Internal Revenue Bulletin 2017-9 (PDF rendition): IRS Revenue Rulings

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.

# INTERNAL REVENUE BULLETIN

IRS

## HIGHLIGHTS OF THIS ISSUE

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

## INCOME TAX

### REG-135122-16, page 1005.

This document contains proposed regulations relating to cer-
tain financial products providing for payments that are contin-
gent upon or determined by reference to U.S. source dividend
payments.

### Notice 2017-19, page 1000.

Resident populations of the 50 states, the District of Columbia,
Puerto Rico, and the insular areas for purposes of determining
the 2017 calendar year (1) state housing credit ceiling under
section 42(h) of the Code, (2) private activity bond volume cap
under section 146, and (3) private activity bond volume limit
under section 142(k) are reproduced.

### T.D. 9815, page 944.

This document provides guidance to nonresident alien individ-
uals and foreign corporations that hold certain financial prod-
ucts providing for payments that are contingent upon or deter-
mined by reference to U.S. source dividend payments. This
document also provides guidance to withholding agents that
are responsible for withholding U.S. tax with respect to a
dividend equivalent, as well as certain other parties to section
871(m) transactions and their agents.

Bulletin No. 2017-9
February 27, 2017

### T.D. 9817, page 968.

These final regulations under section 7704(d)(1)(E) of the In-
ternal Revenue Code relate to the qualifying income exception
for publicly traded partnerships to not be treated as corpora-
tions for Federal income tax purposes. Specifically, these reg-
ulations define the activities that generate qualifying income
from exploration, development, mining or production, process-
ing, refining, transportation, and marketing of minerals or nat-
ural resources.

## EMPLOYEE PLANS

### Rev. Rul. 2017-05, page 1000.

This revenue ruling provides tables of covered compensation
under § 401(l)(5)(E) of the Internal Revenue Code and the
Income Tax Regulations thereunder, effective January 1, 2017.

### Notice 2017-18, page 997.

This notice sets forth updates on the corporate bond monthly
yield curve, the corresponding spot segment rates for February
2017 used under § 417(e)(3)(D), the 24-month average segment
rates applicable for February 2017, and the 30-year Treasury
rates. These rates reflect the application of § 430(h)(2)(C)(iv),
which was added by the Moving Ahead for Progress in the 21st
Century Act, Public Law 112-141 (MAP-21) and amended by
section 2003 of the Highway and Transportation Funding Act of
2014 (HATFA).

<!-- PageFooter="Finding Lists begin on page ii." -->
<!-- PageBreak -->

## The IRS Mission

Provide America's taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force the law with integrity and fairness to all.

## Introduction

The Internal Revenue Bulletin is the authoritative instrument of
the Commissioner of Internal Revenue for announcing official
rulings and procedures of the Internal Revenue Service and for
publishing Treasury Decisions, Executive Orders, Tax Conven-
tions, legislation, court decisions, and other items of general
interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all
substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of internal
management are not published; however, statements of inter-
nal 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, identify-
ing details and information of a confidential nature are deleted
to prevent unwarranted invasions of privacy and to comply with
statutory requirements.

Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

### Part I .- 1986 Code.

This part includes rulings and decisions based on provisions of
the Internal Revenue Code of 1986.

### Part II .- Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A, Tax
Conventions and Other Related Items, and Subpart B, Legisla-
tion and Related Committee Reports.

Part III .- Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury's Office of the Assistant Sec-
retary (Enforcement).

### Part IV .- Items of General Interest.

This part includes notices of proposed rulemakings, disbar-
ment and suspension lists, and announcements.

The last 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 last Bulletin of each semiannual period.

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.

<!-- PageFooter="February 27, 2017" -->
<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

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

26 CFR 1.871-15; 26 CFR 1.871-15T; 26 CFR
1.1441-1; 26 CFR 1.1441-1T; 26 CFR 1.1441-2; 26
CFR 1.1441-7; 26 CFR 1.1461-1

### T.D. 9815

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

### Dividend Equivalents from Sources within the United States

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Final regulations and tempo-
rary regulations.

SUMMARY: This document provides
guidance to nonresident alien individuals
and foreign corporations that hold certain
financial products providing for payments
that are contingent upon or determined by
reference to U.S. source dividend pay-
ments. This document also provides guid-
ance to withholding agents that are re-
sponsible for withholding U.S. tax with
respect to a dividend equivalent, as well as
certain other parties to section 871(m)
transactions and their agents.

DATES: Effective Date: These regula-
tions are effective on January 19, 2017.

Applicability Dates: For dates of ap-
plicability, see §§ 1.871-15(r); 1.871-
15T(r)(4); 1.1441-1(f)(5); 1.1441-2(f);
1.1441-7(a)(4); 1.1461-1(i).

FOR FURTHER INFORMATION CON-
TACT: D. Peter Merkel or Karen Walny at
(202) 317-6938 (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
numbers 1545-0096 and 1545-1597. The

collections of information in these regula-
tions are in § 1.871-15T(p) and are an
increase in the total annual burden in the
current regulations under §§ 1.1441-1
through 1.1441-9. This information is re-
quired to establish whether a payment is
treated as a U.S. source dividend for pur-
poses of section 871(m) of the Internal
Revenue Code (Code). This information
will be used for audit and examination
purposes. The IRS intends that these in-
formation collection requirements will be
satisfied by persons complying with chap-
ter 3 reporting requirements and the re-
quirements of the applicable qualified in-
termediary (QI) revenue procedure, or
alternative certification and documenta-
tion requirements set out in these regula-
tions. An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control number.

Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mate-
rial in the administration of any internal
revenue law. Generally, tax returns and
return information are confidential, as re-
quired by 26 U.S.C. 6103.

#### Background

On January 23, 2012, the Federal Reg-
ister published temporary regulations (TD
9572) at 77 FR 3108 (2012 temporary
regulations), and a notice of proposed
rulemaking by cross-reference to the
temporary regulations and notice of
public hearing at 77 FR 3202 (2012
proposed regulations, and together with
the 2012 temporary regulations, 2012 sec-
tion 871(m) regulations) under section
871(m) of the Code. The 2012 section
871(m) regulations relate to dividend
equivalents from sources within the
United States paid to nonresident alien
individuals and foreign corporations. Cor-
rections to the 2012 temporary regulations
were published on February 6, 2012, and
March 8, 2012, in the Federal Register at
77 FR 5700 and 77 FR 13969, respec-
tively. A correcting amendment to the
2012 temporary regulations was also pub-
lished on August 31, 2012, in the Federal

Register at 77 FR 53141. The Department
of the Treasury (Treasury Department)
and the IRS received written comments on
the 2012 proposed regulations, and a pub-
lic hearing was held on April 27, 2012.

On December 5, 2013, the Federal
Register published final regulations and
removal of temporary regulations (TD
9648) at 78 FR 73079 (2013 final regula-
tions), which finalized a portion of the
2012 section 871(m) regulations. On the
same date, the Federal Register pub-
lished a withdrawal of notice of proposed
rulemaking, a notice of proposed rulemak-
ing, and a notice of public hearing at 78
FR 73128 (2013 proposed regulations). In
light of comments on the 2012 proposed
regulations, the 2013 proposed regula-
tions described a new approach for deter-
mining whether a payment made pursuant
to a notional principal contract (NPC) or
an equity-linked instrument (ELI) is a div-
idend equivalent based on the delta of the
contract. In response to written comments
on the 2013 proposed regulations, the
Treasury Department and the IRS re-
leased Notice 2014-14, 2014-13 IRB
881, on March 24, 2014 (see § 601.601(d)
(2)(ii)(b)), stating that the Treasury De-
partment and the IRS anticipated limiting
the application of the rules with respect to
specified ELIs described in the 2013 pro-
posed regulations to ELIs issued on or
after 90 days after the date of publication
of final regulations.

On September 18, 2015, the Federal
Register published final regulations and
temporary regulations (TD 9734), at 80
FR 56866, which finalized a portion of the
2013 proposed regulations and introduced
new temporary regulations based on com-
ments received with respect to the 2013
proposed regulations (2015 final regula-
tions and 2015 temporary regulations, re-
spectively, and together, the 2015 regula-
tions). On the same date, the Federal
Register published a notice of proposed
rulemaking by cross-reference to tempo-
rary regulations and a notice of public
hearing at 80 FR 56415 (2015 proposed
regulations, and together with the 2015
final regulations, 2015 section 871(m)
regulations). A correcting amendment to

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

the 2015 final regulations and the 2015
proposed regulations was published on
December 7, 2015, in the Federal Regis-
ter at 80 FR 75946 and 80 FR 75956,
respectively.

The Treasury Department and the IRS
received written comments on the 2015
proposed regulations, which are available
at www.regulations.gov. The public hear-
ing scheduled for January 15, 2016, was
cancelled because no request to speak was
received.

On July 1, 2016, the Treasury Depart-
ment and the IRS released Notice 2016-
42, 2016-29 IRB 67 (see § 601.601
(d)(2)(ii)(b)) (QI Notice), containing a
proposed amended qualified intermediary
agreement. The QI Notice included the
requirements and obligations applicable to
a QI that acts as a qualified derivatives
dealer (QDD). The Treasury Department
and the IRS received written comments on
Notice 2016-42, which to the extent re-
lated to section 871(m) and QDDs are
discussed in the "Qualified Derivatives
Dealer" section of this preamble. On De-
cember 30, 2016, the Treasury Depart-
ment and the IRS released Revenue Pro-
cedure 2017-15, 2017-3 IRB 437 (2017
QI Agreement), which contains the final
QI withholding agreement and the re-
quirements and obligations applicable to
QDDs.

On December 2, 2016, the Treasury
Department and the IRS released Notice
2016-76, 2016-51 IRB 834, providing
guidance for complying with the final and
temporary regulations under sections
871(m) and 1441, 1461, and 1473 in 2017
and 2018 and explaining how the IRS
intends to administer those regulations in
2017 and 2018.

On March 6, 2014, temporary regula-
tions (TD 9658) revising certain provi-
sions of the final chapters 3 and 61 regu-
lations were published in the Federal
Register (79 FR 12726), and corrections
to those temporary regulations were pub-
lished in the Federal Register (79 FR
37181) on July 1, 2014. Those regulations
were issued to coordinate with certain
provisions of the 2013 final chapter 4 reg-
ulations, as well as temporary regulations
(TD 9657) under chapter 4 published in
the Federal Register (79 FR 12812). A
notice of proposed rulemaking cross-
referencing the 2014 temporary coordina-

tion regulations was published in the Fed-
eral Register on March 6, 2014 (79 FR
12880). On January 6, 2017, the Treasury
Department and IRS published in the Fed-
eral Register (82 FR 2046) final chapters
3 and 61 regulations, as well as temporary
regulations (TD 9808).

This Treasury decision generally adopts
the 2015 proposed regulations with the
changes discussed in this preamble. This
Treasury decision also includes several
technical amendments to the 2015 final reg-
ulations in response to comments on those
regulations, which are discussed in this pre-
amble. Finally, this Treasury decision pro-
vides new temporary regulations based on
comments received with respect to the 2015
proposed regulations.

#### Summary of Comments and Explanation of Provisions

##### I. Technical corrections to certain definitions

###### A. Broker

Section 1.871-15(p) generally pro-
vides that a broker or dealer is responsible
for determining whether a potential sec-
tion 871(m) transaction is a section
871(m) transaction and for reporting to
the customer the timing and amount of
any dividend equivalent. Section 1.871-
15(a)(1) defines the term broker as "a bro-
ker within the meaning provided in sec-
tion 6045(c)." Comments explained that
many regulated investment companies
satisfy the definition of a broker under
section 6045(c) and the regulations there-
under because the term broker includes a
corporation that regularly redeems its own
shares. The comments noted that these
regulated investment companies may en-
ter into transactions as a short party with a
foreign financial institution who is the
long party. In these transactions, the com-
ments asserted, the foreign financial insti-
tution (not the regulated investment com-
pany) is more capable of determining
delta and making other calculations.

The Treasury Department and the IRS
agree that an entity should not be treated
as a broker for purposes of section 871(m)
solely because it redeems its own shares.
The rules are intended to assign responsi-
bility for making the determinations re-
lated to potential section 871(m) transac-

tions to the party that regularly enters into
equity derivatives with customers or holds
equity derivatives on behalf of customers.
When a regulated investment company is
the short party in a transaction with a
financial institution, the Treasury Depart-
ment and the IRS agree that the financial
institution is in the better position to de-
termine delta and make other determina-
tions required by section 871(m). Accord-
ingly, the definition of the term broker has
been revised in the temporary regulations
so that it will not apply to a corporation
that would be treated as a broker pursuant
to section 6045(c) solely because it regu-
larly redeems its own shares.

###### B. Dividend equivalents

Section 1.871-15(c) provides that, sub-
ject to certain exceptions, a dividend
equivalent includes any payment that ref-
erences the payment of a dividend from an
underlying security pursuant to a securi-
ties lending or sale-repurchase transac-
tion, specified NPC, or specified ELI. A
dividend is defined in § 1.871-15(a)(3) as
"a dividend as described in section 316."
Section 1.871-15(c)(2)(ii) reduces a divi-
dend equivalent by any amount treated in
accordance with sections 305(b) and (c) as a
dividend (a "section 305(c) dividend") with
respect to the underlying security referenced
by the section 871(m) transaction.

A comment suggested that the regula-
tions clarify how this rule applies when a
derivative references an underlying secu-
rity that has a section 305(c) dividend.
Another comment noted that § 1.871-
15(c)(2)(ii) reduces the dividend equiva-
lent amount by section 305(c) dividends,
and that this reduction arguably applies
both to the person who holds the underly-
ing security giving rise to the section
305(c) dividend and to a holder of a sec-
tion 871(m) transaction that references the
underlying security that gives rise to the
section 305(c) dividend.

To address these comments, these final
regulations revise the definition of a divi-
dend to explicitly provide that it applies
without regard to whether there is an actual
distribution of cash or property. A conform-
ing change is also made to § 1.871-
15(c)(2)(ii), which is revised to clarify that
only a long party that is treated as receiving
a section 305(c) dividend is entitled to re-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

duce its dividend equivalent amount and
that a section 305(c) dividend gives rise to a
dividend equivalent.

Thus, for example, a long party that
owns a convertible note that is a section
871(m) transaction and has a section
305(c) dividend can reduce its dividend
equivalent by the section 305(c) dividend.
In contrast, a long party that owns a spec-
ified NPC that references the same con-
vertible note would receive a dividend
equivalent that includes the section 305(c)
dividend and would not be entitled to re-
duce its dividend equivalent by the section
305(c) dividend on the convertible note
because the long party does not own the
note, and therefore, is not treated as re-
ceiving a section 305(c) dividend for fed-
eral income tax purposes.

###### C. Simple Contract

To be a simple contract as defined in
§ 1.871-15(a)(14)(i), the number of
shares required to calculate the amounts
paid or received on any payment determi-
nation date must be ascertainable at the
time the delta for the transaction is calcu-
lated. Several comments noted that trans-
actions may provide for anti-dilution ad-
justments to the number of shares as a
result of certain corporate actions, and that
these adjustments could cause contracts
that otherwise would be simple contracts
subject to the delta test to become com-
plex contracts subject to the more compli-
cated substantial equivalence test. Adjust-
ments that are intended to maintain the
status quo of shareholders generally
should not preclude a transaction from
being treated as a simple contract. Ac-
cordingly, a sentence is added to § 1.871-
15(a)(14)(i) to provide that an adjustment
to the number of shares of the underlying
security for a merger, stock split, cash
dividend, or similar corporate action that
impacts all the holders of the underlying
security will not prevent the transaction
from being a simple contract.

###### II. Certain Insurance Contracts

The exceptions for payments made
pursuant to annuity, endowment, and life
insurance contracts were issued as a tempo-
rary rule in § 1.871-15T(c)(2)(iv) of the
2015 temporary regulations. Comments

generally agreed with the result in § 1.871-
15T(c)(2)(iv)(A) with respect to insurance
contracts issued by domestic insurance
companies. Several comments requested
that § 1.871-15T(c)(2)(iv)(A) be issued as a
final regulation without any change. These
comments noted that any U.S. source divi-
dend that a foreign insurer receives on U.S.
stock it owns with respect to an annuity,
endowment, or life insurance contract is al-
ready subject to withholding tax.

Another comment recommended changes
to make the exception for insurance issued
by a foreign company more administrable.
That comment suggested that the regula-
tions be extended to any foreign insurance
company, without regard to whether the
company is predominantly engaged in the
business of insurance and would be sub-
ject to tax under subchapter L. This com-
ment also recommended that the regula-
tions define the terms "annuity contract,"
"insurance contract," "life insurance con-
tract," "endowment contract," and "for-
eign insurance company" based on regu-
lations under section 1471. Finally, the
comment noted that the requirement that a
company be "predominantly engaged in
an insurance business" is unnecessary in
light of the requirement that a corporation
"would be subject to tax under subchapter
L if it were a domestic corporation" be-
cause a corporation that would be "subject
to tax under subchapter L if it were a
domestic corporation" necessarily would
be "predominantly engaged in an insur-
ance business."

Comments also recommended that the
temporary rule relating to reinsurance
should be finalized. Another comment
noted that reinsurance subject to the U.S.
federal excise tax under section 4371 is
not subject to withholding and expressed
concern about the interaction of the excise
tax and the application of section 871(m)
if the reinsurance exception in the tempo-
rary regulations was allowed to expire.

These regulations finalize § 1.871-
15T(c)(2)(iv) with one change. The Trea-
sury Department and the IRS agree that
a company that is taxable under sub-
chapter L as an insurance company is
necessarily predominantly engaged in
an insurance business. Accordingly, in
finalizing § 1.871-15T(c)(2)(iv)(B), the
redundant phrase "predominantly en-
gaged in an insurance business " is re-

moved. Although comments suggested
other modifications to certain terms and
the addition of certain defined terms,
these final regulations do not make these
additional changes. The Treasury De-
partment and the IRS have determined
that the scope of entities and contracts
described in the temporary regulations
as eligible for the exception is appropri-
ate for section 871(m), and that it is
beyond the scope of these regulations to
define terms relating to insurance.

###### III. Determining delta and the initial hedge

Section 1.871-15(g)(2) provides that
the delta of a potential section 871(m)
transaction is determined only when the
contract is issued. For this purpose, an
NPC or ELI is issued at the time of the
contract's inception, original issuance, or
issuance as a result of a deemed exchange
pursuant to section 1001. See § 1.871-
15(a)(6). The same standard is used to
determine when a contract is issued for
purposes of the substantial equivalence
test for complex contracts.

For simple contracts, comments gener-
ally suggested changing the time for cal-
culating delta to the earlier of the trade
date or the date on which the parties
agreed to the material terms or final pric-
ing for the contract. One comment recom-
mended that the date and time when the
material terms are finalized is the appro-
priate date for determining delta because
that is the time when the economic terms
of the potential section 871(m) transac-
tions are established. Finally, the parties
to the contract are generally bound by the
terms on the pricing date, not the settle-
ment date. A comment suggested using
the trade date if the pricing date is more
than 14 days before the issue date because
providing too long a period between the
pricing and issue date may present an op-
portunity for abuse.

For listed options, comments suggested
a different method for determining the
delta of the contract. These comments rec-
ommend that the delta for listed options
should be based on the closing price from
the prior trading day. The comments ac-
knowledged that this approach would be
less accurate than the requirement in the
final regulations; however, these com-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

ments asserted that using the delta calcu-
lation from the prior day for listed options
would substantially reduce the burden on
taxpayers and make the rules more admin-
istrable. Comments also noted that the
Options Clearing Corporation currently
calculates the end-of-day delta for options
listed on U.S. options exchanges.

For complex contracts, comments rec-
ommended that the substantial equiva-
lence test should be conducted on the date
when the short party's hedge is estab-
lished. According to the comments, the
issuer of a complex contract enters into a
hedge on the pricing date, not the settle-
ment date. The pricing date therefore re-
flects the economics of a complex contract
more accurately than the settlement date,
as long as the two dates are not separated
by too much time.

The Treasury Department and the IRS
agree with the comments that the date for
determining delta and for performing the
substantial equivalence test should be re-
vised to be more administrable and to
reflect more accurately the economics of
the transactions. Accordingly, these regu-
lations provide that the delta of a simple
contract is determined on the earlier of the
date that the potential section 871(m)
transaction is priced and the date when the
potential section 871(m) transaction is is-
sued; however, the issue date must be
used to determine the delta if the potential
section 871(m) transaction is priced more
than 14 calendar days before it is issued.
A similar rule also applies to the substan-
tial equivalence test.

In addition, the regulations provide a
new rule for determining the delta of an
option listed on a regulated exchange. For
these options, the delta is determined
based on the delta of the option at the
close of business on the business day be-
fore the date of issuance. For this purpose,
the regulations define a regulated ex-
change. A regulated exchange is any ex-
change defined in § 1.871-15(1)(3)(vii) or
a foreign exchange that (A) is regulated
by a government agency in the jurisdic-
tion in which the exchange is located, (B)
maintains certain requirements designed
to protect investors and to prevent fraud
and manipulation, (C) maintains rules to
promote active trading of listed options,
and (D) had trades for which the notional

value exceeded $10 billion per day during
the prior calendar year.

The 2015 final regulations provided a
simplified delta calculation for certain
simple contracts that reference 10 or more
underlying securities, provided that the
short party uses an exchange-traded secu-
rity that references substantially all the
underlying securities to hedge the NPC or
ELI at the time it is issued (the "hedge
security"). The simplified delta calcula-
tion allows the short party to calculate the
delta of the NPC or ELI by reference to
changes in the value of the hedge security.
Comments suggested that this rule be ex-
tended to cases in which the short party
could fully hedge its position by acquiring
the exchange-traded security even if it
does not in fact hedge in this manner.
Because the exchange-traded security
must provide a full hedge of the NPC or
ELI for this rule to apply, the Treasury
Department and the IRS agree that the
exchange-traded security will provide an
acceptable delta calculation whether or
not the short party actually uses that se-
curity as its hedge. Accordingly, the reg-
ulations are amended to permit the delta
with respect to those NPCs and ELIs to be
calculated by determining the ratio of the
change in the fair market value of the simple
contract to a small change in the fair market
value of an exchanged-traded security when
the exchange-traded security would fully
hedge the NPC or ELI.

Some comments noted that third-party
data, including delta calculations, may be
available for certain potential section 871(m)
transactions. These comments requested
that the final regulations be amended to
explicitly permit withholding agents to
rely on this data. Although the final regu-
lations are not amended, the Treasury De-
partment and the IRS note that nothing in
the regulations prohibits a taxpayer from
obtaining information from a third party.
While taxpayers and withholding agents can
use third party data to determine whether a
potential section 871(m) transaction is a sec-
tion 871(m) transaction, taxpayers and with-
holding agents that rely on third-party data
remain responsible for the accuracy of that
information.

One comment noted that the issuer of a
structured note (or an affiliate of the is-
suer) may act as a market maker for the
structured note, and thus may purchase the

note in its dealer capacity and then sell the
note to the market. According to the com-
ment, if the purchase is treated as a re-
demption by the issuer of the instrument
for tax purposes, the subsequent sale to
the market would be treated as a new issue
for section 871(m) purposes, in which
case the delta for the instrument (or sub-
stantial equivalence test) would need to be
recomputed at such time. The comment
suggested that rules similar to those in
section 108 with respect to the purchase of
debt instruments by an issuer acting in a
dealer capacity could apply to equity de-
rivative structured notes. The Treasury
Department and the IRS acknowledge the
concern raised by the comment. However,
the Treasury Department and the IRS are
concerned that an overly broad exception
for dealer activity may facilitate transac-
tions that are inconsistent with section
871(m) by allowing dealers to offer instru-
ments that would be subject to section
871(m) so long as the instruments were
originally issued with a delta below 0.80.
While a dealer that issued such an instru-
ment holds the instrument in inventory, the
dealer does not need to hedge the position
with an unrelated party. For this reason,
market making activity by the issuer of an
instrument (or an affiliate of the issuer) pres-
ents different policy concerns from market
making by an unrelated dealer. The Trea-
sury Department and the IRS invite further
comments on the appropriate treatment of
structured notes and similar instruments that
are acquired by the issuer or an affiliate in its
dealer capacity.

###### IV. Substantial Equivalence Test

Comments to the 2013 proposed regu-
lations generally agreed that the delta test
was fair and practical for the majority of
equity-linked derivatives. However, com-
ments explained that the delta test would
be impractical or impossible to apply to
more exotic equity derivatives, such as
structured notes in which the long party's
return was determined based on an ini-
tially indeterminate number of shares of
the underlying security. The 2015 section
871(m) regulations address this concern
by providing an alternative test-the
"substantial equivalence test"-for con-
tracts with indeterminate deltas. For pur-
poses of applying this test, the regulations

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

distinguish between simple and complex
contracts. Generally, a simple contract is a
contract that references a single, fixed
number of shares and has a single matu-
rity or exercise date. A complex contract
is any contract that is not a simple con-
tract. Contracts with indeterminate deltas
are classified as complex contracts and are
subject to the substantial equivalence test.

Generally, the substantial equivalence
test measures the change in value of a
complex contract when the price of the
underlying security referenced by that
contract is hypothetically increased by
one standard deviation or decreased by
one standard deviation (each, a "testing
price") and compares that change to the
change in value of the shares of the un-
derlying security that would be held to
hedge the complex contract when the con-
tract is issued (the "initial hedge") at each
testing price. The smaller the proportion-
ate difference between the change in value
of the complex contract and the change in
value of its initial hedge at multiple test-
ing prices, the more equivalence there is
between the contract and the referenced
underlying security. When this difference
is equal to or less than the difference for a
simple contract benchmark with a delta of
0.80 and its initial hedge, the complex
contract is treated as substantially equiva-
lent to the underlying security. When the
steps of the substantial equivalence test can-
not be applied to a particular complex con-
tract, a taxpayer must use the principles of
the substantial equivalence test to reason-
ably determine whether the complex con-
tract is a section 871(m) transaction with
respect to each underlying security.

The Treasury Department and the IRS
requested comments regarding the sub-
stantial equivalence test. In particular,
comments were requested on whether two
testing points were adequate to ensure that
the test would capture appropriate trans-
actions and on the administrability of the
test. Comments also were requested on
the application of the test to complex
contracts that reference multiple securi-
ties, including path-dependent instru-
ments (that is, an instrument for which the
final value depends, in whole or in part, on
the price sequence (or path) of the under-
lying security before the maturity of the
instrument). Comments generally did not
recommend material changes to the test.

As a result, these final regulations adopt the
substantial equivalence test as proposed in
the 2015 proposed regulations with minor
changes as described in this section.

One comment noted that the substan-
tial equivalence test might be unduly bur-
densome in certain cases, such as when it
is obvious that a particular instrument
would satisfy the test and application of
the test would have no effect on the
amount of withholding. This comment
suggested that an issuer of a complex con-
tract be allowed to use an alternative test
to determine the withholding tax imposed
with respect to a dividend equivalent as
long as the alternative test resulted in the
same amount of withholding tax as would
have been the case if the issuer had used
the substantial equivalence test. These fi-
nal regulations do not adopt this comment.
Even in those cases where the result for a
potential section 871(m) transaction is in-
tuitive, administration of such an alterna-
tive approach would generally require ap-
plying the substantial equivalence test to
demonstrate that the alternative test re-
sults in the same amount of withholding
tax as the substantial equivalence test. As
issuers of complex contracts become pro-
ficient with the substantial equivalence
test it is expected that it will be relatively
straightforward to determine whether a
particular instrument is subject to with-
holding under section 871(m).

Another comment suggested that the
Treasury Department and the IRS con-
sider whether the substantial equivalence
test could be manipulated to allow taxpay-
ers to understate the similarity of a com-
plex contract to the underlying security.
This comment suggested that more guid-
ance should be offered about the criteria
for determining whether a simple contract
is "closely comparable" to a complex con-
tract for purposes of choosing a simple
contract benchmark. The same comment
recommended that the regulations specify
that the benchmark contract could be a
hypothetical instrument, and that the ma-
terial terms, including the treatment of
dividends, should be consistent with the
terms of the complex contract (aside from
the terms that make the contract complex
and that make the delta of the closely
comparable benchmark 0.8).

In response to this comment, the final
regulations provide that the simple con-

tract benchmark may be an actual or hy-
pothetical simple contract that, at the time
the substantial equivalence test is applied
to the complex contract, has a delta of 0.8,
references the applicable underlying secu-
rity referenced by the complex contract,
and has terms that are consistent with all
the material terms of the complex con-
tract, including the maturity date. In addi-
tion, to further ensure comparability be-
tween the simple contract benchmark and
the complex contract, the final regulations
provide that the simple contract bench-
mark must consistently apply reasonable
inputs, including a reasonable time period
for the contract. For example, the reason-
able time period for the contract must be
consistently applied in determining the
standard deviation and probability, as well
as the maturity date and any other terms
dependent on that time period.

##### V. Amount and Timing of a Taxpayer's Liability

Section 1.871-15(j) contains rules for
determining the amount of the dividend
equivalent. In addition, § 1.871-15(j) re-
quires that the amount of a dividend equiv-
alent be determined on the earlier of the
record date of the dividend and the day
before the ex-dividend date with respect to
the dividend. In many cases, the amount of
a dividend equivalent will be determined
before a withholding agent will be required
to withhold any tax pursuant to newly
redesignated § 1.1441-2(e)(7) (formerly
§ 1.1441-2(e)(8)). Comments requested that
a foreign holder's tax liability be deferred
until withholding is required, in order to
avoid the need for the foreign holder to file
a return and pay tax. The comments noted
that this approach would be consistent with
the general withholding regime under chap-
ter 3 of the Code. With respect to a section
871(m) transaction acquired by a foreign
investor after its initial issuance, a comment
requested clarification that the foreign in-
vestor is only liable for dividends deter-
mined on the underlying security during the
period that the foreign investor is the bene-
ficial owner of the section 871(m) transac-
tion.

These regulations include several new
provisions in response to these comments.
First, § 1.871-15(j)(4) is added to provide
that a long party generally is liable for tax

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

on a dividend equivalent in the year the
dividend equivalent payment is subject to
withholding pursuant to § 1.1441-2(e)(7),
or in the case of a QDD, when the payment
of the applicable dividend on the underlying
security is subject to withholding.

Second, the regulations are amended to
clarify that the amount of a dividend
equivalent subject to tax will not change
because the tax is withheld at a later date.
Section 1.871-15(j)(2) establishes the
time for determining the amount of a div-
idend equivalent; the amount of the long
party's tax liability should not change be-
cause the withholding agent does not
withhold at the time the tax liability arises.
Therefore, changes in facts (such as the tax
rate or whether the recipient is a qualified
resident of a country with which the U.S.
has an income tax treaty) between the time
that the amount of a dividend equivalent is
determined and the time that withholding
occurs, do not affect tax liability. For exam-
ple, if at the time for determining the divi-
dend equivalent amount, the long party
qualifies for a treaty, but in the year the
amount is withheld the long party does not,
the dividend equivalent would qualify for
treaty benefits.

Finally, § 1.871-15(j)(1) expressly
provides that the long party is only liable
for tax on dividend equivalents that arise
while the long party is a party to the
transaction. For example, if long party A,
a foreign person, enters into a section
871(m) transaction on an underlying stock
that pays quarterly dividends, and sells the
transaction to B, a foreign person, after
four dividends on the underlying stock
have been paid, A will be subject to tax on
those four dividend equivalents and B will
be subject to tax on subsequent dividend
equivalents as long as B holds the section
871(m) transaction. Alternatively, if A is a
U.S. person, B would still only be subject
to tax on the dividend equivalents after it
acquires the transaction.

##### VI. Qualified Index

Section 1.871-15(1) provides a safe
harbor for derivatives based on certain
qualified indices. Section 1.871-15(1)(1)
provides that the purpose of the exception
for qualified indices is to provide a safe
harbor for potential section 871(m) trans-
actions that reference certain passive indi-

ces, and that an index is not a qualified
index if treating the index as a qualified
index would be contrary to this purpose.
Section 1.871-15(1)(4) provides a specific
safe harbor for derivatives based on an
index in which the U.S. stock components
comprise, in the aggregate, 10 percent or
less of the weighting of all the component
securities in the index. A comment regard-
ing the 10 percent safe harbor indicated
that some taxpayers, notwithstanding
the purpose test for indices in § 1.871-
15(l)(1), may seek to use a customized
index to make tax-advantaged invest-
ments in specific U.S. stocks. Although
the index described by the comment may
not be a qualified index as a result of the
purpose rule in § 1.871-15(1)(1), the final
regulations are revised to clarify that, in
order to meet this 10 percent safe harbor,
an index must be widely traded and must
not be formed or availed of with a princi-
pal purpose of tax avoidance.

Comments to the qualified indices
rules in the 2015 final regulations also
requested that the Treasury Department
and the IRS address how the rules apply to
an index in the first year it is created.
Accordingly, these final regulations add
§ 1.871-15(1)(2)(ii) to provide that, for the
first year, an index is tested on the first
business day it is listed, and the dividend
yield calculation is determined using the
dividend yield that the index would have
had in the immediately preceding year if it
had the same components throughout that
year that it has on the day it is created.

##### VII. Combined transactions

For purposes of determining whether
transactions are section 871(m) transac-
tions, the 2015 final regulations treat two
or more transactions as a single transac-
tion when a long party (or a related per-
son) enters into multiple transactions that
reference the same underlying security,
the combined potential section 871(m)
transactions replicate the economics of
a transaction that would be a section
871(m) transaction, and the transactions
were entered into in connection with each
other. The 2015 final regulations also pro-
vide brokers acting as short parties with
two presumptions that may be applied to
determine whether to combine potential
section 871(m) transactions. First, a bro-

ker may presume that transactions are not
entered into in connection with each other
if the long party holds the transactions in
separate accounts. Second, a broker may
presume that transactions entered into two
or more business days apart are not en-
tered into in connection with each other. A
broker, however, cannot rely on the first
presumption if it has actual knowledge
that the long party created or used sepa-
rate accounts to avoid section 871(m). In
addition, neither presumption applies if
the broker has actual knowledge that
transactions were entered into in connec-
tion with each other. Section 1.1441-
1(b)(4)(xxiii) also permits withholding
agents to rely on these presumptions.

Comments suggested several changes to
the combined transaction rules. Comments
noted that it will be burdensome to identify
every contract that a customer entered into
with respect to the same underlying security
within two days of each other. To replace
the presumptions, comments recommended
that a withholding agent only be required to
combine contracts if the withholding agent
had actual knowledge that two contracts
were priced, marketed, or sold in connection
with each other.

The Treasury Department and the IRS
disagree that the priced, marketed, or sold
standard should replace the combination
presumptions. Comments noted a "not un-
common" example of an active foreign
investor who acquires or sells within a
two-day period hundreds of listed options
referencing the same underlying security.
The Treasury Department and the IRS,
however, intended to treat those transac-
tions as combined to the extent that the
potential section 871(m) transactions are
entered into in connection with each other
and satisfy the other requirements of
§ 1.871-15(n)(1). The priced, marketed,
or sold standard provides an inadequate
substitute for the combined transaction
test and the presumptions because inves-
tors can replicate a section 871(m) trans-
action by entering into multiple potential
section 871(m) transactions. For example,
an investor could replicate a delta one
transaction by entering into a put option
and a call option on the same underlying
security at the same time, with the same
strike price, whether or not the options are
priced, marketed, or sold together. For this
reason, the priced, marketed, or sold stan-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

dard provides an inadequate substitute for
the presumptions. The comments submit-
ted with respect to the combination rule
acknowledge short parties and withhold-
ing agents are aware that foreign investors
use multiple transactions in a manner that
are combined under the final regulations.
The "priced, marketed, or sold" standard
would undermine the enforcement of the
combination rules.

Notwithstanding the prior paragraph,
Notice 2016-76 provides a simplified
standard for withholding agents to deter-
mine whether transactions entered into in
2017 are combined transactions. A with-
holding agent will only be required to
combine transactions entered into in 2017
for purposes of determining whether the
transactions are section 871(m) transactions
when the transactions are over-the-counter
transactions that are priced, marketed, or
sold in connection with each other. With-
holding agents will not be required to com-
bine any transactions that are listed securi-
ties that are entered into in 2017.

Another comment noted that the final
regulations indicated that transactions
would only be combined into simple con-
tracts. This comment recommended that
the final regulation be amended if the
Treasury Department and the IRS dis-
agreed with this reading of the combina-
tion rule. The Treasury Department and
the IRS agree that transactions will only
be combined into simple transactions pur-
suant to § 1.871-15(n); therefore, the final
regulations are not amended.

Other comments suggested some clar-
ifications to the combination rules to re-
solve ambiguities. For example, com-
ments requested, among other things, that
(1) ordering rules provide that a contract
cannot be combined more than once and
(2) no combination transaction should
have a delta of more than one. The final
regulations are not amended to address
these issues because the final regulations
are intended to provide a general frame-
work for determining when two or more
transactions should be combined. The
comments received to date show that in-
dustry understanding of how the combi-
nation rules may be administered contin-
ues to develop as financial institutions
work to establish systems. As this under-
standing evolves, the Treasury Depart-
ment and the IRS may publish subse-

quent guidance to address the issues
raised by these comments. Until such
further guidance is issued, taxpayers
may adopt any reasonable methodology
to combine transactions within the gen-
eral framework of the final regulations.

##### VIII. Party Responsible for Determining Delta and Other Information

The 2015 final regulations provide that
when one of the parties to a potential
section 871(m) transaction is a broker or
dealer, that broker or dealer is responsible
for determining whether the transaction is
a section 871(m) transaction. When both
parties to a potential section 871(m) trans-
action are a broker or dealer or neither party
to a potential section 871(m) is a broker or
dealer, the short party to the transaction
must determine whether the transaction is a
section 871(m) transaction.

Comments noted that multiple parties
could be responsible for determining
whether a transaction is a section 871(m)
transaction because the definition of a
"party to the transaction" includes a long
party, a short party, any agent acting on
behalf of a long party or short party, and
any person acting as an intermediary with
respect to a potential section 871(m)
transaction. Comments noted that both a
short party and one or more agents of the
short party may be a broker or dealer; in this
case, the 2015 final regulations do not iden-
tify which of the responsible parties has the
primary obligation to determine whether the
transaction is a section 871(m) transaction.

Comments requested that the regula-
tions clarify which broker has the obliga-
tion to determine whether a listed option
is a section 871(m) transaction when mul-
tiple brokers or dealers are involved. One
comment recommended that the long par-
ty's broker that has custody of the trans-
action at the end of the day would be best
suited to act as the responsible party.
Comments also noted that the short party
or the agent of a short party may not have
the relevant information necessary to de-
termine when withholding should take
place. For example, when a long party has
sold an instrument in the secondary mar-
ket, the short party and its agent may not
have any knowledge of that sale. As a
result, the long party's broker should be
the responsible party.

Other comments indicated that the is-
suer should be the responsible party when
the issuer itself is a broker or a dealer, or
when the issuer has an affiliate that is a
broker or dealer. In these cases, the issuer
or its affiliate is likely to have the infor-
mation necessary to determine whether
the transaction is a section 871(m) trans-
action. As noted in other comments, an
intermediary to a transaction issued by a
broker or dealer, such as a clearinghouse,
will not have the information necessary
to determine whether a potential section
871(m) transaction is a section 871(m)
transaction, and is unlikely to know either
the time or the amount to withhold.

The Treasury Department and the IRS
agree that the final regulations may result
in multiple parties to a transaction quali-
fying as the party responsible for deter-
mining whether a potential section 871(m)
transaction is a section 871(m) transac-
tion. New temporary regulations resolve
this duplication of responsible parties un-
der § 1.871-15(p)(1) in the following cir-
cumstances: (1) both the short party and
an agent or intermediary of the short party
are a broker or a dealer; (2) the short party
is not a broker or dealer and more than
one of the agents or intermediaries of the
short party is a broker or dealer; (3) the
short party and its agents or intermediaries
are not brokers or dealers, and more than
one agent or intermediary acting on behalf
of the long party is a broker or dealer; and
(4) potential section 871(m) transactions
are traded on an exchange and cleared by
a clearing organization.

Specifically, § 1.871-15T(p)(1)(ii)
provides that the short party is the respon-
sible party when both the short party and
an agent or intermediary acting on behalf
of the short party are a broker or dealer. In
these circumstances, the Treasury Depart-
ment and the IRS have determined that the
short party should be the responsible party
because it will have access to the relevant
data regarding that transaction, whereas
an agent or intermediary may not have the
necessary information. As the responsible
party, the short party may contract with a
third party to make the determinations on
its behalf; however, the short party re-
mains responsible for the accuracy of any
calculations by the third party.

In addition, if the short party is not a
broker or dealer, but more than one agent

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

or intermediary acting on behalf of the
short party is a broker or dealer, § 1.871-
15T(p)(1)(ii) provides that the broker or
dealer closest to the short party in the
payment chain is the responsible party.
The Treasury Department and the IRS
have determined that the agent or interme-
diary closest in the chain to the short party
will have the best access to any informa-
tion the short party has that is necessary to
determine whether a potential section
871(m) transaction is a section 871(m)
transaction and to make other relevant de-
terminations.

