Part IV. Items — Internal Revenue Bulletin 1997-7

estimated annual burden per respondent varies from 21 minutes to 8.3 hours, depending on individual circumstances, with an estimated average of 35 minutes. Estimated number of respondents: 1030. Estimated annual frequency of responses: On occasion.

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

Books or records relating to a 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 proposed Income Tax Regulations (26 CFR part 1) under sections 1293 and 1295 of the Internal Revenue Code. Sections 1293 and 1295 were added by the Tax Reform Act of 1986 (the Act) and were amended by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA). The sections, as amended, were effective for taxable years of foreign corporations beginning after December 31, 1986. Section 1293 also was amended by the Omnibus Reconciliation Act of 1993 (OBRA). Guidance for making the section 1295 election was provided in proposed regulation § 1.1295–1 and Notice 88–125, 1988–2 C.B. 535. Guidance regarding the annual income inclusion rule for shareholders making a section 1295 election was provided in proposed regulation § 1.1293–1.

Explanation of Provisions

Special Preferred Section 1295 Election

Introduction

The passive foreign investment company (PFIC) rules of the Code are designed to eliminate potential tax deferral opportunities associated with equity investments by United States persons in foreign corporations that have substantial levels of passive income or assets. The PFIC rules eliminate tax deferral opportunities by applying the section 1291 interest charge regime to PFIC shareholders that fail to make a

Notice of Proposed Rulemaking and Notice of Public Hearing

Qualified Electing Fund Elections

REG–209040–88

AGENCY: Internal Revenue Service (IRS), Treasury

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations permitting certain shareholders to make a special election under section 1295, in lieu of the election currently provided for under that section, with respect to certain preferred shares of a passive foreign investment company (PFIC). A shareholder that makes a special election must account for dividend income on the shares subject to the special election under special income inclusion rules, rather than under the general income inclusion rules of section 1293. This document also provides notice of a public hearing on these proposed regulations.

DATES: Written comments must be received by March 24, 1997. Requests to speak and outlines of oral comments to be discussed at the public hearing scheduled for May 8, 1997, at 10:00 a.m. must be received by April 17, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–209040–88), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R REG–209040–88), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the ‘‘Tax Regs’’ option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs.ustreas.gov/prod/ tax_regs/comments.html. The public hearing will be held in room 3313, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Judith Cavell Cohen, (202) 622–3880; concerning submissions and the hearing, Evangelista Lee, (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed rulemaking has been submitted to the Office of Management and Budget for review in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)). Comments on the collection of information should be sent to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies to the Internal Rev- enue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, DC 20224. Comments on the collection of information should be received by February 24, 1997. Comments are specifically requested concerning: Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the information will have practical utility; The accuracy of the estimated burden associated with the proposed collection of information (see below); How the quality, utility, and clarity of the information to be collected may be enhanced; How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

The collection of information in this proposed regulation is in proposed regulation § 1.1295–2(c)(3) and proposed regulation § 1.1295–2(e) and (f). This information will notify the Commissioner that certain shareholders have made the special election. In addition, this information will enable the IRS to determine if a shareholder qualifies for the special election and is satisfying the income inclusion requirements of proposed regulation § 1.1293–2. The collection of information is mandatory. The likely respondents are individuals, businesses, and other for-profit organizations. Estimated total annual reporting/ recordkeeping burden: 600 hours. The section 1295 annual income inclusion election (section 1295 election). In general, the section 1291 interest charge regime applies to the ‘‘extraordinary’’ portion of any distribution received by the shareholder, and any gain recognized on a disposition of shares.

The PFIC rules apply to investments in both common and preferred shares of a PFIC. Preferred shares, unlike common shares, generally provide for limited dividend and liquidation or redemption rights, and thus do not participate significantly in corporate growth. Accordingly, preferred shares of a PFIC generally do not afford U.S. investors with the same potential for U.S. tax deferral as common shares of a PFIC.

Preferred shareholders, like common shareholders, may make the section 1295 election to avoid the interest charge regime of section 1291. Shareholders that make the section 1295 election are required under section 1293 to include in income annually, as ordinary income, their pro rata share of the PFIC’s ordinary earnings and, as longterm capital gain, their pro rata share of the PFIC’s net capital gain for the year. In order to determine their pro rata share of ordinary earnings and net capital gain, shareholders that have made a section 1295 election must obtain certain U.S. tax accounting information from the PFIC regarding the PFIC’s earnings. If this information is not available, the shareholders cannot make the section 1295 election. If the requisite information is available, the annual information reporting and collection requirements associated with the section 1295 election may render the election impractical for smaller investors. Because preferred shares often do not afford investors with significant taxdeferral opportunity, commenters have suggested that the current section 1295 election regime should be simplified for certain types of preferred shares.

The proposed regulations adopt a special section 1295 election regime that would require holders of certain preferred shares of a PFIC that elect to be subject to the regime to accrue annually ordinary dividend income with respect to the preferred shares regardless of the holder’s pro rata share of ordinary earnings or net capital gain of the PFIC for the year. Because shareholders would accrue income regardless of the earnings and net capital gain of the PFIC, shareholders that elect to be subject to the regime would not have to report and collect any U.S. tax accounting informa

tion regarding the PFIC in order to make the special section 1295 election.

The proposed regulations are issued under two sections of the Code. Section 1.1295–2 of the proposed regulations provides rules for making a QEF election under the special proposed section 1295 election regime (special preferred QEF election). Section 1.1293–2 describes the annual income inclusion rules for shareholders that have made the special preferred QEF election.

The proposed regulations would apply only with respect to qualifying preferred shares issued after the date the proposed regulations are finalized.

Rules for making the special preferred QEF election

Under proposed regulation § 1.1295– 2(a), the special preferred QEF election may be made in lieu of the section 1295 election described in proposed regulation § 1.1295–1 and Notice 88–125, 1988–2 C.B. 535 (regular section 1295 election), with respect to certain types of preferred shares (qualified preferred shares) by certain holders satisfying prescribed ownership requirements.

The special preferred QEF election may only be made with respect to qualified preferred shares as defined in proposed regulation § 1.1295–2(b). To ensure that the special preferred QEF election cannot be used for tax avoidance purposes and to reduce complexity, the proposed regulations define qualified preferred shares narrowly to include only a limited class of preferred shares likely to be marketed to U.S. retail investors. Although the definition of qualified preferred shares includes both cumulative and non-cumulative preferred shares, the definition excludes various types of preferred shares, including preferred shares denominated in a foreign currency and preferred shares issued at a significant discount to their liquidation or redemption amounts. The PFIC issuing the preferred shares must represent that it intends to pay dividends currently. Proposed regulation § 1.1295–2(b) provides additional restrictions with respect to preferred shares acquired in secondary market transactions.

Proposed regulation § 1.1295–2(c) describes shareholders who may make the election. Under proposed regulation § 1.1295–2(c)(1), any United States person that acquires qualified preferred shares for cash or in certain nonrecognition transactions and that holds such shares directly may make the election.

United States persons that are passthrough entities, including partnerships, S corporations, trusts and estates, may qualify as shareholders.

The special preferred QEF election regime is narrowly targeted to eliminate certain of the information reporting and collection requirements associated with the existing section 1295 election and annual inclusion rules for U.S. retail investors in preferred shares of PFICs. Treasury and the Service believe that the special preferred QEF election regime should only apply with respect to foreign corporations that are not expected to be in a position to provide U.S. tax accounting information to shareholders. Accordingly, proposed regulation § 1.1295–2(c)(2) provides that the special preferred QEF election does not apply to holders of preferred shares in a PFIC that is a controlled foreign corporation. Further, proposed regulation § 1.1295–2(c)(3) provides that the special preferred QEF election does not apply to holders that own 5 percent or more of the vote or value of any class of shares of the PFIC. Holders of five percent or more of the vote or value of any class of shares generally are not the type of retail investor that the proposed regulations are designed to assist. Such holders may only make the section 1295 election provided under current rules.

Proposed regulation § 1.1295–2(c)(3) requires the corporation to provide to electing shareholders a statement, directly or in a disclosure document generally available to all U.S. shareholders, either that it is or that it reasonably believes that it is a PFIC and that it is not a controlled foreign corporation. Shareholders that fail to receive such a statement are not permitted to make a special preferred QEF election

Proposed regulation § 1.1295–2(d) describes the effect of the special preferred QEF election. Proposed regulation § 1.1295–2(d)(1) provides that shares subject to a special preferred QEF election will be treated as shares of a pedigreed QEF (as defined in proposed regulation § 1.1291–1(b)(2)(ii)) for all taxable years of the foreign corporation that are included wholly or partly in the shareholder’s holding period of the shares. Under the proposed regulations, the election will apply to all qualified preferred shares of a foreign corporation owned directly by the shareholder that are acquired in the taxable year with respect to which the election is made. Although a special preferred QEF election will not apply automatically to

35 1997–7 I.R.B.

qualified preferred shares acquired in subsequent taxable years of a shareholder, the proposed regulations permit the shareholder to make separate special preferred QEF elections with respect to qualified preferred shares acquired in later years.

Proposed regulation § 1.1295–2(d)(2) provides that the special preferred QEF election regime applies whether or not the foreign corporation is a PFIC in any year subsequent to the year of the election. Accordingly, shareholders that make the special preferred QEF election must make annual § 1.1293–2 income inclusions, as provided in proposed regulation § 1.1295–2(d)(3), even if the foreign corporation does not qualify as a PFIC for a particular year.

Proposed regulation § 1.1295–2(e) specifies the time and manner of making the special preferred QEF election. In order to make the special preferred QEF election, a shareholder files Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), for the taxable year of the election, checking the appropriate box in Form 8621, Part I, for making the section 1295 election, and indicating in the margin of Part I that the shareholder is making a special preferred QEF election with respect to certain specified shares. In addition, the shareholder must attach to Form 8621 a brief statement containing the information and representations contained in proposed regulation § 1.1295–2(e)(2)(ii). Under proposed regulation § 1.1295–2(f), in subsequent years, the shareholder must file Form 8621 with respect to the foreign corporation but need not attach any statement to the form. For all taxable years covered by the election, the shareholder must report on Line 6a of Part II of Form 8621 the amount includible under proposed regulation § 1.1293–2 with respect to qualified preferred shares subject to a special preferred QEF election.

Proposed regulation § 1.1293–2(g) states that a sale, exchange or other disposition of shares subject to a special preferred QEF election terminates the election with respect to those shares. Also, the Commissioner may terminate or invalidate an election if a shareholder fails to satisfy the initial or ongoing requirements of the election. For example, the Commissioner may terminate or invalidate a special preferred QEF election if the shareholder owns five percent or more of the vote or value of any class of shares of the PFIC at any

time during the period that the shareholder owns qualified preferred shares subject to the election. A shareholder may not itself terminate a special preferred QEF election.

Annual inclusion rules for electing shareholders

Under proposed regulation § 1.1293– 2(a), a shareholder that has made a special preferred QEF election must make annual income inclusions with respect to qualified preferred shares subject to the election. Unlike the annual income inclusions provided under section 1293 and proposed regulation § 1.1293–1, the annual inclusions under the special preferred QEF election regime are determined without regard to the shareholder’s pro rata share of the foreign corporation’s ordinary earnings or net capital gains.

Proposed regulation § 1.1293–2(b) provides rules for determining the amount that a shareholder must include in income annually under the special preferred QEF election regime. Under the proposed regulations, this annual amount consists of two components. The first component is an annual inclusion amount based on a ratable daily portion of dividend income that accrues on the qualified preferred shares (annual dividend amount). This ratable inclusion rule for the annual dividend amount is analogous to the rule for inclusion of income with respect to periodic payments on notional principal contracts under § 1.446–3. The second component of the preferred QEF amount arises only in respect of fixed term preferred shares, as described proposed regulation § 1.1295–2(b)(vii), acquired in a secondary market transaction, and is calculated based on the ratable inclusion of the excess, if any, of the redemption price of the shares over the acquisition cost of the shares (preferred discount amount). This ratable inclusion rule for the preferred discount amount is analogous to the rule for the ratable inclusion of market discount on certain debt under section 1276(b)(1). The Service and Treasury solicit comments regarding the income inclusion rules of the proposed regulations, including comments as to whether foreign corporations and their agents could effectively assist holders in complying with the income inclusion rules applicable to preferred discount.

Proposed regulation § 1.1293–2(c) provides certain special rules regarding the annual income inclusion required under proposed regulation § 1.1293–

2(a). Under § 1.1293–2(c)(1), annual amounts are included in income by shareholders irrespective of the PFIC’s earnings and profits. In this regard, the special preferred QEF election differs from the regular section 1295 election in that shareholders making the special preferred QEF election must accrue the annual amount as ordinary income even if the amount exceeds the shareholder’s pro rata share of the foreign corporation’s earnings and profits. Proposed regulation § 1.1293–2(c)(3) requires the shareholder to include the annual dividend amount as ordinary income regardless of whether any portion of the PFIC’s earnings for the year represents net capital gain. Proposed regulation § 1.1293–2(c)(4) provides rules for the tax-free distribution of previously taxed amounts. Proposed regulation § 1.1293– 2(c)(5) provides certain basis adjustment rules similar to the basis adjustment rule of section 1293(d). Finally, proposed regulation § 1.1293–2(c)(6) provides rules intended to limit the effect of a special preferred QEF election to the shareholder making the election. Accordingly, a special preferred QEF election will not affect the foreign corporation’s calculation of its earnings and profits, and will have no consequences for shareholders that have not made a special preferred QEF election.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations do not have a significant economic impact on a substantial number of small entities. This certification is based on the fact that these regulations represent a wholly elective simpler alternative to the section 1295 election described in § 1.1295–1 and Notice 88–125, 1988–2 C.B. 535, and impose a lighter collection of information burden. Further, the requirement that electing shareholders indicate their special election on Form 8621 annually and attach a statement, providing certain information in the first year of the election only, is minimal and will not impose a significant economic impact on electing shareholders. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the for a period (wholly or partly within the shareholder’s taxable year) for which dividends on the share are calculated based upon the redemption or liquidation price of the share multiplied by a fixed percentage rate.

