The agreement may also be modified by
either QI or the IRS upon mutual agree-
ment. Such amendments or modifications
shall be in writing.
Sec. 12.03.Any waiver of a provision of
this Agreement is a waiver solely of that
provision. The waiver does not obligate
the IRS to waive other provisions of this
Agreement or the same provision at a
later date.
Sec. 12.04.This Agreement shall be gov-
erned by the laws of the United States. Any
legal action brought under this Agreement
shall be brought only in a United States
court with jurisdiction to hear and resolve
matters under the internal revenue laws of
the United States. For this purpose, QI
agrees to submit to the jurisdiction of such
United States court.
Sec. 12.05. QI’s rights and responsibili-
ties under this Agreement cannot be as-
signed to another person.
Sec. 12.06.Notices provided under this
Agreement shall be mailed registered,
first class airmail. Notice shall be di-
rected as follows:
To the IRS
Assistant Commissioner (International)
Foreign Payments Division
OP:IN:I:FP
950 L’Enfant Plaza South, SW
Washington, DC 20024
All notices sent to the IRS must include
the QI’s QI-EIN.
To QI:
Sec. 12.07.QI, acting in its capacity as a
qualified intermediary or in any other ca-
pacity, does not act as an agent of the IRS,
nor does it have the authority to hold itself
out as an agent of the IRS.
IN WITNESS WHEREOF, the above
parties have subscribed their names to
these presents, in duplicate.
Signed this day of ,
(name and title of person signing for QI)
(name and title of person signing for IRS)
January 24, 20004122000–4 I.R.B.
Appendix A
[Name of QI]
[Name of country] (see Attachment 1, for description of know-your customer rules).
[Name of country] (see Attachment 2, for description of know-your customer rules).
.
.
.
.
[Name of entity affiliated with QI]
[Name of country] (see Attachment ____, for description of know-your customer rules).
[Name of country] (see Attachment ____, for description of know-your customer rules).
Appendix B
QI and the IRS agree that any of the following auditors may be used by QI, or any PAI with which QI has an agreement, to per-
form the external audits required by section 10 of this Agreement.
[Names, addresses, telephone, and fax numbers of external auditors]
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ATTACHMENT
1. QI is subject to the following laws and
regulations of [name of country] govern-
ing the requirements of QI to obtain docu-
mentation confirming the identity of QI’s
account holders.
2. QI represents that [name and citations
to laws and regulations identified in item
1, above] are enforced by [name of en-
forcement body] and QI shall provide the
IRS with an English translation of any re-
ports or other documentation issued by
[name of enforcement body] that relates
to QI’s failure to comply with [laws and
regulations identified in 1, above].
3. QI represents that the following penal-
ties apply for failure to obtain, maintain,
and evaluate documentation obtained
under [name and citations to laws and
regulations identified in item 1].
4. QI shall use the following specific doc-
umentary evidence to comply with sec-
tion 5 of this Agreement:
a. For natural persons:
b. For legal persons:
5. QI shall follow the procedures set forth
below to confirm the identity of account
holders that do not open accounts in person.
SECTION 5. EFFECTIVE DATE
This revenue procedure is effective on
January 24, 2000. The IRS may conclude
agreements under this revenue procedure
at any time after that date, but such agree-
ments will not have effect before the date
specified in the agreement.
SECTION 6. EFFECT ON OTHER
REVENUE PROCEDURES
This revenue procedure supersedes
Rev. Proc. 98–27, 1998–15 I.R.B. 30. In
addition, Notice 99–8, 1999–5 I.R.B. 26
is obsoleted.
SECTION 7. FURTHER
INFORMATION
For further information regarding this
revenue procedure, telephone the Office of
Assistant Commissioner (International) at
(202) 874-1800 (not a toll-free number).
Cash or Deferred Arrangements;
Nondiscrimination
Notice 2000–3
I. PURPOSE
This notice provides additional guidance
regarding 401(k) plans that are intended to
satisfy the 401(k) safe harbors. This guid-
ance responds to comments and sugges-
tions regarding ways to make it easier for
employers both to adopt and to administer
401(k) safe harbor plans. The notice:
•Encourages adoption of 401(k) safe
harbor plans by giving sponsors of ex-
isting 401(k) plans the flexibility to
wait as late as December 1 of a calen-
dar year to decide to adopt the 401(k)
safe harbor 3-percent employer non-
elective contribution method for that
calendar year;
•Permits 401(k) safe harbor plans to
match elective or employee contribu-
tions on the basis of compensation for
a payroll period, month, or quarter;
•Provides an extended period of time
— until May 1, 2000 — for 401(k)
plan sponsors adopting the 401(k)
safe harbor methods for the first time
in 2000 to provide the required safe
harbor notice to employees;
•Provides explicitly that 401(k) safe
harbor plans are permitted to require
salary reduction elections to be made
using whole percentages of pay or
whole dollar amounts;
•Permits plan sponsors to provide the
401(k) safe harbor notice electroni-
cally and otherwise simplifies the no-
tice requirement;
•Permits 401(k) safe harbor plans to
provide matching contributions on an
employee’s aggregate employee and
elective contributions;
•Makes clear that 401(k) safe harbor
plans are permitted to apply to em-
ployee after-tax contributions a suspen-
sion similar to the 12-month suspen-
sion that may be applied to employee
elective contributions after an in-ser-
vice withdrawal of those contributions;
•Permits plan sponsors using the
401(k) safe harbor matching contribu-
tion method to exit the safe harbor
prospectively during a plan year (and
switch to ADP and ACP nondiscrimi-
nation testing) if employees are noti-
fied beforehand;
•Clarifies the interaction between the
401(k) safe harbors and the election to
separately test otherwise excludable
employees for purposes of the
§ 410(b) minimum coverage require-
ments; and
•Makes clear how the 401(k) safe har-
bor rules apply in the case of a profit
sharing plan to which a 401(k) feature
is added for the first time during a
plan year.
In addition to modifying the guidance
provided in Notice 98–52, 1998–46 I.R.B.
16, relating to 401(k) safe harbor plans,
this notice requests comments regarding
two significant areas that relate to 401(k)
plans in general. The two areas are (1)
potential approaches for simplifying the
multiple use test applicable to § 401(k)
plans, and (2) potential approaches for ap-
plying the highly compensated employee
definition under § 414(q), the nondiscrim-
ination requirements under § 401(k) and
401(m), and possibly other applicable
qualification requirements, when a plan
sponsor is involved in a merger, acquisi-
tion, disposition, or similar transaction.
II. BACKGROUND
A. SBJPA Amendments to §§ 401(k),
401(m), and 414(q)
Under § 401(k)(3) and § 401(m)(2) of
the Code, the actual deferral percentage
(“ADP”) and the actual contribution per-
centage (“ACP”) of highly compensated
employees (“HCEs”) are compared with
those of nonhighly compensated employ-
ees (“NHCEs”). Section 414(q) defines a
highly compensated employee for pur-
poses of §§ 401(k) and 401(m), and for
other purposes under the Code.
Section 1433(a) and (b) of the Small
Business Job Protection Act of 1996
(“SBJPA”) added new §§ 401(k)(12) and
401(m)(11) to the Code, effective for plan
years beginning after December 31, 1998,
to provide design-based safe harbor meth-
ods for satisfying the ADP test contained
in § 401(k)(3)(A)(ii) and the ACP test
contained in § 401(m)(2). Section
401(k)(12) provides that a cash or de-
ferred arrangement (“CODA”) is treated
as satisfying the ADP test if the CODA
meets certain contribution and notice re-
quirements. Section 401(m)(11) provides
that a defined contribution plan is treated
as satisfying the ACP test with respect to
matching contributions if the plan meets
the contribution and notice requirements
contained in § 401(k)(12) and in addition
meets certain limitations on the amount
and rate of matching contributions avail-
able under the plan.
2000–4 I.R.B.413January 24, 2000
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Section 1433(c) of SBJPA amended
§ 401(k)(3)(A) and § 401(m)(2)(A), ef-
fective for plan years beginning after De-
cember 31, 1996, to provide for the use of
prior year data in determining the ADP
and ACP of NHCEs, while current year
data is used for HCEs. Alternatively, an
employer may elect to use current year
data for determining the ADP and ACP
for both HCEs and NHCEs, but this elec-
tion may be changed only as provided by
the Secretary. Prior to the effective date
of these amendments, plans were required
to use current year data in determining the
ADP and ACP for both HCEs and
NHCEs. Section 1433(d) of SBJPA
amended § 401(k)(3) and § 401(m)(3) to
provide a special rule for determining the
ADP and ACP for NHCEs for the first
plan year of a plan (other than a successor
plan) where the prior year testing method
is used.
Section 1433(e) of SBJPA amended
§ 401(k)(8)(C) and § 401(m)(6)(C), effec-
tive for plan years beginning after De-
cember 31, 1996, to provide that the dis-
tribution of excess contributions and
excess aggregate contributions will be
made on the basis of the amount of contri-
butions by, or on behalf of, each HCE.
Prior to the effective date of these amend-
ments, plans were required to distribute
excess contributions and excess aggregate
contributions using a method based on the
actual deferral ratio or actual contribution
ratio of each HCE.
Section 1431 of SBJPA amended
§ 414(q)(1) to provide that the term
“highly compensated employee” means
any employee who (1) was a 5-percent
owner at any time during the year or the
preceding year, or (2) for the preceding
year had compensation from the employer
in excess of $80,000 (as adjusted) and, if
the employer so elects, was in the top-
paid group for the preceding year. The
amendments made by § 1431 generally
apply to years beginning after December
31, 1996.
B.Previous Guidance on the SBJPA
Amendments to §§ 401(k), 401(m), and
414(q)
Notice 972, 1997–1 C.B. 348, provides
guidance on determining the individuals
who are taken into account in computing
the ADP or ACP for NHCEs for the prior
year under the prior year testing method.
The notice also prescribes rules for distri-
butions of excess contributions and ex-
cess aggregate contributions.
Notice 97–45, 1997–2 C.B. 296, pro-
vides guidance relating to the definition
of highly compensated employee under
§ 414(q), as amended by § 1431 of
SBJPA.
Notice 98–1, 1998–3 I.R.B. 42, pro-
vides guidance relating to the current and
prior year ADP and ACP testing methods.
Notice 98–52 provides guidance on the
safe harbor methods under § 401(k)(12)
for satisfying the ADP test contained in
§ 401(k)(3)(A)(ii) and safe harbor meth-
ods under § 401(m)(11) for satisfying the
ACP test contained in § 401(m)(2).
C. Definitions
Any term used in this notice that is de-
fined in Notice 97–45, 98–1, or 98–52, or
in the regulations under § 401(k), 401(m),
or 414(q) has the same meaning as in
those notices and regulations. For exam-
ple, the term “employee contribution”
means any mandatory or voluntary contri-
bution to the plan that is treated at the
time of contribution as an after-tax em-
ployee contribution (e.g., by reporting the
contribution as taxable income subject to
applicable withholding requirements) and
is allocated to a separate account to which
the attributable earnings and losses are al-
located.
