Part I. Rulings — Internal Revenue Bulletin 1996-20

subject to a lease must be depreciated using the straight-line method over a period equal to the greater of the property’s class life or 125 percent of the lease term. Under section 168(i)(3), options to renew generally must be taken into account in determining the lease term and the periods of certain successive leases must be aggregated with the period of an original lease.

Lease term

The proposed regulations generally include an additional period of time during which a lessee may not continue to be the lessee in the lease term if the lessee (or a related person) has agreed that one or both of them will or could be obligated to make a payment of rent, or a payment in the nature of rent, with respect to such period. The arrangements described in the proposed regulations are frequently referred to as ‘‘replacement leases.’’ One commentator requested that the portion of the proposed regulations dealing with replacement leases be withdrawn. The commentator argued that Congress would not have intended that the term of the replacement lease be taken into account in determining lease term. The IRS and Treasury believe that the proposed regulations are consistent with Congressional intent, and thus the final regulations retain this portion of the proposed regulations.

Another commentator indicated that application of the proposed regulations was unclear where property is subject to multiple leases, possibly involving multiple parties. The final regulations clarify that if property is subject to more than one lease (including any sublease) entered into as part of a single transaction (or a series of related transactions), the lease term shall include all periods described in one or more of such leases. Thus, for example, if one taxable corporation leases property to another taxable corporation for a 20-year term and, as part of the same transaction, the lessee subleases the property to a tax-exempt entity for a 10-year term, then the lease term of the property is 20 years, and during the period of tax-exempt use it must be depreciated using the straight line method over the greater of its class life or 25 years.

Finally, the final regulations provide that lease term also includes any period

Section 167.—Depreciation

If a taxpayer changes from claiming less than the allowable depreciation to claiming the allowable depreciation for property subject to section 167, is this change a change in method of accounting. See Rev. Proc. 96–31, page 11.

26 CFR 1.167(e)–1: Change in method.

If a taxpayer changes from claiming less than the allowable depreciation to claiming the allowable depreciation, is this change a change in method of accounting. See Rev. Proc. 96–31, page 11.

Section 168.—Accelerated Cost Recovery System

26 CFR 1.168(h)(1): Like-kind exchanges involving tax-exempt use property.

T.D. 8667

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Lease Term; Exchanges of Tax- Exempt Use Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the lease term of tax-exempt use property. The final regulations also provide guidance regarding certain like-kind exchanges among related parties involving taxexempt use property.

DATES: These regulations are effective April 29, 1996.

For dates of applicability see ‘‘Effective dates’’ section under the ‘‘SUPPLEMENTARY INFORMATION’’ portion of the preamble and §§1.168(h)–1(e) and 1.168(i)–2(g).

FOR FURTHER INFORMATION CONTACT: John M. Aramburu of the Office of Assistant Chief Counsel (Income Tax and Accounting) at (202) 622-4960 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains final regulations under section 168 of the Internal Revenue Code of 1986 (Code). The regulations provide guidance relating to certain exchanges of tax-exempt use property among related parties and the determination of lease term under certain circumstances. Proposed regulations (IA–18–95 [1995–1 C.B. 955]) were published in the Federal Register on April 21, 1995 (60 FR 19868). The IRS received a number of comments on the proposed regulations. A scheduled public hearing was cancelled because there were no requests to testify. After consideration of all the comments, the regulations proposed by IA–18–95 are adopted as revised by this Treasury decision. The revisions are discussed below.

Overview

Under section 168, property used in a trade or business, or held for the production of income, generally may be depreciated under the general depreciation system (GDS) using accelerated methods over relatively short recovery periods. However, certain property, including ‘‘tax-exempt use property,’’ must be depreciated under the alternative depreciation system (ADS) described in section 168(g). Section 168(h)(1)(A) generally defines taxexempt use property to include tangible property (other than nonresidential real property) leased to a tax-exempt entity. For this purpose, certain foreign entities and persons are considered taxexempt entities.

Congress subjected tax-exempt use property to a slower depreciation system than GDS to prevent tax-exempt entities from indirectly claiming tax benefits (in the form of reduced rentals) ‘‘from investment incentives for which they [would] not qualify directly, and effectively gain[ing] the advantage of taking income tax deductions and credits while having no corresponding liability to pay any tax on income from the property.’’ S. Rep. No. 169 (Vol. 1), 98th Cong., 2d Sess. 123 (1984). In particular, section 168(g)(3)(A) provides that tax-exempt use property

(Income Tax and Accounting). However, other personnel from the IRS and Treasury Department participated in their development.

- - - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * - Section 1.168(h)–1 also issued under 26 U.S.C. 168. * - Section 1.168(i)–2 also issued under 26 U.S.C. 168. * - Par. 2. Sections 1.168(h)–1 and 1.168(i)–2 are added to read as follows:

§1.168(h)–1 Like-kind exchanges involving tax-exempt use property .

(a) Scope . (1) This section applies with respect to a direct or indirect transfer of property among related persons, including transfers made through a qualified intermediary (as defined in §1.1031(k)–1(g)(4)) or other unrelated person, (a transfer) if—

(i) Section 1031 applies to any party to the transfer or to any related transaction; and

(ii) A principal purpose of the transfer or any related transaction is to avoid or limit the application of the alternative depreciation system (within the meaning of section 168(g)).

(2) For purposes of this section, a person is related to another person if they bear a relationship specified in section 267(b) or section 707(b)(1).

(b) Allowable depreciation deduction for property subject to this section —(1) In general . Property (tainted property) transferred directly or indirectly to a taxpayer by a related person (related party) as part of, or in connection with, a transaction in which the related party receives tax-exempt use property (related tax-exempt use property) will, if the tainted property is subject to an allowance for depreciation, be treated in the same manner as the related taxexempt use property for purposes of determining the allowable depreciation

during which the lessee (or a related party) has assumed or retained any risk of loss with respect to the property (including, for example, by holding a note secured by the property). The IRS and Treasury believe that such an arrangement is generally similar to the replacement leases described in the proposed regulations. As in the case of a replacement lease, the lessee is assuming risk with respect to the value of the property at the termination of the initial lease term. In addition, the term of the debt provides an objective indication that the useful life of the property exceeds the original term of the lease, in which case failure to include the term of the debt in the lease term could allow a tax-exempt lessee to benefit from depreciation deductions that exceed economic depreciation, which would be contrary to Congressional intent.

Like-kind exchanges

The proposed regulations also address certain transactions between related persons that are designed to circumvent the tax-exempt use property rules through the use of a like-kind exchange described in section 1031. The proposed regulations provide that property (tainted property) transferred directly or indirectly to the taxpayer by a related person (the related party) as part of, or in connection with, a transaction described in section 1031 where the related party receives taxexempt use property (related taxexempt use property) will, if the tainted property is subject to an allowance for depreciation, be treated in the same manner as the related tax-exempt use property for purposes of determining the allowable depreciation deduction under section 167(a). Under this rule, the tainted property is depreciated by the taxpayer over the remaining recovery period of, and using the same depreciation method and convention as that of, the related tax-exempt use property.

The rule applies only with respect to direct or indirect transfers of property involving related persons where (1) section 1031 applies to any party, and (2) a principal purpose of the transfer is to avoid or limit the application of ADS. For purposes of this rule, a person is related to another person if they bear a relationship specified in section 267(b) or section 707(b)(1). An exchange between members of a con

solidated group in a taxable year beginning on or after July 12, 1995, will not be subject to this provision because section 1031 does not apply to intercompany transactions. See §1.1502–80(f).

No comments were received with respect to the treatment of like-kind exchanges under the proposed regulations. Accordingly, these provisions of the proposed regulations are adopted without modification by this Treasury decision.

Effective dates

The definition of lease term is generally applicable to leases entered into on or after April 20, 1995. The changes made by the final regulations apply to leases entered into after April 26, 1996. The treatment of like-kind exchanges is applicable to transfers made on or after April 20, 1995. No inference is intended by these effective dates as to the treatment of any transaction under prior law. The regulations do not preclude the application of common law doctrines (such as the substance over form or step transaction doctrines) and other authorities to transactions described in the regulations ( e.g., as to whether a particular transaction should be characterized as a lease or a conditional sale for federal income tax purposes).

Special analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and therefore, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

The principal author of these regulations is John M. Aramburu of the Office of Assistant Chief Counsel

deduction under section 167(a). Under this paragraph (b), the tainted property is depreciated by the taxpayer over the remaining recovery period of, and using the same depreciation method and convention as that of, the related tax-exempt use property.