(c) Special rules of application —(1) Earnings and profits disregarded. The amounts to be included in income pursuant to this section are determined without regard to the earnings and profits of the foreign corporation with respect to which the special preferred QEF election applies.

(2) Year of inclusion. The shareholder includes the preferred QEF amount in its taxable year without regard to the taxable year of the foreign corporation with respect to which the special preferred QEF election applies.

(3) Character of inclusions. The shareholder includes all preferred QEF amounts in income as ordinary earnings.

(4) Treatment of distributions. Distributions received by a shareholder on shares subject to a special preferred QEF election that are paid out of earnings and profits of the foreign corporation are not included in gross income of the shareholder to the extent the distributions do not exceed the preferred QEF amounts (other than any portion of preferred QEF amounts consisting of preferred discount amounts) previously includible in income pursuant to this section. These distributions will, however, be treated as dividends for all other purposes of the Code and regulations. Amounts distributed to a shareholder with respect to shares subject to a special preferred QEF election that exceed amounts previously included in income under this section with respect to such shares are treated for all purposes of the Code and regulations as a distribution of property subject to the rules of section 301.

(5) Basis adjustment rules. The adjusted basis of a shareholder in shares that are subject to a special preferred QEF election shall be—

(i) Increased by any amount that is included in the gross income of the shareholder under paragraph (a) of this section; and

(ii) Decreased by any dividends (not to exceed the amount included in gross income under paragraph (a) of this section) actually paid to the shareholder in respect of such shares.

(6) Effect limited to electing share- holder. This section does not apply to the foreign corporation with respect to which a special preferred QEF election

Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight (8) copies) that are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled for May 8, 1997, at 10:00 a.m. in room 3313, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington DC. Because of access restrictions, visitors will not be admitted beyond the Internal 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 comments at the hearing must submit written comments by March 24, 1997, and submit an outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by April 17, 1997.

A period of 10 minutes will be allotted to each person for making comments.

An agenda showing the schedule of 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 regulations is Judith Cavell Cohen of the Office of Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 - - Section 1.1293–2 also issued under 26 U.S.C. 1297(f).

Section 1.1295–2 also issued under 26 U.S.C. 1297(f). - -

Par. 2. Section 1.1293–2 is added to read as follows:

§ 1.1293–2 Special Inclusion Rules for Special Preferred QEF Election

(a) In general. A shareholder (including a shareholder that is a pass-through entity, as described in § 1.1295–2(c)(1)) that makes a special preferred QEF election under § 1.1295–2 must, regardless of the shareholder’s method of accounting, include in income in respect of each share subject to the election, an annual amount (preferred QEF amount) determined according to the rules of paragraph (b) of this section. A shareholder that makes a special preferred QEF election must include the preferred QEF amount in income under this section for each year in which the taxpayer continues to hold a share that is subject to the election. The rules of this section apply in lieu of the general rules of section 1293 and § 1.1293–1. ¹

(b) Preferred QEF amount —(1) In general. The preferred QEF amount for any share subject to a special preferred QEF election is the sum of the ratable daily portion of each periodic dividend amount (as described in paragraph (b)(2) of this section) on the share for the taxable year of the shareholder to which that portion relates, plus the preferred discount amount (as defined below), if any, for the taxable year. For purposes of this section, the preferred discount amount for a taxable year is the amount that bears the same ratio to the total amount of preferred discount (as described in § 1.1295–2(b)(2)(i)) on the share as the number of days that the taxpayer held the share in the taxable year bears to the number of days after the date the taxpayer acquired the share and up to (and including) the share’s redemption date as established under the principles of § 1.305–5(b). Notwithstanding the preceding sentence, the preferred discount amount for a taxable year is zero if the preferred discount on the share at the time of its acquisition by the shareholder was less than an amount equal to 1/4 of 1 percent of the redemption price of the stock, multiplied by the number of complete years from the date of acquisition of the stock to the redemption date of the stock.

(2) Periodic dividend amount. A periodic dividend amount is the amount payable with respect to a share, whether on a cumulative or noncumulative basis,

1 This proposed regulation was published on April 1, 1992, at 57 Fed. Reg. 11024.

37 1997–7 I.R.B.

applies. Accordingly, the provisions of this section will not affect the foreign corporation’s calculation of its earnings and profits for any purpose of the Code or regulations. In addition, the rules of this section apply only for purposes of determining the tax consequences for holders of shares subject to the election. Thus, the election shall have no effect on the application of the Code or regulations with respect to the tax consequences of the ownership of shares that are not subject to the election, including for purposes of determining whether any distributions from the foreign corporation with respect to such shares should be treated as having been included in the income of any United States person pursuant to section 1293(c) or section 959. (d) Examples. The following examples illustrate the rules of paragraphs (a), (b) and (c) of this section. Although these examples assume a 30-day month, 360-day year, any reasonable counting method may be used to compute the length of accrual periods. For purposes of simplicity, the relevant amounts as stated are rounded to two decimal places. However, the computations do not reflect any such rounding convention. The examples are as follows:

Example 1. Preferred QEF amount —(i) Facts. (A) On May 1, 1998, A, an individual who files his returns on a calendar year basis, purchased for $10,000 in a single secondary market transaction 100 shares of nonconvertible Class A $100 par value preferred stock (the Class A Stock) of FC, a foreign corporation with a taxable year ending on March 31.

(B) The terms of the Class A Stock provide for a mandatory redemption of the Class A Stock by the issuer at par on June 1, 2012. The Class A Stock is not redeemable pursuant to an issuer call or holder put on any other date. Each share of Class A Stock provides for a semi-annual cumulative distribution payable in dollars on June 1 and December 1 equal to one-half the product of the par value of the Class A Stock and the applicable annual dollar LIBOR in effect on the distribution date immediately prior to the relevant distribution date. The shares of the Class A stock are qualified preferred shares in the hands of A. A purchases no other qualified preferred shares of FC during its 1998 or 1999 taxable years. (C) A made a special preferred QEF election for A’s taxable year ended December 31, 1998, which applies to the Class A Stock acquired by A on May 1, 1998. FC is a PFIC under section 1296 for its taxable year ending March 31, 1999, but FC is not a PFIC for its taxable year ending March 31, 2000. FC paid no current dividends on June 1, 1998, and December 1, 1998, paid the June 1, 1999, dividend currently on June 1, 1999, together with accumulated distributions from June 1, 1998, and December 1, 1998, and paid the December 1, 1999, dividend currently on December 1, 1999. The applicable annual LIBOR is 8 percent on December 1, 1997, 7 percent on June 1, 1998, 9 percent on December 1, 1998, 10 percent on June 1, 1999, and 9 percent on

December 1, 1999. FC had sufficient earnings and profits, within the meaning of section 312, for its taxable year ending on March 31, 2000, so that actual distributions to all shareholders of Class A Stock in that year were treated as paid out of earnings and profits of FC.

(ii) Tax consequences to A for A’s taxable year ending December 31, 1998. As required under paragraph (a) of this section, A must include in gross income for its 1998 taxable year the 1998 preferred QEF amount. The preferred QEF amount, as determined under paragraph (b) of this section, for A’s 1998 taxable year is the ratable portion of each periodic dividend amount for that year. For 1998, there are three periodic dividend amounts: The periodic dividend amount for the period from December 1, 1997, to June 1, 1998 (periodic dividend amount 1), the periodic dividend amount for the period from June 1, 1998, to December 1, 1998 (periodic dividend amount 2), and the periodic dividend amount for the period from December 1, 1998, to June 1, 1999 (periodic dividend amount 3). Periodic dividend amount 1 in respect of each share owned by A is $4 (1/2 multiplied by the applicable annual LIBOR of 8 percent set on December 1, 1997, multiplied by the $100 amount payable on redemption). Because A acquired the shares on May 1, 1998, A’s ratable portion of periodic dividend amount 1 for 1998 is approximately $.67 (30/180 multiplied by $4) per share. Periodic dividend amount 2 in respect of each share owned by A is $3.50 (1/2 multiplied by the applicable annual LIBOR of 7 percent set on June 1, 1998, multiplied by $100). Because A owned the shares for the entire period associated with periodic dividend amount 2, A’s ratable portion of periodic dividend amount 2 for 1998 is the full $3.50 per share. Periodic dividend amount 3 in respect of each share owned by A is $4.50 (1/2 multiplied by the applicable annual LIBOR of 9 percent set on December 1, 1998, multiplied by $100). Because the portion of 1998 associated with periodic dividend amount 3 is only the month of December, 1998, A’s ratable portion of periodic dividend amount 3 for 1998 is approximately $.75 (30/180 multiplied by $4.50). Accordingly, A’s preferred QEF amount for 1998 is approximately $4.92 ($.67 + $3.5 + $.75) per share. A must include approximately $492 (approximately $4.92 per share, multiplied by 100 shares) in income as ordinary earnings for its 1998 tax year even though FC paid no actual dividend to shareholders of Class A Stock for the period in 1998 during which A held the Class A Stock.

(iii) Tax consequences to A for A’s taxable year ending December 31, 1999. As required under paragraph (a) of this section, A includes in gross income for its 1999 taxable year its preferred QEF amount for 1999. The preferred QEF amount, as determined under paragraph (b) of this section, for A’s 1999 taxable year is the ratable portion of each periodic dividend amount for that year. For 1999, there are three periodic dividend amounts: The periodic dividend amount for the period from December 1, 1998, to June 1, 1999 (periodic dividend amount 1), the periodic dividend amount for the period from June 1, 1999, to December 1, 1999 (periodic dividend amount 2), and the periodic dividend amount for the period from December 1, 1999, to June 1, 2000 (periodic dividend amount 3). Periodic dividend amount 1 in respect of each share owned by A is $4.50 (1/2 multiplied by the applicable annual LIBOR of 9 percent set on December 1, 1998, multiplied by $100). Because A held each share of Class A Stock for five months in 1999 for the period associated with periodic dividend amount 1, A’s ratable portion of periodic dividend amount 1 for 1999 is approxi

mately $3.75 (150/180 multiplied by $4.50). Periodic dividend amount 2 in respect of each share owned by A is $5 (1/2 multiplied by the applicable annual LIBOR of 10 percent set on June 1, 1999, multiplied by $100). Because A owned the share for the entire period associated with periodic dividend amount 2, A’s ratable portion of periodic dividend amount 2 for 1999 is the full $5. Periodic dividend amount 3 in respect of each share owned by A is $4.50 (1/2 multiplied by the applicable annual LIBOR of 9 percent set on December 1, 1999, multiplied by $100). Because A held each share of Class A Stock for one month in 1999 for the period associated with periodic dividend amount 3, A’s ratable portion of periodic dividend amount 3 for 1999 is approximately $.75 (30/180 multiplied by $4.50). Accordingly, A’s preferred QEF amount for 1998 is approximately $9.50 ($3.75 + $5 + $.75). A must include approximately $950 ($9.50 per share, multiplied by 100 shares) in income as ordinary income for its 1999 taxable year even though FC was not a PFIC for FC’s taxable year ending in 2000. The current distributions and arrearages actually paid to A with respect to the Class A Stock are not includible in income by A under paragraph (c)(4) of this section because they constitute amounts previously included in income.

Example 2. Preferred Discount —(i) Facts. The facts are the same as in Example 1 except that A acquired the 100 shares of Class A Stock for $9000.

(ii) Tax Consequences to A for A’s taxable year ending December 31, 1998. (A) Because the Class A Stock is fixed term preferred stock (as described in § 1.1295–2(b)(1)(vii)) and A acquired each share of the Class A stock with $10 of preferred discount, as described in § 1.1295–2(b)(2), A’s preferred QEF amount to be included by A for the taxable year consists of the sum of the ratable daily portion of each periodic dividend amount, as calculated in paragraph (d)(ii) of Example 1 of this section, plus the preferred discount amount described in paragraph (b)(1) of this section.

(B) The preferred discount amount with respect to each share is approximately $.47 ($10 multiplied by 240 days/5070 days to maturity). A must include approximately $47 ($.47 per share, multiplied by 100 shares), together with the amount calculated in paragraph (d)(ii) of Example 1 of this section, in income as ordinary earnings for its 1998 tax year even though FC paid no actual dividend to shareholders of Class A Shares for the period in 1998 during which A held the Class A Stock.

(iii) Tax consequences to A for A’s taxable year ending December 31, 1999. The portion of the preferred discount on each share includible under paragraph (a) of this section is approximately $.71 ($10 multiplied by 360 days/5070 days to maturity). A must include this amount, together with the amount calculated in paragraph (d)(iii) of Example 1 of this section, in income as ordinary earnings for its 1999 tax year even though FC was not a PFIC for FC’s taxable year ending in 2000. The current distributions and arrearages actually paid to A in 1999 with respect to the Class A Stock are not includible in income by A under paragraph (c)(4) of this section, because they constitute amounts previously included in income.

(e) Effective date. The rules under this section apply with respect to qualified preferred stock subject to a special preferred QEF election made after the

1997–7 I.R.B. 38

(ix) If redeemable, the share is redeemable only in whole and not in part and is not subject to mandatory redemption within five years of the issue date of the share. Further, the share is not subject to a holder put or issuer call that, based on all the facts and circumstances as of the issue date of the share, is more likely than not to be exercised at a time within five years of the issue date;

(x) If convertible, the share is not convertible into a share other than a share meeting all the conditions set forth in paragraphs (b)(1)(i) through (b)(1)(ix) of this section; and

(xi) The issuer of the share has indicated in an offering document relating to the original issuance of the share or in a written statement available to U.S. holders that the issuer has no current intention or belief that it will not pay dividends on the share on a current basis and that the share meets the conditions set forth in paragraphs (b)(1)(i) through (b)(1)(x) of this section and this paragraph (b)(1)(xi).