In addition, for purposes of this notice,
(1) a “401(k) safe harbor plan” means a
CODA that is intended to satisfy the ADP
test safe harbor under section V of Notice
98–52, and, if applicable, a defined con-
tribution plan (including a § 403(b) plan)
that is intended to satisfy the ACP test
safe harbor under section VI of Notice
98–52, (2) the “401(k) safe harbor non-
elective contribution method” means the
alternative for satisfying the safe harbor
contribution requirement of the ADP test
safe harbor under section V.B. of Notice
98–52 that includes satisfying the non-
elective contribution requirement under
section V.B.2. of Notice 98–52, (3) the
“401(k) safe harbor matching contribu-
tion method” means the alternative for
satisfying the safe harbor contribution re-
quirement of the ADP test safe harbor
under section V.B. of Notice 98–52 that
includes satisfying the matching contribu-
tion requirement under section V.B.1. of
Notice 98–52, and (4) a “401(k) safe har-
bor method” means the 401(k) safe harbor
nonelective contribution method or the
401(k) safe harbor matching contribution
method.
D. Effect on Regulations
Because of the amendments made to
§§ 401(k), 401(m), and 414(q) by SBJPA,
as well as by other recent legislation, cer-
tain portions of §§ 1.401(k)–1,
1.401(m)–1, 1.401(m)–2, and
1.414(q)–1T of the Income Tax Regula-
tions no longer reflect current law. How-
ever, these regulations continue to apply
to the extent they are not inconsistent with
the Code, Notices 97–2, 97–45, 98–1, and
98–52, this notice, and any subsequent
guidance.
III. Questions and Answers Relating to
the 401(k) and (m) Safe Harbor Methods
Flexibility in Adoption of 401(k) Safe
Harbor Nonelective Contribution Method
Q-1. By what date must the sponsor of
a 401(k) plan adopt the 401(k) safe harbor
nonelective contribution method for a
plan year?
A-1. Generally, a plan that is intended
to satisfy the 401(k) safe harbor require-
ments for a plan year must, prior to the
beginning of the plan year, contain lan-
guage to that effect and must specify the
401(k) safe harbor method that will be
used. (However, see section XI.B. of No-
tice 98–52 and Rev. Proc. 99–23,
1999–16 I.R.B. 5, for the remedial
amendment period applicable to plan
changes incorporating the 401(k) safe
harbor provisions.)
Notwithstanding section XI.A. of No-
tice 98–52, a plan that provides that it will
satisfy the current year ADP (and, if ap-
plicable, ACP) testing method for a plan
year may be amended not later than 30
days before the last day of the plan year to
specify that the 401(k) safe harbor non-
elective contribution method will be used
for the plan year (including that the safe
harbor nonelective contribution will be
made), provided that the plan otherwise
satisfies the ADP (and, if applicable,
ACP) test safe harbor for the plan year
(including the notice requirement under
section V.C. of Notice 98–52, as modified
by this notice). For purposes of the pre-
ceding sentence, in applying the content
requirement of section V.C.1 of Notice
98–52:
(1) Instead of stating the amount of the
safe harbor nonelective contribution to
be made under the plan, the notice
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given to eligible employees before the
beginning of the plan year must pro-
vide that (a) the plan may be amended
during the plan year to provide that the
employer will make a safe harbor non-
elective contribution of at least 3 per-
cent to the plan for the plan year, and
(b) if the plan is so amended, a supple-
mental notice will be given to eligible
employees 30 days prior to the last day
of the plan year informing them of such
an amendment, and
(2) A supplemental notice must be pro-
vided to all eligible employees no later
than 30 days prior to the last day of the
plan year stating that a 3 percent safe
harbor nonelective contribution will be
made for the plan year. For administra-
tive convenience, the supplemental no-
tice may be provided separately or as
part of the safe harbor notice for the
following plan year.
Similar rules apply if, pursuant to sec-
tion IX.A.1. of Notice 98–52, the safe
harbor nonelective contribution is made
to another plan of the employer.
Thus, for example, a plan sponsor that
maintains a calendar-year 401(k) plan
using the current year ADP testing
method and that wishes to have the flexi-
bility to decide toward the end of a plan
year whether or not to adopt the 401(k)
safe harbor nonelective contribution
method with respect to its 401(k) plan
could achieve that flexibility by providing
the initial notice described in section V.C.
of Notice 98–52 (as modified by this
Q&A-1, and Q&A-7 and Q&A-8 of this
notice) before the beginning of the plan
year, as provided under section V.C.2. of
Notice 98–52 (as modified by Q&A-9 of
this notice). If the plan sponsor then de-
cides to adopt the 401(k) safe harbor non-
elective contribution method for the plan
year, the plan sponsor must, by December
1 of the plan year, (1) amend the 401(k)
plan accordingly and (2) provide a sup-
plemental notice to all eligible employees
stating that a 3-percent safe harbor non-
elective contribution will be made for the
plan year.
A plan sponsor that takes advantage of
the flexibility provided under this Q&A-1
is not required to continue using the
401(k) safe harbor nonelective contribu-
tion method for the following plan year
and is not limited in the number of years
that it takes advantage of this flexibility.
In order to further facilitate the adoption
of the 401(k) safe harbor nonelective con-
tribution method under this Q&A-1, the
Service intends to provide a simplified,
pre-approved means of adopting the
401(k) safe harbor nonelective contribu-
tion method under the Service’s master
and prototype plan program.
Safe Harbor Matching Contribution
Requirements
Q-2. Can a 401(k) safe harbor plan
match elective and employee contribu-
tions on a payroll-by-payroll basis (in-
stead of on an annual basis) without mak-
ing additional contributions at the end of
the year to take into account the total
amount of an employee’s compensation
for the plan year?
A-2. Notwithstanding section VII.A.
(or any other provision) of Notice 98–52,
the requirements of sections V.B.1. and
VI.B. of Notice 98–52 that relate to
matching contributions may be met for a
plan year by meeting such requirements
either (1) with respect to the plan year as a
whole, or (2) if the plan so provides, sepa-
rately with respect to each payroll period
(or with respect to all payroll periods end-
ing with or within each month or plan-
year quarter) taken into account under the
arrangement for the plan year (the “payroll
period method”). If the payroll period
method is used, however, matching contri-
butions with respect to elective or em-
ployee contributions made during a plan
year quarter beginning after May 1, 2000
must be contributed to the plan by the last
day of the following plan year quarter.
Accordingly, in the case of a calendar year
plan that uses the payroll period method,
matching contributions with respect to
elective or employee contributions made
during the calendar quarter beginning July
1, 2000, must be contributed to the plan by
December 31, 2000. The payroll period
method applies only for purposes of satis-
fying the ADP safe harbor matching con-
tribution requirements of § 401(k)(12)
(section V.B.1. of Notice 98–52) and the
ACP safe harbor matching contribution re-
quirements of § 401(m)(11) (section VI.B.
of Notice 98–52).
Q-3. Can a 401(k) safe harbor plan re-
quire that employees make elective con-
tributions in whole percentages of pay or
whole dollar amounts?
A-3. Notwithstanding section
V.B.1.c.ii. of Notice 98–52, a plan will
not fail to satisfy the requirements of sec-
tions V.B.1. and VI.B. of Notice 98–52
that relate to matching contributions
merely because the plan requires employ-
ees to make cash or deferred or employee
contribution elections in whole percent-
ages of compensation or whole dollar
amounts.
Q-4. Can a 401(k) safe harbor plan
suspend additional employee contribu-
tions for up to 12 months after the in-ser-
vice withdrawal of employee contribu-
tions?
A-4. Notwithstanding section V.B.1.c.
and section VI.B.3. of Notice 98–52, a
plan will not fail to satisfy the ACP test
safe harbor of section VI of Notice 98–52
merely because, after a withdrawal of em-
ployee contributions from the plan, the
plan suspends additional employee contri-
butions for a period that does not exceed
12 months. See section V.B.1.c.iv. of No-
tice 98–52 for a similar exception that ap-
plies for purposes of hardship distribu-
tions of elective contributions.
Q-5. How do the rules of sections
V.B.1. and VI.B.3. of Notice 98–52 apply
to a plan that provides matching contribu-
tions on both elective contributions and
employee contributions?
A-5. A plan will not fail to satisfy the
requirements of section V.B.1.a., V.B.1.b.,
or VI.B.3.(iii) of Notice 98–52 merely be-
cause the plan provides matching contri-
butions on both elective contributions and
employee contributions if, under the
terms of the plan, either (1) the matching
contributions provided on an employee’s
elective contributions are not affected by
the amount of the employee’s employee
contributions or (2) matching contribu-
tions are made with respect to the sum of
an employee’s elective and employee
contributions under the same terms as
matching contributions are made with re-
spect to elective contributions.
For example, a plan will not fail to sat-
isfy the matching contribution require-
ment of section V.B.1. or the ACP test
safe harbor of section VI of Notice 98–52
merely because the plan provides a re-
quired matching contribution equal to 100
percent of the sum of each eligible em-
ployee’s elective and employee contribu-
tions up to 4 percent of compensation.
This is the case even if, during a plan
year, an eligible employee first makes
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employee contributions of 4 percent of
compensation that are matched by the em-
ployer and subsequently makes elective
contributions that go unmatched, pro-
vided that the same match would have
been available if the employee had in-
stead made only elective contributions.
Q-6. May a plan that uses the 401(k)
safe harbor matching contribution method
suspend matching contributions on future
elective and employee contributions dur-
ing a plan year and instead use the current
year ADP (and, if applicable, ACP) test-
ing method for the plan year?
A-6. A plan that uses the 401(k) safe
harbor matching contribution method will
not fail to satisfy § 401(k) (or § 401(m))
for a plan year merely because the plan is
amended during the plan year to reduce or
eliminate matching contributions, pro-
vided:
(1) A supplemental notice is given to all
eligible employees explaining the con-
sequences of the amendment and in-
forming them of the effective date of
the reduction or elimination of match-
ing contributions and that they have a
reasonable opportunity (including a
reasonable period) to change their cash
or deferred elections and, if applicable,
their employee contribution elections;
(2) The reduction or elimination of
matching contributions is effective no
earlier than the later of (i) 30 days after
eligible employees are given the sup-
plemental notice and (ii) the date the
amendment is adopted;
(3) Eligible employees are given a rea-
sonable opportunity (including a rea-
sonable period) prior to the reduction
or elimination of matching contribu-
tions to change their cash or deferred
elections and, if applicable, their em-
ployee contribution elections;
(4) The plan is amended to provide that
the ADP test and, if applicable, the
ACP test will be performed and satis-
fied for the entire plan year using the
current year testing method; and
(5) All other safe harbor requirements
are satisfied through the effective date
of the amendment.
Notice Requirement
Q-7. Can a plan use electronic media
to satisfy the 401(k) safe harbor notice re-
quirement?
