Internal Revenue Bulletin 2012-38 (PDF rendition): IRS Announcements

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Bulletin No. 201
2-38
September 17, 20
12
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
T.D. 9598, page 343.
REG–138489–09, page 355.
Final, temporary, and proposed regulations under section 988
of the Code address certain integrated transactions that in-
volve a foreign currency denominated debt instrument and mul-
tiple associated hedging transactions. The regulations provide
that if a taxpayer has identified multiple hedgers as being part
of a qualified hedging transaction, and the taxpayer has termi-
nated at least one but less than all of the hedges (including a
portion of one or more of the hedges), the taxpayer must treat
the remaining hedges as having been sold for fair market value
on the date of disposition of the terminated hedge.
REG–126770–06, page 347.
Proposed regulations under section 263A of the Code provide
that, in general, taxpayers may not use negative amounts to
allocate additional section 263A costs under the simplified pro-
duction method. The proposed regulations provide a new mod-
ified simplified production method under which producers may
include negative amounts in allocating additional section 263A
costs by using a preproduction cost absorption ratio and a pro-
duction cost absorption ratio.
ADMINISTRATIVE
Announcement 2012–35, page 356.
This document contains corrections to temporary regulations
(T.D. 9572, 2012–11 I.R.B. 471) that extend the definition
of a specified NPC with respect to payments made before
January 1, 1014.
Finding Lists begin on page ii.

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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 and may be obtained from the
Superintendent of Documents on a subscription basis. Bulletin
contents are compiled semiannually into Cumulative Bulletins,
which are sold on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application of
the tax laws, including all rulings that supersede, revoke, mod-
ify, or amend any of those previously published in the Bulletin.
All published rulings apply retroactively unless otherwise indi-
cated. Procedures relating solely to matters of internal man-
agement are not published; however, statements of internal
practices and procedures that affect the rights and duties of
taxpayers are published.
Revenue rulings represent the conclusions of the Service on the
application of the law to the pivotal facts stated in the revenue
ruling. In those based on positions taken in rulings to taxpayers
or technical advice to Service field offices, identifying details
and information of a confidential nature are deleted to prevent
unwarranted invasions of privacy and to comply with statutory
requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and 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.—19
86 Code.
This part i
ncludes rulings and decisions based on provisions of
the Intern
al 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, Leg-
islation 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 Secre-
tary (Enforcement).
Part IV
.—Items of General Interest.
This par
t includes notices of proposed rulemakings, disbar-
ment an
d 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 c
ontents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.
September 17, 20122012–38 I.R.B.

Part I. Rulings
and Decisions Under the Internal Revenue Code
of 1986
Section 988.—
Treatment of
Certain Forei
gn Currency
Transactions
26 CFR 1.988–5: Section 988(d) hedging transac-
tions.
T.D. 9598
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1
Integrated Hedging
Transactions of Qualifying
Debt
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary and final regula-
tions.
SUMMARY: This document contains tem-
porary regulations thataddress certain in-
tegrated transactions that involve a foreign
currency denominated debt instrument and
multiple associated hedging transactions.
The regulations provide that if a taxpayer
has identified multiple hedges as being
part of a qualified hedging transaction, and
the taxpayer has terminated at least one but
less than all of the hedges (including a por-
tion of one or more of the hedges), the tax-
payer must treat the remaining hedges as
having been sold for fair market value on
the date of disposition of the terminated
hedge. The text of the temporary regula-
tions also serves as the text of the proposed
regulations (REG–138489–09) set forth in
the notice of proposed rulemaking on this
subject in this issue of the Bulletin.
DATES:Effective Date:These regulations
are effective on September 6, 2012.
Applicability Date:These regulations
apply to leg-outs within the meaning of
§1.988–5(a)(6)(ii) which occur on or after
September 6, 2012.
FOR
FURTHER INFORMATION
CON
TACT: Sheila Ramaswamy, at (202)
622
–3870 (not a toll-free number).
SUPPLEMENTAR
Y INFORMATION:
Background
Section 1.988
–5 provides detailed rules
that permit th
e integration of a qualifying
debt instrum
ent with a §1.988–5(a) hedge.
The effect of
integration under the regu-
lations is to
create a synthetic debt instru-
ment. Genera
lly, if a taxpayer enters into
a qualified h
edging transaction and meets
the require
ments of the regulations, no
exchange ga
in or loss is recognized on the
debt instru
ment or the hedge for the period
that it is pa
rt of a qualified hedging trans-
action (pr
ovided that the synthetic debt
instrumen
t is not denominated in a non-
functiona
l currency). See §1.988–5(a)(9).
A qualifie
d hedging transaction is an in-
tegrated
economic transaction consisting
of a quali
fying debt instrument and a
§1.988–5
(a) hedge. See §1.988–5(a)(1).
A qualify
ing debt instrument is any debt
instrume
nt described in §1.988–1(a)(2)(i)
regardle
ss of its denominated currency.
See §1.9
88–5(a)(3). A §1.988–5(a) hedge
is a spot
contract, futurescontract, for-
ward con
tract, option contract, notional
princip
al contract, currency swap contract,
or simi
lar financial instrument, or series
or comb
inations of such instruments, that
when in
tegrated with a qualifying debt in-
strume
nt permits the calculation of a yield
to matu
rity in the currency in which the
synth
etic debt instrument is denominated.
See §1
.988–5(a)(4).
Under
§1.988–5(a)(6)(ii), a taxpayer
that d
isposes of all or a part of the qualify-
ing de
bt instrument or hedge prior to the
matur
ity of the qualified hedging trans-
actio
n, or that changes a material term of
the q
ualifying debt instrument or hedge,
is vi
ewed as “legging out” of integrated
trea
tment. One of the consequences of
legg
ing out is that if the hedge is dis-
pose
d of, the qualifying debt instrument
is tr
eated as sold for its fair market value
on t
he date of disposition of the hedge
(le
g-out date). See §1.988–5(a)(6)(ii)(B).
Any
gain or loss on the qualifying debt
ins
trument from the date of identification
to t
he leg-out date is recognized on the
le
g-out date. The intended result of this
de
emed disposition rule is that the gain or
loss on the qua
lifying debt instrument will
generally be o
ffset by the gain or loss on
the hedge.
The Internal R
evenue Service (IRS)
and the Depart
ment of the Treasury (Trea-
sury Departm
ent) have become aware that
some taxpaye
rs who are in a loss position
with respect
to a qualifying debt instru-
ment that is p
art of a qualified hedging
transactio
n are interpreting the legging-out
rules of §1.
988–5(a)(6)(ii)(B) to permit
the recogni
tion of the loss on the debt
instrument
without recognition of all of
the corres
ponding gain on the hedging
component
of the transaction. Taxpayers
claim to ac
hieve this result by hedging
nonfuncti
onal currency debt instruments
with multi
ple financial instruments and se-
lectivel
y disposing of less than all of these
position
s. Taxpayers take the position that
§1.988–5
(a)(6)(ii)(B) triggers the entire
loss in th
e qualifying debt instrument but
not the ga
in in the remaining components
of the he
dging side of the integrated trans-
action.
For exam
ple, a taxpayer may fully
hedgeaf
ixed rate nonfunctional currency
denomin
ated debt instrument that it has
issued w
ith two swaps—a nonfunctional
curren
cy/dollar currency swap and a fixed
for flo
ating dollar interest rate swap. The
effect
of matching the currency swap with
the for
eign currency denominated debt
is to cr
eate synthetic fixed rate U.S. dol-
lar de
bt while the effect of the interest
rate s
wap is to simultaneously transform
the sy
nthetic fixed rate U.S. dollar debt
into s
ynthetic floating rate U.S. dollar
debt.
Thus, assuming that the rules of
§1.9
88–5(a) are otherwise satisfied, the
taxp
ayer will have effectively converted
the f
ixed rate foreign currency denom-
inat
ed debt instrument into a synthetic
floa
ting rate U.S. dollar denominated debt
inst
rument.
As th
e U.S. dollar declines in value rel-
ativ
etotheforeigncurrencyinwhichthe
deb
t instrument is denominated, the tax-
pay
er disposes of the interest rate swap
whi
le keeping the currency swap in exis-
ten
ce. The taxpayer takes the position that
the
disposition of the interest rate swap al-
lo
ws it to treat the debt instrument as hav-
in
g been terminated on the date of dispo-
2012–38 I.R.B.343September 17, 2012

