Internal Revenue Bulletin 1997-48 (PDF rendition): IRS Notices

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

INCOME TAX
Rev. Rul. 97–49, page 4.
1997 base period T-bill rate.The “base period T-bill rate”
for the period ending September 30, 1997, is published, as
required by section 995(f)(4) of the Code.
REG–105162–97, page 13.
Proposed regulations under section 7701 of the Code de-
scribe how elective changes in entity classification will be
treated for Federal tax purposes. A public hearing will be
held on February 24, 1998.
REG–251985–96, page 18.
Proposed regulations under section 863 of the Code relate
to the source of income from sales of inventory produced in
the United States and sold in a U.S. possession or produced
in a U.S. possession and sold in the United States. A public
hearing will be held on January 29, 1998.
Notice 97–66, page 8.
Securities lending transaction notice.Guidance is pro-
vided to payors of substitute interest payments made after
November 13, 1997, and before January 1, 1999, to com-
ply with the statement requirement of section 871(h)(5) of
the Code in order to qualify the payments as portfolio inter-
est payments for purposes of the tax imposed under sec-
tions 871 and 881 of the Code. Guidance is also provided to
determine the amount of tax imposed and withheld on sub-
stitute dividend payments made by one foreign person to an-
other foreign person.
Notice 97–68, page 11.
This notice informs taxpayers that the rules in sections
1.664–2(a)(1)(i) and 1.664–3(a)(1)(i)(e) of the proposed In-
come Tax regulations, published in REG–209823–96,
1997–18 I.R.B. 47, will not be effective for certain charita-
ble remainder trusts for the 1997 tax year.
EMPLOYEE PLANS
Notice 97–69, page 12.
Weighted average interest rate update.Guidelines are
set forth for determining for November 1997 the weighted
average interest rate and the resulting permissible range of
interest rates used to calculate current liability for purposes
of the full funding limitation of section 412(c)(7) of the Code
as amended by the Omnibus Budget Reconciliation Act of
1987 and by the Uruguay Round Agreements Act (GATT).
EXEMPT ORGANIZATIONS
Announcement 97–116, page 25.
A list is provided of organizations now classified as private
foundations.
ADMINISTRATIVE
Notice 97–61, page 8.
This notice informs the public of the Service’s Year 2000
Date Standard Policy.
Notice 97–67, page 10.
Accounting method requests for grace period interest.
This notice informs taxpayers that the Service will issue
guidance that provides the procedures for a taxpayer to
automatically change its method of accounting to comply
with section 1004 of the Taxpayer Relief Act of 1997 for the
taxpayer’s first taxable year beginning after August 5, 1997.
The notice provides that the Service will not grant any
requests filed on or after August 5, 1997, to change to a
method of accounting for grace period interest other than
the method required by section 1004 of the Act.
Internal Revenue
bbuulllleettiinn
Bulletin No. 1997–48
December 1, 1997
HIGHLIGHTS
OF THIS ISSUE
These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.
Department of the Treasury
Internal Revenue Service
Finding Lists begin on page 28.
Index for July–November begins on page 30.

Mission of the Service
The purpose of the Internal Revenue Service is to collect
the proper amount of tax revenue at the least cost; serve
the public by continually improving the quality of our prod-
ucts and services; and perform in a manner warranting
the highest degree of public confidence in our integrity, effi-
ciency, and fairness.
2
Statement of Principles
of Internal Revenue
Tax Administration
The function of the Internal Revenue Service is to adminis-
ter the Internal Revenue Code. Tax policy for raising revenue
is determined by Congress.
With this in mind, it is the duty of the Service to carry out that
policy by correctly applying the laws enacted by Congress;
to determine the reasonable meaning of various Code provi-
sions in light of the Congressional purpose in enacting them;
and to perform this work in a fair and impartial manner, with
neither a government nor a taxpayer point of view.
At the heart of administration is interpretation of the Code. It
is the responsibility of each person in the Service, charged
with the duty of interpreting the law, to try to find the true
meaning of the statutory provision and not to adopt a
strained construction in the belief that he or she is “protect-
ing the revenue.” The revenue is properly protected only
when we ascertain and apply the true meaning of the statute.
The Service also has the responsibility of applying and
administering the law in a reasonable, practical manner.
Issues should only be raised by examining officers when
they have merit, never arbitrarily or for trading purposes.
At the same time, the examining officer should never hesi-
tate to raise a meritorious issue. It is also important that
care be exercised not to raise an issue or to ask a court to
adopt a position inconsistent with an established Service
position.
Administration should be both reasonable and vigorous. It
should be conducted with as little delay as possible and
with great courtesy and considerateness. It should never
try to overreach, and should be reasonable within the
bounds of law and sound administration. It should, howev-
er, be vigorous in requiring compliance with law and it
should be relentless in its attack on unreal tax devices and
fraud.

The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing offi-
cial rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly and may be obtained
from the Superintendent of Documents on a subscription
basis. Bulletin contents of a permanent nature are consoli-
dated semiannually into Cumulative Bulletins, which are sold
on a single-copy basis.
It is the policy of the Service to publish in the Bulletin all sub-
stantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless other-
wise indicated. Procedures relating solely to matters of in-
ternal management are not published; however, statements
of internal practices and procedures that affect the rights
and duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service on
the application of the law to the pivotal facts stated in the
revenue ruling. In those based on positions taken in rulings
to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature
are deleted to prevent unwarranted invasions of privacy and
to comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have
the force and effect of Treasury Department Regulations,
but they may be used as precedents. Unpublished rulings
will not be relied on, used, or cited as precedents by Service
personnel in the disposition of other cases. In applying pub-
lished rulings and procedures, the effect of subsequent leg-
islation, regulations, court decisions, rulings, and proce-
dures must be considered, and Service personnel and oth-
ers concerned are cautioned against reaching the same con-
clusions in other cases unless the facts and circumstances
are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions, and Subpart B, Legislation and Related
Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to
these subjects are contained in the other Parts and Sub-
parts. Also included in this part are Bank Secrecy Act Admin-
istrative Rulings. Bank Secrecy Act Administrative Rulings
are issued by the Department of the Treasury’s Office of the
Assistant Secretary (Enforcement).
Part IV.—Items of General Interest.
With the exception of the Notice of Proposed Rulemaking
and the disbarment and suspension list included in this part,
none of these announcements are consolidated in the Cumu-
lative Bulletins.
The first Bulletin for each month includes a cumulative index
for the matters published during the preceding months.
These monthly indexes are cumulated on a quarterly and
semiannual basis, and are published in the first Bulletin of the
succeeding quarterly and semiannual period, respectively.
3
Introduction
The contents of this publication are not copyrighted and may be reprinted freely.A citation of the Internal Revenue Bulletin as the source would be appropriate.
For sale by the Superintendent of Documents, U.S.Government Printing Office, Washington, DC 20402.

December 1, 199741997–48 I.R.B.
Section 861.—Income From
Sources Within the United
States
26 CFR 1.861–2: Interest.
Guidance is provided to the payors of U.S. source
substitute interest payments made after November
13, 1997, and before January 1, 1999, for complying
with the statement requirement of § 871(h)(5) in
order to qualify as portfolio interest. See Notice
97–66, page 8.
26 CFR 1.861–3: Dividends.
Guidance is provided on the determination of the
amount of tax imposed under §§ 871 and 881 on
U.S. source substitute dividend payments which are
made by a foreign person to another foreign person
(“foreign-to-foreign” payments).
Section 864.—Definitions and
Special Rules
26 CFR 1.864–5: General provisions relating to
withholding agent.
Ageneral election to defer the effective date of
final securities lending regulations (published Octo-
ber 14, 1997, TD 8735, 62 FR 53498) for substitute
payments made after November 13, 1997, to Janu-
ary 1, 1999, does not apply for substitute interest
and substitute dividend payments received that are
foreign source effectively connected income under
§ 1.864–5(b)(2) of the final regulations. Notice
97–66, page 8.
Section 871.—Tax on
Nonresident Alien Individuals
26 CFR 1.871–7: Taxation of nonresident alien in-
dividuals not engaged in U.S. business.
Guidance is provided as to the amount of tax to
be imposed under § 1.871–7(b)(2) with respect to
substitute interest or substitute dividend payments
made by one foreign person to another foreign per-
son. See Notice 97–66, page 8.
26 CFR 1.871–14: Rules relating to repeal of tax on
interest of nonresident alien individuals and foreign
corporations received from certain portfolio debt in-
vestments.
Guidance is provided to payors of substitute in-
terest payments made after November 13, 1997, and
before January 1, 1999,i.e., prior to the effective
date of §1.871–14, for complying with the statement
requirement of § 871(h)(5) in order to qualify the
payments as portfolio interest payments for pur-
poses of the tax imposed under §§ 871 and 881. See
Notice 97–66, page 8.
Section 881.—Tax on Income
of Foreign Corporations Not
Connected With United States
Business
26 CFR 1.881–2: Income of foreign corporations
treated as effectively connected with U.S. business.
Guidance is provided as to the amount of tax to
be imposed under § 1.881–2(b)(2) with respect to
substitute interest or substitute dividend payments
made by one foreign person to another foreign per-
son. See Notice 97–66, page 8.
Section 995.—Taxation of DISC
Income to Shareholders
1997 base period T-bill rate.The
“base period T-bill rate” for the period
ending September 30, 1997, is published,
as required by section 995(f)(4) of the
Code.
Rev. Rul. 97–49
Section 995(f)(l) of the Internal Rev-
enue Code provides that a shareholder of
a DISC shall pay interest each taxable
year in an amount equal to the product of
the shareholder’s DISC-related deferred
tax liability for the year and the “base pe-
riod T-bill rate.” Under section 995(f)(4),
the base period T-bill rate is the annual
rate of interest determined by the Secre-
tary to be equivalent to the average in-
vestment yield of United States Treasury
bills with maturities of 52 weeks which
were auctioned during the one-year pe-
riod ending on September 30 of the calen-
dar year ending with (or of the most re-
cent calendar year ending before) the
close of the taxable year of the share-
holder. The base period T-bill rate for the
period ending September 30, 1997, is
5.68 percent.
Pursuant to section 6622 of the Code,
interest must be compounded daily. The
table below provides factors for com-
pounding the base period T-bill rate daily
for any number of days in the share-
holder’s taxable year (including a 52–53
week accounting period) for the 1997
base period T-bill rate. To compute the
amount of the interest charge for the
shareholder’s taxable year, multiply the
amount of the shareholder’s DISC-related
deferred tax liability (as defined in section
995(f)(2)) for that year by the base period
T-bill rate factor corresponding to the
number of days in the shareholder’s tax-
able year for which the interest charge is
being computed. Generally, one would
use the factor for 365 days. One would
use a different factor only if the share-
holder’s taxable year for which the inter-
est charge being determined is a short tax-
able year, if the shareholder uses the
52-53 week taxable year, or if the share-
holder’s taxable year is a leap year.
For the base period T-bill rates for the
periods ending in prior years, see: Rev.
Rul. 86–132, 1986–2 C.B. 137; Rev. Rul.
87–129, 1987–2 C.B. 196; Rev. Rul.
88–94, 1988–2 C.B. 301; Rev. Rul.
89–116, 1989–2 C.B. 197; Rev. Rul.
90–96, 1990–2 C.B. 188; Rev. Rul.
91–59, 1991–2 C.B. 347; Rev. Rul.
92–98, 1992–2 C.B. 201; Rev. Rul.
93–77, 1993–2 C.B. 253; Rev. Rul.
94–68, 1994–2 C.B. 177; Rev. Rul.
95–77, 1995–2 C.B. 122; and Rev. Rul.
96–55, 1996–2 C.B. 57.
DRAFTING INFORMATION
The principal author of this revenue
ruling is David Bergkuist of the Office of
the Associate Chief Counsel (Interna-
tional). For further information about this
revenue ruling, contact Mr. Bergkuist on
(202) 622-3850 (not a toll-free call).
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1.000155616
2.000311257
3.000466922
4.000622611
5.000778324
6.000934062
7.001089824
8.001245610
9.001401420
10.001557255
11.001713113
12.001868996
13.002024904
14.002180835
15.002336791
16.002492771
17.002648775
18.002804804
Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

19.002960857
20.003116934
21.003273036
22.003429161
23.003585312
24.003741486
25.003897685
26.004053908
27.004210155
28.004366426
29.004522722
30.004679043
31.004835387
32.004991756
33.005148149
34.005304567
35.005461009
36.005617475
37.005773966
38.005930481
39.006087020
40.006243584
41.006400172
42.006556784
43.006713421
44.006870082
45.007026768
46.007183478
47.007340212
48.007496971
49.007653754
50.007810561
51.007967393
52.008124249
53.008281130
54.008438035
55.008594965
56.008751919
57.008908897
58.009065900
59.009222927
60.009379979
61.009537055
62.009694155
63.009851280
64.010008430
65.010165604
66.010322802
67.010480025
68.010637272
69.010794544
70.010951840
71.011109161
72.011266506
73.011423876
74.011581270
75.011738689
76.011896132
77.012053600
78.012211092
79.012368608
80.012526150
81.012683715
82.012841306
83.012998920
84.013156560
85.013314223
86.013471912
87.013629625
88.013787362
89.013945124
90.014102911
91.014260722
92.014418557
93.014576418
94.014734302
95.014892212
96.015050146
97.015208104
98.015366087
99.015524095
100.015682127
101.015840184
102.015998265
103.016156371
104.016314502
105.016472657
106.016630837
107.016789042
108.016947271
109.017105524
110.017263803
111.017422106
112.017580433
113.017738786
114.017897162
115.018055564
116.018213990
117.018372441
118.018530916
119.018689417
120.018847941
121.019006491
122.019165065
123.019323664
124.019482287
125.019640936
126.019799609
127.019958306
128.020117028
129.020275775
130.020434547
131.020593343
132.020752165
133.020911010
134.021069881
135.021228776
136.021387696
137.021546641
138.021705610
139.021864604
140.022023623
141.022182667
142.022341736
143.022500829
144.022659947
145.022819089
146.022978257
147.023137449
148.023296666
149.023455908
150.023615174
151.023774466
152.023933782
153.024093123
1997–48 I.R.B.5December 1, 1997
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR

154.024252489
155.024411879
156.024571294
157.024730734
158.024890199
159.025049689
160.025209204
161.025368743
162.025528307
163.025687896
164.025847510
165.026007149
166.026166813
167.026326501
168.026486214
169.026645953
170.026805716
171.026965503
172.027125316
173.027285154
174.027445016
175.027604903
176.027764816
177.027924753
178.028084715
179.028244702
180.028404713
181.028564750
182.028724812
183.028884898
184.029045010
185.029205146
186.029365307
187.029525493
188.029685704
189.029845940
190.030006201
191.030166487
192.030326798
193.030487134
194.030647495
195.030807880
196.030968291
197.031128727
198.031289187
199.031449673
200.031610183
201.031770719
202.031931279
203.032091865
204.032252475
205.032413111
206.032573771
207.032734457
208.032895167
209.033055902
210.033216663
211.033377448
212.033538259
213.033699094
214.033859955
215.034020841
216.034181751
217.034342687
218.034503648
219.034664633
220.034825644
221.034986680
222.035147741
223.035308827
224.035469938
225.035631074
226.035792236
227.035953422
228.036114633
229.036275870
230.036437131
231.036598418
232.036759730
233.036921067
234.037082428
235.037243816
236.037405228
237.037566665
238.037728127
239.037889615
240.038051128
241.038212666
242.038374229
243.038535817
244.038697430
245.038859068
246.039020732
247.039182420
248.039344134
249.039505873
250.039667638
251.039829427
252.039991242
253.040153081
254.040314946
255.040476836
256.040638752
257.040800692
258.040962658
259.041124649
260.041286665
261.041448706
262.041610773
263.041772864
264.041934981
265.042097124
266.042259291
267.042421484
268.042583702
269.042745945
270.042908213
271.043070507
272.043232826
273.043395170
274.043557539
275.043719934
276.043882354
277.044044799
278.044207270
279.044369766
280.044532287
281.044694833
282.044857405
283.045020002
284.045182624
285.045345272
286.045507945
287.045670643
288.045833366
December 1, 199761997–48 I.R.B.
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR

289.045996115
290.046158889
291.046321689
292.046484514
293.046647364
294.046810240
295.046973140
296.047136067
297.047299018
298.047461995
299.047624998
300.047788025
301.047951078
302.048114157
303.048277260
304.048440390
305.048603544
306.048766724
307.048929929
308.049093160
309.049256416
310.049419698
311.049583005
312.049746337
313.049909695
314.050073078
315.050236487
316.050399921
317.050563380
318.050726865
319.050890376
320.051053912
321.051217473
322.051381060
323.051544672
324.051708309
325.051871972
326.052035661
327.052199375
328.052363115
329.052526880
330.052690670
331.052854486
332.053018327
333.053182194
334.053346087
335.053510005
336.053673948
337.053837917
338.054001912
339.054165932
340.054329977
341.054494048
342.054658145
343.054822267
344.054986415
345.055150588
346.055314787
347.055479011
348.055643261
349.055807537
350.055971838
351.056136164
352.056300516
353.056464894
354.056629297
355.056793726
356.056958181
357.057122661
358.057287166
359.057451698
360.057616255
361.057780837
362.057945445
363.058110079
364.058274738
365.058439423
366.058604134
367.058768870
368.058933632
369.059098419
370.059263232
371.059428071
1997–48 I.R.B.7December 1, 1997
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
1997 ANNUALRATE,
COMPOUNDED DAILY
5.68 PERCENT
DAYSFACTOR
Section 1441.—Withholding of
Tax on Nonresident Aliens
26 CFR 1.1441–7: Requirement for the deduction
and withholding of tax on payments to foreign
persons.
Guidance is provided to payors of substitute in-
terest and dividend concerning their obligations as
withholding agents on payments made to foreign
beneficial owners that are individuals. See Notice
97–66, page 8.
Section 1442.—Withholding of
Tax on Nonresident
Corporations
26 CFR 1.1441–7: Requirement for the deduction
and withholding of tax on payments to foreign per-
sons.
Guidance is provided to payors of substitute in-
terest and dividend concerning their obligations as
withholding agents on payments made to foreign
beneficial owners that are corporations. See Notice
97–66, page 8.