(2) Limitations —(i) Taxpayer’s basis in related tax-exempt use property . The rules of this paragraph (b) apply only with respect to so much of the taxpayer’s basis in the tainted property as does not exceed the taxpayer’s adjusted basis in the related tax-exempt use property prior to the transfer. Any excess of the taxpayer’s basis in the tainted property over its adjusted basis in the related tax-exempt use property prior to the transfer is treated as property to which this section does not apply. This paragraph (b)(2)(i) does not apply if the related tax-exempt use property is not acquired from the taxpayer ( e.g., if the taxpayer acquires the tainted property for cash but section 1031 nevertheless applies to the related party because the transfer involves a qualified intermediary).

(ii) Application of section 168(i)(7) . This section does not apply to so much of the taxpayer’s basis in the tainted property as is subject to section 168(i)(7). (c) Related tax-exempt use property . (1) For purposes of paragraph (b) of this section, related tax-exempt use property includes—

(i) Property that is tax-exempt use property (as defined in section 168(h)) at the time of the transfer; and

(ii) Property that does not become tax-exempt use property until after the transfer if, at the time of the transfer, it was intended that the property become tax-exempt use property.

(2) For purposes of determining the remaining recovery period of the related tax-exempt use property in the circumstances described in paragraph (c)(1)(ii) of this section, the related taxexempt use property will be treated as having, prior to the transfer, a lease term equal to the term of any lease that causes such property to become taxexempt use property.

(d) Examples . The following examples illustrate the application of this section. The examples do not address common law doctrines or other authorities that may apply to recharacterize or alter the effects of the transactions described therein. Unless otherwise indicated, parties to the

transactions are not related to one another.

Example 1 . (i) X owns all of the stock of two subsidiaries, B and Z. X, B and Z do not file a consolidated federal income tax return. On May 5, 1995, B purchases an aircraft ( FA ) for $1 million and leases it to a foreign airline whose income is not subject to United States taxation and which is a tax-exempt entity as defined in section 168(h)(2). On the same date, Z owns an aircraft ( DA ) with a fair market value of $1 million, which has been, and continues to be, leased to an airline that is a United States taxpayer. Z’s adjusted basis in DA is $0. The next day, at a time when each aircraft is still worth $1 million, B transfers FA to Z (subject to the lease to the foreign airline) in exchange for DA (subject to the lease to the airline that is a United States taxpayer). Z realizes gain of $1 million on the exchange, but that gain is not recognized pursuant to section 1031(a) because the exchange is of like-kind properties. Assume that a principal purpose of the transfer of DA to B or of FA to Z is to avoid the application of the alternative depreciation system. Following the exchange, Z has a $0 basis in FA pursuant to section 1031(d). B has a $1 million basis in DA.

(ii) B has acquired property from Z, a related person; Z’s gain is not recognized pursuant to section 1031(a); Z has received tax-exempt use property as part of the transaction; and a principal purpose of the transfer of DA to B or of FA to Z is to avoid the application of the alternative depreciation system. Accordingly, the transaction is within the scope of this section. Pursuant to paragraph (b) of this section, B must recover its $1 million basis in DA over the remaining recovery period of, and using the same depreciation method and convention as that of, FA, the related tax-exempt use property.

(iii) If FA did not become tax-exempt use property until after the exchange, it would still be related tax-exempt use property and paragraph (b) of this section would apply if, at the time of the exchange, it was intended that FA become tax-exempt use property.

Example 2 . (i) X owns all of the stock of two subsidiaries, B and Z. X, B and Z do not file a consolidated federal income tax return. B and Z each own identical aircraft. B’s aircraft ( FA ) is leased to a tax-exempt entity as defined in section 168(h)(2) and has a fair market value of $1 million and an adjusted basis of $500,000. Z’s aircraft ( DA ) is leased to a United States taxpayer and has a fair market value of $1 million and an adjusted basis of $10,000. On May 1, 1995, B and Z exchange aircraft, subject to their respective leases. B realizes gain of $500,000 and Z realizes gain of $990,000, but neither person recognizes gain because of the operation of section 1031(a). Moreover, assume that a principal purpose of the transfer of DA to B or of FA to Z is to avoid the application of the alternative depreciation system.