A-7. The Service and Treasury are cur-
rently reviewing the legal and policy is-
sues relating to the satisfaction of the safe
harbor notice requirement through the use
of electronic media. Prior to the issuance
of additional guidance on this matter,
however, a plan will not fail to satisfy the
notice requirement of section V.C. of No-
tice 98–52 (as modified by this notice)
with respect to an employee merely be-
cause, instead of receiving the notice on a
written paper document, the employee re-
ceives the notice through an electronic
medium reasonably accessible to the em-
ployee, provided that (1) the system under
which the electronic notice is provided is
reasonably designed to provide the notice
in a manner no less understandable to the
employee than a written paper document
and (2) under such system, at the time the
notice is provided, the employee is ad-
vised that the employee may request and
receive the notice on a written paper doc-
ument at no charge, and, upon request,
that document is provided to the em-
ployee at no charge. This Q&A-7 also ap-
plies for purposes of providing the sup-
plemental notices under Q&A-1 and
Q&A-6 of this notice.
Q-8. Can a safe harbor notice cross-
reference the plan’s summary plan de-
scription for a portion of the information
required in the notice?
A-8. Section V.C. of Notice 98–52 pro-
vides that the notice requirement of that
section is satisfied if each eligible em-
ployee for the plan year is given written
notice of the employee’s rights and oblig-
ations under the plan and the notice satis-
fies the content requirement of paragraph
1 of that section and the timing require-
ment of paragraph 2 of that section.
Notwithstanding paragraph 1.a. of sec-
tion V.C. of Notice 98–52, a plan will not
fail to satisfy the content requirement
merely because, in the case of the infor-
mation described in items (ii) (relating to
any other contributions under the plan),
(iii) (relating to the plan to which safe
harbor contributions will be made), (iv)
(relating to the type and amount of com-
pensation that may be deferred), and (vii)
(relating to withdrawal and vesting provi-
sions) of paragraph 1.a., the notice instead
cross-references the relevant portions of
an up-to-date summary plan description
that has been provided (or concurrently is
provided) to the employee. However, the
notice must still accurately describe (1)
the safe harbor matching or nonelective
contribution formula used under the plan
(including a description of the levels of
matching contributions, if any, available
under the plan) and state that these contri-
butions (as well as elective contributions)
are fully vested when made and (2) how
to make cash or deferred elections (in-
cluding any administrative requirements
that apply to such elections) and the peri-
ods available under the plan for making
such elections. In addition, the notice
must also provide information that makes
it easy for eligible employees to obtain
additional information about the plan (in-
cluding an additional copy of the sum-
mary plan description) such as telephone
numbers, addresses and, if applicable,
electronic addresses, of the individuals or
offices from whom employees can obtain
such plan information.
Q-9. By what date must the safe harbor
notice be provided to employees in the
case of a plan that adopts a 401(k) safe
harbor method for the first time in the
year 2000?
A-9. Generally, the notice required
under section V.C. of Notice 98–52 must
be provided in accordance with the timing
requirements of section V.C.2. (i.e., the
notice must be provided within a reason-
able period before the beginning of the
plan year (or, in the year an employee be-
comes eligible, within a reasonable period
before the employee becomes eligible)).
However, in an effort to allow plan spon-
sors that are considering the adoption of a
401(k) safe harbor method to fully utilize
the guidance provided in this notice for
plan years beginning in the year 2000, the
Service and Treasury have determined
that transition relief is appropriate. Ac-
cordingly, in the case of a plan sponsor
that adopts a 401(k) safe harbor method
for the first time with respect to a plan for
a plan year that begins on or after January
1, 2000 and on or before June 1, 2000, the
notice described in section V.C. of Notice
98–52 satisfies the timing requirement for
that plan year if the notice is given on or
before May 1, 2000. This transition relief
applies whether the 401(k) safe harbor
method is adopted under a newly estab-
lished 401(k) plan or under a preexisting
401(k) plan.
In order to satisfy the 401(k) safe har-
bor requirements for the plan year, how-
ever, a plan that uses the transition relief
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provided under this Q&A-9 still must sat-
isfy the otherwise applicable require-
ments of Notice 98–52 (as modified by
this notice) with respect to the entire plan
year. Thus, for example, in the case of a
401(k) plan that uses the 401(k) safe har-
bor matching contribution method,
matching contributions still must be made
with respect to elective contributions
made prior to the date the safe harbor no-
tice is provided to employees in the same
amount as if the 401(k) safe harbor
matching contribution method had been
in place since the beginning of the plan
year.
Interaction Between Safe Harbor
Methods and § 410(b)(4) Election
Q-10. Is a plan required to provide safe
harbor matching or nonelective contribu-
tions to participants who have not yet at-
tained age 21 and completed a year of ser-
vice if the plan uses one of the 401(k) safe
harbor methods?
A-10. As provided in section IX.B.1.
of Notice 98–52, if, pursuant to
§ 410(b)(4)(B), an employer applies
§ 410(b) separately to the portion of a
plan (within the meaning of § 414(l)) that
benefits only employees who satisfy age
and service conditions under the plan that
are lower than the greatest minimum age
and service conditions permitted under
§ 410(a), the plan is treated as two sepa-
rate plans for purposes of § 401(k), and
the ADP test safe harbor need not be satis-
fied with respect to both plans in order for
one of the plans to take advantage of the
ADP test safe harbor. Accordingly, a plan
that uses one of the 401(k) safe harbor
methods is not required to provide safe
harbor matching or nonelective contribu-
tions to participants who have not yet at-
tained age 21 and completed a year of ser-
vice. Those employees do not have to be
treated as eligible employees for purposes
of the 401(k) safe harbors, so long as the
employer has elected to treat them sepa-
rately for coverage purposes pursuant to
§ 410(b)(4). However, in such a case, the
plan must specifically provide that elec-
tive contributions (and, if applicable,
matching contributions) on behalf of
those employees will satisfy the ADP test
(and, if applicable, the ACP test).
Addition of 401(k) Safe Harbor
Provisions to Existing Profit-Sharing
Plans
Q-11. Can a CODA that is added to an
existing profit-sharing plan for the first
time during a plan year use a 401(k) safe
harbor method for that plan year?
A-11. Generally, the safe harbor re-
quirements must be satisfied for the entire
plan year (see sections V.A. and VI.A. of
Notice 98–52). In addition, except in the
case of a newly established plan, the plan
year must be 12 months long (see section
X of Notice 98–52). Notwithstanding
these requirements, however, in the case
of a CODA that is added to an existing
profit-sharing, stock bonus, or pre-ERISA
money purchase pension plan for the first
time during a plan year, the requirements
of section V of Notice 98–52 will be
treated as being satisfied for the entire
plan year and the CODA will not be
treated as failing to satisfy the require-
ments of section X of Notice 98–52, pro-
vided (1) the plan is not a successor plan
(within the meaning of Notice 98–1), (2)
the CODA is made effective no later than
3 months prior to the end of the plan year,
and (3) the requirements of Notice 98–52
are otherwise satisfied for the entire pe-
riod from the effective date of the CODA
to the end of the plan year. Thus, an exist-
ing calendar-year profit-sharing plan that
does not contain a CODA may be
amended as late as October 1 to add a
CODA that uses a 401(k) safe harbor
method for that plan year.
A similar rule applies for purposes of
section VI of Notice 98–52 in the case of
the addition of matching contributions for
the first time to an existing defined contri-
bution plan at the same time as the adop-
tion of the CODA.
IV SIMPLIFYING THE LIMITATION
ON MULTIPLE USE
The limitation on multiple use applies
to the current and prior year ADP and
ACP testing methods (i.e., the nondis-
crimination testing methods that § 401(k)
plans must satisfy if they do not satisfy
the 401(k) safe harbors or the SIMPLE
401(k) requirements). The limitation on
multiple use is a nondiscrimination provi-
sion intended to limit the extent to which
highly compensated employees receive
greater benefits (as a percentage of pay)
than nonhighly compensated employees,
primarily under § 401(k) plans that pro-
vide for matching contributions. The Ser-
vice and Treasury are considering ap-
proaches that would substantially sim-
plify the limitation on multiple use
administratively, while retaining most of
the value of this limitation in ensuring a
fairer distribution of benefits under
§ 401(k) plans and, in many cases, en-
couraging employers to make fully-vested
nonelective contributions on behalf of
nonhighly compensated employees.
Generally, the average rate of elective
contributions under a § 401(k) plan on be-
half of highly compensated employees
may not exceed 125 percent of the aver-
age rate of elective contributions on be-
half of nonhighly compensated employ-
ees. However, the Code provides an
“alternative limitation” that permits the
average rate of elective contributions
under a § 401(k) plan on behalf of highly
compensated employees to exceed 125
percent of the average rate on behalf of
nonhighly compensated employees, pro-
vided that average rate for highly com-
pensated employees is not greater than 2
percentage points more than the average
rate for nonhighly compensated employ-
ees and is not greater than 200 percent of
that of nonhighly compensated employ-
ees. The alternative limitation is particu-
larly relevant where the average rate of
elective contributions on behalf of non-
highly compensated employees is rela-
tively low. For example, if the average
rate of elective contributions on behalf of
nonhighly compensated employees is 4
percent of pay, then the average rate of
elective contributions on behalf of highly
compensated employees may not exceed
6 percent of pay. Absent the alternative
limitation, the average rate of elective
contributions on behalf of highly compen-
sated employees could not exceed 5 per-
cent in such a case. Similar rules apply
separately to the average rate of matching
and employee after-tax contributions of
highly compensated employees under a
§ 401(m) plan.
Section 401(m)(9) requires the Secre-
tary of the Treasury to “prescribe such
regulations as may be necessary to carry
out the purposes of this subsection and
subsection (k) including . . . such regula-
tions as may be necessary to prevent the
multiple use of the alternative limitation
with respect to any highly compensated
employee.” Accordingly, while the alter-
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native limitation may be used to satisfy
either the nondiscrimination test for elec-
tive contributions or the nondiscrimina-
tion test for matching and employee after-
tax contributions, the alternative
limitation is not available to satisfy both
tests. Absent the statutorily contemplated
limitation on multiple use, the combined
rates of elective and matching contribu-
tions on behalf of highly compensated
employees under a § 401(k) plan that pro-
vides for matching contributions could,
for example, be as much as 8 percent (i.e.,
an ADP of 4 percent and an ACP of 4 per-
cent) while the combined rates for non-
highly compensated employees could be
as little as 4 percent (i.e., an ADP of 2 per-
cent and an ACP of 2 percent). In this
case, the limitation on multiple use would
reduce this 4-percentage-point disparity
to 2_ percentage points.
While many employers choose to com-
ply with the limitation on multiple use by
reducing or limiting the elective and/or
matching contributions on behalf of
highly compensated employees, other
employers instead increase the employer
contributions made on behalf of non-
highly compensated employees. Accord-
ingly, because of the limitation on multi-
ple use, some moderate-income
employees covered under 401(k) plans
that provide matching contributions re-
ceive employer-provided benefits that
amount to hundreds of dollars a year.