December 1, 199781997–48 I.R.B.
Notice 97–61
The Internal Revenue Service has un-
dertaken a large-scale effort to address
the year 2000 issue. The Year 2000 Con-
version Project’s primary goal is to make
all current and future IRS information
systems year 2000 compliant. That is,
ensure that all computer systems func-
tion correctly before and after January 1,
2000.
The Internal Revenue Service has
adopted a standard for the year represen-
tation and date representation. This stan-
dard will be used in all data exchanges
with external trading partners (ETPs),
Federal, state and local governments as
well as the private sector. The standard
is:
—an 8-position year when using
the Gregorian data format; the 8 charac-
ters (YYYYMMDD) must be contiguous
and the 4-position year field must be at
the beginning of the date field;
—a four-position year when using
the Julian date format; the date field
would be represented as YYYYDDD;
—a four-position year when using
the Epock/Offset date format where the
Epoch (year field) contains four charac-
ters and the Offset is a time element de-
termined by the system owner; and,
— a four-position year will be used
in conjunction with all other date for-
mats and the other elements of the date
field.
The IRS said it will be contacting its
external trading partners to inform them
of the date by which data exchanges will
be converted. The trading partners will
be expected to certify that they will be
ready to receive the data and that they
will provide any related exchanges to the
IRS as specified in the standard.
External Trading Partners who pro-
vide data in accord with specifications
generally issued in Revenue Procedures
will continue to be informed of the date
requirements through Revenue Proce-
dures. Others, with whom IRS has
agreements for specific exchanges, such
as with state revenue departments in-
volved in tax administration, will be con-
tacted individually by the IRS.
Certain Payments Made
Pursuant to a Securities
Lending Transaction
Notice 97–66
SECTION 1. SUMMARY
On October 14, 1997, final regulations
were published in the Federal Register
[T.D. 8735], RIN 1545-AP71, (the “final
regulations”) which source substitute in-
terest and substitute dividend payments
that are made pursuant to a securities
lending or sale-repurchase transaction by
reference to the income that would be
earned with respect to the underlying
transferred debt security or stock. The
final regulations also provide that substi-
tute interest and dividend payments that
are U.S. source under the regulations are
also characterized as interest and divi-
dends for purposes of determining the
fixed or determinable annual or periodical
income of foreign resident individuals
and corporations subject to tax under sec-
tions 871, 881, 4948(a) and Chapter 3 of
the Internal Revenue Code and for pur-
poses of granting tax treaty benefits with
respect to interest and dividends. As pro-
mulgated, the final regulations were made
applicable in all respects for substitute in-
terest (as defined in § 1.861–2(a)(7) of
the income tax regulations) and substitute
dividend payments (as defined in §
1.861–3(a)(6)) made after November 13,
1997.
This Notice provides guidance on com-
plying with the statement requirement of
section 871(h)(5) for substitute interest
payments made after November 13, 1997,
and before January 1, 1999. In addition,
the Treasury and the Service intend to
propose new regulations to provide spe-
cific guidance on how substitute dividend
payments made by one foreign person to
another foreign person (“foreign-to-for-
eign payments”) are to be treated. Until
the proposed regulations are promulgated,
this Notice clarifies how the amount of
the tax imposed under §§ 1.871–7(b)(2)
and 1.881–2(b)(2) will be determined
with respect to foreign-to-foreign pay-
ments. The Treasury and the Service re-
quest comments on the treatment of for-
eign-to-foreign payments provided in this
Notice.
SECTION 2. SUBSTITUTE INTEREST
PAYMENTS
Substitute interest payments made by a
foreign person that are U.S. source inter-
est under the final regulations must satisfy
the statement requirement of section
871(h)(5) to qualify as portfolio interest.
The final regulations refer taxpayers to §
1.871–14(c) for this purpose, but those
regulations are not generally applicable
until January 1, 1999. Under this Notice,
the statement requirement of section
871(h)(5) will be satisfied with respect to
substitute interest payments made after
November 13, 1997 and before January 1,
1999, if any written, electronic, or oral
statement that reasonably establishes that
the payee is a foreign person is given or
made to the payor prior to, or within a
reasonable period of time after, the pay-
ment. The statement requirement of the
preceding sentence is deemed to be satis-
fied if the payor is subject to, and satisfies
with respect to the payee, the regulatory
rules in the jurisdiction in which the payor
is operating regarding establishing the
identity of a customer (i.e., “know your
customer” rules). Also, if a taxpayer
makes an election under § 1.1441-
1(f)(2)(ii), such election will be effective,
pursuant to this Notice, to allow a with-
holding agent to apply retroactively
the documentation requirements of
§ 1.871–14(c) with respect to one or more
substitute interest payments made
after November 13, 1997. Treas. Reg.
§ 1.871–14(c)(3) allows a withholding
agent to collect a certificate or documen-
tary evidence at any time until the expira-
tion of the beneficial owner’s period of
limitation for claiming a refund of tax
with respect to portfolio interest.
SECTION 3. SUBSTITUTE DIVIDEND
PAYMENTS
The final regulations were adopted to
eliminate unjustifiable differences be-
tween the taxation of similar economic in-
vestments. It has been brought to the at-
Part III. Administrative, Procedural, and Miscellaneous

1997–48 I.R.B.9December 1, 1997
tention of the Treasury and the Service,
however, that, in certain circumstances,
the total U.S. withholding tax paid with
respect to a securities loan or sale-repur-
chase transaction, or series of such trans-
actions, could be excessive due to the ap-
plication of the final regulations. The
Treasury and the Service believe that tax-
payers can avoid such excessive with-
holding taxes in the vast majority of cases
by structuring their transactions appropri-
ately. In some circumstances, however,
such structuring may be difficult or im-
possible.
To address these concerns, under this
Notice, the amount of U.S. withholding tax
to be imposed under §§ 1.871–7(b)(2) and
1.881–2(b)(2) with respect to a foreign-to-
foreign payment will be the amount of the
underlying dividend multiplied by a rate
equal to the excess of the rate of U.S. with-
holding tax that would be applicable to
U.S. source dividends paid by a U.S. per-
son directly to the recipient of the substitute
payment over the rate of U.S. withholding
tax that would be applicable to U.S. source
dividends paid by a U.S. person directly to
the payor of the substitute payment. This
amount may be reduced or eliminated to
the extent that the total U.S. tax actually
withheld on the underlying dividend and
any previous substitute payments is greater
than the amount of U.S. withholding tax
that would be imposed on U.S. source divi-
dends paid by a U.S. person directly to the
payor of the substitute payment. The recip-
ient of a substitute payment may not, how-
ever, disregard the form of its transaction in
order to reduce the U.S. withholding tax.
Therefore, a recipient of a foreign-to-for-
eign payment will not be entitled to a re-
fund or tax credit against any other U.S. tax
liability to reflect the fact that the rate of
U.S. withholding tax that would be applica-
ble to a U.S. source dividend paid by a U.S.
person directly to such recipient is less than
the rate of U.S. withholding tax that would
be applicable to a U.S. source dividend
paid by a U.S. person directly to the payor
of the substitute payment (or any payor of a
previous substitute payment or the underly-
ing dividend).
As a result of this formula, substitute
payments with respect to foreign-to-for-
eign securities loans and sale-repurchase
transactions that do not reduce the over-
all U.S. withholding tax generally will
not be subject to withholding tax. For
example, no withholding tax is required
in situations where transactions are en-
tered into between residents of the same
country. The Treasury and the Service
believe that this Notice adequately ad-
dresses the concerns of those foreign
persons who are required by their local
regulators to enter into transactions only
with residents of the same country.
Conversely, to the extent a foreign-to-
foreign securities loan or sale-repurchase
transaction would reduce the overall
U.S. withholding tax, an incremental
amount of U.S. withholding tax is im-
posed on the substitute payment.
SECTION 4. LIABILITYOF
WITHHOLDING AGENTS
Each person who makes a foreign-to-
foreign payment shall be treated as a
withholding agent under section 1.1441–7
with respect to such payment. If a U.S.
withholding agent withholds the highest
rate of tax which would be imposed on all
foreign recipients of dividends and substi-
tute payments in a chain of such pay-
ments, each foreign withholding agent
will be treated as having satisfied its with-
holding obligation under §1.1441–7.
SECTION 5. EXAMPLES
The following examples illustrate the
principles of this Notice:
Example 1. Same Country Securities Loan.FP, a
pension fund resident in Country X, owns stock is-
sued by USCo, a corporation resident in the United
States. An income tax treaty between Country X
and the United States limits the U.S. withholding tax
on gross dividends to 15 percent. USBroker, a U.S.
broker-dealer, needs to borrow the stock owned by
FP. Under Country X rules intended to safeguard
the interests of workers, however, FPis required to
deal only with Country X residents in connection
with its investment activities. Accordingly, FPen-
ters into a securities loan with FBroker, a broker-
dealer also resident in Country X. FBroker then en-
ters into a securities loan with USBroker. USCo
pays a dividend of $100 on March 15, 1998. US-
Broker is the shareholder of record with respect to
the dividend. Since USBroker is a U.S. person,
USCo does not withhold on the dividend. USBroker
makes a substitute payment of $100 to FBroker from
which USBroker withholds $15. The rate of with-
holding tax that would be applicable to a U.S. source
dividend payment made by a U.S. person directly to
FPis the same as the rate of withholding tax that
would be applicable to a U.S. source dividend pay-
ment made by a U.S. person directly to FBroker.
Accordingly, no U.S. withholding tax is imposed
under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the
substitute payments made by FBroker to FP.
Example 2. Non-Same Country Securities Loan.
A, a resident of Country X, owns shares of USCo, a
U.S. resident corporation. Country X has a treaty
with the United States which limits the United States
tax on gross dividends to 15 percent. Aenters into a
securities loan with B, a resident of Country Y,
whose treaty with the United States also limits the
United States tax on gross dividends to 15 percent.
USCo pays a dividend of $100 on March 15, 1998.
B is the shareholder of record with respect to the
dividend. USCo withholds $15 and pays B a net
dividend of $85. B makes a substitute payment of
$85 to A. The rate of withholding tax that would be
applicable to a U.S. source dividend payment made
by a U.S. person directly to Ais the same as the rate
of withholding tax that would be applicable to a U.S.
source dividend payment made by a U.S. person di-
rectly to B. Accordingly, no U.S. withholding tax is
imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)
on the substitute payments made by B to A.
Example 3. Increased Treaty Benefits.The facts
are the same as in example 2, except that Country X
has no treaty with the United States. Since a divi-
dend payment made by a U.S. person directly to A
would have been subject to a 30-percent withhold-
ing tax, B must withhold an additional $15 ((30 per-
cent - 15 percent) x $100) on the substitute payment
it makes to A. Alternatively, USCo could have with-
held 30 percent from the dividend payment made to
B, thereby satisfying B’s withholding liability under
§ 1.1441–7.
Example 4. Multiple Country Securities Loans.
A, a resident of Country W, owns shares of USCo, a
U.S. resident corporation. Country Whas an in-
come tax treaty with the United States that limits the
United States tax on gross dividends to 15 percent.
B, a resident of Country X, enters into a securities
loan with A. Country X does not have an income tax
treaty with the United States. C, a resident of Coun-
try Y, enters into a securities loan with B. Country Y
has an income tax treaty with the United States
which limits the United States tax on gross divi-
dends to 10 percent. D, a resident of country Z, en-
ters into a securities loan with C. Country Z has an
income tax treaty with the United States which lim-
its the United States tax on gross dividends to 15
percent.
USCo pays a dividend of $100 on March 15,
1998. D is the shareholder of record with respect to
the dividend. USCo withholds $15 and pays D a net
dividend of $85. D makes a substitute payment of
$85 to C. The rate of withholding tax that would be
applicable to a U.S. source dividend payment made
by a U.S. person directly to C is less than the rate of
withholding tax that would be applicable to a U.S.
source dividend payment made by a U.S. person di-
rectly to D. Accordingly, no U.S. withholding tax is
imposed under § 1.871–7(b)(2) or § 1.881–2(b)(2)
on the substitute payments received by C. However,
C is not entitled to a refund or tax credit against any
other U.S. tax liability for the additional 5-percent
tax reflected in its substitute payment from D over
the amount to which C would have been subject had
C received a dividend directly from USCo.
C makes a substitute payment of $85 to B from
which C withholds $15. Since a dividend payment
made by a U.S. person directly to B would have
been subject to a 30-percent withholding tax, C gen-
erally would be required to withhold an additional
$20 ((30 percent - 10 percent) x $100) on the substi-
tute payment it makes to B. However, because $15

December 1, 1997101997–48 I.R.B.
actually was withheld with respect to a $100 gross
dividend paid to D, C may reduce by $5 ((15 percent
- 10 percent) x $100) the $20 withholding obligation
on its substitute payment to B.
B makes a substitute payment of $70 to A. The
rate of withholding tax that would be applicable to a
U.S. source dividend payment made by a U.S. per-
son directly to Ais less than the rate of withholding
tax that would be applicable to a U.S. source divi-
dend payment made by a U.S. person directly to B.
Accordingly, no U.S. withholding tax is imposed
under § 1.871–7(b)(2) or § 1.881–2(b)(2) on the
substitute payment received by A. However, Ais
not entitled to a refund or tax credit against any
other U.S. tax liability for the additional 15-percent
tax reflected in its substitute payment from B over
the amount to which Awould have been subject had
Areceived a dividend directly from USCo.
Alternatively, USCo could have withheld 30 per-
cent from the dividend payment made to D, thereby
satisfying C’s withholding obligation under §
1.1441–7.
SECTION 6. EFFECTIVE DATE OF
REGULATIONS
The provisions of this Notice are ef-
fective for purposes of applying the final
regulations as of November 14, 1997, the
effective date of those regulations. Be-
cause some withholding agents may re-
quire additional time to adjust their busi-
ness practices to implement the
provisions of the final regulations and
this Notice, a withholding agent can
elect to defer the application of the final
regulations, other than Treas. Reg. §
1.864–5(b)(2)(ii), and this Notice until
January 1, 1998. Awithholding agent
makes such an election by attaching a
statement to such effect to a timely filed
tax return (Form 1042) for the period
that includes November 14, 1997, or if
no such return is otherwise required for
the period including that date, on a
timely filed return (Form 1042) for the
period that includes January 1, 1998.
Withholding agents making this election
must apply the provisions of the final
regulations and this Notice for substitute
payments made after December 31,
1997.
SECTION 7. REQUESTFOR
COMMENTS
Treasury and the Service invite
comments on the guidance provided
by this Notice. Written comments should
be submitted by January 12, 1998,
to the Internal Revenue Service, P.O.
Box 7604 Ben Franklin Station, Atten-
tion: CC:CORP:T:R: (Notice 97-66)
Room 5228, Washington, DC 20044. Al-
ternatively, comments may be
submitted via the internet at:
http://www.irs.ustreas.gov/prod/tax_regs/
comments.html. The comments submitted
will be available for public inspection and
copying.
SECTION 8. PAPERWORK
REDUCTION ACT
The collections of information con-
tained in this Notice have been reviewed
and approved by the Office of Manage-
ment and Budget in accordance with the
Paperwork Reduction Act (44 U.S.C.
3507) under control number 1545–1566.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number.
The collections of information con-
tained in this Notice are in Sections 2 and
6. The information is required to qualify
substitute interest payments as portfolio
interest and to defer, on election by the
taxpayer, the effective date of this Notice
and the final securities lending regula-
tions (T.D. 8735, 62 FR 53498) for substi-
tute payments made after December 31,
1997. The information will be used for
the same purpose described in the preced-
ing sentence. The collections of informa-
tion are required to obtain a benefit. The
likely respondents are businesses or other
for-profit institutions.
The estimated total annual reporting
and/or recordkeeping burden is 61,750
hours.
The estimated annual burden per re-
spondent/recordkeeper varies from 1
minute to 15 minutes, depending on indi-
vidual circumstances, with an estimated
average of 10 minutes. The estimated
number of respondents and/or record-
keepers is 377,500.
The estimated frequency of responses
(used for reporting requirements only) is
once.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
SECTION 9. CONTACT
INFORMATION
The principal author of this Notice is
Paul Epstein of the Office of the Associ-
ate Chief Counsel (International) within
the Office of Chief Counsel, Internal Rev-
enue Service, 1111 Constitution Avenue,
NW, Washington, DC 20224. For further
information regarding this Notice contact
Milton Cahn or Paul Epstein at 202-622-
3870 (not a toll-free call).
Grace Period Interest
Notice 97–67
Many credit card agreements provide
for a grace period during which the credit
card issuer does not charge interest for a
billing cycle if the credit card holder pays
off its account balance by a specified date.
Under section 1004 of the Taxpayer Relief
Act of 1997 (the “Act”), Pub. L. No.
105–34, 111 Stat. 788, 911, if a taxpayer
holds a pool of credit card receivables, the
taxpayer must accrue interest and original
issue discount on the receivables based on
a reasonable assumption regarding the
timing of the payments by the obligors of
the receivables in the pool. Thus, the tax-
payer is not permitted to assume that all of
its credit card holders will pay their bal-
ances by the date specified in the grace pe-
riod provision of the credit card agreement
and, based on this assumption, defer the
inclusion of grace period interest. Section
1004 of the Act is effective for taxable
years beginning after August 5, 1997. The
Internal Revenue Service will issue guid-
ance that provides the procedures for a
taxpayer to automatically change its
method of accounting to comply with sec-
tion 1004 for the taxpayer’s first taxable
year beginning after August 5, 1997.
The Service will process requests by
taxpayers to change their methods of ac-
counting for grace period interest that
were pending with the Service on August
4, 1997. For any requests filed on or
after August 5, 1997 (the date of enact-
ment of the Act), the Service will exer-
cise its discretion to deny requests to
change to a method of accounting for
grace period interest other than the
method required by section 1004 of the
Act. See§ 446(e) of the Internal Rev-
enue Code. See alsoH.R. Conf. Rep. No.