Section 1.871-15T(p)(1)(ii) also gen-
erally provides that when one or more
agents or intermediaries acting on behalf
of the long party are brokers or dealers,
the agent or intermediary that is closest to
the long party in the payment chain is the
responsible party when neither the short
party nor any agent or intermediary acting
on behalf of the short party is a broker or
dealer. In this situation, the temporary reg-
ulations place the responsibility with the
agent or intermediary closest to the long
party because this agent or intermediary will
know whether or not the long party is sub-
ject to tax under section 871 or 881 and
when the long party has terminated or oth-
erwise disposed of the transaction.

Similarly, these temporary regulations
also provide a rule for determining the
responsible party when potential section
871(m) transactions are traded on an ex-
change and cleared by a clearing organi-
zation. When more than one broker or
dealer acts as an agent or intermediary
between the short party and a foreign in-
vestor on an exchange-traded contract, the
broker or dealer that has an ongoing cus-
tomer relationship with the foreign inves-
tor is the responsible party. Generally, this
intermediary will be the clearing firm.

Finally, these temporary regulations
provide that the issuer of a potential sec-
tion 871(m) transaction will be the re-
sponsible party for certain ELIs. Specifi-
cally, the issuer is the responsible party
for structured notes (including contingent
payment debt instruments), warrants, con-
vertible stocks, and convertible debt in-
struments. Because the issuer of these
ELIs ordinarily will have structured the
ELI, determined the pricing of the ELI,
and hedged the ELI, the issuer ordinarily
will be in the best position to act as the

responsible party. While the issuer of an
ELI may not be a broker or dealer, an
issuer of an ELI typically is advised by a
broker or dealer.

##### IX. Qualified Derivatives Dealer

Section 1.871-15T(q) permits a QDD
to reduce its liability under section 871 or
881 for a dividend or dividend equivalent
to the extent it makes an offsetting divi-
dend equivalent payment in its dealer ca-
pacity. Only an eligible entity that has
entered into a QI agreement can be a
QDD. An eligible entity is defined as: (1)
a dealer in securities subject to regulatory
supervision as a dealer, (2) a bank subject
to regulatory supervision as a bank, or (3)
a wholly-owned entity of a bank subject to
regulatory supervision as a bank when the
wholly-owned entity (a) issues potential
section 871(m) transactions to customers
and (b) receives dividends or dividend
equivalent payments from stock or poten-
tial section 871(m) transactions that hedge
the potential section 871(m) transactions
issued to customers. § 1.1441-1T(e)(6).
An entity is only a QDD when acting in its
QDD capacity.

##### A. Income Tax Treaties

In general, section 871(m) and the reg-
ulations thereunder apply to a dividend
equivalent payment without regard to
whether the payor of the dividend equiv-
alent payment is domestic or foreign. Sec-
tion 1.894-1(c)(2) provides that "[t]he
provisions of an income tax convention
relating to dividends paid to or derived by
a foreign person apply to the payment of a
dividend equivalent described in section
871(m) and the regulations thereunder."
Consistent with the foregoing, the 2017
QI Agreement provides that a QDD must
treat any dividend equivalent as a divi-
dend from sources within the United
States for purposes of section 881 and
chapters 3 and 4 consistent section 871(m)
and the regulations thereunder. The 2017
QI Agreement provides that a QDD may
reduce the rate of withholding under chap-
ter 3 based only on a beneficial owner's
claim that it is entitled to a reduced rate of
withholding for portfolio dividends under
the dividends article of an applicable in-
come tax treaty.

##### B. Eligible Entities

Comments requested that the Treasury
Department and the IRS expand the scope
of entities that qualify as an eligible entity
under § 1.1441-1(e), and therefore can act
as a QDD under a QI agreement. One
comment requested that the eligibility cri-
teria be expanded to permit a controlled
foreign corporation (CFC) of a U.S finan-
cial institution to act as a QDD even if the
CFC is not a QI. Other comments recom-
mended that the definition of an eligible
entity be expanded to include a bank hold-
ing company if the entity regularly issues
potential section 871(m) transactions to
customers and receives dividends or div-
idend equivalent payments pursuant to po-
tential section 871(m) transactions to
hedge the transactions issued to custom-
ers. Comments noted that a bank holding
company is subject to a wide range of
regulatory regimes.

Comments also recommended that the
scope of eligible entities be expanded to
include subsidiaries of securities dealers and
bank holding companies that regularly issue
potential section 871(m) transactions to cus-
tomers and receive dividends or dividend
equivalent amounts with respect to hedges
of those customer transactions. Comments
noted that these entities are part of a regu-
lated financial group.

In response to comments, the 2017 QI
Agreement announced the expansion of
the definition of eligible entities to include
a bank holding company and subsidiaries
of a bank holding company. The Treasury
Department and the IRS agree that a bank
holding company and subsidiaries of a
bank holding company should be included
in the definition of an eligible entity be-
cause these entities are regulated financial
institutions.

The 2017 QI Agreement clarified that
the eligible entity test is applied at the
home office or branch level, and that each
home office or branch is a separate QDD.
The 2017 QI Agreement also expanded
what constitutes an eligible entity to in-
clude a foreign branch of a U.S. financial
institution that would meet the require-
ments of an eligible entity if the branch
were a separate entity, though such a
branch will not be subject to tax on its
QDD tax liability because it is otherwise
subject to tax on a net income basis under

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

chapter 1. Both of these changes are in-
corporated in these final regulations.
These final regulations also clarify that a
subsidiary of a bank or bank holding com-
pany could be indirectly wholly-owned by
the qualifying bank or bank holding com-
pany provided that the subsidiary, acting in
its equity derivatives dealer capacity, (1)
issues potential section 871(m) transactions
to customers, and (2) receives dividends
with respect to stock or dividend equivalent
payments pursuant to potential section
871(m) transactions that hedge potential
section 871(m) transactions that it issues.

These final regulations do not expand
the eligible entity definition to specifically
include CFCs. The comments generally
did not adequately explain why CFCs can-
not avail themselves of the QI regime
(with the QDD provisions). Permitting
CFCs that are not QIs to be QDDs would
eliminate the compliance benefits pro-
vided in the 2017 QI Agreement and
would make it more difficult for the IRS
to verify compliance with the QDD rules.
However, to provide the IRS with flex-
ibility to administer the QDD regime, an
eligible entity is defined to include any
other person acceptable to the IRS,
which is similar to the allowance pro-
vided to the IRS in defining persons
eligible to enter into a QI agreement as
provided in § 1.1441-1(e)(5)(ii)(D).

A comment also raised a technical is-
sue with who can qualify as a QI, express-
ing concern that some eligible entities that
are not foreign financial institutions may
not be able to enter into QI agreements
because they are not eligible to become a
QI. The 2017 QI Agreement and these
final regulations now clarify that an eligi-
ble entity (notwithstanding that the entity
otherwise would not be eligible to be a
QI) can enter into a QI agreement in order
to implement the QDD provisions.

C. Section 871(m) Amount and QDD's
Tax Liability

Section 1.871-15T(q)(1) of the 2015
temporary regulations provided that a
QDD generally would not be liable for tax
under section 871 or 881 on a dividend or
dividend equivalent payment that the
QDD receives in its capacity as a QDD,
provided that the QDD complies with its
obligations under the qualified intermedi-

ary agreement. Section 1.1441-1T(e)(6)
of the 2015 temporary regulations pro-
vided that a QDD would not be subject to
withholding on such dividends or divi-
dend equivalents. Section D of this Part
IX describes certain changes to the fore-
going rules that the Treasury Department
and the IRS determined are appropriate in
light of the adoption of the net delta ap-
proach described in this Part IX.C.

Section 1.871-15T(q)(1) of the 2015
temporary regulations further provides
that, if a QDD receives a dividend or
dividend equivalent payment and the off-
setting dividend equivalent payment the
QDD is contractually obligated to make
on the same underlying security is less
than the dividend and dividend equivalent
amount the QDD received, the QDD
would be liable for tax under section
871(a) or 881 for the difference.

The QI Notice described proposed
changes to the QI agreement that would
implement the QDD tax liability de-
scribed in § 1.871-15T(q). Under the QI
Notice, a QDD's section 871(m) amount
for a dividend was the excess of the div-
idends on underlying securities associated
with potential section 871(m) transactions
and dividend equivalent payments that it
received that reference the same dividend
over dividend equivalent payments and any
qualifying dividend equivalent offsetting
payment that the QDD made or was con-
tractually obligated to make with respect to
the same dividend. The QI Notice described
a qualifying dividend equivalent offsetting
payment as (a) any payment made or con-
tractually obligated to be made to a United
States person that would be a dividend
equivalent payment if made to a person who
was not a United States person and (b) any
payment made to a foreign person that
would be a dividend equivalent payment if
the payment were not treated as income
effectively connected with the conduct of a
U.S. trade or business.

In addition, the QI Notice proposed
rules regarding how a QDD would calcu-
late its QDD tax liability. Specifically,
under the QI Notice, the QDD tax liability
was the sum of a QDD's liability under
sections 871(a) and 881 for (a) its section
871(m) amount; (b) its dividends that are
not on underlying securities associated
with potential section 871(m) transactions
and its dividend equivalent payments re-

ceived as a QDD in its non-dealer capac-
ity; and (c) any other payments, such as
interest, received as a QDD with respect
to potential section 871(m) transactions or
underlying securities that are not dividend
or dividend equivalent payments.

Comments requested that a QDD be
permitted to elect to calculate its section
871(m) amount either by using (1) the
method described in the QI Notice or (2)
its net delta exposure to an underlying
security. According to comments, the net
delta exposure is a calculation, measured
in shares of stock, that aggregates all the
shares of an underlying security and all
equity derivative transactions referring
to the same underlying security that the
QDD has entered into in a dealer capac-
ity (whether customer transactions or
hedging transactions). Comments ex-
plained that net delta accurately mea-
sures a QDD's residual exposure to an
underlying security. Comments noted
that financial institutions use net delta
exposure for business and non-tax reg-
ulatory purposes.

Comments also requested that the
Treasury Department and the IRS ex-
pand the offsetting dividend equivalent
payment to include all customer trans-
actions, such as potential section 871(m)
transactions with a delta below 0.8,
grandfathered transactions, and transac-
tions that reference a qualified index.

In response to comments relating to the
QI Notice, Notice 2016-76 announced
that the regulations would be revised to
require a QDD to calculate its section
871(m) amount based on the net delta
approach. The Treasury Department and
the IRS agree that the net delta approach
provides an administrable and accurate
method for a QDD to determine its residual
exposure to underlying securities. The Trea-
sury Department and the IRS, however, do
not agree with comments indicating that
QDDs should be permitted to elect to use
the net delta exposure method or the rule
described in the QI Notice. It would be
burdensome to the IRS to administer a sys-
tem that permits a QDD to use multiple
methods to calculate its section 871(m)
amount. The Treasury Department and the
IRS, however, will consider comments that
explain in more detail why a choice of
methods for determining the section 871(m)

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

amount is in the best interests of both tax-
payers and the government.

These final regulations further explain
how a QDD's section 871(m) amount is
computed. The amount is determined sepa-
rately for each dividend on an underlying
security. For example, if a QDD enters into
section 871(m) transactions that reference
stock A (which pays a $5 dividend per
share), hedges the transactions by acquiring
actual shares of stock, and has a net delta
exposure to one share of stock, the QDD
will have a tax liability pursuant to sections
871(a) and 881 with respect to a $5 dividend
based on its net delta exposure to one share
of stock A. Amounts with respect to other
dividends on the same stock or another
stock are not taken into account.

Because these final regulations adopt
the net delta exposure method for calcu-
lating the section 871(m) amount, the con-
cepts of offsetting dividend equivalent
payments and qualifying dividend equiv-
alent offsetting payments have been elim-
inated from these final regulations.

These final regulations revise the calcu-
lation of a QDD's tax liability on the section
871(m) amount to correspond with the
changes regarding the determination of the
section 871(m) amount discussed in this
section and the changes to withholding on
payments to a QDD that are discussed in the
following section of this preamble. Specifi-
cally, a QDD's tax liability on its section
871(m) amount is, for each dividend on
each underlying security, the amount by
which its tax liability under section 881 for
its section 871(m) amount exceeds the
amount of tax paid by the QDD under sec-
tion 881 (including amounts withheld on
payments to the QDD) on dividend pay-
ments received by the QDD in its capacity
as an equity derivatives dealer. The QDD
also is liable for tax under section 881 for
dividend equivalent payments received by a
QDD in its non-equity derivatives dealer
capacity and for any other payments (in-
cluding dividends) it receives as a QDD to
the extent the full liability was not satisfied
by withholding.

###### D. Withholding on Dividends Paid to a QDD

In general, under the law in effect prior
to 2017, an eligible entity that would qual-
ify as a QDD under these final regulations

generally was subject to tax under section
881 and to withholding tax under chapters
3 and 4 on actual dividends in the same
manner as any other foreign recipient. As
described in the preceding section, the
2015 temporary regulations provided that
a QDD would no longer be subject to tax
or to withholding on actual dividends re-
ceived in its capacity as a QDD. The Trea-
sury Department and the IRS are con-
cerned that this exemption in the 2015
temporary regulations, when combined
with the net delta exposure method, could
result in U.S. source dividends escaping
U.S. tax completely in certain circum-
stances. For example, if a QDD holds
physical shares of an underlying security
that it uses to hedge a delta 0.5 option,
both the dividend and the option would
not be subject to tax under section 871 or
section 881. In response to this concern,
Notice 2016-76 announced that the Trea-
sury Department and the IRS intended to
revise §§ 1.871-15T(q)(1) and 1.1441-
1(b)(4)(xxii) to provide that a QDD will
remain liable for tax under section
881(a)(1) and subject to withholding un-
der chapters 3 and 4 on dividends on
physical shares and deemed dividends
received. These final regulations revise
§§ 1.871-15T(q)(1) and 1.1441-1(b)(4)
(xxii) accordingly. However, as an-
nounced in the 2017 QI Agreement, in
order to allow taxpayers time to imple-
ment the net delta approach, these reg-
ulations continue to provide that divi-
dends on physical shares and deemed
dividends received by a QDD in its
QDD capacity in 2017 will not be sub-
ject to tax under section 881(a)(1) or
subject to withholding under chapters 3
and 4. A QDD will be subject to with-
holding on dividends (including deemed
dividends) received on or after January
1, 2018.

The Treasury Department and the
IRS will consider comments recom-
mending approaches for alleviating any
overwithholding (and preventing any
underwithholding) that might occur on
dealer transactions with customers and
on positions that hedge customer trans-
actions when withholding on dividends
(including deemed dividends) paid to
QDDs resumes in 2018.

The QI Notice provided that a with-
holding agent (other than a withholding

agent that itself was acting as a QDD)
would not be required to withhold or re-
port on payments made to a QDD with
respect to potential section 871(m) trans-
actions and underlying securities, other
than reporting for dividends and substitute
dividends. A comment requested that a
withholding agent should only be exempt
from withholding and reporting on divi-
dends and dividend equivalents paid to a
QDD. In response to this comment, the
2017 QI Agreement provides that all pay-
ments (other than dividend equivalent
payments) made to a QDD with respect to
underlying securities will be subject to
withholding and reporting if the payments
would be subject to withholding and re-
porting to a non-QDD. Consistent with the
2017 QI Agreement, the final regulations
provide that all payments (other than div-
idend equivalent payments) made to a
QDD with respect to underlying securities
will be subject to withholding and report-
ing if those payments would be subject to
withholding and reporting when received
by a foreign person.

##### E. Dealer Versus Proprietary Capacity

The 2015 temporary regulations only
permitted a taxpayer to act as a QDD with
respect to certain payments received in its
dealer capacity. Comments requested that a
taxpayer be permitted to act as a QDD for
payments received in its proprietary capac-
ity for administrative reasons. The QI No-
tice and the 2017 QI Agreement reflect this
change to the scope of QDD payments. The
change in QDD scope does not impact the
limitation on amounts entitled to be offset,
which remain limited to dealer activity.

Consistent with the 2015 regulations,
the QI Notice and the 2017 QI Agreement
provide that, for purposes of determining
the QDD tax liability, payments received
by a QDD acting as a proprietary trader
are treated as payments received in its
non-dealer capacity, while transactions
properly reflected in a QDD's dealer book
are presumed to be held by a dealer in its
dealer capacity. For purposes of determin-
ing the QDD tax liability, dealer activity is
limited to its activity as an equity deriva-
tives dealer. One comment requested that
the regulations clarify and qualify the dis-
tinction between receiving a payment in a
dealer versus in a proprietary trader ca-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

pacity and the impact of the distinction on
the ability of an entity to act as a QDD.
The Treasury Department and the IRS
have determined that the regulations ade-
quately delineate between dealer and pro-
prietary transactions in § 1.871-15(q)(2).

##### F. Timing of Withholding

Generally, newly redesignated § 1.1441-
2(e)(7) (formerly § 1.1441-2(e)(8)) pro-
vides that a withholding agent must with-
hold on a dividend equivalent on the later of
the date on which the amount of the divi-
dend equivalent is determined and the date
that a payment occurs. A payment generally
occurs when money or other property is
paid to or by the long party, or the long party
sells, exchanges, transfers, or otherwise dis-
poses of a section 871(m) transaction. Not-
withstanding this general rule applicable to
withholding agents, the QI Notice an-
nounced that a QDD must withhold with
respect to a dividend equivalent payment on
the dividend payment date for the applicable
dividend on the underlying security as de-
termined in § 1.1441-2(e)(4).

Comments noted that this change
would require a QDD to pay tax prior to
the date that other withholding agents
would have been required to withhold. In
addition, comments expressed concern
that this rule would result in cashless
withholding for many transactions. Com-
ments also noted that withholding agents
have been building withholding systems
according to the general rule provided in
the final section 871(m) regulations. Com-
ments recommended that the final section
871(m) regulations be amended to permit
a QDD to elect to withhold on the pay-
ment of the dividend equivalent as pro-
vided in newly redesignated § 1.1441-
2(e)(7) or on the dividend payment date as
determined in § 1.1441-2(e)(4).

The Treasury Department and the IRS
have determined that a QDD should con-
tinue to be required to withhold on the
dividend payment date as determined in
§ 1.1441-2(e)(4), because the time that a
QDD withholds on customer transactions
should match the time period for which it
determines its own tax liability with re-
spect to the section 871(m) amount. This
is because the withholding tax that may
apply to customer transactions is the jus-
tification for relieving the QDD from tax

on its section 871(m) amount. In addition,
this rule simplifies the reconciliation state-
ment, makes it easier for reviewers and
the IRS to verify that a QDD has complied
with the requirements of the 2017 QI
Agreement, and avoids a number of other
issues that would arise under the re-
quested approach, including statute of
limitation issues. With respect to the con-
cerns expressed regarding the need to
build systems, the Treasury Department
and the IRS note that this timing rule is
consistent with the rule that was proposed
in the QI Notice, released July 1, 2016.
Moreover, as described in Notice 2016-
76, during 2017, the IRS will take into
account the extent to which a QDD has
made a good faith effort to comply with
the QDD provisions in the QI agreement
when enforcing those provisions.

##### G. Qualified Securities Lenders (QSL) and Credit Forward

Notice 2010-46, 2010-24 I.R.B. 757
(see § 601.601(d)(2)(ii)(b)), (QSL Notice)
outlined a proposed credit forward system
that allowed a withholding agent to limit
the aggregate U.S. gross-basis tax in a
series of securities lending transactions to
the amount of U.S. gross-basis tax appli-
cable to the foreign taxpayer receiving a
substitute or actual dividend in the series
of transactions who bears the highest rate
of U.S. gross-basis tax. The preamble to
the 2015 regulations indicated that the
credit forward system remained under
consideration, but noted that, during the
transition period provided in Notice
2010-46, the IRS has experienced diffi-
culty verifying that prior withholding has
occurred. Comments were requested on
the need for the regime and how it could
be implemented.

Comments requested that the credit
forward system be retained. One comment
requested that the credit forward system
be retained when QDD status was not
available. In contrast, another comment
suggested that the stringency resulting
from tightening the eligibility require-
ments for QDDs to QIs that are subject to
reporting and compliance requirements
would improve the ability to verify that
prior withholding occurred.

As discussed in Part IX.B of this pre-
amble the Treasury Department and the

IRS have concluded that it is not appro-
priate to permit credits or offsets for
any entity that does not qualify as an
eligible entity. In reaching this conclu-
sion, the Treasury Department and the
IRS agree with the comment that indi-
cated that the QDD rules provide a more
administrable method of determining that
withholding properly occurred. If the en-
tity is acting as an intermediary instead of
acting as a principal, it may choose to be
a QI that is not a QDD. The second com-
ment did not explain why the existing
QDD regime is insufficient.

In addition to comments regarding the
credit forward system, a comment re-
quested that QSL status be preserved as a
standalone rule for securities lending
transactions that are part of a separate line
of business from other potential section
871(m) transactions. Another comment
recommended reverting to the eligibility
requirements for a QSL in the QSL Notice
by extending QDD status to custodian QIs
that are subject to regulatory supervision
by a governmental authority in the juris-
diction in which the entity was created, as
long as the entity agrees to assume pri-
mary withholding and reporting responsi-
bility with respect to dividend equivalent
payments and complies with all QDD cer-
tification requirements.

While the Treasury Department and
the IRS understand that the QSL regime
was administratively more convenient
for taxpayers than the QI regime, it cre-
ated administrability problems, particu-
larly with respect to verification, for the
IRS. That regime is being replaced by
incorporating the QDD rules into the
existing QI framework, including the
specific rules for pooled reporting on
Form 1042-S, and the QI requirements
for compliance review and certification.
With respect to banks, custodians, and
clearing organizations that do not issue
potential section 871(m) transactions to
customers, the Treasury Department and
the IRS are concerned that reverting to the
eligibility requirements for a QSL in the
QSL Notice would permit an entity to act
as a QDD that does not act as a financial
intermediary in a chain of section 871(m)
transactions.

As part of the transition relief an-
nounced in Notice 2016-76, the Treasury
Department and the IRS announced that

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

taxpayers may continue to rely on the
QSL Notice during 2017. The QSL Notice
will be obsoleted as of January 1, 2018.

##### X. Rules for withholding on dividend equivalents

Newly designated § 1.1441-2(e)(7)
provides that a withholding agent is not
obligated to withhold on a dividend equiv-
alent until the later of when a payment is
made with respect to a section 871(m)
transaction and when the amount of a div-
idend equivalent is determined. For pur-
poses of § 1.1441-2(e)(7), a payment with
respect to a section 871(m) transaction
occurs when the long party receives or
makes a payment, when there is a final
settlement of the section 871(m) transac-
tion, or when the long party sells or oth-
erwise disposes of the section 871(m)
transaction. The 2015 final regulations ad-
opted this approach in response to tax-
payer comments.

##### A. Transactions transferred to a different account

The 2015 final regulations provide that
a payment occurs when the long party
sells or disposes of a section 871(m) trans-
action; however, when a long party trans-
fers a section 871(m) transaction from one
broker or custodian to another broker or
custodian, the 2015 final regulations do
not treat that transfer as a payment. A
comment noted that it is common for in-
vestors to change relationships with bro-
kers and custodians who hold their secu-
rities, which may result in section 871(m)
transactions being transferred from one
broker or custodian to another. The
comment asserted that it is inappropriate
and burdensome for a withholding agent
to be responsible for dividend equivalent
amount calculations relating to dividends
that occurred before the date that the new
broker or custodian holds the section
871(m) transaction on behalf of a long
party. The comment recommended that
the Treasury Department and the IRS
amend the 2015 final regulations to pro-
vide that a transfer of a section 871(m)
transaction from one broker or custodian
to another, without a change in beneficial
ownership, constitutes a payment for pur-
poses of § 1.1441-2(e)(7).

The Treasury Department and the IRS
agree that requiring a broker or custodian
to withhold on dividend equivalent pay-
ments that occurred before holding a sec-
tion 871(m) transaction on behalf of a
customer would be burdensome to the
withholding agent. As a result, § 1.1441-
2(e)(7) is revised to provide that a pay-
ment of a dividend equivalent occurs
when a section 871(m) transaction is
transferred to an account not maintained
by the withholding agent or upon a termi-
nation of the account relationship.

##### B. Option to withhold on dividend payment date

While § 1.1441-2(e)(7) generally de-
fers withholding on a section 871(m)
transaction until there is a payment made
pursuant to the transaction, comments
noted that § 1.1441-2(e)(7) will require
cashless withholding in certain circum-
stances. To implement the 2015 final reg-
ulations, comments noted that market par-
ticipants would be required to develop or
amend collateral and indemnity arrange-
ments with customers. Some comments
recommended amending the 2015 final
regulations to allow withholding agents to
treat a dividend equivalent as paid and
subject to withholding on the dividend
payment date for the underlying security
referenced by the section 871(m) transac-
tion. Comments indicated that some with-
holding agents believe that it will be
easier to implement withholding on the
dividend payment date for the underly-
ing security because their systems are al-
ready designed to track the time and
amount of actual dividends. Many with-
holding agents, however, have contractual
agreements with customers that prohibit
withholding earlier than a date permitted
by regulations.

The Treasury Department and the IRS
appreciate that some withholding agents
would rather not develop new systems to
track dividend equivalents over multiple
years, while other financial institutions
prefer the time for withholding provided
by § 1.1441-2(e)(7). To accommodate
both approaches, the Treasury Department
and the IRS are amending the regulations
to allow withholding agents the flexibility
to withhold either based on the "later of"
rule, as determined under § 1.1441-

2(e)(7), or on the dividend payment date
for the underlying security. This change
will allow withholding agents that prefer
to withhold on the dividend payment date
to do so, without eliminating the "later of"
rule in § 1.1441-2(e)(7) that generally ties
withholding to a cash payment. As dis-
cussed in Part IX.F of this preamble, if a
withholding agent acts as a QDD, it will
be required to use the dividend payment
date.

A withholding agent that chooses to
withhold on the dividend payment date for
the underlying security referenced by the
section 871(m) transaction must apply the
election consistently to all section 871(m)
transactions of the same type. In other
words, a withholding agent that chooses to
withhold on the dividend payment date for
securities lending transactions must do so
for all securities lending transactions, but
may choose to withhold on NPCs under
the rule in § 1.1441-2(e)(7). When a with-
holding agent withholds on the dividend
payment date under this alternate method,
the withholding agent must notify each
payee in writing before the time for deter-
mining the long party's first dividend
equivalent payment. A withholding agent
that withholds on the dividend payment
date for the underlying security also must
attach a statement to its Form 1042 for the
year of the change notifying the IRS of the
change and when it applies.

##### XI. Applicability date

The current regulations provide that
§ 1.871-15(d)(2) and (e) apply to any
payment made on or after January 1,
2017, with respect to any transaction is-
sued on or after January 1, 2017. Several
comments requested that implementation
of these provisions be delayed until at
least January 1, 2018. One comment re-
quested that implementation be delayed
until at least one year after the date guid-
ance resolving all issues raised by the
comment is issued. The primary reasons
comments provided for the requests to
delay implementation were the need for
additional guidance, the need for addi-
tional time to make systems operational,
and the recent release of additional QDD
guidance in the QI Notice and in Notice
2016-76. Comments also requested a de-
lay in the combination rule generally. An-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

other comment agreed with the request for
a delayed effective date for the combina-
tion rule, unless the rule was revised to
require withholding agents only to com-
bine transactions that the withholding
agent has actual knowledge are priced,
marketed, or sold in connection with each
other. A comment also requested a transi-
tion period until December 31, 2018, for
enforcement and administration of QDD
obligations.

The 2013 proposed regulations pro-
vided that the proposed sections would
apply to payments made on or after the
date the regulations were finalized. How-
ever, when the regulations were finalized
in 2015, the Treasury Department and the
IRS provided that the regulations gener-
ally would only apply to transactions is-
sued on or after January 1, 2017, to ensure
adequate time to develop systems needed
to implement the regulations.

Both the 2015 regulations and the
amendments to those regulations that are
included in these regulations, many of
which were previously announced in the
QI Notice, Notice 2016-76, and the 2017
QI Agreement, make the withholding re-
quired under section 871(m) easier to im-
plement and more administrable. In light
of these revisions, the Treasury Depart-
ment and the IRS have determined that it
is not necessary or appropriate to uni-
formly extend the applicability date for all
section 871(m) transactions. In particular,
taxpayers have had ample time to develop
systems to implement withholding on sec-
tion 871(m) transactions that are delta one
transactions. The Treasury Department
and the IRS have determined, however,
that taxpayers and withholding agents
need additional time to implement the
section 871(m) regulations for section
871(m) transactions other than delta one
transactions. Accordingly, these regula-
tions postpone the implementation of the
section 871(m) regulations with respect to
non-delta one transactions until January 1,
2018.

In addition, in response to comments,
Notice 2016-76 announced transition re-
lief for combined transactions by provid-
ing a simplified rule for withholding
agents to determine whether transactions
entered into in 2017 are combined trans-
actions. Also in response to comments,
Notice 2016-76 delayed the application

of section 871(m) for certain exchange-
traded notes. Notice 2016-76 also an-
nounced that calendar years 2017 and
2018 would be phase-in years. In enforc-
ing and administering section 871(m) (1)
with respect to delta-one transactions in
2017, and (2) with respect to non-delta-
one transactions in 2018, the IRS will take
into account the extent to which the tax-
payer or withholding agent made a good
faith effort to comply with the section
871(m) regulations. Similarly, Notice
2016-76 and the 2017 QI Agreement pro-
vide that calendar year 2017 will be a
phase-in year for QDDs. As discussed in
Part XI.D, the 2017 QI Agreement and
these regulations provide that a QDD will
not be subject to withholding on actual or
deemed dividends in 2017. Finally, the
2017 QI Agreement and these final regu-
lations do not impose tax on a QDD's
section 871(m) amount for tax years be-
ginning before January 1, 2018.

### Effect on Other Documents

Notice 2010-46 (2010-24 I.R.B. 757)
is obsolete as of January 1, 2018.

### Special Analyses

Certain IRS regulations, including
these, are exempt from the requirements
of Executive Order 12866, as supple-
mented and reaffirmed by Executive Or-
der 13563. Therefore, a regulatory impact
assessment is not required. It is hereby
certified that these regulations will not
have a significant economic impact on a
substantial number of small entities. This
certification is based on the fact that few,
if any, small entities will be affected by
these regulations. The regulations primar-
ily will affect multinational financial in-
stitutions, which tend to be larger busi-
nesses, and foreign persons. Therefore, a
Regulatory Flexibility Analysis is not re-
quired. Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
preceding this regulation was submitted to
the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on their impact on small business.

### Drafting Information

The principal authors of these regula-
tions are D. Peter Merkel and Karen
Walny of the Office of Associate Chief

Counsel (International). Other personnel
from the Treasury Department and the
IRS also participated in the development
of these regulations.
* * * * *

### 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 is amended by removing the sec-
tional authority for § 1.871-15 and adding
in its place a sectional authority for
§§ 1.871-15 and 1.871-15T to read in
part as follows:

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

§§ 1.871-15 and 1.871-15T also is-
sued under 26 U.S.C. 871(m). * * *

Par. 2. Section 1.871-15 is amended
by:

1\. Revising paragraph (a)(1).

2\. Revising paragraph (a)(14)(i).

3\. Adding a new second sentence to
paragraph (a)(14)(ii)(B).

4\. Revising paragraph (c)(2)(ii).

5\. Revising paragraph (c)(2)(iv).

6\. Revising paragraphs (g)(2) through
(g)(3), redesignating paragraph (g)(4)
as (g)(5), and adding new paragraph
(g)(4).

7\. Revising paragraph (h).

8\. Revising paragraphs (i)(3)(ii) and
(i)(3)(iii).

9\. Adding introductory text to para-
graph (j)(1).

10\. Adding paragraph (j)(4).

11\. Revising paragraph (l)(2).

12\. Revising paragraph (l)(4).

13\. Redesignating paragraphs (n)(3)(i)
and (n)(3)(ii) as (n)(3)(ii) and (n)(3)
(iii), respectively.

14\. Adding new paragraph (n)(3)(i).

15\. Revising paragraph (p)(1).

16\. Adding paragraphs (p)(4)(iii) and
(p)(5).

17\. Revising paragraph (q).

18\. Revising paragraphs (r)(3) and (r)(4).

19\. Adding paragraph (r)(5).

The additions and revisions read as
follows:

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

§ 1.871-15 Treatment of dividend
equivalents.

(a) * * * (1) Broker. [Reserved]. For
further guidance, see § 1.871-15T(a)(1).
* * * * *

(14) * * * (i) Simple contract. A simple
contract is an NPC or ELI for which, with
respect to each underlying security, all
amounts to be paid or received on matu-
rity, exercise, or any other payment deter-
mination date are calculated by reference
to a single, fixed number of shares (as
determined in paragraph (j)(3) of this sec-
tion) of the underlying security, provided
that the number of shares can be ascer-
tained at the calculation time for the con-
tract, and there is a single maturity or
exercise date with respect to which all
amounts (other than any upfront payment
or any periodic payments) are required to
be calculated with respect to the underly-
ing security. For purposes of this section,
a contract that provides an adjustment to
the number of shares of the underlying
security for a merger, stock split, cash
dividend, or similar corporate action that
affects all holders of the underlying secu-
rities proportionately will not cease to be
treated as referencing a single, fixed num-
ber of shares solely as a result of that
provision. A contract has a single exercise
date even though it may be exercised by
the holder at any time on or before the
stated expiration of the contract. An NPC
or ELI that includes a term that discontin-
uously increases or decreases the amount
paid or received (such as a digital option),
or that accelerates or extends the maturity
is not a simple contract. A simple contract
that is an NPC is a simple NPC. A simple
contract that is an ELI is a simple ELI.
* * * * *

(ii) * * * (B) Example. * * * Pursuant
to paragraph (j)(3) of the section, the ELI
references 200 shares when Stock X ap-
preciates, but only 100 shares when Stock
X depreciates. * * *

(c) * * *

(2) * * * (ii) Section 305 coordination.
A dividend equivalent received by a long
party, who is a shareholder as defined in
§ 1.305-1(d) of an instrument that gives
rise to a dividend pursuant to sections
305(b) and (c) (including a debt instru-
ment that is convertible into shares of
stock and stock that is convertible into

shares of another class of stock) that is
also a section 871(m) transaction, is re-
duced by any amount treated as a dividend
by sections 305(b) and (c) to the long
party. For other section 871(m) transac-
tions that reference an underlying security
that is an instrument treated as paying a
dividend pursuant to sections 305(b) and
(c) and for which the long party is not a
shareholder as defined in § 1.305-1(d),
the dividend equivalent received by the
long party with respect to the section
871(m) transaction includes (and is not
reduced by) any amount treated as a div-
idend pursuant to sections 305(b) and (c).
* * * * *

(iv) Payments made pursuant to annu-
ity, endowment, and life insurance con-
tracts-(A) Insurance contracts issued by
domestic insurance companies. A pay-
ment made pursuant to a contract that is
an annuity, endowment, or life insurance
contract issued by a domestic corporation
(including its foreign or U.S. possession
branch) that is a life insurance company
described in section 816(a) does not in-
clude a dividend equivalent if the payment
is subject to tax under section 871(a) or
section 881.

(B) Insurance contracts issued by for-
eign insurance companies. A payment
does not include a dividend equivalent if it
is made pursuant to a contract that is an
annuity, endowment, or life insurance
contract issued by a foreign corporation
that would be subject to tax under sub-
chapter L if it were a domestic corpora-
tion.

(C) Insurance contracts held by for-
eign insurance companies. A payment
made pursuant to a policy of insurance
(including a policy of reinsurance) does
not include a dividend equivalent if it is
made to a foreign corporation that would
be subject to tax under subchapter L if it
were a domestic corporation.

* * * * *

(g) * * *

(2) Time for determining delta-(i) In
general. Except as provided in paragraph
(g)(4) of this section, the delta of a poten-
tial section 871(m) transaction is deter-
mined at the calculation time for the po-
tential section 871(m) transaction.

(ii) Calculation time. The calculation
time for a potential section 871(m) trans-
action is the earlier of when the potential

section 871(m) transaction is priced and
when the potential section 871(m) trans-
action is issued. Notwithstanding the pre-
ceding sentence, if the pricing time is
more than 14 calendar days before the
potential section 871(m) transaction is is-
sued, the calculation time is when the
potential section 871(m) transaction is is-
sued.

(iii) Pricing time. A potential section
871(m) transaction is priced when all ma-
terial economic terms for the transaction
have been agreed upon, including the
price at which the transaction is sold.

(3) Simplified delta calculation for cer-
tain simple contracts that reference mul-
tiple underlying securities. If an NPC or
ELI references 10 or more underlying se-
curities and an exchange-traded security
(for example, an exchange-traded fund) is
available that would fully hedge the NPC
or ELI at the calculation time, the delta of
the NPC or ELI may be calculated by
determining the ratio of the change in the
fair market value of the simple contract to
a small change in the fair market value of
the exchange-traded security. A delta de-
termined under this paragraph (g)(3) must
be used as the delta for each underlying
security for purposes of calculating the
amount of a dividend equivalent as pro-
vided in paragraph (j)(1)(ii) of this sec-
tion.

(4) Delta calculation for listed op-
tions-(i) In general. The delta of an op-
tion contract that is listed on a regulated
exchange described in paragraph (g)(4)(ii)
of this section is the delta of that option at
the close of business on the business day
before the date of issuance. On the date an
option contract is listed for the first time,
the delta is the delta of that option at the
close of business on the date of issuance.
Notwithstanding the preceding two sen-
tences, the delta of a listed option that is
also a customized option is determined
under the rules of paragraphs (g)(2) and
(g)(3) of this section.

(ii) Regulated exchange. For purposes of
paragraph (g)(4)(i) of this section, a regu-
lated exchange is any exchange that is ei-
ther:

(A) Described in paragraph (l)(3)(vii)
of this section; or

(B) [Reserved]. For further guidance,
see § 1.871-15T(g)(4)(ii)(B).
* * * * *

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

(h) Substantial equivalence test-(1)
In general. The substantial equivalence
test described in this paragraph (h) applies
to determine whether a complex contract
is a section 871(m) transaction. The sub-
stantial equivalence test assesses whether
a complex contract substantially replicates
the economic performance of the underly-
ing security by comparing, at various test-
ing prices for the underlying security, the
differences between the expected changes
in value of that complex contract and its
initial hedge with the differences between
the expected changes in value of a simple
contract benchmark (as described in para-
graph (h)(2) of this section) and its initial
hedge. If the complex contract contains
more than one reference to a single under-
lying security, all references to that under-
lying security are taken into account
for purposes of applying the substantial
equivalence test with respect to that un-
derlying security. With respect to an eq-
uity derivative that is embedded in a debt
instrument or other derivative, the sub-
stantial equivalence test is applied to the
complex contract without taking into ac-
count changes in the market value of the
debt instrument or other derivative that
are not directly related to the equity ele-
ment of the instrument. The complex con-
tract is a section 871(m) transaction with
respect to an underlying security if, for
that underlying security, the expected
change in value of the complex contract
and its initial hedge is equal to or less than
the expected change in value of the simple
contract benchmark and its initial hedge
when the substantial equivalence test de-
scribed in this paragraph (h) is calculated
at the calculation time for the complex
contract. To the extent that the steps of the
substantial equivalence test set out in this
paragraph (h) cannot be applied to a partic-
ular complex contract, a taxpayer must use
the principles of the substantial equivalence
test to reasonably determine whether the
complex contract is a section 871(m) trans-
action with respect to each underlying secu-
rity. For purposes of this section, the test
must be applied and the inputs must be
determined in a commercially reasonable
manner. The term of the simple contract
benchmark must be, and the inputs must
use, a reasonable time period, consistently
applied (for example, in determining the
standard deviation and probability). If a tax-

payer calculates any relevant input for non-
tax business purposes, that input ordinarily
is the input used for purposes of this section.

(2) Simple contract benchmark. The
simple contract benchmark is an actual or
hypothetical simple contract that, at the
calculation time for the complex contract,
has a delta of 0.8, references the applica-
ble underlying security referenced by the
complex contract, and has terms that are
consistent with all the material terms of
the complex contract, including the matu-
rity date. If an actual simple contract does
not exist, the taxpayer must create a hy-
pothetical simple contract. Depending on
the complex contract, the simple contract
benchmark might be, for example, a call
option, a put option, or a collar.

(3) Substantial equivalence. A complex
contract is a section 871(m) transaction with
respect to an underlying security if the com-
plex contract calculation described in para-
graph (h)(4) of this section results in an
amount that is equal to or less than the
amount of the benchmark calculation de-
scribed in paragraph (h)(5) of this section.

(4) Complex contract calculation-(i)
In general. The complex contract calcula-
tion for each underlying security refer-
enced by a potential section 871(m) trans-
action that is a complex contract is
computed by:

(A) Determining the change in value
(as described in paragraph (h)(4)(ii) of
this section) of the complex contract with
respect to the underlying security at each
testing price (as described in paragraph
(h)(4)(iii) of this section);

(B) Determining the change in value of
the initial hedge for the complex contract
at each testing price;

(C) Determining the absolute value of
the difference between the change in value
of the complex contract determined in para-
graph (h)(4)(i)(A) of this section and the
change in value of the initial hedge deter-
mined in paragraph (h)(4)(i)(B) of this sec-
tion at each testing price;

(D) Determining the probability (as de-
scribed in paragraph (h)(4)(iv) of this sec-
tion) associated with each testing price;

(E) Multiplying the absolute value for
each testing price determined in paragraph
(h)(4)(i)(C) of this section by the corre-
sponding probability for that testing price
determined in paragraph (h)(4)(i)(D) of
this section;

(F) Adding the product of each calcula-
tion determined in paragraph (h)(4)(i)(E) of
this section; and

(G) Dividing the sum determined in
paragraph (h)(4)(i)(F) of this section by
the initial hedge for the complex contract.