(ii) As in Example 1, B has acquired property from Z, a related person; Z’s gain is not recognized pursuant to section 1031(a); Z has received tax-exempt use property as part of the transaction; and a principal purpose of the transfer of DA to B or of FA to Z is to avoid the application of the alternative depreciation system. Thus, the transaction is within the scope of this section even though B has held tax-exempt use property for a period of time and, during that time, has used the alternative depreciation system with respect to such property. Pursuant to

paragraph (b) of this section, B, which has a substituted basis determined pursuant to section 1031(d) of $500,000 in DA, must depreciate the aircraft over the remaining recovery period of FA, using the same depreciation method and convention. Z holds tax-exempt use property with a basis of $10,000, which must be depreciated under the alternative depreciation system.

(iii) Assume the same facts as in paragraph (i) of this Example 2, except that B and Z are members of an affiliated group that files a consolidated federal income tax return. Of B’s $500,000 basis in DA, $10,000 is subject to section 168(i)(7) and therefore not subject to this section. The remaining $490,000 of basis is subject to this section. But see §1.1502–80(f) making section 1031 inapplicable to intercompany transactions occurring in consolidated return years beginning on or after July 12, 1995.

(e) Effective date . This section applies to transfers made on or after April 20, 1995.

§1.168(i)–2 Lease term .

(a) In general . For purposes of section 168, a lease term is determined under all the facts and circumstances. Paragraph (b) of this section and §1.168(j)–1T, Q&A 17, describe certain circumstances that will result in a period of time not included in the stated duration of an original lease (additional period) nevertheless being included in the lease term. These rules do not prevent the inclusion of an additional period in the lease term in other circumstances.

(b) Lessee retains financial obliga- tion —(1) In general . An additional period of time during which a lessee may not continue to be the lessee will nevertheless be included in the lease term if the lessee (or a related person)—

(i) Has agreed that one or both of them will or could be obligated to make a payment of rent or a payment in the nature of rent with respect to such period; or

(ii) Has assumed or retained any risk of loss with respect to the property for such period (including, for example, by holding a note secured by the property).

(2) Payments in the nature of rent . For purposes of paragraph (b)(1)(i) of this section, a payment in the nature of rent includes a payment intended to substitute for rent or to fund or supplement the rental payments of another. For example, a payment in the nature of rent includes a payment of any kind (whether denominated as supplemental

rent, as liquidated damages, or otherwise) that is required to be made in the event that—

(i) The leased property is not leased for the additional period;

(ii) The leased property is leased for the additional period under terms that do not satisfy specified terms and conditions;

(iii) There is a failure to make a payment of rent with respect to such additional period; or

(iv) Circumstances similar to those described in paragraph (b)(2)(i), (ii), or (iii) of this section occur.

(3) De minimis rule . For the purposes of this paragraph (b), obligations to make de minimis payments will be disregarded.

(c) Multiple leases or subleases . If property is subject to more than one lease (including any sublease) entered into as part of a single transaction (or a series of related transactions), the lease term includes all periods described in one or more of such leases. For example, if one taxable corporation leases property to another taxable corporation for a 20-year term and, as part of the same transaction, the lessee subleases the property to a tax-exempt entity for a 10-year term, then the lease term of the property for purposes of section 168 is 20 years. During the period of tax-exempt use, the property must be depreciated under the alternative depreciation system using the straight line method over the greater of its class life or 25 years (125 percent of the 20-year lease term).

(d) Related person . For purposes of paragraph (b) of this section, a person is related to the lessee if such person is described in section 168(h)(4).

(e) Changes in status . Section 168(i)(5) (changes in status) applies if an additional period is included in a lease term under this section and the leased property ceases to be tax-exempt use property for such additional period.

(f) Example . The following example illustrates the principles of this section. The example does not address common law doctrines or other authorities that may apply to cause an additional period to be included in the lease term or to recharacterize a lease as a conditional sale or otherwise for federal income tax purposes. Unless otherwise indicated, parties to the transactions are not related to one another.

Example . Financial obligation with respect to an additional period —(i) Facts . X, a taxable

corporation, and Y, a foreign airline whose income is not subject to United States taxation, enter into a lease agreement under which X agrees to lease an aircraft to Y for a period of 10 years. The lease agreement provides that, at the end of the lease period, Y is obligated to find a subsequent lessee (replacement lessee) to enter into a subsequent lease (replacement lease) of the aircraft from X for an additional 10-year period. The provisions of the lease agreement require that any replacement lessee be unrelated to Y and that it not be a tax-exempt entity as defined in section 168(h)(2). The provisions of the lease agreement also set forth the basic terms and conditions of the replacement lease, including its duration and the required rental payments. In the event Y fails to secure a replacement lease, the lease agreement requires Y to make a payment to X in an amount determined under the lease agreement.