sition and claims a loss on the debt instru-
ment without taking into account the off-
setting gain on the remaining component
of the hedge. Thus, the taxpayer claims the
transaction generates a net loss. The IRS
and the Treasury Department believe that
these results are inappropriate under the
legging-out rules since the claimed loss is
largely offset by unrealized gain on the re-
maining component of the hedging trans-
action. Therefore, the IRS and the Trea-
sury Department are issuing these regu-
lations to clarify the rules regarding the
consequences of legging-out of qualified
hedging transactions that consist of multi-
ple components. No inference is intended
regarding the merits of the position taken
by the taxpayer with respect to the trans-
action described above (or comparable po-
sitions taken by taxpayers with respect to
similar transactions) in the case of trans-
actions occurring prior to the applicabil-
ity date of these regulations, and in ap-
propriate cases the IRS may challenge the
claimed results.
Explanation of Provisions
Section 1.988–5(a) is amended to pro-
vide that if a hedge with more than one
component has been properly identified as
being part of a qualified hedging transac-
tion, and at least one but not all of the com-
ponents of the hedge that is a part of the
qualified hedging transaction has been ter-
minated or disposed of, all of the remain-
ing components of the hedge (as well as the
qualifying debt) shallbe treated as sold for
their fair market value on the leg-out date
of the terminated hedge. Similarly, if a part
of any component of a hedge (whether a
hedge consists of a single or multiple com-
ponents) has been disposed of, the remain-
ing part of that component (as well as other
components in the case of a hedge with
multiple components) that is still in exis-
tence (as well as the qualifying debt instru-
ment) shall be treated as sold for its fair
market value on the leg-out date of the ter-
minated hedge.
Effective/Applicability Date
The regulation applies to leg-outs
within the meaning of §1.988–5(a)(6)(ii)
which occur on or after September 6, 2012.
Special Analyses
It has been determined that these regu-
lations are not a significant regulatory ac-
tion as defined in Executive Order 12866.
Therefore, a regulatory assessment is not
required. It has also been determined that
section553(b)oftheAdministrativePro-
cedure Act (5 U.S.C. chapter 5) does not
apply to these regulations, and because
these regulations do not impose a collec-
tion of information on small entities, the
provisions of the Regulatory Flexibility
Act (5 U.S.C. chapter 6) do not apply.
Pursuant to section 7805(f) of the Internal
Revenue Code, these regulations will be
submitted to the Chief Counsel for Advo-
cacy of the Small Business Administration
for comment on their impact on small
business.
Drafting Information
The principal author of these regu-
lations is Sheila Ramaswamy, Office of
Associate Chief Counsel (International).
However, other personnel from the IRS
and the Treasury Department participated
in their development.
*****
Amendment 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 1.988–5 is amended by:
1. Revising paragraph (a)(6)(ii).
2. AddingExample 11in paragraph
(a)(9)(iv).
The revision and addition read as fol-
lows:
§1.988–5 Section 988(d) hedging
transactions.
(a) * * *
(6) * * *
(ii) [Reserved]. For further guidance,
see §1.988–5T(a)(6)(ii).
*****
(9) * * *
(iv)***
Example 11. [Reserved]. For further
guidance, see §1.988–5T(a)(9)(iv).
Example 11.
*****
Par. 3. Section 1.988–5T is added to
read as follows:
§1.988–5T Section 988(d) hedging
transactions (temporary).
(a) through (a)(6)(i) [Reserved]. For
further guidance, see §1.988–5(a) through
(a)(6)(i).
(ii)Legging out.With respect to a qual-
ifying debt instrument and hedge that are
properly identified as a qualified hedg-
ing transaction, “legging out” of integrated
treatment under this paragraph (a) means
that the taxpayer disposes of or otherwise
terminates all or any portion of the qual-
ifying debt instrument or the hedge prior
to maturity of the qualified hedging trans-
action, or the taxpayer changes a material
term of the qualifying debt instrument (for
example,exercises an option to change the
interest rate or index, or the maturity date)
or the hedge (for example,changes the
interest or exchange rates underlying the
hedge, or the expiration date) prior to ma-
turity of the qualified hedging transaction.
A taxpayer that disposes of or terminates a
qualified hedging transaction (that is, dis-
poses of or terminates both the qualifying
debt instrument and the hedge in their en-
tirety on the same day) shall be considered
to have disposed of or otherwise termi-
nated the synthetic debt instrument rather
than legging out. If a taxpayer legs out
of integrated treatment, the following rules
shall apply:
(A) The transaction will be treated as
a qualified hedging transaction during the
time the requirements of this paragraph (a)
were satisfied.
(B)Ifalloftheinstrumentscomprising
the hedge (each such instrument, a compo-
nent) are disposed of or otherwise termi-
nated, the qualifying debt instrument shall
be treated as sold for its fair market value
on the date the hedge is disposed of or oth-
erwise terminated (the leg-out date), and
any gain or loss (including gain or loss re-
sulting from factors other than movements
in exchange rates) from the identification
date to the leg-out date is realized and rec-
ognized on the leg-out date. The spot rate
September 17, 20123442012–38 I.R.B.

on the leg-out date shall be used to deter-
mine exchange gain or loss on the debt in-
strument for the period beginning on the
leg-out date and ending on the date such
instrument matures or is disposed of or
otherwise terminated. Proper adjustment
must be made to reflect any gain or loss
taken into account. The netting rule of
§1.988–2(b)(8) shall apply.
(C) If a hedge has more than one com-
ponent (and such components have been
properly identified as being part of the
qualified hedging transaction) and at least
one but not all of the components that
comprise the hedge has been disposed of
or otherwise terminated, or if part of any
component of the hedge has been termi-
nated (whether a hedge consists of a sin-
gle or multiple components), the date such
component (or part thereof) is disposed
of or terminated shall be considered the
leg-out date and the qualifying debt instru-
ment shall be treated as sold for its fair
market value in accordance with the rules
of paragraph (a)(6)(ii)(B) of this section on
such leg-out date. In addition, all of the
remaining components (or parts thereof)
that have not been disposed of or other-
wise terminated shall be treated as sold for
their fair market value on the leg-out date,
and any gain or loss from the identifica-
tion date to the leg-out date is realized and
recognized on the leg-out date. To the ex-
tent relevant, the spot rate on the leg-out
date shall be used to determine exchange
gain or loss on the remaining components
(or parts thereof) for the period beginning
on the leg-out date and ending on the date
such components (or parts thereof) are dis-
posed of or otherwise terminated.
(D) If the qualifying debt instrument
is disposed of or otherwise terminated in
wholeorinpart,thedateofsuchdis-
position or termination shall be consid-
ered the leg-out date. Accordingly, the
hedge (including all components making
up the hedge in their entirety) that is part of
the qualified hedging transaction shall be
treated as sold for its fair market value on
the leg-out date, and any gain or loss from
the identification date to the leg-out date
is realized and recognized on the leg-out
date. To the extent relevant, the spot rate
on the leg-out date shall be used to deter-
mine exchange gain or loss on the hedge
(including all components thereof) for the
period beginning on the leg-out date and
ending on the date such hedge is disposed
of or otherwise terminated.
(E) Except as provided in paragraph
(a)(8)(iii) of this section (regarding identi-
fication by the Commissioner), the part of
the qualified hedging transaction that has
not been terminated (that is, the remain-
ing debt instrument in its entirety even if
partially hedged, or the remaining com-
ponents of the hedge) cannot be part of a
qualified hedging transaction for any pe-
riod subsequent to the leg-out date.
(F) If a taxpayer legs out of a quali-
fied hedging transaction and realizes a gain
with respect to the disposed of or termi-
nated debt instrument or hedge, then para-
graph (a)(6)(ii)(B), (C), and (D) of this sec-
tion, as appropriate, will not apply if dur-
ing the period beginning 30 days before the
leg-out date and ending 30 days after that
date the taxpayer enters into another trans-
action that, taken together with any re-
maining components of the hedge, hedges
at least 50 percent of the remaining cur-
rency flow with respect to the qualifying
debt instrument that was part of the quali-
fied hedging transaction or, if appropriate,
an equivalent amount under the hedge (or
any remaining components thereof) that
was part of the qualified hedging trans-
action. Similarly, in a case in which a
hedge has multiple components that are
part of a qualified hedging transaction, if
the taxpayer legs out of a qualified hedg-
ingtransactionbyterminatingonesuch
component or a part of one or more such
components and realizes a gain with re-
spect to the terminated component, com-
ponents, or portions thereof, then para-
graphs (a)(6)(ii)(B), (C), and (D) of this
section, as appropriate, will not apply if the
remaining components of the hedge (in-
cluding parts thereof) by themselves hedge
at least 50 percent of the remaining cur-
rency flow with respect to the qualifying
debt instrument that was part of the quali-
fied hedging transaction.
(a)(7) through (a)(9)(iv)Examples 10
[Reserved]. For further guidance, see
§1.988–5(a)(7) through (a)(9)(iv)Exam-
ple 10.
Example 11. (i) K is a U.S. corporation with the
U.S. dollar as its functional currency. On January 1,
2013, K borrows 100 British pounds (£) for two years
at a 10% rate of interest payable on December 31 of
each year with no principal payment due until ma-
turity on December 31, 2014. Assume that the spot
rate on January 1, 2013, is £1=$1. On the same date,
K enters into two swap contracts with an unrelated
counterparty that economically results in the transfor-
mation of the fixed rate £100 borrowing to a floating
rate dollar borrowing. The terms of the swaps are as
follows:
(A)Swap #1, Currency swap. On January 1,
2013, K will exchange £100 for $100.
(1) On December 31 of both 2013 and 2014, K
will exchange $8 for £10;
(2) On December 31, 2014, K will exchange $100
for £100.
(B)Swap #2, Interest rate swap. On December 31
of both 2013 and 2014, K will pay LIBOR times a
notional principal amount of $100 and will receive
8% times the same $100 notional principal amount.
(ii) Assume that K properly identifies the pound
borrowing and the swap contracts as a qualified hedg-
ing transaction as provided in paragraph (a)(8) of this
section and that the other relevant requirements of
paragraph (a) of this section are satisfied.
(iii) Assume also that on January 1, 2014, the
spot exchange rate is £1:$2; the U.S. dollar LIBOR
rate of interest is 9%; and the market value of K’s
note in pounds has not changed. K terminates swap
#2. K will incur a loss of ($.91) (the present value of
$1) with respect to the termination of such swap on
January 1, 2014. Pursuant to paragraph (a)(6)(ii)(C)
of this section, K must treat swap #1 as having been
sold for its fair market value on the leg-out date,
which is the date swap #2 is terminated. K must real-
ize and recognize gain of $100.92 [the present value
of £110 discounted in pounds to equal £100 x $2
($200) less the present value of $108 ($99.08)]. The
loss inherent in the pound borrowing from January 1,
2013 to January 1, 2014 is realized and recognized
on January 1, 2014. Such loss is exchange loss in
the amount of $100 [the present value of £110 that
was to be paid at the end of the year discounted at
pound interest rates to equal £100 times the change
in exchange rates: (£100 x $1, the spot rate on
January 1, 2013) - (£100 x $2, the spot rate on
January 1, 2014)]. Except as provided in paragraph
(a)(8)(iii) of this section (regarding identification
by the Commissioner), the pound borrowing and
currency swap cannot be part of a qualified hedging
transaction for any period subsequent to the leg-out
date.
(iv) Assume the facts are the same as in paragraph
(iii) of this section except that on January 1, 2014, the
U.S. dollar LIBOR rate of interest is 7% rather than
9%. When K terminates swap #2, K will realize gain
of $0.93 (the present value of $1) received with re-
spect to the termination on January 1, 2014. Fifty
percent or more of the remaining pound cash flow
of the pound borrowing remains hedged after the ter-
mination of swap #2. Accordingly, under paragraph
(a)(6)(ii)(F) of this section, paragraphs (a)(6)(ii)(B)
and(C)ofthissectiondonotapplyandthegainon
swap #1 and the loss on the qualifying debt instru-
ment is not taken into account. Thus, K will include
in income $0.93 realized from termination of swap
#2.
(a)(10) through (g) [Reserved]. For
further guidance, see §1.988–5(a)(10)
through (g).
(h)Effective/applicability date.This
section applies to leg-outs that occur on or
after September 6, 2012.
2012–38 I.R.B.345September 17, 2012

(i)Expiration date. This section expires
on September 4, 2015.
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
Approved August 17, 2012.
Mark J. Mazur,
Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on September 5,
2012, 8:45 a.m., and published in the issue of the Federal
Register for September 6, 2012, F.R. 54808)
September 17, 20123462012–38 I.R.B.