(ii) Determining the change in value.
The change in value of a complex contract
is the difference between the value of the
complex contract with respect to the un-
derlying security at the calculation time
for the complex contract and the value of
the complex contract with respect to the
underlying security if the price of the un-
derlying security were equal to the testing
price at the calculation time for the com-
plex contract. The change in value of the
initial hedge of a complex contract with
respect to the underlying security is the
difference between the value of the initial
hedge at the calculation time for the com-
plex contract and the value of the initial
hedge if the price of the underlying secu-
rity were equal to the testing price at the
calculation time for the complex contract.

(iii) Testing price. The testing prices
must include the prices of the underlying
security if the price of the underlying se-
curity at the calculation time for the com-
plex contract were alternatively increased
by one standard deviation and decreased
by one standard deviation, each of which
is a separate testing price. In circum-
stances where using only two testing
prices is reasonably likely to provide an
inaccurate measure of substantial equiva-
lence, a taxpayer must use additional test-
ing prices as necessary to determine
whether a complex contract satisfies the
substantial equivalence test. If additional
testing prices are used for the substantial
equivalence test, the probabilities as de-
scribed in paragraph (h)(4)(iv) of this sec-
tion must be adjusted accordingly.

(iv) Probability. For purposes of para-
graphs (h)(4)(i)(D) and (E) of this section,
the probability of an increase by one stan-
dard deviation is the measure of the like-
lihood that the price of the underlying
security will increase by any amount from
its price at the calculation time for the
complex contract. For purposes of para-
graphs (h)(4)(i)(D) and (E) of this section,
the probability of a decrease by one stan-
dard deviation is the measure of the like-
lihood that the price of the underlying
security will decrease by any amount from

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

its price at the calculation time for the
complex contract.

(5) Benchmark calculation. The bench-
mark calculation with respect to each under-
lying security referenced by the potential
section 871(m) transaction is determined by
using the computation methodology de-
scribed in paragraph (h)(4) of this section
with respect to a simple contract benchmark
for the underlying security.

(6) Substantial equivalence calculation
for certain complex contracts that reference
multiple underlying securities. If a complex
contract references 10 or more underlying
securities and an exchange-traded security
(for example, an exchange-traded fund) is
available that would fully hedge the com-
plex contract at its calculation time, the sub-
stantial equivalence calculations for the
complex contract may be calculated by
treating the exchange-traded security as the
underlying security. When the exchange-
traded security is used for the substantial
equivalence calculation pursuant to this
paragraph (h)(6), the initial hedge is the
number of shares of the exchange-traded
security for purposes of calculating the
amount of a dividend equivalent as provided
in paragraph (j)(1)(iii) of this section.

(7) Example. The following example
illustrates the rules of paragraph (h) of this
section. For purposes of this example,
Stock X is common stock of domestic
corporation X. FI is the financial institu-
tion that structures the transaction de-
scribed in the example, and is the short
party to the transaction. Investor is a non-
resident alien individual.

Example. Complex contract that is not substan-
tially equivalent. (i) FI issues an investment contract
(the Contract) that has a stated maturity of one year,
and Investor purchases the Contract from FI at issu-
ance for $10,000. At maturity, the Contract entitles
Investor to a return of $10,000 (i) plus 200 percent of
any appreciation in Stock X above $100 per share,
capped at $110, on 100 shares or (ii) minus 100
percent of any depreciation in Stock X below $90 on
100 shares. At the calculation time for the Contract,
the price of Stock X is $100 per share. Thus, for
example, Investor will receive $11,000 if the price of
Stock X is $105 per share at maturity of the Contract,
but Investor will receive $9,000 if the price of Stock
X is $80 per share when the Contract matures. At
issuance, FI acquires 64 shares of Stock X to fully
hedge the Contract issued to Investor. The calcula-
tion time for this example is the issuance.

(ii) The Contract references an underlying secu-
rity and is not an NPC, so it is classified as an ELI
under paragraph (a)(4) of this section. At the calcu-
lation time for the Contract, the Contract does not
provide for an amount paid at maturity that is cal-

culated by reference to a single, fixed number of
shares of Stock X. When the Contract matures, the
amount paid is effectively calculated based on either
200 shares of Stock X (if the price of Stock X has
appreciated up to $110) or 100 shares of Stock X (if
the price of Stock X has declined below $90). Con-
sequently, the Contract is a complex contract de-
scribed in paragraph (a)(14) of this section.

(iii) Because it is a complex ELI, FI applies the
substantial equivalence test described in paragraph
(h) of this section to determine whether the Contract
is a specified ELI. FI determines that the price of
Stock X would be $120 if the price of Stock X were
increased by one standard deviation, and $79 if the
price of Stock X were decreased by one standard
deviation. Based on these results, FI next determines
the change in value of the Contract to be $2000 at the
testing price that represents an increase by one stan-
dard deviation ($12,000 testing price minus $10,000
issue price) and a negative $1,100 at the testing price
that represents a decrease by one standard deviation
($10,000 issue price minus $8,900 testing price). FI
performs the same calculations for the 64 shares of
Stock X that constitute the initial hedge, determining
that the change in value of the initial hedge is $1,280
at the testing price that represents an increase by one
standard deviation ($6,400 at issuance compared to
$7,680 at the testing price) and negative $1,344 at
the testing price that represents a decrease by one
standard deviation ($6,400 at issuance compared to
$5,056 at the testing price).

(iv) FI then determines the absolute value of the
difference between the change in value of the initial
hedge and the Contract at the testing price that
represents an increase by one standard deviation and
a decrease by one standard deviation. Increased by
one standard deviation, the absolute value of the
difference is $720 ($2,000-$1,280); decreased by
one standard deviation, the absolute value of the
difference is $244 (negative $1,100 minus negative
$1,344). FI determines that there is a 52% chance
that the price of Stock X will have increased in value
when the Contract matures and a 48% chance that
the price of Stock X will have decreased in value at
that time. FI multiplies the absolute value of the
difference between the change in value of the initial
hedge and the Contract at the testing price that
represents an increase by one standard deviation by
52%, which equals $374.40. FI multiplies the abso-
lute value of the difference between the change in
value of the initial hedge and the Contract at the
testing price that represents a decrease by one stan-
dard deviation by 48%, which equals $117.12. FI
adds these two numbers and divides by the number
of shares that constitute the initial hedge to deter-
mine that the transaction calculation is 7.68 ((374.40
plus 117.12) divided by 64).

(v) FI then performs the same calculation with
respect to the simple contract benchmark, which is a
one-year call option that references one share of
Stock X, settles on the same date as the Contract, and
has a delta of 0.8. The one-year call option has a
strike price of $79 and has a cost (the purchase
premium) of $22. The initial hedge for the one-year
call option is 0.8 shares of Stock X.

(vi) FI first determines that the change in value of
the simple contract benchmark is $19.05 if the test-
ing price is increased by one standard deviation

($22.00 at issuance to $41.05 at the testing price) and
negative $20.95 if the testing price is decreased by
one standard deviation ($22.00 at issuance to $1.05
at the testing price). Second, FI determines that the
change in value of the initial hedge is $16.00 at the
testing price that represents an increase by one stan-
dard deviation ($80 at issuance to $96 at the testing
price) and negative $16.80 at the testing price that
represents a decrease by one standard deviation
($80.00 at issuance to $63.20 at the testing price).

(vii) FI determines the absolute value of the
difference between the change in value of the initial
hedge and the one-year call option at the testing
price that represents an increase by one standard
deviation is $3.05 ($16.00 minus $19.05). FI next
determines the absolute value of the difference be-
tween the change in value of the initial hedge and the
option at the testing price that represents a decrease
by one standard deviation is $4.15 (negative $16.80
minus negative $20.95). FI multiplies the absolute
value of the difference between the change in value
of the initial hedge and the option at the testing price
that represents an increase by one standard deviation
by 52%, which equals $1.586. FI multiplies the
absolute value of the difference between the change
in value of the initial hedge and the option at the
testing price that represents a decrease by one stan-
dard deviation by 48%, which equals $1.992. FI adds
these two numbers and divides by the number of
shares that constitute the initial hedge to determine
that the benchmark calculation is 4.473 ((1.586 plus
1.992) divided by .8).

(viii) FI concludes that the Contract is not a
section 871(m) transaction because the transaction
calculation of 7.68 exceeds the benchmark calcula-
tion of 4.473.

(i) * * *

(3) * * * (ii) Publicly available divi-
dend amount. For purposes of paragraph
(i)(3)(i) of this section, if a section 871(m)
transaction references the same underly-
ing securities as a security (for example,
stock in an exchange-traded fund) or in-
dex for which there is a publicly available
quarterly dividend amount, the publicly
available dividend amount may be used to
determine the per-share dividend amount
for the section 871(m) transaction with
any adjustment for special dividends.

(iii) Dividend amount for a section
871(m) transaction using the simplified
delta calculation. When the delta of a
section 871(m) transaction is determined
under paragraph (g)(3) of this section, the
per-share dividend amount for that section
871(m) transaction must be determined
using the dividend amount for the
exchange-traded security that would fully
hedge the section 871(m) transaction
(whether or not the exchange-traded secu-
rity is actually acquired).

** * * *

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

(j) * * * (1) Calculation of the amount
of a dividend equivalent. The long party is
liable for tax on any dividend equivalents
required to be determined pursuant to
paragraph (j)(2) of this section only with
respect to dividend equivalents that arise
while the long party is a party to the
transaction. The amount of any dividend
equivalent is determined as follows:

* * * * *

(4) Taxable year of a dividend equiva-
lent. A long party is liable for tax on a
dividend equivalent in the year the divi-
dend equivalent is subject to withholding
pursuant to § 1.1441-2(e)(7). Notwith-
standing the preceding sentence, a long
party that is a qualified derivatives dealer
is liable for tax on a dividend equivalent
when the applicable dividend on the un-
derlying security would be subject to
withholding pursuant to § 1.1441-2(e)(4).
The amount of the long party's tax liabil-
ity, however, is determined by reference
to the amount that would have been due at
the time the dividend equivalent amount is
determined pursuant to paragraph (j)(2) of
this section based on the beneficial owners
at that time (for example, based on the tax
rate at that time, whether the long party
qualified for a treaty benefit at that time,
and in the case of a partnership, based on
the partners at that time).

* * * * *

(l) * * *

(2) Qualified index not treated as an
underlying security-(i) In general. For
purposes of this section, a qualified index is
treated as a single security that is not an
underlying security. The determination of
whether an index referenced in a potential
section 871(m) transaction is a qualified in-
dex is made at the calculation time for the
transaction based on whether the index is a
qualified index on the first business day of
the calendar year containing the calculation
time.

(ii) Rule for the first year of an index.
In the case of an index that was not in
existence on the first business day of the
calendar year containing the calculation
time for the transaction, paragraph (l)(2)
of this section is applied by testing the
index on the first business day it is cre-
ated, and the dividend yield calculation
required by paragraph (l)(3)(vi) of this
section is determined by using the divi-
dend yield that the index would have had

in the immediately preceding year if it had
the same components throughout that year
that it has on the day it is created.
* * * * *

(4) Safe harbor for certain indices that
reference assets other than underlying se-
curities. Notwithstanding paragraph (l)(3)
of this section, an index is a qualified
index if the index is widely traded, the
referenced component underlying securi-
ties in the aggregate comprise 10 percent
or less of the weighting of the component
securities in the index, and the index was
not formed or availed of with a principal
purpose of avoiding U.S. withholding tax.
* * * * *

(n) * * *

(3) Short party presumptions regarding
combined transactions-(i) In general. If a
short party relies on the presumption pro-
vided in paragraph (n)(3)(ii) of this section
or in paragraph (n)(3)(iii) of this section, the
short party is not required to treat those
potential section 871(m) transactions as part
of a single transaction pursuant to paragraph
(n)(1) of this section.

* * * * *

(p) * * * (1) Responsible party-(i) In
general. If a broker or dealer is a party to a
potential section 871(m) transaction with a
counterparty or customer that is not a broker
or dealer, the broker or dealer is required to
determine whether the potential section
871(m) transaction is a section 871(m)
transaction. If both parties to a potential
section 871(m) transaction are brokers or
dealers, or neither party to a potential sec-
tion 871(m) transaction is a broker or dealer,
the short party must determine whether the
potential section 871(m) transaction is a sec-
tion 871(m) transaction.

(ii) [Reserved]. For further guidance,
see § 1.871-15T(p)(1)(ii).

(iii) [Reserved]. For further guidance,
see § 1.871-15T(p)(1)(iii).

(iv) [Reserved]. For further guidance,
see § 1.871-15T(p)(1)(iv).

(v) Obligations of the responsible
party. The party to the transaction that is
required to determine whether a transaction
is a section 871(m) transaction must also
determine and report to the counterparty or
customer the timing and amount of any div-
idend equivalent (as described in paragraphs
(i) and (j) of this section). Except as other-
wise provided in paragraph (n)(3) of this
section, the party required to make the de-

terminations described in this paragraph is
required to exercise reasonable diligence to
determine whether a transaction is a section
871(m) transaction, the amount of any div-
idend equivalents, and any other informa-
tion necessary to apply the rules of this
section. The information must be provided
in the manner prescribed in paragraphs
(p)(2) and (p)(3) of this section. The deter-
minations required by paragraph (p) of this
section are binding on the parties to the
potential section 871(m) transaction and on
any person who is a withholding agent with
respect to the potential section 871(m) trans-
action unless the person knows or has rea-
son to know that the information received is
incorrect. The determinations are not bind-
ing on the Commissioner.

* * * * *

(4) * * *

(iii) Recordkeeping required for certain
options. With respect to any option to which
paragraph (g)(4) of this section applies, con-
temporaneous documentation is not re-
quired to be retained provided that there is a
pre-existing documented methodology that
is sufficient to permit the delta for the trans-
action to be verified at a later time.

(5) [Reserved]. For further guidance,
see § 1.871-15T(p)(5).

(q) Dividend and dividend equivalent
payments to a qualified derivatives deal-
er-(1) In general. Except as otherwise
provided in this paragraph (q), a qualified
derivatives dealer described in § 1.1441-
1(e)(6) that receives a payment (within the
meaning of paragraph (i) of this section)
of a dividend equivalent in its equity de-
rivatives dealer capacity will not be liable
for tax under section 881 on that dividend
equivalent, provided that the qualified de-
rivatives dealer complies with its obliga-
tions under the qualified intermediary
agreement described in §§ 1.1441-1(e)(5)
and 1.1441-1(e)(6). A qualified deriva-
tives dealer is liable for tax under section
881(a)(1) on its section 871(m) amount
for each dividend on each underlying se-
curity. This tax liability is reduced (but
not below zero) by the amount of tax paid
by the qualified derivatives dealer under
section 881(a)(1) on dividends it receives
with respect to that underlying security on
that same dividend in its capacity as an
equity derivatives dealer. In addition, a
qualified derivatives dealer is liable for tax
under section 881(a)(1) for all dividend

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

equivalents it receives that are not received
in its equity derivatives dealer capacity. A
qualified derivatives dealer also is liable for
tax under section 881(a)(1) for all dividends
it receives, other than dividends received in
2017 in its equity derivatives dealer capac-
ity. This paragraph does not apply for a
qualified derivatives dealer that is a foreign
branch of a United States financial institu-
tion (within the meaning of § 1.1471-5(e)).

(2) Transactions on the books of an
equity derivatives dealer. Transactions
properly reflected in a qualified deriva-
tives dealer's equity derivatives dealer
book are presumed to be held by the
dealer in its equity derivatives dealer ca-
pacity for purposes of determining the
qualified derivatives dealer's tax liability.
For purposes of determining whether a
dealer is acting in its equity derivatives
dealer capacity, only the dealer's activities
as an equity derivatives dealer are taken
into account. Accordingly, for purposes of
this paragraph (q), a dividend or dividend
equivalent is treated as received by a qual-
ified derivatives dealer acting in its non-
equity derivatives dealer capacity if the
dividend or dividend equivalent is re-
ceived by a qualified derivatives dealer
acting as a proprietary trader.

(3) Section 871(m) amount. For each
dividend on each underlying security, the
section 871(m) amount is the product of:

(i) The qualified derivatives dealer's net
delta exposure to the underlying security for
the applicable dividend, multiplied by;

(ii) The applicable dividend amount per
share.

(4) Net delta exposure. The net delta
exposure to an underlying security is the
amount (measured in number of shares)
by which (A) the aggregate number of
shares of an underlying security that the
qualified derivatives dealer has exposure
to as a result of positions in the underlying
security (including as a result of owning
the underlying security) with values that
move in the same direction as the under-
lying security (the long positions) exceeds
(B) the aggregate number of shares of an
underlying security that the qualified de-
rivatives dealer has exposure to as a result
of positions in the underlying security
with values that move in the opposite di-
rection from the underlying security (the
short positions). The net delta exposure
calculation only includes long positions

and short positions that the qualified de-
rivatives dealer holds in its equity deriva-
tives dealer capacity (as described in para-
graph (q)(2) of this section). Any long
positions or short positions that are treated
as effectively connected with the qualified
derivatives dealer's conduct of a trade or
business in the United States for U.S. fed-
eral income tax purposes are excluded
from the net delta exposure computation.
The net delta exposure to an underlying
security is determined at the end of the
day on the date provided in § 1.871-
15(j)(2) for the applicable dividend. For
purposes of this calculation, net delta must
be determined in a commercially reason-
able manner. If a qualified derivatives
dealer calculates net delta for non-tax busi-
ness purposes, the net delta ordinary will be
the delta used for that purpose, subject to the
modifications required by this definition.
Each qualified derivatives dealer must de-
termine its net delta exposure separately
only taking into account transactions that
are recognized and are attributable to that
qualified derivatives dealer for U.S. federal
income tax purposes.

(5) Examples. The following examples
illustrate the rules of this paragraph (q):

Example 1. Forward contract entered into by a
foreign equity derivatives dealer. (i) Facts. FB is a
foreign bank that is a qualified intermediary that acts as
a qualified derivatives dealer. On April 1, Year 1, FB
enters into a cash settled forward contract initiated by a
foreign customer (Customer) that entitles Customer to
receive from FB all of the appreciation and dividends
on 100 shares of Stock X, and obligates Customer to
pay FB any depreciation on 100 shares of Stock X, at
the end of three years. FB hedges the forward contract
by entering into a total return swap contract with a
domestic broker (U.S. Broker) and maintains the swap
contract as a hedge for the duration of the forward
contract. The swap contract entitles FB to receive an
amount equal to all of the dividends on 100 shares of
Stock X and obligates FB to pay an amount referenced
to a floating interest rate each quarter, and also entitles
FB to receive from or pay to U.S. Broker, as the case
may be, the difference between the value of 100 shares
of Stock X at the inception of the swap and the value of
100 shares of Stock X at the end of 3 years. Stock X
pays a quarterly dividend of $0.25 per share. At the end
of the day on the date provided in paragraph (j)(2) of
this section for the dividend, FB owns the forward
contract and total return swap; FB does not own any
shares of Stock X or any other transactions that refer-
ence Stock X. FB provides valid documentation to U.S.
Broker that FB will receive payments under the swap
contract in its capacity as a qualified derivatives dealer,
and FB contemporaneously enters both the swap con-
tract with U.S. Broker and the forward contract with
Customer on its equity derivatives dealer books.

(ii) Application of rules. At the end of the day on
the date provided in paragraph (j)(2) of this section

for the dividend, FB is a long party on a delta one
contract (the total return swap) and a short party on
a delta one contract (the forward contract with Cus-
tomer). Pursuant to § 1.1441-1(b)(4)(xxii), U.S.
Broker is not obligated to withhold on the dividend
equivalent payments to FB on the swap contract that
are referenced to Stock X dividends because U.S.
Broker has received valid documentation that it may
rely upon to treat the payment as made to FB acting
as a qualified derivatives dealer. Pursuant to para-
graph (q)(1) of this section, FB is not liable for tax
under sections 871(m) and 881 on the payments it
receives from U.S. Broker referenced to Stock X
dividends because FB's net delta exposure with re-
spect to 100 shares of Stock X is zero at the end of
the day on the date provided in paragraph (j)(2) of
this section for the dividend. The net delta exposure
is zero because the taxpayer has 100 shares of Stock
X long position exposure as a result of the total
return swap that is reduced by 100 shares of Stock X
short position exposure as a result of the forward
contract. FB is required to withhold on dividend
equivalent payments to Customer on the forward
contract in accordance with § 1.1441-2(e)(7).

Example 2. At-the-money option contract entered
into by a foreign equity derivatives dealer. (i) Facts.
The facts are the same as Example 1, but Customer
purchases from FB an at-the-money call option on
100 shares of Stock X with a term of one year. The
call option has a delta of 0.5, and FB hedges the call
option by entering into a total return swap that ref-
erences 50 shares of Stock X with U.S. Broker. At
the end of the day on the date provided in paragraph
(j)(2) of this section for the dividend, the call option
has a delta of 0.6, FB hedges the call option with a
total return swap that references 60 shares of Stock
X with U.S. Broker, and FB has no shares of Stock
X or other transactions that reference Stock X.

(ii) Application of rules. At the end of the day on
the date provided in paragraph (j)(2) of this section for
the dividend, FB is a long party on 60 shares of Stock
X through the total return swap and a short party on an
option. Because the option has a delta of less than 0.8
at the calculation time, it is not a section 871(m) trans-
action. Therefore, there will be no dividend equivalent
payments made by FB to Customer that are subject to
withholding. Pursuant to § 1.1441-1(b)(4)(xxii), U.S.
Broker is not obligated to withhold on the dividend
equivalents with respect to Stock X paid to FB because
U.S. Broker has received valid documentation that it
may rely upon to treat the dividend equivalents as paid
to FB acting as a qualified derivatives dealer. The net
delta exposure is zero at the end of the day on the date
provided in paragraph (j)(2) of this section for the
dividend because FB has a long position of 60 shares as
a result of the total return swap, which is reduced by
FB's short position of 60 shares as a result of the
option.

Example 3. In-the-money option contract entered
into by a foreign equity derivatives dealer. (i) Facts.
The facts are the same as Example 2, but Customer
purchases from FB an in-the-money call option on
100 shares of Stock X with a term of one year. The
call option has a delta of 0.8 and FB hedges the call
option by purchasing 80 shares of Stock X, which
are held in an account with U.S. Broker, who also
acts as paying agent. The price of Stock X declines
substantially and the option lapses unexercised. At

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

the end of the day on the date provided in paragraph
(j)(2) of this section for the dividend, the call option
has a delta of 0.48 and FB has reduced its hedge to
50 shares of Stock X with U.S. Broker. In addition,
on that date, FB owns no other shares of Stock X or
any other transactions that reference Stock X in its
equity derivatives dealer capacity.

(ii) Application of rules. At the end of the day on
the date provided in paragraph (j)(2) of this section
for the dividend, FB is a long party on 50 shares of
Stock X and a short party on an option. Because the
option has a delta of 0.8 at the calculation time, it is
a section 871(m) transaction. Therefore, FB is re-
quired to withhold on dividend equivalent payments
to Customer on the option contract in accordance
with § 1.1441-2(e)(7). U.S. Broker is required to
withhold on the Stock X dividends paid to FB.
Assuming that FB is a qualified resident of a country
that provides withholding on dividends at a 15 per-
cent rate, U.S. Broker is required withhold on the
dividends with respect to the 50 shares of stock held
by FB. FB's net delta exposure is two shares of
Stock X at the end of the day on the date provided in
paragraph (j)(2) of this section because FB has a
long position of 50 shares , reduced by FB's short
position of 48 shares as a result of the option. FB's
section 881 tax on the $0.50 (two shares multiplied

by a dividend of $0.25 per share) is reduced (but not
below zero) by the section 881 tax amount paid by
qualified derivatives dealer on the 50 shares. There-
fore, FB's section 871(m) amount is zero.

(r) * * *

(3) Effective/applicability date for
paragraphs (d)(2) and (e). Paragraphs
(d)(2) and (e) of this section apply to any
payment made on or after January 1,
2017, with respect to any transaction with
a delta of one issued on or after January 1,
2017. Paragraphs (d)(2) and (e) of this
section apply to any payment made on or
after January 1, 2018, with respect to any
other transaction issued on or after Janu-
ary 1, 2018. Notwithstanding the prior
sentence, paragraphs (d)(2) and (e) of this
section will apply to any payments made
on or after January 1, 2020, with respect
to the exchange-traded notes issued on or
after January 1, 2017, that are identified in
a separate notice, and not payments made
before January 1, 2020, with respect to
those notes. Notwithstanding the first sen-

tence of this paragraph (r)(3), paragraphs
(d)(2) and (e) of this section do not apply
to payments made in 2017 to a qualified
derivatives dealer in its equity derivatives
dealer capacity to hedge transactions that
have a delta of less than one.

(4) Effective/applicability date for para-
graphs (c)(2)(iv), (h), and (q) of this section.
Paragraphs (c)(2)(iv), (h), and (q) of this
section apply to payments made on or after
January 1, 2017.

(5) Effective/applicability date for para-
graphs (g)(4)(ii)(B), (p)(1)(ii) through (iv),
and (p)(5) of this section. [Reserved]. For
further guidance, see § 1.871-15T(r)(5).

##### § 1.871-15 [Amended]

Par. 3. For each section listed in the table,
remove the language in the "Remove" col-
umn and add in its place the language in the
"Add" column as set forth below:

Section

Remove

Add

§ 1.871-15(a)(3)

section 316.

section 316 (even if there is no actual distribution of cash or property).

§ 1.871-15(a)(5)

the time the NPC or ELI is issued,

the calculation time for the NPC or ELI,

§ 1.871-15(a)(14)(ii)(B), newly

issuance

the calculation time

designated third sentence

§ 1.871-15(a)(15), first sentence

a payment with respect to

§ 1.871-15(c)(1) introductory text

paragraph (2)

paragraph (c)(2) of this section

§ 1.871-15(c)(1)(i)

references the payment of a dividend

references a dividend

§ 1.871-15(c)(1)(ii)

references the payment of a dividend

references a dividend

§ 1.871-15(c)(1)(iii)

references the payment of a dividend

references a dividend

§ 1.871-15(c)(2)(i), first sentence and second sentence

section 871

section 871(a)

§ 1.871-15(d)(2)(i)

when the NPC is issued

at the calculation time for the NPC

§ 1.871-15(d)(2)(ii)

when the NPC is issued

at the calculation time for the NPC

§ 1.871-15(e)(1)

when the ELI is issued

at the calculation time for the ELI

§ 1.871-15(e)(2)

when the ELI is issued

at the calculation time for the ELI

§ 1.871-15(i)(1)

references the payment of a dividend

references a dividend

§ 1.871-15(i)(2)(i)

estimated payment of dividends

estimated dividend

§ 1.871-15(i)(2)(ii)

estimated dividend payment

estimated dividend

§ 1.871-15(i)(2)(iii), first sentence and second sentence

the time the transaction is issued

the calculation time

§ 1.871-15(i)(2)(iii), last sentence

to pay a dividend

to have a dividend

§ 1.871-15(j)(1)(i)

each underlying security

each dividend on an underlying security

§ 1.871-15(j)(1)(ii) introductory text

each underlying security

each dividend on an underlying security

§ 1.871-15(j)(1)(iii) introductory text

each underlying security

each dividend on an underlying security

§ 1.871-15(1)(1), first sentence

The purpose of this section

The purpose of this paragraph (l)

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

Section

Remove

Add

§ 1.871-15(1)(1), second sentence § 1.871-15(1)(7)

described in this paragraph. references a security (for example, stock in an exchange-traded fund)

described in this paragraph (l). references an exchange-traded fund

§ 1.871-15(m)(2)(ii), first sentence

at the time the potential 871(m) transaction referencing that partner- ship interest is issued

at the calculation time for the potential section 871(m) transaction referencing that partnership interest

§ 1.871-15(m)(2)(ii), first sentence

paragraph (m)(2)(i).

paragraph (m)(2)(i) of this section.

§ 1.871-15(n)(4)(iii), heading and first sentence

less than

fewer than

§ 1.871-15(p)(4)(ii)

10 business days of the date the potential section 871(m) transaction is issued.

10 business days of the date containing the calculation time for the potential section 871(m) transaction.

§ 1.871-15(r)(4), heading

paragraphs (c)(2)(iv), (h), and (q)

paragraphs (g)(4)(ii)(B), (p)(1)(ii) through (iv), and (p)(5)

Par. 4. Revise § 1.871-15T to read as
follows:

§ 1.871-15T Treatment of dividend
equivalents (temporary).

(a) [Reserved]. For further guidance,
see § 1.871-15(a).

(1) Broker. A broker is a broker within
the meaning provided in section 6045(c),
except that the term does not include any
corporation that is a broker solely because
it regularly redeems its own shares.

(a)(2) through (g)(4)(ii)(A) [Reserved].
For further guidance, see § 1.871-15(a)(2)
through (g)(4)(ii)(A).

(B) A foreign securities exchange that:

(1) Is regulated or supervised by a gov-
ernmental authority of the country in
which the market is located;

(2) Has trading volume, listing, financial
disclosure, surveillance, and other require-
ments designed to prevent fraudulent and
manipulative acts and practices, to remove
impediments to and perfect the mechanism
of a free and open, fair and orderly market,
and to protect investors, and the laws of the
country in which the exchange is located
and the rules of the exchange ensure that
those requirements are actually enforced;

(3) Has rules that effectively promote
active trading of listed options on the ex-
change; and

(4) Has an average daily trading vol-
ume on the exchange exceeding $10 bil-
lion during the immediately preceding
calendar year. If an exchange in a foreign
country has more than one tier or market
level on which listed options may be sep-

arately listed or traded, each tier or market
level is treated as a separate exchange.

(g)(5) through (p)(1)(i) [Reserved]. For
further guidance, see § 1.871-15(g)(5)
through (p)(1)(i).

(ii) Transactions with multiple brokers.
For a potential section 871(m) transaction
in which both the short party and an agent
or intermediary acting on behalf of the
short party are a broker or dealer, the short
party must determine whether the poten-
tial section 871(m) transaction is a section
871(m) transaction. For a potential section
871(m) transaction in which the short
party is not a broker or dealer and more
than one agent or intermediary acting on
behalf of the short party is a broker or
dealer, the broker or dealer that is a party
to the transaction and closest to the short
party in the payment chain must deter-
mine whether the potential section 871(m)
transaction is a section 871(m) transac-
tion. For a potential section 871(m) trans-
action in which neither the short party nor
any agent or intermediary acting on behalf
of the short party is a broker or dealer, and
the long party and an agent or intermedi-
ary acting on behalf of the long party are
a broker or dealer, or more than one agent
or intermediary acting on behalf of the
long party is a broker or dealer, the broker
or dealer that is a party to the transaction
and closest to the long party in the pay-
ment chain must determine whether the
potential section 871(m) transaction is a
section 871(m) transaction.

(iii) Responsible party for transactions
traded on an exchange and cleared by a
clearing organization. Except as provided

in paragraph (p)(1)(iv) of this section, for a
potential section 871(m) transaction that is
traded on an exchange and cleared by a
clearing organization, and for which more
than one broker-dealer acts as an agent or
intermediary between the short party and a
foreign payee, the broker or dealer that has
an ongoing customer relationship with the
foreign payee with respect to that transac-
tion (generally the clearing firm) must de-
termine whether the potential section
871(m) transaction is a section 871(m)
transaction.

(iv) Responsible party for certain struc-
tured notes, warrants, and convertible in-
struments. When a potential section 871(m)
transaction is a structured note, warrant,
convertible stock, or convertible debt, the
issuer is the party responsible for determin-
ing whether a potential section 871(m)
transaction is a section 871(m) transaction.

(p)(1)(v) through (p)(4) [Reserved]. For
further guidance, see § 1.871-15(p)(1)(v)
through (p)(4).

(5) Example. The following example illus-
trates the rules of paragraph (p) of this section:

Example 1. CO is a domestic clearing organiza-
tion and is not a broker as defined in § 1.871-
15(a)(1). CO serves as a central counterparty clear-
ing and settlement service provider for derivatives
exchanges in the United States. EB and CB are
brokers organized in the United States and members
of CO. FC, a foreign corporation, instructs EB to
execute the purchase of a call option that is a spec-
ified ELI (as described in § 1.871-15(e)). EB effects
the trade for FC on the exchange and then, as in-
structed by FC, transfers the option to CB to be
cleared with CO. The exchange matches FC's order
with an order for a written call option with the same
terms and then sends the matched trade to CO, which
clears the trade. CB and the clearing member repre-
senting the person who sold the call option settle the

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

trade with CO. Upon receiving the matched trade,
the option contracts are novated and CO becomes the
counterparty to CB and the counterparty to the clear-
ing member representing the person who sold the
call option. Both EB and CB are broker-dealers
acting on behalf of FC for a potential section 871(m)
transaction. Under paragraph (p)(1)(iii) of this sec-
tion, however, only CB is required to make the
determinations described in § 1.871-15(p).

(q) through (r)(4) [Reserved]. For further
guidance, see § 1.871-15(r)(1) through (4).

(5) Effective/applicability date. This
section applies to payments made on or
after on January 19, 2017.

(s) Expiration date. This section ex-
pires January 17, 2020.

Par. 5. Section 1.1441-1 is amended by:

1\. Revising paragraphs (b)(4)(xxii),
(e)(3)(ii)(E),(e)(5),and (e)(6).

2\. Adding a new sentence to the end
of paragraph (e)(2)(i).

3\. Adding new paragraph (f)(5).

The additions and revisions read as
follows:

§ 1.1441-1 Requirement for the deduction
and withholding of tax on payments to
foreign persons.

* * * * *

(b) * * *

(4) * * *

(xxii) Certain payments to qualified de-
rivatives dealers (as described in para-
graph (e)(6) of this section). For purposes
of this withholding exemption, the quali-
fied derivatives dealer must furnish to the
withholding agent the documentation de-
scribed in paragraph (e)(3)(ii) of this sec-
tion. A withholding agent that makes a
payment to a qualified intermediary that is
acting as a qualified derivatives dealer is
not required to withhold on the following
payments if the withholding agent can re-
liably associate the payment with a valid
qualified intermediary withholding certif-
icate as described in paragraph (e)(3)(ii)
of this section, including the certification
described in paragraph (e)(3)(ii)(E):

(A) A payment with respect to a poten-
tial section 871(m) transaction that is not
an underlying security;

(B) A payment of a dividend equiva-
lent; or

(C) A payment of a dividend in 2017.
* * * * *

(e) * * *

(2) * * *

(i) * * * For purposes of a qualified
intermediary acting as a qualified deriva-
tives dealer, a qualified intermediary with-
holding certificate, as described in para-
graph (e)(3)(ii) of this section is a
beneficial owner withholding certificate
for purposes of treaty claims for divi-
dends.

* * * * *

(3) * * *

(ii) * * *

(E) In the case of any payment with
respect to a potential section 871(m)
transaction (including any dividend equiv-
alent payment within the meaning of
§ 1.871-15(i)) or underlying security (as
defined in § 1.871-15(a)(15)) received by
a qualified intermediary acting as a qualified
derivatives dealer, a certification that the
home office or branch receiving the pay-
ment, as applicable, meets the requirements
to act as a qualified derivatives dealer as
further described in paragraph (e)(6) of this
section and that the qualified derivatives
dealer assumes primary withholding and re-
porting responsibilities under chapters 3, 4,
and 61, and section 3406 with respect to any
payments it makes with respect to potential
section 871(m) transactions;
* * * * *

(5) Qualified intermediaries-(i) In
general. A qualified intermediary, as de-
fined in paragraph (e)(5)(ii) of this sec-
tion, may furnish a qualified intermediary
withholding certificate to a withholding
agent. The withholding certificate pro-
vides certifications on behalf of other per-
sons for the purpose of claiming and ver-
ifying reduced rates of withholding under
section 1441 or 1442 and for the purpose
of reporting and withholding under other
provisions of the Code, such as the provi-
sions under chapter 61 and section 3406
(and the regulations under those provi-
sions), or for the qualified derivative
dealer (if applicable). Furnishing such a
certificate is in lieu of transmitting to a
withholding agent withholding certificates
or other appropriate documentation for the
persons for whom the qualified intermedi-
ary receives the payment, including inter-
est holders in a qualified intermediary that
is fiscally transparent under the regula-
tions under section 894. Although the
qualified intermediary is required to ob-
tain withholding certificates or other ap-
propriate documentation from beneficial

owners, payees, or interest holders pursu-
ant to its agreement with the IRS, it is
generally not required to attach such doc-
umentation to the intermediary withhold-
ing certificate. Notwithstanding the pre-
ceding sentence, a qualified intermediary
must provide a withholding agent with the
Forms W-9, or disclose the names, ad-
dresses, and taxpayer identifying num-
bers, if known, of those U.S. non-exempt
recipients for whom the qualified interme-
diary receives reportable amounts (within
the meaning of paragraph (e)(3)(vi) of this
section) to the extent required in the qual-
ified intermediary's agreement with the
IRS. When a qualified intermediary is act-
ing as a qualified derivatives dealer, the
withholding certificate entitles a withhold-
ing agent to make payments with respect
to potential section 871(m) transactions
that are not underlying securities and div-
idend equivalent payments on underlying
securities to the qualified derivatives
dealer free of withholding. A withholding
agent is required to withhold on all other
U.S. source FDAP payments made to a
qualified derivatives dealer as required by
applicable law. Paragraph (e)(6) of this
section contains detailed rules prescribing
the circumstances in which a qualified in-
termediary can act as a qualified deriva-
tives dealer. A person may claim qualified
intermediary status before an agreement is
executed with the IRS if it has applied for
such status and the IRS authorizes such
status on an interim basis under such pro-
cedures as the IRS may prescribe.

(ii) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(ii).

(A) Through (C) [Reserved]. For addi-
tional guidance, see § 1.1441-1T(e)(5)
(ii)(A)-(C).

(D) A foreign person that is a home
office or has a branch that is an eligible
entity as described in paragraph (e)(6)(ii)
of this section, without regard to the re-
quirement that the person be a qualified
intermediary; or

(E) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(ii)(E).

(iii) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(iii).

(iv) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(iv).

(v) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(v).

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

(A) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(v)(A).

(B) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(v)(B).

(1) - (3) [Reserved]. For additional guid-
ance, see § 1.1441-1T(e)(5)(v)(B)(1)-(3).

(4) If a qualified intermediary is acting
as a qualified derivatives dealer, designate
the accounts:

(i) For which the qualified derivatives
dealer is receiving payments with respect
to potential section 871(m) transactions or
underlying securities as a qualified deriv-
atives dealer;

(ii) For which the qualified derivatives
dealer is receiving payments with respect
to potential section 871(m) transactions
(and that are not underlying securities) for
which withholding is not required;

(iii) For which qualified derivatives
dealer is receiving payments with respect
to underlying securities for which with-
holding is required; and

(iv) If applicable, identifying the home
office or branch that is treated as the
owner for U.S. income tax purposes; and

(6) Qualified derivatives dealers-(i)
In general. To act as a qualified deriva-
tives dealer under a qualified intermediary
withholding agreement, the home office or
branch that is a qualified intermediary
must be an eligible entity as described in
paragraph (e)(6)(ii) of this section and, in
accordance with the qualified intermedi-
ary agreement, must-

(A) Furnish to a withholding agent a
qualified intermediary withholding certif-
icate (described in paragraph (e)(3)(ii) of
this section) that indicates that the home
office or branch receiving the payment is a
qualified derivatives dealer with respect to
the payments associated with the with-
holding certificate;

(B) Agree to assume the primary with-
holding and reporting responsibilities, in-
cluding the documentation provisions under
chapters 3, 4, and 61, and section 3406, the
regulations under those provisions, and
other withholding provisions of the Internal
Revenue Code, for payments made as a
qualified derivatives dealer with respect to
potential section 871(m) transactions. For
this purpose, a qualified derivatives dealer is
required to obtain a withholding certificate
or other appropriate documentation from
each counterparty to whom the qualified
derivatives dealer makes a reportable pay-

ment (including a dividend equivalent pay-
ment within the meaning of § 1.871-15(i)).
The qualified derivatives dealer is also re-
quired to determine whether any payment it
makes with respect to a potential section
871(m) transaction is, in whole or in part, a
dividend equivalent;

(C) Agree to remain liable for tax un-
der section 881, if any, on any payment
with respect to a potential section 871(m)
transaction (including a dividend equiva-
lent payment within the meaning of
§ 1.871-15(i)) and underlying securities
(including dividends) it receives as a qual-
ified derivatives dealer, or in the case of
dividend equivalents received in the eq-
uity derivatives dealer capacity, the taxes
required pursuant to § 1.871-15(q);

(D) Comply with the compliance re-
view procedures applicable to a qualified
intermediary that acts as a qualified deriv-
atives dealer under the qualified interme-
diary withholding agreement, which will
specify the time and manner in which a
qualified derivatives dealer must:

(1) Certify to the IRS that it has com-
plied with the obligations to act as a qual-
ified derivatives dealer (including its per-
formance of a periodic review applicable
to a qualified derivatives dealer);

(2) Report to the IRS any amounts sub-
ject to reporting on Forms 1042-S (in-
cluding dividend equivalent payments that
it made);

(3) Report to the IRS on the appropriate
U.S. tax return, its tax liabilities, including
its tax liability pursuant to § 1.871-15(q)(1)
and any other taxes on payments with re-
spect to potential section 871(m) transac-
tions or underlying securities as defined in
§ 1.871-15(a)(15) it receives; and

(4) Respond to inquiries from the IRS
about obligations it has assumed as a qual-
ified derivatives dealer in a timely manner;

(E) Agree to act as a qualified derivatives
dealer for all payments made as a principal
with respect to potential section 871(m)
transactions and all payments received as a
principal with respect to potential section
871(m) transactions and underlying securi-
ties as defined in § 1.871-15(a)(15) (includ-
ing dividend equivalent payments within the
meaning of § 1.871-15(i)), excluding any
payments made or received by the qualified
derivatives dealer to the extent the payment
is treated as effectively connected with the
conduct of a trade or business within the

United States within the meaning of section
864, and not act as a qualified derivatives
dealer for any other payments. For purposes
of this paragraph (E), any securities lending
or sale-repurchase transaction that the qual-
ified intermediary enters into that is a sec-
tion 871(m) transaction is treated as entered
into as a principal unless the qualified inter-
mediary determines that it is acting as an
intermediary with respect to that transac-
tion; and

(F) Each home office or branch must
qualify and be approved for qualified de-
rivatives dealer status and must represent
itself as a QDD on its Form W-8IMY and
separately identify the home office or
branch as the recipient on a withholding
statement (if necessary). The home office
means a foreign person, excluding any
branches of the foreign person, that ap-
plies for qualified derivatives dealer sta-
tus. Each home office or branch that ob-
tains qualified derivatives dealer status
must be treated as a separate qualified
derivatives dealer.