1997–48 I.R.B.11December 1, 1997
220, 105th Cong., 1st Sess. 523 (1997);
H.R. Rep. No. 148, 105th Cong., 1st
Sess. 457 (1997).
For further information about this no-
tice, contact William E. Blanchard of the
Office of Assistant Chief Counsel (Finan-
cial Institutions and Products) at (202)
622-3950, or Wendy MacDonald of the
Office of Assistant Chief Counsel (In-
come Tax and Accounting), at (202) 622-
6299 (not toll-free numbers).
Guidance on Making Payments
for Charitable Remainder Trusts
Notice 97–68
This notice informs taxpayers that the
rules in §§ 1.664–2(a)(1)(i) and
1.664–3(a)(1)(i)(e) of the proposed In-
come Tax Regulations, published in a No-
tice of Proposed Rulemaking on April 18,
1997 (62 Fed. Reg. 19072), will not be ef-
fective for certain charitable remainder
trusts (CRTs) for the 1997 taxable year.
BACKGROUND
Generally, a CRTis a trust that pro-
vides for a specified distribution at least
annually over a specified period to one or
more noncharitable beneficiaries and
holds an irrevocable remainder interest in
the trust for a charitable organization.
Section 664 of the Internal Revenue Code
provides for two types of CRTs: a charita-
ble remainder annuity trust (CRAT) and a
charitable remainder unitrust (CRUT). A
CRATpays a fixed annuity amount at
least annually to the noncharitable benefi-
ciary or beneficiaries. ACRUTpays a
fixed percentage of the fair market value
of the assets held by the trust as of the an-
nual valuation date (the unitrust amount)
at least annually to the noncharitable ben-
eficiary or beneficiaries.
Section 664(d) provides that to qualify
as a CRT, the trust must pay the annuity
or unitrust amount at least annually to the
noncharitable beneficiaries. As an admin-
istrative convenience, §§ 1.664–2(a)(1)
and 1.664–3(a)(1) of the Income Tax Reg-
ulations have allowed CRTs to pay the an-
nuity or unitrust amount within a reason-
able time after the close of the tax year in
which it is due without the timing of the
payment causing the trust to fail to func-
tion exclusively as a CRT.
PROPOSED REGULATIONS
REGARDING PAYING ANNUITY
OR UNITRUSTAMOUNT
The proposed amendments to
§§ 1.664–2(a)(1)(i) and 1.664–3(a)-
(1)(i)(e) of the proposed regulations (the
proposed timing amendments) would re-
quire a CRTto pay the annuity amount or
the unitrust amount under the fixed per-
centage method of § 664(d)(2) by the
close of the tax year in which the payment
is due in order to function exclusively as a
CRT. Under the effective date in the pro-
posed regulations, once final, the pro-
posed timing amendments would apply to
taxable years ending after April 18, 1997,
the date the proposed regulations were
published in the Federal Register.
The Service and Treasury issued the
proposed timing amendments in response
to abuses associated with the use of accel-
erated CRTs described in Notice 94–78,
1994–2 C.B. 555. Taxpayers using accel-
erated CRTs characterize the payment of
the annuity or unitrust amount as a distri-
bution of trust corpus that is not subject to
tax by delaying the required payment
until after the end of the tax year in which
it is due.
Since publishing the proposed regula-
tions, the Service and Treasury have re-
ceived a significant number of comments
expressing concern that the proposed
timing amendments will place a signifi-
cant burden on many trusts that are not
engaging in abuses. Some commentators
observed that for many CRTs the charac-
ter of the annuity or unitrust amount is
not affected by the time at which the pay-
ment is made. Because these trusts have
accumulated sufficient income in the or-
dinary, capital gains, and other income
categories of § 664(b)(1), (2), and (3), no
portion of the annuity or unitrust amount
distributed will be characterized as trust
corpus under § 664(b)(4) irrespective of
whether the amount is paid before or
after the close of the tax year for which it
is due. The commentators add that being
required to pay the annuity or unitrust
amount by the close of the calendar year
would create a hardship if the trustee is
relying on end-of-the-year dividends and
similar income, which may not arrive
until January of the following year, to
make the annuity or unitrust payment.
The commentators also argue that the
proposed timing amendments would cre-
ate a hardship for trustees of CRUTs that
have a December 31 valuation date be-
cause such a trustee would be forced to
value the assets in the trust and make a
payment of the unitrust amount after the
close of business and before midnight on
that date.
In light of the enactment of the Tax-
payer Relief Act of 1997 (the Act) on Au-
gust 5, 1997, other commentators have ar-
gued that the proposed timing
amendments are no longer necessary to
stop the abuses created by accelerated
CRTs. The Act amended the definition of
a CRTto include a maximum allowable
percentage of 50 percent for calculating
the annuity amount or unitrust amount
and a minimum 10 percent present value
for the charitable remainder interest. Tax-
payer Relief Act of 1997, Pub. L. No.
105–34, § 1089, 111 Stat. 960, 961. We
note that the Senate Finance Committee
explicitly stated that it did not intend for
the Act to “limit or alter the validity of the
regulations proposed by the Treasury De-
partment on April 18, 1997, or the Trea-
sury Department’s authority to address
this or other abuses of the rules governing
the taxation of charitable remainder trusts
or their beneficiaries.” S. Rep. No. 33,
105th Cong., 1st Sess. 201 (1997).
Several commentators have asked for
relief from the effective date for the pro-
posed timing amendments while their
comments are considered and before the
regulations are finalized.
APPLICATION OF PROPOSED
TIMING AMENDMENTS
The Service and Treasury recognize
that complying with the proposed timing
amendments in 1997 may create an un-
necessary burden on those trusts for
which the potential for abuse is minimal.
Therefore, when the proposed regulations
are adopted as final regulations under a
Treasury Decision, the Service and Trea-
sury intend to provide that for the taxable
year 1997 a CRTcreated before January
1, 1998, will not be made subject to the
rules stated in §§ 1.664–2(a)(1)(i) and
1.664–3(a)(1)(i)(e) of the proposed regu-
lations if in 1997 the trust is:
(1) ACRATunder which the sum cer-
tain to be paid each year to one or more
persons is 15 percent or less of the initial

December 1, 1997121997–48 I.R.B.
net fair market value of all property
placed in the trust, or
(2) ACRUTunder which the fixed per-
centage of the net fair market value of the
unitrust’s assets to be paid each year to one
or more persons is 15 percent or less, or
(3) ACRATor CRUTfrom which all
of the annuity amounts or unitrust
amounts paid for 1997 are characterized
in the hands of the beneficiary as income
from the categories described in §
664(b)(1), (2), and (3), and not as trust
corpus. Thus, a CRTcreated before Janu-
ary 1, 1998, that meets any one of these
three exceptions may pay its annuity
amount or unitrust amount for the taxable
year 1997 within a reasonable period of
time after the close of the tax year under
§§ 1.664–2(a)(1)(i) and 1.664–3(a)(1)(i)
of the Income Tax Regulations.
The Service and Treasury will continue
to consider the comments submitted on
the proposed regulations before deciding
whether to adopt an amended version of
the proposed regulations as final regula-
tions.
For further information regarding this
notice, please call Mary Beth Collins or
Jeff Erickson of the Office of the Assis-
tant Chief Counsel (Passthroughs and
Special Industries) on (202) 622-3070
(not a toll-free call).
Weighted Average Interest Rate
Update
Notice 97–69
Notice 88–73 provides guidelines for
determining the weighted average interest
rate and the resulting permissible range of
interest rates used to calculate current lia-
bility for the purpose of the full funding
limitation of § 412(c)(7) of the Internal
Revenue Code as amended by the Om-
nibus Budget Reconciliation Act of 1987
and as further amended by the Uruguay
Round Agreements Act, Pub. L. 103–465
(GATT).
The average yield on the 30-year Trea-
sury Constant Maturities for October
1997 is 6.33 percent.
The following rates were determined
for the plan years beginning in the month
shown below.
DRAFTING INFORMATION
The principal author of this notice is
Donna Prestia of the Employee Plans Di-
90% to 107%90% to 110%
WeightedPermissiblePermissible
MonthYearAverageRangeRange
November19976.816.13 to 7.296.13 to 7.49
vision. For further information regarding
this notice, call (202) 622-6076 between
2:30 and 3:30 p.m. Eastern time (not a
toll-free number). Ms. Prestia’s number
is (202) 622-7377 (also not a toll-free
number).

1997–48 I.R.B.13December 1, 1997
Notice of Proposed Rulemaking
and Notice of Public Hearing
Treatment of Changes in
Elective Entity Classification
REG–105162–97
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations addressing elective
changes in entity classification. The pro-
posed regulations describe how elective
changes in classification will be treated
for federal tax purposes. The proposed
regulations would affect business entities
and their members. This document also
contains a notice of public hearing on
these proposed regulations.
DATES: Written comments must be re-
ceived by January 26, 1998. Requests to
speak (with outlines of oral comments) at
the public hearing scheduled for February
24, 1998, must be submitted by January
26, 1998.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (REG-105162–97),
room 5228, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative, sub-
missions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–105162–97),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue NW,
Washington, DC. Alternatively, taxpayers
may submit comments electronically
via the Internet by selecting the “Tax
Regs” option of the IRS Home Page, or
by submitting comments directly to the
IRS Internet site at: http://www.irs.us-
treas.gov/prod/tax_regs/comments.html.
The public hearing will be held in room
2615, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC.
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations,
Jeff Erickson, (202) 622-3070 (not a toll-
free number); concerning international is-
sues, Philip Tretiak or Ronald M.
Gootzeit, (202) 622-3860 (not a toll free
number); concerning submissions and the
hearing, Evangelista Lee, (202) 622-7190
(not a toll-free number).
SUPPLEMENTARYINFORMATION:
Background
This document proposes to amend the
current Income Tax Regulations (26 CFR
Parts 1 and 301) relating to the classifica-
tion of entities for federal tax purposes.
On December 18, 1996, the IRS and Trea-
sury published final regulations under
section 7701 (final regulations), replacing
the former classification rules with an
elective regime. See T.D. 8697 (1997–2
I.R.B. 11).
Under the final regulations, a business
entity that is not specifically classified as
a corporation in the final regulations (an
eligible entity) can elect its classification
for federal tax purposes under certain cir-
cumstances. An eligible entity with at
least two members can elect to be classi-
fied as a partnership or as an association
taxable as a corporation. An eligible en-
tity with a single member can elect to be
classified as an association or as an entity
that is disregarded as an entity separate
from its owner. An eligible entity may
also elect to change its classification, ex-
cept that an election may not be made
more than once in any sixty month period.
An eligible entity that does not make an
election is classified under certain default
provisions.
Explanation of Provisions
Characterization of Elective Changes in
Classification
The proposed regulations describe how
elective changes in an entity’s classifica-
tion will be treated for federal tax pur-
poses. Under the final regulations, there
are four possible changes in classification
by election: (i) a partnership elects to be
an association; (ii) an association elects to
be a partnership; (iii) an association elects
to be a disregarded entity; and (iv) a disre-
garded entity elects to be an association.
There are two other possible ways in
which an entity’s classification could
change (a partnership converts to a disre-
garded entity or a disregarded entity con-
verts to a partnership) but these changes
occur only as a result of a change in the
number of members, not as the result of
an elective change. The proposed regula-
tions do not address the form of these two
possible types of changes.
The proposed regulations provide a
specific characterization for each of the
four possible elective changes. In each
case, the characterization provided in the
proposed regulations attempts to mini-
mize the tax consequences of the change
in classification and achieve administra-
tive simplicity. The proposed regulations
provide that if an association elects to be
classified as a partnership, the association
is deemed to liquidate by distributing its
assets and liabilities to its shareholders.
Then, the shareholders are deemed to
contribute all of the distributed assets and
liabilities to the partnership. This charac-
terization of an elective change from an
association to a partnership is consistent
with Rev. Rul. 63–107 (1963–1 C.B. 71).
If a partnership elects to be classified as
an association, the partnership is deemed
to contribute all of its assets and liabilities
to the association in exchange for stock in
the association. Then, the partnership is
deemed to liquidate by distributing stock
in the association to its partners. The pro-
posed regulations do not affect the hold-
ings in Rev. Rul. 84–111 (1984–2 C.B.
88), in which the IRS ruled that it would
respect the particular form undertaken by
the taxpayers when a partnership converts
to a corporation.
If an association elects to be disre-
garded as an entity separate from its
owner, the association is deemed to liqui-
date by distributing its assets and liabili-
ties to its sole owner. Conversely, if an el-
igible entity that is disregarded as an
entity separate from its owner elects to be
classified as an association, the owner of
the eligible entity is deemed to contribute
all of the assets and liabilities of that en-
tity to the association in exchange for
stock of the association.
The proposed regulations also provide
that the tax treatment of an elective
change in classification is determined
under all relevant provisions of the Inter-
nal Revenue Code and general principles
of tax law, including the step transaction
Part IV. Items of General Interest

December 1, 1997141997–48 I.R.B.
doctrine. This provision in the proposed
regulations is intended to ensure that the
tax consequences of an elective change
will be identical to the consequences that
would have occurred if the taxpayer had
actually taken the steps described in the
proposed regulations. The IRS and Trea-
sury request comments on the application
of general principles of tax law to the
transactions that are deemed to occur on
an elective change in classification.
Change in Number of Members of Entity
The proposed regulations address the
effect of a change in the number of mem-
bers on the classification of an entity.
Under the proposed regulations, if there
is a change in the number of members of
an association, the classification of the
entity is not affected. If an eligible en-
tity classified as a partnership subse-
quently has only one member (and is still
treated as an entity under local law), the
entity will be disregarded as an entity
separate from its owner. If a single
member entity that is disregarded as an
entity separate from its owner subse-
quently has more than one member, the
entity is classified as a partnership as of
the date the entity has more than one
member. The classifications provided in
the proposed regulations can be changed
by election, assuming that the entity is
not subject to the sixty month limitation
on elections.
Timing of Elective Changes in
Classification
The proposed regulations provide that
an election to change the classification of
an entity is treated as occurring at the start
of the day for which the election is effec-
tive. Any transactions that are deemed to
occur as a result of the change in classifi-
cation are treated as occurring immedi-
ately before the close of the day before
the effective date of the election. For ex-
ample, if an election is made to convert
from an association to a partnership effec-
tive on January 1, the entity is treated as a
partnership on January 1, and the deemed
transactions specified in the proposed reg-
ulations are treated as occurring immedi-
ately before the close of December 31.
As a result, the last day of the associa-
tion’s taxable year will be December 31
and the first day of the partnership’s tax-
able year will be January 1.
Treatment of Foreign Eligible Entities
Any eligible entity, including a foreign
eligible entity whose classification is not
relevant for federal tax purposes, may
elect to change its classification. The IRS
and Treasury request comments on the ap-
propriateness of allowing such a foreign
eligible entity to make a classification
election, and comments on what the fed-
eral tax consequences of such an election
should be (e.g., with respect to the basis
of property held by the entity).
Foreign Per Se Entities
The final regulations provide a list of
the names of certain foreign business enti-
ties that are treated as corporations for
federal tax purposes. In most cases, the
name by which an entity will be known is
provided by the statutory corporate law of
the relevant jurisdiction. In certain cases,
however, the corporate law does not pro-
vide a statutory name. In these jurisdic-
tions, taxpayers and practitioners often
fill the statutory void with a name derived
from a number of the statutory character-
istics of the entity. In an effort to make
the list of foreign per se corporations
more accessible, the final regulations use
the commonly used non-statutory term in
certain cases where the statute does not
provide a defined name. To minimize any
uncertainty, however, the provisions of
§301.7701–2(b)(8)(iii) and (iv) were in-
cluded in the final regulations to address
this issue. In response to comments from
taxpayers, these subsections of the final
regulations are clarified to provide guid-
ance on the terms used in the final regula-
tions. Furthermore, the regulations clar-
ify that the term Berhad used with regard
to Malaysia does not include a “Sendirian
Berhad” (the equivalent of a private lim-
ited company). The regulations also clar-
ify that, in relation to Mexico, the term
Sociedad Anonima includes a Sociedad
Anonima that chooses to apply the vari-
able capital provision of Mexican corpo-
rate law (Sociedad Anonima de Capital
Variable). The fact that capital may be
varied does not make this a different type
of entity from a Sociedad Anonima that
does not choose to apply the variable cap-
ital provision. These clarifications are not
intended to change the interpretation of
the final regulations.
The proposed regulations also clarify
the treatment of the Finnish, Maltese, and
Norwegian entities specified in the final
regulations. Effective January 1, 1996,
Maltese and Norwegian corporate law
recognized a distinction between public
and private companies, and the proposed
regulations reflect this change. The pro-
posed regulations also provide that the
rules of the final regulations with regard
to the Maltese and Norwegian entities
may be applied (when these proposed reg-
ulations are finalized) as though the enti-
ties specified in the proposed regulations
had been included in the final regulations
issued on December 18, 1996. Thus, a
Maltese or Norwegian entity that is no
longer treated as a per se corporation
under the regulations would be able to
make an election within 75 days of the
date these proposed regulations are final-
ized, and such election could be effective
as of January 1, 1997. Finnish law, since
September 1, 1997, has recognized a sim-
ilar distinction between public and private
companies. It is proposed that a Finnish
entity that is no longer treated as a per se
corporation under the regulations would
be able to make an election within 75
days of the date these proposed regula-
tions are finalized, and such election
could be effective as of September 1,
1997.
Special Basis Adjustments Under
Section 743
Section 743 provides that the basis of
partnership property is not adjusted as the
result of a transfer of an interest in the
partnership by sale or exchange unless the
partnership has made an election under
section 754. If a section 754 election is
made, the transferee partner is treated as
having a special basis adjustment with re-
spect to partnership property. This adjust-
ment constitutes an adjustment to the
basis of partnership property with respect
to the transferee partner only. Some un-
certainty has remained as to the treatment
of this special basis adjustment upon the
contribution of the partnership property to
a corporation in a section 351 exchange,
and because the proposed regulations pro-
vide for a deemed contribution by the
partnership to a corporation in an elective
conversion to an association, the pro-
posed regulations address this uncer-
tainty.
The proposed regulations provide that a