(ii) Application of this section . The lease agreement between X and Y obligates Y to make a payment in the event the aircraft is not leased for the period commencing after the initial 10year lease period and ending on the date the replacement lease is scheduled to end. Accordingly, pursuant to paragraph (b) of this section, the term of the lease between X and Y includes such additional period, and the lease term is 20 years for purposes of section 168.

(iii) Facts modified . Assume the same facts as in paragraph (i) of this Example, except that Y is required to guarantee the payment of rentals under the 10-year replacement lease and to make a payment to X equal to the present value of any excess of the replacement lease rental payments specified in the lease agreement between X and Y, over the rental payments actually agreed to be paid by the replacement lessee. Pursuant to paragraph (b) of this section, the term of the lease between X and Y includes the additional period, and the lease term is 20 years for purposes of section 168.

(iv) Changes in status . If, upon the conclusion of the stated duration of the lease between X and Y, the aircraft either is returned to X or leased to a replacement lessee that is not a tax-exempt entity as defined in section 168(h)(2), the subsequent method of depreciation will be determined pursuant to section 168(i)(5).

(g) Effective date —(1) In general . Except as provided in paragraph (g)(2) of this section, this section applies to leases entered into on or after April 20, 1995. (2) Special rules . Paragraphs (b)(1)(ii) and (c) of this section apply to leases entered into after April 26, 1996.

Margaret Milner Richardson, Commissioner of Internal Revenue

Approved March 26, 1996.

Leslie Samuels, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on

April 26, 1996, 8:45 a.m., and published in the issue of the Federal Register for April 29, 1996, 61 F.R. 18675)

Section 168.—Accelerated Cost Recovery System

If a taxpayer changes from claiming less than the allowable depreciation to claiming the allowable depreciation for property subject to section 168, is this change a change in method of accounting. See Rev. Proc. 96–31, page 11.

Section 197.—Amortization of Goodwill and Certain Other Intangibles

If a taxpayer changes from claiming less than the allowable amortization to claiming the allowable amortization for an amortizable section 197 intangible, is this change a change in method of accounting. See Rev. Proc. 96–31, page 11.

Section 446.—General Rule for Methods of Accounting

If a taxpayer changes from claiming less than the allowable depreciation or amortization to claiming the allowable depreciation or amortization, is this change a change in method of accounting. See Rev. Proc. 96–31, page 11.

26 CFR 1.446–1: General rule for methods of accounting.

Section 6049.—Returns Regarding Payments of Interest

26 CFR 1.6049–4: Return of information as to interest paid and original issue discount includible in gross income after December 31, 1982.

T.D. 8664

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 31 and 602

Information Reporting and Backup Withholding

Agency: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations that provide rules

regarding the reporting on Form 1042– S of certain bank deposit interest paid with respect to a United States bank account to an individual who is a nonresident alien of the United States and a resident of Canada. The IRS has determined that information concerning those deposits would be of significant use in furthering its compliance efforts, which include exchange of tax information with Canada.

EFFECTIVE DATE: January 1, 1997.

FOR FURTHER INFORMATION CONTACT: Teresa Burridge Hughes, (202) 622-3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this final regulation has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545–0096. Responses to this collection of information are mandatory.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number.

The estimated annual burden per respondent/recordkeeper is approximately .10 hour, depending on individual circumstances.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington DC 20224, and the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This document contains final regulations to be added to the Income Tax Regulations (26 CFR part 1) under section 6049 of the Internal Revenue Code (Code). The final regulations provide rules regarding reporting on Form 1042–S of certain bank deposit interest paid with respect to a United States bank account to a nonresident alien individual who is a resident of Canada.

Proposed regulations on this subject were set forth, at §§1.6049–5(e)(2), 1.6049–6(e)(6), and 31.3406(a)–3(b)(1), in a notice of proposed rulemaking published in the Federal Register (53 FR 5991) on February 29, 1988

[INTL–52–86 (1988–1 C.B. 892)]. The IRS received comments on the proposed regulations and held a public hearing on June 15, 1989. Having considered the comments and the statements made at the hearing, the IRS and the Treasury Department adopt the proposed regulations as modified by this Treasury decision.