(ii) Definition of eligible entity. An el-
igible entity is a home office or branch
that is a qualified intermediary and that,
treating the home office or branch as a
separate entity, is-

(A) An equity derivatives dealer subject
to regulatory supervision as a dealer by a
governmental authority in the jurisdiction in
which it was organized or operates;

(B) A bank or bank holding company
subject to regulatory supervision as a bank
or bank holding company (as applicable)
by a governmental authority in the juris-
diction in which it was organized, or op-
erates or an entity that is wholly-owned
(directly or indirectly) by a bank or bank
holding company subject to regulatory su-
pervision as a bank or bank holding com-
pany (as applicable) by a governmental
authority in the jurisdiction in which the
bank or bank holding company (as appli-
cable) was organized or operates and that
in its equity derivatives dealer capacity-

(1) Issues potential section 871(m)
transactions to customers; and

(2) Receives dividends with respect to
stock or dividend equivalent payments
pursuant to potential section 871(m) trans-
actions that hedge potential section 871(m)
transactions that it issued;

(C) A foreign branch of a U.S. financial
institution, if the foreign branch would meet

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

the requirements of paragraph (A) or (B) of
this section if it were a separate entity; or

(D) Any person otherwise acceptable
to the IRS.

* * * * *

(f) * * *

(5) Effective/applicability date. Para-
graphs (e)(5)(ii)(D) and (e)(5)(v)(B)(4) of
this section apply to payments made on or
after on January 19, 2017.

Par. 6. Section 1.1441-1T is amended by:

1\. Redesignating paragraph (e)(5)(ii)(D)
as paragraph (e)(5)(ii)(E), redesignating
paragraph (e)(5)(v)(B)(4) as paragraph
(e)(5)(v)(B)(5) and adding new paragraphs
(e)(5)(ii)(D) and (e)(5)(v)(B)(4).

2\. Revising paragraphs (e)(3)(ii)(E),
(e)(5)(i), (e)(5)(v)(B)(4), and (e)(6).

3\. Removing the language "Except for
paragraphs (e)(3)(ii)(E) and (e)(6), this
section" from the first sentence of para-
graph (f)(3) and adding in its place "This
section", and removing the third sentence
in paragraph (f)(3), and

4\. Removing the language "Except for
paragraphs (e)(3)(ii)(E) and (e)(6), the ap-
plicability" from the first sentence of para-
graph (g) and adding in its place "The
Applicability" and removing the second
sentence in paragraph (g).

§ 1.1441-1T Requirement for the
deduction and withholding of tax on
payments to foreign persons (temporary).

** * * *

(e) * * *

(3) * * *

(ii) * * *

(E) [Reserved]. For additional guid-
ance, see § 1.1441-1(e)(3)(ii)(E).

* * * * *

(5) Qualified Intermediaries-(i) [Re-
served]. For additional guidance, see
§ 1.1441-1(e)(5)(i).

(ii) * * *

(D) [Reserved]. For additional guid-
ance, see § 1.1441-1(e)(5)(ii)(D).

* * * * *

(v) * * *

(B) * * *

(4) [Reserved]. For additional guid-
ance, see § 1.1441-1(e)(5)(v)(B)(4).

** * * *

(6) [Reserved]. For additional guid-
ance, see § 1.1441-1(e)(6).

* * * * *

Par. 7. Section 1.1441-2 is amended by:

1\. Revising paragraphs (e)(7)(i) and
(e)(7)(ii).

2\. Removing "paragraph (e)(8)(ii)(A)"
from paragraph (e)(7)(iii) and add-
ing in "paragraph (e)(7)(ii)(A)" in
its place.

3\. Adding paragraphs (e)(7)(iv) through
(ix).

4\. Revising the last sentence of para-
graph (f)(1) and adding a new last
sentence.

The revisions and additions read as
follows:

§ 1.1441-2 Amounts subject to
withholding.

* * * * *

(e) * * *

(7) Payments of dividend equiva-
lents-(i) In general. Subject to para-
graphs (e)(7)(iv), (vi), and (vii) of this
section, a payment of a dividend equiva-
lent is not considered to be made until the
later of when-

(A) The amount of a dividend equiva-
lent is determined as provided in § 1.871-
15(j)(2), and

(B) A payment occurs with respect to
the section 871(m) transaction after the
amount of a dividend equivalent is deter-
mined as provided in § 1.871-15(j)(2).

(ii) Payment. For purposes of para-
graph (e)(7) of this section, a payment
occurs with respect to a section 871(m)
transaction when-

(A) Money or other property is paid to or
by the long party, unless the section 871(m)
transaction is described in § 1.871-15(i)(3), in
which case a payment is treated as being made
at the end of the applicable calendar quarter;

(B) The long party sells, exchanges,
transfers, or otherwise disposes of the sec-
tion 871(m) transaction (including by set-
tlement, offset, termination, expiration,
lapse, or maturity); or

(C) The section 871(m) transaction is
transferred to an account that is not main-
tained by the withholding agent or the
long party terminates the account relation-
ship with the withholding agent.

* * * * *

(iv) Option to withhold on dividend pay-
ment date. A withholding agent may with-
hold on the payment date described in para-
graph (e)(4) of this section for the applicable
dividend on the underlying security (the div-

idend payment date) if it withholds on that
date for all section 871(m) transactions of
the same type (securities lending or sale-
repurchase transaction, NPC, or ELI) and
satisfies the requirements to paragraph
(e)(7)(v) of this section.

(v) Changes to time of withholding.
This paragraph describes how a withhold-
ing agent changes the time that it with-
holds on a dividend equivalent payment to
a time described in paragraph (e)(7)(i) or
(iv) of this section and these requirements
must be satisfied for a withholding agent
to change the time it withholds. A with-
holding agent must apply the change con-
sistently to all transactions of the same
type entered into on or after the change.
For transactions of the same type entered
into before the change, a withholding
agent must withhold under the original
approach throughout the term of the trans-
action. When a withholding agent changes
the time that it will withhold, the with-
holding agent must notify each payee in
writing that it will withhold using the ap-
proach described in paragraph (e)(7)(i) or
(iv) of this section, as applicable, before
the time for determining the payee's first
dividend equivalent payment (as deter-
mined under § 1.871-15(j)(2)). With re-
spect to transactions held by an interme-
diary or foreign flow-through entity, a
withholding agent is treated as providing
notice to each payee holding that transac-
tion through the entity when it notifies the
intermediary or foreign flow-through en-
tity of the time it will withhold, as de-
scribed in the preceding sentence, pro-
vided that the intermediary or foreign
flow-through entity agrees to provide the
same notice to each payee. The withhold-
ing agent must attach a statement to its
relevant income tax return (filed by the
due date, including extensions) for the year
of the change notifying the IRS of the
change and when it applies, identifying
the types of section 871(m) transaction to
which the change applies, and certifying
that has notified its payees. For purposes
of this paragraph, a withholding agent will
be considered to have entered into a trans-
action on the first date the withholding
agent becomes responsible for withhold-
ing on the transaction (based on the rule in
paragraph (e)(7)(ix) of this section).

(vi) Withholding by qualified derivatives
dealers. A withholding agent that is acting

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

as a qualified derivatives dealer must with-
hold with respect to a dividend equivalent
payment on the payment date described in
paragraph (e)(4) of this section for the ap-
plicable dividend on the underlying security
and must notify each payee in writing that it
will withhold on the dividend payment date
before the time for determining the payee's
first dividend equivalent payment (as deter-
mined under § 1.871-15(j)(2)).

(vii) Withholding with respect to deriv-
atives that reference partnerships. To the
extent that a withholding agent is required
to withhold with respect to a partnership
interest described in § 1.871-15(m), the
liability for withholding arises on March
15 of the year following the year in which
the payment of a dividend equivalent (de-
termined under § 1.871-15(i)) occurs.

(viii) Notification to holders of with-
holding timing. If a withholding agent is
required to notify a payee of when it will
withhold under paragraph (e)(7)(v) of this
section, it may use the reporting methods
prescribed in § 1.871-15(p)(3)(i).

(ix) Withholding agent responsibility. A
withholding agent is only responsible for
dividend equivalent amounts determined (as
provided in § 1.871-15(j)(2)) during the pe-
riod the withholding agent is a withholding
agent for the section 871(m) transaction.
* * * * *

(f) * * * (1) Except as otherwise pro-
vided in this paragraph, paragraph (e)(7)
of this section applies to payments made
on or after September 18, 2015. Para-
graphs (e)(7)(ii)(D) and (e)(7)(iv) through

(viii) of this section apply to payments
made on or after January 19, 2017.

Par. 8. Section 1.1441-7 is amended by:

1\. Revising Example 7 in paragraph
(a)(3).

2\. Adding Example 8 and 9 to para-
graph (a)(3).

3\. Adding a sentence to the end of
paragraph (a)(4).

The additions read as follows:

§ 1.1441-7 General provisions relating
to withholding agents.

(a) * * *

(3) * * *

Example 7. CO is a domestic clearing organiza-
tion. CO serves as a central counterparty clearing and
settlement service provider for derivatives exchanges in
the United States. CB is a broker organized in Country
X, a foreign country, and a clearing member of CO. CB
is a nonqualified intermediary, as defined in § 1.1441-
1(c)(14). FC is a foreign corporation that has an ac-
count with CB. FC instructs CB to purchase a call
option that is a specified ELI (as described in § 1.871-
15(e)). CB effects the trade for FC on the exchange.
The exchange matches FC's order with an order for a
written call option with the same terms. The exchange
then sends the matched trade to CO, which clears the
trade. CB and the clearing member representing the
person who sold the call option settle the trade with
CO. Upon receiving the matched trade, the option
contracts are novated and CO becomes the counter-
party to CB and the counterparty to the clearing mem-
ber representing the person who sold the call option. To
the extent that there is a dividend equivalent with
respect to the call option, both CO and CB are with-
holding agents as described in paragraph (a)(1) of this
section. As a withholding agent, CO and CB must each
determine whether it is obligated to withhold under
chapter 3 of the Internal Revenue Code and the regu-
lations thereunder.

Example 8. FCO is a foreign clearing organization.
FCO serves as a central counterparty clearing and set-
tlement service provider for derivatives exchanges in
Country A, a foreign country. CB is a broker organized
in Country A, and a clearing member of FCO. CB is a
nonqualified intermediary, as defined in § 1.1441-
1(c)(14). FC is a foreign corporation that has an ac-
count with CB. FC instructs CB to purchase a call
option that is a section 871(m) transaction. CB effects
the trade for FC on the exchange. The exchange
matches FC's order with an order for a written call
option with the same terms. The exchange then sends
the matched trade to FCO, which clears the trade. CB
and the clearing member representing the call option
seller settle the trade with FCO. Upon receiving the
matched trade, the option contracts are novated and
FCO becomes the counterparty to CB and the counter-
party to the clearing member representing the call op-
tion seller. To the extent that there is a dividend equiv-
alent with respect to the call option, both FCO and CB
are withholding agents as described in paragraph (a)(1)
of this section.

Example 9. The facts are the same as Example 8,
except that CB is a qualified intermediary, as defined
in § 1.1441-1(c)(15), that has assumed the primary
obligation to withhold, deposit, and report amounts
under chapters 3 and 4 of Internal Revenue Code.
CB provides a written statement to FCO representing
that it has assumed primary withholding responsibil-
ity for any dividend equivalent payment with respect
to the call option. FCO, therefore, is not required
withhold on a dividend equivalent payment to CB.

(4) * * * Example 8 and Example 9 of
paragraph (a)(3) of this section apply to pay-
ments made on or after January 19, 2017.
* * * * *

###### § 1.1461-1 [Amended]

Par. 9. For each section listed in the table,
remove the language in the "Remove" col-
umn and add in its place the language in the
"Add" column as set forth below:

Section

Remove

Add

§ 1.1461-1(c)(2)(i) introductory text, fourth sentence

a withholding agent withheld an amount

a withholding agent withheld (including under § 1.1441-2(e)(7)) an amount

§ 1.1461-1(c)(2)(i)(M)

references the payment of a dividend

references a dividend

§ 1.1461-1(c)(2)(ii)(J)

or (xxiii);

or (xxiii). This exception does not apply to withholding agents that are qualified derivatives dealers;

John Dalrymple Deputy Commissioner for Services and Enforcement.

Mark J. Mazur Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on January 19, 2017, 4:15 p.m., and published in the issue of the Federal Register for January 24, 2017, 82 F.R. 8144)

Approved: January 11, 2017

26 CFR 1.7704-4: Qualifying income - mineral and natural resources

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

<!-- PageHeader="T.D. 9817" -->

## DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

## Qualifying Income from Activities of Publicly Traded Partnerships With Respect to Minerals or Natural Resources

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-
nal regulations under section 7704(d)
(1)(E) of the Internal Revenue Code
(Code) relating to the qualifying income
exception for publicly traded partnerships
to not be treated as corporations for Fed-
eral income tax purposes. Specifically,
these regulations define the activities that
generate qualifying income from explora-
tion, development, mining or production,
processing, refining, transportation, and
marketing of minerals or natural re-
sources. These regulations affect publicly
traded partnerships and their partners.

DATES: Effective Date: These regula-
tions are effective January 19, 2017.

Applicability Date: For dates of appli-
cability, see § 1.7704-4(g).

FOR FURTHER INFORMATION CON-
TACT: Caroline E. Hay, (202) 317-5279
(not a toll-free number).

SUPPLEMENTARY INFORMATION:
Background

This document contains amendments
to 26 CFR part 1 under section 7704(d)
(1)(E) of the Code relating to qualifying
income from certain activities with re-
spect to minerals or natural resources.

Congress enacted section 7704 as part
of the Omnibus Budget Reconciliation
Act of 1987 (Section 10211(a), Public
Law 100-203, 101 Stat. 1330 (1987)).
The following year, Congress clarified
section 7704 in the Technical and Miscel-
laneous Revenue Act of 1988 (Section
2004(f), Public Law 100-647, 102 Stat.

3342 (1988)). Section 7704(a) provides
that, as a general rule, publicly traded
partnerships (PTPs) will be treated as cor-
porations for Federal income tax pur-
poses. In section 7704(c), Congress pro-
vided an exception to this rule if 90
percent or more of a PTP's gross income
is "qualifying income." Qualifying in-
come is generally passive-type income,
such as interest, dividends, and rent. Sec-
tion 7704(d)(1)(E) provides, however,
that qualifying income also includes in-
come and gains derived from the explora-
tion, development, mining or production,
processing, refining, transportation, or
marketing of minerals or natural re-
sources.

There has been no prior guidance that
PTPs can rely on that defines the specific
activities that generate qualifying income
in the mineral and natural resource indus-
tries. In order to obtain certainty that in-
come from their activities constitutes
qualifying income under section 7704(d)
(1)(E), PTPs have sought opinion letters
from legal counsel or private letter rulings
(PLRs) from the IRS. For the first 20 years
in which the legislation has been in force,
demand for PLRs under section 7704(d)
(1)(E) was minimal. The IRS issued only
a few letters each year and often none.
More recently, however, demand for
PLRs has increased sharply, and in 2013,
the IRS received more than 30 PLR re-
quests under section 7704(d)(1)(E).

The increase in PLR requests has been
driven by a combination of factors. First,
legal counsel have told the Department of
the Treasury (Treasury Department) and
the IRS that they are reluctant to issue
opinion letters unless a certain activity
was clearly contemplated by Congress,
which has required PTPs to seek PLRs as
their activities expand beyond more tradi-
tional qualifying activities, for example be-
cause of technological advances, deconsoli-
dation, and specialization. Second, investor
demand for higher yields has increased the
incentive to push for an expanded definition
of qualifying income through PLR requests
concerning novel or non-traditional activi-
ties. See Todd Keator, "Hydraulically Frac-
turing" Section 7704(d)(1)(E) - Stimulating
Novel Sources of "Qualifying Income" for
MLPs, 29 Tax Mgmt. Real Est. J. 223, 227
(2013). Third, a PLR may not be used as
precedent, requiring each PTP to obtain its

own PLR for activities similar to those of a
competitor. See section 6110(k)(3).

Absent regulatory guidance prescrib-
ing a uniform framework for determining
which activities generate qualifying in-
come, the IRS has historically reviewed
PLR requests one-by-one as they have
arisen and without the benefit of codified
or regulatory principles demarcating the
outer boundary of activities that Congress
intended to generate qualifying income.
PLR requests often seek approval not only
for activities that have been approved in a
competitor's PLR, but also for additional
activities similar to, but marginally differ-
ent from, activities approved in earlier
PLRs. The absence of regulatory guidance
can make it difficult for the IRS to distin-
guish between such activities, creating the
potential for treating similarly situated
taxpayers differently or expanding the
scope of qualifying income beyond what
Congress intended. This risk of expansion
persists and increases in the absence of
regulatory guidance.

Given the increased demand for PLRs,
the responsibility to treat all taxpayers
equally, and the desire to apply section
7704(d)(1)(E) consistent with congressio-
nal intent, the Treasury Department and
the IRS determined there was a clear pub-
lic need for guidance in this area. In
March 2014, the IRS announced a pause
in issuing PLRs under section 7704(d)
(1)(E), which it lifted on March 6, 2015.
On May 6, 2015, the Treasury Department
and the IRS published a notice of pro-
posed rulemaking (REG-132634-14) in
the Federal Register (80 FR 25970) pro-
viding guidance on whether income from
activities with respect to minerals or nat-
ural resources is qualifying income under
section 7704(d)(1)(E). On June 18, 2015,
the Treasury Department and the IRS pub-
lished in the Federal Register (80 FR
34856) several non-substantive correc-
tions to the proposed regulations.

The Treasury Department and the IRS
received numerous written and electronic
comments in response to the proposed
regulations. All comments are available at
www.regulations.gov. The Treasury De-
partment and the IRS held a public hear-
ing on the proposed regulations on Octo-
ber 27, 2015. In addition, the Treasury
Department and the IRS met with industry
representatives and worked extensively

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

with IRS engineers specializing in petro-
leum, mining, and forestry to understand
the relevant industries. The many com-
ments, hearing, and meetings were invalu-
able in understanding the technical
aspects of exploration, development, min-
ing and production, processing, refining,
transportation, and marketing of minerals
and natural resources, and how these final
regulations can best provide needed guid-
ance. After consideration of all of the
comments received, including the com-
ments made at the hearing, the proposed
regulations are adopted as final regula-
tions as revised by this Treasury decision.
In general, these final regulations follow
the approach of the proposed regulations
with some modifications based on the rec-
ommendations made in public comments.
This preamble describes the comments re-
ceived by the Treasury Department and
the IRS and the revisions made.

These final regulations are divided into
seven parts. The first part establishes the
basic rule that qualifying income includes
income and gains from qualifying activi-
ties with respect to minerals or natural
resources. Qualifying activities are either
"section 7704(d)(1)(E) activities" or "in-
trinsic activities." The second part defines
"mineral or natural resource" consistent
with the definition set forth in section
7704(d)(1) of the Code. The third part
defines and identifies the specific compo-
nent activities that are included in each of
the section 7704(d)(1)(E) activities, that
is, exploration, development, mining or
production, processing, refining, transpor-
tation, and marketing. Where necessary,
component activities are listed by type
of mineral or natural resource. The
fourth part provides rules for determin-
ing whether activities that are not section
7704(d)(1)(E) activities are nonetheless
intrinsic activities, which are those that
are specialized, essential, and require sig-
nificant services by the PTP with respect
to a section 7704(d)(1)(E) activity. The
fifth and sixth parts provide, respectively,
a rule regarding interpretations of sections
611 and 613 of the Code (dealing with
depletion of minerals and natural re-
sources) in relation to § 1.7704-4 and
examples illustrating the provisions in
§ 1.7704-4. Finally, the last part provides
that the final regulations apply to income
received by a partnership in a taxable year

beginning on or after January 19, 2017,
but also contains a 10-year transition pe-
riod for certain PTPs.

## Summary of Comments and Explanation of Revisions

### I. General Interpretation of Congressional Intent

These final regulations prescribe a uni-
form framework for determining which
mineral and natural resource activities
generate qualifying income based on the
statutory language and congressional in-
tent as interpreted by the Treasury Depart-
ment and the IRS. In relevant part, section
7704(d)(1)(E) provides merely that "in-
come and gains derived from the explora-
tion, development, mining or production,
processing, refining, transportation (in-
cluding pipelines transporting gas, oil, or
products thereof), or the marketing of any
mineral or natural resource (including fer-
tilizer, geothermal energy, and timber)" is
qualifying income. The limited statutory
text supplies only one relevant defini-
tion-for "mineral or natural resource."
See section 7704(d)(1). The legislative
history regarding the specific text at issue
is likewise brief and susceptible to differ-
ent interpretations, as demonstrated by the
comment letters received.

Although the statute and the legislative
history do not provide definitions or a
clear demarcation of the eight active terms
and industry experts disagree on the scope
of these terms, certain guiding principles
can be gleaned. First, the Treasury De-
partment and the IRS regard as particu-
larly significant the fact that Congress
passed section 7704 in whole to restrict
the growth of PTPs, which it viewed as
eroding the corporate tax base. See H.R.
Rep. No. 100-391, at 1065 (1987) ("The
recent proliferation of publicly traded
partnerships has come to the committee's
attention. The growth in such partnerships
has caused concern about long-term ero-
sion of the corporate tax base.") Congress
expressed alarm that the changes enacted
in the Tax Reform of Act of 1986 that
reflected their intent to preserve the cor-
porate level of tax were "being circum-
vented by the growth of publicly traded
partnerships that are taking advantage of
an unintended opportunity for disincorpo-
ration and elective integration of the cor-

porate and shareholder levels of tax." Id.
at 1066. Congress made an exception for
passive-type income and "certain types of
natural resources" because "special con-
siderations appl[ied]." Id. at 1066, 1069.
Well-established statutory construction
principles direct that, because section
7704(d)(1)(E) was an exception to the
general rule, it should be read narrowly.
See, for example, Comm'r v. Jacobson,
336 U.S. 28, 49 (1949) ("The income
taxed is described in sweeping terms and
should be broadly construed in accor-
dance with an obvious purpose to tax in-
come comprehensively. The exemptions,
on the other hand, are specifically stated
and should be construed with restraint in
the light of the same policy.").

Second, the eight listed active terms in
section 7704(d)(1)(E) represent stages in
the extraction of minerals or natural re-
sources and the eventual offering of cer-
tain products for sale. A mineral or natural
resource may be explored for and, if
found, is developed, mined or produced,
processed, refined, transported, and ulti-
mately marketed. Manufacturing is not an
activity referenced in the statute, although
as some might argue, processing and re-
fining are forms of manufacturing. The
omission of manufacturing is significant
especially in light of other directives from
the legislative history. Most importantly,
the Conference Committee Report pro-
vides, by example, an endpoint to activi-
ties the income from which would be
qualifying, by indicating that "[o]il, gas,
or products thereof are not intended to
encompass oil or gas products that are
produced by additional processing beyond
that of petroleum refineries or field facil-
ities, such as plastics or similar petroleum
derivatives." H.R. Rep. No. 100-495, at
947 (1987). The Treasury Department and
the IRS have interpreted this language to
mean that Congress did not intend to in-
clude extended processing or manufactur-
ing activities beyond getting an extracted
mineral or natural resource to market in a
form in which those products are gener-
ally sold.

This interpretation is reinforced by
Congress's explanation in the legislative
history that natural resources were granted
an exception to the general rule of corpo-
rate taxation in section 7704 because the
activities in those industries "have com-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

monly or typically been conducted in part-
nership form, and the committee considers
that disruption of present practices in such
activities is currently inadvisable due to
general economic conditions in these in-
dustries." H.R. Rep. No. 100-391, at
1066 (1987). The committees responsible
for drafting the legislation had previously
held three days of hearings dedicated to
reviewing the use and taxation of master
limited partnerships (MLPs), another term
for PTPs, and heard multiple witnesses
discuss the use of partnerships and joint
ventures to raise capital for oil and gas
exploration, the difference between in-
vesting in wasting natural resource assets
and investing in active businesses, the
price of commodities, and the importance
of natural resource development to the
nation's security. See, for example, Mas-
ter Limited Partnerships: Hearings Before
the H. Subcomm. on Select Revenue Mea-
sures of the Comm. on Ways and Means,
100th Cong. 10 and 189 (1987) (statement
of J. Roger Mentz, Asst. Sec. for Tax
Policy, U.S. Dep't of the Treasury, ex-
pressing concern that the rise in MLPs
was "not limited to passive ownership or
wasting assets such as oil and gas or nat-
ural resource properties," but instead were
"increasingly being used for active busi-
ness enterprises," and statement of Chris-
topher L. Davis, President, Investment
Partnership Association, explaining that
"[o]il and gas exploration and develop-
ment are among the riskiest of business
ventures," but that partnerships had been
"an economical way to share the risks").
See also Master Limited Partnerships:
Hearing before the S. Subcomm. on
Taxation and Debt Management of the
Comm. on Finance, 100th Cong. 90
(1987) (statement of James R. Moffett,
CEO, Freeport-McMoran, Inc., stating
that the "commodities in this country have
been decimated" and that the mining and
natural resources businesses must be com-
pletely rebuilt). There was no testimony
about the need to protect manufacturing
industries.

These principles have informed the
scope and approach of these final regula-
tions and the responses to commenters in
this Summary of Comments and Explana-
tion of Revisions. The Treasury Depart-
ment and the IRS have concluded that in
using general terms without technical def-

initions, Congress did not intend a uni-
form definition of such terms across all
minerals and natural resources. Rather,
Congress meant to capture those activities
customary to each industry that move a
depletable asset to a point at which it is
commonly sold, and did not mean to in-
clude those activities that create a new or
different product through further, ex-
tended processing or manufacturing. Ac-
cordingly, these final regulations describe
as qualifying income the income and gains
from the activities performed to produce
products typically found at field facilities
and petroleum refineries or the equivalent
for other natural resources, certain transpor-
tation and marketing activities with respect
to those products, and intrinsic service ac-
tivities that are specialized, essential, and
require significant services with respect to
exploration, development, mining and pro-
duction, processing, refining, transportation,
and marketing.

### II. Definition of Mineral or Natural Resource

In section 7704(d)(1), Congress de-
fined the term "mineral or natural re-
source" as "any product of a character
with respect to which a deduction for de-
pletion is allowable under section 611;
except that such term shall not include any
product described in subparagraph (A) or
(B) of section 613(b)(7)." Products de-
scribed in section 613(b)(7)(A) and (B)
are soil, sod, dirt, turf, water, mosses, and
minerals from sea water, the air, or other
similar inexhaustible sources. The pro-
posed regulations adopted, almost verba-
tim, this same definition, but also specif-
ically included fertilizer, geothermal
energy, and timber in the definition of
mineral or natural resource, and explained
that the regulations did not address indus-
trial source carbon dioxide, fuels de-
scribed in section 6426(b) through (e), any
alcohol fuel defined in section 6426(b)
(4)(A), or any biodiesel fuel as defined in
section 40A(d)(1).

Many commenters recommended that
the definition of mineral or natural re-
source be expanded to include not only
products of a character with respect to
which a deduction for depletion is allow-
able under section 611, but also "products
thereof." These commenters believed

Congress intended the definition of min-
eral or natural resource to be read expan-
sively, citing to the 1987 legislative his-
tory, which provides that: "[N]atural
resources include fertilizer[,] geothermal
energy, and timber, as well as oil, gas or
products thereof. . . . For this purpose, oil,
gas, or products thereof means gasoline,
kerosene, number 2 fuel oil, refined lubri-
cating oils, diesel fuel, methane, butane,
propane, and similar products which are
recovered from petroleum refineries or
field facilities." H.R. Rep. No. 100-495,
at 946-947 (1987). The significance of
these commenters' expansive definition is
that, under this view, so long as a product
was depletable at the time of its produc-
tion or extraction, it remains a "product
thereof" throughout its processing, refin-
ing, transportation, and marketing. Under
this theory, a depletable product does not
lose its status as a mineral or natural re-
source by being processed or refined, and
can therefore be further processed or re-
fined without limitation.

These final regulations do not adopt this
recommendation. As originally passed in
1987, section 7704(d)(1)(E) did not define
the term mineral or natural resource. Con-
gress added the definition in 1988 (one year
after the 1987 legislative history cited by the
commenters) as part of the Technical and
Miscellaneous Revenue Act of 1988. It is
that same statutory definition added by Con-
gress that these final regulations adopt al-
most word for word. Moreover, in the stat-
utory text, the phrase "products thereof" is
used only in a parenthetical describing
transportation. See section 7704(d)(1)(E)
("income and gains derived from the . . .
transportation (including pipelines trans-
porting gas, oil, or products thereof)"). The
1988 legislative history likewise used the
phrase "products thereof" in a limited man-
ner, that is only when describing transpor-
tation and marketing. See, for example,
H.R. Rep. No. 100-1104(II), at 17 (1988)
("In the case of transportation activities with
respect to oil and gas and products thereof"')
and S. Rep. 100-445, at 424 (1988) ("With
respect to the marketing of minerals and
natural resources (e.g., oil and gas and prod-
ucts therefof [sic])"). Finally, defining min-
eral and natural resource without including
products thereof is the most logical interpre-
tation of the statute, taking into account the
enumerated activities the statute contem-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

plates to be undertaken with respect to those
minerals or natural resources. One does not
explore for gasoline, kerosene, or number 2
fuel oil, for example; rather, one explores
for the depletable product, such as crude oil
or natural gas. Once that crude oil or natural
gas has been refined or processed, however,
Congress intended to make clear that the
"products thereof" (the gasoline, kerosene,
number 2 fuel oil, etc.) could be transported
and marketed and still give rise to qualifying
income.

Commenters cautioned, however, that
the Treasury Department and the IRS
should take into account the words "of a
character" in the definition of mineral or
natural resource and the additional legis-
lative history from 1988. That legislative
history explained: "The reference in the
bill to products for which a depletion
deduction is allowed is intended only to
identify the minerals or natural re-
sources and not to identify what income
from them is treated as qualifying in-
come. Consequently, whether income is
taken into account in determining per-
centage depletion under section 613
does not necessarily determine whether
such income is qualifying income under
section 7704(d)." S. Rep. No. 100-445,
at 424 (1988). Commenters expressed
the concern that the Treasury Depart-
ment and the IRS would interpret the
statutory definition to require those per-
forming qualifying activities to have
started with a depletable product them-
selves or otherwise be eligible to claim
depletion deductions under section 611.

The Treasury Department and the IRS
agree with the commenters that the defi-
nition of mineral or natural resource under
section 7704(d)(1) does not require con-
tinual ownership or control of the deplet-
able asset from extraction through each of
the eight listed active terms, but that qual-
ifying activities can take place beginning
at different points along that progression
of activities described by the active terms
by those who purchase, take control of, or
merely perform section 7704(d)(1)(E) ac-
tivities with respect to partially processed
or refined minerals or natural resources.
Compare with §§ 1.611-1(b) and (c) and
1.613-1(a) (providing that annual deple-
tion deductions are allowed only to the
owner of an economic interest in mineral
deposits or standing timber). In adding the

definition of minerals or natural resources
to section 7704(d)(1), Congress meant to
delineate the type of asset involved, and
not to require any particular type of con-
trol or ownership of the property. See
H.R. Rep. No. 100-1104(II), at 16 (1988)
("the Senate amendment includes as qual-
ifying income of publicly traded partner-
ships the income from any depletable
property (rather than from property eligi-
ble for percentage depletion. . . )"). The
definitions of the eight listed active terms
in these final regulations contemplate that
qualifying income may arise from certain
activities that may be performed on prod-
ucts altered by earlier qualifying activi-
ties.

In addition to the income and gains
derived from certain activities related to
minerals or natural resources, Congress
expanded section 7704(d)(1)(E) in 2008
to include income and gains from certain
activities related to industrial source car-
bon dioxide, fuels described in section
6426(b) through (e), alcohol fuel defined
in section 6426(b)(4)(A), or biodiesel fuel
as defined in section 40A(d)(1) as quali-
fying income. Because the IRS has not
received many PLR requests related to
these products, the preamble to the pro-
posed regulations asked whether guidance
is needed with respect to those activities
and, if so, the specific items the guidance
should address. In response, commenters
suggested that although liquefied natural
gas (LNG) and liquefied petroleum gas
(LPG) are included within those fuels de-
scribed in section 6426(b), they should
also be specifically identified as natural
resources under section 7704(d)(1)(E). In
the alternative, commenters requested that
the final regulations treat the liquefaction
and regasification of natural gas as part of
transportation.

These final regulations do not list LNG
and LPG as natural resources since they
are not a mineral or natural resource under
the definition provided by Congress. Nei-
ther LNG nor LPG is found in mines,
wells, or other natural deposits listed in
section 611, but each is instead a result of
processing or refining petroleum or natu-
ral gas, as well as of activities to prepare
the processed or refined product for stor-
age and transportation. The Treasury De-
partment and the IRS thus agree with
commenters that liquefaction and regasifi-

cation of natural gas may be part of trans-
portation as further discussed in section
III.E of this Summary of Comments and
Explanation of Revisions. Therefore,
these final regulations include liquefying
or regasifying natural gas on the list of
qualifying transportation activities. Be-
cause the Treasury Department and the
IRS received no other comments seeking
guidance with respect to industrial source
carbon dioxide, fuels described in section
6426(b) through (e), alcohol fuel defined
in section 6426(b)(4)(A), or biodiesel fuel
as defined in section 40A(d)(1), these final
regulations do not provide any further
guidance with respect to those items.

### III. Section 7704(d)(1)(E) Activities

#### A. Replacement of exclusive list

The proposed regulations provided that
qualifying income included only income
and gains from qualifying activities,
which were defined to include section
7704(d)(1)(E) activities and intrinsic ac-
tivities. The proposed regulations further
provided an exclusive list of operations
that comprised the section 7704(d)(1)(E)
activities. Although the list could be ex-
panded by the Commissioner through notice
or other forms of published guidance, the
proposed regulations specifically stated that
"[n]o other activities qualify as section
7704(d)(1)(E) activities."

Numerous commenters objected to
the use of an exclusive list of section
7704(d)(1)(E) activities. They argued that
a static list would ignore technological
advances in the dynamic mineral and nat-
ural resource industries and doubted the
ability of the Treasury Department and the
IRS to expeditiously issue guidance up-
dating the list when needed. One com-
menter noted that an exclusive list is ap-
propriate only when the universe of
matters to be included or excluded is
known, defined, considered, and catego-
rized. The commenter questioned whether
the Treasury Department and the IRS are
aware of all of the current activities taking
place in the mineral and natural resource
industries. Illustrating these concerns,
many commenters cited examples of ac-
tivities they believed were omitted from
the list (either through inadvertence or
lack of knowledge). Rather than an exclu-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

sive list, some commenters recommended
that the final regulations provide a general
description of the eight listed active terms
in section 7704(d)(1)(E) (that is, explora-
tion, development, mining or production,
processing, refining, transportation, and
marketing), followed by a non-exclusive
list of examples of qualifying activities
and, where appropriate, non-qualifying
activities. They suggested that such a list
would provide helpful guidance to PTPs,
while allowing other activities to be
treated as qualifying, including through
the issuance of PLRs.

Recognizing the practical difficulties
of ensuring comprehensive coverage of
the activities generating qualifying in-
come, the Treasury Department and the
IRS agree with commenters that the list of
section 7704(d)(1)(E) activities should not
be exclusive. Therefore, these final regu-
lations provide a general definition of
each of the eight listed active terms in
section 7704(d)(1)(E) followed by a non-
exclusive list of examples of each. The
Treasury Department and the IRS antici-
pate that by setting forth the known activ-
ities that generate qualifying income, the
guidance will be clearer and, as a result,
the number of PLR requests the IRS re-
ceives will decrease. At the same time, the
Treasury Department and the IRS do not
intend that these final regulations be inter-
preted or applied in an expansive manner.
Instead, they should be interpreted and
applied in a manner that is consistent with
their plain meaning and the overall intent
of Congress to restrict this exception to
treatment as a corporation under section
7704(a) as described in section I of this
Summary of Comments and Explanation
of Revisions.

#### B. Exploration and development

The proposed regulations defined ex-
ploration as an activity performed to as-
certain the existence, location, extent, or
quality of any deposit of mineral or natu-
ral resource before the beginning of the
development stage of the natural deposit
by: (1) drilling an exploratory or strati-
graphic type test well; (2) conducting drill
stem and production flow tests to verify
commerciality of the deposit; (3) conduct-
ing geological or geophysical surveys; or
(4) interpreting data obtained from geo-

logical or geophysical surveys. For min-
erals, exploration also included testpitting,
trenching, drilling, driving of exploration
tunnels and adits, and similar types of
activities described in Rev. Rul. 70-287
(1970-1 CB 146), if conducted prior to
development activities with respect to the
minerals.

Separately, the proposed regulations
defined development as an activity per-
formed to make minerals or natural re-
sources accessible by: (1) drilling wells to
access deposits of minerals or natural re-
sources; (2) constructing and installing
drilling, production, or dual purpose plat-
forms in marine locations, or any similar
supporting structures necessary for ex-
traordinary non-marine terrain (such as
swamps or tundra); (3) completing wells,
including by installing lease and well
equipment, such as pumps, flow lines,
separators, and storage tanks, so that wells
are capable of producing oil and gas and
the production can be removed from the
premises; (4) performing a development
technique such as, for minerals, stripping,
benching and terracing, dredging by dra-
gline, stoping, and caving or room-and-
pillar excavation, and for oil and natural
gas, fracturing; or (5) constructing and
installing gathering systems and custody
transfer stations.

One commenter noted that the pro-
posed regulations provided a workable
definition of exploration and development
activities consistent with past standards of
industry practice, but did not allow for
changes in technologies developed in the
future. Another commenter recommended
expanding the list to include any activity
the payment for which is: (1) a geological
or geophysical cost under section 167(h);
(2) an intangible drilling cost under sec-
tion 263(c); or (3) a mine exploration or
development cost under section 616(a) or
617(a). According to the commenter, the
benefit of such a rule is that the relevant
industries understand the costs covered by
those Code provisions and the law in the
area is well developed.

The only change made to the defini-
tions of exploration and development in
these final regulations is the addition of
the word "including" to show that the list
of activities is not exclusive, as discussed
in section III.A of this Summary of Com-
ments and Explanation of Revisions.

These final regulations do not adopt the
suggestion to include as a qualifying ac-
tivity all services giving rise to costs un-
der section 167(h), 263(c), 616(a), or
617(a). Some of the activities are already
specifically included in the definitions of
section 7704(d)(1)(E) activities, but oth-
ers would expand the list of qualifying
activities beyond that intended by Con-
gress and allow service-provider PTPs to
circumvent the intrinsic test in § 1.7704-
4(d). As discussed in section I of this
Summary of Comments and Explanation
of Revisions, Congress enacted section
7704 to restrict the growth of PTPs due to
"concern about long-term erosion of the
corporate tax base." H.R. Rep. No. 100-
391, at 1065 (1987). Congress made an
exception for natural resource activities in
part because it recognized the fragile eco-
nomic conditions in those industries at the
time. Id. at 1066. Although Congress in-
tended to benefit oil and gas developers, it
did not intend to exempt, for example,
construction and debris removal compa-
nies, suppliers, or other non-specialized
service providers to those industries. In-
tangible drilling costs, for example, in-
clude amounts paid for fuel, repairs, haul-
ing, and supplies. See §§ 1.263(c)-1 and
1.612-4(a). Although these costs may be
necessarily incurred by oil and gas devel-
opers, that does not mean that a third-
party service provider that receives pay-
ment for those services is performing
activities giving rise to qualifying income.