Part IV. Items o
fGeneralInterest
Notice of Prop
osed
Rulemaking
Allocation of
Costs Under the
Simplified Me
thods
REG–126770–
06
AGENCY: Inte
rnal Revenue Service
(IRS), Treas
ury.
ACTION: Noti
ce of proposed rulemaking.
SUMMARY: Thi
s document contains pro-
posed regula
tions on allocating costs to
certain prop
erty produced by the taxpayer
or acquired
by the taxpayer for resale. The
proposed re
gulations affect taxpayers that
are produce
rs or resellers of property that
are require
d to capitalize certain costs to
the proper
ty and that allocate costs under
the simpli
fied production method or the
simplifie
d resale method. The proposed
regulatio
ns provide rules for the treatment
of negativ
e additional costs.
DATES: Wri
tten (including electronic)
comments
and requests for a public hear-
ing must b
e received by December 4,
2012.
ADDRESSE
S: Send submissions to:
CC:PA:LP
D:PR(REG–126770–06),
room 5205
, Internal Revenue Service,
PO Box 76
04, Ben Franklin Station,
Washing
ton, DC 20044.Submis-
sions ma
y be hand delivered between
the hour
s of 8 a.m. and 4 p.m. to
CC:PA:L
PD:PR(REG–126770–06),
Courie
r’s Desk, Internal Revenue
Servic
e, 1111 Constitution Avenue,
N.W., W
ashington, DC. Taxpayers also
may sub
mit comments electronically
viathe
FederaleRulemaking
Porta
latwww.regulations.gov(IRS
REG–1
26770–06).
FOR FU
RTHER INFORMATION
CONTA
CT: Concerning the proposed
regul
ations, Christopher Call, (202)
622–4
970; concerning submissions of
comme
nts or to request a public hearing,
Oluw
afunmilayo Taylor, (202) 622–7180
(not
toll-free numbers).
SUPPLEMENTAR
Y INFORMATION:
Background
This document
contains proposed
amendments to
the Income Tax Regu-
lations, 26 CF
R part 1, relating to the
allocation of
costs under the simplified
methods of ac
counting under section 263A
of the Intern
al Revenue Code (Code).
Section 263A
requires taxpayers to
capitalize t
he direct costs and indirect
costs that ar
e properly allocable to: (1)
real or tangi
ble personal property the tax-
payer produ
ces, and (2) real property and
personal pr
operty described in section
1221(a)(1)
that the taxpayer acquires for
resale. Sec
tion 1.263A–1(e)(2)(i) of the
Income Tax R
egulations provides that
direct cos
ts for producers are direct mate-
rial costs
and direct labor costs. Section
1.263A–1(
e)(2)(ii) provides that resellers
must capit
alize the acquisition cost of
property
acquired for resale. Section
1.263A–1
(e)(3)(i) defines indirect costs as
all costs
other than direct material costs
and direc
t labor costs (in the case of prop-
erty prod
uced) or acquisition costs (in
the case
of property acquired for resale).
Indirec
t costs are properly allocable to
propert
y produced or acquired for resale
when the
costs directly benefit or are in-
curred b
y reason of the performance of
produc
tion or resale activities.
Section
263A generally requires tax-
payers
to allocate capitalizable section
263A co
sts to specific items in inventory.
The leg
islative history of section 263A
indica
tes that Congress intended that tax-
payers
would allocate additional section
263A c
osts (costs, other than interest, that
were n
ot capitalized under the taxpayer’s
metho
d of accounting immediately prior to
the ef
fective date of section 263A, but that
are re
quired to be capitalized under section
263A
) with the same degree of specificity
that
was required of inventoriable costs
prio
r to the enactment of section 263A.
Cong
ress contemplated that taxpayers
woul
d continue to use the same methods of
allo
cating costs to items in their inventory
tha
t were available under prior law.See
S. R
ep. No. 313, 99
th
Cong. 2d Sess. 142
(19
86). Consistent with these principles,
the
regulations under §1.263A–1(f)(2)
and
(f)(3) provide that taxpayers may
elect to use a “
facts-and-circumstances”
allocation me
thod, such as the specific
identificati
on method, burden rate,
standard cost
method, or any other method
to allocate di
rect and indirect costs to
units of prop
erty produced or acquired for
resale, if th
e method is reasonable within
the meaning o
f §1.263A–1(f)(4).
Section 1.26
3A–1(f)(1) authorizes
taxpayers to
use the simplified methods
provided in §
1.263A–2(b) (the simpli-
fied produc
tion method) or §1.263A–3(d)
(the simpli
fied resale method) to allocate
costs to eli
gible property produced or el-
igible prop
erty acquired for resale in lieu
of a facts-
and-circumstances allocation
method. Th
e simplified methods differ
from facts
-and-circumstances methods
in that, as
applied to inventories, they
allocate a
pool of capitalizable costs (addi-
tional se
ction 263A costs) between ending
inventor
y and cost of goods sold using a
defined r
atio and are an exception to the
general r
ule that additional section 263A
costs mu
st be allocated to specific items
of inven
tory. Thus, the simplified meth-
ods are i
ntended to reduce the complexity
and admi
nistrative burdens of having to
develop
detailed cost accounting systems
for the
additional costs required to be cap-
italiz
ed under section 263A.
Under t
he simplified production
method
, a taxpayer must allocate addi-
tional
section 263A costs to produced
proper
ty on hand at the end of the taxable
year ba
sed on the ratio of these costs in-
curre
d during the year to the taxpayer’s
total
section 471 costs incurred during the
year (
the absorption ratio). The current
regul
ations define additional section 263A
costs
as the costs, other than interest, that
were
not capitalized under the taxpayer’s
meth
od of accounting immediately prior to
the e
ffective date of section 263A, but that
are r
equired to be capitalized under section
263A
. See §1.263A–1(d)(3). The current
reg
ulations define section 471 costs as
cos
ts, other than interest, capitalized un-
der
the taxpayer’s method of accounting
imm
ediately prior to the effective date of
sec
tion 263A. If a taxpayer was not in
exi
stence before the effective date of sec-
ti
on 263A, section 471 costs are generally
th
ose costs that would have been required
to
be capitalized under §1.471–11. See
2012–38 I.R.B.347September 17, 2012

§1.263A–1(d)(2). The absorption ratio
is multiplied by the section 471 costs in-
curred during the taxable year that remain
in ending inventory or are otherwise on
hand at year end to determine the ad-
ditional section 263A costs allocable to
produced property on hand at the end of
the taxable year.
Under the simplified resale method,
an eligible taxpayer computes a com-
bined absorption ratio and multiplies it
by the section 471 costs incurred during
the taxable year that remain in its end-
ing inventory or are otherwise on hand
at year end to determine the additional
section 263A costs allocable to eligible
property on hand at year end. Section
1.263A–3(d)(3)(i)(C)(1) defines the com-
bined absorption ratio as the sum of the
storage and handling costs absorption ratio
as defined by §1.263A–3(d)(3)(i)(D) and
the purchasing costs absorption ratio as
defined by §1.263A–3(d)(3)(i)(E).
Notice 2007–29, 2007–1 C.B. 881, re-
quests comments on the treatment of neg-
ative amounts under the simplified meth-
ods. A negative amount generally oc-
curs when a taxpayer capitalizes a cost as
a section 471 cost in an amount that is
greater than the amountrequired to be cap-
italized for tax purposes. For example,
if a taxpayer included book depreciation
in section 471 costs in accordance with
§1.471–11(c)(2)(iii)(b) and the book de-
preciation is greater than tax depreciation
for the year, the taxpayer would have cap-
italized more depreciation than is required
to be capitalized under section 263A for
that year. A negative amount may result if
the taxpayer does not remove this excess
depreciation amount by adjusting section
471 costs but instead makes an adjustment
to its additional section 263A costs. See
§601.601(d)(2)(ii)(b).
In some situations, including negative
amounts in the numerator of the simpli-
fied production method formula may result
in significant distortions of the amount of
additional section 263A costs that is allo-
cated to ending inventory. Distortions may
also occur when the method used to cap-
italize a cost under section 471 is differ-
ent than the method used under the sim-
plified production method to remove the
cost from ending inventory. The extent
of the distortion, and whether it is favor-
able or unfavorable to the taxpayer, gen-
erally depends on when the cost is in-
curred in the production process and how
the cost was allocated to raw materials,
work-in-process, or finished goods inven-
tories for purposes of section 471.
Notice 2007–29 provides that, pending
the issuance of additional published guid-
ance, the IRS will not challenge the inclu-
sion of negative amounts in computing ad-
ditional costs under section 263A or the
permissibility of aggregate negative addi-
tional section 263A costs. The notice so-
licits public comments regarding possible
changes to the simplified methods involv-
ing negative additional section 263A costs.
Comments were received and considered
in developing these proposed regulations.
Explanation of Provisions
1.Prohibition on Negative Amounts
To reduce the distortions that occur
by including negative amounts under the
simplified methods,the proposed reg-
ulations provide that, subject to certain
exceptions described later in this pream-
ble, taxpayers may not include negative
amounts in additional section 263A costs.
Specific comments are requested on tran-
sition rules for taxpayers currently using
the simplified production method with
the historic absorption ratio election (see
section 1.263A–2(b)(4)), including com-
ments on how the regulations should apply
to taxpayers that are part way through the
qualifying period as described in section
1.263A–2(b)(4)(ii)(C).
To reduce the administrative burden
for smaller taxpayers using the simpli-
fied production method for which the
costs and burdens of excluding negative
amounts from additional section 263A
costs may otherwise outweigh the benefits,
the proposed regulations allow produc-
ers with average annual gross receipts of
$10,000,000 or less to include negative
amounts in additional section 263A costs
under the simplified production method.
Additionally, because negative ad-
ditional section 263A costs cause less
distortion under the simplified resale
method than under the simplified pro-
duction method, the proposed regulations
allow taxpayers using the simplified resale
method to remove section 471 costs that
are not required to be capitalized for tax
purposes from ending inventory by treat-
ing them as negative additional section
263A costs.
The proposed regulations generally
prohibit treating cash or trade discounts
described in §1.471–3(b) as negative
amounts under any of the simplified meth-
ods. Comments are requested on reason-
able methods of allocating between ending
inventory and cost of goods sold cash or
trade discounts that taxpayers do not capi-
talize for book purposes (and therefore are
not section 471 costs within the meaning
of §1.263A–1(d)(2)).
2.New Modified Simplified Production
Method
In response to Notice 2007–29, a com-
mentator suggested an alternative to the
simplified production method that would
reduce overcapitalization and distortion,
including distortions resulting from in-
cluding negative amounts in additional
section 263A costs. The commentator
suggested that the simplified production
method may allocate an excessive amount
of section 263A costs to raw materials
inventories because the formula does not
take into account the fact that taxpayers
incur fewer indirect costs for raw mate-
rials and because different inventoriable
costs turn over at different rates. The com-
mentator’s alternative simplified method
would allocate additional section 263A
costs related to raw materials using a for-
mula that is different from the formula
used to allocate additional section 263A
costs related to work-in-process and fin-
ished goods.
As suggested by this comment, the
proposed regulations allow producers to
use a new modified simplified produc-
tion method that reduces the distortions
that exist under the traditional simpli-
fied methods by more precisely allocating
additional section 263A costs, including
negative amounts, among raw materials,
work-in-process, and finished goods in-
ventories. Under the modified simplified
production method, producers determine
the allocable portion of preproduction re-
lated additional section 263A costs (such
as storage and handling for raw materi-
als) using a preproduction cost absorption
ratio. The preproduction cost absorption
ratio is applied to raw material section
471 costs incurred during the taxable year
and remaining on hand at year end. For
September 17, 20123482012–38 I.R.B.