(2) Special rules for shares acquired in secondary market transactions —(i) Fixed term preferred stock. A share of fixed term preferred stock (as described in paragraph (b)(1)(vii) of this section) that satisfies the conditions set forth in paragraph (b)(1) of this section and that is acquired in a transaction other than in connection with the initial issuance of the share (a secondary market transaction), shall constitute a qualified preferred share with respect to a shareholder, but only if the shareholder acquires the share for cash and the share has preferred discount (as defined below) that is less than or equal to an amount equal to 1 percent of the redemption price, multiplied by the number of complete years from the date of acquisition of the share to the redemption date as established under the principles of § 1.305–5(b). Sales of shares to bond houses, brokers, or similar persons or organizations acting in the capacity as underwriters, placement agents, or wholesalers are ignored for purposes of determining whether a share is acquired in connection with the initial issuance of the share. For purposes of this section, the preferred discount for a share is the excess of the redemption price of the share payable on the redemption date over the shareholder’s acquisition cost for the share.

(ii) Perpetual preferred stock. A share of perpetual preferred stock, within the meaning of paragraph (b)(1)(viii) of this

date that is 30 days after the date of publication of this document as a final regulation.

Par. 3. Section 1.1295–2 is added to read as follows:

§ 1.1295–2 Special Preferred QEF Election.

(a) In general. This section provides rules permitting certain shareholders to make a special election under section 1295 (special preferred QEF election) in lieu of the election described in § 1.1295–1 ² and Notice 88–125, 1988–2 C.B. 535 (see § 601.601(d)(2)(ii)( b ) of this chapter), with respect to certain preferred shares (qualified preferred shares) of a foreign corporation that certifies either that it is a PFIC (as defined in § 1.1291–1(b)(1)(i)) ³ or that it reasonably believes that it is a PFIC. In order to make a special preferred QEF election, a shareholder must satisfy the stock ownership requirement of paragraph (c)(2) of this section. A special preferred QEF election of a shareholder applies only to those qualified preferred shares acquired and held directly by the shareholder in the taxable year of the shareholder for which the election is made. A shareholder making a special preferred QEF election must account for dividend income on shares subject to the election under the special income inclusion rules described in § 1.1293–2, rather than under the general income inclusion rules of section 1293 and § 1.1293–1. In addition, for purposes of determining the tax consequences of owning shares subject to the special preferred QEF election, an electing shareholder must treat the foreign corporation as a PFIC for the entire period during which the shareholder continues to hold any of such shares. Paragraph (b) of this section defines qualified preferred share. Paragraph (c) of this section provides rules for determining who may make the special preferred QEF election. Paragraph (d) of this section provides rules concerning the effect of the election. Paragraph (e) of this section provides rules for the time and manner of making the election. Paragraph (f) of this section sets forth the annual reporting requirement for the election. Paragraph (g) of this section provides rules concerning the possible termination or invalidation of the elec 2 This proposed regulation was published on April 1, 1992, at 57 Fed. Reg. 11024. 3 This proposed regulation was published on April 1, 1992, at 57 Fed. Reg. 11024.

tion. For the applicability date of this section, see paragraph (h) of this section.

(b) Qualified preferred share de- fined —(1) In general. For purposes of this section, a share of a foreign corporation is a qualified preferred share only if—

(i) The share was originally issued for cash or in exchange for qualified preferred shares of the foreign corporation in a transaction to which section 354(a)(1) applied; (ii) If the share were to constitute a debt obligation, the share would be in registered form within the meaning of § 5f.103–1(c) of this chapter;

(iii) All amounts payable with respect to the share are denominated in U.S. dollars and are not determined by reference to the value of a currency other than the U.S. dollar;

(iv) The share is limited and preferred as to dividends and does not participate in corporate growth to any significant extent within the meaning of section 1504(a)(4)(B);

(v) The share has a fixed redemption or liquidation price;

(vi) The share provides for cumulative or noncumulative dividend rights that are limited to an annual (or shorter period) amount computed by multiplying either the redemption or liquidation price of the share by a specified index described in § 1.446–3(c)(2)(i), (iii), or (iv) (specified index), or by a specified index periodically re-established pursuant to an auction reset mechanism, set in advance of the period with respect to which the specified index applies;

(vii) If the share may be redeemed under circumstances described in § 1.305–5(b) such that redemption premium (as described in § 1.305–5(b)) could be treated under section 305(c) as a constructive distribution (fixed term preferred stock), the share was not issued with redemption premium exceeding the de minimis amount described in section 305(c)(1) and § 1.305–5(b)(1);

(viii) If the share may not be redeemed under circumstances described in § 1.305–5(b) such that redemption premium would not be treated under section 305 as a constructive distribution (perpetual preferred stock), the share does not provide shareholders with the right to receive an amount upon liquidation or redemption that exceeds the issue price of the share (as determined under the principles of section 1273(b)) by an amount in excess of 5 percent of such liquidation or redemption amount;

39 1997–7 I.R.B.

that it reasonably believes that it is, a PFIC, and that it is not a controlled foreign corporation within the meaning of section 957(a) for such taxable year of the corporation. The statement must be provided directly to the electing shareholder or in a disclosure or other document generally available to all U.S. holders. Electing shareholders must retain a copy of the statement for their records.

(d) Effect of election —(1) In general. Unless terminated or invalidated pursuant to paragraph (g) of this section, shares subject to a special preferred QEF election will be treated as shares of a pedigreed QEF (as defined in § 1.1291–1(b)(2)(ii)) for all taxable years of the foreign corporation that are included wholly or partly in the shareholder’s holding period of the shares. A special preferred QEF election applies to all qualified preferred shares owned directly by the shareholder that are acquired in the taxable year of the election. Separate special preferred QEF elections may be made for qualified preferred shares acquired in other taxable years of the taxpayer. A special preferred QEF election is personal to the shareholder that made the election and does not apply to a transferee of the shares. A shareholder that has made a special preferred QEF election may not make, with respect to the foreign corporation, any other election permitted under sections 1291 through 1297 and the regulations under those sections, including a section 1295 election as described in § 1.1295–1 and Notice 88–125, 1988–2 C.B. 535 (see § 601.601(d)(2)(ii)(b) of this chapter), for any period during which the special preferred QEF election remains in effect with respect to any shares of the shareholder.

(2) Continued PFIC Characteriza- tion. By making the special preferred QEF election, the shareholder agrees to treat the foreign corporation as a PFIC with respect to qualified preferred shares subject to the election at all times during its holding period for such shares, without regard to whether the foreign corporation is a PFIC for any taxable year of the foreign corporation during which the preferred QEF election remains in effect.

(3) Section 1293 inclusions. For each taxable year of the shareholder to which an election under this section applies, the shareholder must include in income the preferred QEF amount, as defined in

section, that satisfies the conditions set forth in paragraph (b)(1) of this section and that is acquired in a secondary market transaction, shall constitute a qualified preferred share with respect to the shareholder, but only if the shareholder acquires the share for cash and the amount payable upon liquidation of the share exceeds the shareholder’s acquisition cost for the share by an amount less than or equal to 10 percent of such liquidation amount.

(iii) Examples. The following examples illustrate the rules of this paragraph (b)(2).

Example 1 —(i) Facts. On May 1, 1998, A, an individual who files her return on a calendar year basis, purchases for $9000 cash in a single secondary market transaction (as defined in paragraph (b)(2)(i) of this section) 100 shares of nonconvertible Class A $100 par value preferred stock (Class A Stock) of FC, a foreign corporation with a taxable year ending March 31. The terms of the Class A Stock satisfy all the conditions described in paragraph (b)(1) of this section and provide for a mandatory redemption of the Class A Stock by the issuer in U.S. dollars at par on June 1, 2012. The Class A Stock is not redeemable pursuant to an issuer call or holder put on any other date.

(ii) Analysis. In order for A to make a special preferred QEF election with respect to the Class A Stock acquired by A, the Class A Stock acquired must constitute qualified preferred shares. Although the Class A Stock meets the requirements for qualified preferred shares set forth in paragraph (b)(1) of this section, the stock also must satisfy the requirements described in paragraph (b)(2) because A acquired the stock in a secondary market transaction. Because the terms of the Class A Stock provide that the stock will be redeemed by the issuer on June 1, 2012, the stock constitutes fixed term preferred stock within the meaning of paragraph (b)(1)(vii) of this section. A purchased the Class A Stock for $90 per share, representing a $10 discount ($100 June 1, 2012, per share redemption price less $90 acquisition cost). Because this $10 discount, which constitutes preferred discount within the meaning of paragraph (b)(2)(i) of this section, is less than $14 (1 percent of the redemption price multiplied by 14 (the number of complete years until the mandatory redemption date)), the Class A Stock acquired by A satisfies the conditions of paragraph (b)(2)(i) of this section and therefore constitutes qualified preferred shares.

Example 2 —(i) Facts. The facts are the same as in Example 1, except that A acquires the 100 shares of Class A Stock for $8000.

(ii) Analysis. In this case, A purchased the Class A Stock for $80 per share, representing a $20 discount ($100 June 1, 2012, redemption price less $80 acquisition cost). Because this $20 of preferred discount is greater than $14 (1 percent of the redemption price multiplied by 14 (the number of complete years until the mandatory redemption date)), the Class A Stock fails to satisfy the conditions of paragraph (b)(2)(i) of this section and therefore fails to qualify as qualified preferred shares.

(c) Who may make the election —(1) In general. A U.S. person that acquires qualified preferred shares for cash or in a nonrecognition transaction described

in § 1.1291–6(a) ⁴ (nonrecognition transaction) and that holds such shares directly may make a special preferred QEF election, provided that, in the case of shares acquired in a nonrecognition transaction, either the qualified preferred shares are treated as stock of a pedigreed QEF, as defined in § 1.1291– 1(b)(2)(ii), immediately prior to the nonrecognition transaction, or the gain, if any, realized on the transaction would be recognized under § 1.1291–6(b) with respect to the nonrecognition transaction. A special preferred QEF election will not apply to any shares with respect to which the electing shareholder is an indirect shareholder, within the meaning of § 1.1291–1(b)(8). Solely for purposes of this section, partnerships, S corporations, trusts and estates (pass-through entities) that directly own qualified preferred shares are treated as shareholders that may make a special preferred QEF election. A shareholder may not make a special preferred QEF election if at any time the shareholder made a section 1295 election (other than a special preferred QEF election) with respect to the foreign corporation. A shareholder may not make a special preferred QEF election unless the shareholder satisfies the stock ownership requirements set forth in paragraph (c)(2) of this section, and the shareholder receives from the foreign corporation the statement described in paragraph (c)(3) of this section.

(2) Ownership requirement. A holder of qualified preferred shares of a foreign corporation may make a special preferred QEF election only if, at all times during the taxable year of the shareholder, the shareholder does not own, directly, indirectly, or constructively, within the meaning of section 958, five percent or more of the vote or value of any class of stock of the foreign corporation. The five percent vote or value limitation must be satisfied for each taxable year of the shareholder during which the shareholder continues to hold shares subject to the special preferred QEF election.

(3) Statement from corporation. A shareholder may make the special preferred QEF election only if the foreign corporation has provided a written statement relating to the taxable year of the corporation that ends with or within the taxable year of the shareholder for which the election is made certifying either that the foreign corporation is, or

4 This proposed regulation was published on April 1, 1992, at 57 Fed. Reg. 11024.

1997–7 I.R.B. 40

1291 through 1297 and the regulations thereunder as if the shareholder never made the election.

(h) Effective date. An election under this section may only be made with respect to qualified preferred shares that are issued after the date that is 30 days after the date of publication of this document as a final regulation.

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 23, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 24, 1996, F.R. 67752)

Notice of Proposed Rulemaking and Notice of Public Hearing

Treatment of Obligation-Shifting Transactions

REG–209817–96

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to the treatment of certain multiple-party financing transactions in which one party realizes income from leases or similar agreements and another party claims deductions related to that income. In order to prevent tax avoidance, the proposed regulations recharacterize these transactions in a manner that clearly reflects income. The proposed regulations affect only persons that engage in these transactions. The regulations generally do not apply to routine transactions lacking characteristics of tax avoidance. This document also provides notice of a public hearing on the proposed regulations.

DATES: Written comments, requests to appear, and outlines of topics to be discussed at the public hearing scheduled for April 29, 1997, at 10 a.m. must be received by April 8, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–209817–96), Room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG–209817–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Al

§ 1.1293–2, in the manner and under the rules provided in that section.

(e) Time for and manner of making the special preferred QEF election —(1) Time for making the election. A special preferred QEF election must be made on or before the due date, as extended, for filing the shareholder’s return for the taxable year during which the shareholder acquired the qualified preferred shares for which the election is being made. A special preferred QEF election may not be made for those shares at any other time pursuant to any other provision of the Code or regulations.

(2) Manner of making the election (i) In general. A shareholder makes the special preferred QEF election under this section for all qualified preferred shares of a foreign corporation acquired during the shareholder’s taxable year by checking the appropriate box in Form 8621 (Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund), Part I, for making the section 1295 election, and indicating in the margin of Part I that the shareholder is making a special preferred QEF election with respect to certain specified shares. The shareholder also must report the preferred QEF amount for the taxable year of the election on Line 6a of Part II of Form 8621. In addition, the shareholder must attach to Form 8621 the statement (preferred QEF statement) described in paragraph (e)(2)(ii) of this section, signed by the shareholder under penalties of perjury, stating that the information and representations provided in the preferred QEF statement are true, correct, and complete to the best of the shareholder’s knowledge and belief.