#### C. Mining or production

The proposed regulations defined min-
ing or production as an activity performed
to extract minerals or other natural re-
sources from the ground by: (1) operating
equipment to extract natural resources
from mines and wells; or (2) operating
equipment to convert raw mined products
or raw well effluent to substances that can
be readily transported or stored (for exam-
ple, passing crude oil through mechanical
separators to remove gas, placing crude
oil in settling tanks to recover basic sedi-
ment and water, dehydrating crude oil,
and operating heater-treaters that separate
raw oil well effluent into crude oil, natural
gas, and salt water).

Generally, commenters sought to ex-
pand the definition of mining or produc-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

tion. They suggested that the regulations
adopt the definition of mining from sec-
tion 613, which includes not only the ex-
traction of ores or minerals from the
ground but also certain mining processes.
See section 613(c)(2). Similarly, com-
menters suggested that the regulations de-
fine production to include not only the
extraction of oil or natural gas from the
well but also certain processing activities
that occur post-production up to the "de-
pletion cut-off point" established under
sections 611 and 613. These commenters
explained that the explicit reference in
section 7704(d)(1) to the depletion rules
in section 611 should be interpreted as
meaning that all the terms in 7704(d)
(1)(E) should be defined the same as the
terms in section 611. A consequence of
expanding the definition of mining or pro-
duction to include certain processing ac-
tivities, commenters reasoned, is that the
definition of processing for purposes of
section 7704(d)(1)(E) would necessarily
encompass something more, further ex-
panding qualifying activities as discussed
in section III.D.3 of this Summary of
Comments and Explanation of Revisions
(concerning processing and refining of
ores and minerals other than crude oil and
natural gas). Finally, one commenter
noted that, in addition to mining from the
ground, minerals and natural resources
can be extracted from waste deposits or
residue from prior mining, and that such
extraction should also be treated as min-
ing or production. See section 613(c)(3)
and § 1.613-4(i).

These final regulations do not adopt the
suggestion to expand the definition of
mining or production to include mining
processes or other processing activities
before the depletion cut-off point. Instead,
these final regulations clarify the proposed
regulations' definition of mining or pro-
duction activities to include only extrac-
tion activities. In addition, the final regu-
lations move activities that convert raw
mined products or raw well effluent into
products that can be readily transported or
stored to the definition of processing. As a
result, qualifying processing activities are
included under the definition of process-
ing in these final regulations. In its en-
tirety, section 7704(d)(1)(E) covers a
broader category of income than and con-
templates a different end point of activi-

ties from those of sections 611 and 613,
and therefore the definitions of mining
and production are not interchangeable
between the two regimes. Sections 611
and 613 describe what is gross income
from the exhaustion of capital assets for
purposes of applying the depletion rules.
See section 611(a) and United States v.
Cannelton Sewer Pipe Co., 364 U.S. 76,
81-85 (1960). For purposes of section
613, mining, an upstream activity, gener-
ally includes those treatments normally
applied to prepare an extracted mineral or
natural resource to the point at which it is
first marketable (which may involve a
limited amount of processing and trans-
portation), but no further. See section
613(c)(2). In contrast, section 7704(d)
(1)(E) separately lists certain upstream,
midstream, and downstream activities, en-
compassing a progression of stages of ac-
tivities performed upon a mineral or nat-
ural resource up to the point at which
products are typically produced at field
facilities and petroleum refineries or the
equivalent for other natural resources, as
well as transportation and marketing
thereafter. It would therefore be duplica-
tive to define mining to include both min-
ing and mining processes as defined in
section 613 for purposes of section
7704(d)(1)(E). The reference in section
7704(d)(1) to section 611 merely defines
the scope of included minerals and natural
resources as discussed in section II of this
Summary of Comments and Explanation
of Revisions. Nothing in the statute indi-
cates that other concepts in section 611
and 613 are intended to be incorporated as
well.

These final regulations adopt the re-
quest that mining or production be defined
to include the extraction of minerals or
natural resources from the waste deposits
or residue of prior mining or production.
The recycling of scrap or salvaged metals
or minerals from previously manufactured
products or manufacturing processes,
however, is not considered to be the ex-
traction of ores or minerals from waste or
residue, and therefore does not give rise to
qualifying income.

#### D. Processing and refining

The proposed regulations combined
the activities of processing and refining

together in one definition that included
both a general definition followed by spe-
cific rules for different categories of nat-
ural resources (natural gas, petroleum,
ores and minerals, and timber). The vast
majority of the comments received on the
proposed regulations concerned the defi-
nition of processing or refining, address-
ing issues related to both the general def-
inition and specific rules. Section III.D.1
of this Summary of Comments and Expla-
nation of Revisions addresses the com-
ments related to the general definition.
Sections III.D.2 through III.D.4 of this
Summary of Comments and Explanation
of Revisions address comments related to
the specific rules.

##### 1. General Definition

The general definition of processing
and refining in the proposed regulations
stated that, except as otherwise provided,
an activity was processing or refining if
done to purify, separate, or eliminate im-
purities, but would not qualify if: (1) the
PTP did not use a consistent Modified Ac-
celerated Cost Recovery System (MACRS)
class life for assets used in the activity
(the MACRS consistency requirement);
(2) the activity caused a substantial phys-
ical or chemical change in a mineral or
natural resource (the physical and chemi-
cal change limitation); or (3) the activity
transformed the extracted mineral or nat-
ural resource into a new or different min-
eral product or into a manufactured prod-
uct (the manufacturing limitation).

#### a. Separate definitions for processing and refining

Multiple commenters argued that the
proposed regulations' use of a joint defi-
nition for processing and refining wrongly
read the term "processing" out of the stat-
ute. These commenters reasoned that Con-
gress used a comma between the terms to
indicate that each term must be accorded
significance and effect, in contrast to the
"or" between mining (for ores and miner-
als) or production (for natural gas and
crude oil), which described the same ac-
tivity but with respect to different indus-
tries. Commenters noted that the version
of the legislation that passed in the House
did not include the term processing.

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

Rather, it was added in conference and
therefore must mean that the two terms
are not synonymous. While some com-
menters admitted that it is not uncommon
in the industry to use the words processing
and refining interchangeably to refer to
the same activities, they maintained that
Congress intended to include a broader
range of activities than either word alone
would allow.

Although the Treasury Department and
the IRS have determined that the terms
can overlap, these final regulations adopt
the suggestion of defining processing and
refining separately in order to better clar-
ify what activities generate qualifying in-
come under section 7704(d)(1)(E). These
final regulations generally define process-
ing for purposes of section 7704(d)(1)(E)
as an activity performed to convert raw
mined or harvested products or raw well
effluent to substances that can be readily
transported or stored as further described
in the specific rules for the different cate-
gories of natural resources. This definition
captures the processing that is generally
performed at the wellhead, mine, field fa-
cilities, or other location where mining
processes are generally applied, as de-
scribed in § 1.613-4(f)(1)(iii), because
the legislative history contemplates that
qualifying activities do not include activ-
ities that create products through addi-
tional processing beyond that of petro-
leum refineries or field facilities.

These final regulations do not provide
a general definition of refining, but instead
set forth the activities that qualify as re-
fining activities under the specific rules
for the different categories of natural re-
sources. Consistent with the discussion in
section III.D.1.e of this Summary of Com-
ments and Explanation of Revisions, the
Treasury Department and the IRS have
concluded that refining does not have gen-
eral application to all minerals and natural
resources.

## b. MACRS consistency requirement

Commenters argued that the require-
ment in the proposed regulations that a
PTP use a consistent MACRS class life
for assets generating qualifying income as
a result of being used for processing or
refining has no statutory support and
would create uncertainty for PTPs and

their investors. They stressed that it would
be inappropriate to deny qualifying in-
come treatment to a PTP whose activities
met the definition of processing or refin-
ing merely because it, or a processor or
refiner further upstream, failed to use the
appropriate MACRS class life. Comment-
ers also challenged the idea that the asset
class lives in Rev. Proc. 87-56 (1987-2
CB 674) are helpful in distinguishing be-
tween qualifying and non-qualifying ac-
tivities. Commenters raised similar con-
cerns regarding the discussion of the
North American Industry Classification
System (NAICS) codes in the preamble of
the proposed regulations to give examples
of qualifying activities.

The proposed regulations included a
MACRS requirement because the Trea-
sury Department and the IRS believed
MACRS provided a useful demarcation of
those processing and refining activities
typically performed by a field facility or a
refinery, as compared to non-qualifying
processing activities performed further
downstream from those activities, such as
petrochemical manufacturing or the man-
ufacturing of pulp and paper. Compare,
for example, Rev. Proc. 87-56, asset class
13.3 (Petroleum Refining) and asset class
28.0 (Manufacture of Chemicals); also,
asset class 24.1 (Cutting of Timber) and
asset class 26.1 (Manufacture of Pulp and
Paper). In addition, the IRS released Rev.
Proc. 87-56 six months before the passage
of section 7704, making that demarcation
contemporaneous with section 7704. Af-
ter consideration of the comments received
on this issue, however, the Treasury Depart-
ment and the IRS are persuaded that the
MACRS class lives are not comprehensive
nor sufficiently detailed for every industry.
Accordingly, these final regulations do not
include a MACRS consistency requirement.
Nor do these final regulations reference the
NAICS codes. Notwithstanding the lack of a
MACRS consistency requirement, MACRS
or NAICS codes nevertheless may provide
useful insight when determining whether an
activity generates qualifying income as pro-
vided in these final regulations.

### c. Physical and chemical change limitation

Many commenters contended that the
physical and chemical change limitation

in the proposed regulations ignored
decades-old authorities that such transfor-
mative changes are an understood and
realistic part of processing and refining.
See § 1.613A-7(s) (refining crude oil is
"any operation by which the physical or
chemical characteristics of crude oil are
changed"); IRM § 4.41.1.6.1 (modern
refining operations may involve the
"separation of components plus the
breaking down, restructuring, and re-
combining of hydrocarbon molecules");
Processing, New Oxford American Dic-
tionary, 1307 (2001 ed.) (to perform a
series of mechanical or chemical opera-
tions on, in order to change or preserve it).
Commenters also criticized the reference
to § 1.613-4(g)(5) in the preamble of the
proposed regulations, cited to show that
the physical and chemical change limita-
tion was consistent with definitions found
elsewhere in the Code and regulations.
They argued that the physical and chem-
ical change prohibition in § 1.613-4(g)(5)
is helpful only in determining what is not
included in calculating gross income from
the exhaustion of capital assets for pur-
poses of applying the depletion rules, but
not in distinguishing when an activity
qualifies as processing or refining under
section 7704(d)(1)(E).

The Treasury Department and the IRS
agree with the commenters that process-
ing and refining may cause a substantial
physical or chemical change, depending
on the mineral or natural resource at issue.
Indeed, the specific rule in the proposed
regulations for the processing or refining
of petroleum recognized that refineries
perform physical and chemical changes,
for example when converting the physi-
cally separated components of crude oil
into gasoline or other fuels. Accordingly,
because the general definition is at odds
with some of the specific rules for certain
natural resources, these final regulations
no longer include a general physical or
chemical change limitation.

### d. Manufacturing limitation

Commenters criticized the manufactur-
ing limitation in the proposed regulations,
arguing that the activities that qualify as
processing and refining under section
7704(d)(1)(E) are types of manufacturing.
Many commenters elaborated that the pro-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

posed regulations wrongly focus on the
output of an activity. These commenters
maintained that the entire analysis should
instead rest on whether or not the input is
a mineral or natural resource, or a product
thereof. That is, so long as an item was
once a mineral or natural resource, the
income derived from any further process-
ing or refining of the item up to and, some
argued, including a plastic is qualifying.
Similar to the comments regarding the
definition of mineral or natural resource
discussed in section II of this Summary of
Comments and Explanation of Revisions,
these comments reflect a belief that the
Treasury Department and the IRS have
misinterpreted the statement in the legis-
lative history that "[o]il, gas, or products
thereof are not intended to encompass oil
or gas products that are produced by ad-
ditional processing beyond that of petro-
leum refineries or field facilities," H.R.
Rep. No. 100-495, at 947 (1987), as a
limitation on processing and refining in-
stead of a clarification of what is included
as a natural resource that can be further
processed and refined. As a corollary to
the comments regarding output, some
commenters argued that Congress knew
how to, but did not, limit processing and
refining to the creation of certain products,
for example by specifying "or any pri-
mary products thereof" as it did when
listing oil and gas as excluded property
under the Foreign Sales Corporation pro-
visions enacted in 1984. See section
927(a)(2)(C), now repealed.

As discussed in section I of this Sum-
mary of Comments and Explanation of
Revisions, the Treasury Department and
the IRS interpret the terms processing and
refining in section 7704(d)(1)(E) and the
legislative history as capturing those ac-
tivities that produce the products typically
found at field facilities and petroleum re-
fineries, or the equivalent for other natural
resources. The Treasury Department and
the IRS do not construe the lack of the
word "primary" in the legislative history
as an indication that products produced
through additional processing beyond the
refinery or field facility should be in-
cluded. Instead, the similarity between the
list of products in the regulations under
former section 927 and in the legislative
history for section 7704(d)(1)(E) indicate
that Congress understood processing and

refining oil and natural gas to result in the
products identified as primary products in
the regulations under former section 927.
Compare § 1.927(a)-1T(g)(2)(i) (defining
"primary product from oil" as crude oil
and all products derived from the destruc-
tive distillation of crude oil, including vol-
atile products, light oils such as motor fuel
and kerosene, distillates such as naphtha,
lubricating oils, greases and waxes, and
residues such as fuel oil) and § 1.927(a)-
1T(g)(2)(ii) (defining "primary product
from gas" as all gas and associated hydro-
carbon components from gas or oil wells,
whether recovered at the lease or upon
further processing, including natural gas,
condensates, liquefied petroleum gases
such as ethane, propane, and butane, and
liquid products such as natural gasoline)
with the Conference Committee Report
for section 7704(d)(1)(E), H.R. Rep. No.
100-495, at 947 (1987) ("gasoline, kero-
sene, number 2 fuel oil, refined lubricating
oils, diesel fuel, methane, butane, pro-
pane").

The Treasury Department and the IRS
recognize, however, that the wording of
the manufacturing limitation in the pro-
posed regulations was vague and could
cause confusion. Therefore, the general
definitions of processing and refining in
the final regulations no longer contain the
specific language that made up the manu-
facturing limitation. Instead, the specific
definitions for the processing and refining
of natural gas and crude oil capture con-
gressional intent by including only those
activities that are generally performed at
field facilities and petroleum refineries, or
those that produce products typically
found at field facilities and refineries. The
definitions for processing and refining do
not include additional processing or man-
ufacturing activities, such as petrochemi-
cal manufacturing. The final regulations
apply a similar end point for the process-
ing and refining of ores, other minerals,
and timber in a manner tailored to the type
of resource at issue.

### e. Specific rules for each category of natural resource

Some commenters dismissed the need
for industry specific rules. These com-
menters maintained that Congress did not
limit qualifying income based on the

different processes used for the various
types of minerals and natural resources,
and therefore one overarching definition
should apply consistently across all re-
sources.

The final regulations retain separate
definitions for processing and refining of
natural gas, crude oil, ores and other min-
erals, and timber. As a practical matter,
the minerals and natural resources subject
to depletion under section 611 are differ-
ent, and there is no uniform way to ad-
dress them. For example, geothermal en-
ergy is not processed or refined. The
processing of timber necessarily differs
from the processing of natural gas. The
absence of specific rules for each type of
natural resource would result in vague
guidelines lacking clear distinctions be-
tween qualifying and non-qualifying ac-
tivities. Furthermore, a more general ap-
proach would lead to an unwarranted
expansion of the scope of qualifying in-
come beyond that intended by Congress,
since a general definition would need to
encompass the activities of the resource
with the broadest definition of processing
and refining.

### 2. Natural Gas and Crude Oil

The proposed regulations defined pro-
cessing or refining of natural gas as an
activity performed to: (1) purify natural
gas, including by removal of oil or con-
densate, water, or non-hydrocarbon gases
(including carbon dioxide, hydrogen sulfide,
nitrogen, and helium); (2) separate natural
gas into its constituents which are normally
recovered in a gaseous phase (methane
and ethane) and those which are normally
recovered in a liquid phase (propane, bu-
tane, pentane, and gas condensate); or (3)
convert methane in one integrated conver-
sion into liquid fuels that are otherwise
produced from petroleum. The proposed
regulations defined processing or refining
of petroleum as an activity, the end prod-
uct of which is not a plastic or similar
petroleum derivative, performed to: (1)
physically separate crude oil into its com-
ponent parts, including, but not limited to,
naphtha, gasoline, kerosene, fuel oil, lu-
bricating base oils, waxes and similar
products; (2) chemically convert the phys-
ically separated components if one or
more of the products of the conversion are

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

recombined with other physically sepa-
rated components of crude oil in a manner
that is necessary to the cost-effective pro-
duction of gasoline or other fuels (for ex-
ample, gas oil converted to naphtha
through a cracking process that is hydro-
treated and combined into gasoline); or
(3) physically separate products created in
(1) and (2). The proposed regulations also
provided a partial list of products that
would not be treated as obtained through
the qualified processing or refining of pe-
troleum, including: (1) heat, steam, or
electricity produced by the refining pro-
cesses; (2) products that are obtained from
third parties or produced onsite for use in
the refinery, such as hydrogen, if excess
amounts are sold; and (3) any product that
results from further chemical change of
the product produced from the separation
of crude oil if it is not combined with
other products separated from the crude
oil. For example, the proposed regulations
indicated that production of petroleum
coke from heavy (refinery) residuum qual-
ifies as processing or refining, but any
upgrading of petroleum coke (such as to
anode-grade coke) does not qualify be-
cause it is further chemically changed.

Numerous commenters argued that the
proposed regulations inappropriately fa-
vored (1) crude oil over natural gas, and
(2) fuel products over other products. For
example, under the proposed regulations,
qualifying processing or refining included
chemically converting the component
parts of crude oil into products that would
be combined into a fuel and products that
could be separated further, sometimes re-
sulting in olefins such as ethylene and
propylene. In contrast, the proposed reg-
ulations recognized as qualifying only the
conversion of one component of natural
gas (methane) into a fuel, and did not treat
as qualifying the creation of olefins from
natural gas. Commenters asserted that
there is no basis for differentiating be-
tween hydrocarbon sources for fuels or
olefins, and that such differentiation
causes difficulties for pipeline operators
and marketers, who cannot tell if the fun-
gible fuels or olefins come from qualify-
ing crude oil processing or non-qualifying
natural gas conversions. Also regarding
this same language in the proposed regu-
lations, one commenter asked that the
phrase "in one integrated conversion" be

clarified so as to not exclude multistep
conversion techniques which result in gas-
oline. Similarly, commenters contended
that the refining of lubricants, waxes, sol-
vents, and asphalts should also be in-
cluded as qualifying activities since they,
like fuel, are products of petroleum refin-
eries.

Two commenters stated that the pro-
posed regulations were not consistent in
favoring fuels since the sale of methanol
was not treated as a qualifying activity.
See proposed § 1.7704-4(e), Example 3
(concluding that "the production and sale
of methanol, an intermediate product in
the conversion [from methane to diesel],
is not a section 7704(d)(1)(E) activity be-
cause methanol is not a liquid fuel other-
wise produced from the processing of
crude oil"). These commenters argued that
the processing and sale of methanol
should be a qualifying activity because it:
(1) is similar to methane or to natural gas
liquids (NGLs), (2) is an intermediate
product produced in the act of converting
gas into gasoline, (3) is itself a fuel (albeit
an alcohol fuel), and (4) can be produced
from oil using typical refinery processes,
catalysts, and equipment.

Rather than the definitions in the pro-
posed regulations, commenters offered
two different possible regulatory stan-
dards for determining whether an activity
qualifies as the processing or refining of
crude oil or natural gas: (1) whether the
activity is performed in a crude oil refin-
ery; or (2) whether the activity produces a
product of a type that is produced in a
crude oil refinery. For the second recom-
mended standard, some commenters sug-
gested that the final regulations adopt the
list of products produced by a refinery as
compiled by the U.S. Energy Information
Administration (EIA). In support of this
second standard, one commenter said that
using the EIA list would give effect to the
congressional intent that oil and gas prod-
ucts necessitating processing beyond the
type of processing that takes place in pe-
troleum refineries should not give rise to
qualifying income. Another commenter
added that using the second standard
would make the regulations administrable
by avoiding inquiry into the nature and
extent of the production process. Other
commenters recommended that the final
regulations provide a list of "bad prod-

ucts," that is products of processing or
refining that do not give rise to qualifying
income, such as a list of plastic resins
maintained by trade industry associations
for the plastic industry.

In response to these comments, these
final regulations make several changes.
First, as discussed in section III.D.1.a of
this Summary of Comments and Explana-
tion of Revisions, these final regulations
separately define processing and refining.
Processing of natural gas and crude oil for
purposes of section 7704(d)(1)(E) encom-
passes those activities that convert raw
well effluent to substances that can be
readily transported or stored, that is, what
is generally performed at the wellhead or
field facilities. For natural gas, processing
is the purification of natural gas, including
by removing oil or condensate, water, or
non-hydrocarbon gases (such as carbon
dioxide, hydrogen sulfide, nitrogen, and
helium), and the separation of natural gas
into its constituents which are normally
recovered in a gaseous phase (methane
and ethane) and those which are normally
recovered in a liquid phase (propane, bu-
tane, pentane, and gas condensate). For
crude oil, processing is the separation of
crude oil by passing it through mechanical
separators to remove gas, placing crude
oil in settling tanks to recover basic sedi-
ment and water, dehydrating crude oil,
and operating heater-treaters that separate
raw oil well effluent into crude oil, natural
gas, and salt water.

Second, consistent with the legislative
history's limitation to products of petro-
leum refineries or field facilities, the Trea-
sury Department and the IRS adopt the
suggestion to list the qualifying products
of a refinery for the definition of refining of
natural gas and crude oil for purposes of
7704(d)(1)(E) and, for this purpose, look
to information compiled by the EIA. The
Treasury Department and the IRS have
determined that the EIA currently pro-
vides an authoritative list of products of a
refinery. Following the oil market disrup-
tion in 1973, Congress established the
EIA in 1977 to collect, analyze, and dis-
seminate comprehensive, independent and
impartial energy information in order to
assess the adequacy of energy resources to
meet economic and social demands. See
42 U.S.C. 7135(a). As part of that man-
date, the EIA is required to gather infor-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

mation from persons engaged in owner-
ship, control, exploration, development,
extraction, refining or otherwise process-
ing, storage, transportation, or distribution
of mineral fuel resources. See 42 U.S.C.
7135(h)(4) and (6). These final regulations
are informed by Form EIA-810,
"Monthly Refinery Report," and Form
EIA-816, "Monthly Natural Gas Liquids
Report," which are the surveys that each
refinery or natural gas processing plant
must complete to report both finished and
unfinished products of their operations.

Specifically, these final regulations de-
fine the refining of natural gas and crude
oil as the further physical or chemical
conversion or separation processes of
products resulting from processing and re-
fining activities, and the blending of pe-
troleum hydrocarbons, to the extent they
give rise to products listed in the defini-
tion of processing or the following prod-
ucts: ethane, ethylene, propane, propyl-
ene, normal butane, butylene, isobutane,
isobutene, isobutylene, pentanes plus, un-
finished naphtha, unfinished kerosene and
light gas oils, unfinished heavy gas oils,
unfinished residuum, reformulated gasoline
with fuel ethanol, reformulated other motor
gasoline, conventional gasoline with fuel
ethanol - Ed55 and lower gasoline, conven-
tional gasoline with fuel ethanol - greater
than Ed55 gasoline, conventional gasoline
with fuel ethanol - other conventional fin-
ished gasoline, reformulated blendstock for
oxygenate (RBOB), conventional blend-
stock for oxygenate (CBOB), gasoline
treated as blendstock (GTAB), other mo-
tor gasoline blending components defined
as gasoline blendstocks as provided in
§ 48.4081-1(c)(3), finished aviation gas-
oline and blending components, special
naphthas (solvents), kerosene-type jet
fuel, kerosene, distillate fuel oil (heating
oils, diesel fuel, ultra-low sulfur diesel
fuel), residual fuel oil, lubricants (lubri-
cating base oils), asphalt and road oil (at-
mospheric or vacuum tower bottom),
waxes, petroleum coke, still gas, and
naphtha less than 401ºF end-point, as well
as any other products of a refinery that the
Commissioner may identify through pub-
lished guidance.

The final regulations have modified or
clarified several of the terms from the EIA
lists to ensure that the listed products are
only those of the type produced in a pe-

troleum refinery or traditional gas field
processing plant. Thus, for example, the
listed product "lubricants" includes the
parenthetical "lubricating base oils" to
clarify that refining does not include cre-
ating a lubricant not of the type produced
in a petroleum refinery that has been
mixed with non-petroleum hydrocarbons.
The EIA reports are required to be filed
only by refiners and natural gas proces-
sors; consequently, the EIA need not cir-
cumscribe the products to include solely
those generally produced by a petroleum
refinery or processing plant. The Treasury
Department and the IRS modified the EIA
list to more specifically identify those
products solely produced by refineries and
field facilities. In addition, the list in the
final regulations must be read consistently
with that view to include only those types
of listed products that are generally pro-
duced in a petroleum refinery or natural
gas processing plant. For example, a lu-
bricant that is not of a type that is gener-
ally produced by a refiner is not within the
product list. Therefore, the definitions
have been slightly adjusted to reflect lu-
bricants of a petroleum refinery as op-
posed to those from a manufacturer or
entity that is adding more than the mini-
mal amount permitted under additization
(discussed in section III.H.5 of this Sum-
mary of Comments and Explanation of
Revisions) of different minerals, natural
resources, or other products to the lubri-
cant.

Also, in adopting the approach of list-
ing the products of a petroleum refinery or
a natural gas processing plant, these final
regulations no longer provide language
regarding converting methane in one inte-
grated conversion into liquid fuels or re-
garding the various acceptable chemical
conversions with respect to crude oil. Ac-
tivities are treated as refining to the extent
they give rise to products listed in the
regulation.

Adopting the EIA's list of products of
a refinery resolved several other issues
raised by commenters. These final regula-
tions no longer differentiate between the
refining of natural gas and the refining of
crude oil, particularly in regard to the cre-
ation of olefins and certain liquid fuels.
Although traditional gas field processing
plants do not produce olefins or certain
fuels from natural gas, these products are

created in petroleum refineries (albeit in
small quantities in the case of olefins).
The Treasury Department and the IRS
recognize that changes in technology have
expanded the ways to create liquid fuels,
and thus continue to be guided by the
stated goal in the legislative history of
including as qualifying those activities
that create products "which are recovered
from petroleum refineries or field facili-
ties." H.R. Rep. No. 100-495, at 947
(1987). Similarly, the final regulations no
longer omit the refining of non-fuel prod-
ucts of a refinery, such as lubricants,
waxes, solvents, and asphalts of the type
produced in petroleum refineries.

Conversely, the EIA list does not in-
clude methanol as a product of a refinery
or natural gas processing plant, and there-
fore these final regulations do not adopt
commenters' suggestion to treat as quali-
fying the creation of methanol. Indeed,
one commenter who recommended adopt-
ing the list of products produced by a
refinery as compiled by the EIA acknowl-
edged that the Treasury Department and
the IRS would need to expand the EIA list
to encompass methanol and synthesis gas
since they are typically not produced at
refineries. Given the EIA's expertise, the
Treasury Department and the IRS decline
to supplement the products of a refinery as
identified by the EIA, and also note that
alcohols (such as methanol) were specifi-
cally not included as a primary product of
oil and gas in the regulations under the
Foreign Sales Corporation provisions,
whose list of oil and gas products is sim-
ilar to that in the legislative history for
section 7704(d)(1)(E). See § 1.927(a)-
1T(g)(2)(iv) and discussion under section
III.D.1.d of this Summary of Comments
and Explanation of Revisions. Whether
methanol is similar to NGLs, is a liquid
fuel, or can be created using typical oil
refining processes is immaterial to the de-
termination of whether the manufacture of
methanol is a qualifying activity. These
final regulations, therefore, amend the rea-
soning in Example 3, now in § 1.7704-
4(f), to reflect that methanol is not in-
cluded among the listed products.

These final regulations also do not
adopt the recommendation to treat as
qualifying all activities performed in a
refinery. Such a standard would allow
PTPs to thwart Congress's limitation on

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

qualifying activities by simply moving
processes that are normally not conducted
in a refinery within the refinery fence. For
example, some refineries have added hy-
drogen production plants to their facilities,
though Congress did not intend the gen-
eration of hydrogen for sale to be a qual-
ifying activity. Indeed, these final regula-
tions continue to provide that products of
refining do not include products produced
onsite for the use in the refinery, such as
hydrogen, if excess amounts are sold. The
Treasury Department and the IRS under-
stand that some commenters suggested
this broader definition of refining in order
to include as qualifying the refining of
non-fuel products (lubricants, waxes, sol-
vents, and asphalts). Their concern, how-
ever, is addressed to the extent those prod-
ucts are included in the list of products of
a refinery, thus avoiding the need for a
broad and potentially vague rule that
would encompass all activities undertaken
in a refinery.

Finally, these final regulations retain
language similar to that in the proposed
regulations clarifying that certain other
products are not products of refining, in-
cluding heat, steam or electricity produced
by refining processes, products obtained
from third parties or produced onsite for
use in the refinery if excess amounts are
sold, any product that results from further
chemical change of a product on the list of
products of a refinery that does not result
in the same or another product listed as a
product of a refinery, and plastics or sim-
ilar petroleum derivatives. For this last
item, these final regulations do not adopt
the suggestion of some commenters to
provide a non-exclusive list of non-
qualifying plastic resins, as the Treasury
Department and the IRS do not agree that
providing such a list aids taxpayers. A list
of some of the non-qualifying products is
not relevant because the final regulations
list all of the qualifying products and
might create confusion if a product were
not included on either list.

### 3. Ores and Minerals

The proposed regulations provided that
an activity constituted processing or refining
of ores and minerals if it met the definition
of mining processes under § 1.613-4(f)(1)(ii)
or refining under § 1.613-4(g)(6)(iii). In ad-

dition, the proposed regulations repeated
part of the definition of refining found in
§ 1.613-4(g)(6)(iii) by stating that, gen-
erally, refining of ores and minerals is any
activity that eliminates impurities or for-
eign matter from smelted or partially pro-
cessed metallic and nonmetallic ores and
minerals, as for example the refining of
blister copper.

Commenters generally sought to ex-
pand the definition of processing and re-
fining of ores and minerals. As discussed
in greater detail in section III.C of this
Summary of Comments and Explanation
of Revisions, commenters maintained that
section 7704(d)(1)(E) should use the def-
inition of mining from section 613(c)(2).
Because that definition already includes
certain mining processes, commenters fur-
ther argued that the definition of process-
ing for section 7704(d)(1)(E) should in-
clude something more, specifically some
or all of the "nonmining processes" listed
in section 613(c)(5) and § 1.613-4(g).
Moreover, they reasoned that unless the
nonmining processes are included in the
definition of processing, there is a hole
between processing and refining, as de-
fined in the proposed regulations, which
could not have been intended. For exam-
ple, the proposed regulations identified the
refining of blister copper as a qualifying
activity, but did not allow as qualifying
the activity that precedes that step (that is,
the smelting of the copper ore concentrate
to produce the blister copper), which oc-
curs after the mining processes identified
in § 1.613-4(f)(2)(i)(d). Additionally, com-
menters elaborated that some of the non-
mining processes under section 613(c)(5)
are themselves activities that "purify, sep-
arate, or eliminate impurities," thus falling
within the general definition of processing
provided in the proposed regulations.
Some commenters argued that the cok-
ing of coal, the making of activated
carbon, and the fine pulverization of
magnetite should all be considered qual-
ifying activities.

Based on the comments received, the
Treasury Department and the IRS have
determined that the definition of process-
ing and refining of ores and minerals in
the proposed regulations needed clarifica-
tion. Like the final regulations on process-
ing and refining of natural gas or crude oil,
and as discussed in section III.D.1.a of

this Summary of Comments and Explana-
tion of Revisions, these final regulations
separately define processing and refining
of ores and minerals other than natural gas
or crude oil.

Processing of ores and minerals other
than natural gas or crude oil is defined in
these final regulations as those activities
that meet the definition of mining pro-
cesses under § 1.613-4(f)(1)(ii), without
regard to § 1.613-4(f)(2)(iv) (related to
who is performing the processing). Ac-
cordingly, processing includes the activi-
ties generally performed at or near the
point of extraction of the ores or minerals
from the ground (generally within a 50-
mile radius or greater if the Commis-
sioner determines that physical or other
requirements cause the plants or mills to
be at a greater distance) that are nor-
mally applied to obtain commercially
marketable mineral products. Therefore,
this definition captures the concept of
"field facilities" in the legislative his-
tory to section 7704(d)(1)(E).

Because the legislative history does not
provide any examples of products pro-
duced from ores and minerals that may
generate qualifying income, other than
those relating to oil, gas, and fertilizer, the
Treasury Department and the IRS have
applied limitations to ores and minerals
that are comparable to those specifically
expressed by Congress regarding oil and
gas. See H.R. Rep. No. 100-495, at 947
(1987) ("[o]il, gas, or products thereof are
not intended to encompass oil or gas prod-
ucts that are produced by additional pro-
cessing beyond that of petroleum refiner-
ies or field facilities, such as plastics or
similar petroleum derivatives"). In con-
trast, commenters' suggestion to include
nonmining processes in the definition of
processing is not consistent with the Trea-
sury Department's and the IRS's view of
congressional intent because the term
"nonmining processes" in § 1.613-4(g) is
a catch-all category that includes any pro-
cess applied beyond mining processes, in-
cluding refining, blending, manufacturing,
transportation, and storage. See § 1.613-
4(g) (which lists various nonmining pro-
cesses, and also provides that "a process
applied subsequent to a nonmining pro-
cess (other than nonmining transportation)
shall also be considered to be a nonmining
process"). In addition to causing the def-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

inition of processing to be partly duplica-
tive of other listed section 7704(d)(1)(E)
activities, adopting this suggestion would
mean that so long as a product started as a
depletable product, any income derived
from any manipulation of that product
would be qualifying income. Such a result
would be in direct conflict with the desire
of Congress to restrict the scope of activ-
ities engaged in by PTPs. Therefore, these
final regulations do not adopt that sugges-
tion.

Nevertheless, in response to com-
ments, these final regulations include
some nonmining processes in the defini-
tion of refining of ores and minerals other
than natural gas or crude oil. Refining of
ores and minerals other than natural gas or
crude oil is defined in these final regula-
tions as those various processes subse-
quent to mining processes performed to
eliminate impurities or foreign matter and
which are necessary steps in the goal of
achieving a high degree of purity from
specified metallic ores and minerals which
are not customarily sold in the form of the
crude mineral product. The specified me-
tallic ores and minerals identified in these
final regulations are: lead, zinc, copper,
gold, silver, and any other ores or miner-
als that the Commissioner may identify
through published guidance. These are the
same metallic ores and minerals treated as
"not customarily sold in the form of the
crude mineral product" under section
613(c)(4)(D), except that fluorspar ores
and potash are not included in these reg-
ulations because they will be addressed in
regulations specifically addressing fertil-
izer and uranium is not included because
it is not purified to a high concentrate.
Uranium is not mined to isolate pure ura-
nium at the high-purity levels as is done
with other metals such as lead, zinc, cop-
per, gold, or silver, but, overwhelmingly,
is instead mined to attain a uranium oxide
(UO2) material for the manufacture of
nuclear fuel pellets. This process rejects
approximately 95-99 percent of the
originally-extracted uranium ore (a U238
\+ U235 mixture), in order to raise the
concentration of the desired uranium iso-
tope (U235), in what the Treasury Depart-
ment and the IRS have concluded is a
manufacturing process.

Refining processes for these specified
metallic ores and minerals include some

non-mining processes (such as fine pul-
verization, electrowinning, electrolytic
deposition, roasting, thermal or electric
smelting, or substantially equivalent pro-
cesses or combinations of processes) to
the extent those processes are used to sep-
arate or extract the metal from the speci-
fied metallic ore for the primary purpose
of producing a purer form of the metal, as
for example the smelting of concentrates
to produce Doré bars or refining of blister
copper. Income from the smelting of iron,
for example, is not qualifying income un-
der the final regulations because iron is an
ore or mineral customarily sold in the
form of the crude mineral product, and thus
not a product listed in section 613(c)(4)(D).
Compare § 1.613-4(f)(2)(i)(c) and (d). In
addition, these final regulations specifi-
cally provide that refining does not in-
clude the introduction of additives that
remain in the metal, for example, in the
manufacture of alloys of gold. Also, the
application of nonmining processes as de-
fined in § 1.613-4(g) to produce a speci-
fied metal that is considered a waste or
by-product during the production of a
non-specified metallic ore or mineral is
not considered refining.

These final regulations provide a more
detailed definition of refining than the pro-
posed regulations and better articulate a
common understanding of what refining
includes, that is in a metallurgical sense.
To eliminate uncertainty, these final reg-
ulations define refining to include only
activities with respect to those ores and
minerals that are generally refined to a
high degree of purity, which are also those
ores and minerals that normally require
more processing before they are sold, as
identified in § 613(c)(4) and § 1.613-
4(f)(2)(i)(d). In addition, these final regu-
lations also allow the necessary, preceding
processes performed to eliminate impuri-
ties from the specified ores and minerals,
thereby addressing commenters' concerns
regarding a hole in processing activities in
the proposed regulations. In providing this
definition, the final regulations also effect
congressional intent to limit qualifying in-
come to certain activities that have "com-
monly or typically been conducted in part-
nership form." H.R. Rep. No. 100-391, at
1066 (1987). Both in 1987 and since,
large manufacturing operations such as
smelting aluminum and manufacturing

steel have generally been conducted by
corporations. Despite the existence of
hundreds of different ores and minerals,
only a handful of businesses that work
with ores and minerals other than natural
gas or crude oil have operated as PTPs,
perhaps reflecting a general understanding
that expanded processing activities were
not considered by Congress to be activi-
ties that could generate qualifying income.
The Treasury Department and the IRS
have determined that it would be inappro-
priate to expand the definition of refining
of ores and minerals beyond that intended
by Congress.

The final regulations do not recognize
as qualifying activities the coking of coal
or the making of activated carbon. The
processing of coal, as contemplated by
§ 1.613-4(f)(2)(i)(a), includes the clean-
ing, breaking, sizing, dust allaying, treat-
ing to prevent freezing, and loading for
shipment. At that point, the coal is ready
for sale. Because Congress intended prod-
ucts resulting from processing to include
only those products produced in field fa-
cilities or refineries, coking of coal is not
a processing activity. Furthermore, coal is
not refined into coke or activated carbon
in the metallurgical sense in which ores
are refined. Coal is itself the mineral or
natural resource for purposes of sections
611 and 613 that is extracted from the
ground. Unlike ores where extraction oc-
curs in order to obtain the mineral at is-
sue-for which refining may be required
to separate the mineral from the ore
rock-coal is extracted to be used sub-
stantially as is. Refining ores to obtain a
purer form of the minerals found in rock is
not analogous to coking coal to obtain
carbon. Cokemaking and creating acti-
vated carbon are manufacturing processes
used to create a new product. Refining is
not changing a mineral into a new or
different mineral product or creating a
product that is, altogether, not a mineral.

Similarly, these final regulations do not
include the fine pulverization of magne-
tite, as requested by a commenter. As dis-
cussed, Congress intended processing to
include only those activities typically per-
formed at the equivalent of field facilities
for minerals and ores. Fine pulverization
is generally not included as a mining pro-
cess as it is not helpful in bringing the ores
or minerals to shipping grade generally,

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

although pulverization may qualify as a
mining process if, with respect to the min-
eral or ore at issue, it is necessary to
another process that is a mining process.
See § 1.613-4(f)(2)(iii). These final reg-
ulations do not alter this treatment.

### 4. Timber

The proposed regulations provided that
an activity constituted processing of tim-
ber if performed to modify the physical
form of timber, including by the applica-
tion of heat or pressure to timber, without
adding any foreign substances. The pro-
posed regulations specified that process-
ing of timber did not include activities that
added chemicals or other foreign sub-
stances to timber to manipulate its physi-
cal or chemical properties, such as using a
digester to produce pulp. Products that
resulted from timber processing included
wood chips, sawdust, rough lumber, kiln-
dried lumber, veneers, wood pellets, wood
bark, and rough poles. Products that were
not the result of timber processing in-
cluded pulp, paper, paper products, treated
lumber, oriented strand board/plywood,
and treated poles.