However, the approach taken under ex-
isting regulations in implementing the
limitation on multiple use may be unnec-
essarily complicated. As a result, the Ser-
vice and Treasury are reviewing potential
changes to these regulations that would
substantially simplify the application of
the limitation on multiple use.
Under one possible approach, the
multi-step mathematical test used in de-
termining the aggregate limit on the rates
of contributions for highly compensated
employees would be replaced by a simple
“look-up” table that is based on ranges of
aggregate contribution rates for nonhighly
compensated employees. For example,
such a table could provide that if the com-
bined ADP and ACP on behalf of non-
highly compensated employees is be-
tween 5 percent and 6 percent, then the
combined ADP and ACP on behalf of
highly compensated employees could be
as much as 3 percentage points higher.
Alternatively, or in addition, the scope
of the limitation’s application might be
narrowed slightly in order to give relief in
cases where the value of the limitation
would be inconsequential in comparison
to the administrative expense of compli-
ance. For example, where the combined
ADP and ACP on behalf of nonhighly
compensated employees exceeds a certain
level (e.g., 9 percent or 10 percent), the
limitation on multiple use might be
deemed satisfied.
The Service and Treasury welcome
comments on these and other potential ap-
proaches for simplifying the limitation on
multiple use. Comments on the effect of
the SBJPA changes to the methods for
correcting excess contributions and ex-
cess aggregate contributions and the rela-
tion of those changes to corrections of
multiple use limitation failures are also
welcome. In addition, comments are wel-
come regarding whether it is more appro-
priate (as a matter of authority or other-
wise) for simplification of the limitation
on multiple use to be effected administra-
tively or legislatively.
V POTENTIAL APPROACHES FOR
APPLYING VARIOUS
QUALIFICATION REQUIREMENTS
IN MERGERS, ACQUISITIONS,
DISPOSITIONS, AND SIMILAR
TRANSACTIONS
The Service and Treasury are in the
process of developing guidance regarding
the application of the nondiscrimination
requirements under § 401(k) and
§ 401(m), and the highly compensated
employee definition under § 414(q), in
situations where the entities sponsoring
the plans are involved in mergers, acquisi-
tions, dispositions, or similar transactions.
Uncertainty among plan sponsors regard-
ing the appropriate application of various
qualification requirements in the context
of business transactions and reorganiza-
tions may be leading to reduced employee
protections, increased transaction costs
for employers, and the inconsistent appli-
cation of these requirements among dif-
ferent employers.
The guidance developed by the Service
and Treasury will be designed to balance
the need to protect employees’ pension
rights and benefits and provide for the fair
distribution of tax-favored pension bene-
fits with the potential burdens on employ-
ers of data collection and compliance in
the context of business transactions and
reorganizations. Simplified alternatives
may be provided to address those types of
transactions in which the information flow
between the selling and purchasing enti-
ties or other entities involved in the trans-
actions traditionally has been minimal.
As part of this process, the Service and
Treasury are seeking comments from plan
participants, plan sponsors, and other in-
terested parties regarding the following:
(1) The types of business transactions
and reorganizations (e.g., stock acquisi-
tions, acquisitions of substantially all
the assets of a trade or business, or
other economically similar transac-
tions) that reasonably would warrant
continuity of treatment for purposes of
the nondiscrimination requirements
under § 401(k) and § 401(m) and the
highly compensated employee defini-
tion under § 414(q), as well as the de-
gree of specificity that is desirable or
appropriate in describing these transac-
tions.
(2) The application of the nondiscrimi-
nation requirements under § 401(k) and
§ 401(m) and the highly compensated
employee definition under § 414(q) in
cases where plans are combined or di-
vided during (instead of at the begin-
ning of) a plan year as a result of a
business transaction or reorganization
that occurs during a plan year.
(3) Whether more than one testing al-
ternative may be appropriate when ap-
plying the nondiscrimination require-
ments under § 401(k) and § 401(m) in
the case of mid-year transactions. For
example, under certain circumstances,
one approach to mid-year business
transactions that also involve combin-
ing plans might be to give plan spon-
sors the option of applying the § 401(k)
and § 401(m) nondiscrimination re-
quirements on a pre-transaction and
post-transaction basis as if there were
separate short plan years for the un-
combined and combined plans, or ap-
plying these requirements once on the
basis of the entire plan year for the
combined plan. A similar approach
might apply in cases where plans are
divided as a result of mid-year business
transactions.
(4) The application of other plan quali-
fication provisions (in addition to the
January 24, 20004182000–4 I.R.B.
IRB 2000-4 1/28/00 10:26 AM Page 418

nondiscrimination requirements for
§ 401(k) and § 401(m) plans and the
highly compensated employee defini-
tion under § 414(q)) in the context of
business transactions and reorganiza-
tions, whether or not such transactions
occur in the middle of a plan year. For
example, § 414(a)(2) grants the Secre-
tary of the Treasury the authority to
prescribe regulations regarding the
treatment of service with a predecessor
employer as service with a successor
employer. Comments are invited on
whether regulations should be pro-
posed to address situations in which
participants experience an interruption
of their vesting service under § 411(a)
and eligibility service under § 410(a)
by reason of certain business transac-
tions or reorganizations.
VI REQUEST FOR COMMENTS
In addition to inviting comments on the
potential approaches for simplifying the
limitation on multiple use and for apply-
ing various qualification requirements in
cases where plan sponsors are involved in
mergers, acquisitions, and similar transac-
tions, the Service and Treasury invite
comments on the 401(k) safe harbor guid-
ance provided in this notice. It is antici-
pated that further guidance in these areas
would take the form of proposed regula-
tions.
Comments should be submitted by
March 24, 2000, in writing, and should
reference Notice 2000–3. Comments can
be addressed to CC:DOM:CORP:R (No-
tice 2000–3), room 5228, Internal Rev-
enue Service, POB 7604, Ben Franklin
Station, Washington, DC 20044. In the
alternative, comments may be hand deliv-
ered between the hours of 8 a.m. and 5
p.m. to CC:DOM:CORP:R (Notice
2000–3), Courier’s Desk, Internal Rev-
enue Service, 1111 Constitution Avenue
NW., Washington, DC. Alternatively, tax-
payers may transmit comments electroni-
cally via the following Internet site: Cyn-
thia.Grigsby@m1.irscounsel.treas.gov.
VII. EFFECT ON OTHER
DOCUMENTS
Notice 98–52 is modified.
PAPERWORK REDUCTION ACT
The collection of information con-
tained in this notice has been reviewed
and approved by the Office of Manage-
ment and Budget (OMB) in accordance
with the Paperwork Reduction Act (44
U.S.C. 3507) under control number 1545-
1669.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
OMB control number.
The collections of information in this
notice are in section III, Q&As 1 and 2.
The collections of information are re-
quired to enable personnel in the Tax Ex-
empt and Government Entities Division
of the Internal Revenue Service to deter-
mine if an employer’s retirement plan sat-
isfies the requirements to obtain favorable
tax treatment and to inform plan partici-
pants of their rights and obligations under
the plan. The likely respondents are busi-
nesses or other for-profit institutions, and
not-for-profit institutions.
The estimated total annual reporting
burden is 8,000 hours.
The estimated annual burden per re-
spondent is 1 hour and 20 minutes. The
estimated number of respondents is 6,000.
The estimated annual frequency of re-
sponses is on occasion.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
DRAFTING INFORMATION
The principal author of this notice is
Roger Kuehnle of the Tax Exempt and
Government Entities Division. For fur-
ther information regarding this notice,
please contact the Employee Plans’ tax-
payer assistance telephone service at
(202) 622-6074/6075 (not toll-free num-
bers) between the hours of 1:30 and 3:30
p.m. Eastern Time, Monday through
Thursday.
Section 1504(d) Elections —
Deferral of Termination
Notice 2000–7
PURPOSE
The purpose of this Notice is to provide
guidance regarding the effect of the repeal
of certain Canadian banking legislation
on elections under section 1504(d) of the
Internal Revenue Code.
BACKGROUND
Section 1504(d) of the Code allows, in
certain circumstances, a domestic corpo-
ration owning or controlling, directly or
indirectly, 100 percent of the capital stock
of a Mexican or Canadian corporation, to
elect to treat such corporation as a domes-
tic corporation for all purposes of subtitle
A of the Code. Among other require-
ments, such an election may be made only
if the sole purpose for maintaining such
corporation is to comply with Canadian or
Mexican law regulating the title and oper-
ation of property.
If an election under section 1504(d) is
in effect with respect to a Canadian or
Mexican corporation, and the relevant
provision in Canadian or Mexican law
regulating the title and operation of prop-
erty is repealed, it is the view of Treasury
and the IRS that the election under section
1504(d) generally is terminated as of the
effective date of the repeal. However, a
foreign corporation may continue to be
viewed as maintained solely for the pur-
pose of complying with Canadian or
Mexican law for a short period of time
following the repeal of that foreign law if
the taxpayer takes reasonable and expedi-
tious measures to respond to the change in
foreign law and for good reason is unable
to complete such measures by the effec-
tive date of the repeal, as would be the
case if the taxpayer is required to obtain
regulatory approval in order to convert
the foreign corporation to a branch of the
U.S. parent and cannot obtain such ap-
proval by the effective date of the repeal.
In such a case, the foreign corporation
will continue to be viewed as maintained
solely for the purpose of complying with
Canadian or Mexican law only for so long
as is reasonably necessary to convert to
branch form and only for so long as the
taxpayer persists in its efforts to convert
to branch form during that period. The
IRS may issue guidance identifying
whether and the extent to which this short
period of time exists in appropriate cir-
cumstances not specifically addressed by
2000–4 I.R.B.419January 24, 2000
IRB 2000-4 1/28/00 10:26 AM Page 419

this Notice. Following the end of any
such period (or immediately upon the ef-
fective date of the repeal of the foreign
law if there is no such period), if the for-
eign corporation remains in existence, it
is no longer maintained solely for the pur-
pose of complying with the repealed for-
eign law.
Repeal of Canadian Banking
Legislation
Until recently, Canada prohibited for-
eign banks from operating in branch form
within Canada, under the Bank Act
(Canada), S.C. 1991, c. 46 (“Original
Act”). Canadian banking operations of a
foreign bank were required to be con-
ducted within a Canadian corporation.
Thus, Canadian banking subsidiaries of
U.S. banks may have qualified for the
election under section 1504(d).
Effective June 28, 1999, the Original Act
was amended to permit foreign banks to
perform certain specified banking functions
in Canada directly through foreign branches
rather than through Canadian subsidiaries
(“Amended Act”). Under the Amended
Act, all Canadian subsidiaries of foreign
banks seeking to convert to a branch opera-
tion must obtain the approval of the Minis-
ter of Finance and the Office of the Superin-
tendent of Financial Institutions.