Explanation of Provisions

A. Reporting of payments to

Canadians

This Treasury decision requires reporting on a Form 1042–S of certain interest paid on deposits maintained at a bank’s office within the United States when paid to a nonresident alien individual who is a resident of Canada. However, interest on certain bearer certificates of deposit targeted to foreign persons is excepted from the reporting requirement if the interest is paid outside the United States. This final regulation makes an exception to the current rule, based on §1.6049– 5(b), that certain interest amounts paid to non-U.S. persons is not subject to reporting if a statement certifying nonU.S. status is furnished to the payor or middleman on a Form W–8 (Certificate of Foreign Status), as described in §1.6049–5(b)(2)(iv). However, although bank deposit interest paid to Canadians is made subject to reporting under this final regulation, backup withholding under section 3406 is not required. Further, in response to suggestions from commentators that segregating interest amounts on the basis of residence would be burdensome, this final regulation allows payors volun

tarily to report on a Form 1042–S payments to all foreign persons receiving bank deposit interest without segregating on the basis of residency.

The payor determines whether a payee is a Canadian resident based on the address in the country of permanent residence required to be provided on the Form W–8. However, if the payor has actual knowledge that the payee is a U.S. person, Form 1099 reporting provisions apply.

See proposed regulations published elsewhere in this issue of the Federal Register regarding proposed changes to the notice of proposed rulemaking published in the Federal Register on February 29, 1988.

B. Comments on Canadian reporting

provisions

Commentors stated that imposing information reporting with respect to deposits of nonresident aliens may undercut the competitiveness of U.S. banks. The IRS and Treasury considered these comments but, in light of our obligations under the United StatesCanada income tax treaty and the reporting by Canadian banks of U.S. depositor interest to Canadian tax authorities, have decided to finalize these proposed regulations.

In response to comments that the reporting requirement be delayed, or at least that a transition period be allowed, because of the time required to identify Canadian account holders and to modify processing systems for reporting purposes, the new reporting requirement will be phased in over a three-year period, starting with payments made on or after January 1, 1997. On or after that date, payors will identify Canadian account holders as Forms W–8 are received from new depositors or renewed by existing depositors. Upon identifying account holders as Canadians, payors must begin reporting bank deposit interest paid to those persons.

Commentors also requested that the IRS develop and permit Form 1042–S reporting on magnetic diskette, as is allowed for Form 1099 filings; permit the Form 1042–S to be the transmittal document for the Form 1042–S filing; and allow financial institutions to file separate tapes or diskettes for each area of the bank, rather than bank-wide. These filing changes have previously been made by the IRS and require no further action.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, a Regulatory Flexibility Analysis is not required.

Drafting Information

The principal author of these regulations is Teresa Burridge Hughes, Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

- - - - -

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 31 and 602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority for part 1 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * - Sections 1.6049–4 also issued under 26 U.S.C. 6049(a), (b), (c), and (d). Section 1.6049–5 also issued under 26 U.S.C. 6049(a), (b), (c), and (d).

- Par. 2. Section 1.6049–4 is amended by:

Removing the reference ‘‘(b)(3)’’ and adding ‘‘(b)(3) and (b)(5)’’ in its place in the first sentence of paragraphs (b)(1) and (b)(2) introductory text.
Revising the first sentence of paragraphs (b)(3) and (b)(4).
Adding paragraph (b)(5).
Removing the authority citation at the end of the section.

The revisions and addition read as follows:

§1.6049–4 Return of information as to interest paid and original issue discount includible in gross income after December 31, 1982 .

(b) - - (3) - - - Except as provided in paragraph (b)(5) of this section, every person acting as a middleman (as defined in paragraph (f)(4) of this section) shall make an information return on Forms 1096 and 1099 for the calendar year. * - (4) - - - Except as provided in paragraph (b)(5) of this section, every person carrying on the banking business who makes payments of interest to another person (whether or not aggregating $10 or more) during a calendar year with respect to a certificate of deposit issued in bearer form shall make an information return on Forms 1096 and 1099. * - (5) Interest payments to Canadian nonresident alien individuals —(i) Gen- eral rule . In the case of interest paid to a Canadian nonresident alien individual (as described in §1.6049–8(a)), the payor or middleman shall make an information return on Form 1042–S for the calendar year in which the interest is paid. The payor or middleman shall prepare and transmit Form 1042–S at the time and in the manner prescribed by section 1461 and the regulations under that section and by the form and its accompanying instructions. See §1.6049–6(e)(4) for furnishing a copy of the Form 1042–S to the payee. To determine whether an information return is required for original issue discount, see §§1.6049–5(c) and 1.6049–8(a). (ii) Effective date . Paragraph (b)(5)(i) of this section shall be effective for payments made after December 31, 1996 with respect to a Form W–8 (Certificate of Foreign Status) furnished to the payor or middleman after that date.