corporate transferee’s basis in property
transferred by a partnership in a transfer
described in section 351 includes any spe-
cial basis adjustment under section 743.
The special basis adjustment is also taken
into account in determining the partner’s
basis in the stock received in the ex-
change. For example, assume a partner-
ship owns Property X, which has a com-
mon basis of $100 for the partnership and
in which Partner Ahas a $5 special basis
adjustment under section 743(b). Subse-
quently, the partnership validly elects to
be classified as an association. The part-
nership is deemed to contribute all of its
assets and liabilities to the association in
exchange for stock in the association, and
immediately thereafter, the partnership
liquidates by distributing the stock of the
association to its partners. If the transfer
of the assets to the association would be a
transfer described in section 351, then
under the proposed regulations, the asso-
ciation’s basis in Property X includes
Partner A’s $5 special basis adjustment.
Thus, the association has a $105 basis in
Property X (Partner A’s $5 special basis
adjustment plus the partnership’s $100
common basis). Partner A’s basis in the
association’s stock will reflect the $5 spe-
cial basis adjustment previously on Prop-
erty X.
The proposed regulations also provide,
however, that the amount of gain, if any,
recognized by the partnership on the
transfer is determined without reference
to any special basis adjustment. The part-
ner with the special basis adjustment can
then use the special basis adjustment to
reduce its share of any gain recognized by
the partnership. This approach of deter-
mining gain at the partnership level and
allowing the partner to use the special
basis adjustment as an offset is similar to
the treatment of a sale of property with a
special basis adjustment.
Proposed Effective Date
Except as otherwise specified, these
regulations are proposed to apply as of the
date the final regulations are published in
the Federal Register.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It also has been de-
termined that section 553(b) of the Ad-
ministrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regula-
tions, and because these regulations do
not impose on small entities a collection
of information requirement, the Regula-
tory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Therefore, a Regulatory
Flexibility Analysis is not required. Pur-
suant to section 7805(f) of the Internal
Revenue Code, this notice of proposed
rulemaking will be submitted to the Chief
Counsel for Advocacy of the Small Busi-
ness Administration for comment on its
impact on small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any written com-
ments (preferably a signed original and
eight (8) copies) that are submitted timely
to the IRS. All comments will be avail-
able for public inspection and copying.
Apublic hearing has been scheduled
for February 24, 1998, at 10 a.m., in room
2615, Internal Revenue Building, 1111
Constitution Avenue NW, Washington,
DC. Because of access restrictions, visi-
tors will not be admitted beyond the Inter-
nal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral com-
ments at the hearing must submit timely
written comments and an outline of the
topics to be discussed and the time to be
devoted to each topic by (preferably a
signed original and eight (8) copies) Janu-
ary 26, 1998.
Aperiod of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal authors of these regula-
tions are Ann M. Veninga, Office of Chief
Counsel (Passthroughs and Special Indus-
tries) and Philip Tretiak, Office of Associ-
ate Chief Counsel (International). How-
ever, other personnel from the IRS and
Treasury Department participated in their
development.
* * * * *
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 301
are proposed to be amended as follows:
PART1—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 1.743-2 is added under
the undesignated centerheading “Transfer
of Interests in a Partnership” to read as
follows:
§1.743-2 Transfer of property
to a corporation.
(a) Basis in transferred property.A
corporation’s adjusted tax basis in prop-
erty transferred to the corporation by a
partnership in a transfer described in sec-
tion 351 is determined with reference to
any special basis adjustment to the prop-
erty under section 743(b) (other than any
special basis adjustment that reduces a
partner’s gain under paragraph (b) of this
section).
(b) Partnership gain.The amount of
gain, if any, recognized by a partnership
on a transfer of property by the partner-
ship to a corporation in a transfer de-
scribed in section 351 is determined with-
out reference to any special basis
adjustment to the transferred property
under section 743(b). The amount of
gain, if any, recognized by the partnership
on the transfer that is allocated to a part-
ner with a special basis adjustment in the
transferred property is adjusted to reflect
the partner’s special basis adjustment in
the transferred property.
(c) Basis in stock. The partnership’s
adjusted tax basis in stock received from a
corporation in a transfer described in sec-
tion 351 is determined without reference
to the special basis adjustment in property
transferred to the corporation in the sec-
tion 351 exchange. Apartner with a spe-
cial basis adjustment in property trans-
ferred to the corporation, however, has a
special basis adjustment in the stock re-
1997–48 I.R.B.15December 1, 1997

ceived by the partnership in the section
351 exchange in an amount equal to the
partner’s special basis adjustment in the
transferred property, reduced by any spe-
cial basis adjustment that reduced the
partner’s gain under paragraph (b) of this
section.
(d) Effective date.This section applies
to transfers that occur on or after the date
final regulations are published in the Fed-
eral Register.
PART301—PROCEDURE AND
ADMINISTRATION
Par. 3. The authority citation for part
301 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 4. Section 301.6109-1 is amended
as follows:
1. Paragraph (d)(2)(ii) is removed and
reserved.
2. Paragraph (h) is redesignated as
paragraph (i) and the first sentence of
newly designated paragraph (i)(1) is
amended by removing the language
“paragraph (h)” and adding “paragraph
(i)” in its place.
3. Anew paragraph (h) is added.
The addition reads as follows:
§301.6109-1 Identifying numbers.
* * * * *
(h) Special rules for certain entities
under §301.7701–3—(1) General rule.
Any entity that has an employer identifi-
cation number (EIN) will retain that EIN
if its federal tax classification changes
under §301.7701–3.
(2) Special rules for entities that are
disregarded as entities separate from
their owners—(i) When an entity becomes
disregarded as an entity separate from its
owner.Except as otherwise provided in
regulations or other guidance, a single
owner entity that is disregarded as an en-
tity separate from its owner under
§301.7701–3, must use its owner’s tax-
payer identifying number (TIN) for fed-
eral tax purposes.
(ii) When an entity that was disre-
garded as an entity separate from its
owner becomes recognized as a separate
entity. If a single owner entity’s classifi-
cation changes so that it is recognized as a
separate entity for federal tax purposes,
and that entity had an EIN, then the entity
must use that EIN and not the TIN of the
single owner. If the entity did not already
have its own EIN, then the entity must ac-
quire an EIN and not use the TIN of the
single owner.
(3) Effective date. This paragraph (h)
applies to changes in classification that
occur on or after the date on which these
regulations are published as final regula-
tions in the Federal Register.
Par. 5. Section 301.7701–2 is amended
as follows:
1. Paragraph (b)(8)(i) is amended by
revising the entries for Finland, Malta,
and Norway.
2. Paragraph (b)(8)(ii)(A) is redesig-
nated as paragraph (b)(8)(ii)(A)(1) and
the language “and” at the end of the para-
graph is removed.
3. Paragraph (b)(8)(ii)(B) is redesig-
nated as paragraph (b)(8)(ii)(A)(2) and
the period at the end of the paragraph is
removed and the language “; and “ is
added in its place.
4. Paragraph (b)(8)(ii) heading and in-
troductory text are redesignated as para-
graph (b)(8)(ii)(A) heading and introduc-
tory text, and a new paragraph heading is
added for paragraph (b)(8)(ii).
5. Paragraphs (b)(8)(ii)(A)(3) and
(b)(8)(ii)(B) are added.
6. Paragraphs (b)(8)(iii), (b)(8)(iv),
and (e) are revised.
The revisions and additions read as fol-
lows:
§301.7701-2 Business entities;
definitions.
* * * * *
(b) * * *
(8) * * *
(i) * * *
Finland, Julkinen Osakeyhtio/Publikt Ak-
tiebolag
* * * * *
Malta, Public Limited Company
* * * * *
Norway, Allment Aksjeselskap
* * * * *
(ii) Clarification of list of corporations
in paragraph (b)(8)(i) of this section—
(A) Exceptions in certain cases.* * *
* * * * *
(3) With regard to Malaysia, a
Sendirian Berhad.
(B) Inclusions in certain cases.With
regard to Mexico, the term Sociedad
Anonima includes a Sociedad Anonima
that chooses to apply the variable capital
provision of Mexican corporate law (So-
ciedad Anonima de Capital Variable).
(iii) Public companies.For purposes of
paragraph (b)(8)(i) of this section, with
regard to Cyprus, Hong Kong, Jamaica,
and Trinidad and Tobago, the term Public
Limited Company includes any Limited
Company that is not defined as a private
company under the corporate laws of
those jurisdictions. In all other cases,
where the term Public Limited Company
is not defined, that term shall include any
Limited Company defined as a public
company under the corporate laws of the
relevant jurisdiction.
(iv)Limited companies.For purposes
of this paragraph (b)(8), any reference to
a Limited Company includes, as the case
may be, companies limited by shares and
companies limited by guarantee.
* * * * *
(e) Effective date. Except as otherwise
provided in this paragraph (e), the rules of
this section apply as of January 1, 1997.
The reference to the Finnish, Maltese, and
Norwegian entities in paragraph (b)(8)(i)
of this section is applicable on the date the
final regulations are published in the Fed-
eral Register. Any Maltese or Norwe-
gian entity that becomes an eligible entity
as a result of paragraph (b)(8)(i) of this
section in effect on the date final regula-
tions are published in the Federal Regis-
termay elect (within 75 days of the date
final regulations are published in the Fed-
eral Register)to be classified for federal
tax purposes as an entity other than a cor-
poration retroactive to any period from
and including January 1, 1997. Any
Finnish entity that becomes an eligible
entity as a result of paragraph (b)(8)(i) of
this section in effect on the date final reg-
ulations are published in the Federal
Registermay elect (within 75 days of the
date final regulations are published in the
Federal Register) to be classified for fed-
eral tax purposes as an entity other than a
corporation retroactive to any period from
and including September 1, 1997.
Par. 6. Section 301.7701–3 is amended
as follows:
1. Asentence is added at the end of
paragraph (c)(1)(iv).
December 1, 1997161997–48 I.R.B.

2. Paragraph (c)(2)(iii) is added.
3. Aheading is added to paragraph
(d)(1).
4. Paragraph (f) is redesignated as
paragraph (h) and newly designated para-
graph (h)(1) is revised.
5. Paragraphs (f) and (g) are added.
The revision and additions read as fol-
lows:
§301.7701–3 Classification of certain
business entities.
* * * * *
(c) * * *
(1) * * *
(iv) Limitation. * * * An election by a
newly-formed eligible entity that is effec-
tive on the date of formation is not con-
sidered a change for purposes of this para-
graph (c)(1)(iv).
* * * * *
(2) * * *
(iii) Changes in classification.For pur-
poses of paragraph (c)(2)(i) of this sec-
tion, if an election under paragraph
(c)(1)(i) of this section is made to change
the classification of an entity, each person
who was an owner on the date that any
transactions under paragraph (g) of this
section are deemed to occur, and who is
not an owner at the time the election is
filed, must also sign the election. This
paragraph (c)(2)(iii) applies to elections
filed on or after the date final regulations
are published in the Federal Register.
(d) Special rules for foreign eligible en-
tities—(1) Definition of relevance.* * *
* * * * *
(f) Changes in number of members of
an entity—(1) Associations.The classifi-
cation of an eligible entity as an associa-
tion is not affected by any change in the
number of members of the entity.
(2) Partnerships and single member
entities. An eligible entity classified as a
partnership is disregarded as an entity
separate from its owner as of the date the
entity has only one member. Asingle
member entity disregarded as an entity
separate from its owner is classified as a
partnership as of the date the entity has
more than one member.
(3) Effect on sixty month limitation.A
change in the number of members of an
entity does not result in the creation of a
new entity for purposes of the sixty month
limitation on elections under paragraph
(c)(1)(iv) of this section.
(4) Examples. The following examples
illustrate the application of this paragraph
(f):
Example 1. (i) On April 1, 1998, Aand B, U.S.
persons, form X, a foreign eligible entity. X is
treated as an association under the default provisions
of paragraph (b)(2)(i) of this section, and X does not
make an election to be classified as a partnership. A
subsequently purchases all of B’s interest in X.
(ii) Under paragraph (f)(1) of this section, X con-
tinues to be classified as an association. X, how-
ever, can subsequently elect to be disregarded as an
entity separate from A. The sixty month limitation
of paragraph (c)(1)(iv) of this section does not pre-
vent X from making an election because X has not
made a prior election under paragraph (c)(1)(i) of
this section.
Example 2.(i) On April 1, 1998, Aand B, U.S.
persons, form X, a foreign eligible entity. X is
treated as an association under the default provisions
of paragraph (b)(2)(i) of this section, and X does not
make an election to be classified as a partnership.
On January 1, 1999, X elects to be classified as a
partnership effective on that date. Under the sixty
month limitation of paragraph (c)(1)(iv) of this sec-
tion, X cannot elect to be classified as an association
until January 1, 2004 (i.e., sixty months after the ef-
fective date of the election to be classified as a part-
nership).
(ii) On June 1, 1999, Apurchases all of B’s inter-
est in X. After A’s purchase of B’s interest, X can no
longer be classified as a partnership because X has
only one member. Under paragraph (f)(2) of this
section, X is disregarded as a separate entity as of
the date Abecomes the only member of X. X, how-
ever, is not treated as a new entity for purposes of
paragraph (c)(1)(iv) of this section. As a result, the
sixty month limitation of paragraph (c)(1)(iv) of this
section continues to apply to X and X cannot elect to
be classified as an association until January 1, 2004
(i.e., sixty months after January 1, 1999, the effec-
tive date of the election by X to be classified as a
partnership).
(5) Effective date.This paragraph (f)
applies as of the date the final regulations
are published in the Federal Register.
(g) Elective changes in classification—
(1) Deemed treatment of elective
change—(i) Partnership to association.If
an eligible entity classified as a partner-
ship elects under paragraph (c)(1)(i) of
this section to be classified as an associa-
tion, the following is deemed to occur:
The partnership contributes all of its as-
sets and liabilities to the association in ex-
change for stock in the association, and
immediately thereafter, the partnership
liquidates by distributing the stock of the
association to its partners.
(ii) Association to partnership.If an
eligible entity classified as an association
elects under paragraph (c)(1)(i) of this
section to be classified as a partnership,
the following is deemed to occur: The as-
sociation distributes all of its assets and li-
abilities to its shareholders in liquidation
of the association, and immediately there-
after, the shareholders contribute all of the
distributed assets and liabilities to a newly
formed partnership.
(iii) Association to disregarded entity.
If an eligible entity classified as an associ-
ation elects under paragraph (c)(1)(i) of
this section to be disregarded as an entity
separate from its owner, the following is
deemed to occur: The association distrib-
utes all of its assets and liabilities to its
single owner in liquidation of the associa-
tion.
(iv) Disregarded entity to an associa-
tion. If an eligible entity that is disre-
garded as an entity separate from its
owner elects under paragraph (c)(1)(i) of
this section to be classified as an associa-
tion, the following is deemed to occur:
The owner of the eligible entity con-
tributes all of the assets and liabilities of
the entity to the association in exchange
for stock of the association.
(2) Effect of elective changes.The tax
treatment of a change in the classification
of an entity for federal tax purposes by
election under paragraph (c)(1)(i) of this
section is determined under all relevant
provisions of the Internal Revenue Code
and general principles of tax law, includ-
ing the step transaction doctrine.
(3) Timing of election.An election
under paragraph (c)(1)(i) of this section
that changes the classification of an eligi-
ble entity for federal tax purposes is
treated as occurring at the start of the day
for which the election is effective. Any
transactions that are deemed to occur
under this paragraph (g) as a result of a
change in classification are treated as oc-
curring immediately before the close of
the day before the election is effective.
For example, if an election is made to
change the classification of an entity from
an association to a partnership effective
on January 1, the deemed transactions
specified in paragraph (g)(1)(ii) of this
section (including the liquidation of the
association) are treated as occurring im-
mediately before the close of December
31 and must be reported by the owners of
the entity on December 31. As a result,
the last day of the association’s taxable
year will be December 31 and the first
1997–48 I.R.B.17December 1, 1997