(ii) Preferred QEF statement con- tents. The preferred QEF statement must include the following information and representations:

(A) The first taxable year of the shareholder for which the special preferred QEF election is made;

(B) The number of shares subject to the election, their acquisition date(s) and acquisition price(s), and the class designation(s) of the shares;

(C) A representation by the shareholder that it did not at any time during its taxable year own directly, indirectly, or constructively, within the meaning of section 958, five percent or more of the vote or value of any class of stock of the foreign corporation with respect to which the election applies;

(D) A representation by the shareholder that it has obtained the written statement described in paragraph (c)(3) of this section; and

(E) A representation by the shareholder that it has never made a section 1295 election other than a special preferred QEF election with respect to the foreign corporation.

(f) Annual reporting requirement. For each taxable year of a shareholder during which the shareholder holds shares of a foreign corporation subject to one or more special preferred QEF elections, the shareholder must file Form 8621 with respect to the foreign corporation regardless of whether the foreign corporation is or is not a PFIC under section 1296 during any portion of the taxable year. The shareholder must indicate in the margin of Part I of Form 8621 the number of special preferred QEF elections of the shareholder that remain in effect with respect to the foreign corporation. In addition, the shareholder must report, on Line 6a of Part II of Form 8621, the aggregate of the preferred QEF amounts for all relevant special preferred QEF elections in effect for the taxable year.

(g) Termination or invalidation of election —(1) In general. A sale, exchange or other disposition of a share that is subject to a special preferred QEF election will terminate the special preferred QEF election with respect to that share. In addition, the Commissioner may, in the Commissioner’s discretion, terminate or invalidate a special preferred QEF election if a shareholder that made the election fails to satisfy the initial or ongoing requirements of the election. Once made, a special preferred QEF election may not be terminated or invalidated by the shareholder.

(2) Effect of termination or invalida- tion. Termination of a special preferred QEF election by the Commissioner will be effective on the first day of the shareholder’s first taxable year following the last taxable year of the shareholder for which the requirements of the election are satisfied. For purposes of sections 1291 through 1297 and the regulations thereunder, the holding period of qualified preferred shares subject to an election that has been terminated will be treated as beginning on the effective date of the termination. A shareholder that has made an election that is invalidated by the Commissioner will be treated for purposes of sections

41 1997–7 I.R.B.

ternatively, 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.ustreas.gov/prod/ tax_regs/comments.html. The public hearing will be held in the IRS Auditorium, Internal Revenue Building, 7th Floor, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Jonathan Zelnik at (202) 622–3940; concerning submissions and the hearing, Christina Vasquez at (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

Whether the proposed collection of information is necessary for the proper performance of the functions of the Internal Revenue Service, including whether the collection will have a practical utility;

The accuracy of the estimated burden associated with the proposed collection of information (see below);

How the quality, utility, and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collection of information may be minimized, including through the application of automated collection techniques or other forms of information technology; and

Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of service to provide information.

The collection of information is in § 1.7701(l)–2(j). This information is required by the IRS to verify pass-through entity compliance with § 1.7701(l)–2. This information will be used to determine whether the amount of tax has been computed correctly. The collection of information is mandatory. The likely recordkeepers are businesses and other organizations. Estimated total annual recordkeeping burden: 500 hours. Estimated average annual burden per recordkeeper: 5 hours. Estimated number of recordkeepers: 100.

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.

Books or records relating to a 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 information are confidential, as required by 26 U.S.C. 6103.

Background

The IRS and Treasury Department have become aware of multiple-party financing transactions (‘‘stripping transactions’’) intended to allow one party to realize income from a lease or similar agreement and to allow another party to report deductions related to that income (for example, cost recovery or rental expenses). Notice 95–53, 1995–2 C.B. 334, describes several examples of these transactions, including transferred basis transactions, transfers of partnership interests, and variations involving licenses, service contracts, and prepayment, frontloading, and retention of rights to receive future payments.

Notice 95–53 states the position of the IRS that the claimed tax treatment of these transactions improperly separates income from related deductions and that the transactions do not produce the tax consequences desired by the parties. The notice also states that regulations will be issued under section 7701(l) of the Internal Revenue Code recharacterizing stripping transactions any significant element of which is entered into or undertaken on or after October 13, 1995. The notice requested comments regarding those regulations.

The IRS received only one set of comments in response to Notice 95–53. Those comments recommended that the regulations under section 7701(l) address a broader class of transactions

than was described in the notice. Specifically, they recommended that the regulations defer the recognition of income in circumstances where there is an advance receipt or assignment of future income and there is the potential for the transactions to become stripping transactions. They also recommended that the regulations recharacterize these transactions without regard to whether there is a tax avoidance purpose. The comments reflected a desire for the regulations to produce an economic accrual of income and to enable taxpayers to determine the proper tax accounting for their transactions without regard to subsequent events.

The proposed regulations generally follow the notice and do not expand the class of transactions subject to recharacterization. The regulations do not require taxpayers to make any assumptions as to subsequent events. They are intended to produce tax results that conform to the economic substance of the transactions that they address. Furthermore, the regulations generally apply to transactions whether or not the parties have a tax avoidance purpose.

Explanation of Provisions

General approach

Section 7701(l) authorizes the Secretary to ‘‘prescribe regulations recharacterizing any multiple-party financing transaction as a transaction directly among any 2 or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent avoidance of any tax imposed by [the Internal Revenue Code].’’ The proposed regulations recharacterize transactions in which the transferee (‘‘the assuming party’’) assumes obligations or acquires property subject to obligations under an existing lease or similar agreement and the transferor (‘‘the property provider’’) or any other party has already received or retains the right to receive amounts that are allocable to periods after the transfer. The recharacterization reflects the general principle that a taxpayer who is treated for federal income tax purposes as the owner of rental property must recognize income that accrues during its period of ownership. See, e.g., Steinway & Sons v. Commissioner, 46 T.C. 375 (1966), acq ., 1967–2 C.B. 3; Alstores Realty Corp. v. Commissioner, 46 T.C. 363 (1966), acq ., 1967–2 C.B. 1. For the period in which an assuming party in such a transaction is a party to the lease or similar agreement, the recharacterization requires the assuming party to report income on a level-rent basis calculated using the rules of the constant rental accrual method described in § 1.467–3(d) as proposed on June 3, 1996 (IA–292–84, 61 FR 27834, 27844). Thus, the assuming party is required to recognize rental income for the period in which it owns the property or leasehold interest. In addition, the transaction is recharacterized to include additional consideration in the form of a note provided by the assuming party to the property provider for the transfer of the property, resulting in interest income and expense for which the parties must account as appropriate. The property provider also must adjust its income for any differences between amounts it recognized and amounts it would have recognized if it had reported income on a level-rent basis for the periods that it owned the property or leasehold interest. Finally, to account for any differences in timing or amount between payments the property provider actually receives after the transaction and payments treated as being made to the property provider under the note from the assuming party, the property provider is treated as an obligor or obligee under a second loan, for which the property provider must account accordingly.

Obligation-shifting transactions

The proposed regulations are not intended to recharacterize transactions with little potential for tax avoidance. Taken together, the definition of ‘‘obligation-shifting transaction’’ and the enumerated exceptions limit the scope of the regulations to transactions that are not routine and that involve shifting of substantial amounts of income away from the taxpayer that recognizes deductions related to the income.

The proposed regulations apply to obligation-shifting transactions, which are defined as any transaction in which an assuming party assumes a property provider’s obligations to a property user (or acquires property subject to a property provider’s obligations to a property user) under a lease or similar agreement if the property provider or any other party has already received, or retains the right to receive, amounts that are allocable to periods after the transaction. The regulations define obligations under a lease or similar agreement as including a continuing obligation to make property available to the lessee or the

ultimate user of the property. These obligations typically give rise to deductions, such as for cost recovery or, in the case of a master-lease/sublease arrangement, for payments under a master lease. The advance receipt of amounts that are allocable to periods after the obligation-shifting transaction often results in accelerated taxable income for the recipient. Thus, the definition describes transactions in which there is the potential for one party to recognize income but a different party to recognize deductions associated with that income.

In some transactions identified in Notice 95–53, one party sells, assigns, or otherwise transfers to a third party the right to receive future payments under a lease and includes as current income the amount received as consideration for the transfer. The underlying property (subject to the lease) is later transferred in a transaction intended to qualify as a transferred basis transaction. These transactions are within the scope of the regulations because the property transferee assumes obligations or acquires the property subject to the obligation to make the property available to the lessee and the property transferor already received amounts that are allocable to periods after the transaction by reason of the assignment of rights to receive future payments. In other transactions, the property transferor does not assign the right to future rental amounts but instead receives prepayment from the lessee or retains the right to receive future amounts over time. Both variations likewise are within the scope of the regulations.

The proposed regulations adopt an aggregate view of partnerships, treating each partner as having a proportionate share of the rights and obligations of the partnership. Thus, for example, if a partnership assigns its right to receive future amounts under a lease and allocates to its current partners the amount recognized, a later transfer of a partnership interest is an obligation-shifting transaction because the transferee partner assumes an allocable share of the partnership’s obligation to make the property available to the lessee and because the transferor partner is treated as having already received amounts that are allocable to periods after the transaction. See Example 3 of the proposed regulations. In appropriate cases, the IRS may assert other authorities to prevent the use of a partnership to effect an

improper separation of income from related deductions. See, e.g., § 1.701– 2(d) ( Example 7 ). The proposed regulations also generally treat an obligation-shifting transaction as occurring if a subsidiary that is a member of a consolidated group becomes a nonmember at a time when the subsidiary has received payments under a lease or similar agreement that are allocable to periods after the transaction.

Lease or similar agreement

Under the proposed regulations, an obligation-shifting transaction involves a lease or similar agreement. The regulations define this term broadly to include any contract for the use or enjoyment of tangible or intangible property, including leaseholds, licenses, other non-fee interests in property, and other contracts (including service contracts) involving the use or enjoyment of property if the value of that use or enjoyment is more than de minimis. The proposed regulations, therefore, do not apply to service contracts that do not involve the use or enjoyment of property. The definition of obligation-shifting transaction, however, does not restrict the IRS’s ability to challenge these transactions under other authorities. For instance, even if a transaction is not within the scope of the proposed regulation, the IRS may challenge it under one or more of the authorities identified in Notice 95–53.

The IRS requests comments on whether additional guidance is needed on the definition of lease or similar agreement.

Exceptions

The proposed regulations are not intended to recharacterize otherwise routine transactions, such as the incorporation of an entire line of business that does not involve significant shifting of income and deductions. See Rev. Rul. 80–198, 1980–2 C.B. 113, subject to the limitations described therein. Accordingly, the regulations provide a number of objective exceptions that generally will protect routine transactions from recharacterization. The regulations do not apply to transactions in which the amounts that are allocable to future periods but are not transferred are less than or equal to $100,000. The regulations do not apply to transactions in which total payments (including the aggregate expected future value of all contingent consideration) under the lease or similar agreement are not reasonably

43 1997–7 I.R.B.

expected to exceed $250,000. The regulations do not apply to transactions in which the fair market value of the property that is subject to the lease or similar agreement and is transferred in the obligation-shifting transaction, plus the value of the amounts that are already received or retained by the property provider but are allocable to periods after the obligation-shifting transaction, is less than ten percent of the total assets (other than Class I and Class II assets as described in § 1.1060–1T(d) and debt issued by the property provider) transferred by the property provider in the transaction. The regulations do not apply to transactions in which the lease or similar agreement is a disqualified leaseback or long-term agreement within the meaning of § 1.467–3(b). The regulations do not apply to transactions described in section 381(a), unless the transaction is deemed to be an obligation-shifting transaction under proposed § 1.7701(l)– 2(k). Finally, the regulations provide that a transaction is exempt from recharacterization if the parties to the transaction establish to the satisfaction of the Commissioner that the transaction does not present a significant potential for tax avoidance.

Because the purpose of recharacterization under section 7701(l) is to prevent tax avoidance, these objective exceptions are unavailable for transactions entered into with a principal purpose of substantially reducing the present value of the aggregate tax liability of the property provider, the assuming party, and any other party whose taxable income is determined by reference to the taxable income of the property provider or the assuming party.

Recharacterization

The proposed regulations recharacterize an obligation-shifting transaction in order to ensure that the property provider and the assuming party both report the income from the underlying property allocable to their respective periods of ownership.

For purposes of determining the amounts that are allocable to periods under the lease or similar agreement, the proposed regulations apply a rentleveling process based on the constant rental accrual method described in § 1.467–3(d) to all amounts that are treated as payable under the lease or similar agreement. At the time of the obligation-shifting transaction, the level

rental amount is determined for the entire term of the lease or similar agreement using 110 percent of the applicable Federal rate based on that term. The amounts that are treated as payable under the lease or similar agreement at the time of the obligation-shifting transaction are the amounts that have already been paid to the property provider and the future amounts that, immediately before the obligation-shifting transaction, are payable to the property provider. Thus, if the property provider assigns the right to receive payments to a third party in exchange for consideration, the consideration is treated as an amount received under the lease or similar agreement. Because the property provider no longer has the right to receive the payments assigned to the third party, those payments (whether past or future) are not treated as amounts that are payable to the property provider for purposes of calculating the level rental amount.

The proposed regulations recharacterize an obligation-shifting transaction by treating the assuming party and the property provider as follows:

The assuming party is treated as acquiring the right to receive all amounts that are allocable to periods after the obligation-shifting transaction. The assuming party includes these amounts in income for the periods that it owns the property.

To reflect the amounts that the assuming party is treated as receiving under the recharacterization but that it does not actually receive, the assuming party also is treated as providing additional consideration to the property provider in the form of a note (a ‘‘section 7701(l) note’’). The original principal balance of the section 7701(l) note equals the excess of the present value of the amounts that are allocable to periods after the obligation-shifting transaction over the present value of the amounts that are payable to the assuming party.