- - - - -

Par. 3. Section 1.6049–5 is amended by:

Revising the introductory text of paragraph (b)(1).
Revising the last sentence in paragraph (c).
Removing authority citation at the end of the section.

The revisions read as follows:

§1.6049–5 Interest and original issue discount subject to reporting after December 31, 1982 .

- - - - -

(b) - - - (1) * - - Subject to the provisions of §1.6049–8, the term interest does not include:

- - - - -

(c) - - - Original issue discount on an obligation (including an obligation with a maturity of not more than 6 months from the date of original issue) held by a nonresident alien individual or foreign corporation is interest described in paragraph (b)(1)(vi)(A) or (B) of this section and, therefore is not interest subject to reporting under section 6049 unless it is described in §1.6049–8(a) (relating to bank deposit interest paid to a Canadian nonresident alien individual).

Par. 4. Section 1.6049–6 is amended by:

Redesignating paragraph (e)(4) as paragraph (e)(5).
Adding new paragraph (e)(4). The addition reads as follows:

§1.6049–6 Statements to recipients of interest payments and holders of obligations for attributed original issue discount.

* * * * * *

(e) - - (4) Special rule for amounts de- scribed in §1.6049–8(a) paid after December 31, 1996 . In the case of amounts described in §1.6049–8(a) (relating to payments of interest to Canadian nonresident alien individuals) paid after December 31, 1996, any person who makes a Form 1042–S under section 6049(a) and §1.6049–4(b)(5) shall furnish a statement to the recipient. The statement shall include a copy of the Form 1042–S required to be prepared pursuant to §1.6049–4(b)(5) and a statement to the effect that the information on the Form is being furnished to the United States Internal Revenue Service and may be furnished to Canada.

- - - - -

Par. 5. Section 1.6049–8 is added to read as follows:

§1.6049–8 Interest and original issue discount paid to residents of Canada .

(a) Interest subject to reporting re- quirement . For purposes of §§1.6049–4, 1.6049–6 and this section and except as provided in paragraph (b) of this

section, the term interest means interest paid to a Canadian nonresident alien individual after December 31, 1996, where the interest is described in section 871(i)(2)(A) with respect to a deposit maintained at an office within the United States. For purposes of the regulations under section 6049, a Canadian nonresident alien individual is an individual who resides in Canada and is not a United States citizen. The payor or middleman may rely upon the permanent residence address (as defined in section 1441 and the regulations under that section) as stated on the Form W–8 (described in section 6049 and the regulations under that section) in order to determine whether the payment is made to a Canadian nonresident alien individual. Amounts described in this paragraph (a) are not subject to backup withholding under section 3406. See §31.3406(g)–1(d) of this chapter.

(b) Interest excluded from reporting requirement . The term interest does not include an amount that is paid by the issuer or its agent outside the United States with respect to an obligation that is described in paragraph (b)(1) or (2) of this section.

(1)(i) The obligation is not in registered form (within the meaning of section 163(f) and the regulations thereunder); is part of a larger single public offering of securities; and is described in section 163(f)(2)(B).

(ii) Unless it has actual knowledge to the contrary, a middleman may treat an obligation as if it is described in section 163(f)(2)(B) if the obligation or coupon therefrom, whichever is presented for payment, contains the statement described in section 163(f)(2)(B)(ii)(II) and the regulations thereunder.

(2)(i) The obligation has a face or principal amount of not less than $500,000, and satisfies the requirements described in paragraphs (b)(2)(i)(A), (B), and (C) of this section.

(A) The obligation satisfies the requirements of sections 163(f)(2)(B)(i) and (ii)(I) and the regulations thereunder (as if it were a registrationrequired obligation within the meaning of section 163(f)(2)(A)) and is issued in accordance with the procedures of §1.163–5(c)(2)(i)(D)).