day of the partnership’s taxable year will
be January 1.
(4) Effective date.This paragraph (g)
applies to elections that are filed on or
after the date the final regulations are
published in the Federal Register.
(h) Effective date—(1) In general.Ex-
cept as otherwise provided in this section,
the rules of this section are applicable as
of January 1, 1997.
* * * * *
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on Octo-
ber 27, 1997, 8:45 a.m., and published in the issue of
the Federal Register for October 28, 1997, 62 F.R.
55768)
Notice of Proposed Rulemaking
and Notice Of Public Hearing
Source of Income From Sales of
Inventory Partly From Sources
Within a Possession of the United
States; Also, Source of Income
Derived From Certain Purchases
From a Corporation Electing
Section 936
REG–251985–96
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Notice of proposed rulemak-
ing and notice of public hearing.
SUMMARY: This document contains
proposed regulations under section 863
governing the source of income from
sales of inventory produced in the United
States and sold in a possession of the
United States or produced in a possession
of the United States and sold in the
United States. It also contains proposed
regulations under section 863 governing
the source of income from sales of inven-
tory purchased in a possession of the
United States and sold in the United
States. This document affects persons
who produce (in whole or in part) inven-
tory in the United States and sell in a pos-
session, or produce (in whole or in part)
inventory in a possession and sell in the
United States, as well as persons who
purchase inventory in a possession and
sell in the United States. This document
also contains proposed regulations under
section 936 governing the source of in-
come of a taxpayer from the sale in the
United States of property purchased from
a corporation that has an election under
section 936 in effect. This document also
provides notice of a public hearing on
these proposed regulations.
DATES: Comments and outlines of oral
comments to be presented at the public
hearing scheduled for January 29, 1998,
at 10 a.m. must be received by January 8,
1998.
ADDRESSES: Send submissions to:
CC:DOM:CORP:R (INTL–0003–95),
room 5228, Internal Revenue Service,
POB 7604, Ben Franklin Station, Wash-
ington, DC 20044. In the alternative, sub-
missions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to:
CC:DOM:CORP:R (REG–251985–96),
Courier’s Desk, Internal Revenue Ser-
vice, 1111 Constitution Avenue NW,
Washington, DC, or electronically, via the
IRS Internet site at: http://www.irs
ustreas.gov/prod/tax_regs/comments.html.
The public hearing will be held in room
2615, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC.
FOR FURTHER INFORMATION CON-
TACT: Concerning the regulations, Anne
Shelburne, (202) 622-3880; concerning
submissions and the hearing, Ms. Evange-
lista Lee, (202) 622-7190 (not toll-free
numbers).
SUPPLEMENTARYINFORMATION:
Paperwork Reduction Act
The collection of information con-
tained in this notice of proposed rulemak-
ing has been submitted to the Office of
Management and Budget (OMB) for re-
view in accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)).
Comments on the collection of infor-
mation should be sent to the Office of
Management and Budget, Attn: Desk
Officer for the Department of Treasury,
Office of Information and Regulatory Af-
fairs, Washington, DC 20503, with
copies to the Internal Revenue Service,
Attn: IRS Reports Clearance Officer,
T:FP, Washington, DC 20224. Com-
ments on the collection of information
should be received by December 9, 1998.
Comments are specifically requested con-
cerning:
Whether the proposed collection of infor-
mation is necessary for the proper perfor-
mance of the functions of the IRS, includ-
ing whether the information will have
practical utility;
The accuracy of the estimated burden as-
sociated with the proposed collection of
information (see below);
How the quality, utility, and clarity of the
information to be collected may be en-
hanced;
How the burden of complying with the
proposed collection of information may
be minimized, including through the ap-
plication of automated collection tech-
niques or other forms of information tech-
nology; and
Estimates of capital or start-up costs and
costs of operation, maintenance, and pur-
chase of services to provide information.
The collection of information require-
ments are in proposed §1.863–3(f)(6).
This information is required by the IRS
to monitor compliance with the federal
tax rules for determining the source of
income from the sale of inventory pro-
duced in the United States and sold in a
possession of the United States or pro-
duced in a possession of the United
States and sold in the United States, or
from the sale of inventory purchased in a
possession of the United States and sold
in the United States. The likely respon-
dents are taxpayers who produce inven-
tory in the United States and sell in a
possession, or who produce inventory in
a possession and sell in the United
States, or who purchase inventory in a
possession and sell in the United States.
Responses to this collection of informa-
tion are required to properly determine
the source of a taxpayer’s income from
such sales.
Books or records relating to a collec-
tion of information must be retained as
long as their contents may become mater-
ial in the administration of any internal
revenue law. Generally, tax returns and
tax return information are confidential, as
required by 26 U.S.C. 6103.
December 1, 1997181997–48 I.R.B.

Estimated total annual reporting burden:
500 hours. The estimated annual burden
per respondent varies from 1 hour to 5
hours, depending on individual circum-
stances, with an estimated average of 2.5
hours.
Estimated number of respondents: 200
Estimated annual frequency of responses:
One time per year.
An agency may not conduct or sponsor,
and a person is not required to respond to,
a collection of information unless the col-
lection of information displays a valid
control number assigned by the Office of
Management and Budget.
Background
These proposed regulations contain
rules under section 863 relating to the
source of income from cross-border sales
of certain property. These regulations
also contain rules under section 936 relat-
ing to the source of income of a taxpayer
from the sale in the United States of prop-
erty purchased from a corporation that has
an election under section 936 in effect.
These regulations are proposed to be ef-
fective for taxable years beginning 30
days after publication of final regulations.
Explanation of Provisions
I. Income Partly From Sources Within a
Possession
A. Current Regulations
Section 863 authorizes the Secretary to
promulgate regulations allocating or ap-
portioning to sources within or without
the United States all items of gross in-
come, expenses, losses, and deductions
other than those items specified in sec-
tions 861(a) and 862(a).
Guidance to determine the source of
possession income is divided into two
types of transactions: transactions de-
scribed in section 863(b)(2) for property
produced in the United States and sold in
a possession (or vice versa), and transac-
tions described in section 863(b)(3) for
property purchased in a possession and
sold in the United States (collectively,
Section 863 Possession Sales).
Section 1.863–3 of the income tax reg-
ulations contains rules for determining the
source of income derived from sales of
certain property. These regulations were
published in the Federal Registeron No-
vember 29, 1996 (61 F.R. 60540), and the
prior regulations were renumbered
§§1.863–3Aand 1.863–3AT. The new
regulations retain the prior rules for Sec-
tion 863 Possession Sales by providing in
paragraph §1.863–3(f) that taxpayers
must apply the rules of §1.863–3A(c) in
allocating and apportioning income de-
rived from sources partly within the
United States and partly within a posses-
sion of the United States. These proposed
regulations would modify the existing
rules for allocating and apportioning in-
come between the United States and a
possession.
1. Property produced and sold
Currently, income derived from sales
of inventory produced in the United
States and sold in a possession of the
United States or produced in a possession
of the United States and sold in the United
States (Possession Production Sales), is
allocated or apportioned between the
United States and a possession according
to one of three methods. Such income is
allocated under the independent factory
price method, apportioned under an ap-
portionment method, or, with permission
of the District Director, allocated or ap-
portioned on the basis of the taxpayer’s
books and records.
Under the current regulations, if an in-
dependent factory or production price
(IFP) exists for Possession Production
Sales, taxpayers must use the IFPmethod
to determine the income attributable to
production activities in both the sale es-
tablishing the IFPand in sales of similar
products.
If an IFPdoes not exist, the current
possessions regulations provide that the
taxable income from Possession Produc-
tion Sales is first computed and then ap-
portioned between the United States and
the possession. One-half of the taxable
income is apportioned on the basis of the
taxpayer’s property within the United
States and within the possession. In ap-
plying the property fraction, the tax-
payer’s property includes property held or
used to produce income derived from
Possession Production Sales. The other
half of the taxpayer’s taxable income is
apportioned between U.S. and possession
sources on the basis of the business of the
taxpayer within the United States and
within the possession. Currently, busi-
ness of the taxpayer is measured by the
sum of certain expenses, including
amounts paid for labor, and the purchase
of certain supplies, plus receipts from
Possession Production Sales. Finally, as a
third method, the existing regulations
allow a taxpayer to request permission
from the District Director to use the tax-
payer’s books and records to allocate or
apportion income to sources within or
without the United States if those books
reflect more clearly than the other meth-
ods the taxable income derived from
sources within the United States.
2. Property purchased and sold
The second type of possession transac-
tion governed by the existing regulations
is the sale of inventory purchased in a
possession and sold in the United States
(Possession Purchase Sales) as described
in section 863(b)(3). Under the current
regulations, the income from such sales is
divided between the United States and
possession sources under one of two
methods. The income can be appor-
tioned, or, with permission of the District
Director, allocated or apportioned on the
basis of the taxpayer’s books and records.
Under the apportionment method, tax-
able income is first determined, and then
apportioned by a fraction, the numerator
being the business of the taxpayer in the
United States, the denominator being the
total business of the taxpayer in the
United States and in the possession. The
fraction is computed in the same manner
as the business fraction discussed previ-
ously, except that such expenses, pur-
chases, and sales are limited to those at-
tributable to Possession Purchase Sales.
B. Issues Under Current Regulations
The IRS and Treasury believe the rules
for allocating and apportioning income
between the United States and the posses-
sions of the United States should be
amended to reflect certain changes made
to the regulations under §1.863–3 govern-
ing cross-border sales of inventory in-
volving the United States and a foreign
country (other than those involving pos-
sessions). Thus, for example, under the
apportionment method provided in the
proposed regulations, the property and
business activity fractions apportioning
income between the United States and a
possession are modified to apportion
1997–48 I.R.B.19December 1, 1997

gross income attributable to an activity,
rather than to apportion net income.
The IRS and Treasury also believe cer-
tain ambiguities exist in the current regu-
lations. The possessions rules were origi-
nally promulgated in 1926, and may not
reflect current business practices. The
current regulations use examples to illus-
trate methods for allocating or apportion-
ing income between the United States and
a possession, and should be modified to
state rules.
Further, although the apportionment
method for allocating Possession Produc-
tion Sales income under the existing pos-
sessions regulations treats half of the in-
come as production income, the
production formula is not necessarily lim-
ited to production assets. The current in-
clusion of sales assets in the formula ap-
portioning production income results in
excessive income being allocated to sales
activities. The production income for-
mula should only take into account assets
directly involved in production of inven-
tory. In addition, the IRS and Treasury
have reexamined the business activity
fraction, and have concluded it should be
revised to more clearly reflect the tax-
payer’s business other than production.
The current fraction, for example, omits
certain investments or expenses, such as
marketing and advertising expenses, al-
though income attributable in part to such
expenses or investments is then included
in the income apportioned by the fraction.
The current regulations also take into ac-
count production expenses in the business
activity fraction apportioning income
from Possession Production Sales. The
Service and Treasury believe that this is
inappropriate in the context of Possession
Production Sales because the business ac-
tivity fraction is not intended to determine
the source of income attributable to pro-
duction activity. In the proposed regula-
tions, the fraction apportioning Posses-
sion Production Sales is renamed the
business sales activity fraction and ex-
cludes factors reflecting production activ-
ity.
The current regulations also do not ad-
dress issues in attributing to the United
States or to the possession, the activities
reflected in the business activity fraction.
For example, the current regulations pro-
vide no guidance on whether a particular
expense should be represented in the frac-
tion as attributable to the United States or
to a possession.
Accordingly, the IRS and Treasury are
issuing proposed regulations under sec-
tion 863 to make the possessions rules
more consistent with the other regulations
governing the source of income from
cross-border sales of inventory, and to ad-
dress certain ambiguities and problems in
the existing regulations.
C. Proposed Regulations
Section 1.863-3(f) generally retains the
methods of the current regulations for di-
viding income between the United States
and a possession of the United States,
with several modifications.
1. Methods to allocate gross income to
activities of the taxpayer
a. Property produced and sold
i. The possession 50/50 method
Consistent with the final regulations
under §1.863–3, paragraph (f)(2)(i)(A) of
the proposed regulations makes the 50/50
method the general rule to allocate gross
income from Possession Production Sales
between production and business sales ac-
tivity, so that the income from each type
of activity can then be apportioned be-
tween U. S. and foreign sources. The tax-
payer, however, may elect to apply the
IFPmethod (described in paragraph
(f)(2)(i)(B)), or, with the consent of the
District Director, the books and records
method (described in paragraph
(f)(2)(i)(C)).
Under the possession 50/50 method,
the proposed regulations allocate half of
the taxpayer’s gross income from Posses-
sion Production Sales to production activ-
ity and half to business sales activity. The
income is then apportioned between U.S.
and possession sources based on a prop-
erty fraction and a business sales activity
fraction. As described below, the pro-
posed regulations make certain changes to
the existing property fraction and to the
existing business activity fraction.
The proposed regulations apply the
property fraction in §1.863–3(c) to appor-
tion the half of a taxpayer’s income allo-
cated to production activity. Thus, in-
come is apportioned to the United States
or to a possession based on the location of
the taxpayer’s production assets. In a
change from the current regulations, and
consistent with the changes made to the
regulations under §1.863–3(c), produc-
tion assets are defined as tangible and in-
tangible assets owned directly by the tax-
payer that are directly used by the tax-
payer to produce inventory sold in
Possession Production Sales, instead of
all its assets that produce income from
Possession Production Sales. Production
assets are included in the fraction at their
adjusted tax basis.
The other half of the taxpayer’s gross
income is apportioned according to a
business sales activity fraction. The por-
tion of this income that is possession
source income is determined by multiply-
ing the income by a fraction, the numera-
tor being the business sales activity of the
taxpayer in the possession, and the de-
nominator being the business sales activ-
ity of the taxpayer within the possession
and outside the possession. The remain-
ing income is sourced in the United
States. Although some of the business
sales activity factors not incurred in a pos-
session may be incurred in a foreign
country, Treasury and the Internal Rev-
enue Service believe that the business
sales activity fraction is only intended to
source the business sales activity portion
of Possession Production Sales outside
the United States to the extent of business
sales activity located in a possession.
The proposed regulations make some
modifications to the factors in the fraction
representing the business sales activity of
the taxpayer. Business sales activity is
measured by the sum of certain expenses,
including amounts paid for labor, materi-
als, advertising, and marketing (but ex-
cluding any expenses or other amounts
that are nondeductible under section
263A, interest, and research and develop-
ment), plus receipts for the sale of goods.
This formula is intended to reflect better
the business sales activity producing the
income by including more of the factors
responsible for producing that income.
Cost of goods sold is also excluded from
the business sales activity fraction appor-
tioning income from Possession Produc-
tion Sales, because such costs generally
reflect production activity. Production
activity is already represented in the for-
mula by the one-half of the taxpayer’s in-
come apportioned according to the loca-
tion of production assets.
Finally, the proposed regulations pro-
vide more explicit guidance for attribut-
ing business sales activity between the
December 1, 1997201997–48 I.R.B.

United States and a possession. Expenses
are allocated and apportioned between the
United States and a possession based on
the rules in §§1.861–8 through
1.861–14T. Gross sales are allocated to
the United States or a possession based on
the place of sale.
ii. The IFPmethod
The proposed regulations make the IFP
method elective, and thus eliminate any
bias against taxpayers choosing to export
through independent distributors. The
regulations rely upon the revised regula-
tions under §1.863–3 for rules in applying
the IFPmethod.
iii. Books and records method
The proposed regulations retain the
books and records method of the existing
regulations, permitting taxpayers to re-
quest permission from the District Direc-
tor to use their books and records to deter-
mine the source of their income. The
proposed regulations refer to revised
§1.863–3(b)(3) in applying the method to
Possession Production Sales.
b. Property purchased and sold
i. The business activity method
Paragraph (f)(3)(i)(A) makes the busi-
ness activity method the general rule to
apportion income from Possession Pur-
chase Sales between the United States and
a possession. The taxpayer may, how-
ever, elect to apply, with consent of the
District Director, the books and records
method.
The proposed regulations retain the
structure of the existing regulations by ap-
portioning the taxpayer’s income from
Possession Purchase Sales on the basis of
a business activity fraction. The portion
of this income that is possession source
income is determined by multiplying the
income by a fraction, the numerator being
the business of the taxpayer in the posses-
sion, and the denominator being the busi-
ness of the taxpayer within the possession
and outside the possession. The remain-
ing income is sourced in the United
States.
The business activity fraction is similar
to that discussed previously, used to ap-
portion the taxpayer’s income in Posses-
sion Production Sales, except that the
fraction applies only to expenses, cost of
goods sold, and sales attributable to Pos-
session Purchase Sales. In addition, the
business activity fraction apportioning
Possession Purchase Sales includes
amounts paid for cost of goods sold.
Such costs are attributed to the posses-
sion, however, only to the extent the prop-
erty purchased is manufactured, pro-
duced, grown, or extracted in the
possession. Treasury and the Internal
Revenue Service anticipate that if a tax-
payer acts in the reasonable belief that the
products were manufactured in the pos-
session, the taxpayer could act on that
basis in preparing its tax return. As modi-
fied, the business activity fraction reflects
the view of Treasury and the Internal Rev-
enue Service that section 863(b)(3)’s pur-
chase rule was intended to apply only to
purchase and resale transactions, where
the goods purchased are created or de-
rived from the possession.
ii. Books and records method
The proposed regulations retain the
books and records method of the existing
regulations, permitting taxpayers to re-
quest permission from the District Direc-
tor to use their books and records to deter-
mine the source of their income. The
proposed regulations refer to revised
§1.863–3(b)(3) in applying the method to
Possession Purchase Sales.
2. Determination of source of gross
income
Unlike the current regulations which
provide specific rules for determining the
source of income attributable to produc-
tion activity and business activity only for
purposes of the 50/50 method, the pro-
posed regulations adopt rules applicable
to each of the methods. Under the pro-
posed regulations, once gross income at-
tributable to production activity, business
activity, or sales activity has been deter-
mined under one of the prescribed meth-
ods, the source of the gross income is de-
termined separately for each type of
income. The source of gross income at-
tributable to production activity (when
applying the possession 50/50 method) is
determined under paragraph (c)(1), based
on the location of production assets. The
source of gross income attributable to
sales activity (when applying the IFP
method or the books and records method)
is determined under paragraph (c)(2),
based generally on the location of the
sale. The source of gross income attribut-
able to business sales activity (when ap-
plying the possession 50/50 method) is
determined under paragraph (f)(2)(ii)(B),
based on expenses, and gross sales attrib-
utable to Possession Production Sales.
The source of gross income attributable to
business activity (when applying the busi-
ness activity method) is determined under
paragraph (f)(3)(ii), based on expenses,
cost of goods sold, and gross sales attrib-
utable to Possession Purchase Sales.
3. Determination of source of
taxable income
Once the source of gross income is de-
termined under paragraph (f)(2) or (3),
taxpayers then determine the source of
taxable income. Under proposed para-
graph (f)(4), taxpayers must allocate or
apportion under §§1.861–8 through
1.861–14Tthe amounts of expenses,
losses and other deductions to gross in-
come determined under each of the pre-
scribed methods. In the case of amounts
of expenses, losses and other deductions
allocated or apportioned to gross income
determined under the IFPmethod or the
books and records method, the taxpayer
must apply the rules of §§1.861–8
through 1.861–14Tto allocate or appor-
tion these amounts between gross income
from sources within the United States and
within a possession. For expenses, losses
and other deductions allocated or appor-
tioned to gross income determined under
the possessions 50/50 method, taxpayers
must apportion expenses and other deduc-
tions pro rata based on the relative
amounts of U.S. and possession source
gross income. The research and experi-
mental (R&E) expense allocation rules in
§1.861–17 apply to taxpayers using the
50/50 method, so that the R&E set aside
(described in §1.861–17) remains avail-
able to such taxpayers.
4. Treatment of gross income derived
from certain purchases from a
corporation that has an election
in effect under section 936
The proposed regulations clarify that
section 863 does not apply to determine
the source of a taxpayer’s gross income
derived from a purchase of inventory
from a corporation that has an election in
effect under section 936, if the taxpayer’s
income from sales of that inventory is
taken into account to determine benefits
under section 936(h)(5)(C) for the section
936 corporation.
1997–48 I.R.B.21December 1, 1997