The property provider must adjust its income to the extent that it accounted for income under the lease or similar agreement before the obligation-shifting transaction in a manner inconsistent with the level-rent method described above. The adjustment, which can increase or decrease the property provider’s income, equals the principal balance of the section 467 loan that would have existed if the property provider had been using the constant rental accrual method to account for amounts under the lease or similar agreement that are allocable

to periods before the obligation-shifting transaction, reduced by any existing section 467 loan if the lease or similar agreement is a section 467 rental agreement. The constant rental amount is calculated using the amounts that are treated as payable under the lease or similar agreement.

Finally, to account for any differences in timing or amount between payments the property provider actually receives after the obligation-shifting transaction and payments treated as being made to the property provider under the section 7701(l) note, the property provider is treated as a party to a loan (a ‘‘section 7701(l) rent-leveling loan’’). The section 7701(l) rent-leveling loan is created at the time of the obligation-shifting transaction. Its balance at that time equals the section 467 loan that would have existed if the property provider had been using the constant rental accrual method to account for amounts under the lease or similar agreement that are allocable to periods before the obligation-shifting transaction. Thus, in the periods after the obligation-shifting transaction, the property provider must account for any interest expense or income resulting from the section 7701(l) rent-leveling loan, in addition to any interest income or expense resulting from the section 7701(l) note. Although section 467 may not apply to an obligation-shifting transaction, the effect of the proposed regulations is to recharacterize the transaction to produce the constant rental amount and associated loans that the parties would have been treated as having if the lease or similar agreement had been a section 467 rental agreement (modified to reflect the amounts already received or payable to the property provider immediately before the obligation-shifting transaction) and had been subject to the constant rental accrual method. Thus, the assuming party is treated as if it had purchased the property in part with a note, had obtained the right to receive rental amounts on the constant rental accrual method during its ownership of the property, and had used those amounts to service the note. For the property provider, the proposed regulations provide a recharacterization that is similar (but not identical) to the treatment required when a lessor disposes of property subject to a section 467 rental agreement that was accounted for under the constant rental accrual method.

The proposed regulations provide the exclusive recharacterization of an obligation-shifting transaction for a property provider and an assuming party. Thus, if an obligation-shifting transaction is recharacterized under this section and the lease or similar agreement is a section 467 rental agreement, the rules of this section supersede the rules of §§ 1.467–1 through 1.467–8 as proposed on June 3, 1996 (IA–292–84, 61 FR 27834) for the property provider (the transferor) and the assuming party (the transferee). The assuming party’s income after the obligation-shifting transaction is determined under this section and not under § 1.467–7(e)(1). Similarly, the rules provided in § 1.467–7(e)(2) for determining the amount of the section 467 loan for the period after the transfer, the amount realized by the property provider, and the assuming party’s basis in the property do not apply to obligation-shifting transactions recharacterized by this section.

The recharacterization does not affect the property user or rent factor (if any), because, even though they are parties to the multiple-party financing transaction, no adjustment to their treatment of the transaction is necessary to prevent the avoidance of tax. Cf. § 1.881– 3(a)(3)(ii)(A) (limiting purposes for which conduit financing arrangements are recharacterized). Thus, if the lease or similar agreement is a section 467 rental agreement, the property user must continue to take section 467 rent and section 467 interest into account without regard to the obligation-shifting transaction and the recharacterization under this section. See § 1.467–7(e)(1).

Issues not addressed

The proposed regulations do not address transactions in which a taxpayer assigns rights to future income but does not transfer the underlying property to another taxpayer, except as provided in the special rules regarding pass-through entities and consolidated groups.

Proposed effective date

Notice 95–53 states that the regulations under section 7701(l) will be effective ‘‘with respect to stripping transactions any significant element of which is entered into or undertaken on or after October 13, 1995.’’ The regulations are proposed to adopt the effective date stated in the notice.

Special Analyses

It is hereby certified that these regula

tions do not have a significant economic impact on a substantial number of small entities. This certification is based on the understanding of the IRS that the total number of entities engaging in transactions affected by these regulations is not substantial and, of those entities, most are not small entities within the meaning of the Regulatory Flexibility Act (5 U.S.C. chapter 6). Therefore, a Regulatory Flexibility Analysis is not required. It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in E.O. 12866. Therefore, a regulatory assessment is not required. Pursuant 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 Business Administration for comments on its impact on small businesses.

Comments and Public Hearing

A public hearing has been scheduled for April 29, 1997, at 10 a.m. in the IRS Auditorium, Internal Revenue Building, 7th Floor, 1111 Constitution Avenue NW, Washington, DC. Because of access restrictions, visitors will not be admitted beyond the 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 comments at the hearing must submit written comments and submit an outline of the topics to be discussed and the time to be devoted to each topic (a signed original and eight (8) copies) by April 8, 1997.

A period 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 regulations is Jonathan R. Zelnik, Office of the Assistant Chief Counsel (Financial

Institutions & Products). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 - - Section 1.7701(l)–2 also issued under 26 U.S.C. 7701(l). - - Par. 2. Section 1.7701(l)–1 is amended as follows:

Paragraphs (b)(6) and (b)(7) are revised.
Paragraph (b)(8) is added. The revisions and addition reads as follows:

§ 1.7701(l)–1 Conduit financing ar- rangements.

- - - - (b) - -
- - - - (6) Section 1.6038A–3(b)(5);

(7) Section 1.6038A–3(c)(2)(vii); and (8) Section 1.7701(l)–2. Par. 3. Section 1.7701(l)–2 is added under the center heading ‘‘General Actuarial Valuations’’ to read as follows:

§ 1.7701(l)–2 Treatment of obligation- shifting transactions.

(a) Purpose. The purpose of this section is to prevent avoidance of tax by parties participating in multiple-party financing transactions that involve an assumption of obligations under a lease or similar agreement. This section should be interpreted in a manner consistent with this purpose.

(b) In general. Obligation-shifting transactions as defined in paragraph (h)(1) of this section are recharacterized in the manner described in paragraph (d) of this section unless an exception in paragraph (c) of this section applies.

(i) The aggregate amounts that have already been received by or are payable to the property provider but are allocable to periods (including partial periods) after the obligation-shifting trans

45 1997–7 I.R.B.

action (as determined under paragraph (g) of this section) are less than or equal to $100,000.

(ii) The sum of the aggregate payments (including contingent payments) under the lease or similar agreement and the aggregate value of other consideration (including contingent consideration) to be received under the lease or similar agreement is not reasonably expected to exceed $250,000. The rules of § 1.467–1(c)(4)(ii) ¹ apply in determining the amount described in this paragraph (c)(1)(ii).

(iii) The fair market value of the leased property is less than ten percent of the aggregate fair market value of all of the property (excluding Class I assets as described in § 1.1060–1T(d)(1), Class II assets as described in § 1.1060–1T(d)(2)(i), and debt issued by the property provider) that the property provider transfers to the assuming party as part of the same transaction or series of related transactions. For this purpose, the fair market value of the leased property is the sum of—

(A) The fair market value of the property subject to the lease or similar agreement and transferred in the obligation-shifting transaction, plus

(B) The value of the amounts that have already been received under the lease or similar agreement or are retained by the property provider or any other party but are allocable to periods (including partial periods) after the obligation-shifting transaction.

(iv) The agreement(s) between the property provider and the property user is a disqualified leaseback or long-term agreement within the meaning of § 1.467–3(b). ²

(v) The transaction is described in section 381(a), unless the transaction is deemed to be an obligation-shifting transaction under paragraph (k) of this section.

(vi) The Commissioner determines that the transaction does not substantially reduce the present value of the tax liability of the assuming party or otherwise result in the avoidance of tax.

(2) Limitation on exceptions. The exceptions listed in paragraph (c)(1) of this section do not apply to obligationshifting transactions entered into with a principal purpose of substantially reduc 1This section appears in proposed regulations published on June 3, 1996 (IA–292–84, 61 FR 27834, 27839). 2This section appears in proposed regulations published on June 3, 1996 (IA–292–84, 61 FR 27834, 27844).

ing the present value of the aggregate tax liability of the assuming party, the property provider, and any person whose taxable income is determined (in whole or in part) by reference to the taxable income of the property provider or the assuming party.

(d) Recharacterization of obligation- shifting transaction —(1) In general. In order to clearly reflect the income of the assuming party and the property provider, an obligation-shifting transaction is recharacterized as follows:

(i) Assuming party treated as receiv- ing all allocable rents. The assuming party is treated as acquiring the right to receive (and as receiving when due) all amounts under the lease or similar agreement that are allocable (as determined under paragraph (g) of this section) to periods (including partial periods) after the obligation-shifting transaction. Thus, the assuming party must include these amounts in income in the periods to which they are allocable.

(ii) Assuming party treated as issuing section 7701(l) note. The assuming party is treated as issuing to the property provider, as additional consideration in the obligation-shifting transaction, a section 7701(l) note, with terms as described in paragraph (e) of this section. Accordingly, the assuming party and the property provider must account for interest expense and income from the section 7701(l) note in the periods (including partial periods) following the obligation-shifting transaction.

(2) Section 7701(l) rent-leveling loan and adjustment to property provider’s income —(i) Section 7701(l) rent-leveling loan. To account for any differences in timing or amount between payments actually received by the property provider after the obligation-shifting transaction and payments (as described in paragraph (e)(3) of this section) treated as being made under the section 7701(l) note, the property provider is treated as a party to a section 7701(l) rent-leveling loan, with terms as described in paragraph (f) of this section. Accordingly, the property provider must account for interest expense or income (as appropriate) in the periods (including partial periods) following the obligationshifting transaction.

(ii) Adjustment to property provider’s income. To account for any differences between amounts previously included by the property provider and amounts that are allocable to periods before the obligation-shifting transaction, on the

date on which the obligation-shifting transaction is consummated, the property provider must treat as an item of expense or income (as appropriate)—

(A) The principal balance of the section 7701(l) rent-leveling loan, minus

(B) The principal balance (plus interest not already included in the principal balance) of the property provider’s section 467 loan (if any) as determined under the principles of § 1.467–4(a)(4) ³

(3) Exclusive recharacterization. If the lease or similar agreement is a section 467 rental agreement, the property provider and the assuming party must account for the recharacterized transaction under the provisions of this section and not under the provisions of §§ 1.467–1 through 1.467–8. ⁴

(e) Section 7701(l) note —(1) Princi- pal. On the date on which the obligation-shifting transaction is consummated, the principal balance of the section 7701(l) note equals the excess of—

(i) The present value of the amounts that are allocable to periods (including partial periods) after the obligationshifting transaction, over

(ii) The present value of the amounts that are payable to the assuming party.

(2) Present value, yield, and com- pounding period. For purposes of paragraph (e)(1) of this section, present value is determined under the rules of § 1.467–2(d). The yield of the section 7701(l) note equals 110 percent of the applicable Federal rate on the date on which the obligation-shifting transaction is consummated, based on the remaining term of the lease or similar agreement. The compounding period for determining both the original principal balance and the yield must equal the period used in determining the amounts that are allocable (as determined under paragraph (g) of this section) to periods under the lease or similar agreement.

(3) Repayment schedule —(i) Amount. The payment for each period under the section 7701(l) note is—

(A) The amount that is taken into account by the assuming party under paragraph (d)(1)(i) of this section, minus

3This section appears in proposed regulation published on June 3, 1996 (IA–292–84, 61 FR 27834, 27845). 4These sections appear in proposed regulations published on June 3, 1996 (IA–292–84, 61 FR 27834). 5This section appears in proposed regulations published on June 3, 1996 (IA–292–84, 61 FR 27834, 27842).

and existing as of that date.

1997–7 I.R.B. 46

(B) The amount received by the assuming party for that period.

(ii) Timing. The timing of section 7701(l) note payments, as determined under paragraph (e)(3)(i) of this section, is the same as the timing of the payments taken into account by the assuming party under paragraph (d)(1)(i) of this section.

(4) Debt for all purposes. A section 7701(l) note is debt for all purposes of the Internal Revenue Code. The principal balance of the section 7701(l) note after the obligation-shifting transaction may be positive or negative. If the principal balance is positive, the note represents an amount owed by the assuming party to the property provider, and if the principal balance is negative, the note represents an amount owed by the property provider to the assuming party.

(f) Section 7701(l) rent-leveling loan —(1) Principal. On the date on which the obligation-shifting transaction is consummated, the principal balance of the section 7701(l) rent-leveling loan equals the principal balance (plus any interest not already included in the principal balance) of the section 467 loan as determined under § 1.467–4(b) that would have existed as of that date if—

(i) The amounts payable under the lease or similar agreement were the amounts described in paragraphs (g)(1) and (g)(2) of this section, and

(ii) The property provider had reported all items of income and expense with respect to the lease or similar agreement by applying the constant rental accrual method described in § 1.467–3(d) and by determining the section 467 rent for each period in accordance with § 1.467–1(d)(2)(i).

(2) Yield and compounding period. The yield of the section 7701(l) rentleveling loan equals 110 percent of the applicable Federal rate on the date on which the obligation-shifting transaction is consummated, based on the original term of the lease or similar agreement. The compounding period for determining the yield must equal the period used in determining the amounts that are allocable (as determined under paragraph (g) of this section) to periods under the lease or similar agreement.

(3) Repayment schedule —(i) Amount. The property provider’s payment (or receipt) for each period under the section 7701(l) rent-leveling loan is—

(A) The amount (as described in paragraph (e)(3)(i) of this section)

treated as paid in satisfaction of the section 7701(l) note, minus

(B) The amount received by the property provider under the lease or similar agreement for that period.

(ii) Timing. The timing of section 7701(l) rent-leveling loan payments, as determined under paragraph (f)(3)(i) of this section, is governed by paragraph (g) of this section (and thus, is the same as the timing of the payments taken into account by the assuming party under paragraph (d)(1)(i) of this section).

(4) Debt for all purposes. A section 7701(l) rent-leveling loan is debt for all purposes of the Internal Revenue Code. The principal balance of the section 7701(l) rent-leveling loan may be positive or negative. If the principal balance is positive, the amount represents a loan on which the property provider is the obligee, and if the principal balance is negative, the amount represents a loan on which the property provider is the obligor.