purposes of computing the allocable por-
tion of preproduction related additional
section 263A costs, raw material costs on
hand at year end include unprocessed raw
materials and raw materials that are inte-
grated into work-in-progress and finished
goods. Under the modified simplified
production method, producers determine
the allocable portion of all other additional
section 263A costs using a production cost
absorption ratio.
In addition to reducing distortions
that exist under the simplified produc-
tion method by more precisely allocating
additional section 263A costs to raw ma-
terials, the modified simplified production
method provides producers with a method
to remove section 471 costs that are not
required to be capitalized for tax purposes
from ending inventory by treating them
as negative additional section 263A costs.
Both resellers and producers, thereby, are
allowed to use methods that more pre-
cisely allocate additional section 263A
costs while alleviating administrative bur-
den, consistent with the purpose of the
simplified methods.
As with other simplified methods, a
taxpayer must maintain adequate records
substantiating proper use of the modified
simplified production method (see section
6001).
Comments are requested on the modi-
fied simplified production method, includ-
ing: (1) whether distortions will occur if
preproduction relatedadditional section
263A costs are not directly traced from
raw materials through work-in-process
and finished goods inventories from year
to year; (2) how mixed service costs
should be allocated between raw materi-
als, work-in-process, and finished goods
inventories under the new formula; and
(3) how the new formula should apply to a
taxpayer using the last-in, first-out method
of accounting.
3.Simplified Definition of Section
471 Costs and Elimination of Separate
Provisions for New Taxpayers
For most taxpayers, section 471 costs
generally are the acquisition or production
costs, other than interest, that the taxpayer
capitalized under its method of accounting
immediately before the effective date of
section 263A. See §1.263A–1(d)(2)(i). If
a taxpayer was not in existence at that
time, section 471 costs generally are the
acquisition or production costs, other than
interest, that the taxpayer would have
been required to capitalize if the taxpayer
had been in existence immediately before
the effective date of section 263A. See
§1.263A–1(d)(2)(ii).
To provide greater simplicity and con-
sistency among taxpayers, the proposed
regulations adopt a single definition of sec-
tion 471 costs that applies to taxpayers
that were in existence before the effective
date of section 263A and to newer taxpay-
ers, whether using the simplified produc-
tion method, the modified simplified pro-
duction method, or the simplified resale
method. The proposed regulations pro-
vide that, for purposes of the simplified
methods, a taxpayer’s section 471 costs,
in general, are the costs, other than inter-
est, that a taxpayer capitalizes to its inven-
tory in its financial statements. However,
a taxpayer must include all direct costs in
its section 471 costs regardless of the tax-
payer’s treatment of the costs in its finan-
cial statements. The proposed regulations
require a taxpayer that is not permitted to
remove section 471 costs as negative ad-
ditional section 263A costs to reduce its
section 471 costs. The proposed regula-
tions provide that a taxpayer that reduces
its section 471 costs must use a reasonable
method that approximates the manner in
which the taxpayer originally capitalized
the costs.
Effective/Applicability Date
The regulations are proposed to apply
to taxable years ending on or after the date
the regulations are published as final regu-
lations in theFederal Register.
Effect on Other Documents
Notice 2007–29 would be superseded
as of the date these regulations are pub-
lished as final regulations in theFederal
Register.
Special Analyses
This notice of proposed rulemaking is
not a significant regulatory action as de-
fined in Executive Order 12866, as supple-
mented by Executive Order 13563. There-
fore, a regulatory assessment is not re-
quired. Section 553(b) of the Adminis-
trative Procedure Act(5 U.S.C. chapter 5)
does not apply to these regulations. Be-
cause the regulations do not impose a col-
lection of information on small entities, the
Regulatory Flexibility Act (5 U.S.C. chap-
ter 6) does not apply. Pursuant to sec-
tion 7805(f) of the Code, this notice of
proposed rulemaking has been submitted
to the Chief Counsel for Advocacy of the
Small Business Administration for com-
ment on its impact on small business.
Comments and Requests for Public
Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any comments that are sub-
mitted timely to the IRS as prescribed in
this preamble under the “Addresses” head-
ing. The IRS and the Treasury Depart-
ment request comments on all aspects of
the proposed rules. All comments will be
available atwww.regulations.govor upon
request.
A public hearing will be scheduled if
requested in writing by any person who
timely submits written comments. If a
public hearing is scheduled, notice of the
date, time, and place for the public hearing
will be published in theFederal Register.
Drafting Information
The principal author of these proposed
regulations is W. Thomas McElroy, Jr.
of the Office of Associate Chief Counsel
(Income Tax and Accounting). However,
other personnel from the IRS and the
Treasury Department participated in their
development.
*****
Proposed Amendments to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART I — INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section1.263A–1alsoissuedunder
26 U.S.C. 263A. * * *
Section1.263A–2alsoissuedunder
26 U.S.C. 263A. * * *
Par. 2. Section 1.263A–0 is amended
as follows:
2012–38 I.R.B.349September 17, 2012

1. Revising the entries in §1.263A–1
for paragraphs (d)(2) and (d)(3).
2. Revising the entries in §1.263A–2
for paragraphs (c) and (d).
3. Adding new entries to §1.263A–2 for
paragraphs (e), (f) and (g).
The revisions and addition read as fol-
lows:
§1.263A–0 Outline of regulations under
section 263A.
*****
§1.263A–1 Uniform capitalization of
costs.
*****
(d) * * *
(2) Section 471 costs.
(i) In general.
(ii) Removal of costs from inventory.
(iii) Method changes.
(3) Additional section 263A costs.
(i) In general.
(ii) Negative amounts.
(A) In general.
(B) Exception for small taxpayers using
the simplified production method.
(C) Exception for modified simplified
production method and simplified resale
method.
*****
§1.263A–2 Rules relating to property
produced by the taxpayer.
*****
(c) Modified simplified production
method.
(1) In general.
(2) Eligible property.
(3) Modified simplified production
method without historic absorption ratio
election.
(i) General allocation formula.
(A) In general.
(B) Allocable preproduction additional
section 263A costs.
(C) Allocable production additional
section 263A costs.
(D) Effect of allocation.
(E) Treatment of mixed service costs.
(ii) Definitions
(A) Preproduction absorption ratio.
(1) In general.
(2) Preproduction additional section
263A costs.
(3) Raw material costs.
(B) Production absorption ratio.
(1) In general.
(2) Production additional section 263A
costs.
(3) Production section 471 costs.
(iii) LIFO taxpayers electing the modi-
fied simplified production method.
(A) In general.
(B) LIFO increment.
(1) In general.
(2) Combined absorption ratio defined.
(C) LIFO decrement.
(iv)De minimisrule for producers with
total indirect costs of $200,000 or less.
(v) Examples.
(4) Modified simplified production
method with historic absorption ratio elec-
tion.
(i) In general.
(ii) General allocation formula.
(A) In general.
(B) Preproduction historic absorption
ratio.
(C) Production historic absorption ra-
tio.
(iii) LIFO taxpayers making the historic
absorption ratio election.
(A) In general.
(B) Combined historic absorption ratio.
(C) Total allocable additional section
263A costs incurred during the test period.
(D) Total section 471 costs remaining
on hand at year end during the test period.
(iv) Extension of qualifying period.
(v) Transition rule.
(vi) Examples.
(d) Additional simplified methods for
producers.
(e) Cross reference.
(f) Change in method of accounting.
(1) In general.
(2) Scope limitations.
(3) Audit protection.
(4) Section 481(a) adjustment.
(5) Time for requesting change.
(g) Effective/applicability date.
Par. 3. Section 1.263A–1 is amended
by:
1. Revising paragraphs (d)(2) and
(d)(3).
2. Adding a sentence to the end of para-
graph (m).
The addition and revisions read as fol-
lows:
§1.263A–1 Uniform capitalization of
costs.
*****
(d) * * *
(2)Section 471 costs—(i)In general.
Except as otherwise provided in paragraph
(d)(2)(ii) of this section, for purposes of
section 263A, a taxpayer’s section 471
costs are the costs, other than interest,
that a taxpayer capitalizes to its inventory
(or other eligible property) in its financial
statements. Thus, although section 471 ap-
plies only to inventories, section 471 costs
include any non-inventory costs, other
than interest, that a taxpayer capitalizes
or includes in acquisition or production
costs in its financial statements. How-
ever, notwithstanding the last sentence of
paragraph (g)(2) of this section, section
471 costs must include all direct costs
of producing property and of acquiring
property held for resale, whether or not
a taxpayer capitalizes these costs to in-
ventory or to other eligible property in
its financial statements. See paragraph
(e)(2) of this section for a description of
direct production costs and direct costs of
acquiring property held for resale.
(ii)Removal of costs from inventory.
A taxpayer must reduce its section 471
costs by those costs that the taxpayer
capitalizes to its inventory (or other eli-
gible property) in its financial statements
that may not be capitalized under either
§1.263A–1(c)(2) or §1.263A–1(j)(2)(ii),
and those period costs that the taxpayer
capitalizes to its inventory (or other eli-
gible property) in its financial statements
that, under §1.263A–1(j)(2), the tax-
payer chooses not to capitalize under
section 263A (for example, section 179
costs). A taxpayer described in paragraph
(d)(3)(ii)(B) or (d)(3)(ii)(C) of this sec-
tion that may remove these costs from
inventory by including them as negative
amounts in additional section 263A costs
instead may reduce its section 471 costs
for these costs. A taxpayer that reduces
its section 471 costs must use a reasonable
method that approximates the manner in
which the taxpayer originally capitalized
the costs to its inventory (or other eligible
property) in its financial statements.
(iii)Method changes. A taxpayer may
change its method of accounting for de-
termining section 471 costs only with the
consent of the Commissioner as required
September 17, 20123502012–38 I.R.B.