5. Treatment of partners and partnerships
The proposed regulations rely on the
rules in §1.863–3(g) for determining the
appropriate treatment in transactions in-
volving partnerships. Under those rules,
the aggregate approach applies to a part-
nership’s production and sales activity for
two purposes only. First, the aggregate ap-
proach applies in determining the character
of a partner’s distributive share of partner-
ship income. Second, the aggregate ap-
proach applies in sourcing income from
sales of inventory property that is trans-
ferred in-kind from or to a partnership.
6. Election and reporting rules
Under paragraph (f)(6)(i) of the pro-
posed regulations, a taxpayer must use the
50/50 method to determine the source of
income from Possession Production Sales
unless the taxpayer elects to use the IFP
method, or elects the books and records
method. For Possession Purchase Sales, a
taxpayer must use the business activity
method, unless the taxpayer elects the
books and records method. The taxpayer
makes an election by using the method on
its timely filed original tax return. That
method must be used in later taxable
years unless the Commissioner or his del-
egate consents to a change. Permission to
change methods in later years will not be
withheld unless the change would result
in a substantial distortion of the source of
income.
Ataxpayer must fully explain the
methodology used in applying either
paragraph (f)(2) or (3), and the amount of
income allocated or apportioned to U.S.
and foreign sources, in a statement at-
tached to its tax return.
II. Income Derived From Certain
Purchases From a Corporation That Has
an Election in Effect Under Section 936
These proposed regulations clarify that
where a taxpayer purchases a product
from a corporation that has an election in
effect under section 936, the source of the
taxpayer’s gross income derived from
sales of that product (in whatever form
sold) in the United States is U.S. source,
if the taxpayer’s income from sales of
that product is taken into account to de-
termine benefits under section
936(h)(5)(C)(i) for the section 936 corpo-
ration. The taxpayer’s income is U.S.
source without regard to whether a pos-
session product is a component, end-
product form, or integrated product. No
inference should be drawn from the pro-
posed effective date concerning the treat-
ment of transactions involving sales of
property purchased from a section 936
corporation entered into before the regu-
lations are applicable.
Proposed Effective Dates
These regulations are proposed to be
effective for taxable years beginning on
or after the date that is 30 days after the
date of publication of final regulations.
Special Analyses
It has been determined that this notice
of proposed rulemaking is not a signifi-
cant regulatory action as defined in EO
12866. Therefore, a regulatory assess-
ment is not required. It is hereby certified
that these regulations will not have a sig-
nificant economic impact on a substantial
number of small entities. This certifica-
tion is based on the fact that the rules of
this section principally impact large
multinationals who pay foreign taxes on
substantial foreign operations and there-
fore the rules will impact very few small
entities. Moreover, in those few instances
where the rules of this section impact
small entities, the economic impact on
such entities is not likely to be significant.
Accordingly, a regulatory flexibility
analysis is not required. Pursuant to sec-
tion 7805(f) of the Internal Revenue
Code, this notice of proposed rulemaking
will be submitted to the Chief Counsel for
Advocacy of the Small Business Admin-
istration for comment on its impact on
small business.
Comments and Public Hearing
Before these proposed regulations are
adopted as final regulations, considera-
tion will be given to any comments that
are submitted timely (in the manner de-
scribed under the ADDRESSES caption)
to the IRS. All comments will be avail-
able for public inspection and copying.
Apublic hearing has been scheduled
for January 29, 1998, at 10 a.m., in room
2615, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington,
DC. Because of access restrictions, visi-
tors will not be admitted beyond the Inter-
nal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3)
apply to the hearing.
Persons that wish to present oral com-
ments at the hearing must submit com-
ments and an outline of topics to be dis-
cussed and the time to be devoted to each
topic (in the manner described under the
ADDRESSES caption of this preamble)
by January 8, 1998.
Aperiod of 10 minutes will be allotted
to each person for making comments.
An agenda showing the scheduling of
the speakers will be prepared after the
deadline for receiving outlines has
passed. Copies of the agenda will be
available free of charge at the hearing.
Drafting Information
The principal author of these regula-
tions is Anne Shelburne, Office of Associ-
ate Chief Counsel (International). How-
ever, other personnel from the IRS and
Treasury Department participated in their
development.
* * * * *
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is pro-
posed to be amended as follows:
PART1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 is amended by revising the entry for
“Section 1.863-3”, removing the entry for
“Sections 1.936-4 through 1.936-7” and
adding entries in numerical order to read
as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.863-3 also issued under 26
U.S.C. 863(a) and (b), and 26 U.S.C.
936(h).***
Section 1.936-4 also issued under 26
U.S.C. 936(h).
Section 1.936-5 also issued under 26
U.S.C. 936(h).
Section 1.936-6 also issued under 26
U.S.C. 863(a) and (b), and 26 U.S.C.
936(h).
Section 1.936-7 also issued under 26
U.S.C. 936(h).***
Par. 2 Section 1.863-3 is amended as
follows:
1. Paragraph (f) is revised.
2. Paragraph (h) is amended by adding
a sentence at the end of the paragraph.
December 1, 1997221997–48 I.R.B.

The revision and addition read as fol-
lows:
§1.863-3 Allocation and apportionment
of income from certain sales of inventory.
* * * * *
(f) Income partly from sources within a
possession of the United States—(1) In
general.This paragraph (f) relates to
gains, profits, and income, which are
treated as derived partly from sources
within the United States and partly from
sources within a possession of the United
States (Section 863 Possession Sales).
This paragraph (f) applies to determine
the source of income derived from the
sale of inventory produced (in whole or in
part) by the taxpayer within the United
States and sold within a possession, or
produced (in whole or in part) by a tax-
payer in a possession and sold within the
United States (Possession Production
Sales). It also applies to determine the
source of income derived from the pur-
chase of personal property within a pos-
session of the United States and its sale
within the United States (Possession Pur-
chase Sales). Ataxpayer subject to this
paragraph (f) must divide gross income
from Section 863 Possession Sales using
one of the methods described in either
paragraph (f)(2)(i) of this section (in the
case of Possession Production Sales) or
paragraph (f)(3)(i) of this section (in the
case of Possession Purchase Sales). Once
a taxpayer has elected a method, the tax-
payer must separately apply that method
to the applicable category of Section 863
Possession Sales in the United States and
to those in a possession. The source of
gross income from each type of activity
must then be determined under either
paragraph (f)(2)(ii) or (3)(ii) of this sec-
tion, as appropriate. The source of taxable
income from Section 863 Possession
Sales is determined under paragraph
(f)(4) of this section. The taxpayer must
apply the rules for computing gross and
taxable income by aggregating all Section
863 Possession Sales to which a method
in this section applies after separately ap-
plying that method to Section 863 Posses-
sion Sales in the United States and to Sec-
tion 863 Possession Sales in a possession.
This section does not apply to determine
the source of a taxpayer’s gross income
derived from a sale of inventory pur-
chased from a corporation that has an
election in effect under section 936, if the
taxpayer’s income from sales of that in-
ventory is taken into account to determine
benefits under section 936 for the section
936 corporation. For rules to be applied
to determine the source of such income,
see §1.936-6(a)(5) Q&A7a and (b)(1)
Q&A13.
(2) Allocation or apportionment for
Possession Production Sales—(i) Meth-
ods for determining the source of gross
income for Possession Production
Sales—(A) Possession 50/50 method.
Under the possession 50/50 method, gross
income from Possession Production Sales
is allocated between production activity
and business sales activity as described in
this paragraph (f)(2)(i)(A). Under the
possession 50/50 method, one-half of the
taxpayer’s gross income will be consid-
ered income attributable to production ac-
tivity and the source of that income will
be determined under the rules of para-
graph (f)(2)(ii)(A) of this section. The re-
maining one-half of such gross income
will be considered income attributable to
business sales activity and the source of
that income will be determined under the
rules of paragraph (f)(2)(ii)(B) of this sec-
tion.
(B) IFPmethod. In lieu of the posses-
sion 50/50 method, a taxpayer may elect
the independent factory price (IFP)
method. Under the IFPmethod, gross in-
come from Possession Production Sales is
allocated to production activity or sales
activity using the IFPmethod, as de-
scribed in paragraph (b)(2) of this section,
if an IFPis fairly established under the
rules of paragraph (b)(2) of this section.
See paragraphs (f)(2)(ii)(A) and (C) of
this section for rules for determining the
source of gross income attributable to
production activity and sales activity.
(C) Books and Records method. A
taxpayer may elect to allocate gross in-
come using the books and records
method described in paragraph (b)(3) of
this section, if it has received in advance
the permission of the District Director
having audit responsibility over its re-
turn. See paragraph (f)(2)(ii) of this sec-
tion for rules for determining the source
of gross income.
(ii) Determination of source of gross
income from production, business sales,
and sales activity—(A) Gross income at-
tributable to production activity. The
source of gross income from production
activity is determined under the rules of
paragraph (c)(1) of this section, except
that the term possession is substituted for
foreign country wherever it appears.
(B) Gross income attributable to busi-
ness sales activity—(1) Source of gross
income. Gross income from the tax-
payer’s business sales activity is sourced
in the possession in the same proportion
that the amount of the taxpayer’s business
sales activity for the taxable year within
the possession bears to the amount of the
taxpayer’s business sales activity for the
taxable year both within the possession
and outside the possession, with respect
to Possession Production Sales. The re-
maining income is sourced in the United
States.
(2) Business sales activity. For pur-
poses of this paragraph (f)(2)(ii)(B), the
taxpayer’s business sales activity is equal
to the sum of—
(i) The amounts for the taxable period
paid for wages, salaries, and other com-
pensation of employees, and other ex-
penses attributable to Possession Produc-
tion Sales (other than amounts that are
nondeductible under section 263A, inter-
est, and research and development); and
(ii) Possession Production Sales for the
taxable period.
(3) Location of business sales activity.
For purposes of determining the location
of the taxpayer’s business activity within
a possession, the following rules apply:
(i) Sales.Receipts from gross sales
will be attributed to a possession under
the provisions of paragraph (c)(2) of this
section.
(ii) Expenses. Expenses will be attrib-
uted to a possession under the rules of
§§1.861–8 through 1.861–14T.
(C) Gross income attributable to sales
activity.The source of the taxpayer’s in-
come that is attributable to sales activity,
as determined under the IFPmethod or
the books and records method, will be de-
termined under the provisions of para-
graph (c)(2) of this section.
(3) Allocation or apportionment for
Possession Purchase Sales—(i) Methods
for determining the source of gross in-
come for Possession Purchase Sales—
(A) Business activity method.Gross in-
come from Possession Purchase Sales is
allocated in its entirety to the taxpayer’s
business activity, and is then apportioned
1997–48 I.R.B.23December 1, 1997

between U.S. and possession sources
under paragraph (f)(3)(ii) of this section.
(B)Books and records method.A
taxpayer may elect to allocate gross in-
come using the books and records method
described in paragraph (b)(3) of this sec-
tion, subject to the conditions set forth in
paragraph (b)(3) of this section. See para-
graph (f)(2)(ii) of this section for rules for
determining the source of gross income.
(ii) Determination of source of gross
income from business activity—(A)
Source of gross income. Gross income
from the taxpayer’s business activity is
sourced in the possession in the same pro-
portion that the amount of the taxpayer’s
business activity for the taxable year
within the possession bears to the amount
of the taxpayer’s business activity for the
taxable year both within the possession
and outside the possession, with respect
to Possession Purchase Sales. The re-
maining income is sourced in the United
States.
(B) Business activity.For purposes of
this paragraph (f)(3)(ii), the taxpayer’s
business activity is equal to the sum of—
(1) The amounts for the taxable period
paid for wages, salaries, and other com-
pensation of employees, and other ex-
penses attributable to Possession Pur-
chase Sales (other than amounts that are
nondeductible under section 263A, inter-
est, and research and development);
(2) Cost of goods sold attributable to
Possession Purchase Sales during the tax-
able period; and
(3) Possession Purchase Sales for the
taxable period.
(C) Location of business activity.For
purposes of determining the location of
the taxpayer’s business activity within a
possession, the following rules apply:
(1) Sales.Receipts from gross sales
will be attributed to a possession under
the provisions of paragraph (c)(2) of this
section.
(2) Cost of goods sold. Payments for
cost of goods sold will be properly attrib-
utable to gross receipts from sources
within the possession only to the extent
that the property purchased was manufac-
tured, produced, grown, or extracted in
the possession (within the meaning of
section 954(d)(1)(A)).
(3) Expenses. Expenses will be attrib-
uted to a possession under the rules of
§§1.861–8 through 1.861–14T.
(iii) Examples. The following exam-
ples illustrate the rules of paragraph
(f)(3)(ii) relating to the determination of
source of gross income from business ac-
tivity:
Example 1. (i) U.S. Co. purchases in a posses-
sion product X for $80 from A. Amanufactures X in
the possession. Without further production, U.S.
Co. sells X in the United States for $100. Assume
U.S. Co. has sales and administrative expenses in
the possession of $10.
(ii) To determine the source of U.S. Co.’s gross
income, the $100 gross income from sales of X is al-
located entirely to U.S. Co.’s business activity.
Forty-seven dollars of U.S. Co.’s gross income is
sourced in the possession. [Possession expenses
($10) plus possession purchases ($80) plus posses-
sions sales ($0), divided by total expenses ($10) plus
total purchases ($80) plus total sales ($100).] The
remaining $53 is sourced in the United States.
Example 2. (i) Assume the same facts as in Ex-
ample 1, except that Amanufactures X outside the
possession.
(ii) To determine the source of U.S. Co.’s gross
income, the $100 gross income is allocated entirely
to U.S. Co.’s business activity. Five dollars of U.S.
Co.’s gross income is sourced in the possession.
[Possession expenses ($10) plus possession pur-
chases ($0) plus possession sales ($0), divided by
total expenses ($10) plus total purchases ($80) plus
total sales ($100).] The $80 purchase is not included
in the numerator used to determine U.S. Co.’s busi-
ness activity in the possession, since product X was
not manufactured in the possession. The remaining
$95 is sourced in the United States.
(4) Determination of source of taxable
income. Once the source of gross income
has been determined under paragraph
(f)(2) or (3) of this section, the taxpayer
must properly allocate and apportion sep-
arately under §§1.861–8 through
1.861–14Tthe amounts of its expenses,
losses, and other deductions to its respec-
tive amounts of gross income from Sec-
tion 863 Possession Sales determined
separately under each method described
in paragraph (f)(2) or (3) of this section.
In addition, if the taxpayer deducts ex-
penses for research and development
under section 174 that may be attributed
to its Section 863 Possession Sales under
§1.861–8(e)(3), the taxpayer must sepa-
rately allocate or apportion expenses,
losses, and other deductions to its respec-
tive amounts of gross income from each
relevant product category that the tax-
payer uses in applying the rules of
§1.861–8(e)(3)(i)(A). In the case of
gross income from Section 863 Posses-
sion Sales determined under the IFP
method or books and records method, a
taxpayer must apply the rules of
§§1.861–8 through 1.861–14Tto prop-
erly allocate or apportion amounts of ex-
penses, losses and other deductions, allo-
cated and apportioned to such gross in-
come, between gross income from
sources within and without the United
States. In the case of gross income from
Possession Production Sales determined
under the possessions 50/50 method or
gross income from Possession Purchase
Sales computed under the business activ-
ity method, the amounts of expenses,
losses, and other deductions allocated
and apportioned to such gross income
must be apportioned between sources
within and without the United States pro
rata based on the relative amounts of
gross income from sources within and
without the United States determined
under those methods.
(5) Special rules for partnerships.In
applying the rules of this paragraph (f) to
transactions involving partners and part-
nerships, the rules of paragraph (g) of this
section apply.
(6) Election and reporting rules—(i)
Elections under paragraph (f)(2) or (3) of
this section.If a taxpayer does not elect
one of the methods specified in paragraph
(f)(2) or (3) of this section, the taxpayer
must apply the possession 50/50 method
in the case of Possession Production Sales
or the business activity method in the case
of Possession Purchase Sales. The tax-
payer may elect to apply a method speci-
fied in either paragraph (f)(2) or (3) of
this section by using the method on a
timely filed original return (including ex-
tensions). Once a method has been used,
that method must be used in later taxable
years unless the Commissioner consents
to a change. Permission to change meth-
ods from one year to another year will be
granted unless the change would result in
a substantial distortion of the source of
the taxpayer’s income.
(ii) Disclosure on tax return. Atax-
payer who uses one of the methods de-
scribed in paragraph (f)(2) or (3) of this
section must fully explain in a statement
attached to the tax return the methodology
used, the circumstances justifying use of
that methodology, the extent that sales are
aggregated, and the amount of income so
allocated.
* * * * *
(h) Effective dates. * * * However,
the rules of paragraph (f) of this section
apply to taxable years beginning on or
December 1, 1997241997–48 I.R.B.