(g) Determining amounts that are al- locable to periods under the lease or similar agreement. The amounts that are allocable to periods under a lease or similar agreement are determined (immediately before the obligation-shifting transaction is consummated) by applying the constant rental accrual method described in § 1.467–3(d) from the inception of the lease or similar agreement based on—

(1) The amounts that have already been received under the lease or similar agreement, and

(2) The amounts that are payable under the lease or similar agreement.

(h) Definitions. The following definitions apply solely for purposes of this section.

(1) An obligation-shifting transaction is any transaction in which an assuming party assumes a property provider’s obligations to a property user (or acquires property subject to a property provider’s obligations to a property user) under a lease or similar agreement if the property provider or any other party has already received, or retains the right to receive, amounts that are allocable to periods after the transaction.

(2) A property user is any person with the right to use property under a lease or similar agreement.

(3) A property provider is any person (other than an assuming party in its capacity as such) that is obligated to make property available to a property user on account of a lease or similar agreement.

(4) An assuming party is any person that assumes obligations or acquires property subject to obligations under an existing lease or similar agreement with a property user.

(5) A lease or similar agreement is any contract for the use or enjoyment of tangible or intangible property, including leaseholds, licenses, other non-fee interests in property, and other contracts (including service contracts) involving the use or enjoyment of property if the fair market value of that use or enjoyment is more than de minimis.

(6) Obligations under a lease or similar agreement include the continuing obligation to make property subject to a lease or similar agreement available to a property user. To the extent that an assuming party assumes obligations of a property provider or acquires property subject to obligations of a property provider, the obligations shall not thereafter be treated as obligations of the property provider.

(7) Amounts that have already been received under the lease or similar agreement include consideration received (as of the date on which the obligation-shifting transaction is consummated) for assigning the rights to receive payments under the lease or similar agreement.

(8) Amounts that are payable under the lease or similar agreement do not include payments the rights to which have been assigned in an arm’s-length transaction to an unrelated third person in exchange for consideration.

(9) A section 7701(l) note is indebtedness arising from the recharacterization described in paragraph (d)(1)(ii) of this section. The terms of a section 7701(l) note are described in paragraph (e) of this section.

(10) A section 7701(l) rent-leveling loan is indebtedness arising from the recharacterization described in paragraph (d)(2)(i) of this section. The terms of a section 7701(l) rent-leveling loan are described in paragraph (f) of this section.

(i) Reserved. (j) Pass-through entity look-through rule. For purposes of determining whether any person is a property user, a property provider, or an assuming party, the person is treated as having the rights and obligations of any pass-through entity in which the person is a partner, shareholder, beneficiary, or other participant, but only to the extent of the person’s allocable share of pass-through entity items relating to the property. The

47 1997–7 I.R.B.

pass-through entity must reflect the required recharacterization on its books.

(k) Consolidated group rule. For purposes of this section, if a subsidiary is a member of a consolidated group and the subsidiary or a successor becomes a nonmember (other than in a transaction described in § 1.1502–13(j)(5)), the nonmember (whether or not a separate legal entity) will be treated as a separate corporation that acquires the assets and assumes the obligations of the subsidiary. For example, assume that P sells all the stock of S, previously a whollyowned subsidiary of P and a member of the P consolidated group, and that, at the time of the sale, S already has received amounts under a lease that are allocable to periods after the sale. Under this paragraph (k), an obligation-shifting transaction occurs when S becomes a nonmember. S, as a nonmember, is treated as having assumed the obligations under the lease. Therefore, S must adjust its income as provided in paragraph (d)(2)(ii) of this section immediately before it becomes a nonmember of the consolidated group. After the sale, S is treated as both a property provider

and an assuming party in the obligationshifting transaction.

(l) Reserved.

(m) Examples. The following examples illustrate the rules of this section. Each example assumes that all taxpayers use the calendar year as the taxable year, all payment periods are the calendar year, and none of the rental agreements are disqualified leasebacks or long-term agreements under § 1.467– 3(b). Except as otherwise provided, none of the exceptions in paragraph (c)(1) of this section apply. The examples read as follows:

Example 1. Retained rents; section 351 trans- fer —(i) Facts. (A) On January 1, 2001, A leases property to B for a five-year period. The lease provides for rent of $10,000,000 per year, payable annually on December 31.

(B) On January 1, 2002, A transfers the leased property to D in exchange for D preferred stock. A retains the right to receive the remaining four years of rent from B. As part of the same transaction, C transfers $100,000,000 to D in exchange for D common stock. After the transaction, A and C own 100 percent of the stock of D. Assume the transaction meets all of the requirements of section 351. C and D are members of the same consolidated group as defined in § 1.1502– 1(h). One hundred ten percent of the applicable

Section 7701(l) note

Federal rate based on annual compounding is 7 percent.

(ii) Obligation-shifting transaction. B is a property user because B has the right to use the property under the lease with A. A is a property provider because A is obligated to make the property available to B on account of the lease. D is an assuming party because in the January 1, 2002, transaction D acquires the property subject to A’s obligations under the lease to make the property available to B for the remaining four years of the lease. The transaction is an obligationshifting transaction because D is an assuming party and A retains the right to receive rent from B allocable to periods after the transaction.

(iii) Recharacterization. As of January 1, 2002, the transaction is recharacterized as follows:

(A) Under the constant rental accrual method described in § 1.467–3(d), the amount accruing for each calendar year period under the lease is $10,000,000. D is treated as acquiring the right to receive the amounts allocable to the four periods after the obligation-shifting transaction. Thus, in 2002, 2003, 2004, and 2005, D must recognize $10,000,000 rental income.

(B) The principal balance of the section 7701(l) note equals $33,872,112.56, with a yield equal to 7 percent based on annual compounding. As part of the obligation-shifting transaction, D is treated as having given A the section 7701(l) note as additional consideration. The amount of the section 7701(l) note is treated as ‘‘other property’’ transferred from D to A in the section 351 exchange. D is treated as making section 7701(l) note payments to A. A has interest income on the section 7701(l) note. D has interest expense on the section 7701(l) note. A and D account for the section 7701(l) note as follows:

Taxable year ending

Beginning

balance Payment Interest Principal

12/31/02 $33,872,112.56 $10,000,000.00 $2,371,047.88 $7,628,952.12 12/31/03 $26,243,160.44 $10,000,000.00 $1,837,021.23 $8,162,978.77 12/31/04 $18,080,181.67 $10,000,000.00 $1,265,612.72 $8,734,387.28 12/31/05 $ 9,345,794.39 $10,000,000.00 $ 654,205.61 $9,345,794.39

years of the lease. The transaction is an obligationshifting transaction because S is an assuming party and Y has already received amounts allocable to periods after the transaction (Y sold to F the right to receive rent payments under the YZ lease for 2002 through 2005). (iii) Recharacterization. As of January 1, 2002, the transaction is recharacterized as follows:

(A) Under the constant rental accrual method described in § 1.467–3(d), the amount accruing for each calendar year period under the YZ lease is $946,396.31, based on the $800,000 Y received from Z on December 31, 2001, and the $3,146,345.27 Y received from F on December 31, 2001. S is treated as acquiring the right to receive the amounts allocable to the four periods after the obligation-shifting transaction. Thus, S must recognize $946,396.31 of rental income for each of the four periods following the obligation-shifting transaction.

(B) The principal balance of the section 7701(l) note equals $2,999,948.96, with a yield equal to 10 percent based on annual compounding. As part of the obligation-shifting transaction, S is treated as having given Y the section 7701(l) note as additional consideration. The amount of the section 7701(l) note is treated as ‘‘other property’’

(C) Because the amount A recognized in the year before the obligation-shifting transaction equals the amount A would have recognized under the constant rental accrual method, A’s adjustment to income on the consummation of the obligationshifting transaction is $0.

(D) At the time of the obligation-shifting transaction, the principal balance of the section 7701(l) rent-leveling loan equals $0. Furthermore, because the amounts A actually receives each year after the obligation-shifting transaction, $10,000,000, equal the amounts D is treated as paying A under the section 7701(l) note, $10,000,000, the balance of the section 7701(l) rent-leveling loan equals $0 for all periods after the obligation-shifting transaction. Thus, A has no interest income or expense arising from the section 7701(l) rent-leveling loan.

Example 2. Rents already received; section 351 transfer - (i) Facts. (A) On January 1, 2001, X leases property to Y for a seven-year period. The XY lease provides for rent of $900,000 per year, payable annually on December 31. Also on January 1, 2001, Y leases the property to Z for a five-year period. The YZ lease provides for rent payable on December 31 of each year as follows: $800,000 in 2001, $900,000 in 2002, $1,000,000

in 2003, $1,100,000 in 2004, and $1,200,000 in 2005. (B) On December 31, 2001, Y sells to F the right to receive all rents from Z for 2002 through 2005. F pays Y $3,146,345.27. Y includes the $3,146,345.27 as ordinary income.

(C) On January 1, 2002, Y contributes to S cash of $2,500,000, Y’s rights and obligations under the lease with X, and Y’s rights and obligations under the lease with Z in exchange for S preferred stock. As part of the same transaction, P transfers cash of $7,500,000 to S in exchange for S common stock. After the transaction, Y and P own 100 percent of the stock of S. Assume the transaction meets all of the requirements of section 351. S and P are members of the same consolidated group as defined in § 1.1502–1(h). One hundred ten percent of the applicable Federal rate based on annual compounding is 10 percent.

(ii) Obligation-shifting transaction. Z is a property user because Z has the right to use the property under the YZ lease. Y is a property provider because Y is obligated to make the property available to Z. S is an assuming party because in the January 1, 2002, transaction, S assumes Y’s obligations under the YZ lease to make the property available for the remaining four transferred from S to Y in the section 351 exchange. S is treated as making section 7701(l)

note payments to Y. Y has interest income on the section 7701(l) note. S has interest expense on the

Section 7701(l) note

section 7701(l) note. S and Y account for the section 7701(l) note as follows:

Taxable year ending

Beginning

balance Payment Interest Principal

12/31/02 $2,999,948.96 $946,396.31 $299,994.90 $646,401.41 12/31/03 $2,353,547.55 $946,396.31 $235,354.75 $711,041.56 12/31/04 $1,642,505.99 $946,396.31 $164,250.60 $782,145.71 12/31/05 $ 860,360.28 $946,396.31 $ 86,036.03 $860,360.28

(C) At the time of the obligation-shifting transaction, the principal balance of the section 467 loan that would have existed if Y had reported all items of income and expense by applying the constant rental accrual method equals negative

$2,999,948.96. Thus, in computing its income on the consummation of the obligation-shifting transaction, Y must take into account an expense equal to $2,999,948.96.

(D) At the time of the obligation-shifting trans

action, the principal balance of the section 7701(l) rent-leveling loan equals negative $2,999,948.96. Y must account for the section 7701(l) rentleveling loan as follows:

Taxable year ending

Section 7701(l) rent-leveling loan

Beginning

balance Payment Interest Principal

12/31/02 ($2,999,948.96) ($946,396.31) ($299,994.90) ($646,401.41) 12/31/03 ($2,353,547.55) ($946,396.31) ($235,354.75) ($711,041.56) 12/31/04 ($1,642,505.99) ($946,396.31) ($164,250.60) ($782,145.71) 12/31/05 ($ 860,360.28) ($946,396.31) ($ 86,036.03) ($860,360.28)

for each calendar year period under the lease is $946,396.31, based on the $800,000 PRS received from X and the $3,146,345.27 PRS received from F. A’s share of the amount payable in each calendar year period under the lease is $851,756.68 (90 percent of $946,396.31). D is treated as acquiring the right to A’s 90 percent share of the amounts allocable to the four periods after the obligation-shifting transaction. Thus, D must recognize $851,756.68 of rental income for each of the four periods following the obligationshifting transaction.

(B) The principal balance of the section 7701(l) note equals $2,699,954.06, with a yield equal to 10 percent based on annual compounding. As part of the obligation-shifting transaction, D is treated as having given A the section 7701(l) note as additional consideration. D is treated as making section 7701(l) note payments to A. A has interest income on the section 7701(l) note. D has interest expense on the section 7701(l) note. A and D account for the section 7701(l) note as follows:

Example 3. Rents already received; sale of a partnership interest —(i) Facts. (A) On January 1, 2001, A, B, and C form partnership PRS by contributing $3,600,000, $396,000, and $4,000, respectively, for proportionate interests (90.0 percent, 9.9 percent, and 0.1 percent, respectively) in the capital and profits of PRS. On the same day, PRS purchases property for $4,000,000 and leases the property to X for a five-year period. The lease provides for rent payable on December 31 of each year as follows: $800,000 in 2001, $900,000 in 2002, $1,000,000 in 2003, $1,100,000 in 2004, and $1,200,000 in 2005.

(B) On December 31, 2001, PRS sells to F the right to receive all rents from X for 2002 through 2005. F pays PRS $3,146,345.27. PRS treats the $3,146,345.27 as ordinary income allocated $2,831,710.74 to A, $311,488.18 to B, and $3,146.35 to C. One hundred ten percent of the applicable Federal rate based on annual compounding is 10 percent.

(C) Immediately following the sale of the rents, A sells its entire partnership interest to D based on the fair market value of 90 percent of PRS’s assets. PRS does not have an election in effect under section 754.

(ii) Obligation-shifting transaction. X is a property user because X has the right to use the property under the lease with PRS. A is a property provider as to its share of the partnership’s obligations under the lease to make the property available to X. D is an assuming party because D acquires A’s partnership interest subject to A’s share of the partnership’s obligations under the lease with X to make the property available for the remaining four years of the agreement. The transaction is an obligation-shifting transaction because D is an assuming party and A has already received income allocable to periods after the transaction (A received allocations of income from the sale of the right to receive rents under the lease in 2002 through 2005). Thus, D is treated as assuming 90 percent of the partnership’s obligations under the lease.