under section 446(e) and the correspond-
ing regulations. If a taxpayer is using
the simplified production method de-
scribed in §1.263A–2(b), the modified
simplified production method described
in §1.263A–2(c), or the simplified resale
method described in §1.263A–3(d), and
changes its financial reporting practices
regarding the costs capitalized to its in-
ventory (or other eligible property) in a
manner that would change its section 471
costs under the general provisions of para-
graph (d)(2)(i) of this section, then the
taxpayer must secure the Commissioner’s
consent prior to computing its taxable in-
come under the new method of accounting
for section 471 costs.
(3)Additional section 263A costs—(i)
In general.Additional section 263A costs
are defined as the costs, other than interest,
that are not included in a taxpayer’s sec-
tion 471 costs, but that are required to be
capitalized under section 263A. Additional
section 263A costs do not include the di-
rectcoststhatarerequiredtobeincludedin
a taxpayer’s section 471 costs under para-
graph (d)(2)(i) of this section.
(ii)Negative amounts—(A)In gen-
eral. Except as otherwise provided by
regulations or other published guidance,
see §601.601(d)(2), a taxpayer may not
include negative amounts in additional
section 263A costs.
(B)Exception for small taxpayers using
the simplified production method. Para-
graph (d)(3)(ii)(A) of this section does not
apply to a taxpayer using the simplified
production method under §1.263A–2(b)
if the taxpayer’s (or its predecessors’) av-
erage annual gross receipts for the three
previous taxable years (test period) do
not exceed $10,000,000. The rules of
§1.263A–3(b) apply for purposes of deter-
mining the amount of a taxpayer’s gross
receipts and the test period.
(C)Exception for modified simplified
production method and simplified resale
method. In general, a taxpayer using the
modified simplified production method
under §1.263A–2(c) or the simplified re-
sale method under §1.263A–3(d) may (but
is not required to) remove as negative
amounts under section 263A indirect costs
that are included in the taxpayer’s section
471 costs but that are not required to be,
or may not be, capitalized into inventory
(or other eligible property) for federal in-
come tax purposes. However, a taxpayer
using the modified simplified production
method or the simplified resale method
may not use negative amounts to adjust
additional section 263A costs for cash or
trade discounts described in §1.471–3(b).
*****
(m) * * * Paragraphs (d)(2) and (d)(3) of
this section apply for taxable years ending
on or after the date these regulations are
published as final regulations in theFed-
eral Register.
Par. 4. Section 1.263A–2 is amended
by:
1. Redesignating paragraphs (c), (d),
(e), and (f) as paragraphs (d), (e), (f), and
(g).
2. Adding a new paragraph (c).
3. Revising newly designated para-
graph (g).
The addition and revisions read as fol-
lows:
§1.263A–2 Rules relating to property
produced by the taxpayer.
*****
(c)Modified simplified production
method—(1)In general. This paragraph
(c) provides a modified simplified method
for determining the additional section
263A costs properly allocable to ending
inventories of property produced and other
eligible property on hand at the end of the
taxable year.
(2)Eligible property. For purposes of
this paragraph (c),eligible propertyhas the
same meaning as in paragraph (b)(2) of
this section.
(3)Modified simplified production
method without historic absorption ra-
tio election—(i)General allocation for-
mula—(A)In general. Except as other-
wise provided in paragraph (c)(3)(iv) of
this section, a taxpayer may compute the
total additional section 263A costs alloca-
ble to eligible property remaining on hand
at the close of the taxable year under the
modified simplified production method as
follows:
Allocable preproduction additional
section 263A costs + Allocable production
additional section 263A costs.
(B)Allocable preproduction additional
section 263A costs. The amount of prepro-
duction additional section 263A costs allo-
cable to ending inventory or to other eligi-
ble property on hand at the end of the tax-
able year is computed as follows:
Preproduction absorption ratio x raw
material section 471 costs incurred during
the taxable year and remaining on hand at
year end.
(C)Allocable production additional
section 263A costs. The amount of pro-
duction additional section 263A costs
allocable to ending inventory or to other
eligible property on hand at the end of the
taxable year is computed as follows:
Production absorption ratio x produc-
tion section 471 costs incurred during the
taxable year and remaining on hand at
year end.
(D)Effect of allocation. The alloca-
ble preproduction additional section 263A
costs and the allocable production addi-
tional section 263A costs are totaled to
compute the additional section 263A costs,
which are added to the taxpayer’s end-
ing section 471 costs to determine the to-
tal section 263A costs that are capitalized.
See, however, paragraph (c)(3)(iii) of this
section for special rules for LIFO taxpay-
ers. Except as otherwise provided in this
section or in §1.263A–1 or §1.263A–3, ad-
ditional section 263A costs that are allo-
cated to inventories on hand at the close of
the taxable year underthe modified simpli-
fied production method are treated as in-
ventory costs for all purposes of the Inter-
nal Revenue Code.
(E)Treatment of mixed service costs.
A taxpayer must apportion capitalizable
mixed service costs (the aggregate portion
of mixed service costs that are properly
allocable to the taxpayer’s production or
resale activities as additional section 263A
costs) between preproduction additional
section 263A costs described in para-
graph (c)(3)(ii)(A)(2) of this section and
production additional section 263A costs
described in paragraph (c)(3)(ii)(B)(2)of
this section. Under the modified simpli-
fied production method, a taxpayer must
allocate capitalizablemixed service costs
to preproduction additional section 263A
costsinproportiontotherawmaterial
costs in total section 471 costs. The tax-
payer must include the capitalizable mixed
service costs that are not allocated to pre-
production additional section 263A costs
in production additional section 263A
costs.
(ii)Definitions—(A)Preproduction ab-
sorption ratio—(1)In general.Underthe
modified simplified production method,
2012–38 I.R.B.351September 17, 2012