In addition, on May 11, 1999, the
Canadian government announced its in-
tention to enact legislation that would
allow an indefinite deferral of the Cana-
dian tax imposed upon the liquidation of a
Canadian banking subsidiary as part of its
conversion to branch form (“Relief Legis-
lation”). Department of Finance Release
99–044 (May 11, 1999). Under the Relief
Legislation, relief will be available only if
the bank complies, on or before Decem-
ber 31, 2000, with paragraphs 1.0(1.1)(b)
and (c) of the draft “Guide to Foreign
Bank Branching” issued by the Office of
the Superintendent of Financial Institu-
tions (“Foreign Branch Guide”). In addi-
tion, the Canadian banking subsidiary
must complete its conversion to branch
form on or before the earlier of (i) the day
that is six months after the day that the
Superintendent of Financial Institutions
makes an order in respect of the foreign
bank under subsection 534(1) of the
Amended Act, or (ii) December 31, 2002.
The terms of the proposed Relief Legisla-
tion indicate that Canada has determined
that the period described above is a rea-
sonable period for taxpayers to take the
steps necessary to convert to branch form.
Effect of Repeal of Canadian Banking
Legislation
Except as provided in the following
sentence, a Canadian banking subsidiary
that was, immediately prior to June 28,
1999, maintained solely for the purpose
of complying with the Original Act shall
be considered to be maintained solely for
the purpose of complying with the Origi-
nal Act until the earlier of the date that is
six months after the day that the Superin-
tendent of Financial Institutions makes an
order in respect of the foreign bank under
subsection 534(1) of the Amended Act, or
December 31, 2002. If, however, the
bank does not comply with paragraphs
1.0(1.1)(b) and (c) of the Foreign Branch
Guide on or before December 31, 2000,
the Canadian banking subsidiary shall be
considered to be maintained solely for the
purpose of complying with the Original
Act only until December 31, 2000.
After the applicable period described in
the preceding paragraph, any Canadian
banking subsidiary remaining in existence
shall be maintained solely for the purpose
of complying with foreign law as to title
and operation of property only if it is
maintained solely for the purpose of com-
plying with the Amended Act or any other
applicable Canadian law regulating the
title and operation of property.
The principal author of this notice is
Kenneth D. Allison of the Office of Associ-
ate Chief Counsel (International). How-
ever, other personnel from the IRS and the
Treasury Department participated in its de-
velopment. For further information regard-
ing this notice contact Mr. Allison at 202-
622-3860 (not a toll-free call).
Weighted Average Interest Rate
Update
Notice 2000–8
Notice 88–73 provides guidelines for
determining the weighted average interest
rate and the resulting permissible range of
interest rates used to calculate current lia-
bility for the purpose of the full funding
limitation of § 412(c)(7) of the Internal
Revenue Code as amended by the Om-
nibus Budget Reconciliation Act of 1987
and as further amended by the Uruguay
Round Agreements Act, Pub. L. 103-465
(GATT).
The average yield on the 30-year Trea-
sury Constant Maturities for December
1999 is 6.35 percent.
The following rates were determined
for the plan years beginning in the month
shown below.
Drafting Information
The principal author of this notice is
Todd Newman of Employee Plans, Tax Ex-
empt and Government Entities Division.
For further information regarding this no-
tice, call the Employee Plans Actuarial hot-
line, (202) 622-6076 between 2:30 and
3:30 p.m. Eastern time (not a toll-free num-
ber). Mr. Newman’s number is (202) 622-
8458 (also not a toll-free number).
January 24, 20004202000–4 I.R.B.
90% to 105%90% to 110%
WeightedPermissiblePermissible
MonthYearAverageRangeRange
January20006.015.41 to 6.315.41 to 6.61
IRB 2000-4 1/28/00 10:26 AM Page 420

2000–4 I.R.B.421January 24, 2000
Notice of Proposed Rulemaking
and Notice of Public Hearing
Credit for Increasing Research
Activities
REG–105606–99
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations relating to the com-
putation of the credit for increasing re-
search activities (the research credit) for
members of a controlled group and the al-
location of the credit under section 41(f)
of the Internal Revenue Code. These pro-
posed regulations are intended to provide
guidance on the proper method for com-
puting the research credit for members of
a controlled group and the proper method
for allocating the group credit to members
of the group. These proposed regulations
reflect changes to section 41 made by the
Revenue Reconciliation Act of 1989 (the
1989 Act). This document also provides
notice of a public hearing on these regula-
tions.
DATES: Written or electronic comments
must be received no later than April 5,
2000. Outlines of topics to be discussed
at the public hearing scheduled for April
26, 2000 at 10 a.m. must be received by
April 5, 2000.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–105606–99),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–105606–99),
Courier’s Desk, Internal RevenueService,
1111 Constitution Avenue NW., Washing-
ton, DC. Alternatively, taxpayers may
submit comments electronically via the
Internet by selecting the “Tax Regs” op-
tion of the IRS Home Page, or by submit-
ting comments directly to the IRS Internet
site at:
http://www.irs.gov/prod/taxregs/regslist.h
tml. The public hearing will be held in
room 2615, Internal Revenue Building,
1111 Constitution Avenue, NW., Wash-
ington, DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the proposed regula-
tions, Lisa J. Shuman at (202)622-3120
(not a toll-free number); concerning sub-
mission of comments, the hearing, and/or
to be placed on the building access list to
attend the hearing, La Nita Van Dyke at
(202)622-7190 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget for review in ac-
cordance with the Paperwork Reduction
Act of 1995 (44 U.S.C. 3507(d)). Com-
ments on the collection of information
should be sent to the Office of Manage-
ment and Budget, Attn: Desk Officer for
the Department of the Treasury, Office of
Information and Regulatory Affairs,
Washington, DC 20503, with copies to
the Internal Revenue Service, Attn: IRS
Reports Clearance Officer, OP:FS:FP,
Washington, DC 20224. Comments on
the collection of information should be re-
ceived by March 6, 2000.
Comments are specifically requested con-
cerning:
Whether the proposed collection of in-
formation is necessary for the proper per-
formance of the functions of the IRS, in-
cluding whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection of
information (see below);
How the quality, utility, and clarity of
the information to be collected may be en-
hanced;
How the burden of complying with the
proposed collection of information may
be minimized, including through the ap-
plication of automated collection tech-
niques or other forms of information tech-
nology; and
Estimates of capital or start-up costs
and costs of operation, maintenance, and
purchase of services to provide informa-
tion.
The collection of information in this
proposed regulation is contained in the
preamble under the heading “Proposed
Effective Date.“ The information is re-
quired by the IRS to ensure that members
of a controlled group filing claims for re-
fund based on a change in method of allo-
cating the research credit to members of
the group do not together claim in excess
of 100% of the credit with respect to prior
taxable years.
Estimated total annual reporting bur-
den: 200 hours.
Estimated average annual burden hours
per respondent: 20 hours.
Estimated number of respondents: 10.
Estimated frequency of responses: On
occasion.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless it dis-
plays a valid control number assigned by
the Office of Management and Budget.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
Background
The research credit provisions originally
appeared in section 44F of the Internal
Revenue Code of 1954 (the 1954 Code), as
added to the 1954 Code by section 221 of
the Economic Recovery Tax Act of 1981.
Section 471(c) of the Tax Reform Act of
1984 redesignated section 44F as section
30. Section 231 of the Tax Reform Act of
1986 (the 1986 Act) redesignated section
30 as section 41 and substantially modified
the research credit provisions. The 1989
Act substantially revised the computation
of the research credit.
On May 17, 1989, the IRS published in
the Federal Register(54 FR 21203) final
regulations under section 41. The 1989
final regulations generally do not reflect
the amendments to section 41 made by
the 1986 Act, the 1989 Act, and other sub-
sequent legislative revisions to the re-
search credit.
The amendments proposed by this doc-
ument contain proposed rules relating to
Part IV. Items of General Interest
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January 24, 20004222000–4 I.R.B.
the computation of the research credit for
members of a controlled group and the al-
location of the credit under section 41(f).
These proposed regulations reflect
changes to the research credit rules made
by the 1989 Act and Small Business Job
Protection Act of 1996, which introduced
the alternative incremental research
credit.
Pre-1990 Rules for Computing the
Research Credit for Members of a
Controlled Group and Allocating the
Credit among Members of the Group
Prior to the enactment of the 1989 Act,
the research credit was computed by mul-
tiplying the credit rate by the excess of the
taxpayer’s current year qualified research
expenses over the average of the tax-
payer’s qualified research expenses for
the preceding three years.
Before amendment by the 1989 Act,
section 41(f)(1) provided rules for com-
puting the research credit for members of
a controlled group (generally a group of
corporations or unincorporated businesses
linked by common ownership of more
than 50 percent). Section 41(f)(1) treated
all members of a controlled group as a
single taxpayer for purposes of computing
the credit and allocated the credit to the
members of the group based on the mem-
ber’s proportionate share of the increase
in qualified research expenses giving rise
to the credit.
The legislative history to the 1981 Act
indicates that the research credit aggrega-
tion rules were enacted to ensure that the
research credit would be allowed only for
actual increases in research expenditures.
The aggregation rules were intended to
prevent artificial increases in research ex-
penditures by shifting expenditures
among commonly controlled or otherwise
related persons. H. Rep. No. 97–201,
1981–3 C.B. (Vol. 2) 364 and Sen. Rep.
97–144, 1981–3 C.B. (Vol. 2) 442.
An example that appears in both
§1.41–8(a)(4) of the 1989 regulations and
the legislative history to the 1981 Act il-
lustrates the computation and allocation
of the research credit under section
41(f)(1) before the 1989 Act amendments
to the research credit computation. In the
example, the allowable group research
credit is allocated among the members ex-
periencing an increase in qualified re-
search expenses over their base period re-
search expenses. The member allocation
is based on the ratio that each member’s
increase in its qualified research expenses
over its base period research expenses
bears to the sum of the group’s increases
in qualified research expenses.
Post-1989 Rules for Computing the
Research Credit for Members of a
Controlled Group and Allocating the
Regular Research Credit among
Members of the Group
In the 1989 Act, Congress revised the
computation of the research credit. Con-
gress retained the incremental structure of
the credit but altered the computation to
focus on whether and the extent to which
a taxpayer increases the proportion of its
qualified research expenses relative to its
gross receipts.
Under section 41, as amended in 1989,
the research credit is computed by multi-
plying the credit rate by the excess of the
taxpayer’s current year qualified research
expenses over a “base amount.” The base
amount is defined in section 41(c) as the
greater of: (1) fifty percent of the tax-
payer’s credit year qualified research ex-
penses (the minimum base amount); or,
(2) the taxpayer’s “fixed-base percent-
age” times the taxpayer’s average annual
gross receipts for the four taxable years
preceding the taxable year for which the
credit is being determined.
In general, a taxpayer’s fixed-base per-
centage is defined in section 41(c)(3)(A)
as the ratio that the taxpayer’s aggregate
qualified research expenses for its taxable
years beginning after December 31, 1983,
and before January 1, 1989 bear to its ag-
gregate gross receipts for the same period.
Section 41(c)(3)(B) provides rules for
computing the fixed-base percentage for
start-up companies. Section 41(c)(3)(C)
provides that the maximum fixed-base
percentage is 16%.