(iii) Recharacterization. As of January 1, 2002, the transaction is recharacterized as follows:

(A) Under the constant rental accrual method described in § 1.467–3(d), the amount accruing

Section 7701(l) note

Taxable year ending

Beginning

balance Payment Interest Principal

12/31/02 $2,699,954.06 $851,756.68 $269,995.41 $581,761.27 12/31/03 $2,118,192.79 $851,756.68 $211,819.28 $639,937.40 12/31/04 $1,478,255.39 $851,756.68 $147,825.54 $703,931.14 12/31/05 $ 774,324.25 $851,756.68 $ 77,432.42 $774,324.26

(C) At the time of the obligation-shifting transaction, the principal balance of the section 467 loan that would have existed if PRS had reported all items of income and expense by applying the constant rental accrual method equals negative

$2,999,948.96. Thus, in computing its income on the consummation of the obligation-shifting transaction, A must take into account an expense equal to $2,699,954.06 (90 percent of $2,999,948.96).

(D) At the time of the obligation shifting

transaction, the principal balance of the section 7701(l) rent-leveling loan equals negative $2,699,954.06. A must account for the section 7701(l) rent-leveling loan as follows:

49 1997–7 I.R.B.

Taxable year ending

Section 7701(l) rent-leveling loan

Beginning

balance Payment Interest Principal

12/31/02 ($2,699,954.06) ($851,756.68) ($269,995.41) ($581,761.27) 12/31/03 ($2,118,192.79) ($851,756.68) ($211,819.28) ($639,937.40) 12/31/04 ($1,478,255.39) ($851,756.68) ($147,825.54) ($703,931.14) 12/31/05 ($ 774,324.25) ($851,756.68) ($ 77,432.42) ($774,324.26)

REG–249819–96

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations relating to the receipt, as part of a reorganization, of rights to acquire stock of a corporation that is a party to the reorganization. This document also provides notice of a public hearing on these regulations.

DATES: Written comments must be received by March 23, 1997. Requests to appear and outlines of topics to be discussed at the public hearing scheduled for March 25, 1997, must be received by March 4, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R [REG–249819–96], room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. In the alternative, submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R [REG–249819–96], Courier’s Desk, Internal Revenue Service, 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 the Commissioner’s Conference Room, room 3313, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, Michael J. Danbury, (202) 622–7750; concerning submissions and the public hearing, Evangelista Lee at (202) 622–7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

A. General information

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) under sections 354, 355, and 356 of the Internal Rev

Example 4. Exception where aggregate amounts retained or already received are less than or equal to $100,000; section 351 transfer —(i) Facts. (A) On January 1, 2001, A leases property to B for a five-year period. The lease provides for rent of $1,000,000 for 2001, and $875,000 for the each of the remaining four years of the lease. Rent is payable annually on December 31.

(B) On January 1, 2002, A transfers the leased property along with the right to receive rent payments for 2002 through 2005 to D in exchange for D preferred stock. As part of the same transaction, C transfers $1,000,000 to D in exchange for D common stock. After the transaction, A and C own 100 percent of the stock of D. Assume that the transaction meets all of the requirements of section 351. C and D are members of the same consolidated group as described in § 1.1502–1(h). Assume that A, C, and D did not enter into the transaction with a principal purpose of substantially reducing the present value of their aggregate tax liabilities. One hundred ten percent of the applicable Federal rate based on annual compounding is 7 percent.

(ii) Obligation-shifting transaction. A is a property provider because it is obligated to make property available to B on account of a lease or similar agreement. B is a property user because it has the right to use property under its lease with A. D is an assuming party because, in the January 1, 2002, transaction, it acquires the property subject to A’s obligation to make the property available to B for the remaining term of the lease. The transaction between A and D is an obligationshifting transaction because D is an assuming party and A retains the right to receive amounts from B allocable to periods after the transaction.

(iii) Availability of exception. Even though the transaction between A and D is an obligationshifting transaction, it is not recharacterized under this section. As of the date of the transaction, A has already received $1,000,000. Under the constant rental accrual method described in § 1.467– 3(d), the constant rental amount accruing for each calendar year during the lease is $903,491.90. The aggregate amount that has already been received by A but that is allocable to periods after the obligation-shifting transaction is $1,000,000 minus $903,491.90, or $96,508.10. Because this amount is less than $100,000, the transaction is excepted from recharacterization under paragraph (c)(1)(i) of this section.

Example 5. Exception where fair market value of leased property is less than 10 percent of value of all property transferred; incorporation of exist- ing business —(i) Facts. (A) On January 1, 2001, A leases property to B for a five-year period. The lease provides for rent of $1,000,000 per year, payable annually on December 31.

(B) On January 1, 2003, the fair market value of the leased property is $4,000,000. On that date, A transfers the property, together with $3,000,000 of Class I and Class II assets and other property with a fair market value of $39,000,000, in exchange for all of the common stock of C. A retains the right to receive the remaining three rent payments from B. The fair market value of the rent payments retained by A is $2,486,851.99

(based on a discount rate of 10 percent). The fair market value of the property subject to the lease and transferred to B, reflecting A’s retention of the right to the remaining three rent payments, is $1,513,148.01. Assume that the transaction meets all of the requirements of section 351. Assume that A and C did not enter into the transaction with a principal purpose of substantially reducing the present value of their aggregate tax liabilities.

(ii) Obligation-shifting transaction. A is a property provider because it is obligated to make property available to B on account of a lease or similar agreement. B is a property user because it has the right to use property under its lease with A. C is an assuming party because, in the January 1, 2003, transaction, it acquires the property subject to A’s obligation to make the property available to B for the remaining three years of the lease. The transaction between A and C is an obligation-shifting transaction because C is an assuming party and A retains the right to receive amounts from B allocable to periods after the transaction.

(iii) Availability of exception. Even though the transaction between A and C is an obligationshifting transaction, it is not recharacterized under this section. The fair market value of the leased property equals $4,000,000. The fair market value of the property subject to the lease and transferred to B is $1,513,148.01, and the fair market value of the rents retained is $2,486,851.99. The aggregate fair market value of all of the property transferred, excluding Class I assets, Class II assets, and debt issued by the property provider, as part of the same transaction is $43,000,000 ($4,000,000 leased property plus $39,000,000 other property, excluding Class I assets, Class II assets, and debt issued by the property provider). Because the value of the leased property, $4,000,000, is less than 10 percent of $43,000,000, the transaction is excepted from recharacterization under paragraph (c)(1)(iii) of this section.

(n) Effective date. This section applies to obligation-shifting transactions any significant element of which was entered into or undertaken on or after October 13, 1995.

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 26, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 27, 1996, 61 F.R. 68175)

Notice of Proposed Rulemaking and Notice of Public Hearing

Reorganizations; Receipt of Securities

1997–7 I.R.B. 50

enue Code of 1986 (Code), relating to exchanges of stock and securities in certain reorganizations. In particular, the proposed regulations address the receipt, as part of a reorganization, of rights to acquire stock of a corporation that is a party to the reorganization.

Section 354 generally provides for the nonrecognition of gain or loss from the exchange of stock or securities in a corporation that is a party to a reorganization for stock or securities in the same corporation or in another corporation that is a party to the reorganization. Gain realized on an exchange of securities is not recognized provided that the principal amount of the securities received does not exceed the principal amount of any securities surrendered pursuant to the plan of reorganization.

Section 355 provides for the nonrecognition of gain or loss upon a distribution by a corporation with respect to its stock of stock in a controlled corporation, or an exchange of securities in a controlled corporation for its securities. As in the case of a transaction described in section 354, gain realized on an exchange of securities is not recognized provided that the principal amount of the securities received does not exceed the principal amount of the securities surrendered pursuant to the plan of reorganization.

Section 356 provides rules for recognition of gain, but not loss, if a shareholder or security holder receives nonqualifying property (i.e., boot) as well as qualifying property in a transaction to which section 354 or 355 would otherwise apply. In particular, realized gain is recognized in an amount not in excess of the fair market value of the excess principal amount of the securities received over the principal amount of any securities surrendered as part of the plan of reorganization.

B. Existing regulations

Existing regulations under sections 354 and 355 provide that stock rights and stock warrants are not included in the term ‘‘stock or securities.’’ Prior to the promulgation of these regulations in 1955, the treatment of such instruments was unclear. Although the Supreme Court had held that stock warrants do not constitute ‘‘stock’’ for purposes of determining whether a transaction is a reorganization, the Board of Tax Appeals had held that stock warrants did constitute ‘‘securities’’ for purposes of section 112(b)(3) of the 1932 Act (a

predecessor to section 354 of the Code). Compare Helvering v. Southwest Con- solidated Corp., 315 U.S. 194 (1942), with Raymond v. Commissioner, 37 B.T.A. 423 (1938).

Since 1955, courts have avoided concluding whether stock rights or stock warrants constitute ‘‘securities’’ for purposes of sections 354 and 355. See, e.g., Carlberg v. United States, 281 F.2d 507, 509 n.3 (8th Cir. 1960); Bateman v. Commissioner, 40 T.C. 408 (1963); Es- tate of Smith v. Commissioner, 63 T.C. 722 (1975).

C. Reasons for Change

A purpose of the reorganization provisions of the Code is to defer the recognition of gain and loss in certain readjustments of corporate structure. Generally, the Code extends nonrecognition to an exchange of stock which effects only a readjustment of continuing interest in modified corporate form. Although a right to acquire stock is not stock, the IRS and Treasury believe that it may generally represent a form of investment in the capital structure of the corporation that justifies nonrecognition treatment as a security under sections 354 and 355. Other provisions of the Code expressly acknowledge the role that stock rights play in the capital structure of a corporation. See, e.g., sections 317 and 1032. Accordingly, the proposed regulations provide that for purposes of sections 354 and 355 the term securities includes ‘‘rights to acquire stock’’ issued by a corporation that is a party to a reorganization.

Explanation of Provisions

A. Scope of proposed rules

The proposed regulations treat rights to acquire stock issued by a corporation that is a party to a reorganization as securities of the corporation. For this purpose, the term ‘‘rights to acquire stock’’ of an issuing corporation has the same meaning as the term has in sections 305(d)(1) and 317(a). It does not include rights exercisable against persons other than the issuer of the stock, or rights that relate to property other than stock of the issuer of the rights. As under current law, a conversion privilege contained in a stock or debt instrument generally will not be considered a separate property right received as part of the reorganization. See Rev. Rul. 69– 265 (1969–1 C.B. 109).

B. Consequences upon receipt of stock rights

For purposes of sections 354, 355 and 356, the proposed regulations treat rights to acquire stock as securities having no principal amount. As a result, a taxpayer will not be required to recognize any gain under section 356 upon the receipt of a stock right. This will generally be the case regardless of whether the taxpayer surrenders stock, stock rights, or debt securities.

C. Effect on other authorities

The proposed rules apply only for the purpose of determining the amount of gain to be recognized in connection with exchanges occurring pursuant to transactions otherwise qualifying under section 368 or 355. They do not address issues concerning the qualification of a transaction under section 368 or 355. For example, the proposed rules do not permit rights to acquire stock to be taken into account in determining continuity of shareholder interest. See South- west Consolidated Corp. (stock options are not stock).

The proposed rules have no effect on other Code provisions governing the treatment of stock options or similar interests for other purposes. Thus, for example, the treatment of an instrument under these rules is not relevant in determining whether the holder of the instrument is treated as holding stock of the issuer for various purposes. See, e.g., sections 318(a)(4), 382(k)(6), and 1504(a)(5). Similarly, an instrument treated as a stock right under these rules may be subject to special rules under other provisions of the Code or regulations relating to compensation related stock options. See, e.g., sections 83 and 421–424 and the regulations thereunder. Nor is any inference intended as to the treatment of an exchange, substitution, or assumption of such options under current law.

D. Proposed effective dates

The proposed regulations change a long-standing regulatory position. To afford taxpayers the opportunity to plan for the change, these regulations are proposed to be effective 60 days after the Treasury decision adopting these rules as final regulations is filed with the Office of the Federal Register.

51 1997–7 I.R.B.

E. Comments regarding need for further guidance

Comments are requested as to whether additional guidance is needed with respect to the scope of these regulations and the general treatment of rights to acquire stock. For example, comments are invited with respect to: the need for additional guidance or special rules to address transactions involving exchanges, substitutions, or assumptions of compensation related stock options; the application of section 306 to the transfer of a right to acquire common stock if the right is received tax-free pursuant to section 305 or 354; whether section 302 should apply to the cash settlement or repurchase of a stock right, for example by treating the holder as having purchased the stock pursuant to the terms of the right and the issuer as having then redeemed that stock for cash; and any other administrative guidance which may be helpful in light of these proposed rules, including suggestions as to existing revenue rulings or revenue procedures that should be modified, reconsidered, or revoked. Note that comments outside of the scope of these regulations will be considered as suggestions for other future guidance.

Special Analyses

It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. Because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any comments submitted timely (in the manner described under the ADDRESSES caption) to the IRS. All comments will be available for public inspection and copying.

A public hearing is scheduled for March 25, 1997, at 10 a.m., in the

Commissioner’s Conference Room, room 3313. Because of access restrictions, visitors will not be admitted beyond the Internal 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 who wish to present oral comments at the hearing must submit an outline of the topics to be discussed by March 4, 1997.

A period 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 regulations is David B. Friedel, formerly of the Office of Assistant Chief Counsel (Corporate). However, other personnel from the IRS and Treasury Department participated in their development.

- - - -

Proposed Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 - - Par 2. Section 1.354–1 is amended by revising paragraph (e) to read as follows:

§ 1.354–1 Exchanges of stock and se- curities in certain reorganizations.