Commenters argued that the proposed
regulations wrongly limited the products
of timber processing and restricted addi-
tives. These commenters noted that the
proposed regulations departed from PLRs
issued in the past that permitted pulping
and other engineered wood products made
with resins and treated with chemicals.
Specific to pulping, commenters applied
the general definition in the proposed reg-
ulations that provided for separation and
purification to reason that the pulping of
cut timber is merely separation into the
component parts of wood-water, cellu-
lose fibers, lignin, and hemicelluloses-
through the addition of water and chemi-
cals. Therefore, they argued, the specific
rule for timber was more restrictive than
the general rule for all natural resources.
In contrast, one commenter acknowledged
that the production of plywood and other
engineered wood products should not gen-
erate qualifying income because a non-
natural resource (that is, a synthetic adhe-
sive) is a material input in the process that
produces engineered wood products.

The final regulations do not adopt com-
menters' requests to expand the definition

of the processing of timber, but adopt the
rule in the proposed regulations without
change. As discussed in section I of this
Summary of Comments and Explanation
of Revisions, the Treasury Department
and the IRS interpret the legislative his-
tory of section 7704(d)(1)(E) to mean that
Congress did not intend to extend process-
ing activities beyond those involved in
getting a natural resource such as timber
to market in a form generally sold. Poten-
tial products made from wood are numer-
ous, and include: pulp, paper and other
paper products, certain chemicals (such as
tar, tall oil, or turpentine), engineered
wood products, lumber, sawdust, wood
chips, and furniture. The point where pro-
cessing turns into manufacturing is defin-
able: the modification of the physical state
of wood is a process, whereas the addition
of chemicals in an attempt to manipulate
the physical or chemical properties of
wood is extended processing more akin to
manufacturing, and thus beyond the scope
of activities intended by Congress to gen-
erate qualifying income. The corollary of
a field processing plant for timber is a
sawmill or pellet mill. Sawmills produce
lumber and lumber products (such as bark,
sawdust, and wood chips) from felled
logs. Pellet mills produce pellets from
logs, chipped wood, lumber scraps, saw-
dust or pulpwood. These processes do not
change the wood into a different product.
The distinction between processing and
manufacturing of timber is demonstrated
in the MACRS class lives in Rev. Proc.
87-56, which separate the sawing of stock
from logs (24.2 and 24.3) from the man-
ufacture of furniture, pulp, and paper
(24.4 and 26.1). Despite commenters'
statements that pulping is like crude oil
refining, timber is not commonly under-
stood to be "refined" to a higher level of
purity. Timber is simply "processed";
therefore, these regulations do not include
timber in the definition of refining.

### E. Transportation

The proposed regulations provided that
transportation was the movement of min-
erals or natural resources and products of
mining, production, processing, or refin-
ing, including by pipeline, barge, rail, or
truck, except for transportation (not in-
cluding pipeline transportation) to a place

that sells or dispenses to retail customers.
Retail customers did not include a person
who acquired oil or gas for refining or
processing, or a utility. The following ac-
tivities qualified as transportation under
the proposed regulations: (i) providing
storage services; (ii) terminalling; (iii) op-
erating gathering systems and custody
transfer stations; (iv) operating pipelines,
barges, rail, or trucks; and (v) construction
of a pipeline only to the extent that a pipe
was run to connect a producer or refiner to
a preexisting interstate or intrastate line
owned by the PTP (interconnect agree-
ments).

Commenters requested both clarifica-
tion and expansion of the definition of
transportation in three main areas. First,
commenters asked that the regulations ex-
plain who can generate qualifying income
from transportation via pipeline and ma-
rine shipping. Specifically, different com-
menters sought assurances that those "op-
erating pipelines" include operators who
move the product, owners and lessors who
receive income for use of their pipelines,
and logistic service providers who sched-
ule the movement of product on pipelines.
Similarly, another commenter asked that
the regulations specify that transportation
under a time charter is a qualifying activ-
ity. Under such contractual arrangements,
a PTP provides a crew and operates a ma-
rine vessel, though the customer (such as an
oil and gas company) directs where the
product is to be delivered. Essential to this
request is the additional proposal that the
term "barges" in the proposed regulations be
read expansively to include marine transpor-
tation via other types of vessels, especially
those that move under their own power
rather than being pushed or towed.

To transport is "to carry or convey (a
thing) from one place to another," and
transportation is "the movement of goods
or persons from one place or another by a
carrier." Black's Law Dictionary (8th ed.
2004). As a general matter, these final
regulations do not require ownership or
control of the assets used to perform a
listed activity so long as the action being
performed is within the definition of a
qualifying activity. Following this ap-
proach, those performing the physical
work to move the product along a pipeline
(such as taking delivery of the product,
metering quantities, monitoring specifica-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

tions, and actually controlling the move-
ment of the product) or to transport the
product via marine vessel (including op-
erating the vessel under a time charter) are
performing a qualifying activity. Also,
given the dedicated use of pipelines in the
oil and gas industry, these final regula-
tions specifically allow as qualifying in-
come the income owners and lessors re-
ceive for the use of their pipelines to
transport minerals or natural resources. In
contrast, a logistics service provider in-
volved in scheduling services alone nei-
ther carries nor conveys, and is therefore
not a transporter. A logistics service pro-
vider may, however, have qualifying in-
come if it meets the intrinsic test de-
scribed in further detail in section IV of
this Summary of Comments and Explana-
tion of Revisions. Additionally, these final
regulations replace the word "barge" with
"marine vessel" so as not to limit marine
transportation to one type of watercraft.

The second area of concern raised by
commenters dealt with the exception for
transportation to retail customers. Com-
menters asked that the regulations clarify
that certain transportation to retail cus-
tomers is a qualifying activity. For exam-
ple, citing to one sentence in the legisla-
tive history that "[i]ncome from any
transportation of oil or gas or products
thereof by pipeline is treated as qualifying
income," one commenter asserted that
Congress intended to include as a quali-
fying activity the transportation of oil and
gas by pipeline directly to homeowners.
H.R. Conf. Rep. 100-1104(II), at 18
(1988) (emphasis added). Likewise, many
other commenters asserted that Congress
intended that the transportation and corre-
sponding marketing of liquefied petro-
leum gas (primarily propane) to retail cus-
tomers generate qualifying income. These
commenters pointed to floor statements
made by Senator Lloyd Bentsen and Rep-
resentative Dan Rostenkowski after enact-
ment of section 7704, which were specif-
ically referenced in a footnote in the
Conference Report to the Technical and
Miscellaneous Revenue Act of 1988. See
133 Cong. Rec. S18651 (December 22,
1987), 133 Cong. Rec. H11968 (Decem-
ber 21, 1987), and H.R. Conf. Rep. 100-
1104(II), at 18 (1988).

To provide more clarity, these final
regulations explain when transportation to

a place that sells to retail customers or
transportation directly to retail customers
is a qualifying activity. Specifically, these
final regulations provide that transporta-
tion includes the movement of minerals or
natural resources, and products produced
under processing and refining, via pipeline
to a place that sells to retail customers, but
do not expand the list of qualifying activ-
ities to include the movement of such
items via pipeline directly to retail cus-
tomers. In addition, these final regulations
provide that transportation includes the
movement of liquefied petroleum gas via
trucks, rail cars, or pipeline to a place that
sells to retail customers as well as directly
to retail customers.

These provisions implement Congres-
sional intent as expressed in the legislative
history accompanying the Technical and
Miscellaneous Revenue Act of 1988
which provided: "in general, income from
transportation of oil and gas and products
thereof to a bulk distribution center such
as a terminal or a refinery (whether by
pipeline, truck, barge or rail) be treated as
qualifying income. Income from any
transportation of oil or gas or products
thereof by pipeline is treated as qualifying
income. Except in the case of pipeline
transport, however, transportation of oil or
gas or products thereof to a place from
which it is dispensed or sold to retail
customers is generally not intended to be
treated as qualifying income. Solely for
this purpose, a retail customer does not
include a person who acquires the oil or
gas for refining or processing, or partially
refined or processed products thereof for
further refining or processing, nor does a
retail customer include a utility providing
power to customers. For example, income
from transporting refined petroleum prod-
ucts by truck to retail customers is not
qualifying income." H.R. Conf. Rep.
100-1104(II), at 17-18 (1988). A foot-
note added that "[i]ncome from transpor-
tation and marketing of liquefied petro-
leum gas in trucks and rail cars or by
pipeline, however, may be treated as qual-
ifying income," citing the floor statements
identified by commenters. Id.

Although the legislative history sup-
ports much of what commenters have
asked to be clarified, it does not support
the proposal that the transportation by
pipeline of oil, gas, and products thereof

(other than liquefied petroleum gas) di-
rectly to homeowners is qualifying in-
come. Although Congress stated that
"any" transportation by pipeline qualifies,
when read in context with the remainder
of the paragraph, it is clear that Congress
was discussing bulk transportation. See
also S. Rep. 100-445, at 424 (1988)
("[i]n the case of transportation activities
with respect to oil and gas and products
thereof, the Committee intends that, in
general, income from bulk transportation
of oil and gas and products thereof be
treated as qualifying income"). This treat-
ment also parallels Congressional intent
regarding marketing, which is a qualifying
activity "at the level of exploration, devel-
opment, processing or refining," but not
"to end users at the retail level." Id.

The third area of comments on trans-
portation were requests to include spe-
cific, additional activities in the list of
examples, in this case, compression ser-
vices, liquefaction and regasification, and
the sale of renewable identification num-
bers (RINs). Each of these activities re-
lates directly to the conveyance of certain
oil and natural gas products and therefore
these final regulations adopt commenters'
suggestions to add them as examples to
the list of qualifying transportation activ-
ities. Natural gas compression is a me-
chanical process whereby a volume of
natural gas is compressed to a required
high pressure in order to transport the gas
though pipelines. A compression service
provider selects appropriate compression
equipment (for example, the number of

compressors and the compressor configu-
ration), then installs, operates, services,
repairs, and maintains that equipment,
typically working on a continuous basis.
More than the mere sale of equipment, a
compression service company is engaged
in transportation activities by making nat-
ural gas move from one point to another.

Similarly, liquefaction and regasifica-
tion are the process of transforming meth-
ane from a gas to a liquid (LNG) to facil-
itate its transportation and storage, and the
process of reconverting the liquid to a gas,
respectively. The regasified natural gas is
fungible with natural gas that has not been
liquefied and regasified. Moreover, in
2008, Congress amended section 7704(d)
(1)(E) to add that income and gains from
the transportation or storage of any fuel

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

described in section 6426(d), which in-
cludes compressed or liquefied natural
gas, generates qualifying income. See
Public Law 110-343, 122 Stat. 3765, Sec-
tion 208(a), and section 6426(d)(2)(C).
Since the transportation and storage of
LNG clearly is a qualifying activity, the
liquefaction and regasification must also
generate qualifying income.

Finally, RINs are part of a
Congressionally-mandated program to en-
sure that transportation fuel sold in the U.S.
contains a minimum percentage of renew-
able fuel. Generally, RINs are assigned to
each gallon of renewable fuel, and are
separated when the renewable fuel is com-
bined with conventional fuel. Companies
who blend such additives into conven-
tional fuels are assigned annual quotas of
RINs that they must acquire. Companies
who acquire more RINs than needed in
any year may sell the surplus to others
who have not met their quota. Although it
is not a direct, physical conveyance of a
mineral or natural resource or product of
processing and refining, the Treasury De-
partment and the IRS agree that the sale of
RINs gives rise to qualifying income as a
part of transportation and marketing activ-
ities-that is, additization, as that activity
is described in more detail in section
III.H.5 of this Summary of Comments and
Explanation of Revisions.

In addition to the three areas of com-
ments discussed regarding transportation
in this section III.E of this Summary of
Comments and Explanation of Revisions,
commenters also suggested that the final
regulations expand the types of intercon-
nect agreements that are treated as giving
rise to qualifying transportation activities.
Because these final regulations address all
construction activities related to perform-
ing section 7704(d)(1)(E) activities in a
new section regarding cost reimburse-
ments, construction of pipelines is moved
from the section on transportation and
those comments are discussed in more
detail in section III.H.1 of this Summary
of Comments and Explanation of Revi-
sions.

### F. Marketing

The proposed regulations provided that
an activity constituted marketing if it was
performed to facilitate sale of minerals or

natural resources and products of mining
or production, processing, and refining,
including by blending additives into fuels.
The proposed regulations explained that
marketing did not include activities and
assets involved primarily in retail sales
(sales made in small quantities directly to
end users), which included, but were not
limited to, operation of gasoline service
stations, home heating oil delivery ser-
vices, and local natural gas delivery ser-
vices.

In addition to the comments received
concerning retail sales of liquid petroleum
gas addressed in section III.E of this Sum-
mary of Comments and Explanation of
Revisions, one commenter recommended
revising the definition of marketing to bet-
ter reflect the common meaning of the
word by including the act of selling and
other activities designed to encourage
sales, including the packaging of prod-
ucts. This same commenter also suggested
rewording the exclusion for retail sales so
that the regulation is more direct and in-
volves an intent test. The commenter pro-
posed eliminating the concepts relating to
"assets" and "involved" in retail sales be-
cause they create uncertainty and chang-
ing the definition from "sales made in
small quantities directly to end users" to
"sales to ultimate consumers to meet per-
sonal needs, rather than for commercial or
industrial uses of the articles sold."

Adopting some of these suggestions,
these final regulations directly state that
marketing is the bulk sale of minerals or
natural resources, and products produced
through processing or refining, and in-
cludes activities that facilitate sales (such
as packaging). These final regulations
continue to provide that marketing gener-
ally does not include retail sales. These
final regulations do not, however, change
the definition of retail sales to create an
intent-based test that looks to determine
the purpose of the purchase. The final
regulations are consistent with the legis-
lative history, which clarified that, "[w]ith
respect to marketing of minerals and nat-
ural resources (e.g., oil and gas and prod-
ucts therefof [sic]), the Committee intends
that qualifying income be income from
marketing at the level of exploration, de-
velopment, processing or refining the
mineral or natural resource. By contrast,
income from marketing minerals and nat-

ural resources to end users at the retail
level is not intended to be qualifying in-
come. For example, income from retail
marketing with respect to refined petro-
leum products (e.g., gas station opera-
tions) is not intended to be treated as
qualifying income." S. Rep. No. 100-
445, at 424 (1988). This legislative history
indicates that a small business owner who
fills his delivery truck at the gas station
before delivering his wares is still an end
user at the retail level, even though the
gasoline is used for commercial purposes.

### G. Fertilizer

The final regulations reserve a para-
graph for fertilizer under section 7704(d)
(1)(E) activities in anticipation of a new
notice of proposed rulemaking that will
define fertilizer as well as explain what
activities involving fertilizer will generate
qualifying income. The Treasury Depart-
ment and the IRS will address the com-
ment received on fertilizer in those pro-
posed regulations.

### H. Additional activities

The Treasury Department and the
IRS received comments regarding cer-
tain other activities that are not exclu-
sive to just one section 7704(d)(1)(E)
activity, including seeking reimburse-
ment for the costs of performing section
7704(d)(1)(E) activities, receiving in-
come from passive interests, blending,
and additization. These final regulations
include these activities as qualifying ac-
tivities, and clarify the extent to which
these activities generate qualifying in-
come. This preamble also discusses
comments received concerning hedging,
and requests further comments.

### 1. Cost Reimbursements

The list of section 7704(d)(1)(E) activ-
ities identified only the overarching pur-
suits undertaken by businesses engaged in
the exploration, development, mining or
production, processing, refining, transpor-
tation, or marketing of minerals or natural
resources. The proposed regulations did
not list as section 7704(d)(1)(E) activities
the many other activities required to run a
business, such as hiring employees, nego-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

tiating contracts, or acquiring assets used
in the business. Normally those typical,
administrative activities are considered to
give rise to business costs, and are not
understood to be the trade or business that
generates income for those in the mineral
and natural resource industries. Under the
proposed regulations, however, a partner-
ship could demonstrate that it performed
intrinsic activities, meaning its activities
were so closely tied to section 7704(d)
(1)(E) activities that income therefrom
should be considered derived from those
section 7704(d)(1)(E) activities, and thus
be treated as qualifying income. Intrinsic
activities included limited, active services
that closely supported section 7704(d)
(1)(E) activities by being specialized, es-
sential, and significant. The proposed reg-
ulations also identified a number of ser-
vice activities that would not meet the
requirements to be considered an intrinsic
activity, including legal, financial, con-
sulting, accounting, insurance, and other
similar services, or activities that princi-
pally involved the design, construction,
manufacturing, repair, maintenance, lease,
rent, or temporary provision of property.
This did not mean that a business per-
forming intrinsic activities was prohibited
from engaging in the typical activities re-
quired to operate its own business, only
that supplying those services to others
would not generate qualifying income un-
der section 7704(d)(1)(E) for those busi-
nesses.

Commenters asked that the final regu-
lations clarify two issues regarding these
general services that are not specific to the
mineral and natural resource industries.
First, commenters recommended that the
section 7704(d)(1)(E) activities be de-
fined to include the functions (such as
engineering, construction, operations,
maintenance, security, billing, hiring,
accounting, and tax financial reporting)
that, taken in the aggregate, are necessary
for the overall operation of the qualifying
activity. Commenters thus recommended
that the final regulations reflect more gen-
erally that income from performing the
functions required for the operation of
qualifying assets or qualifying businesses
(including cost reimbursements) consti-
tutes qualifying income, even if the oper-
ator does not own the underlying assets.
As an illustration of this request, one com-

menter provided the example of a pipeline
or processing facility operator that pro-
vides all of the services to run assets
owned by a third party (such as contract-
ing with customers for the use of the pipe-
line or processing facility, loading/un-
loading the product, performing tasks
necessary to transport or process the prod-
uct, metering quantities, and monitoring
specifications), but also manages the con-
struction of any assets necessary for the
completion of the activities and handles
all of the back-office functions such as
payroll and other administrative services.
Although the costs of providing that work
may be imbedded in the charge to its
client for operating the pipeline or pro-
cessing facility, sometimes an operating
partnership may instead send its client a
bill with a separate line item for construc-
tion or back office expenses.

The Treasury Department and the IRS
agree with commenters that operating in-
come (including from construction and
back-office functions) should constitute
qualifying income so long as the activities
to which the income is attributable are
part of the partnership's business of per-
forming the section 7704(d)(1)(E) activ-
ity. Whether the partnership adds the cost
to a general overhead account or provides
the client with a separate line item detail-
ing that cost in its bill should not matter-
that income is still derived from perform-
ing the section 7704(d)(1)(E) activity. A
partnership performing a section 7704(d)
(1)(E) activity that recoups its costs is
markedly different from a business solely
performing one of the services identified
in the intrinsic activities section that are
identified as not essential or not signifi-
cant. Therefore, to clarify this issue, these
final regulations provide that if the part-
nership is, itself, in the trade or business
of performing a section 7704(d)(1)(E) ac-
tivity, income received to reimburse the
partnership for its costs incurred in per-
forming that section 7704(d)(1)(E) activ-
ity, whether imbedded in the rate the part-
nership charges or separately itemized, is
qualifying income. Reimbursable costs
may include, but are not limited to, the
cost of designing, constructing, installing,
inspecting, maintaining, metering, moni-
toring, or relocating an asset used in that
section 7704(d)(1)(E) activity, or of pro-
viding office functions necessary to the

operation of that section 7704(d)(1)(E) ac-
tivity (such as staffing, purchasing sup-
plies, billing, accounting, and financial re-
porting). For example, a pipeline operator
that charges a customer for its cost to
build, repair, or schedule flow on the pipe-
lines that it operates will have qualifying
income from such activity whether or not
the operator itemizes those costs when it
bills the customer.

Because these final regulations address
reimbursement to a PTP for the construc-
tion of assets used by it to perform a
section 7704(d)(1)(E) activity more gen-
erally, these final regulations remove the
narrow provision under the definition of
transportation that listed construction of a
pipeline as a qualified activity but only to
the extent that the pipe was run to connect
a producer or refiner to a preexisting in-
terstate or intrastate line owned by the
partnership. Many commenters protested
that the provisions were too limited, ex-
plaining that the Federal Energy Regula-
tory Commission, which regulates pipe-
lines, may require pipelines to connect
with other pipelines to facilitate the effi-
cient movement of product, and that many
other new and existing operations (such as
gathering systems, utilities, power gener-
ation facilities, refineries, local distribu-
tion companies, or other commercial or
governmental clients) may also wish to
connect to pipelines. Based on the hear-
ings held before the passage of section
7704 and the legislative history, it is clear
that Congress was concerned about cer-
tain mineral and natural resource partner-
ships being able to acquire necessary cap-
ital to build the assets to be used in their
section 7704(d)(1)(E) activities. Building
a new facility or pipeline is capital inten-
sive and, to the extent that a partnership
passes some of those costs on to the client,
the income from the reimbursement of
those costs, when received, is a part of the
partnership's income from performing the
section 7704(d)(1)(E) activity.

The second issue raised by comment-
ers is an extension of the first. Comment-
ers suggested that management fees
earned by a direct or indirect co-owner of
a business performing a section 7704(d)
(1)(E) activity should be treated as quali-
fying income. One commenter noted that
the partner of the business may provide
such legal, financial or accounting ser-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

vices for efficiency purposes or under
agreement where one partner performs the
section 7704(d)(1)(E) activities while an-
other performs the administrative activi-
ties. These final regulations do not adopt
this suggestion. To the extent a partner of
a PTP is receiving a management fee (as
distinguished from a distributive share of
partnership income) for such administra-
tive tasks as legal, financial or accounting
services, it is no different than any other
business providing a service to the PTP.
Whether income from the services is qual-
ifying will depend on whether the partner
can demonstrate that it is performing an
intrinsic activity as discussed in section
IV of this Summary of Comments and
Explanation of Revisions.

### 2. Hedging

The proposed regulations did not ad-
dress whether income from hedging trans-
actions was qualifying income. Several
commenters noted this and specifically re-
quested guidance on this question. Com-
menters noted that commodity prices are
volatile and PTPs must hedge their risks
to ensure consistent cash flows, both from
an operational and working capital per-
spective, and from an investor demand
perspective. Commenters recommended
that the final regulations provide that in-
come derived from any hedging transac-
tions that are entered into by a PTP in the
normal course of its trade or business and
that manage the PTP's risk with respect to
price fluctuations of the minerals or natu-
ral resources should be included as qual-
ifying income. Other commenters would
include income from any hedging transac-
tions entered into by a PTP in order to
manage its prudent business concerns, in-
cluding transactions hedging interest rate
risks and foreign currency transactions re-
lated to its qualifying activities. One com-
menter further recommended that a hedge
of an aggregate risk with respect to both a
qualifying activity and a non-qualifying
activity should be considered income
from the qualifying activity if substan-
tially all of the risk hedged relates to the
qualifying activity.

The Treasury Department and the IRS
agree with commenters that hedging in-
come, when it is derived from a section
7704(d)(1)(E) activity, should give rise to

qualifying income under section 7704(d)
(1)(E). Engaging in hedging activities is a
common part of the industry and repre-
sents prudent business practice. However,
because hedging transactions are gener-
ally used to fix the price of property with
respect to a section 7704(d)(1)(E) activity,
the Treasury Department and the IRS be-
lieve that both the income and gains, as
well as the deductions and losses, with
respect to hedges should be taken into
account in determining the income from a
section 7704(d)(1)(E) activity. These final
regulations reserve on the issue of hedg-
ing while the Treasury Department and
the IRS consider what types of hedging
transactions would result in qualifying in-
come and whether to adjust gross income
for such hedging transactions. To that end,
the Treasury Department and the IRS re-
quest comments on methods to account
for the income and gains, as well as the
deductions and losses, with respect to
hedges. For example, future regulations
may generally provide that income, de-
duction, gain, or loss from a hedging
transaction entered into by the partnership
primarily to manage risk of price changes
or currency fluctuations with respect to
ordinary property (as defined in § 1.1221-
2(c)(2)) with respect to which qualify-
ing income is derived from a section
7704(d)(1)(E) activity is treated as an ad-
justment to qualifying income, provided
that the transaction is entered into in the
ordinary course of the PTP's business and
is clearly identified by the end of the day
on which it is entered into. The principles
of section 1221(b)(2)(B) and the regula-
tions thereunder, regarding identification,
recordkeeping, and the effect of identifi-
cation and non-identification, would apply
to hedging transactions entered into by the
PTP.

For example, a partnership might have
gain or loss on a forward contract that it
enters into to hedge the price risk related
to its sale of a commodity with respect to
which qualifying income is derived from a
qualifying activity. If the partnership has
gain that is recognized on the hedge under
its method of accounting, then such gain
would be treated, for purposes of section
7704(c)(2), as an additional amount real-
ized with respect to the commodity and
would be treated under these rules as in-
creasing the amount of qualifying income

derived from the qualifying activity.
Conversely, if the taxpayer recognizes
loss under its accounting method with re-
spect to the hedge, then the loss would
be treated, for purposes of section
7704(c)(2), as a decrease in the amount
realized on the commodity thus decreas-
ing the qualifying income derived from
the qualifying activity.

The Treasury Department and the IRS
do not agree, however, that income from
hedging with respect to an activity that is
not a section 7704(d)(1)(E) activity
should give rise to qualifying income un-
der section 7704(d)(1)(E). Other types of
hedges, however, may be included under
other provisions of section 7704. For
example, as noted by some of the com-
menters, the existing regulations under
§ 1.7704-3 provide that qualifying in-
come includes (1) income from notional
principal contracts (NPC) if the property,
income, or cash flow that measures the
amount to which the partnership is enti-
tled under the NPC would give rise to
qualifying income if held or received di-
rectly by the partnership and (2) other
substantially similar income from ordi-
nary and routine investments to the extent
determined by the Commissioner. See
§ 1.7704-3(a)(1).

### 3. Passive Interests

Income from passive interests was not
addressed in the proposed regulations.
Commenters suggested that income from
passive, non-operating economic interests
in minerals and natural resources (for ex-
ample, royalty interests, net profits inter-
ests, rights to production payments, delay
rental payments, and lease bonus pay-
ments) should be qualifying income. One
commenter explained that passive eco-
nomic interest owners have an economic
interest in the minerals in place (for ex-
ample, they are treated as the owner of the
mineral or natural resource when it is in
fact produced) and a right to share and
participate in the proceeds derived from
the production of the minerals and natural
resources. Another commenter noted that
surface damage payments may arise as a
part of mining or production. For exam-
ple, if surface ownership and mineral
ownership are separate, a miner may pay
royalties to both the surface owner and

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

mineral owner. One commenter explained
that several parties may derive income
from exploration, development, mining,
production, or marketing: (1) owners of
passive economic interests that them-
selves do not engage in the production
operations associated with mineral or nat-
ural resource properties, but benefit from
their respective shares of production
revenue; (2) working interest owners
(whether or not the "operator") that are
responsible for the activities of exploring
for, drilling for, and producing natural re-
sources from the mineral properties, and
(3) third-party service providers, who gen-
erally do not own an economic interest in
the mineral properties, but charge the
working interest owners fees or service
charges. The commenter noted that the
proposed regulations addressed income of
working interest owners and third-party
service providers, but not those with pas-
sive economic interests.

Because income from passive eco-
nomic interests can be generated at many
different stages throughout the process of
getting minerals and natural resources to a
marketable form, these final regulations
include income from passive economic
interests in minerals and natural resources
as qualifying income.

### 4. Blending

Commenters raised several questions
about the extent to which the blending
of the same mineral or natural resource,
or products thereof, was a qualifying
activity. The proposed regulations refer-
enced some blending activities by treating
as a section 7704(d)(1)(E) activity the
chemical conversion of the physically
separated components of crude oil if one
or more of the products of the conversion
were recombined with other physically
separated components of crude oil in a
manner that was necessary to the cost-
effective production of gasoline or other
fuels. The proposed regulations also in-
cluded "blending additives into fuel" as a
marketing activity.

Commenters noted that terminal oper-
ators also perform blending services as a
part of their transportation activities, and
requested that the regulations be clarified
to list blending as a transportation activity.
Commenters explained that terminals may

blend different grades of crude oil to-
gether to achieve the desired grade or
quality of crude oil, or they may blend a
diluent (such as diesel fuel, or a lighter
grade of crude oil) into heavier crude oil
to achieve a level of viscosity appropriate
for the subsequent mode of transportation.
Another commenter stated that refineries
also perform some blending activities, and
asked that income from such blending be
treated as qualifying income. Commenters
also raised concerns that the restriction in
the proposed regulations to the blending
of just fuels does not account for the other
products of a refinery that may be pro-
duced through blending activities. In ad-
dition, one commenter noted that termi-
nals for other natural resources perform
blending activities. For example, the com-
menter explained that coal terminals may
mix or homogenize grades of coal from
different mines or mining regions with
dissimilar characteristics (for example,
higher sulfur coal and lower sulfur coal)
to achieve coal that meets product speci-
fications.

Expanding on this idea, some com-
menters asked for clarification that the
combination of different minerals and nat-
ural resources, or products thereof, should
also be a qualifying activity where all
products combined are natural resources
or products thereof. For example, one
commenter suggested that the physical
mixing of asphalt with aggregates to pro-
duce road paving material should be
treated as processing provided that the
primary purpose of the mixing is to en-
hance the inherent use of each of the prod-
ucts mixed. That commenter thought that
a product would no longer be considered a
natural resource if the product does not
retain a majority of the physical and
chemical characteristics of the mineral or
natural resource from which it was pro-
duced.

These final regulations adopt the rec-
ommendation that qualifying income
should include income from the blending
of the same mineral or natural resource, or
products thereof. Income from blending is
thus added as a type of additional quali-
fying income because blending may be
part of processing, refining, transporta-
tion, or marketing. In response to com-
ments, these final regulations also provide
that, for purposes of the blending rules in

these regulations, products of crude oil
and natural gas will be considered as from
the same natural resource. These final reg-
ulations do not, however, expand the def-
inition of processing or refining to include
the combination of different minerals or
natural resources, except as permitted un-
der the rules related to additization, which
are discussed in section III.H.5 of this
Summary of Comments and Explanation
of Revisions. Allowing the combination
of different natural resources would
greatly expand the scope of qualifying
activities beyond that intended by Con-
gress, and is akin to additional processing
to the point of manufacturing a new prod-
uct. For example, once asphalt is mixed
with rock aggregate, it is no longer a prod-
uct of a refinery or a product of mineral
processing, but has become a new road
paving product.

### 5. Additization

As they did for blending, commenters
raised several questions about the extent
to which the addition of a minimal amount
of different minerals or natural resources
or other materials to minerals or natural
resources is a qualifying activity. The pro-
posed regulations recognized that some
additization was a qualifying activity, but
only to the extent it was a marketing ac-
tivity and only with respect to fuels.

The proposed regulations left unde-
fined what additization included. One
commenter recommended that the addi-
tion of additives to enhance, preserve, or
complement the mineral or natural re-
source product, such as the chemical treat-
ment of sand, should qualify. Another
commenter recommended that additiza-
tion activities that do not change a natural
resource into a new product should give
rise to qualifying income whether done as
part of processing, refining, transporta-
tion, or marketing and no matter the type
of product (allowing, for example, additi-
zation with respect to lubricants or as-
phalt).

The Treasury Department and the IRS
agree that it is appropriate to treat some
additization services as qualifying activi-
ties. For example, certain additization
may occur in order to safely transport a
product (sand terminals, for example, may
treat sand with a detergent to prevent dust

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

as the sand travels by rail or truck to its
final destination) or to comply with Fed-
eral, state, or local regulations concerning
product specifications (as, for example, in
the case of the addition of dyes to gaso-
line). However, the Treasury Department
and the IRS remain concerned about dis-
tinguishing between products of refineries
and field facilities, and products of addi-
tional processing. Accordingly, and con-
sistent with some of the comments re-
ceived, these final regulations distinguish
between additives that are merely a small
addition to a product of a refinery, field
facility, or mill, and additives that may
change the product into a new or different
product. These final regulations thus pro-
vide rules regarding additization tailored
to crude oil, natural gas, other ores and
minerals, and timber.

With respect to crude oil, natural gas,
and products thereof, commenters ex-
plained that the additives, which are typ-
ically not natural resources for the pur-
poses of section 7704, are often required
by applicable regulations or otherwise en-
hance motor fuel blend stock. These ad-
ditives are added at the terminal because it
allows products owned by different cus-
tomers to be commingled for storage, but
then customized for each customer as
loaded into carriers for shipment. Typical
additives include detergents, dyes, cetane
improvers, cold flow improvers, fuel oil
stabilizers, isotopic markers, lubricity/
conductivity improvers, anti-icing agents,
and proprietary gasoline additives. Etha-
nol is also typically blended into gasoline
to satisfy EPA guidelines, and biodiesel is
often blended into diesel fuel. Comment-
ers noted that ethanol typically constitutes
10 percent of the blend but can be higher,
while biodiesel typically constitutes 20
percent of the blend but can be lower or
higher. Other additives typically make up
a very small portion of the blended stock
(typically less than 1 percent).

Commenters also argued that, just as
additives were permitted in the proposed
regulations with respect to fuels, additiza-
tion should also be allowed for other prod-
ucts of oil and natural gas processing and
refining. These commenters noted that
there is no practical difference between
adding ethanol, biodiesel, or other addi-
tives into fuels, and adding additives into
lubricating oils and waxes. For example,

commenters explained that lubricating
oils, waxes, and other refined products
may be blended together and with addi-
tives to provide increased anti-wear pro-
tection, reduce friction, extend oil life,
improve corrosion protection, give the
ability to separate from water, and reduce
energy usage. Lubricants may also be
mixed with a detergent and a thickener to
produce greases in multiple grades and for
many uses. These commenters also rec-
ommended that additization should not be
limited to just a marketing activity as, for
example, terminals and refineries both
may perform additization activities.

The Treasury Department and the IRS
agree that, since additization activities are
commonly performed by refineries and by
terminals with respect to all products of a
refinery, additization should be treated as
a qualifying activity that generates quali-
fying income. These final regulations
adopt this change and provide that, to the
extent the additives generally constitute
less than 5 percent of the total volume for
products of natural gas and crude oil and
are added into the product by the terminal
operator or upstream of the terminal op-
erator, the additization activity generates
qualifying income. As previously ex-
plained, added ethanol and biodiesel may
constitute up to 20 percent of the total
volume for products of natural gas and
crude oil; therefore, the final regulations
provide for a 20 percent threshold for eth-
anol and biodiesel. Although the Treasury
Department and the IRS remain con-
cerned that qualifying income not include
the manufacture of new products beyond
those generally produced in field facilities
or refineries, the Treasury Department and
the IRS have concluded that the small
amount of additives discussed in some of
the comments do not pose a risk if they
are consistent with the limitations set forth
in the final regulations.

In the case of minerals other than oil
and gas, the final regulations provide that
the addition of incidental amounts of ma-
terial such as paper dots to identify ship-
ments, anti-freeze to aid in shipping, or
compounds to allay dust as required by
law or reduce losses during shipping is
permissible.

Regarding timber, one commenter
noted that the treatment of lumber and
poles with an immaterial amount of addi-

tives that protect or enhance the natural
resource or that are necessary to meet
environmental or regulatory standards
should also constitute timber processing.
This commenter noted that the proposed
regulations included an intent-based test
that looks to whether chemicals are added
to "manipulate" physical or chemical
properties of the timber. The commenter
argued that there is no manipulation of
physical or chemical properties of the tim-
ber in the case of relatively small amounts
of additives, such as those that constitute
five percent or less of the product. This
commenter provided no examples of what
types of treatment processes would be re-
quired under environmental or regulatory
standards for lumber and poles, but did
argue that, although wood pellets are com-
monly made without the addition of any
non-timber additives, it is possible that
customers or regulators may require the
addition of an additive to reduce the emis-
sions profile of wood pellets.

As previously discussed, these final reg-
ulations generally allow for small amounts
of additives where required in order to
comply with Federal, state, or local law
when such additives do not rise to the
level of a manufacturing activity. As such,
the final regulations provide that, for tim-
ber, additization of incidental amounts of
material as required by law is permissible,
to the extent such additions do not create
a new product. These final regulations
clarify, however, that the application of
chemicals and pressure to produce pres-
sure treated wood does not give rise to
qualifying income. This is a process gen-
erally completed at a separate site from
the mill, and creates a new and different
manufactured product.

### IV. Intrinsic Activities

The proposed regulations provided that
for purposes of section 7704(d)(1)(E),
qualifying income includes only income
and gains from qualifying activities with
respect to minerals or natural resources.
Qualifying activities were defined to in-
clude section 7704(d)(1)(E) activities and
intrinsic activities. The preamble to the
proposed regulations explained that the
Treasury Department and the IRS be-
lieved that certain limited support activi-
ties intrinsic to section 7704(d)(1)(E) ac-

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

tivities also gave rise to qualifying income
because the income is "derived from" the
section 7704(d)(1)(E) activities. The pro-
posed regulations set forth three require-
ments for a support activity to be intrinsic
to a section 7704(d)(1)(E) activity: the
activity must be specialized to support the
section 7704(d)(1)(E) activity, essential to
the completion of the section 7704(d)
(1)(E) activity, and require the provision
of significant services to support the sec-
tion 7704(d)(1)(E) activity. The preamble
further explained that the Treasury De-
partment and the IRS intended that intrin-
sic activities constitute active support of
section 7704(d)(1)(E) activities, and not
merely the supply of goods.

#### A. General issues

The intrinsic activities provision pro-
vided a way for businesses whose activi-
ties were not listed as section 7704(d)
(1)(E) activities to demonstrate that they
were so closely tied to section 7704(d)
(1)(E) activities that they should be con-
sidered a part of the mineral or natural
resource industries, and that their activi-
ties therefore generated qualifying in-
come. Because these intrinsic activities
were discussed as support or service ac-
tivities, some commenters mistakenly be-
lieved that all service providers that did
not own or possess control of the under-
lying mineral or natural resource (such as
a subcontractor) must test whether their
activities generated qualifying income
solely under the intrinsic activities test,
even if the activity being performed was
listed as a section 7704(d)(1)(E) activity.
For example, one commenter recom-
mended an alternative intrinsic activity
standard whereby activities of a service
provider would qualify as intrinsic to a
section 7704(d)(1)(E) activity if they
would have qualified as a section 7704(d)
(1)(E) activity, or an indispensable part
thereof, if performed directly by the ser-
vice recipient.

Conversely, one commenter argued
that the simplest and most direct way to
define what activities are qualifying for
purposes of section 7704(d)(1)(E) is to
require possession of the mineral or natu-
ral resource. This commenter argued that
the Treasury Department and the IRS ex-
panded the scope of qualifying income

beyond that intended by Congress by ac-
commodating additional support activities
such as water delivery and disposal.

Like the proposed regulations, these
final regulations do not contain any re-
quirement that a PTP engaged in a section
7704(d)(1)(E) activity must own or pos-
sess control of the underlying mineral or
natural resource. Such a requirement con-
flicts with some of the listed 7704(d)
(1)(E) activities. For example, a PTP pipe-
line company may not own the products
being transported. Many of the examples
of activities defining each of the listed
7704(d)(1)(E) activities can be performed
without having ownership or possession
of the mineral or natural resource. Fur-
thermore, the legislative history clarified
that "[t]he reference provided in the bill to
depletable products is intended only to
identify the minerals or natural resources
and not to identify what income from
them is treated as qualifying income. Con-
sequently, whether income is taken into
account in determining percentage deple-
tion under section 613 is not necessarily
relevant in determining whether such in-
come is qualifying income under section
7704(d)." H.R. Rep. No. 100-795, at 400
(1988). Because the activities listed in
section 7704(d)(1)(E) may commonly be
performed by persons without ownership
of the underlying resource, the ownership
requirements in sections 611 and 613 are
not relevant in determining whether in-
come is qualifying for purposes of section
7704(d)(1)(E). Finally, section 7704(d)
(1)(E) provides that qualifying income is
income "derived from" exploration, de-
velopment, mining or production, pro-
cessing, refining, transportation, and mar-
keting. The intrinsic activities test applies
to those PTPs who engage in activities
other than those listed as a section
7704(d)(1)(E) activity but that may re-
ceive income "derived from" a section
7704(d)(1)(E) activity. Although the exis-
tence of the intrinsic activities test was
especially important in the proposed
regulations since the list of section
7704(d)(1)(E) activities was exclusive, the
test retains purpose in the final regulations
because it potentially allows as qualifying
some activities that closely support, but do
not specifically constitute, an enumerated
section 7704(d)(1)(E) activity.

To the extent the commenter who sug-
gested the alternative intrinsic activities
standard was also asking that an activity
be considered a qualifying activity when a
subcontractor performs only a subset of
the tasks of a larger qualifying activity,
that suggestion ignores the main thrust of
section 7704(d)(1)(E), which looks to the
activity that is being performed that gen-
erates the income received. For example,
this commenter argued that, because a re-
finer may use an air separation unit to
separate air into its primary components
for use in refining, a taxpayer that is solely
engaged in providing air separation unit
services to that refiner should have quali-
fying income. However, the use of air to
produce nitrogen and oxygen is clearly
not a section 7704(d)(1)(E) activity. Air is
not a mineral or natural resource. See sec-
tions 7704(d)(1) and 613(b)(7)(B). A re-
finery may use such gases in its activities,
but that does not mean the provision of the
air separation unit to create the gases
somehow should give rise to qualifying
income solely because the nitrogen and
oxygen are provided to a refinery. The
provision and operation of an air separa-
tion unit would only qualify to the extent
such activity meets the intrinsic test.