(B) If the obligation is in registered form, it is registered in the name of an exempt recipient described in §1.6049– 4(c)(1)(ii).

(C) The obligation has on its face and on any detachable coupons the following statement (or a similar statement having the same effect): ‘‘By accepting this obligation or coupon, the holder represents and warrants that it is not a United States person (other than an exempt recipient described in the regulations under section 6049(b)(4) of the Internal Revenue Code and the regulations thereunder) and that it is not acting for or on behalf of a United States person (other than an exempt recipient described in the regulations under section 6049(b)(4) of the Internal Revenue Code and the regulations thereunder).’’

(ii) Unless the middleman has actual knowledge to the contrary, it may treat an obligation as satisfying the requirements of sections 163(f)(2)(B)(i) and (ii)(I) and the regulations thereunder if the obligation or a coupon therefrom, whichever is presented for payment, contains the statement in paragraph (b)(2)(i)(C) of this section.

PART 31—EMPLOYMENT TAXES AND COLLECTION OF INCOME TAX AT SOURCE

Par. 6. The authority for part 31 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * - Par. 7. Section 31.3406(g)–1 is amended by adding paragraph (d) to read as follows:

§31.3406(g)–1 Exception for payments to certain payees and certain other payments .

- - - - -

(d) Reportable payments made to Canadian nonresident alien individuals . A payment of interest made to a Canadian nonresident alien individual under §1.6049–8(a) of this chapter is not subject to withholding under section 3406.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 8. The authority for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805. Par. 9. Section 602.101, paragraph (c) is amended by removing the entry ‘‘§31.3406(a)–1 – §31.3406(i)–1’’ and adding entries to the table in numerical order to read as follows:

§602.101 OMB Control numbers .

- - - - -

CFR part or section Current OMB where identified control number and described

- - - - -

1.6049–6 . . . . . . . . . . . . . . . 1545–0096

31.3406(a)–1 . . . . . . . . . . . . 1545–0112 31.3406(a)–2 . . . . . . . . . . . . 1545–0112 31.3406(a)–3 . . . . . . . . . . . . 1545–0112 31.3406(a)–4 . . . . . . . . . . . . 1545–0112 31.3406(b)(2)–1 . . . . . . . . . . 1545–0112 31.3406(b)(2)–2 . . . . . . . . . . 1545–0112 31.3406(b)(2)–3 . . . . . . . . . . 1545–0112 31.3406(b)(2)–4 . . . . . . . . . . 1545–0112 31.3406(b)(2)–5 . . . . . . . . . . 1545–0112 31.3406(b)(3)–1 . . . . . . . . . . 1545–0112 31.3406(b)(3)–2 . . . . . . . . . . 1545–0112 31.3406(b)(3)–3 . . . . . . . . . . 1545–0112 31.3406(b)(3)–4 . . . . . . . . . . 1545–0112 31.3406(b)(4)–1 . . . . . . . . . . 1545–0112 31.3406(c)–1 . . . . . . . . . . . . 1545–0112 31.3406(d)–1 . . . . . . . . . . . . 1545–0112 31.3406(d)–2 . . . . . . . . . . . . 1545–0112 31.3406(d)–3 . . . . . . . . . . . . 1545–0112 31.3406(d)–4 . . . . . . . . . . . . 1545–0112 31.3406(e)–1 . . . . . . . . . . . . 1545–0112 31.3406(f)–1 . . . . . . . . . . . . 1545–0112 31.3406(g)–1 . . . . . . . . . . . . 1545–0096 1545–0112 31.3406(g)–2 . . . . . . . . . . . . 1545–0112 31.3406(g)–3 . . . . . . . . . . . . 1545–0112 31.3406(h)–1 . . . . . . . . . . . . 1545–0112 31.3406(h)–2 . . . . . . . . . . . . 1545–0112 31.3406(h)–3 . . . . . . . . . . . . 1545–0112 31.3406(i)–1 . . . . . . . . . . . . 1545–0112

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Margaret Milner Richardson, Commissioner of Internal Revenue.

Approved March 27, 1996.

Leslie Samuels, Assistant Secretary of the Treasury.

(Filed by the Office of the Federal Register on

April 15, 1996, 10:24 a.m., and published in the issue of the Federal Register for April 22, 1996, 61 F.R. 17572)