the preproduction absorption ratio is de-
termined as follows:
P
reproductionadditionalsection263Acosts
Raw material costs
(2)Preproduction additional section
263A costs. Preproduction additional
section 263A costs are the sum of the
additional section 263A costs (as defined
in §1.263A–1(d)(3)) incurred during the
current taxable year that are described in
paragraph (a)(3)(ii) of this section to the
extent the costs are not treated as section
471 costs and the allocable portion of cap-
italizable mixed service costs as described
in paragraph (c)(3)(i)(E) of this section.
(3)Raw material costs. Raw material
costs are defined as the direct costs of ac-
quiring raw materials that a taxpayer pur-
chases during its current taxable year. Raw
material section 471 costs incurred during
the taxable year and remaining on hand
at year end include the raw material costs
in work-in-process and finished goods as
well as unprocessed raw materials.
(B)Production absorption ratio—(1)
In general. Under the modified simplified
production method, the production absorp-
tion ratio is determined as follows:
P
roductionadditionalsection263Acosts
Production section 471 costs
(2)Production additional section
263A costs. Production additional sec-
tion 263A costs are the sum of all ad-
ditional section 263A costs (as defined
in §1.263A–1(d)(3)) incurred during the
current taxable yearthat are not prepro-
duction additional section 263A costs as
described in this section and the alloca-
ble portion of capitalizable mixed service
costs as described in paragraph (c)(3)(i)(E)
of this section. For example, production
additional section 263A costs include the
additional section 263A costs that consti-
tute post-production costs as defined in
paragraph (a)(3)(iii) of this section.
(3)Production section 471 costs.Pro-
duction section 471 costs are defined as the
total section 471 costs that a taxpayer in-
curs during its current taxable year less the
taxpayer’s raw material costs.
(iii)LIFO taxpayers electing the mod-
ified simplified production method—(A)
In general. Under the modified simpli-
fied production method, a taxpayer using
a LIFO method must calculate a partic-
ular year’s index (for example, under
§1.472–8(e)) without regard to its addi-
tional section 263A costs. Similarly, a
taxpayer that adjusts current-year costs by
applicable indexes to determine whether
there has been an inventory increment
or decrement in the current year for a
particular LIFO pool must disregard the
additional section 263A costs in making
that determination.
(B)LIFO increment—(1)In general.If
a taxpayer determines there has been an in-
ventory increment, the taxpayer must state
the amount of the increment in current-
year dollars (stated in terms of section 471
costs). The taxpayer then multiplies this
amount by the combined absorption ratio,
as defined in paragraph (c)(3)(iii)(B)(2)of
this section. The resulting product is the
additional section 263A costs that must be
added to the taxpayer’s increment for the
year stated in terms of section 471 costs.
(2)Combined absorption ratio defined.
For purposes of this paragraph (c)(3)(iii),
the numerator of the combined absorption
ratio is the total additional section 263A
costs allocable to eligible property remain-
ing on hand at the close of the taxable year,
as described in paragraph (c)(3)(i)(A) of
this section. The denominator of the com-
bined absorption ratio is the total section
471costsremainingonhandatyearend,
as described in paragraph (b)(3)(ii)(B) of
this section.
(C)LIFO decrement. If a taxpayer
determines there has been an inventory
decrement, the taxpayer must state the
amount of the decrement in dollars for the
particular year for which the LIFO decre-
ment has occurred. The additional section
263A costs incurred in prior years that ap-
ply to the decrement are included in cost of
goods sold. The taxpayer determines the
additional section 263A costs that apply
to the decrement by multiplying the addi-
tional section 263A costs allocated to the
layer of the pool in which the decrement
occurred by the ratio of the decrement
(excluding additional section 263A costs)
to the section 471 costs in the layer of that
pool.
(iv)De minimis rule for producers with
total indirect costs of $200,000 or less.
Paragraph (b)(3)(iv) of this section, which
provides that the additional section 263A
costs allocable to eligible property remain-
ing on hand at the close of the taxable year
are deemed to be zero for producers with
total indirect costs of $200,000 or less, ap-
plies to the modified simplified production
method.
(v)Examples. The rules of this para-
graph (c)(3) are illustrated by the follow-
ing examples:
Example 1.FIFO inventory method. (i) Taxpayer
Pu
ses the first-in, first-out (FIFO) method of ac-
counting for inventories and a calendar taxable year.
P’s beginning inventory for 2010 is $2,500,000, in-
cl
uding $2,000,000 of section 471 costs and $500,000
of additional section 263A costs.
(ii) During 2010, P incurs $10,000,000 of section
47
1 costs, including $4,000,000 of raw material costs
(as defined in paragraph (c)(3)(ii)(A)(3)ofthissec-
tion) and $6,000,000 of production section 471 costs
(
as defined in paragraph (c)(3)(ii)(B)(3)ofthissec-
tion). P also incurs $1,060,000 of additional section
263A costs, including $340,000 of preproduction ad-
d
itional section 263A costs (as defined in paragraph
(c)(3)(ii)(A)(2) of this section) and $720,000 of pro-
duction additional section 263A costs (as defined in
p
aragraph (c)(3)(ii)(B)(2) of this section).
(iii) At the end of 2010, P’s section 471 costs in-
curred during the taxable year remaining in ending in-
ventory are $3,500,000, including $2,000,000 of raw
materials section 471 costs and $1,500,000 of produc-
tion section 471 costs.
(iv) P computes its preproduction absorption ratio
for 2010 under paragraph (c)(3)(ii)(A) of this section
as follows:
September 17, 20123522012–38 I.R.B.

Preproduction additional section 263A costs
=
$ 340,000
=
8.5 percent
Raw material costs
$4,000,000
(v) P computes its production absorption ratio for
2010 under paragraph (c)(3)(ii)(B)(1)ofthissection
as follows:
Production additional section 263A costs
=
$ 720,000
=
12 percent
Production section 471 costs
$6,000,000
(vi) Under paragraph (c)(3)(i)(B) of this section, P
computes its allocable preproduction additional sec-
tion 263A costs by multiplying the preproduction ab-
sorption ratio by raw materials section 471 costs in-
curred during the taxable year and remaining in end-
ing inventory (8.5 percent * $2,000,000 = $170,000).
(vii) Under paragraph (c)(3)(i)(C) of this sec-
tion, P computes its allocable production additional
section 263A costs by multiplying the production
absorption ratio by production section 471 costs
incurred during the taxable year and remaining in
ending inventory at year end (12 percent * $1,500,000
= $180,000).
(viii) Under paragraph (c)(3)(i)(A) of this section,
P computes its total additional section 263A costs
allocable to ending inventory by adding its alloca-
ble preproduction additional section 263A costs to
its allocable production additional section 263A costs
($170,000 + $180,000 = $350,000).
(ix) P adds the $350,000 additional section 263A
costs to the $3,500,000 of section 471 costs remaining
in its ending inventory to calculate its total ending in-
ventory of $3,850,000. P includes the balance of P’s
additional section 263A costs incurred during 2010,
$710,000 ($1,060,000 less $350,000), in P’s cost of
goods sold.
Example 2.LIFO inventory method. (i) The facts
are the same as inExample 1, except that P uses the
LIFO inventory method rather than the FIFO method.
P’s 2010 LIFO increment is $1,500,000.
(ii) Under paragraph (c)(3)(iii)(B)(1) of this sec-
tion, P determines the additional section 263A costs
allocable to its 2010 LIFO increment by multiplying
the increment by a combined absorption ratio. Under
paragraph (c)(3)(iii)(B)(2) of this section, P computes
the combined absorption ratio as follows:
Additional section 263A costs allocable to
eligible property remaining in ending
inventory at the close of 2010
=$ 350,000=10 percent
Section 471 costs remaining in ending
inventory at the end of 2010
$3,500,000
(iii) P’s additional section 263A costs allocable
to its 2010 increment are $150,000 (10 percent *
$1,500,000). Under paragraph (c)(3)(iii)(B)(1)of
this section, P adds the $150,000 additional section
263A costs to its $1,500,000 LIFO increment to deter-
mine a total 2010 LIFO increment of $1,650,000. P’s
ending inventory is $4,150,000 (its beginning inven-
tory of $2,500,000 plus the $1,650,000 increment).
P includes the remaining $910,000 ($1,060,000 less
$150,000) of additional section 263A costs incurred
during 2010 in P’s cost of goods sold.
Example 3.Mixed service costs.(i)During
2010, Taxpayer R incurs $200,000 of capitalizable
mixed service costs (within the meaning of paragraph
(c)(3)(i)(E) of this section). R incurs $8,000,000 of
section 471 costs, including $2,000,000 of raw ma-
terial costs (as defined in paragraph (c)(3)(ii)(A)(3)
of this section).
(ii) Under paragraph (c)(3)(i)(E) of this section,
R allocates its mixed service costs to preproduc-
tion additional section 263A costs by computing
the proportion of raw material costs in its sec-
tion 471 costs and multiplying its mixed service
costs by this percentage. The proportion of raw
material costs in R’s section 471 costs is 25 per-
cent ($2,000,000/$8,000,000). R allocates $50,000
(25 percent * $200,000) of mixed service costs to
preproduction additional section 263A costs. R
includes the remaining $150,000 ($200,000 less
$50,000) of capitalizable mixed service costs as
production additional section 263A costs.
(4)Modified simplified production
method with historic absorption ratio elec-
tion—(i)In general. Except as otherwise
provided in this paragraph (c)(4), para-
graph (b)(4) of this section applies to the
historic absorption ratio election under the
modified simplified production method.
(ii)General allocation formula—(A)In
general. Except as provided in paragraph
(c)(4)(iii) of this section (relating to LIFO
taxpayers), a taxpayer making the historic
absorption ratio election under the modi-
fied simplified production method uses a
preproduction historic absorption ratio and
a production historic absorption ratio in
place of the actual preproduction absorp-
tion ratio and production absorption ratio
under paragraph (c)(3)(ii) of this section.
The preproduction and production historic
absorption ratios are based on costs a tax-
payer capitalizes during its test period.
(B)Preproduction historic absorption
ratio. The preproduction historic absorp-
tion ratio is computed as follows:
P
reproductionadditionalsection263Acostsincurredduringthetestperiod
Raw material costs incurred during the test period
(C)Production historic absorption ratio. The production historic absorption ratio is computed as follows:
P
roductionadditionalsection263Acostsincurredduringthetestperiod
Production section 471 costs incurred during the test period
(iii)LIFO taxpayers making the his-
toric absorption ratio election—(A)In
general. Instead of the combined absorp-
tion ratio under paragraph (c)(3)(iii)(B)(2)
of this section, a LIFO taxpayer making
the historic absorption ratio election un-
2012–38 I.R.B.353September 17, 2012