Aside from general criticism that the
intrinsic activities provision was too sub-
jective overall and challenging to apply in
situations that require a high level of cer-
tainty, the remainder of the comments on
the intrinsic activities provision requested
changes to the requirements of two spe-
cific prongs of the test dealing with spe-
cialization and significant services, as
discussed in sections IV.B and IV.C, re-
spectively, of this Summary of Comments
and Explanation of Revisions. The Trea-
sury Department and the IRS received no
comments recommending changes to the
essential prong of the intrinsic activities
test in the proposed regulations, which
required that the activity be necessary to
(a) physically complete the section
7704(d)(1)(E) activity (including in a
cost-effective manner, such as by making
the activity economically viable), or (b)
comply with Federal, state, or local law
regulating the section 7704(d)(1)(E) activ-
ity. These final regulations thus adopt the
essential prong of the intrinsic activities
test with no changes.

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

#### B. Specialization

The proposed regulations provided that
an activity was specialized if the partner-
ship provided personnel to perform or
support a section 7704(d)(1)(E) activity
and those personnel received training
unique to the mineral or natural resource
industry that was of limited utility other
than to perform or support a section
7704(d)(1)(E) activity (hereinafter “spe-
cialized personnel requirement"). In addi-
tion, to the extent that the activity in-
cluded the sale, provision, or use of
property, the proposed regulations re-
quired that either: (1) the property was
primarily tangible property that was ded-
icated to, and had limited utility outside
of, section 7704(d)(1)(E) activities and
was not easily converted to another use
(hereinafter "specialized property require-
ment"); or (2) the property was used as an
injectant to perform a section 7704(d)
(1)(E) activity that was also commonly
used outside of section 7704(d)(1)(E) ac-
tivities (such as water, lubricants, and
sand) and, as part of the activity, the part-
nership also collected and cleaned, recy-
cled, or otherwise disposed of the inject-
ant after use in accordance with Federal,
state, or local regulations concerning
waste products from mining or production
activities (hereinafter "injectants excep-
tion").

Commenters identified concerns with
all three parts of the specialization prong.
Regarding the specialized personnel re-
quirement, one commenter said it was un-
clear how much training was necessary
for a skill to be considered specialized.
Regarding the specialized property re-
quirement, the same commenter criticized
as vague the language about property
having limited utility outside section
7704(d)(1)(E). Other commenters argued
that the specialized property requirement
should be removed entirely or that the use
of specialized property should be treated
as an indication that a certain activity was
specialized rather than being required.
They explained that service companies
use a lot of equipment, some of which
would not be specialized (for example,
telephones, hammers, or bulldozers) in
performing their duties. Finally, one com-
menter recommended that the specializa-
tion prong be amended to recognize that

activities may be specialized if they sup-
port a section 7704(d)(1)(E) activity in a
remote or difficult environment (for ex-
ample, marine locations). This commenter
described as an example of such activities
allowing access to and use of its marine
docks and terminals, as a support base for
unrelated third-party oilfield service com-
panies selling products and providing ser-
vices in the Gulf of Mexico in support of
production of oil and gas.

Overall, the Treasury Department and
the IRS remain concerned that the final
regulations provide a means to differenti-
ate between the mere provision of general
services, goods, or equipment to others
and the active support of a section
7704(d)(1)(E) activity. The final regula-
tions thus do not adopt the recommenda-
tion that the test be amended to include
any support provided for section 7704(d)
(1)(E) activities performed in remote or
difficult environments. Support is a vague
term that could include the provision of
food or everyday supplies to workers on a
marine platform. In addition, merely mak-
ing docks available for use by third parties
does not give rise to qualifying income
under section 7704(d)(1)(E). The Trea-
sury Department and the IRS continue to
consider the specialized personnel and
specialized property requirements impor-
tant in insuring that the services or goods
provided have a clear nexus to section
7704(d)(1)(E) activities.

The final regulations also do not adopt
the suggestion to provide requirements for
how much training is necessary to meet
the specialized personnel requirement. In-
stead, these regulations retain the provi-
sion that personnel must have received
training unique to the mineral or natural
resource industry. The particular industry
at issue would determine the type and
amount of training necessary to perform
the support activity. However, the Trea-
sury Department and the IRS agree with
commenters that the specialized property
requirement in the proposed regulations
was overly broad. These final regulations
specifically provide that the use of non-
specialized property typically used inci-
dentally in operating a business will not
cause a PTP to fail the specialized prop-
erty requirement. However, these final
regulations retain the restrictions in the
specialized personnel requirement and the

specialized property requirement that
training provided for and property (other
than property typically used incidentally
in operating a business) involved in the
activity must not have applications out-
side of section 7704(d)(1)(E) activities.

Commenters provided many sugges-
tions for changes regarding the injectants
exception. Multiple commenters recom-
mended that sand should be removed from
the examples of injectants because it is a
natural resource, and therefore the bulk
sale or wholesale of sand would, in itself,
qualify as a section 7704(d)(1)(E) activi-
ty-marketing. These final regulations
adopt this recommendation and remove
sand as an example of an injectant in the
injectants exception.

Another commenter recommended ex-
panding the injectants exception to en-
compass the supply, cleaning, or recycling
of all products required for any section
7704(d)(1)(E) activity, not just injectants.
This commenter provided as an example
the supply and recycling of sulfuric acid,
used as a catalyst for purposes of alkyla-
tion (a process used to produce alkylates).
These final regulations do not adopt this
suggestion. A general rule that allows for
supply, cleaning, and recycling of any
good provided to others engaged in sec-
tion 7704(d)(1)(E) activities is too broad
and contrary to the stated goal of the in-
trinsic test in differentiating section
7704(d)(1)(E) support activities from the
mere provision of a good. The Treasury
Department and the IRS continue to con-
sider it appropriate to limit the exception
to just injectants because Federal, state,
and local law require that producers recy-
cle or otherwise properly dispose of in-
jectants, such as water, after use in mining
and production activities. Oilfield service
companies providing that service are thus
a required part of the mining and produc-
tion process-their income is thus "de-
rived from" the production activity. Ex-
panding the injectants exception as
requested would lead to many industrial
waste recycling activities potentially be-
ing included in what is intended to be a
limited exception for a legally required
step in section 7704(d)(1)(E) activities.
Thus, these regulations do not adopt this
suggestion.

Commenters also had a number of
comments specifically concerning water

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

under the injectants exception. Multiple
commenters noted that, although they
generally supported the proposed regula-
tions in their effort to provide a frame-
work for the types of oilfield service ac-
tivities that would generate qualifying
income, as a practical matter, they be-
lieved that a requirement that a PTP per-
form both the water delivery and disposal
activities at each well or development site
in order for that water delivery service to
qualify would be satisfied infrequently.
These commenters also argued that, so
long as they also are engaged in per-
forming disposal services, their business
model is not merely supplying a good,
that is, water. Multiple commenters rec-
ommended that the injectants exception
should not require that the product (in
particular, water) that is delivered must be
the product that is picked up and recy-
cled-what these commenters described
as a "well by well" approach. These com-
menters explained that it is common in the
industry for a well operator to source its
water supply and disposal service require-
ments with multiple providers and that it
may be difficult or impossible for a PTP to
satisfy the necessary "well by well" fac-
tual determination. Accordingly, com-
menters suggested several alternatives to
the "well by well" approach.

One commenter recommended that
water delivery services should qualify as
intrinsic activities only if exclusively pro-
vided by a PTP to those engaged in one or
more section 7704(d)(1)(E) activities in
cases where the PTP's operations also in-
clude conducting necessary water disposal
services on an ongoing or frequent basis,
though not necessarily in the same loca-
tion. Another commenter recommended
that the injectants exception be met if the
partnership providing the injectant also
provides other specialized services with
respect to such injectant at the wellsite,
such as transporting the water to smaller
temporary storage facilities at the wellsite,
treating the water prior to it going down-
hole, and monitoring and testing the utili-
zation of water throughout the transfer
and pressure pumping process. This com-
menter alternatively recommended that
the regulations only require that there be
delivery and clean up in the same geo-
graphic area (a "basin by basin" ap-
proach). Others suggested that mere water

delivery should qualify so long as the wa-
ter is delivered to those engaged in one or
more section 7704(d)(1)(E) activities, or
the water enhances the producers' ability
to produce oil or gas (as opposed to being
provided for other purposes). Finally, one
commenter argued that the regulations
should not require disposal in compliance
with Federal, state, or local regulations
since making a tax determination contin-
gent on such compliance introduces a
standard that would be difficult to admin-
ister.

The Treasury Department and the IRS
do not find support for the argument that
the mere delivery of water qualifies. Sec-
tion 7704(d)(1) is clear that a mineral or
natural resource does not include water;
thus, income from the simple marketing
and transportation of water is not qualify-
ing income. As explained previously, the
Treasury Department and the IRS have
concluded that companies that provide
water with legally required disposal ser-
vices have a strong nexus to a section
7704(d)(1)(E) activity (in particular, min-
ing and production). Some commenters
share that belief and support the efforts of
the Treasury Department and the IRS,
agreeing that there is a difference between
companies that simply provide water (the
mere provision of a good) and those that
provide both water and specialized ser-
vices. Nor do the final regulations adopt
the suggestion to remove the language
that the injectants are disposed after use in
accordance with Federal, state, or local
regulations concerning waste products
from mining or production activities. Al-
though, for tax compliance purposes, the
IRS will generally not confirm that the
PTP actually disposed of the injectants as
required under Federal, state, or local law,
the injectants exception is based on the
PTP providing disposal services where re-
quired by Federal, state, or local law.

The Treasury Department and the IRS
agree with commenters that the injections
exception should be revised to account for
industry practice in which a miner or pro-
ducer may not hire the same company to
provide both water delivery and disposal
services. Accordingly, these final regula-
tions instead adopt the "basin by basin"
approach recommended in comments-so
long as the PTP provides the water exclu-
sively to those engaged in section

7704(d)(1)(E) activities and both delivers
and recycles within the same geographic
area, the PTP's income from such activi-
ties is qualifying. The Treasury Depart-
ment and the IRS have concluded that this
requirement would provide a clear, ad-
ministrable rule concerning when water
delivery is not merely the delivery of a
good, but part of the provision of special-
ized disposal services.

#### C. Significant services

The proposed regulations provided that
an activity requires significant services to
support the section 7704(d)(1)(E) activity
if it must be conducted on an ongoing or
frequent basis by the partnership's person-
nel at the site or sites of the section
7704(d)(1)(E) activities. Alternatively,
those services could be conducted offsite
if the services are performed on an ongo-
ing or frequent basis and are offered ex-
clusively to those engaged in one or more
section 7704(d)(1)(E) activities. Whether
services are conducted on an ongoing or
frequent basis is determined based on all
the facts and circumstances, including rec-
ognized best practices in the relevant in-
dustry. Partnership personnel performed
significant services only if those services
were necessary for the partnership to per-
form an activity that is essential to the
section 7704(d)(1)(E) activity, or to sup-
port the section 7704(d)(1)(E) activity. Fi-
nally, an activity did not constitute signif-
icant services with respect to a section
7704(d)(1)(E) activity if the activity prin-
cipally involved the design, construction,
manufacturing, repair, maintenance, lease,
rent, or temporary provision of property.

One commenter argued that a facts and
circumstances test to determine whether
services are conducted on an ongoing ba-
sis is vague and would be subject to var-
ious interpretations. Another commenter
recommended the removal of the signifi-
cant services prong completely, arguing
that the frequency with which an activity
is performed is not relevant to determin-
ing whether an activity should qualify.
Instead, the test should focus on the needs
and activities of the operator, rather than
the activities of the service provider. One
commenter suggested that the proposed
regulations wrongly listed repair and
maintenance as activities that do not con-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

stitute significant services with respect to
a section 7704(d)(1)(E) activity, arguing
that the repair and maintenance of equip-
ment and facilities are often required by
the operator on a near-continuous basis
under typical services agreements.

The Treasury Department and the IRS
do not find support for the contention that
the test should solely focus on the needs
of the operator. Section 7704(d)(1) applies
to determine whether a PTP's income is
qualifying income; therefore, the focus of
these regulations is on the activities per-
formed by the PTP giving rise to the in-
come at issue. The significant services
prong is an important part of determining
whether the activity performed by a sup-
port services PTP has the required nexus
with a section 7704(d)(1)(E) activity. As
such, these final regulations do not adopt
these changes and retain the "significant
services" prong of the intrinsic services
test as well as the statement that signifi-
cant services do not include an activity
principally involving repair or mainte-
nance of property.

One commenter recommended that the
restriction that services conducted offsite
must be offered exclusively to those en-
gaged in performing section 7704(d)
(1)(E) activities should be removed, since
activities such as clean-up and disposal
happen offsite and may be performed for
service recipients other than those en-
gaged in section 7704(d)(1)(E) activities.
These final regulations modify this provi-
sion to provide that services may be con-
ducted offsite if the services are offered to
those engaged in one or more section
7704(d)(1)(E) activities. If the services are
monitoring services, those services must
be offered exclusively to those engaged in
one or more section 7704(d)(1)(E) activi-
ties.

Finally, commenters also expressed
concerns that it was not clear whether
services are counted for purposes of the
personnel requirement if they are pro-
vided by an affiliate, subcontractor, or in-
dependent contractor. These commenters
noted that it is common for PTPs to work
through related companies and subcontrac-
tors. One commenter recommended that the
definition of "qualifying activities" in the
regulations make clear that an activity is
no less a qualifying activity because it is
performed by a subcontractor or consists

of a subset of the tasks of a larger quali-
fying activity.

The Treasury Department and the IRS
agree that a PTP should be able to meet
the personnel requirement through affili-
ates or subcontractors in addition to the
PTP's own employees. This is true for
purposes of satisfying the specialization
prong (including determining whether the
personnel have received specialized train-
ing) or the significant services prong. Ac-
cordingly, the final regulations adopt this
change and clarify that these prongs can
be met through employees of affiliates or
subcontractors, so long as they are being
compensated by the PTP.

### V. Effective Date

The proposed regulations provided
that, except as otherwise provided, the
regulations would apply to income earned
by a partnership in a taxable year begin-
ning on or after the date the final regula-
tions are published in the Federal Regis-
ter. An exception was made for certain
income earned during a transition period,
which would end on the last day of the
partnership's taxable year that included
the date that is ten years after the date the
final regulations are published in the Fed-
eral Register (the Transition Period).
That exception provided that a partnership
could treat income from an activity as
qualifying income during the Transition
Period if: (a) the partnership received a
private letter ruling from the IRS holding
that the income from that activity is qual-
ifying income; (b) prior to the publication
of the final regulations, the partnership
was publicly traded, engaged in the activ-
ity, and treated the activity as giving rise
to qualifying income under section
7704(d)(1)(E), and that income was qual-
ifying income under the statute as reason-
ably interpreted prior to the issuance of
the proposed regulations; or (c) the part-
nership is publicly traded and engages in
the activity after the issuance of the pro-
posed regulations but before the date the
final regulations are published in the Fed-
eral Register and the income from that
activity is qualifying income under the
proposed regulations.

Commenters objected that the Transi-
tion Period is not sufficient and that the
IRS should allow PTPs that have received

favorable PLRs that are contrary to these
final regulations to continue to rely on
them permanently. They argued that re-
voking a PLR sets a bad precedent that
will cause taxpayers and investors not to
rely on PLRs. They also argued that the
revocation of a PLR would hurt them ec-
onomically and would harm investors. Fi-
nally, some commenters requested that the
final regulations clarify that a technical
termination of a partnership under section
708(b)(1)(B) does not end the Transition
Period.

The Transition Period is a reasonable
amount of time for PTPs to rearrange their
affairs as necessary and is consistent with
comments made in Congress concerning
the ten-year transition relief granted when
section 7704(d)(1)(E) was added in 1987.
The IRS may revoke a PLR when the
letter is found to be in error or not in
accord with the current views of the Ser-
vice, or there is a material change in fact.
If the revocation is as a result of an error
or a change in view, this revocation may
occur through the issuance of final regu-
lations. See Section 11.04 of Rev. Proc.
2016-1, 2016-1 I.R.B. 1. Therefore, the
final regulations do not adopt the sugges-
tion that the IRS permanently allow PTPs
with favorable PLRs that are contrary to
these final regulations to continue to rely
on them. The final regulations do, how-
ever, adopt the request for clarification
that a technical termination does not end
the Transition Period. This addition is
consistent with statements made concern-
ing the original 10-year transition period
provided by Congress when section
7704(d)(1)(E) was added. See Joint
Comm. on Taxation, 100th Cong., De-
scription of the Technical Corrections Act
of 1988 (H.R. 4333 and S. 2238), JCS-
10-88, at 412 (1988) ("[i]t is intended
that a publicly traded partnership not be
treated as ceasing to be an existing part-
nership solely by reason of a termination
of the partnership (within the meaning of
section 708) caused by the sale or ex-
change through trading of 50 percent or
more of the partnership interests.")

## Special Analyses

Certain IRS regulations, including these,
are exempt from the requirements of Ex-
ecutive Order 12866, as supplemented and
reaffirmed by Executive Order 13563.

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

Therefore, a regulatory impact assessment
is not required. Because these regulations
do not impose a collection of information
on small entities, the Regulatory Flexibil-
ity Act (5 U.S.C. chapter 6) does not ap-
ply. Pursuant to section 7805(f) of the
Code, the notice of proposed rulemaking
that preceded these final regulations was
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administra-
tion for comment on its impact on small
business, and no comments were received.

## Drafting Information

The principal author of these regula-
tions is Caroline E. Hay, Office of the
Associate Chief Counsel (Passthroughs
and Special Industries). However, other
personnel from the Treasury Department
and the IRS participated in their develop-
ment.

* * * * *

## 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 1.7704-4 is added to
read as follows:

§ 1.7704-4 Qualifying income -
mineral and natural resources.

(a) In general. For purposes of section
7704(d)(1)(E), qualifying income is in-
come and gains from qualifying activities
with respect to minerals or natural re-
sources as defined in paragraph (b) of this
section. Qualifying activities are section
7704(d)(1)(E) activities (as described in
paragraph (c) of this section) and intrinsic
activities (as described in paragraph (d) of
this section).

(b) Mineral or natural resource. The
term mineral or natural resource (includ-
ing fertilizer, geothermal energy, and tim-
ber) means any product of a character
with respect to which a deduction for de-
pletion is allowable under section 611,
except that such term does not include any
product described in section 613(b)(7)(A)

or (B) (soil, sod, dirt, turf, water, mosses,
or minerals from sea water, the air, or
other similar inexhaustible sources). For
purposes of this section, the term mineral
or natural resource does not include indus-
trial source carbon dioxide, fuels de-
scribed in section 6426(b) through (e), any
alcohol fuel defined in section 6426(b)
(4)(A), or any biodiesel fuel as defined in
section 40A(d)(1).

(c) Section 7704(d)(1)(E) activities-
(1) Definition. Section 7704(d)(1)(E) ac-
tivities include the exploration, develop-
ment, mining or production, processing,
refining, transportation, or marketing of
any mineral or natural resource. Solely for
purposes of section 7704(d), such terms
are defined as provided in this paragraph
(c).

(2) Exploration. An activity constitutes
exploration if it is performed to ascertain
the existence, location, extent, or quality
of any deposit of mineral or natural re-
source before the beginning of the devel-
opment stage of the natural deposit in-
cluding by-

(i) Drilling an exploratory or strati-
graphic type test well;

(ii) Conducting drill stem and produc-
tion flow tests to verify commerciality of
the deposit;

(iii) Conducting geological or geo-
physical surveys;

(iv) Interpreting data obtained from
geological or geophysical surveys; or

(v) For minerals, testpitting, trenching,
drilling, driving of exploration tunnels
and adits, and similar types of activities
described in Rev. Rul. 70-287 (1970-1
CB 146), (see § 601.601(d)(2)(ii)(b) of
this chapter) if conducted prior to devel-
opment activities with respect to the min-
erals.

(3) Development. An activity consti-
tutes development if it is performed to
make accessible minerals or natural re-
sources, including by-

(i) Drilling wells to access deposits of
minerals or natural resources;

(ii) Constructing and installing drilling,
production, or dual purpose platforms in
marine locations, or any similar support-
ing structures necessary for extraordinary
non-marine terrain (such as swamps or
tundra);

(iii) Completing wells, including by in-
stalling lease and well equipment, such as

pumps, flow lines, separators, and storage
tanks, so that wells are capable of produc-
ing oil and gas, and the production can be
removed from the premises;

(iv) Performing a development tech-
nique such as, for minerals other than oil
and natural gas, stripping, benching and
terracing, dredging by dragline, stoping,
and caving or room-and-pillar excavation,
and for oil and natural gas, fracturing; or

(v) Constructing and installing gather-
ing systems and custody transfer stations.

(4) Mining or production. An activity
constitutes mining or production if it is
performed to extract minerals or natural
resources from the ground including by
operating equipment to extract minerals or
natural resources from mines and wells, or
to extract minerals or natural resources
from the waste or residue of prior mining
or production allowable under this sec-
tion. The recycling of scrap or salvaged
metals or minerals from previously man-
ufactured products or manufacturing pro-
cesses is not considered to be the extrac-
tion of ores or minerals from waste or
residue.

(5) Processing. An activity constitutes
processing if it is performed to convert
raw mined or harvested products or raw
well effluent to substances that can be
readily transported or stored, as described
in this paragraph (c)(5).

(i) Natural gas. An activity constitutes
processing of natural gas if it is performed
to-

(A) Purify natural gas, including by
removal of oil or condensate, water, or
non-hydrocarbon gases (such as carbon
dioxide, hydrogen sulfide, nitrogen, and
helium); and

(B) Separate natural gas into its con-
stituents which are normally recovered in
a gaseous phase (methane and ethane) and
those which are normally recovered in a
liquid phase (propane, butane, pentane,
and heavier streams).

(ii) Crude oil. An activity constitutes
processing of crude oil if it is performed
to separate produced fluids by passing
crude oil through mechanical separators to
remove gas, placing crude oil in settling
tanks to recover basic sediment and water,
dehydrating crude oil, and operating
heater-treaters that separate raw oil well
effluent into crude oil, natural gas, and salt
water.

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

(iii) Ores and minerals other than nat-
ural gas or crude oil. An activity consti-
tutes processing of ores and minerals
other than natural gas or crude oil if it
meets the definition of mining processes
under § 1.613-4(f)(1)(ii), without regard
to § 1.613-4(f)(2)(iv).

(iv) Timber. An activity constitutes
processing of timber if it is performed to
modify the physical form of timber, in-
cluding by the application of heat or pres-
sure to timber, without adding any foreign
substances. Processing of timber does not
include activities that add chemicals or
other foreign substances to timber to ma-
nipulate its physical or chemical proper-
ties, such as using a digester to produce
pulp. Products that result from timber pro-
cessing include wood chips, sawdust,
rough lumber, kiln-dried lumber, veneers,
wood pellets, wood bark, and rough poles.
Products that are not the result of timber
processing include pulp, paper, paper
products, treated lumber, oriented strand
board/plywood, and treated poles.

(6) Refining. An activity constitutes re-
fining if the activity is set forth in this
paragraph (c)(6).

(i) Natural gas and crude oil. (A) The
refining of natural gas and crude oil in-
cludes the further physical or chemical
conversion or separation processes of
products resulting from activities listed in
paragraph (c)(5)(i) and (ii) of this section,
and the blending of petroleum hydrocar-
bons, to the extent they give rise to a
product listed in paragraph (c)(5)(i) or (ii)
of this section or to the products of a type
produced in a petroleum refinery or natu-
ral gas processing plant listed in this para-
graph (c)(6)(i)(A). Refining of natural gas
and crude oil also includes the further
physical or chemical conversion or sepa-
ration processes and blending of the prod-
ucts listed in this paragraph (c)(6)(i)(A),
to the extent that the resulting product is
also listed in this paragraph (c)(6)(i)(A).
The following products are of a type pro-
duced in a petroleum refinery or natural
gas processing plant:

(1) Ethane.

(2) Ethylene.

(3) Propane.

(4) Propylene.

(5) Normal butane.

(6) Butylene.

(7) Isobutane.

(8) Isobutene.

(9) Isobutylene.

(10) Pentanes plus.

(11) Unfinished naphtha.

(12) Unfinished kerosene and light gas
oils.

(13) Unfinished heavy gas oils.

(14) Unfinished residuum.

(15) Reformulated gasoline with fuel
ethanol.

(16) Reformulated other motor gaso-
line.

(17) Conventional gasoline with fuel
ethanol - Ed55 and lower gasoline.

(18) Conventional gasoline with fuel
ethanol - greater than Ed55 gasoline.

(19) Conventional gasoline with fuel
ethanol - other conventional finished gas-
oline.

(20) Reformulated blendstock for oxy-
genate (RBOB).

(21) Conventional blendstock for oxy-
genate (CBOB).

(22) Gasoline treated as blendstock
(GTAB).

(23) Other motor gasoline blending
components defined as gasoline blend-
stocks as provided in § 48.4081-1(c)(3) of
this chapter.

(24) Finished aviation gasoline and
blending components.

(25) Special naphthas (solvents).

(26) Kerosene-type jet fuel.

(27) Kerosene.

(28) Distillate fuel oil (heating oils,
diesel fuel, and ultra-low sulfur diesel
fuel).

(29) Residual fuel oil.

(30) Lubricants (lubricating base oils).

(31) Asphalt and road oil (atmospheric
or vacuum tower bottom).

(32) Waxes.

(33) Petroleum coke.

(34) Still gas.

(35) Naphtha less than 401ºF end-
point.

(36) Other products of a refinery that
the Commissioner may identify through
published guidance.

(B) For purposes of this section, the
products listed in this paragraph (c)(6)
(i)(B) are not products of refining:

(1) Heat, steam, or electricity produced
by processing or refining.

(2) Products that are obtained from
third parties or produced onsite for use in

the refinery, such as hydrogen, if excess
amounts are sold.

(3) Any product that results from fur-
ther chemical change of a product listed in
paragraph (c)(6)(i)(A) of this section that
does not result in the same or another
product listed in paragraph (c)(6)(i)(A) of
this section (for example, production of
petroleum coke from heavy (refinery) re-
siduum qualifies, but any upgrading of
petroleum coke (such as to calcined coke)
does not qualify because it is further
chemically changed and does not result in
the same or another product listed in para-
graph (c)(6)(i)(A) of this section).

(4) Plastics or similar petroleum deriv-
atives.

(ii) Ores and minerals other than nat-
ural gas or crude oil. (A) An activity
constitutes refining of ores and minerals
other than natural gas or crude oil if it is
one of the various processes performed
subsequent to mining processes (as de-
fined in paragraph (c)(5)(iii) of this sec-
tion) to eliminate impurities or foreign
matter and which are necessary steps in
achieving a high degree of purity from
metallic ores and minerals which are not
customarily sold in the form of the crude
mineral product, as specified in paragraph
(c)(6)(ii)(B) of this section. Refining pro-
cesses include: fine pulverization, electrow-
inning, electrolytic deposition, roasting,
thermal or electric smelting, or substan-
tially equivalent processes or combina-
tions of processes used to separate or
extract the specified metals listed in para-
graph (c)(6)(ii)(B) of this section from the
ore for the primary purpose of producing a
purer form of the metal, as for example
the smelting of concentrates to produce
Doré bars or refining of blister copper.

(B) For purposes of this section, the
specified metallic ores or minerals which
are not customarily sold in the form of the
crude mineral product are-

(1) Lead;

(2) Zinc;

(3) Copper;

(4) Gold;

(5) Silver; and

(6) Any other ores or minerals that the
Commissioner may identify through pub-
lished guidance.

(C) Refining does not include the in-
troduction of additives that remain in the
metal, for example, in the manufacture of

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

alloys of gold. Also, the application of non-
mining processes as defined in § 1.613-4(g)
in order to produce a specified metal that is
considered a waste or by-product of produc-
tion from a non-specified mineral deposit is
not considered refining for purposes of this
section.

(7) Transportation-(i) General rule.
An activity constitutes transportation if it
is performed to move minerals or natural
resources, and products under paragraph
(c)(4), (5), or (6) of this section, including
by pipeline, marine vessel, rail, or truck.
Except as provided in paragraph (c)(7)(ii)
of this section, transportation does not in-
clude the movement of minerals or natural
resources, and products produced under
paragraph (c)(4), (5), or (6) of this section,
directly to retail customers or to a place
that sells or dispenses to retail customers.
Retail customers do not include a person
who acquires oil or gas for refining or
processing, or a utility. Transportation in-
cludes the following activities:

(A) Providing storage services.

(B) Providing terminalling services, in-
cluding the following: receiving products
from pipelines, marine vessels, railcars, or
trucks; storing products; loading products
to pipelines, marine vessels, railcars, or
trucks for distribution; testing and treat-
ing, as well as blending and additization,
if income from such activities would be
qualifying income pursuant to paragraph
(c)(10)(iv) and (v) of this section; and
separating and selling excess renewable
identification numbers acquired as part of
additization services to comply with envi-
ronmental regulations.

(C) Moving or carrying (whether by
owner or operator) products via pipelines,
gathering systems, and custody transfer
stations.

(D) Operating marine vessels (includ-
ing time charters), railcars, or trucks.

(E) Providing compression services to
a pipeline.

(F) Liquefying or regasifying natural
gas.

(ii) Transportation to retail customers
or to a place that sells to retail customers.
Transportation includes the movement of
minerals or natural resources, and prod-
ucts under paragraph (c)(4), (5), or (6) of
this section, via pipeline to a place that
sells to retail customers. Transportation
also includes the movement of liquefied

petroleum gas via trucks, rail cars, or
pipeline to a place that sells to retail cus-
tomers or directly to retail customers.

(8) Marketing-(i) General rule. An
activity constitutes marketing if it is the
bulk sale of minerals or natural resources,
and products under paragraph (c)(4), (5),
or (6) of this section. Except as provided
in paragraph (c)(8)(ii) of this section, mar-
keting does not include retail sales (sales
made in small quantities directly to end
users), which includes the operation of
gasoline service stations, home heating oil
delivery services, and local natural gas
delivery services.

(ii) Retail sales of liquefied petroleum
gas. Retail sales of liquefied petroleum
gas are included in marketing.

(iii) Certain activities that facilitate
sale. Marketing also includes certain ac-
tivities that facilitate sales that constitute
marketing under paragraphs (c)(8)(i) and
(ii) of this section, including packaging, as
well as and blending and additization, if
income from blending and additization
would be qualifying income pursuant to
paragraph (c)(10)(iv) and (v) of this sec-
tion.

(9) Fertilizer. [Reserved]

(10) Additional activities. The follow-
ing types of income as described in para-
graph (c)(10)(i) through (v) of this section
will be considered derived from a section
7704(d)(1)(E) activity.

(i) Cost reimbursements. If the partner-
ship is in the trade or business of perform-
ing a section 7704(d)(1)(E) activity, qual-
ifying income includes income received to
reimburse the partnership for its costs in
performing that section 7704(d)(1)(E) ac-
tivity, whether imbedded in the rate the
partnership charges or separately item-
ized. Reimbursable costs may include the
cost of designing, constructing, installing,
inspecting, maintaining, metering, moni-
toring, or relocating an asset used in that
section 7704(d)(1)(E) activity, or provid-
ing office functions necessary to the oper-
ation of that section 7704(d)(1)(E) activity
(such as staffing, purchasing supplies,
billing, accounting, and financial report-
ing). For example, a pipeline operator that
charges a customer for its cost to build,
repair, or schedule flow on the pipelines
that it operates will have qualifying in-
come from such activity whether or not it

itemizes those costs when it bills the cus-
tomer.

(ii) Hedging. [Reserved]

(iii) Passive Interests. Qualifying in-
come includes income and gains from a
passive interest or non-operating interest,
including production royalties, minimum
annual royalties, net profits interests, de-
lay rentals, and lease-bonus payments, if
the interest is in a mineral or natural re-
source as defined in paragraph (b) of this
section. Payments received on a produc-
tion payment will not be qualifying in-
come if they are properly treated as loan
payments under section 636.

(iv) Blending. Qualifying income in-
cludes income and gains from performing
blending activities or services with respect
to products under paragraph (c)(4), (5), or
(6) of this section, so long as the products
being blended are component parts of the
same mineral or natural resource. For pur-
poses of this paragraph (c)(10)(iv), prod-
ucts of oil and natural gas will be consid-
ered as from the same natural resource.
Blending does not include combining dif-
ferent minerals or natural resources or
products thereof together. However, see
paragraph (c)(10)(v) of this section for
rules concerning additization.

(v) Additization. Qualifying income in-
cludes income and gains from providing
additization services with respect to prod-
ucts under paragraph (c)(4), (5), or (6) of
this section to the extent specifically per-
mitted in this paragraph (c)(10)(v). The
addition of additives described in para-
graph (c)(10)(v)(A) through (C) of this
section is permissible if the additives aid
in the transportation of a product, enhance
or protect the intrinsic properties of a
product, or are necessary as required by
federal, state, or local law (for example, to
meet environmental standards), but only if
such additives do not create a new prod-
uct.

(A) The addition of additives to prod-
ucts of natural gas and crude oil is per-
missible, provided that such additives
constitute less than 5 percent (except that
ethanol or biodiesel may be up to 20 per-
cent) of the total volume for products of
natural gas and crude oil and are added
into the product by the terminal operator
or upstream of the terminal operator.

(B) In the case of ores and minerals
other than natural gas or crude oil, the

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

addition of incidental amounts of material
such as paper dots to identify shipments,
anti-freeze to aid in shipping, or com-
pounds to allay dust as required by law or
reduce losses during shipping is permissi-
ble.

(C) In the case of timber, additization
of incidental amounts to comply with gov-
ernment regulations is permissible, to the
extent such additization does not create a
new product. For example, the pressure
treatment of wood is impermissible be-
cause it creates a new product.

(d) Intrinsic activities-(1) General re-
quirements. An activity is an intrinsic ac-
tivity only if the activity is specialized to
support a section 7704(d)(1)(E) activity, is
essential to the completion of the section
7704(d)(1)(E) activity, and requires the
provision of significant services to support
the section 7704(d)(1)(E) activity. Whether
an activity is an intrinsic activity is deter-
mined on an activity-by-activity basis.

(2) Specialization. An activity is a spe-
cialized activity if-

(i) The partnership provides personnel
(including employees of the partnership,
an affiliate, subcontractor, or independent
contractor performing work on behalf of
the partnership) to support a section
7704(d)(1)(E) activity and those person-
nel have received training in order to sup-
port the section 7704(d)(1)(E) activity that
is unique to the mineral or natural re-
source industry and of limited utility other
than to perform or support a section
7704(d)(1)(E) activity; and

(ii) To the extent that the activity in-
volves the sale, provision, or use of spe-
cific property, either-

(A) The property is primarily tangible
property that is dedicated to, and has lim-
ited utility outside of, section 7704(d)
(1)(E) activities and is not easily con-
verted (as determined based on all the
facts and circumstances, including the
cost to convert the property) to another
use other than supporting or performing
the section 7704(d)(1)(E) activities (ex-
cept that the use of non-specialized prop-
erty typically used incidentally in operat-
ing a business will not cause a partnership
to fail this paragraph (d)(2)(ii)(A)); or

(B) If the property is used as an inject-
ant to perform a section 7704(d)(1)(E)
activity that is also commonly used out-
side of section 7704(d)(1)(E) activities

(such as water and lubricants), the part-
nership provides the injectants exclusively
to those engaged in section 7704(d)(1)(E)
activities; the partnership is also in the
trade or business of collecting, cleaning,
recycling, or otherwise disposing of in-
jectants after use in accordance with Fed-
eral, state, or local regulations concerning
waste products from mining or production
activities; and the partnership operates its
injectant delivery and disposal services
within the same geographic area.

(3) Essential. (i) An activity is essential
to the section 7704(d)(1)(E) activity if it is
required to-

(A) Physically complete a section
7704(d)(1)(E) activity (including in a
cost-effective manner, such as by making
the activity economically viable), or

(B) Comply with Federal, state, or lo-
cal law regulating the section 7704(d)
(1)(E) activity.

(ii) Legal, financial, consulting, ac-
counting, insurance, and other similar ser-
vices do not qualify as essential to a sec-
tion 7704(d)(1)(E) activity.

(4) Significant services. (i) An activity
requires significant services to support the
section 7704(d)(1)(E) activity if those ser-
vices must be conducted on an ongoing or
frequent basis by the partnership's person-
nel at the site or sites of the section
7704(d)(1)(E) activities. Alternatively,
those services may be conducted offsite if
the services are performed on an ongoing
or frequent basis and are offered to those
engaged in one or more section 7704(d)
(1)(E) activities. If the services are moni-
toring, those services must be offered ex-
clusively to those engaged in one or more
section 7704(d)(1)(E) activities. Whether
services are conducted on an ongoing or
frequent basis is determined based on all
the facts and circumstances, including rec-
ognized best practices in the relevant in-
dustry.

(ii) Personnel perform significant ser-
vices only if those services are necessary
for the partnership to perform an activity
that is essential to the section 7704(d)
(1)(E) activity, or to support the section
7704(d)(1)(E) activity. Personnel include
employees of the partnership, an affiliate,
subcontractor, or independent contractor
performing work on behalf of the partner-
ship.

(iii) Services are not significant ser-
vices with respect to a section 7704(d)
(1)(E) activity if the services principally
involve the design, construction, manu-
facturing, repair, maintenance, lease, rent,
or temporary provision of property.

(e) Interpretations of section 611 and
section 613. This section and interpreta-
tions of this section have no effect on
interpretations of sections 611 and 613, or
other sections of the Code, or the regula-
tions thereunder; however, this section in-
corporates some of the interpretations
under section 611 and 613 and the regu-
lations thereunder as provided in this sec-
tion.

(f) Examples. The following examples
illustrate the provisions of this section:

Example 1. Petrochemical products sourced
from an oil and gas well. (i) Z, a publicly traded
partnership, chemically converts a mixture of ethane
and propane (obtained from physical separation of
natural gas) into ethylene and propylene through use
of a steam cracker. Z sells the ethylene and propyl-
ene in bulk to a third party.

(ii) Ethylene and propylene are products of re-
fining as provided in paragraph (c)(6)(i) of this
section; therefore, Z is engaged in a section
7704(d)(1)(E) activity. The income Z receives from
the sale of ethylene and propylene is qualifying
income for purposes of section 7704(d)(1)(E).

Example 2. Petroleum streams chemically con-
verted into refinery grade olefins byproducts. (i) Y, a
publicly traded partnership, owns a petroleum refin-
ery. The refinery physically separates crude oil, ob-
taining heavy gas oil. The refinery then uses a cata-
lytic cracking unit to chemically convert the heavy
gas oil into a liquid stream suitable for gasoline
blending and a gas stream containing ethane, ethyl-
ene, and other gases. The refinery also further phys-
ically separates the gas stream, resulting in refinery-
grade ethylene. Y sells the ethylene in bulk to a third
party.

(ii) Y's activities give rise to products of refining
as provided in paragraph (c)(6)(i) of this section;
therefore, Y is engaged in a section 7704(d)(1)(E)
activity. The income Y receives from the sales of
ethylene is qualifying income for purposes of section
7704(d)(1)(E).

Example 3. Converting methane gas into syn-
thetic fuels through chemical change. (i) Y, a pub-
licly traded partnership, chemically converts meth-
ane into methanol and synthesis gas, and further
chemically converts those products into gasoline and
diesel fuel. Y receives income from bulk sales of
gasoline and diesel created during the conversion
processes, as well as from sales of methanol.

(ii) With respect to the production of gasoline or
diesel from methane, gasoline and diesel are prod-
ucts of refining as provided in paragraph (c)(6)(i) of
this section; therefore, Y is engaged in a section
7704(d)(1)(E) activity. Y's income from the sale of
gasoline and diesel is qualifying income for purposes
of section 7704(d)(1)(E).

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

(iii) The income from the sale of methanol, an
intermediate product in the conversion process, is
not qualifying income for purposes of section
7704(d)(1)(E) because methanol is not a product of
processing or refining as defined in paragraph (c)(5)
and (6) of this section.

Example 4. Converting methanol into gasoline
and diesel. (i) Assume the same facts as in Example
3 of this paragraph (f), except Y purchases methanol
and synthesis gas and chemically converts the meth-
anol and synthesis gas into gasoline and diesel.

(ii) The chemical conversion of methanol and
synthesis gas into gasoline and diesel is not refining
as provided in paragraph (c)(6)(i) of this section
because it is not the physical or chemical conversion
or the separation or blending of products listed in
paragraph (c)(6)(i)(A) of this section. Accordingly,
the income from the sales of the gasoline and diesel
is not qualifying income for purposes of section
7704(d)(1)(E).

Example 5. Delivery of refined products. (i) X, a
publicly traded partnership, sells diesel to a govern-
ment entity at wholesale prices and delivers those
goods in bulk.

(ii) X's sale of a refined product to the govern-
ment entity is a section 7704(d)(1)(E) activity be-
cause it is a bulk transportation and sale as described
in paragraph (c)(7) and (8) of this section and is not
a retail sale.

Example 6. Constructing a pipeline. (i) X, a
publicly traded partnership, operates interstate and
intrastate natural gas pipelines. Y, a corporation, is a
construction firm. X pays Y to build a pipeline. X
later seeks reimbursement for its cost to build the
pipeline from A, a refiner who contracts with X to
transport gasoline.