Section 41(f)(1), as amended by the
1989 Act, continues to provide rules for
computing the research credit for mem-
bers of a controlled group. As under prior
law, all members of a controlled group are
treated as a single taxpayer for purposes
of computing the credit. However, the al-
location rule was amended to eliminate
any reference to an “increase” in qualified
research expenses. Under the amended
allocation rule, the group credit is allo-
cated among the members of the group
based on each member’s “proportionate
share of the qualified research expenses
and basic research payments giving rise to
the credit.”
In explaining the 1989 Act revisions to
the research credit, the House Report sim-
ply states that the rules relating to the ag-
gregation of related persons and changes
in ownership are the same as under pre-
sent law with the modification that when
a business changes hands, qualified re-
search expenses and gross receipts for pe-
riods prior to the change of ownership are
treated as transferred with the trade or
business which gave rise to those expen-
ditures and receipts for purposes of re-
computing a taxpayer’s fixed-base per-
centage. H. Rep. No. 101-247 at 1202.
The legislative history to the 1989 Act
does not refer to the elimination of the
word “increase” from the allocation rule.
In the light of the statutory changes en-
acted in 1989, taxpayers have questioned
the proper method for computing the re-
search credit for members of a controlled
group and the proper method for allocat-
ing the group credit to members of the
group under the new rules.
The proposed regulations provide that,
for purposes of computing the group
credit, all of the computational rules of
section 41 are applied on an aggregate
basis. This is consistent with the statutory
prescription that the controlled group be
treated as a single taxpayer and is neces-
sary to preclude taxpayers from creating
artificial increases in the credit by shifting
qualified research expenses and gross re-
ceipts among commonly controlled or
otherwise related persons.
In proposing rules for the allocation of
the credit, Treasury and the IRS consid-
ered, but were not persuaded by, certain
taxpayers’ argument that the elimination
of the word “increase” from the allocation
rule in the statute requires that the credit
be allocated on the basis of the gross
amount of qualified research expenses in-
curred by the various members of the con-
trolled group. Treasury and the IRS be-
lieve that elimination of the word
“increase” was necessitated by the 1989
statutory amendments to the computation
of the research credit, which afford a
credit in certain circumstances even where
the taxpayer (or each member of a con-
trolled group) is decreasing its gross
amount of qualified research expenses
IRB 2000-4 1/28/00 10:26 AM Page 422

2000–4 I.R.B.423January 24, 2000
(e.g., because the taxpayer’s gross receipts
also are decreasing). However, there is no
indication that the elimination of the word
“increase” was intended to suggest that the
credit be allocated without regard to its in-
cremental nature. To the contrary, the
statutory prescription that the credit be al-
located according to each member’s pro-
portionate share of the qualified research
expenses “giving rise to” the credit sup-
ports a rule that allocates the credit to
those members whose share of current
year qualified research expenses exceeds
their share of the base amount. Thus, the
proposed regulation provides that the
group research credit is allocated to each
member based on the ratio that the mem-
ber’s increase in its qualified research ex-
penses over its base amount bears to the
sum of each member’s increase in quali-
fied research expenses over its base
amount. The member’s base amount is
computed by multiplying the group fixed-
base percentage by the member’s average
annual gross receipts for the four preced-
ing tax years.
In order to prevent manipulation of the
amount of credit allocated to a consoli-
dated group of corporations that is a
member of a controlled group with other
taxpayers, Treasury and the IRS consid-
ered a special rule for allocating the re-
search credit that would treat all members
of a consolidated group as a single tax-
payer for purposes of allocating the re-
search credit among members of the con-
trolled group. Treasury and the IRS
request comments on special rules for al-
locating the research credit among mem-
bers of a controlled group that contains a
consolidated group of corporations.
Allocation of the Credit for Basic
Research Payments and the Alternative
Incremental Research Credit
The proposed regulations also address
the computation and allocation of the
group credit for basic research payments
(certain amounts paid to qualified organi-
zations for basic research) and for the al-
ternative incremental research credit (an
elective alternative method of computing
the research credit, under which taxpayers
are assigned a lower three-tiered fixed
base percentage, and the credit rate is re-
duced).
As in the case of the regular credit for
qualified research expenses, the proposed
regulations provide that all computations
with respect to the group credit for basic
research payments and the alternative in-
cremental research group credit are un-
dertaken on an aggregate basis. Similarly,
these group credits are allocated to the
various group members on an incremental
basis.
Proposed Effective Date
The regulations generally are proposed
to be applicable for taxable years ending
on or after the date proposed regulations
are filed with the Federal Register, but are
also proposed to be retroactive in certain
limited circumstances to prevent abuse.
To prevent taxpayers that are members of
a controlled group from together claiming
in excess of 100% of the credit with re-
spect to prior taxable years, the rules for
allocating the group credit would apply to
any taxable year beginning after Decem-
ber 31, 1989, in which, as a result of in-
consistent methods of allocation, the
members of a controlled group as a whole
claimed more than 100% of the allowable
group credit. In the case of a group whose
members have different taxable years and
whose members used inconsistent meth-
ods of allocation, the members of the
group as a whole shall be deemed to have
claimed more than 100% of the allowable
group credit.
No claim for refund (1) attributable to a
change in method of allocation; (2) per-
taining to a taxable year ending before
December 30, 1999; and (3) filed after
December 30, 1999, will be allowed un-
less the taxpayer submits a statement
identifying all members of the controlled
group for the taxable year at issue. The
statement must contain a declaration
signed by the taxpayer under penalties of
perjury that states: “To the best of my
knowledge and belief, taking into account
prior claims, this amended claim and any
related adjustments, no more than the
total amount of the group credit will be al-
located to the members of the controlled
group.”
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in Ex-
ecutive Order 12866. Therefore, a regu-
latory assessment is not required. It also
has been determined that section 553(b)
of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to
these regulations. It is hereby certified
that the collection of information con-
tained in these regulations will not have
a significant economic impact on a sub-
stantial number of small entities. This
certification is based on the expectation
that few, if any, small entities will file
claims for refund attributable to a
change in method of allocating the re-
search credit among members of its con-
trolled group. Accordingly, a Regula-
tory Flexibility Analysis under the
Regulatory Flexibility Act (5 U.S.C.
chapter 6) is not required. Pursuant to
section 7805(f) of the Internal Revenue
Code, this notice of proposed rulemak-
ing will be submitted to the Chief Coun-
sel for Advocacy of the Small Business
Administration for comment on its im-
pact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written com-
ments (preferably a signed original and
eight (8) copies) or electronic comments
are submitted timely to the IRS. Treasury
and the IRS request comments on the
clarity of the proposed regulations and
how they may be made easier to under-
stand. All comments will be available for
public inspection and copying.
A public hearing has been scheduled
for April 26, 2000 at 10 a.m. in room
2615, Internal Revenue Building, 1111
Constitution Avenue, NW., Washington,
DC. Due to building security procedures,
visitors must enter at the 10
th
Street en-
trance, located between Constitution and
Pennsylvania Avenues, NW. In addition,
all visitors must present photo identifica-
tion to enter the building. Because of ac-
cess restrictions, visitors will not be ad-
mitted beyond the immediate entrance
area more than 15 minutes before the
hearing starts. For information about
having your name placed on the building
access list to attend the hearing, see the
“FOR FURTHER INFORMATION
CONTACT” section of this preamble.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing. Persons who wish to
present oral comments at the hearing must
submit written or electronic comments
and an outline of the topics to be dis-
IRB 2000-4 1/28/00 10:26 AM Page 423

January 24, 20004242000–4 I.R.B.
cussed and the time to be devoted to each
topic (preferably a signed original and
eight (8) copies by April 5, 2000). A pe-
riod of 10 minutes will be allotted to each
person making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these proposed
regulations is Lisa J. Shuman of the Of-
fice of the Assistant Chief Counsel
(Passthroughs and Special Industries).
However, personnel from other offices of
the IRS and the Treasury Department par-
ticipated in their development.
* * * * *
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In §1.41-0, the table of contents
is amended by revising the entries for
§1.41–8(a), (a)(1), (a)(4), and (b) and
adding entries for §1.41–8(a)(5) and
(a)(6) to read as follows:
§1.41–0 Table of contents.
* * * * *
§1.41–8 Aggregation of expenditures.
(a) Controlled group of corporations; trades
or businesses under common control.
(1) In general.
* * * * *
(4) Allocation of credit for basic research
payments.
(5) Allocation of alternative incremental
research credit.
(6) Examples.
(b) For taxable years beginning before
January 1, 1990.
* * * * *
Par. 3. In §1.41–8, paragraphs (a)(1),
(a)(4), (b), and (c)(1) are revised and
paragraphs (a)(5) and (a)(6) are added to
read as follows:
§1.41–8 Aggregation of expenditures.
(a) Controlled group of corporations;
trades or businesses under common con-
trol—(1) In general. In determining the
amount of the credit for increasing re-
search activities allowed with respect to a
trade or business that at the end of its tax-
able year is a member of a controlled
group of corporations or a member of a
group of trades or businesses under com-
mon control, all members of the group are
treated as a single taxpayer. Thus, for
purposes of determining the amount of
the credit, all of the rules in section 41, in-
cluding, for example, the rules in section
41(c)(2) (pertaining to the minimum base
amount), section 41(c)(3)(B) (pertaining
to the fixed-base percentage for start-up
companies), and section 41(c)(3)(C) (per-
taining to maximum base amount) are ap-
plied only to the aggregate computation
of the base amount. The credit (if any) al-
lowed to any member is determined on
the basis of the ratio that its increase (if
any) in its qualified research expenses
over its base amount bears to the aggre-
gate increases in qualified research ex-
penses over the base amount of all mem-
bers of the group. For purposes of the
preceding sentence, a member computes
its base amount by multiplying the group
fixed-base percentage by the member’s
average annual gross receipts for the four
preceding tax years.
* * * * *
(4) Allocation of credit for basic re-
search payments. The credit (if any) at-
tributable to basic research payments al-
lowed to a member is determined on the
basis of the ratio that its excess (if any) of
basic research payments over its qualified
organization base period amount bears to
the aggregate excess of basic research
payments over the qualified organization
base period amount of all members in the
group. For purposes of the preceding sen-
tence, a member computes its qualified
organization base period amount using
similar principles to those used in para-
graph (a)(1) to determine the member’s
base amount.
(5) Allocation of alternative incremen-
tal research credit. If the credit is com-
puted under the alternative incremental
research credit rules, the credit (if any) al-
lowed to the member is determined on the
basis of the ratio that its excess (if any) of
qualified research expenses over 1% of its
average annual gross receipts for the four
taxable years preceding the taxable year
for which the credit is being determined
bears to the aggregate excess of qualified
research expenses over 1% of the average
annual gross receipts of all members of
the group for the four taxable years pre-
ceding the taxable year for which the
credit is being determined.