der the modified simplified production
method calculates a combined historic
absorption ratio based on costs a taxpayer
capitalizes during its test period.
(B)Combined historic absorption ra-
tio. The combined historic absorption ratio
is computed as follows:
T
otalallocableadditionalsection263Acostsincurredduringthetestperiod
Total section 471 costs remaining on hand at each year end of the test period
(C)Total allocable additional section
263A costs incurred during the test pe-
riod. Total allocable additional section
263A costs incurred during the test period
are the sum of the total additional section
263A costs allocable to eligible property
on hand at year end as described in para-
graph (c)(3)(i)(A) ofthissection,forall
years in the test period.
(D)Total section 471 costs remaining
on hand at each year end of the test pe-
riod. Total section 471 costs remaining on
hand at each year end of the test period are
the sum of the total section 471 costs re-
maining on hand at year end described in
paragraph (b)(3)(ii)(B) of this section, for
all taxable years in the test period.
(iv)Extension of qualifying period.In
the first taxable year following the close of
each qualifying period (for example, the
sixth taxable year following the test pe-
riod), a taxpayer must compute the actual
absorption ratios under paragraph (c)(3) of
this section (preproduction and production
absorption ratios or, for LIFO taxpayers,
the combined absorption ratio). If the ac-
tual combined absorption ratio or both the
actual preproduction and production ab-
sorption ratios, as applicable, computed
for this taxable year (the recomputation
year) is within one-half of one percentage
point (plus or minus) of the correspond-
ing historic absorption ratio or ratios used
in determining capitalizable costs for the
qualifying period (the previous five tax-
able years), the qualifying period is ex-
tended to include the recomputation year
and the following five taxable years, and
the taxpayer must continue to use the his-
toric absorption ratio or ratios throughout
the extended qualifying period. If, how-
ever, the actual combined historic absorp-
tion ratio or either the actual preproduction
absorption ratio or production absorption
ratio, as applicable, is not within one-half
of one percentage point (plus or minus) of
the corresponding historic absorption ra-
tio, the taxpayer must use the actual ab-
sorption ratio or ratios beginning with the
recomputation year and throughout the up-
dated test period. The taxpayer must re-
sume using the historic absorption ratio or
ratios based on the updated test period in
the third taxable year following the recom-
putation year.
(v)Transition rule. [Reserved].
(vi)Examples. The provisions of this
paragraph (c)(4) are illustrated by the fol-
lowing examples:
Example 1.FIFO inventory method. (i) Taxpayer
S uses the FIFO method of accounting for invento-
ries and a calendar taxable year, and in 2010 elects
to use the modified simplified production method. In
2013, S makes the historic absorption ratio election.
S identifies the following costs incurred during the
test period:
201020112012
Preproduction additional section 263A costs
$100$200$300
Production additional section 263A costs200
350450
Raw material costs2,000
2,500
3,000
Production section 471 costs
2,5003,500
4,000
In 2013, S incurs $10,000 of section 471 costs of
which $1,000 raw material costs and $2,000 produc-
tion 471 costs remain in ending inventory.
(ii) Under paragraph (c)(4)(ii)(B) of this section,
in 2013 S computes the preproduction historic ab-
sorption ratio as follows:
Preproduction additional
section 263A costs
=$100 + 200 + 300=600=8 percent
Raw material costs
$2,000 + 2,500 + 3,000
7,500
(iii) Under paragraph (c)(4)(ii)(C) of this section,
S computes the production historic absorption ratio
as follows:
Production additional
section 263A costs
=$200 + 350 + 450=1,000=10 percent
Production 471 costs
$2,500 + 3,500 + 4,000
10,000
(iv) Under paragraph (c)(4)(ii)(A) of this section,
S determines the preproduction additional section
263A costs allocable to its ending inventory for 2013
by multiplying its raw materials section 471 costs
incurred during the 2013 taxable year and remaining
in its ending inventory by its preproduction historic
absorption ratio. S allocates $80 preproduction ad-
ditional section 263A costs to its ending inventory
($1,000*8percent).
(v) S determines the production additional sec-
tion 263A costs allocable to its ending inventory for
September 17, 20123542012–38 I.R.B.

2013 by multiplying its production section 471 costs
incurred during the 2013 taxable year and remaining
in its ending inventory by its production historic ab-
sorption ratio. S allocates $200 production additional
section 263A costs to its ending inventory ($2,000 *
10 percent).
(vi) Under paragraph (c)(4)(ii) of this section, S’s
total additional section 263A costs allocable to end-
ing inventory in 2013 are $280, which is the sum of
the allocable preproduction additional section 263A
costs ($80) and the allocable production additional
section 263A costs ($200). S’s ending inventory in
2013 is $3,280, which is the sum of S’s additional
section 263A costs allocable to ending inventory and
S’s section 471 costs remaining in ending inventory
($280 + $3,000). S includes the balance of S’s addi-
tional section 263A costs incurred during 2013 in S’s
cost of goods sold.
Example 2.LIFO inventory method. (i) The facts
are the same as inExample 1, except that S uses the
LIFO inventory method rather than the FIFO method.
S calculates additional section 263A costs incurred
during the taxable year and allocable to ending in-
ventory under paragraph (c)(3)(iii) of this section and
identifies the following costs incurred during the test
period:
201020112012
Additional section 263A costs incurred during the taxable year allocable to ending inventory
$100$150$200
Section 471 costs incurred during the taxable year that remain in ending inventory1,0001,4002,100
In 2013, the LIFO value of S’s increment is
$1,500.
(ii) Under paragraph (c)(4)(iii) of this section, S
computes a combined historic absorption ratio as fol-
lows:
Additional section 263A costs
incurred during each taxable year
in the test period allocable
to ending inventory
=$100 + 150 + 200=$ 450=10 percent
Section 471 costs incurred
during each taxable year in the test
period that remain in ending inventory
$1,000 + 1,400 + 2,100$4,500
(iii) S’s additional section 263A costs allocable to
its 2013 LIFO increment is $150 ($1,500 beginning
LIFO increment * 10 percent combined historic ab-
sorption ratio). S adds the $150 to the $1,500 LIFO
increment to determine a total 2013 LIFO increment
of $1,650.
*****
(g)Effective/applicability date. Para-
graphs (b)(2)(i)(D), and (f) of this section
apply for taxable years ending on or af-
ter August 2, 2005. Paragraph (c) of this
section applies for taxable years ending on
or after the date these regulations are pub-
lished as final regulations in theFederal
Register.
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on September 4,
2012, 8:45 a.m., and published in the issue of the Federal
Register for September 5, 2012, 77 F.R. 54482)
Notice of Proposed
Rulemaking by
Cross-Reference to
Temporary Regulations
Integrated Hedging
Transactions of Qualifying
Debt
REG–138489–09
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemaking
by cross-reference to temporary regula-
tions.
SUMMARY: In this issue of the Bulletin,
the IRS and the Treasury Department are
issuing temporary regulations (T.D. 9598)
under section 988(d) of the Internal Rev-
enue Code. These regulations address
certain integrated transactions that involve
a foreign currency denominated debt in-
strument and multiple associated hedging
transactions. The text of the temporary
regulations also serves as the text of these
proposed regulations.
DATES: Written or electronic comments
and requests for a public hearing must be
received by December 6, 2012.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–138489–09), room
5203, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washing-
ton, DC 20044. Submissions may be
hand-delivered Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to CC:PA:LPD:PR (REG–138489–09),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue, NW,
Washington, DC, or sent electroni-
cally, via the Federal eRulemaking Por-
tal atwww.regulations.gov(IRS and
REG–138489–09).
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations,
Sheila Ramaswamy, at (202) 622–3870;
concerning submissions and delivery
of comments, Oluwafunmilayo Taylor,
202–622–7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
The temporary regulations published in
this issue of the Bulletin provide guidance
regarding certain integrated transactions
2012–38 I.R.B.355September 17, 2012

that involve a foreigncurrency denomi-
nated debt instrument and multiple asso-
ciated hedging transactions. The text of
those temporary regulations also serves
as the text of these proposed regulations.
The preamble to the temporary regulations
explains the temporary regulations and
these proposed regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a significant
regulatory action as defined in Executive
Order 12866. Therefore, a regulatory as-
sessment is not required. It has also been
determined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C. chap-
ter 5) does not apply to these regulations,
and because these regulations do not im-
pose a collection of information on small
entities, the provisions of the Regulatory
Flexibility Act (5 U.S.C. chapter 6) do not
apply. Pursuant to section 7805(f) of the
Internal Revenue Code, this notice of pro-
posed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, consideration
will be given to any written (a signed origi-
nal and eight (8) copies) or electronic com-
ments that are submitted timely to the IRS.
The IRS and the Treasury Department re-
quest comments on the clarity of the pro-
posed rules and how they can be made eas-
ier to understand. All comments will be
available for public inspection and copy-
ing. A public hearing may be scheduled
ifrequestedinwritingbyanypersonthat
timely submits written comments. If a
public hearing is scheduled, notice of the
date, time, and place for a public hearing
will be published in theFederal Register.
Drafting Information
The principal author of these pro-
posed regulations is Sheila Ramaswamy,
Office of Associate Chief Counsel
(International). However, other personnel
from the IRS and the Treasury Department
participated in their development.
*****
Proposed Amendment to the
Regulations
Accordingly, 26 CFR part 1 is proposed
to be amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.988–5 is amended
by revising paragraph (a)(6)(ii) and adding
paragraph (a)(9)(iv)Example 11and para-
graph (h) to read as follows:
§1.988–5 Section 988(d) hedging
transactions.
(a) * * *
(6) * * *
(ii) [The text of these proposed amend-
ments to §1.988–5(a)(6)(ii) is the same as
the text of §1.988–5T(a)(6)(ii) published
elsewhere in this issue of the Bulletin.]
*****
(9) * * *
(iv) * * *
*****
Example 11[The text of these pro-
posed amendments to §1.988–5(a)(9)(iv)
Example 11is the same as the text of
§1.988–5T(a)(9)(iv)Example 11pub-
lished elsewhere in this issue of the Bul-
letin.]
*****
(h) [The text of these proposed amend-
ments to §1.988–5(h) is the same as the
text of §1.988–5T(h) published elsewhere
in this issue of the Bulletin.]
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on September 5,
2012, 8:45 a.m., and published in the issue of the Federal
Register for September 6, 2012, 77 F.R. 54862)
Dividend Equivalents from
Sources Within the United
States; Correction
Announcement 2012–35
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Temporary regulations; correct-
ing amendment.
SUMMARY: This document amends tem-
porary regulations (T.D. 9572, 2012–11
I.R.B. 471) relating to dividend equiva-
lents for purposes of section 871(m) of
the Internal Revenue Code (Code). The
regulations affect nonresident aliens and
foreign corporations that hold notional
principal contracts (NPCs) providing for
payments determined by reference to pay-
ments of dividends from sources within
the United States.
DATES:Effective Date: These regulations
are effective August 31, 2012.
Applicability Date: For dates of appli-
cability, see § 1.871–16T(g).
FOR FURTHER INFORMATION
CONTACT: Mark E. Erwin or
D. Peter Merkel at (202) 622–3870 (not
a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 23, 2012, the Department
of the Treasury (Treasury) and the In-
ternal Revenue Service (IRS) published
in theFederal Registeratemporary
regulation and a notice of proposed rule-
making relating to dividend equivalents
from sources within the United States.
SeeT.D. 9572, 77 FR 3108 (Temporary
Regulations); REG–120282–10, 2012–11
I.R.B. 487 [77 FR 3202] (Proposed
Regulations). Section 871(m)(2) defines
the term “dividend equivalent” to include,
in part, any payment made pursuant to
a specified notional principal contract
(specified NPC) that is contingent upon or
determined by reference to a U.S. source
dividend. Section 871(m)(3)(A) provides
a definition for the term specified NPC that
is applicable to payments made through
March 18, 2012. Section 1.871–16T(b)
of the Temporary Regulations provides
that the definition of specified NPC
contained in paragraphs (i) through (iv)
of section 871(m)(3)(A) will apply to
payments made after March 18, 2012, and
before January 1, 2013. The Proposed
Regulations provide a different definition
of specified NPC that would apply to
payments made on or after January 1,
2013.
September 17, 20123562012–38 I.R.B.