(ii) X, as an operator of pipelines, is engaged in
transportation pursuant to paragraph (c)(7)(i)(C) of
this section. The reimbursement X receives from A
for X's cost to build the pipeline is qualifying in-
come pursuant to paragraph (c)(10)(i) of this section
because X receives the income to reimburse X for its
costs in performing X's transportation activity and
reimbursable costs may include construction costs.
In contrast, Y is not in the trade or business of
performing a 7704(d)(1)(E) activity, thus income Y
received from X for building the pipeline is not
qualifying income to Y.

Example 7. Delivery of water. (i) X, a publicly
traded partnership, owns interstate and intrastate nat-
ural gas pipelines. X built a water delivery pipeline
along the existing right of way for its natural gas
pipeline to deliver water to A for use in A's fractur-
ing activity. A uses the delivered water in fracturing
to develop A's natural gas reserve in a cost-efficient
manner. X earns income for transporting natural gas
in the pipelines and for delivery of water.

(ii) X's income from transporting natural gas in
its interstate and intrastate pipelines is qualifying
income for purposes of section 7704(c) because trans-
portation of natural gas is a section 7704(d)(1)(E)
activity as provided in paragraph (c)(7)(i)(C) of
this section.

(iii) The income X obtains from its water deliv-
ery services is not a section 7704(d)(1)(E) activity as
provided in paragraph (c) of this section. However,
because X's water delivery supports A's develop-
ment of natural gas, a section 7704(d)(1)(E) activity,

X's income from water delivery services may be
qualifying income for purposes of section 7704(c) if
the water delivery service is an intrinsic activity as
provided in paragraph (d) of this section. An activity
is an intrinsic activity if the activity is specialized to
support the section 7704(d)(1)(E) activity, is essen-
tial to the completion of the section 7704(d)(1)(E)
activity, and requires the provision of significant
services to support the section 7704(d)(1)(E) activ-
ity. Under paragraph (d)(2)(ii)(B) of this section, the
provision of water for use as an injectant in a section
7704(d)(1)(E) activity is specialized to that activity
only if the partnership (1) provides the water exclu-
sively to those engaged in section 7704(d)(1)(E)
activities, (2) is also in the trade or business of
cleaning, recycling, or otherwise disposing of water
after use in accordance with Federal, state, or local
regulations concerning waste products from mining
or production activities, and (3) operates these dis-
posal services within the same geographic area as
that in which it delivers water. Because X does not
perform such disposal services, X's water delivery
activities are not specialized to support the section
7704(d)(1)(E) activity. Thus, X's water delivery is
not an intrinsic activity. Accordingly, X's income
from the delivery of water is not qualifying income
for purposes of section 7704(c).

Example 8. Delivery of water and recovery and
recycling of flowback. (i) Assume the same facts as
in Example 7 of this paragraph (f), except that X also
collects and treats flowback at the drilling site in
accordance with state regulations as part of its water
delivery services and transports the treated flowback
away from the site. In connection with these ser-
vices, X provides personnel to perform these ser-
vices on an ongoing or frequent basis that is consis-
tent with best industry practices. X has provided
these personnel with specialized training regarding
the recovery and recycling of flowback produced
during the development of natural gas, and this train-
ing is of limited utility other than to perform or
support the development of natural gas.

(ii) The income X obtains from its water delivery
services is not a section 7704(d)(1)(E) activity as
provided in paragraph (c) of this section. However,
because X's water delivery supports A's develop-
ment of natural gas, a section 7704(d)(1)(E) activity,
X's income from water delivery services may be
qualifying income for purposes of section 7704(c) if
the water delivery service is an intrinsic activity as
provided in paragraph (d) of this section.

(iii) An activity is an intrinsic activity if the
activity is specialized to support the section
7704(d)(1)(E) activity, is essential to the completion
of the section 7704(d)(1)(E) activity, and requires
the provision of significant services to support the
section 7704(d)(1)(E) activity. Under paragraph
(d)(2)(ii)(B) of this section, the provision of water
for use as an injectant in a section 7704(d)(1)(E)
activity is specialized to that activity only if the
partnership (1) provides the water exclusively to
those engaged in section 7704(d)(1)(E) activities, (2)
is also in the trade or business of cleaning, recycling,
or otherwise disposing of water after use in accor-
dance with Federal, state, or local regulations con-
cerning waste products from mining or production
activities, and (3) operates these disposal services
within the same geographical area as where it deliv-

ers water. X's provision of personnel is specialized
because those personnel received training regarding
the recovery and recycling of flowback produced
during the development of natural gas, and this train-
ing is of limited utility other than to perform or
support the development of natural gas. The provi-
sion of water is also specialized because water is an
injectant used to perform a section 7704(d)(1)(E)
activity, and X also collects and treats flowback in
accordance with state regulations as part of its water
delivery services. Therefore, X meets the specializa-
tion requirement. The delivery of water is essential
to support A's development activity because the
water is needed for use in fracturing to develop A's
natural gas reserve in a cost-efficient manner. Fi-
nally, the water delivery and recovery and recycling
activities require significant services to support the
development activity because X's personnel provide
services necessary for the partnership to perform the
support activity at the development site on an ongo-
ing or frequent basis that is consistent with best
industry practices. Because X's delivery of water
and X's collection, transport, and treatment of flow-
back is a specialized activity, is essential to the
completion of a section 7704(d)(1)(E) activity, and
requires significant services, the delivery of water
and the transport and treatment of flowback is an
intrinsic activity. X's income from the delivery of
water and the collection, treatment, and transport of
flowback is qualifying income for purposes of sec-
tion 7704(c).

(g) Effective/applicability date and
transition rule. (1) In general. Except as
provided in paragraph (g)(2) of this sec-
tion, this section applies to income earned
by a partnership in a taxable year begin-
ning on or after January 19, 2017. Para-
graph (g)(2) of this section applies during
the period that ends on the last day of the
partnership's taxable year that includes
January 19, 2027 (Transition Period).

(2) Income during Transition Period.
A partnership may treat income from an
activity as qualifying income during the
Transition Period if-

(i) The partnership received a private
letter ruling from the IRS holding that the
income from that activity is qualifying
income;

(ii) Prior to May 6, 2015, the partner-
ship was publicly traded, engaged in the
activity, and treated the activity as giving
rise to qualifying income under section
7704(d)(1)(E), and that income was qual-
ifying income under the statute as reason-
ably interpreted prior to May 6, 2015;

(iii) Prior to May 6, 2015, the partner-
ship was publicly traded and had entered
into a binding agreement for construction
of assets to be used in such activity that
would give rise to income that was qual-

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

ifying income under the statute as reason-
ably interpreted prior to May 6, 2015; or

(iv) The partnership is publicly traded
and engages in the activity after May 6,
2015 but before January 19, 2017, and the
income from that activity is qualifying in-
come under the proposed regulations
(REG-132634-14) contained in the Inter-
nal Revenue Bulletin (IRB) 2015-21 (see
https://www.irs.gov/pub/irs-irbs/irb15-21.pdf).

(3) Relief from technical termination.
In the event of a technical termination

under section 708(b)(1)(B) of a partner-
ship that satisfies the requirements of
paragraph (g)(2) of this section without
regard to the technical termination, the
resulting partnership will be treated as the
partnership that satisfies the requirements
of paragraph (g)(2) of this section for pur-
poses of applying the Transition Period.

John Dalrymple
Deputy Commissioner for Services and

Enforcement.
Approved: January 12, 2017

Mark J. Mazur
Assistant Secretary of the Treasury (Tax
Policy).

(Filed by the Office of the Federal Register on January 19,
2017, 4:15 p.m., and published in the issue of the Federal
Register for January 24, 2017, 82 F.R. 8318)

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

# Part III. Administrative, Procedural, and Miscellaneous

## Update for Weighted Average Interest Rates, Yield Curves, and Segment Rates

## Notice 2017-18

This notice provides guidance on the
corporate bond monthly yield curve, the
corresponding spot segment rates used un-
der § 417(e)(3), and the 24-month average
segment rates under § 430(h)(2) of the
Internal Revenue Code. In addition, this
notice provides guidance as to the interest
rate on 30-year Treasury securities under
§ 417(e)(3)(A)(ii)(II) as in effect for plan
years beginning before 2008 and the 30-
year Treasury weighted average rate un-
der § 431(c)(6)(E)(ii)(I).

## YIELD CURVE AND SEGMENT RATES

Generally, except for certain plans un-
der sections 104 and 105 of the Pension
Protection Act of 2006 and CSEC plans
under § 414(y), § 430 of the Code speci-
fies the minimum funding requirements

that apply to single-employer plans pursu-
ant to § 412. Section 430(h)(2) specifies
the interest rates that must be used to
determine a plan's target normal cost and
funding target. Under this provision, pres-
ent value is generally determined using
three 24-month average interest rates
("segment rates"), each of which applies
to cash flows during specified periods. To
the extent provided under § 430(h)(2)
(C)(iv), these segment rates are adjusted
by the applicable percentage of the 25-
year average segment rates for the period
ending September 30 of the year preced-
ing the calendar year in which the plan
year begins.1 However, an election may
be made under § 430(h)(2)(D)(ii) to use
the monthly yield curve in place of the
segment rates.

Notice 2007-81, 2007-44 I.R.B. 899,
provides guidelines for determining the
monthly corporate bond yield curve, and
the 24-month average corporate bond seg-
ment rates used to compute the target nor-
mal cost and the funding target. Consis-
tent with the methodology specified in
Notice 2007-81, the monthly corporate
bond yield curve derived from January
2017 data is in Table I at the end of this

notice. The spot first, second, and third
segment rates for the month of January
2017 are, respectively, 2.00, 3.91, and
4.66.

The 24-month average segment rates
determined under § 430(h)(2)(C)(i) through
(iii) must be adjusted pursuant to
§ 430(h)(2)(C)(iv) to be within the appli-
cable minimum and maximum percent-
ages of the corresponding 25-year average
segment rates. For plan years beginning
before 2021, the applicable minimum per-
centage is 90% and the applicable maxi-
mum percentage is 110%. The 25-year
average segment rates for plan years be-
ginning in 2015, 2016, and 2017 were
published in Notice 2014-50, 2014-40
I.R.B. 590, Notice 2015-61, 2015-39
I.R.B. 408, and Notice 2016-54, 2016-40
I.R.B. 429, respectively.

## 24-MONTH AVERAGE CORPORATE BOND SEGMENT RATES

The three 24-month average corporate
bond segment rates applicable for Febru-
ary 2017 without adjustment for the 25-
year average segment rate limits are as
follows:

Applicable Month

First Segment

Second Segment

Third Segment

February 2017

1.60

3.79

4.74

Based on § 430(h)(2)(C)(iv), the 24-
month averages applicable for February

2017 adjusted to be within the applicable
minimum and maximum percentages of

the corresponding 25-year average seg-
ment rates, are as follows:

For Plan Years Beginning In

Adjusted 24-Month Average Segment Rates

Applicable Month

First Segment

Second Segment

Third Segment

2016

February

2017

4.43

5.91

6.65

2017

February

2017

4.16

5.72

6.48

## 30-YEAR TREASURY SECURITIES INTEREST RATES

Generally for plan years beginning af-
ter 2007, § 431 specifies the minimum

funding requirements that apply to mul-
tiemployer plans pursuant to § 412. Sec-
tion 431(c)(6)(B) specifies a minimum
amount for the full-funding limitation de-
scribed in § 431(c)(6)(A), based on the

plan's current liability. Section 431(c)(6)
(E)(ii)(I) provides that the interest rate
used to calculate current liability for this
purpose must be no more than 5 percent
above and no more than 10 percent below

1Pursuant to § 433(h)(3)(A), the 3rd segment rate determined under § 430(h)(2)(C) is used to determine the current liability of a CSEC plan (which is used to calculate the minimum amount
of the full funding limitation under § 433(c)(7)(C)).

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

the weighted average of the rates of inter-
est on 30-year Treasury securities during
the four-year period ending on the last day
before the beginning of the plan year.
Notice 88-73, 1988-2 C.B. 383, provides
guidelines for determining the weighted

average interest rate. The rate of interest
on 30-year Treasury securities for January
2017 is 3.02 percent. The Service deter-
mined this rate as the average of the daily
determinations of yield on the 30-year
Treasury bond maturing in November

2046\. For plan years beginning in the
month shown below, the weighted aver-
age of the rates of interest on 30-year
Treasury securities and the permissible
range of rates used to calculate current
liability are as follows:

For Plan Years Beginning in

30-Year Treasury Weighted Average

Permissible Range

Month

Year

90%

to

105%

February

2017

2.90

2.61

3.05

MINIMUM PRESENT VALUE
SEGMENT RATES

In general, the applicable interest rates
under § 417(e)(3)(D) are segment rates

computed without regard to a 24-month
average. Notice 2007-81 provides guide-
lines for determining the minimum pres-
ent value segment rates. Pursuant to that
notice, the minimum present value seg-

ment rates determined for January 2017
are as follows:

First Segment

Second Segment

Third Segment

2.00

3.91

4.66

## DRAFTING INFORMATION

The principal author of this notice is
Tom Morgan of the Office of the Associ-
ate Chief Counsel (Tax Exempt and Gov-
ernment Entities). However, other person-
nel from the IRS participated in the
development of this guidance. For further
information regarding this notice, contact
Mr. Morgan at 202-317-6700 or Tony
Montanaro at 202-317-8698 (not toll-free
numbers).

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

# Table I Monthly Yield Curve for January 2017 Derived from January 2017 Data

Maturity

Yield

Maturity

Yield

Maturity

Yield

Maturity

Yield

Maturity

Yield

0.5

1.16

20.5

4.45

40.5

4.68

60.5

4.76

80.5

4.81

1.0

1.41

21.0

4.46

41.0

4.68

61.0

4.77

81.0

4.81

1.5

1.63

21.5

4.47

41.5

4.69

61.5

4.77

81.5

4.81

2.0

1.83

22.0

4.48

42.0

4.69

62.0

4.77

82.0

4.81

2.5

2.00

22.5

4.49

42.5

4.69

62.5

4.77

82.5

4.81

3.0

2.14

23.0

4.50

43.0

4.70

63.0

4.77

83.0

4.81

3.5

2.28

23.5

4.51

43.5

4.70

63.5

4.77

83.5

4.81

4.0

2.40

24.0

4.51

44.0

4.70

64.0

4.77

84.0

4.81

4.5

2.53

24.5

4.52

44.5

4.70

64.5

4.77

84.5

4.81

5.0

2.65

25.0

4.53

45.0

4.71

65.0

4.78

85.0

4.81

5.5

2.77

25.5

4.54

45.5

4.71

65.5

4.78

85.5

4.81

6.0

2.89

26.0

4.54

46.0

4.71

66.0

4.78

86.0

4.81

6.5

3.02

26.5

4.55

46.5

4.71

66.5

4.78

86.5

4.81

7.0

3.13

27.0

4.56

47.0

4.72

67.0

4.78

87.0

4.81

7.5

3.25

27.5

4.56

47.5

4.72

67.5

4.78

87.5

4.82

8.0

3.36

28.0

4.57

48.0

4.72

68.0

4.78

88.0

4.82

8.5

3.46

28.5

4.58

48.5

4.72

68.5

4.78

88.5

4.82

9.0

3.56

29.0

4.58

49.0

4.72

69.0

4.78

89.0

4.82

9.5

3.65

29.5

4.59

49.5

4.73

69.5

4.79

89.5

4.82

10.0

3.73

30.0

4.59

50.0

4.73

70.0

4.79

90.0

4.82

10.5

3.81

30.5

4.60

50.5

4.73

70.5

4.79

90.5

4.82

11.0

3.88

31.0

4.60

51.0

4.73

71.0

4.79

91.0

4.82

11.5

3.95

31.5

4.61

51.5

4.73

71.5

4.79

91.5

4.82

12.0

4.01

32.0

4.61

52.0

4.74

72.0

4.79

92.0

4.82

12.5

4.06

32.5

4.62

52.5

4.74

72.5

4.79

92.5

4.82

13.0

4.11

33.0

4.62

53.0

4.74

73.0

4.79

93.0

4.82

13.5

4.15

33.5

4.63

53.5

4.74

73.5

4.79

93.5

4.82

14.0

4.19

34.0

4.63

54.0

4.74

74.0

4.79

94.0

4.82

14.5

4.23

34.5

4.64

54.5

4.75

74.5

4.80

94.5

4.82

15.0

4.26

35.0

4.64

55.0

4.75

75.0

4.80

95.0

4.82

15.5

4.28

35.5

4.65

55.5

4.75

75.5

4.80

95.5

4.83

16.0

4.31

36.0

4.65

56.0

4.75

76.0

4.80

96.0

4.83

16.5

4.33

36.5

4.65

56.5

4.75

76.5

4.80

96.5

4.83

17.0

4.35

37.0

4.66

57.0

4.75

77.0

4.80

97.0

4.83

17.5

4.37

37.5

4.66

57.5

4.76

77.5

4.80

97.5

4.83

18.0

4.39

38.0

4.66

58.0

4.76

78.0

4.80

98.0

4.83

18.5

4.40

38.5

4.67

58.5

4.76

78.5

4.80

98.5

4.83

19.0

4.42

39.0

4.67

59.0

4.76

79.0

4.80

99.0

4.83

19.5

4.43

39.5

4.67

59.5

4.76

79.5

4.80

99.5

4.83

20.0

4.44

40.0

4.68

60.0

4.76

80.0

4.80

100.0

4.83

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

# 2017 Calendar Year Resident Population Figures

## Notice 2017-19

This notice advises State and local
housing credit agencies that allocate low-
income housing tax credits under § 42 of
the Internal Revenue Code, and States and
other issuers of tax-exempt private activ-
ity bonds under § 141, of the population
figures to use in calculating: (1) the 2017
calendar year population-based compo-
nent of the State housing credit ceiling
(Credit Ceiling) under § 42(h)(3)(C)(ii);
(2) the 2017 calendar year volume cap
(Volume Cap) under § 146; and (3) the
2017 volume limit (Volume Limit) under
§ 142(k)(5).

Generally, § 146(j) requires determining
the population figures for the population-
based component of both the Credit Ceiling
and the Volume Cap for any calendar year
on the basis of the most recent census esti-
mate of the resident population of a State (or
issuing authority) released by the U.S. Cen-
sus Bureau before the beginning of the cal-
endar year. Similarly, § 142(k)(5) bases the
Volume Limit on the State population.

Sections 42(h)(3)(H) and 146(d)(2) re-
quire adjusting for inflation the population-
based component of the Credit Ceiling and
the Volume Cap. The adjustments for the
2017 calendar year are in Rev. Proc. 2016-
55, 2016-45 I.R.B. 707. Section 3.08 of
Rev. Proc. 2016-55 provides that, for cal-
endar year 2017, the amount for calculating
the Credit Ceiling under § 42(h)(3)(C)(ii) is
the greater of $2.35 multiplied by the State
population, or $2,710,000. Further, section
3.20 of Rev. Proc. 2016-55 provides that
the amount for calculating the Volume Cap
under § 146(d)(1) for calendar year 2017 is
the greater of $100 multiplied by the State
population, or $305,315,000.

For the 50 states, the District of Co-
lumbia, and Puerto Rico, the population
figures for calculating the Credit Ceiling,
the Volume Cap, and the Volume Limit
for the 2017 calendar year are the resident
population estimates released electroni-
cally by the U.S. Census Bureau on De-
cember 20, 2016, and described in Press
Release CB16-214. For American Sa-

moa, Guam, the Northern Mariana Is-
lands, and the U.S. Virgin Islands, the
population figures for the 2017 calendar
year are the 2016 midyear population fig-
ures in the U.S. Census Bureau's Interna-
tional Data Base (IDB). The U.S. Census
Bureau electronically announced an up-
date of the IDB on August 17, 2016, in
Press Release CB16-TPS128.

For convenience, these figures are re-
printed below.

Resident Population Figures

Alabama

4,863,300

Alaska

741,894

American

54,194

Samoa

Arizona

6,931,071

Arkansas

2,988,248

California

39,250,017

Colorado

5,540,545

Connecticut

3,576,452

Delaware

952,065

District of

681,170

Columbia

Florida

20,612,439

Georgia

10,310,371

Guam

162,742

Hawaii

1,428,557

Idaho

1,683,140

Illinois

12,801,539

Indiana

6,633,053

Iowa

3,134,693

Kansas

2,907,289

Kentucky

4,436,974

Louisiana

4,681,666

Maine

1,331,479

Maryland

6,016,447

Massachusetts

6,811,779

Michigan

9,928,300

Minnesota

5,519,952

Mississippi

2,988,726

Missouri

6,093,000

Montana

1,042,520

Nebraska

1,907,116

Nevada

2,940,058

New Hampshire

1,334,795

New Jersey

8,944,469

New Mexico

2,081,015

New York

19,745,289

Resident Population Figures

North Carolina

10,146,788

North Dakota

757,952

Northern Mariana 53,467 Islands

Ohio

11,614,373

Oklahoma

3,923,561

Oregon

4,093,465

Pennsylvania

12,784,227

Puerto Rico

3,411,307

Rhode Island

1,056,426

South Carolina

4,961,119

South Dakota

865,454

Tennessee

6,651,194

Texas

27,862,596

Utah

3,051,217

Vermont

624,594

Virginia

8,411,808

Virgin Islands,

102,951

U.S.

Washington

7,288,000

West Virginia

1,831,102

Wisconsin

5,778,708

Wyoming

585,501

The principal authors of this notice are
James A. Holmes, Office of the Associate
Chief Counsel (Passthroughs and Special
Industries), and Timothy L. Jones, Office
of the Associate Chief Counsel (Financial
Institutions and Products). For further in-
formation regarding this notice, please
contact Mr. Holmes at (202) 317-4137
(not a toll-free number).

# Section 401 .- Qualified Pension, Profit-Sharing, and Stock Bonus Plans

26 CFR 1.401(1)-1: Permitted disparity in employer-
provided contributions or benefits

Rev. Rul. 2017-05

This revenue ruling provides tables of
covered compensation under § 401(l)
(5)(E) of the Internal Revenue Code and
the Income Tax Regulations thereunder,
for the 2017 plan year.

Section 401(l)(5)(E)(i) defines covered
compensation with respect to an employee
as the average of the contribution and

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

benefit bases in effect under section 230
of the Social Security Act (the "Act") for
each year in the 35-year period ending
with the year in which the employee at-
tains social security retirement age.

Section 401(l)(5)(E)(ii) states that the
determination for any year preceding the
year in which the employee attains social
security retirement age shall be made by
assuming that there is no increase in cov-
ered compensation after the determination
year and before the employee attains so-
cial security retirement age.

Section 1.401(1)-1(c)(34) of the In-
come Tax Regulations defines the taxable
wage base as the contribution and benefit
base under section 230 of the Act.

Section 1.401(1)-1(c)(7)(i) defines cov-
ered compensation for an employee as the

average (without indexing) of the taxable
wage bases in effect for each calendar
year during the 35-year period ending
with the last day of the calendar year in
which the employee attains (or will attain)
social security retirement age. A 35-year
period is used for all individuals regard-
less of the year of birth of the individual.
In determining an employee's covered
compensation for a plan year, the taxable
wage base for all calendar years beginning
after the first day of the plan year is as-
sumed to be the same as the taxable wage
base in effect as of the beginning of the plan
year. An employee's covered compensation
for a plan year beginning after the 35-year
period applicable under § 1.401(1)-1(c)(7)(i) is
the employee's covered compensation for a
plan year during which the 35-year period

ends. An employee's covered compensa-
tion for a plan year beginning before the
35-year period applicable under § 1.401(1)-
1(c)(7)(i) is the taxable wage base in effect
as of the beginning of the plan year.

Section 1.401(1)-1(c)(7)(ii) provides
that, for purposes of determining the
amount of an employee's covered com-
pensation under § 1.401(1)-1(c)(7)(i), a
plan may use tables, provided by the
Commissioner, that are developed by
rounding the actual amounts of covered
compensation for different years of birth.

For purposes of determining covered
compensation for the 2017 year, the tax-
able wage base is $127,200.

The following tables provide covered
compensation for 2017.

## ATTACHMENT I

### 2017 COVERED COMPENSATION TABLE

CALENDAR YEAR OF BIRTH

CALENDAR YEAR OF SOCIAL SECURITY RETIREMENT AGE

2017 COVERED COMPENSATION TABLE II

1907

1972

$ 4,488

1908

1973

4,704

1909

1974

5,004

1910

1975

5,316

1911

1976

5,664

1912

1977

6,060

1913

1978

6,480

1914

1979

7,044

1915

1980

7,692

1916

1981

8,460

1917

1982

9,300

1918

1983

10,236

1919

1984

11,232

1920

1985

12,276

1921

1986

13,368

1922

1987

14,520

1923

1988

15,708

1924

1989

16,968

1925

1990

18,312

1926

1991

19,728

1927

1992

21,192

1928

1993

22,716

1929

1994

24,312

1930

1995

25,920

1931

1996

27,576

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

## ATTACHMENT I

### 2017 COVERED COMPENSATION TABLE

CALENDAR YEAR OF BIRTH

CALENDAR YEAR OF SOCIAL SECURITY RETIREMENT AGE

2017 COVERED COMPENSATION TABLE II

1932

1997

29,304

1933

1998

31,128

1934

1999

33,060

1935

2000

35,100

1936

2001

37,212

1937

2002

39,444

1938

2004

43,992

1939

2005

46,344

1940

2006

48,816

1941

2007

51,348

1942

2008

53,952

1943

2009

56,628

1944

2010

59,268

1945

2011

61,884

1946

2012

64,560

1947

2013

67,308

1948

2014

69,996

1949

2015

72,636

1950

2016

75,180

1951

2017

77,880

1952

2018

80,496

1953

2019

83,052

1954

2020

85,560

1955

2022

90,372

1956

2023

92,724

1957

2024

94,980

1958

2025

97,152

1959

2026

99,264

1960

2027

101,304

1961

2028

103,296

1962

2029

105,204

1963

2030

107,088

1964

2031

108,924

1965

2032

110,700

1966

2033

112,380

1967

2034

113,940

1968

2035

115,392

1969

2036

116,724

1970

2037

117,936

1971

2038

119,088

1972

2039

120,204

1973

2040

121,272

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

#### ATTACHMENT I

##### 2017 COVERED COMPENSATION TABLE

CALENDAR YEAR OF BIRTH

CALENDAR YEAR OF SOCIAL SECURITY RETIREMENT AGE

2017 COVERED COMPENSATION TABLE II

1974

2041

122,220

1975

2042

123,060

1976

2043

123,780

1977

2044

124,368

1978

2045

124,944

1979

2046

125,532

1980

2047

126,024

1981

2048

126,408

1982

2049

126,696

1983

2050

126,948

1984 and

2051 and Later

127,200

Later

### ATTACHMENT II

2017 ROUNDED COVERED COMPENSATION TABLE

CALENDAR YEAR OF BIRTH

COVERED COMPENSATION ROUNDED

1937

$ 39,000

1938-1939

45,000

1940

48,000

1941

51,000

1942

54,000

1943

57,000

1944

60,000

1945

63,000

1946-1947

66,000

1948

69,000

1949

72,000

1950

75,000

1951

78,000

1952

81,000

1953

84,000

1954

87,000

1955

90,000

1956

93,000

1957-1958

96,000

1959

99,000

1960-1961

102,000

1962

105,000

1963-1964

108,000

1965-1966

111,000

1967-1968

114,000

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

#### ATTACHMENT II

2017 ROUNDED COVERED COMPENSATION TABLE

CALENDAR YEAR OF BIRTH

COVERED COMPENSATION ROUNDED

1969-1970

117,000

1971-1973

120,000

1974-1977

123,000

1978-1981

126,000

1982 and Later

127,200

### DRAFTING INFORMATION

The principal author of this notice is
Tom Morgan of the Office of the Associ-

ate Chief Counsel (Tax Exempt and Gov-
ernment Entities). However, other person-
nel from the IRS participated in the
development of this guidance. For further

information regarding this notice, contact
Mr. Morgan at 202-317-6700 or Michael
Spaid at 206-946-3480 (not toll-free
numbers).

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

### Part IV. Items of General Interest

Notice of Proposed
Rulemaking.
Dividend Equivalents from
Sources within the United
States

#### REG-135122-16

AGENCY: Internal Revenue Service (IRS),
Treasury.

ACTION: Notice of proposed rulemaking
by cross-reference to temporary regulations.

SUMMARY: This document contains pro-
posed regulations relating to certain finan-
cial products providing for payments that
are contingent upon or determined by ref-
erence to U.S. source dividend payments.

DATES: Written or electronic comments
must be received by April 24, 2017.

ADDRESSES: Send submissions to CC:
PA:LPD:PR (REG-135122-16), room
5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be hand deliv-
ered Monday through Friday between the
hours of 8 a.m. and 4 p.m. to CC:PA:
LPD:PR (REG-135122-16), Courier's
desk, Internal Revenue Service, 1111 Con-
stitution Avenue, NW., Washington, DC
20044, or sent electronically, via the Federal
eRulemaking Portal at www.regulations-
.gov (IRS REG-135122-16). The public
hearing will be held in the IRS Auditorium,
Internal Revenue Building, 1111 Constitu-
tion Avenue, N.W., Washington, DC.

FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, D. Pe-
ter Merkel or Karen Walny at (202) 317-
6938; concerning submissions of com-
ments, the hearing, and/or to be placed on
the building access list to attend the hear-
ing Regina Johnson at (202) 317-6901
(not toll-free numbers).

SUPPLEMENTARY INFORMATION:

##### Background and Explanation of Provisions

Final and temporary regulations in the
Rules and Regulations section of this is-
sue of the Internal Revenue Bulletin

contain amendments to the Income Tax
Regulations (26 CFR Part 1), which pro-
vide rules relating to dividend equivalents
for purposes of section 871(m). The tem-
porary regulations provide guidance relat-
ing to when the delta of an option that is
listed on a foreign regulated exchange
may be calculated based on the delta of
that option at the close of business on the
business day prior to the date of issuance.
The temporary regulations also provide
guidance identifying which party to a po-
tential section 871(m) transaction is re-
sponsible for determining whether a trans-
action is a section 871(m) transaction
when multiple brokers or dealers are in-
volved in the transaction. The text of those
temporary regulations also serves as the
text of these proposed regulations. The
preamble to the final and temporary reg-
ulations explains the temporary regula-
tions and these proposed regulations. The
regulations affect nonresident alien indi-
viduals, foreign corporations, and with-
holding agents, as well as certain other
parties to section 871(m) transactions and
their agents.

#### Special Analyses

Certain IRS regulations, including this
one, are exempt from the requirements of
Executive Order 12866, as supplemented
and reaffirmed by Executive Order 13563.
Therefore, a regulatory impact assessment
is not required. Because the regulations do
not impose a collection of information on
small entities, the Regulatory Flexibility
Act (5 U.S.C. chapter 6) does not apply.
Pursuant to section 7805(f), these regula-
tions have been submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.

#### Comments and Request for Public Hearing

Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are
submitted timely to the IRS as prescribed
in this preamble under the "Addresses"
heading. The Treasury Department and
the IRS request comments on all aspects
of the proposed rules. All comments will

be available at www.regulations.gov or
upon request. A public hearing will be
scheduled if requested in writing by any
person that timely submits written com-
ments. If a public hearing is scheduled,
notice of the date, time, and place for the
public hearing will be published in the
Federal Register.

#### Drafting Information

The principal authors of these regula-
tions are D. Peter Merkel and Karen
Walny of the Office of Chief Counsel
(International). However, other personnel
from the Treasury Department and the
IRS participated 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 * * *

§ 1.871-15 also issued under 26 U.S.C.
871(m). * * *

Par. 2. Section 1.871-15 is amended
by revising paragraph (a)(1), paragraph
(g)(4)(ii)(B), paragraphs (p)(1)(ii) through
(p)(1)(iv), and paragraph (p)(5) to read as
follows:

§ 1.871-15 Treatment of dividend
equivalents.

(a) * * *

(1) [The text of the proposed amend-
ments to § 1.871-15(a)(1) is the same as
the text of § 1.871-15T(a)(1) published
elsewhere in this issue of the Bulletin.]
* * * * *

(g) * * *

(4) * * *

(ii) * * *

(B) [The text of the proposed amend-
ments to § 1.871-15(g)(4)(ii)(B) is the same
as the text of § 1.871-15T(g)(4)(ii)(B)
published elsewhere in this issue of the
Bulletin.]

* * * * *

(p) ***

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

(1) * * *

(ii) [The text of the proposed amend-
ments to § 1.871-15(p)(1)(ii) is the same as
the text of § 1.871-15T(p)(1)(ii) pub-
lished elsewhere in this issue of the Bul-
letin.

(iii) [The text of the proposed amend-
ments to § 1.871-15(p)(1)(iii) is the same as
the text of § 1.871-15T(p)(1)(iii) published
elsewhere in this issue of the Bulletin.]

(iv) [The text of the proposed amend-
ments to § 1.871-15(p)(1)(iv) is the same
as the text of § 1.871-15T(p)(1)(iv) pub-
lished elsewhere in this issue of the Bul-
letin.]

*** * *

(5) [The text of the proposed amend-
ments to § 1.871-15(p)(5) is the same as
the text of § 1.871-15T(p)(5) published
elsewhere in this issue of the Bulletin.]
* * * * *

John Dalrymple
Deputy Commissioner for Services and
Enforcement.

(Filed by the Office of the Federal Register on January 19,
2017, 4:15 p.m., and published in the issue of the Federal
Register for January 24, 2017, 82 F.R. 8172)

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

# Definition of Terms

Revenue rulings and revenue procedures
(hereinafter referred to as "rulings") that
have an effect on previous rulings use the
following defined terms to describe the
effect:

Amplified describes a situation where
no change is being made in a prior 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 ap-
plied 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.

Distinguished describes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.

Modified is used where the substance
of a previously published position is being
changed. Thus, if a prior ruling held that a
principle applied to A but not to B, and the
new ruling holds that it applies 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 rul-
ings that are obsoleted because of changes
in laws or regulations. A ruling may also
be obsoleted because the substance has
been included in regulations subsequently
adopted.

Revoked describes situations where the
position in the previously published ruling
is not correct and the correct position is
being stated in a 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 sub-

stance of a prior ruling, a combination of
terms is used. For example, modified and
superseded describes a situation where the
substance of a previously published ruling
is being changed in part and is continued
without change in part and it is desired to
restate the valid portion of the previously
published ruling in a new ruling that is
self contained. In this case, the previously
published ruling is first modified and then,
as modified, is superseded.

Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and that
list is expanded by adding further names
in subsequent rulings. After the original
ruling has been supplemented several
times, a new ruling may be published that
includes the list in the original ruling and
the additions, and supersedes all prior rul-
ings 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 formerly used will appear in ma-
terial published in the Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

TFE-Transferee.

TFR-Transferor.

CI-City.

GR-Grantor.

IC-Insurance Company.

TP-Taxpayer.

Ct.D .- Court Decision.

I.R.B .- Internal Revenue Bulletin.

TR-Trust.

CY-County.

LE-Lessee.

TT-Trustee.

U.S.C .- United States Code.

DC-Dummy Corporation.

LR-Lessor.

X-Corporation.

DE-Donee.

Del. Order-Delegation Order.

Nonacq .- Nonacquiescence.

O Organization.

DR-Donor.

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 .- Statement of Procedural Rules.

Stat .- Statutes at Large.

T-Target Corporation.

T.C .- Tax Court.

T.D .- Treasury Decision.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

GP-General Partner.

T.I.R .- Technical Information Release.

COOP-Cooperative.

D-Decedent.

LP-Limited Partner.

M-Minor.

Y-Corporation.

Z-Corporation.

DISC-Domestic International Sales Corporation.

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 Contributions Act.

FISC-Foreign International Sales Company.

FPH-Foreign Personal Holding Company.

BK-Bank.

B.T.A .- Board of Tax Appeals.

C-Individual.

<!-- PageFooter="Bulletin No. 2017-9" -->

<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

## Numerical Finding List1

Bulletin 2017-1 through 2017-9

Action on Decision:

2017-1, 2016-7 I.R.B. 868

### Announcements:

2017-01, 2017-08 I.R.B. 941

Notices:

2017-1, 2017-2 I.R.B. 367
2017-2, 2017-4 I.R.B. 539
2017-3, 2017-2 I.R.B. 368
2017-4, 2017-4 I.R.B. 541
2017-5, 2017-6 I.R.B. 779
2017-6, 2017-3 I.R.B. 422
2017-7, 2017-3 I.R.B. 423
2017-8, 2017-3 I.R.B. 423
2017-9, 2017-4 I.R.B. 542
2017-10, 2017-4 I.R.B. 544
2017-12, 2017-5 I.R.B. 742
2017-13, 2017-6 I.R.B. 780
2017-14, 2017-6 I.R.B. 783
2017-15, 2017-6 I.R.B. 783
2017-16, 2017-7 I.R.B. 913
2017-18, 2017-9 I.R.B. 997
2017-19, 2017-9 I.R.B. 1000

## Proposed Regulations:

REG-137604-07, 2017-7 I.R.B. 923
REG-128276-12, 2017-2 I.R.B. 369
REG-103477-14, 2017-5 I.R.B. 746
REG-112324-15, 2017-4 I.R.B. 547
REG-127203-15, 2017-7 I.R.B. 918
REG-131643-15, 2017-6 I.R.B. 865
REG-134438-15, 2017-2 I.R.B. 373
REG-112800-16, 2017-4 I.R.B. 569
REG-123829-16, 2017-5 I.R.B. 764
REG-123841-16, 2017-5 I.R.B. 766
REG-133353-16, 2017-2 I.R.B. 372
REG-134247-16, 2017-5 I.R.B. 744
REG-135122-16, 2017-9 I.R.B. 1005

## Revenue Procedures:

2017-1, 2017-1 I.R.B. 1
2017-2, 2017-1 I.R.B. 106
2017-3, 2017-1 I.R.B. 130
2017-4, 2017-1 I.R.B. 146
2017-5, 2017-1 I.R.B. 230
2017-7, 2017-1 I.R.B. 269
2017-12, 2017-3 I.R.B. 424
2017-13, 2017-6 I.R.B. 787
2017-14, 2017-3 I.R.B. 426
2017-15, 2017-3 I.R.B. 437
2017-16, 2017-3 I.R.B. 501
2017-18, 2017-5 I.R.B. 743

Revenue Procedures :- Continued

2017-19, 2017-7 I.R.B. 913
2017-21, 2017-6 I.R.B. 791

2017-22, 2017-6 I.R.B. 863
2017-23, 2017-7 I.R.B. 915
2017-24, 2017-7 I.R.B. 916

## Revenue Rulings:

2017-1, 2017-3 I.R.B. 377
2017-2, 2017-2 I.R.B. 364
2017-3, 2017-4 I.R.B. 522
2017-4, 2017-6 I.R.B. 776
2017-5, 2017-9 I.R.B. 1000

Treasury Decisions:

9794, 2017-2 I.R.B. 273
9795, 2017-2 I.R.B. 326
9796, 2017-3 I.R.B. 380
9801, 2017-2 I.R.B. 355
9802, 2017-2 I.R.B. 361
9803, 2017-3 I.R.B. 384
9804, 2017-3 I.R.B. 406
9806, 2017-4 I.R.B. 524
9807, 2017-5 I.R.B. 573
9808, 2017-5 I.R.B. 580
9809, 2017-5 I.R.B. 664
9810, 2017-6 I.R.B. 775
9811, 2017-7 I.R.B. 869
9814, 2017-7 I.R.B. 878
9815, 2017-9 I.R.B. 944
9817, 2017-9 I.R.B. 968

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016-27 through 2016-52 is in Internal Revenue Bulletin
2016-52, dated December 26, 2016.

<!-- PageFooter="February 27, 2017" -->

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageBreak -->

# Finding List of Current Actions on Previously Published Items1

Bulletin 2017-1 through 2017-9

Notices:

2002-1
Amplified by
Notice 2017-1, 2017-2 I.R.B. 367

2010-46
Obsoleted by
Notice 2017-1, 2017-2 I.R.B. 367

2016-29
Modified by
Notice 2017-6, 2017-3 I.R.B. 422

## Revenue Procedures:

2013-22
Clarified by
Rev. Proc. 2017-18, 2017-05 I.R.B. 743

2015-57
Modified by
Rev. Proc. 2017-24, 2017-07 I.R.B. 916

## Treasury Decisions:

2010-46
Obsoleted by
T.D. 9815 2017-09 I.R.B. 944

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016-27 through 2016-52 is in Internal Revenue Bulletin
2016-52, dated December 26, 2016.

<!-- PageFooter="Bulletin No. 2017-9" -->
<!-- PageFooter="February 27, 2017" -->
<!-- PageBreak -->

# Internal Revenue Service Washington, DC 20224

Official Business
Penalty for Private Use, $300

# INTERNAL REVENUE BULLETIN

The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue
Bulletins are available at www.irs.gov/irb/.

# We Welcome Comments About the Internal Revenue Bulletin

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we
would be pleased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page
(www.irs.gov) or write to the Internal Revenue Service, Publishing Division, IRB Publishing Program Desk, 1111 Constitution Ave.
NW, IR-6230 Washington, DC 20224.