after the date that is 30 days after the date
of publication of final regulations.
Par. 3. In §1.936-6, paragraph (a)(5)
Q&A7a is added to read as follows:
§1.936-6 Intangible property income
when an election out is made: Cost
sharing and profit split options; covered
intangibles.
* * * * *
(a) * * *
(5) * * *
Q.7a: What is the source of the tax-
payer’s gross income derived from a sale
in the United States of a possession prod-
uct purchased by the taxpayer (or an affil-
iate) from a corporation that has an elec-
tion in effect under section 936, if the
income from such sale is taken into ac-
count to determine benefits under cost
sharing for the section 936 corporation?
Is the result different if the taxpayer (or an
affiliate) derives gross income from a sale
in the United States of an integrated prod-
uct incorporating a possession product
purchased by the taxpayer (or an affiliate)
from the section 936 corporation, if the
taxpayer (or an affiliate) processes the
possession product or an excluded com-
ponent in the United States?
A.7a: Under either scenario, the in-
come is U.S. source, without regard to
whether the possession product is a com-
ponent, end-product, or integrated prod-
uct. Section 863 does not apply in deter-
mining the source of the taxpayer’s
income. This Q&A7a is applicable for
taxable years beginning on or after the
date that is 30 days after the date of publi-
cation of final regulations.
* * * * *
Michael P. Dolan,
Acting Commissioner of
Internal Revenue.
(Filed by the Office of the Federal Register on Octo-
ber 9, 1997, 8:45 a.m., and published in the issue of
the Federal Register for October 10, 1997, 62 F.R.
52953)
Foundations Status of Certain
Organizations
Announcement 97–116
The following organizations have
failed to establish or have been unable to
maintain their status as public charities or
as operating foundations. Accordingly,
grantors and contributors may not, after
this date, rely on previous rulings or des-
ignations in the Cumulative List of Orga-
nizations (Publication 78), or on the pre-
sumption arising from the filing of notices
under section 508(b) of the Code. This
listing does notindicate that the organiza-
tions have lost their status as organiza-
tions described in section 501(c)(3), eligi-
ble to receive deductible contributions.
Former Public Charities.The following
organizations (which have been treated as
organizations that are not private founda-
tions described in section 509(a) of the
Code) are now classified as private foun-
dations:
Babys Exchange, Parker, AZ
Bachman Northwest Highway
Community Association, Dallas, TX
Baillie Players Inc., Columbia, SC
Bainbridge-Decatur County Council for
the Arts, Inc., Bainbridge, GA
Balkan Relief Fund, Inc.,
Fern Park, FL
Bamberg Kiddie Kampus Inc.,
Bamberg, SC
Bandits Football Association,
Ofallon, MO
Bankhead Learning Academy Inc.,
Atlanta, GA
Baptist Hill House Inc., Detroit, MI
Baptist Ministrers Conference of
Cincinnati and Vicinity, Cincinnati, OH
Baptist Village Residents Association,
Phoenix, AZ
Barnabas Ministries, Springfield, OH
Bartow County Coalition for Substance
Abuse Prevention, Cartersville, GA
BASE Camp Childrens Cancer
Foundation, Inc., Windermere, FL
Basic Interdenominational Lackland
Shelter, Incorporated, San Antonio, TX
Bastrop County Crime Stoppers, Inc.,
Bastrop, TX
Baton Rouge Black Alcoholism Council,
Baton Rouge, LA
Battered Women as Survivors Inc.,
Columbus, OH
Bay Area Neighborhood Development
Corporation, Sandusky, OH
Bay Area Raiders Football Inc.,
Tampa, FL
Bay Area Youth Wheelchair Athletic
Association, St. Petersburg, FL
Bay Hope House, Bokeelia, FL
Bayou-River Social Services, Luling, LA
Bayshore Volunteer Fire Department,
Inc., North Ft. Myers, FL
Baytown Youth Development Center,
Inc., Baytown, TX
Beall Society for Sight Preservation, Inc.,
Cleveland, OH
Bear Buddies Educational Resources,
Inc., Hudson, WI
Bedford City Schools Foundation,
Bedford, OH
Beech Economic Development
Association, Philadelphia, PA
Beechwood Resource Center Inc.,
River Rouge, MI
Behavioral Communication Research,
Lexington, KY
Bel Canto Lyric Opera Company,
Philadelphia, PA
Belle Babb Nansfield Foundation,
Des Moines, IA
Belleville Public Library Foundation,
Belleville, KS
Ben Davis Youth Sports Association,
Inc., Indianapolis, IN
Bengali Association of Greater Dallas-Ft.
Worth, Plano, TX
Benjamin House Inc., Cleveland, OH
Benzie Housing Council, Benzonia, MI
Berlitz Gallery Theatre, Chandler, AZ
Berryville Baseball Association, Inc.,
Berryville, AR
Best Southwest Business Center,
Duncanville, TX
Bethel Foundation, Des Moines, IA
Bethlehem Ministries Inc., Paterson, NJ
Better Business Bureau of the Golden
Spread Educational Foundation,
Amarillo, TX
Better Community Relations Inc.,
Toledo, OH
Better Homes for North Carolina Inc.,
Raleigh, NC
Better Life Inc., Birmingham, MI
Better Way of Life, Chicago, IL
1997–48 I.R.B.25December 1, 1997

Bexar Metropolitan Housing Association,
San Antonio, TX
Beyer School Parent Teacher
Organization, Rockford, IL
Beyond the Limits–Childrens Outreach
Services, Jackson, MS
Bhagavat Dharma Samaj Inc.,
Baltimore, MD
Bibleway Community Outreach Projects,
Inc., Annapolis, MD
Biblical Counseling MinistriesInc.,
Merrian, KS
Big Bend People and Goats, Alpine, TX
Big Brothers-Big Sisters of Ford County,
Inc., Dodge City, KS
Big Brothers-Big Sisters of Owensboro,
Inc., Owensboro, KY
Big Brothers-Big Sisters of Morgan
County, Inc., Decatur, AL
Big Horn Basin of Wyoming Resource
Conservation and Developmental
Project, Worland, WY
Billings Senior High Band Parents Inc.,
Billings, MT
Binghampton Fellowship Foundation,
Inc., Memphis, TN
Birmingham Chapter of the American
Association of Energy,
Birmingham, AL
Birmingham Regional Sports Club Inc.,
Birmingham, AL
Birmingham Schools Athletic Foundation,
Birmingham, AL
Birthline of Wellington Inc.,
Wellington, KS
Birthright of Sterling, Sterling, CO
BJ Nutritional Service Inc., Houston, TX
Black & White Medical Transportation,
Inc., Pine Bluff, AR
Black Activities at a Glance,
Columbus, OH
Black Bear Awareness, Trufant, MI
Black Belt Improvement Group,
Hope Hull, AL
Black Business Entrepreneurs, Sandy, UT
Black Professional Men Inc.,
Baltimore, MD
Black State Employees Association,
Dallas, TX
Blind Comprehensive Action Network,
St. John,MO
Blind People of America Entertainment
BPOA, Inc., Albuquerque, NM
Blossomland Arts and Cultural Council,
Saint Joseph, MI
Blue Ash Revitalization Inc.,
Blue Ash, OH
Blue Ridge Home for Boys, Greer, SC
Bluebirds Over Georgia Inc., Atlanta, GA
Bluegrass Brass Inc., Lexington, KY
Blues Club Inc., Jonesboro, AR
Blues Society of Indiana Incorporated,
Indianapolis, IN
Bnai Brith Athletic and Achievement
Award Endowment Fund, Roanoke, VA
Bnai Brith Covenant House of Tucson
Arizona Inc., Tucson, AZ
Boardwalk Estates Inc., Garden City, KS
Bob Johnson Ice Hockey Foundation,
Colorado Springs, CO
Bogalusa Humane Society, Bogalusa, LA
Bone Marrow International,
Greensboro, NC
Book Bank Project, Mesa, AZ
Book of Hope Inc., Deerfield, FL
Booksellers for Social Responsibility,
Chicago, IL
Boone County Youth Soccer Association,
Florence, KY
Bootstrap Inc., New Berlin, WI
Boston Township Hall Committee Inc.,
Peninsula, OH
Bowling Green Choral Society Inc.,
Bowling Green, KY
Boys & Girls Club of the Smoky
Mountains, Inc., Sevierville, TN
BRACE Inc., Winston-Salem, NC
BREATHE, Boulder, CO
If an organization listed above submits
information that warrants the renewal of
its classification as a public charity or as a
private operating foundation, the Internal
Revenue Service will issue a ruling or de-
termination letter with the revised classi-
fication as to foundation status. Grantors
and contributors may thereafter rely upon
such ruling or determination letter as pro-
vided in section 1.509(a)–7 of the Income
Tax Regulations. It is not the practice of
the Service to announce such revised clas-
sification of foundation status in the Inter-
nal Revenue Bulletin.
December 1, 1997261997–48 I.R.B.

1997–48 I.R.B.27December 1, 1997
Revenue rulings and revenue procedures
(hereinafter referred to as “rulings”) that
have an effect on previous rulings use the
following defined terms to describe the
effect:
Amplified describes a situation where
no change is being made in a prior pub-
lished position, but the prior position is
being extended to apply to a variation of
the fact situation set forth therein. Thus,
if an earlier ruling held that a principle
applied to A, and the new ruling holds
that the same principle also applies to B,
the earlier ruling is amplified. (Compare
with modified, below).
Clarified is used in those instances
where the language in a prior ruling is
being made clear because the language
has caused, or may cause, some confu-
sion. It is not used where a position in a
prior ruling is being changed.
Distinguisheddescribes a situation
where a ruling mentions a previously
published ruling and points out an essen-
tial difference between them.
Modified is used where the substance
of a previously published position is
being changed. Thus, if a prior ruling
held that a principle applied to Abut not
to B, and the new ruling holds that it ap-
plies to both Aand B, the prior ruling is
modified because it corrects a published
position. (Compare with amplified and
clarified, above).
Obsoleted describes a previously pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used
in a ruling that lists previously published
rulings that are obsoleted because of
changes in law or regulations. Aruling
may also be obsoleted because the sub-
stance has been included in regulations
subsequently adopted.
Revoked describes situations where the
position in the previously published rul-
ing is not correct and the correct position
is being stated in the new ruling.
Superseded describes a situation where
the new ruling does nothing more than
restate the substance and situation of a
previously published ruling (or rulings).
Thus, the term is used to republish under
the 1986 Code and regulations the same
position published under the 1939 Code
and regulations. The term is also used
when it is desired to republish in a single
ruling a series of situations, names, etc.,
that were previously published over a pe-
riod of time in separate rulings. If the
new ruling does more than restate the
substance of a prior ruling, a combination
of terms is used. For example, modified
and superseded describes a situation
where the substance of a previously pub-
lished ruling is being changed in part and
is continued without change in part and it
is desired to restate the valid portion of
the previously published ruling in a new
ruling that is self contained. In this case
the previously published ruling is first
modified and then, as modified, is super-
seded.
Supplemented is used in situations in
which a list, such as a list of the names of
countries, is published in a ruling and
that list is expanded by adding further
names in subsequent rulings. After the
original ruling has been supplemented
several times, a new ruling may be pub-
lished that includes the list in the original
ruling and the additions, and supersedes
all prior rulings in the series.
Suspended is used in rare situations to
show that the previous published rulings
will not be applied pending some future
action such as the issuance of new or
amended regulations, the outcome of
cases in litigation, or the outcome of a
Service study.
Abbreviations
The following abbreviations in current use and for-
merly used will appear in material published in the
Bulletin.
A—Individual.
Acq.—Acquiescence.
B—Individual.
BE—Beneficiary.
BK—Bank.
B.T.A.—Board of Tax Appeals.
C.—Individual.
C.B.—Cumulative Bulletin.
CFR—Code of Federal Regulations.
CI—City.
COOP—Cooperative.
Ct.D.—Court Decision.
CY—County.
D—Decedent.
DC—Dummy Corporation.
DE—Donee.
Del. Order—Delegation Order.
DISC—Domestic International Sales Corporation.
DR—Donor.
E—Estate.
EE—Employee.
E.O.—Executive Order.
ER—Employer.
ERISA—Employee Retirement Income Security Act.
EX—Executor.
F—Fiduciary.
FC—Foreign Country.
FICA—Federal Insurance Contribution Act.
FISC—Foreign International Sales Company.
FPH—Foreign Personal Holding Company.
F.R.—Federal Register.
FUTA—Federal Unemployment Tax Act.
FX—Foreign Corporation.
G.C.M.—Chief Counsel’s Memorandum.
GE—Grantee.
GP—General Partner.
GR—Grantor.
IC—Insurance Company.
I.R.B.—Internal Revenue Bulletin.
LE—Lessee.
LP—Limited Partner.
LR—Lessor.
M—Minor.
Nonacq.—Nonacquiescence.
O—Organization.
P—Parent Corporation.
PHC—Personal Holding Company.
PO—Possession of the U.S.
PR—Partner.
PRS—Partnership.
PTE—Prohibited Transaction Exemption.
Pub. L.—Public Law.
REIT—Real Estate Investment Trust.
Rev. Proc.—Revenue Procedure.
Rev. Rul.—Revenue Ruling.
S—Subsidiary.
S.P.R.—Statements of Procedral Rules.
Stat.—Statutes at Large.
T—Target Corporation.
T.C.—Tax Court.
T.D.—Treasury Decision.
TFE—Transferee.
TFR—Transferor.
T.I.R.—Technical Information Release.
TP—Taxpayer.
TR—Trust.
TT—Trustee.
U.S.C.—United States Code.
X—Corporation.
Y—Corporation.
Z—Corporation.
Definition of Terms

December 1, 1997281997–48 I.R.B.
Numerical Finding List
1
Bulletins 1997–27 through 1997–47
Announcements:
97–61, 1997–29 I.R.B. 13
97–67, 1997–27 I.R.B. 37
97–68, 1997–28 I.R.B. 13
97–69, 1997–28 I.R.B. 13
97–70, 1997–29 I.R.B. 14
97–71, 1997–29 I.R.B. 15
97–72, 1997–29 I.R.B. 15
97–73, 1997–30 I.R.B. 86
97–74, 1997–31 I.R.B.16
97–75, 1997–32 I.R.B. 28
97–76, 1997–32 I.R.B. 28
97–77, 1997–33 I.R.B. 58
97–78, 1997–34 I.R.B. 11
97–79, 1997–35 I.R.B. 8
97–80, 1997–34 I.R.B. 12
97–81, 1997–34 I.R.B. 12
97–82, 1997–34 I.R.B. 12
97–83, 1997–34 I.R.B. 13
97–84, 1997–34 I.R.B. 13
97–85, 1997–35 I.R.B. 8
97–86, 1997–35 I.R.B. 9
97–87, 1997–35 I.R.B. 9
97–88, 1997–35 I.R.B. 9
97–89, 1997–36 I.R.B. 10
97–90, 1997–36 I.R.B. 10
97–91, 1997–37 I.R.B. 25
97–92, 1997–37 I.R.B. 26
97–93, 1997–36 I.R.B. 11
97–94, 1997–36 I.R.B. 12
97–95, 1997–36 I.R.B. 12
97–96, 1997–39 I.R.B.15
97–97, 1997–38 I.R.B. 22
97–98, 1997–39 I.R.B. 15
97–99, 1997–40 I.R.B. 7
97–100, 1997–40 I.R.B. 8
97–101, 1997–41 I.R.B. 13
97–102, 1997–41 I.R.B. 15
97–103, 1997–41 I.R.B. 16
97–104, 1997–42 I.R.B. 39
97–105, 1997–42 I.R.B. 40
97–106, 1997–45 I.R.B. 11
97–107, 1997–43 I.R.B. 25
97–108, 1997–43 I.R.B. 25
97–109, 1997–45 I.R.B. 12
97–110, 1997–45 I.R.B. 14
97–111, 1997–47 I.R.B. 15
97–112, 1997–46 I.R.B. 20
97–113, 1997–46 I.R.B.21
97–114, 1997–46 I.R.B. 21
97–115, 1997–47 I.R.B. 17
Court Decisions:
2061, 1997–31 I.R.B. 5
2062, 1997–32 I.R.B. 8
Delegation Orders:
97 (Rev. 34), 1997–41 I.R.B. 14
172 (Rev. 5), 1997–28 I.R.B. 6
Notices:
97–37, 1997–27 I.R.B. 4
97–38, 1997–27 I.R.B. 8
Notices–Continued
97–39, 1997–27 I.R.B. 8
97–40, 1997–28 I.R.B. 6
97–41, 1997–28 I.R.B. 6
97–42, 1997–29 I.R.B. 12
97–43, 1997–30 I.R.B. 9
97–44, 1997–31 I.R.B. 15
97–45, 1997–33 I.R.B. 7
97–46, 1997–34 I.R.B. 10
97–47, 1997–35 I.R.B. 5
97–48, 1997–35 I.R.B. 5
97–49, 1997–36 I.R.B. 8
97–50, 1997–37 I.R.B. 21
97–51, 1997–38 I.R.B. 20
97–52, 1997–38 I.R.B. 20
97–53, 1997–40 I.R.B. 6
97–54, 1997–41 I.R.B. 7
97–55, 1997–40 I.R.B. 6
97–56, 1997–43 I.R.B. 19
97–57, 1997–43 I.R.B. 19
97–58, 1997–45 I.R.B. 7
97–59, 1997–45 I.R.B. 7
97–60, 1997–46 I.R.B.8
97–63, 1997–47 I.R.B. 6
97–64, 1997–47 I.R.B. 7
Railroad Retirement Quarterly Rate:
1997–28 I.R.B. 5
Public Laws
105–35, 1997–43 I.R.B. 13
Proposed Regulations:
REG–104893–97, 1997–29 I.R.B. 13
REG–105160–97, 1997–37 I.R.B. 22
REG–106043–97, 1997–37 I.R.B. 24
REG–107644–97, 1997–32 I.R.B. 24
REG–107872–97, 1997–47 I.R.B. 11
REG–114000–97, 1997–47 I.R.B. 13
REG–208151–91, 1997–38 I.R.B. 21
REG–246250–96, 1997–42 I.R.B. 30
Revenue Procedures:
97–32, 1997–27 I.R.B. 9
97–32A, 1997–34 I.R.B. 10
97–33, 1997–30 I.R.B. 10
97–34, 1997–30 I.R.B.14
97–35, 1997–33 I.R.B. 11
97–36, 1997–33 I.R.B. 14
97–37, 1997–33 I.R.B. 18
97–38, 1997–33 I.R.B. 43
97–39, 1997–33 I.R.B. 48
97–40, 1997–33 I.R.B. 50
97–41, 1997–33 I.R.B. 5
97–42, 1997–33 I.R.B. 57
97–43, 1997–39 I.R.B. 12
97–44, 1997–41 I.R.B. 8
97–45, 1997–41 I.R.B. 10
97–46, 1997–42 I.R.B. 10
97–47, 1997–42 I.R.B. 19
97–48, 1997–43 I.R.B. 19
97–49, 1997–43 I.R.B. 22
97–50, 1997–45 I.R.B. 8
97–51, 1997–45 I.R.B. 9
97–52, 1997–46 I.R.B.17
97–53, 1997–47 I.R.B.10
Revenue Rulings:
97–27, 1997–27 I.R.B. 4
97–28, 1997–28 I.R.B. 4
97–29, 1997–28 I.R.B. 4
97–30, 1997–31 I.R.B.12
97–31, 1997–32 I.R.B.4
97–32, 1997–33 I.R.B. 4
97–33, 1997–34 I.R.B. 4
97–34, 1997–34 I.R.B. 14
97–35, 1997–35 I.R.B. 4
97–36, 1997–36 I.R.B. 5
97–37, 1997–37 I.R.B.15
97–38, 1997–38 I.R.B.14
97–39, 1997–39 I.R.B. 4
97–40, 1997–39 I.R.B. 8
97–41, 1997–40 I.R.B. 4
97–42, 1997–41 I.R.B. 4
97–43, 1997–42 I.R.B. 8
97–44, 1997–45 I.R.B. 5
97–45, 1997–46 I.R.B.4
97–46, 1997–46 I.R.B.7
97–47, 1997–47 I.R.B.4
Treasury Decisions:
8722, 1997–29 I.R.B. 4
8723, 1997–30 I.R.B. 4
8724, 1997–36 I.R.B. 4
8725, 1997–37 I.R.B. 16
8726, 1997–34 I.R.B. 7
8727, 1997–34 I.R.B. 5
8728, 1997–37 I.R.B. 4
8729, 1997–38 I.R.B. 4
8730, 1997–38 I.R.B. 16
8731, 1997–42 I.R.B. 6
8732, 1997–42 I.R.B. 4
8733, 1997–43 I.R.B. 8
8734, 1997–44 I.R.B. 5
8735, 1997–43 I.R.B. 4
1
Acumulative list of all revenue rulings, revenue
procedures, Treasury decisions, etc., published in
Internal Revenue Bulletins 1997–1 through 1997–26
will be found in Internal Revenue Bulletin 1997–27,
dated July 7, 1997.