(6) Examples. The following examples
illustrate the provisions of this paragraph
(a):
Example 1. (i) Facts. A controlled group of three
corporations (all of which are calendar-year taxpay-
ers) had qualified research expenses for the credit
year 1999, qualified research expenses for the period
1984 through 1988, gross receipts for the period
1984 through 1988, and average annual gross re-
ceipts for the four years preceding the credit year as
follows:
ABCTotal
Credit Year Qualified $200x$20x$110x$330x
Research Expenses
1984-1988 Qualified $40x$10x$100x$150x
Research Expenses
1984-1988 Gross Receipts$1,000x$350x$150x$1500x
Average Annual Gross $1,200x$200x$300x$1700x
Receipts for 4 years
preceding Credit Year
IRB 2000-4 1/28/00 10:26 AM Page 424

Example 2. (i) Facts. The facts are the same as
in Example 1except that A had no qualified re-
search expenses during the credit year. The fol-
lowing table shows the group’s qualified research
expenses for the credit year, qualified research ex-
penses for the period 1984 through 1988, gross re-
ceipts for the period 1984 through 1988, and aver-
age annual gross receipts for the four years preced-
ing the credit year:
2000–4 I.R.B.425January 24, 2000
(ii) Computation of the group credit. (A) The
group research credit is computed as if the three cor-
porations are one taxpayer. The research credit is
equal to 20 percent of the excess of the group’s ag-
gregate credit year qualified research expenses over
the group’s base amount.
(B) The group’s base amount equals the greater
of fifty percent of the group’s credit year qualified
research expenses (the minimum base amount); or,
the group’s fixed-base percentage times the group’s
average annual gross receipts for the four taxable
years preceding the credit year. The group’s fixed-
base percentage is the ratio that the group’s aggre-
gate qualified research expenses for the taxable
years beginning after December 31, 1983, and be-
fore January 1, 1989 bear to its aggregate gross re-
ceipts for the same period. Therefore, the group’s
fixed-base percentage is 150x/1500x or 10% and the
group’s base amount is $170x, the greater of 50% of
$330 or 10% of $1,700x.
(C) The group’s research credit is equal to 20 per-
cent of the excess of the group’s aggregate credit
year qualified research expenses over the group’s
base amount. That is 20% of ($330x - $170x) or
$32x.
(iii) Allocation of the group credit. The group re-
search credit of $32x is allocated to the members of
the group based on the ratio that the member’s in-
crease in its qualified research expenses over the
member’s base amount bears to the sum of the mem-
ber increases in qualified research expenses over
their base amounts. The member’s base amount is
computed by multiplying the group fixed-base per-
centage of 10% by the member’s average annual
gross receipts for the four preceding tax years. The
$32x credit is allocated as follows:
MemberCredit Year MemberIncreaseRatioCredit
Qualified Base
Research Amount
Expenses
A$200x$120x$80x80/160$16x
B$20x$20x0
C$110x$30x$80x80/160$16x
ABCTotal
Credit Year Qualified 0$20x$110x$130x
Research Expenses
1984-1988 Qualified $40x$10x$100x$150x
Research Expenses
1984-1988 Gross Receipts$1,000x$350x$150x$1500x
Average Annual Gross $1,200x$200x$300x$1700x
Receipts for 4 years
preceding Credit Year
MemberCredit 1 % of MemberIncreaseRatioCredit
Year Average
Qualified Annual Gross
Research Receipts for
Expenses4 Preceding
Tax Years
A$0$12x00
B$20x$2x$18x18/125$.427284x
C$110x$3x$107x107/125$2.539966x
(ii) Computation of the group credit. Under
these facts, the controlled group’s credit year qual-
ified research expenses are less than the group’s
base amount of $170x, and no credit is allowed to
the group unless the group elects to use the alter-
native incremental research credit under section
41(c)(4).
If the group elects to use the alternative incre-
mental credit under section 41(c)(4), the group is
allowed a credit equal to .0165($25.5x - $17x) +
.022($34x - $25.5x) + .0275($130x - $34x) or
$2.96725x.
(iii) Allocation of the group credit. Assuming
that the group elects to use the alternative incre-
mental research credit under section 41(c)(4), the
group research credit of $2.96725x is allocated to
the members of the group based on the ratio that
the member’s qualified research expenses over one
percent of the member’s average annual gross re-
ceipts for the four preceding years bears to the
sum of the member increases in qualified research
expenses over one percent of their average annual
gross receipts for the four preceding years. The
$2.96725x credit is allocated as follows:
IRB 2000-4 1/28/00 10:26 AM Page 425

January 24, 20004262000–4 I.R.B.
Example 3.(i) Facts. A controlled group of three
corporations (all of which are calendar-year taxpay-
ers) had qualified research expenses for the credit
year 1999, qualified research expenses for the period
1984 through 1988, gross receipts for the period
1984 through 1988, and average annual gross re-
ceipts for the four years preceding the credit year as
follows:
AB C
1
Total
Credit Year Qualified $200x$20x$50x$270x
Research Expenses
1984-1988 Qualified $55x$15x0$70x
Research Expenses
1984-1988 Gross Receipts$1000x$400x0$1400x
Average Annual Gross $1200x$200x0$1400x
Receipts for 4 years
preceding Credit Year
MemberCreditYear MemberIncreaseRatioCredit
Qualified Base
ResearchAmount
Expenses
A$200x$60x$140x14/20$18.9x
B$20x$10x$10x1/20$1.35x
C$50x0$50x5/20$6.75x
ABCTotal
Credit Year Qualified $200x$20x$50x$270x
Research Expenses
1984-1988 Qualified $55x$15x0$70x
Research Expenses
1984-1988 Gross Receipts$1,000x$400x0$1,400x
Average Annual Gross$1,200x$200x$1,000x$2,400x
Receipts for 4 years
preceding Credit Year
1
C began business in 1999.
(ii) Computation of the group credit. (A) The
group research credit is computed as if the three cor-
porations are one taxpayer. The research credit is
equal to 20 percent of the excess of the group’s ag-
gregate credit year qualified research expenses over
the group’s base amount.
(B) The group’s base amount equals the greater
of: fifty percent of the group’s credit year qualified
research expenses (the minimum base amount), or,
the group’s fixed-base percentage times the group’s
average annual gross receipts for the four taxable
years preceding the credit year. The group’s fixed-
base percentage is the ratio that the group’s aggre-
gate qualified research expenses for the taxable
years beginning after December 31, 1983, and be-
fore January 1, 1989 bear to its aggregate gross re-
ceipts for the same period. Therefore, the group’s
fixed-base percentage is 70x/1400x or 5% and the
group’s base amount is $135x, the greater of 50% of
$270x or 5% of $1,400x.
(C) The group’s research credit is equal to 20 per-
cent of the excess of the group’s aggregate credit year
qualified research expenses over the group’s base
amount. That is 20% of ($270x - $135x) or $27x.
(iii) Allocation of the group credit. The group re-
search credit of $27x is allocated to the members of
the group based on the ratio that the member’s in-
crease in its qualified research expenses over the
member’s base amount bears to the sum of the mem-
ber increases in qualified research expenses over
their base amounts. The member’s base amount is
computed by multiplying the group fixed-base per-
centage of 5% by the member’s average annual
gross receipts for the four preceding tax years. The
$27x credit is allocated as follows:
Example 4. (i) Facts.The facts are the same as in
Example 3except that C began business in 1989. A,
B, and C had qualified research expenses for the
credit year 1999, qualified research expenses for the
period 1984 through 1988, gross receipts for the pe-
riod 1984 through 1988, and average annual gross
receipts for the four years preceding the credit year
as follows:
IRB 2000-4 1/28/00 10:26 AM Page 426

(b) For taxable years beginning before
January 1, 1990.For taxable years begin-
ning before January 1, 1990, see § 1.41-8
in effect prior to December 30, 1999 as
contained in 26 CFR part 1 revised April
1, 1999.
(c) Tax accounting periods used—(1)
In general. The credit allowable to a
member of a controlled group of corpora-
tions or of a group of trades or businesses
under common control is that member’s
share of the aggregate credit computed as
of the end of such member’s taxable year.
In computing the aggregate credit in the
case of a group whose members have dif-
ferent taxable years, a member shall gen-
erally treat the taxable year of another
member that ends with or within the
credit year of the computing member as
the credit year of that other member. In
computing the aggregate base amount, the
gross receipts taken into account with re-
spect to another member shall include that
other member’s gross receipts for the four
taxable years of that other member pre-
ceding the credit year of that other mem-
ber.
* * * * *
John M. Dalrymple,
Acting Deputy Commissioner
of Internal Revenue.
(Filed by the Office of the Federal Register on De-
cember 30, 1999, 2:06 p.m., and published in the
issue of the Federal Register for January 4, 2000, 65
F.R. 258)
Deposits of Excise Tax
Announcement 2000–5
AGENCY: Internal Revenue Service
(IRS), Treasury
ACTION: Advance notice of proposed
rulemaking.
SUMMARY: This document invites
comments from the public on issues that
the IRS may address in proposed regula-
tions relating to the requirements for ex-
cise tax returns and deposits. All materi-
als submitted will be available for public
inspection and copying.
DATES: Written and electronic comments
must be submitted by April 6, 2000.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG–103827–99),
room 5226, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. Submissions may be
hand delivered Monday through Friday
between the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–103827–99),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue NW.,
Washington, DC. Alternatively, taxpayers
may send submissions electronically via
the Internet by selecting the “Tax Regs”
option on the IRS Home Page, or directly
to the IRS Internet site at
http://www.irs.ustreas.gov/tax_regs/regsli
st.html.
FOR FURTHER INFORMATION CON-
TACT: Concerning submissions, the
Regulations Unit, (202) 622-7180; con-
cerning the proposals, Susan Athy, (202)
622-3130 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
The Excise Tax Procedural Regulations
(26 CFR part 40) set forth the require-
ments related to filing the Quarterly Fed-
eral Excise Tax Return, Form 720, and
making deposits of excise taxes. Certain
provisions of the current regulations are
complicated. The IRS is interested in
simplifying the filing and deposit rules
both as to the timing and the calculation
of the correct amount to deposit. Simpli-
fication would reduce recordkeeping bur-
dens and costs for taxpayers, improve
compliance, and facilitate proper admin-
istration of the excise taxes and trust
funds. The IRS requests comments on
how the regulations can be simplified;
comments are requested in particular on
the following issues.
Time for Filing Returns
The regulations currently provide that
the Form 720 generally must be filed by the
last day of the first calendar month follow-
ing the quarter for which it is made. How-
ever, in the case of returns related to taxes
imposed by chapter 33 (communications
and air transportation) and section 4681
(ozone-depleting chemicals), the due date
is the last day of the second calendar month
2000–4 I.R.B.427January 24, 2000
(ii) Computation of the group credit.(A) The
group research credit is computed as if the three cor-
porations are one taxpayer. The research credit is
equal to 20 percent of the excess of the group’s ag-
gregate credit year qualified research expenses over
the group’s base amount.