Explanation of Provisions
Treasury and the IRS received numer-
ous comments on the Proposed Regula-
tions, stating that the proposed effective
date of January 1, 2013, would not al-
low taxpayers sufficient time to build and
test the systems required to implement the
withholding rules for specified NPCs and
equity-linked instruments. In response to
these comments, this document amends
§ 1.871–16T(b) of the Temporary Regula-
tions so that the definition of a specified
NPC contained in paragraphs (i) through
(iv) of section 871(m)(3)(A) will apply to
payments made after March 18, 2012, and
before January 1, 2014. When final reg-
ulations are issued adopting the Proposed
Regulations, Treasury and the IRS intend
that the rules contained in the final regu-
lations will apply to payments made on or
after January 1, 2014.
Treasury and the IRS continue to con-
sider the other public comments made on
the Temporary Regulations and the Pro-
posed Regulations.
Drafting Information
The principal author of these regula-
tions is D. Peter Merkel, the Office of
Associate Chief Counsel (International).
Other personnel from Treasury and the IRS
participated in their development.
*****
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 * * *
Section 1.871–16T also issued under
26 U.S.C. 871(m).
§ 1.871–16T(b) [Amended]
Par. 2. Section 1.871–16T(b) is
amended by removing the language
“2013” and adding the language “2014” in
its place wherever it appears.
Steven T. Miller,
Deputy Commissioner for
Services and Enforcement.
Approved August 16, 2012.
Mark J. Mazur,
Assistant Secretary
oftheTreasury(TaxPolicy).
(Filed by the Office of the Federal Register on August 30,
2012, 8:45 a.m., and published in the issue of the Federal
Register for August 31, 2012, F.R. 53141)
2012–38 I.R.B.357September 17, 2012

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 ef-
fect:
Amplifieddescribes a situation where
no change is being made in a prior pub-
lished position, but the prior position is be-
ingextendedtoapplytoavariationofthe
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 withmodi-
fied,below).
Clarifiedis used in those instances
where the language in a prior ruling is be-
ing made clear because the language has
caused, or may cause, some confusion.
It is not used where a position in a prior
ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously pub-
lished ruling and points out an essential
difference between them.
Modifiedis 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
withamplifiedandclarified, above).
Obsoleteddescribes 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.
Revokeddescribes situations where the
position in the previously published ruling
is not correct and the correct position is
beingstatedinanewruling.
Supersededdescribes a situation where
the new ruling does nothing more than re-
state the substance and situation of a previ-
ously published ruling (or rulings). Thus,
the term is used to republish under the
1986 Code and regulations the same po-
sition published under the 1939 Code and
regulations. The term is also used when
it is desired to republish in a single rul-
ing a series of situations, names, etc., that
were previously published over a period of
time in separate rulings. If the new rul-
ing does more than restate the substance
of a prior ruling, a combination of terms
is used. For example,modifiedandsu-
persededdescribes 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 pub-
lished ruling is first modified and then, as
modified, is superseded.
Supplementedis 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 rul-
ing has been supplemented several times, a
new ruling may be published that includes
the list in the original ruling and the ad-
ditions, and supersedes all prior rulings in
the series.
Suspendedis 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 fol
lowing abbreviations in current use
and for
merly used will appear in material
publis
hedintheBulletin.
A—Individual.
Acq.—A
cquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank
.
B.T.A.—Board of Tax Appeals.
C—Individual.
C.B.—Cu
mulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Coo
perative.
Ct.D.—Court Decision.
CY—County.
D—Decede
nt.
DC—Dummy Corporation.
DE—Donee.
Del. Order
—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Emp
loyer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduc
iary.
FC—Foreign Country.
FICA—Federal Insurance Contributions Act.
FISC—Fo
reign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Fed
eral Unemployment Tax Act.
FX—Foreign corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grante
e.
GP—General Partner.
GR—Grantor.
IC—Insura
nce Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited
Partner.
LR—Lessor.
M—Minor.
Nonacq.—No
nacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Persona
l Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Pa
rtnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Re
al Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsi
diary.
S.P.R.—Statement of Procedural Rules.
Stat.—Statutes at Large.
T—Target
Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Trans
feree.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpay
er.
TR—Trust.
TT—Trustee.
U.S.C.—Uni
ted States Code.
X—Corporation.
Y—Corporation.
Z—Corporat
ion.
September 17, 2012i2012–38 I.R.B.

Numerical Finding List
1
Bulletins 2012–27 through 2012–38
Announcements:
2012-26, 2012-27 I.R.B.8
2012-27, 2012-27 I.R.B.10
2012-28, 2012-27 I.R.B.10
2012-30, 2012-34 I.R.B.314
2012-31, 2012-34 I.R.B.315
2012-32, 2012-35 I.R.B.325
2012-33, 2012-35 I.R.B.325
2012-34, 2012-36 I.R.B.334
2012-35, 2012-38 I.R.B.356
Notices:
2012-39, 2012-31 I.R.B.95
2012-44, 2012-28 I.R.B.45
2012-45, 2012-29 I.R.B.59
2012-46, 2012-30 I.R.B.86
2012-47, 2012-31 I.R.B.98
2012-48, 2012-31 I.R.B.102
2012-49, 2012-31 I.R.B.119
2012-50, 2012-31 I.R.B.121
2012-51, 2012-33 I.R.B.150
2012-52, 2012-35 I.R.B.317
2012-53, 2012-35 I.R.B.317
2012-55, 2012-36 I.R.B.332
Proposed Regulations:
REG-126770-06, 2012-38 I.R.B.347
REG-101812-07, 2012-34 I.R.B.311
REG-134042-07, 2012-27 I.R.B.5
REG-153627-08, 2012-29 I.R.B.60
REG-136491-09, 2012-35 I.R.B.321
REG-138489-09, 2012-38 I.R.B.355
REG-125570-11, 2012-30 I.R.B.93
REG-130266-11, 2012-32 I.R.B.126
REG-134935-11, 2012-29 I.R.B.64
REG-141832-11, 2012-28 I.R.B.54
REG-107889-12, 2012-28 I.R.B.53
REG-113738-12, 2012-29 I.R.B.66
Revenue Procedures:
2012-28, 2012-27 I.R.B.4
2012-29, 2012-28 I.R.B.49
2012-30, 2012-33 I.R.B.165
2012-31, 2012-33 I.R.B.256
2012-32, 2012-34 I.R.B.267
2012-33, 2012-34 I.R.B.272
2012-34, 2012-34 I.R.B.280
2012-35, 2012-37 I.R.B.341
Revenue Rulings:
2012-19, 2012-28 I.R.B.16
2012-20, 2012-27 I.R.B.1
Revenue Rulings— Continued:
2012-21, 2012-32 I.R.B.123
2012-24, 2012-36 I.R.B.329
2012-25, 2012-37 I.R.B.337
Treasury Decisions:
9591, 2012-28 I.R.B.32
9592, 2012-28 I.R.B.41
9593, 2012-28 I.R.B.17
9594, 2012-29 I.R.B.57
9595, 2012-30 I.R.B.71
9596, 2012-30 I.R.B.84
9597, 2012-34 I.R.B.258
9598, 2012-38 I.R.B.343
1
A cumulative list of all revenue rulings, revenueprocedures, Treasury decisions, etc., publishedin Internal Revenue Bulletins 2012–1 through 2012–26 is in Internal Revenue Bulletin
2012–26, dated June 25, 2012.
2012–38 I.R.B.iiSeptember 17, 2012

Finding List of Current Actions on
Previously Published Items
1
Bulletins 2012–27 through 2012–38
Announcements:
83-196
Superseded by
Rev. Proc. 2012-31, 2012-33 I.R.B.256
85-141
Superseded by
Rev. Proc. 2012-31, 2012-33 I.R.B.256
2008-105
Modified and superseded by
Ann. 2012-34, 2012-36 I.R.B.334
Notices:
2009-24
Amplified by
Notice 2012-51, 2012-33 I.R.B.150
2012-51
Amplified by
Notice 2012-51, 2012-33 I.R.B.150
Proposed Regulations:
REG-100276-97
Withdrawn by
Ann. 2012-27, 2012-27 I.R.B.10
Revenue Procedures:
94-22
Modified and superseded by
Rev. Proc. 2012-35, 2012-37 I.R.B.341
95-15
Superseded by
Rev. Proc. 2012-31, 2012-33 I.R.B.256
98-32
Modified and superseded by
Rev. Proc. 2012-33, 2012-34 I.R.B.272
2007-38
Modified and superseded by
Rev. Proc. 2012-32, 2012-34 I.R.B.267
2011-40
Superseded by
Rev. Proc. 2012-30, 2012-33 I.R.B.165
Treasury Decisions:
9752
Corrected by
Ann. 2012-35, 2012-38 I.R.B.356
1
A cumulative list of current actions on previously published items in Internal Revenue Bulletins 2012–1 through 2012–26 is in Internal Revenue Bulletin 2012–26, dated June 25, 2012.
September 17, 2012iii2012–38 I.R.B.

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