1997–48 I.R.B.29December 1, 1997
Finding List of Current Action on
Previously Published Items
1
Bulletins 1997–27 through 1997–47
*Denotes entry since last publication
Revenue Procedures:
82–36
Modified and superseded by
97–49, 1997–43 I.R.B. 22
96–36
Superseded by
97–34, 1997–30 I.R.B. 14
96–42
Superseded by
97–27, 1997–27 I.R.B. 9
97–32
Modified and amplified by
97–32A, 1997–34 I.R.B. 10
Revenue Rulings:
73–67
Revoked by
97–46, 1997–46 I.R.B. 7
89–42
Supplemented by
97–31, 1997–32 I.R.B. 4
93–76
Clarified, modified, partially
obsoleted, and superceded by
97–39, 1997–39 I.R.B 4
94–7
Clarified, modified, partially
obsoleted, and superceded by
97–39, 1997–39 I.R.B 4
1
Acumulative finding list for previously published
items mentioned in Internal Revenue Bulletins
1997–1 through 1997–26 will be found in Internal
Revenue Bulletin 1997–27, dated July 7, 1997.

Index
Internal Revenue Bulletins
1997–27 Through 1997–47
For the index of items published during
the first six months of 1997, see I.R.B.
1997–27, dated July 7, 1997.
The abbreviation and number in paren-
thesis following the index entry refer to
the specific item; numbers in roman and
italic type following the parenthesis refer
to the Internal Revenue Bulletin in which
the item may be found and the page
number on which it appears.
Key to Abbreviations:
RRRevenue Ruling
RPRevenue Procedure
TDTreasury Decision
CDCourt Decision
PLPublic Law
EOExecutive Order
DODelegation Order
TDOTreasury Department Order
TCTax Convention
SPRStatement of Procedural
Rules
PTEProhibited Transaction
Exemption
EMPLOYMENT TAX
Penalty:
Guidance regarding waiver of failure to
deposit penalty for certain taxpayers
required to begin using electronic
funds transfer on or after July 1,
1997 (Notice 43) 30, 86
Railroad retirement:
Rate determination; quarterly (July 1,
1997) 28, 5
Regulations:
26 CFR 31.0–1(a), 31.0–3(f), amended;
31.6302–1(h), added; 31.6302–1(i),
redesignated; 31.6302–1T, removed;
31.6302(c)–3, amended; 31.6302–3T,
removed; federal tax deposits by elec-
tronic funds transfer (TD 8723) 30, 4
26 CFR 31.3401(a)(6)–1, 31.3406–0,
31.3406(d)–3, 31.3406(h)–2, 31.6413-
(a)–3, amended; 31.3406(g)–1(e),
added; 31.9999–0, added effective
10/14/97; 31.9999–0, removed effec-
tive 1/1/99; 35a.9999–0T, removed
effective 10/14/97; 35a.9999–0,
added effective 10/14/97; 35a.9999–0,
–1, –2, –3, –3A, –4T, –5, removed ef-
fective 1/1/99; withholding of tax on
certain U.S. source income paid to
foreign persons (TD 8734) 44,5
26 CFR 301.6634–1, 301.6601–1,
301.6651–1, 1.6013–2(b)(1),
amended; 301.6656–3, added;
301.7122–1(e), revised; 301.7430–0,
–1, –2, –4, –5, amended; 301.7430–6,
revised; miscellaneous sections af-
fected by TBOR 2 and PRWORA
1996 (TD 8725) 37, 16
ESTATE TAX
Marital or charitable bequests (CtD 2062)
32, 8
26 CFR 301.6634–1, 301.6601–1,
301.6651–1, 1.6013–2(b)(1), amended;
301.6656–3, added; 301.7122–1(e), re-
vised; 301.7430–0, –1, –2, –4, –5,
amended; 301.7420–6, revised; miscel-
laneous sections affected by TBOR 2
and PRWORA1996 (TD 8725) 37, 16
EXCISE TAX
Group health plans; access, portability,
and renewability requirements; correc-
tion (Notice 41) 28, 6
Regulations:
26 CFR 40.6302(c)–1, amended;
40.6302(c)–1T, removed; federal tax
deposits by electronic funds transfer
(TD 8723) 30, 4
26 CFR 301.6634–1, 301.6601–1,
301.6651–1, 1.6013–2(b)(1), amended;
301.6656–3, added; 301.7122–1(e), re-
vised; 301.7430–0, –1, –2, –4, –5,
amended; 301.7420– 6, revised; mis-
cellaneous sections affected by TBOR
2 and PRWORA1996 (TD 8725)
37, 16
Rural airport list (RP46) 42, 10
GIFTTAX
Regulations:
26 CFR 301.6634–1, 301.6601–1,
301.6651–1, 1.6013–2(b)(1), amended;
301.6656–3, added; 301.7122–1(e), re-
vised; 301.7430–0, –1, –2, –4, –5,
amended; 301.7420–6, revised; miscel-
laneous sections affected by TBOR 2
and PRWORA1996 (TD 8725) 37, 16
INCOMETAX
Accuracy-related penalty, TD 8656 cor-
rection (Notice 55) 40, 6
Allocation of interest expense among
taxpayer’s expenditures (Notice 46)
34, 10
Automatic relief for S elections (RP48)
43, 19
Calculation of partner’s limited deficit
restoration obligation (RR 38) 38, 14
Capital gain dividends by RICs or REITs;
designation of classes (Notice 64) 47,
7
Capital gains and losses; rates (Notice 59)
45, 7
Changes to RP96–11 (Notice 48) 37, 5
Charitable contributions; business ex-
penses (RP52) 46, 17
Consent to change accounting method to
comply with section 475 mark-to-market
rules (RP43) 39, 12
Depreciation:
Retail motor fuels outlet (RR29) 28, 4
Elections into mark-to-market account-
ing (Notice 37) 27, 8
Education incentives; credits; interest de-
duction; individual retirement accounts
(Notice 60) 46, 8
Electing Small Business Trust (ESBT)
qualification (Notice 49) 36, 8
Electronic filing of Form 941, Employer’s
Quarterly Federal Tax Return (RP47)
42, 19
Electronic or magnetic media filing:
Specifications for 1997 Forms 1098,
1099, 5498, and W–2G (RP34) 30,
14
Employee plans:
Cost-of-living adjustments, 1998 (No-
tice 58) 45, 7
Covered compensation tables; 1998
(RR 45) 46, 4
Delegation of authority (DO 97 (Rev.
34)) 41, 14
Highly compensated employee, defini-
tion (Notice 45) 33, 7
Individual retirement plans, definition of
academic period (Notice 53) 40, 6
Organizations, functions, and authority
delegations; director, Employee
Plans Division (DO 172(Rev. 5)) 28,
6
Remedial amendment period extension
(RP41) 33, 51
Funding:
Full funding limitations, weighted av-
erage interest rate, July 1997 (Notice
44) 31, 15; August 1997 (Notice 47)
35, 5; September 1997 (Notice 51)
38, 20; October 1997 (Notice 56) 43,
19
December 1, 1997301997–48 I.R.B.

Enhanced oil recovery credit for 1997
(Notice 39) 27, 8
Extension of time to file, Form 926 (No-
tice 42) 29, 12
Forms 1096, 1098, 1099 series, 5498,
W–2G:
Reproduction of forms; RP97–32, mod-
ified and amplified (RP97–32A) 34,
10;Requirements for reproducing
paper substitutes (RP27) 27, 9
Fringe benefits aircraft valuation formula
(RR 33) 34, 4
Insurance companies; segregated asset ac-
counts (RR 46) 46, 7
Intercompany transactions on separate en-
tity basis (RP49) 43, 22
Interest:
Investment:
Federal short-term, mid-term, and
long-term rates for July 1997 (RR 27)
27, 4; August 1997 (RR 30) 31, 12;
September 1997 (RR 36) 36, 5;
October 1997 (RR 41) 40,4; Novem-
ber 1997 (RR 44) 45, 5
Rates:
Underpayments and overpayments for
calendar quarter beginning October 1,
1997 (RR 40) 39, 8
International operation of ships and air-
craft; income exempt from tax (RR 31) 32,
4
Inventories:
LIFO:
Automobile dealers (RR 42) 41, 4;
(RP44) 41, 8
Price indexes, department stores,
May 1997 (RR 28) 28, 4; June
1997 (RR 32) 33, 4; July 1997
(RR 37) 37, 15; August 1997 (RR
43) 42,8; September 1997 (RR
47) 47, 4
Late S corporation elections (RP40) 33, 50
Low-income housing:
Bond factor amounts, July–September
1997 (RR 34) 34, 4
Tax credit (RP42) 33, 57
Marginal production rates for 1997 (No-
tice 38) 27, 8
Mark-to-market accounting method for
dealers in securities (RR 39) 39, 4
Material limitation on surviving spouse’s
right to income (Notice 63) 47, 6
Methods of accounting:
Automatic consent to change (RP37)
33, 18
Last-in, first-out inventory method (RP
36) 33, 14
Original issue discount (RP39) 33, 48
Package design costs (RP35) 33, 11
Warranty contracts (RP38) 33, 43
Mutual life insurance companies; differ-
ential earnings rate (RR 35) 35, 4
Optional rules for substantiating certain
travel etc., expenses (RP45) 41, 10
Private delivery services; timely filing or
payment (Notice 50) 37, 21
Proposed regulations:
26 CFR 1.263A–0, amended; rules for
property produced in a farming busi-
ness (REG–208151–91) 38,
21
26 CFR 1.401(b)–1; remedial amend-
ment period (REG–106043–97) 37, 24
26 CFR 1.411(d)–4, amended; permitted
elimination of preretirement optional
forms benefit (REG–107644–97)
32, 24
26 CFR 1.465–27, added; qualified
nonrecourse financing under section
465(b)(6) (REG–105160–97) 37, 22
26 CFR 1.894–1(d), added; guidance
regarding claims for certain income
tax convention (REG–104893–97)
29, 13
26 CFR 1.1441–1 (e)(4)(iv), revised;
Form W–8, electronic filing
(REG–107872–97) 47, 11
26 CFR 1.1441–3(b), revised; sales of
obligations between interest pay-
ment dates; Withholding on interest
(REG–114000–97) 47, 13
26 CFR 301.6104(e)–0, –1, –2, –3,
added; tax-exempt organizations,
public disclosure requirements,
guidance availability and hearing
(REG–246250–96) 42, 30
Punitive damages for personal injuries
(CtD 2061) 31, 5
Qualified state tuition programs (Notice
52) 38, 20
Regulations:
26 CFR 1.42–15, added; low-income
housing tax credit, available unit rule
(TD 8732) 42, 4
26 CFR 1.42–16, added; 1.42–16T, re-
moved; low-income housing tax
credit, federal grants (TD 8731) 42, 6
26 CFR 1.61–4, 1.162–12(a), 1.263A–
1, 1.471–6, amended; 1.263A–4T, re-
vised; rules for property produced in
a farming business (TD 8729) 38, 4
26 CFR 1.163–5(c)(2)(i)(B)(5),
1.165–12, 1.817–7, 1.1441–8, 1.1445–5,
1.6041–1, –2, –3, 1.6041–7, 1.6042–2,
–4, 1.6043–2, 1.6044–2, 1.6045–1, –2,
1.6049–4, –5, –6, –7, –8(a), 1.6050A,
1.6050H–1, 1.6050N–1, 1.6071–1,
301.6109–1, 301.6114–1,301.6402–3,
301.6721–0, 1.1441–3, 1.871–14,
1.1441–0, –9, 1.1442–3, 1.6041–8,
1.6041A–1, added; 1.871–6,1.1441–1,
–2, –5, –6,1.1442–1, –2, 1.1443–1,
1.1461–1, –2, 1.1462–1, 1.1463–1,
1.6041–4, 1.6044–3, –5, 1.6091–1-
(b)(15),revised; 1.1441–4T, 1.1461–3,
–4, 1.6045–1T, –2T, removed;
1.1441–8T,redesignated; withhold-
ing of tax on certain U.S. source in-
come paid to foreign persons and re-
lated collection, refunds, and credits
(TD 8734) 44, 5
26 CFR 1.263A–0, –1, –15, amended;
1.263A, added; 1.263A–7T, re-
moved; procedure for changing a
method of accounting under section
263A(TD 8728) 37, 4
26 CFR 1.302–2, amended; 1.1059-
(e)(1), added; extraordinary divi-
dends (TD 8724) 36, 4
26 CFR 1.401(b)–1, amended; 1.401-
(b)–1T, added; remedial amendment
period (TD 8727) 34, 5
26 CFR 1.501(c)(5)–1, amended; tax-
exempt organizations, requirements
(TD 8726) 34, 7
26 CFR 1.704–3, 1.1245–1, amended;
allocations of depreciation recapture
among partners in a partnership (TD
8730) 38, 16
26 CFR 1.861–2, 1.864–5, 1.871–7,
1.881–2, 1.884–1, 1.7701(1)–1; se-
curities lending transactions, certain
payments made (TD 8735) 43, 4
26 CFR 1.894–1T(a) through (c),
added; guidance regarding claims for
certain income tax convention (TD
8722) 29, 4
26 CFR 1.6038–2, 1.6046–1(g),
301.6114–1, 301.7701(b)–0, –3, –7,
–8; treaty-based return positions (TD
8733) 43, 8
26 CFR 1.6302–1, –2, amended;
1.6302–1T, –2T, –3T, –4T, removed;
1.6302–3(c), revised; 1.6302–4,
added; federal tax deposits by elec-
tronic funds transfer (TD 8723) 30, 4
1997–48 I.R.B.31December 1, 1997
INCOMETAX—ContinuedINCOMETAX—ContinuedINCOMETAX—Continued

December 1, 1997321997–48 I.R.B.
26 CFR 301.6334–1, 301.6601–1,
301.6651–1, 1.6013–2(b)(1), amended;
301.6656–3, added; 301.7122–1(e), re-
vised; 301.7430–0, –1, –2, –4, –5,
amended; 301.7430–6, revised; miscel-
laneous sections affected by TBOR 2
and PRWORA1996 (TD 8725) 37, 16
Section 911(d)(4) waiver (RP51) 45,9
Tax forms and instructions:
Electronic Federal Tax Payment Sys-
tem (EFTPS); electronic remittance
system for federal tax deposits and
payments (RP33) 30, 10
Taxpayer Browsing Protection Act (PL
105–35) 43, 13
Treatment of Hong Kong and China
(Notice 40) 28, 6
Work Opportunity and Welfare-to-Work
tax credits (Notice 54) 41, 7
Year 2000 costs; computer software (RP
50) 45, 8
INCOMETAX—ContinuedINCOMETAX—ContinuedINCOMETAX—Continued

Notes
1997–48 I.R.B.33December 1, 1997

Notes
December 1, 1997341997–48 I.R.B.

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INTERNAL REVENUE BULLETIN
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