(B) The group’s base amount equals the greater
of: fifty percent of the group’s credit year qualified
research expenses (the minimum base amount), or,
the group’s fixed-base percentage times the group’s
average annual gross receipts for the four taxable
years preceding the credit year. The group’s fixed-
base percentage is the ratio that the group’s aggre-
gate qualified research expenses for the taxable
years beginning after December 31, 1983, and be-
fore January 1, 1989 bear to its aggregate gross re-
ceipts for the same period. Therefore, the group’s
fixed-base percentage is 70x/1400x or 5% and the
group’s base amount is $135x, the greater of 50% of
$270x or 5% of $2,400x.
(C) The group’s research credit is equal to 20 per-
cent of the excess of the group’s aggregate credit year
qualified research expenses over the group’s base
amount. That is 20% of ($270x- $135x) or $27x.
(iii) Allocation of the group credit. The group re-
search credit of $27x is allocated to the members of
the group based on the ratio that the member’s in-
crease in its qualified research expenses over the
member’s base amount bears to the sum of the mem-
ber increases in qualified research expenses over
their base amounts. The member’s base amount is
computed by multiplying the group fixed-base per-
centage of 5% by the member’s average annual
gross receipts for the four preceding tax years. The
$27x credit is allocated as follows:
MemberCreditYear MemberChangeRatioCredit
Qualified Base
ResearchAmount
Expenses
A$200x$60x$140x14/15$25.2x
B$20x$10x$10x1/15$1.8x
C$50x50x000
IRB 2000-4 1/28/00 10:26 AM Page 427

following the quarter for which it is made.
The IRS requests comments on
whether there should be one filing date
for all Form 720 filers, such as 30 days
after the end of the quarter. This would
be a simple rule that would apply equally
to all taxpayers.
Use of Government Depositaries
Background.The regulations currently
provide that excise taxes must be deposited
on a semimonthly basis. Generally, taxes
must be deposited by the 9
th
day of the
semimonthly period following the semi-
monthly period for which the deposit is
made (the 9-day rule). There are, however,
exceptions to this rule. Taxes on ozone-de-
pleting chemicals must be deposited by the
end of the second semimonthly period fol-
lowing the semimonthly period for which
the deposit is made (the 30-day rule). In
addition, for taxes imposed by section 4081
(gasoline, diesel fuel, and kerosene), com-
munications taxes, and air transportation
taxes, taxpayers may choose a deposit rule
other than the 9-day rule. For section 4081
taxes, section 518 of the Highway Revenue
Act of 1982 provides that a qualified per-
son may deposit by the 14
th
day of the
semimonthly period following the semi-
monthly period for which it is made if the
deposit is made by electronic funds transfer
(the 14-day rule). For communications and
air transportation taxes, if a person com-
putes the amount of tax to be reported and
deposited on the basis of amounts consid-
ered as collected, the person may deposit
the taxes considered as collected during a
semimonthly period by the third banking
day after the seventh day of the semi-
monthly period (the alternative method).
The regulations also provide that the
amount of the deposit for a semimonthly
period must equal the amount of net tax
liability incurred during that period unless
either the look-back quarter safe harbor
rule or the current liability safe harbor
rule applies. In general, the look-back
quarter safe harbor rule is met if the de-
posits for each semimonthly period in the
quarter are at least 1/6 of the net liability
reported for that tax in the second calen-
dar quarter preceding the current quarter,
and the current liability safe harbor rule is
met if the deposit for each semimonthly
period is at least 95 percent of the net tax
liability for the semimonthly period. Safe
harbor rules apply separately to each class
of tax. Each semimonthly deposit must
be timely made at an authorized Govern-
ment depository. Also, the amount of any
underpayment must be paid by the due
date of the return, without extension. A
failure to meet all the deposit require-
ments of a safe harbor rule for any semi-
monthly period eliminates the availability
of that safe harbor for the entire quarter.
As the above description of current regu-
lations illustrates, the deposit rules are quite
complicated, and taxpayers have experi-
enced difficulty in complying with them.
In addition, under existing safe harbor
rules, penalties for failure to deposit may be
imposed for all semimonthly periods in a
quarter if a taxpayer fails to deposit timely
and in the correct amount during any semi-
monthly period in that quarter.
Request for Comments. With respect to
the deposit rules, the IRS specifically re-
quests comments on the following issues:
1. Whether there should be a single de-
posit date for all excise taxes, such as 14
days after the end of the semimonthly pe-
riod. (The IRS believes it would be ap-
propriate to retain the alternative method
allowing communications and air trans-
portation tax collectors to file returns and
make deposits based on amounts billed or
tickets sold.)
2. Whether a taxpayer should have to
deposit at least 95 percent of tax liability in-
curred for the corresponding semimonthly
period (in lieu of the current requirement of
100 percent with safe harbor rules).
3. Whether the amount required to be
deposited for a quarter should be com-
puted without reduction for the amounts
of any claims made on Schedule C of
Form 720 for that quarter.
Judith C. Dunn,
Associate Chief
Counsel (Domestic).
(Filed by the Office of the Federal Register on Janu-
ary 6, 2000, 8:45 a.m. , and published in the issue of
the Federal Register for January 7, 2000, 65 F.R.
1076)
Adequate Disclosure of Gifts;
Correction
Announcement 2000–6
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Correction to final regulations.
SUMMARY: This document contains
corrections to final regulations (T.D.
8845, 1999–51 I.R.B. 684) which were
published in the Federal Registeron Fri-
day, December 3, 1999, 64 FR 67767, re-
lating to the valuation of priorgifts in de-
termining estate and gift tax liability, and
the period of limitations for assessing
andcollecting gift tax.
DATES: This correction is effective De-
cember 3, 1999.
FOR FURTHER INFORMATION CON-
TACT: William L. Blodgett, (202) 622-
3090, (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
The final regulations that are subject to
these corrections are under section 6501
of the Internal Revenue Code.
Need for Correction
As published, final regulations (TD
8845) contain errors that may prove to be
misleadingand are in need of clarification.
Correction of Publication
Accordingly, the publication of the
final regulations (TD 8845), which were
the subject of FR Doc. 99–30944, is cor-
rected as follows:
§301.6501(c)–1 [Corrected]
1. On page 67772, column 3,
§301.6501(c)–1(f)(5), line 9 from the top of
the column, thelanguage “transfer will not
be subject to inclusion” is corrected to read
“transfer will be subject to inclusion”.
2. On page 67772, column 3,
§301.6501(c)–1(f)(5), line 11 from the
top of the column, the language “pur-
poses. On the other hand, if the” is cor-
rected to read “purposes only to the extent
that a completed gift would be so in-
cluded. On the other hand, if the”.
Cynthia E. Grigsby,
Chief, Regulations Unit
Assistant Chief Counsel (Corporate).
(Filed by the Office of the Federal Regis-
ter on January 6, 2000, 8:45 a.m., and
published in the issue of the Federal Reg-
ister for January 7, 2000, 65 F.R. 1059)
January 24, 20004282000–4 I.R.B.
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2000–4 I.R.B.iJanuary 24, 2000
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to A but not
to B, and the new ruling holds that it ap-
plies to both A and B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. A ruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms
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January 24, 2000ii2000–4 I.R.B.
Numerical Finding List
1
Bulletins 2000–1 through 2000–3
Announcements:
2000–1, 2000–2 I.R.B. 294
2000–2, 2000–2 I.R.B. 295
2000–3, 2000–2 I.R.B. 296
2000–4, 2000–3 I.R.B. 317
Notices:
2000–1, 2000–2 I.R.B. 288
2000–4, 2000–3 I.R.B. 313
2000–5, 2000–3 I.R.B. 314
2000–6, 2000–3 I.R.B. 315
Proposed Regulations:
REG–101492–98, 2000–3 I.R.B. 326
REG–106012–98, 2000–2 I.R.B. 290
REG–116704–99, 2000–3 I.R.B. 325
Revenue Procedures:
2000–1, 2000–1 I.R.B. 4
2000–2, 2000–1 I.R.B. 73
2000–3, 2000–1 I.R.B. 103
2000–4, 2000–1 I.R.B. 115
2000–5, 2000–1 I.R.B. 158
2000–6, 2000–1 I.R.B. 187
2000–7, 2000–1 I.R.B. 227
2000–8, 2000–1 I.R.B. 230
2000–9, 2000–2 I.R.B. 280
2000–10, 2000–2 I.R.B. 287
2000–11, 2000–3 I.R.B. 309
Revenue Rulings:
2000–1, 2000–2 I.R.B. 250
2000–2, 2000–3 I.R.B. 305
2000–3, 2000–3 I.R.B. 297
Treasury Decisions:
8849, 2000–2 I.R.B. 245
8850, 2000–2 I.R.B. 265
8851, 2000–2 I.R.B. 275
8852, 2000–2 I.R.B.253
8854, 2000–3 I.R.B.306
8856, 2000–3 I.R.B.298
1
A cumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1999–27 through
1999–52 is in Internal Revenue Bulletin 2000–1,
dated January 3, 2000.
IRB 2000-4 1/28/00 10:26 AM Page 430

2000–4 I.R.B.iiiJanuary 24, 2000
Finding List of Current Action on
Previously Published Items
1
Bulletins 2000–1 through 2000–3
Notices:
97–19
Modified by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
Revenue Procedures:
92–13
Modified, amplified, and superseded by
Rev. Proc. 2000–11, 2000–3 I.R.B. 309
92–13A
Modified, amplified, and superseded by
Rev. Proc. 2000–11, 2000–3 I.R.B. 309
94–12
Modified, amplified, and superseded by
Rev. Proc. 2000–11, 2000–3 I.R.B. 309
96–13
Modified by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
98–64
Superseded by
Rev. Proc. 2000–9, 2000–2 I.R.B. 280
99–1
Superseded by
Rev. Proc. 2000–1, 2000–1 I.R.B. 4
99–2
Superseded by
Rev. Proc. 2000–2, 2000–1 I.R.B. 73
99–3
Superseded by
Rev. Proc. 2000–3, 2000–1 I.R.B. 103
99–4
Superseded by
Rev. Proc. 2000–4, 2000–1 I.R.B. 115
99–5
Superseded by
Rev. Proc. 2000–5, 2000–1 I.R.B. 158
99–6
Superseded by
Rev. Proc. 2000–6, 2000–1 I.R.B. 187
99–7
Superseded by
Rev. Proc. 2000–7, 2000–1 I.R.B. 227
99–8
Superseded by
Rev. Proc. 2000–8, 2000–1 I.R.B. 230
99–49
Modified and amplified by
Notice 2000–4, 2000–3 I.R.B. 313
99–51
Superseded by
Rev. Proc. 2000–3, 2000–1 I.R.B. 103
Treasury Decisions:
8734
Modified by
T.D. 8856, 2000–3, I.R.B. 298
8804
Modified by
T.D. 8856, 2000–3, I.R.B. 298
1
A cumulative list of previously published items in
Internal Revenue Bulletins 1999–27 through
1999–52 is in Internal Revenue Bulletin 2000–1,
dated January 3, 2000.
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INTERNAL REVENUE BULLETIN
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IRB 2000-4 1/28/00 10:27 AM Page 434