- - - - (e) For purposes of section 354, the

term securities includes rights issued by a party to the reorganization (the issuing corporation ) to acquire its stock. For purposes of this section and section 356(d)(2)(B), a right to acquire stock has no principal amount. This paragraph (e) applies to exchanges occurring on or after the day that is 60 days after the Treasury decision adopting these regulations is filed with the Federal Register.

Par 3. Section 1.355–1 is amended by removing the last sentence of paragraph (b) and adding paragraph (c) to read as follows:

§ 1.355–1 Distribution of stock and se- curities of a controlled corporation.

- - - (c) Stock rights. For purposes of section 355, the term securities includes

rights to acquire the stock of the distributing corporation or the controlled corporation (the issuing corporation ). For purposes of this section and section 356(d)(2)(B), a right to acquire stock has no principal amount. This paragraph (c) applies to distributions occurring on or after the day that is 60 days after the Treasury decision adopting these regulations is filed with the Federal Register.

Par 4. Section 1.356–3 is amended by:

Redesignating existing paragraph (b) as paragraph (c).
Adding a new paragraph (b) to read as follows:

§ 1.356–3 Rules for treatment of secu- rities as ‘‘other property’’.

- - - - (b) For purposes of this section, a

right to acquire stock of the issuing corporation is treated as a security with no principal amount. Thus, such right is not other property when received in a transaction to which section 356 applies (regardless of whether securities are surrendered in the exchange). This paragraph (b) applies to transactions occurring on or after the day that is 60 days after the Treasury decision adopting these regulations is filed with the Federal Register.

- - - -

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 20, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 23, 1996, 61 F.R. 67508)

Notice of Proposed Rulemaking and Notice of Public Hearing

Continuity of Interest

REG–252231–96

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed regulations providing that the continuity of shareholder interest requirement for corporate reorganizations is satisfied if the acquiring corporation furnishes consideration which represents a proprietary interest in the affairs of the acquiring corporation and such consideration represents a substantial part of the value of the stock or properties transferred. Dispositions of stock of the acquiring corporation by a former target shareholder generally are not taken into account in determining whether continuity of shareholder interest has been satisfied. This document also provides notice of a public hearing on these proposed regulations.

DATES: Comments must be received by March 24, 1997. Requests to speak and outlines of topics to be discussed at the public hearing scheduled for Wednesday, May 7, 1997 must be received by Wednesday, April 16, 1997.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG–252231–96), room 5228, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044. In the alternative, submissions may be hand delivered between the hours of 8 a.m. and 5 p.m. to CC:DOM:CORP:R (REG–252231–96), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC. Alternatively, taxpayers may submit comments electronically via the Internet by selecting the ‘‘Tax Regs’’ option on the IRS Home Page, or by submitting comments directly to the IRS Internet site at http://www.irs. ustreas.gov/prod/tax_regs/comments. html. The public hearing will be held in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Phoebe Bennett, (202) 622–7750; concerning submissions and the hearing, Christina Vasquez, (202) 622–6808 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

This document contains proposed amendments to the Income Tax Regulations (26 CFR part 1) under section 368. The proposed regulations provide that the continuity of shareholder interest (COSI) requirement is satisfied if the acquiring corporation furnishes consideration which represents a proprietary interest in the affairs of the acquiring corporation and such consideration represents a substantial part of the value of the stock or properties transferred.

Background

The Internal Revenue Code of 1986 (Code) provides general nonrecognition treatment for reorganizations specifically described in section 368 of the Code. Literal compliance with the statutory requirements is not sufficient for nonrecognition. For example, to qualify as a reorganization the COSI requirement must also be satisfied.

The early statutory definitions of reorganizations did not specify the type of consideration required for a transaction to qualify as a reorganization. As a result, a transaction may have satisfied the literal definition of a reorganization even if the transaction resembled a sale. To prevent such transactions from qualifying as reorganizations, the COSI requirement was established by the courts to ensure that the consideration furnished by the acquiring corporation represented a proprietary interest in the affairs of the acquiring corporation and that such consideration represented a substantial part of the value of the stock or properties transferred. See Helvering v. Minnesota Tea Co., 296 U.S. 378 (1935); Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462 (1933); Cortland Specialty Co. v. Commissioner, 60 F.2d 937 (2d Cir. 1932), cert. denied 288 U.S. 599 (1933). ‘‘Reorganization, merger and consolidation are words indicating corporate readjustments of existing interests. They all differ fundamentally from a sale where the vendor corporation parts with its interest for cash and receives nothing more.’’ Cortland, 60 F.2d at 939.

The cases that gave rise to the COSI requirement did not involve situations in which shareholders of the target corporation disposed of stock consideration from the acquiring corporation after having received it. In those cases, the relevant inquiry was whether the acquiring corporation furnished the proper type of consideration in the reorganization. Over the years, issues have arisen regarding whether the COSI requirement is satisfied if the target shareholders, as contemplated at the time of the reorganization, subsequently dispose of the stock received from the acquiring corporation. Compare McDonald’s Restau- rants of Illinois, Inc. v. Commissioner, 688 F.2d 520 (7th Cir. 1982), rev’g McDonald’s of Zion v. Commissioner, 76 T.C. 972 (1981), with Penrod v. Com- missioner, 88 T.C. 1415 (1987). Various bar associations have asked the Treasury Department and the IRS to provide

guidance to clarify existing law and reduce uncertainty in applying COSI principles in the context of postreorganization sales. See New York State Bar Association Tax Section, Postreorganization Continuity of Interest, reprinted in 73 Tax Notes 481 (1996); Committee on Taxation of Corporations of the Association of the Bar of the City of New York, Postreorganization Transactions and Continuity of Shareholder Interest, reprinted in 72 Tax Notes 1401 (1996).

Explanation of Proposed Regulations

The proposed regulations provide that the COSI requirement is satisfied if the acquiring corporation furnishes consideration in the reorganization that represents a proprietary interest in the affairs of the acquiring corporation and such consideration represents a substantial part of the value of the stock or properties transferred. Dispositions of stock of the acquiring corporation by a former target shareholder generally are not taken into account in determining whether COSI has been satisfied. However, the proposed regulations emphasize that all facts and circumstances must be considered in determining whether the acquiring corporation has in substance furnished the required consideration. For example, if the acquiring corporation or a related party (within the meaning of section 707(b)(1) or section 267(b) (without regard to section 267(e))) purchases the acquiring corporation stock shortly after the reorganization, all of the facts and circumstances may indicate that the transaction should be properly recast to treat the acquiring corporation as furnishing cash in the reorganization, in which case the reorganization would not satisfy the COSI requirement. This approach refocuses the COSI requirement on its initial purpose of ensuring that the acquiring corporation furnishes the proper type of consideration and also promotes simplicity and administrability in applying the COSI requirement.

Effect on Other Authorities

The proposed regulations do not specifically address the effect on COSI of dispositions of target stock before a transaction potentially qualifying as a reorganization. See, e.g., King Enter- prises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969); J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (1995); Superior Coach of Florida, Inc. v. Com-

53 1997–7 I.R.B.

missioner, 80 T.C. 895 (1983); Yoc Heating Corp. v. Commissioner, 61 T.C. 168 (1973). The Treasury Department and IRS are studying this question and also the role of the COSI requirement in section 368(a)(1)(D) reorganizations and section 355 transactions. See § 1.355– 2(c). The Treasury Department and IRS solicit comments on these issues.

Effect on Other Documents

The IRS will modify or obsolete publications as necessary to conform with this regulation as of the date of publication in the Federal Register of the final regulations. See, e.g., Rev. Proc. 86–42 (1986–2 C.B. 722); Rev. Proc. 77–37 (1977–2 C.B. 568). The IRS solicits comments as to whether other publications should be modified or obsoleted.

Proposed Effective Date

The revisions and additions in the proposed regulations apply to transactions occurring after these regulations are published as final regulations in the Federal Register, except that they shall not apply to any transactions occurring pursuant to a written agreement which is (subject to customary conditions) binding on or before these regulations are published as final regulations in the Federal Register.

Special Analyses

It has been determined that this notice of proposed rulemaking 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) does not apply to these regulations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any written comments (a signed original and eight copies) or comments transmitted via

Internet that are submitted timely to the IRS. All comments will be available for public inspection and copying.

A public hearing has been scheduled at 10 a.m. on Wednesday, May 7, 1997, in the Auditorium, Internal Revenue Service, 1111 Constitution Avenue NW, Washington DC. Because of access restrictions, visitors will not be admitted beyond the Internal 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 comments at the hearing must request to speak by Wednesday, April 16, 1997, and submit an outline of the topics to be discussed and the time to be devoted to each topic by Wednesday, April 16, 1997. A period 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 regulations is Phoebe Bennett of the Office of the Assistant Chief Counsel (Corporate), IRS. However, other personnel from the IRS and Treasury Department participated in their development.

Proposed Amendments to the Regula- tions

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805. - - Par. 2. Section 1.368–1 is amended by:

Revising the third sentence of paragraph (b).
Adding two sentences between the fourth and fifth sentences of paragraph (b).
Adding paragraph (e). The revisions and additions read as follows:

§ 1.368–1 Purpose and scope of excep- tion of reorganization exchanges.

- - - -

(b) - - - Requisite to a reorganization under the Code are a continuity of the business enterprise under the modified corporate form, and (except as provided in section 368(a)(1)(D)) a continuity of shareholder interest. - - - The continuity of shareholder interest requirement is described in paragraph (e) of this section. The third and fifth sentences of this paragraph apply to transactions occurring after these regulations are published as final regulations in the Federal Register, except that they shall not apply to any transactions occurring pursuant to a written agreement which is (subject to customary conditions) binding on or before these regulations are published as final regulations in the Federal Register . - -

- - - - (e) Continuity of shareholder inter-

est —(1) General rule. The purpose of the continuity of shareholder interest requirement is to prevent transactions that resemble sales from qualifying for nonrecognition of gain or loss available to corporate reorganizations. Continuity of shareholder interest requires that the acquiring corporation furnish consideration representing a proprietary interest in the affairs of the acquiring corporation and that such consideration represents a substantial part of the value of the stock or properties transferred. In determining whether the acquiring corporation has furnished such consideration, all facts and circumstances must be considered, including any plan or arrangement for the acquiring corporation or its successor corporation (or a person related to the acquiring corporation or its successor corporation within the meaning of section 707(b)(1) or section 267(b) (without regard to section 267(e))) to redeem or acquire the consideration provided in the reorganization. Thus, for example, if based on all the facts and circumstances the acquiring corporation has furnished solely cash, the continuity of shareholder interest requirement is not satisfied.

(2) Triangular reorganizations. For purposes of this paragraph (e), in the case of a triangular reorganization described in § 1.358–6(b), the continuity of shareholder interest requirement will be applied with reference to the stock of the corporation which is in control of the acquiring corporation (in a forward triangular merger) or in control of the merged corporation (in a reverse triangular merger).

1997–7 I.R.B. 54

Minneapolis, MN Homer Civic Association, Winona, MN Ken Petty Ministries, Benton, IL Lake City Athletic Boosters Club Inc.,

(3) Examples. The following examples illustrate the application of this paragraph (e):

Example 1. A owns all of the stock of T. T merges into P. In the merger, A receives stock of P having a fair market value of $50x and cash of $50x. Immediately after the merger, and pursuant to a preexisting binding contract negotiated by A, A sells all of the stock of P received by A in the merger to B, a party not related to P. The transaction satisfies the continuity of shareholder interest requirement because A received stock of P representing a substantial part of the value of the total consideration transferred in the acquisition.

Example 2. A owns 80 percent of the stock of T and none of the stock of P, which is widely held. T merges into P. In the merger, A receives stock of P. In addition, A obtains registration rights pursuant to an agreement with P to register the P stock and sells such stock shortly after the acquisition in the open market. The transaction satisfies the continuity of shareholder interest requirement.

Example 3. A owns 80 percent of the stock of T and none of the stock of P. T merges into P. In the merger, A receives stock of P. In addition, A arranges with an independent investment banker to hedge the risk of loss on the P stock received in the merger. Neither P nor a party related to P enters directly or indirectly into the hedging transaction. The transaction satisfies the continuity of shareholder interest requirement.

Example 4. A owns 80 percent of the stock of T and none of the stock of P. T merges into P. In the merger, A receives stock of P but with an agreement that it will be redeemed shortly by P. Pursuant to the agreement, shortly after the merger P redeems all of the stock of P received by A in the merger for cash. Under all of the facts and circumstances, the cash is treated as furnished by P in the merger, so that the merger does not satisfy the continuity of shareholder interest requirement. The result is the same if S, P’s wholly owned subsidiary, buys all of the stock of P received by A in the merger for cash. The result is also the same if pursuant to a plan between P, its investment banker, and A, P’s investment banker buys all of the stock of P received by A in the merger for cash and, shortly thereafter, P redeems the stock held by the investment banker for cash.

(4) Effective date. Paragraph (e) applies to transactions occurring after these regulations are published as final regulations in the Federal Register, except that it shall not apply to any transactions occurring pursuant to a written agreement which is (subject to customary conditions) binding on or before these regulations are published as final regulations in the Federal Regis- ter.

Par. 3. In § 1.368–2, paragraph (a) is amended by removing the second sentence and adding two new sentences in its place to read as follows:

§ 1.368–2 Definition of terms.

(a) - - - The term does not embrace the mere purchase by one corporation of the properties of another corporation. The preceding sentence applies to transactions occurring after these regulations are published as final regulations in the

Federal Register, except that it shall not apply to any transactions occurring pursuant to a written agreement which is (subject to customary conditions) binding on or before these regulations are published as final regulations in the Federal Register . - - - - - -

Margaret Milner Richardson, Commissioner of Internal Revenue.

(Filed by the Office of the Federal Register on December 20, 1996, 8:45 a.m., and published in the issue of the Federal Register for December 23, 1996, 61 F.R. 67512)

Foundations Status of Certain Organizations

Announcement 97–12

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 designations in the Cumulative List of Organizations (Publication 78), or on the presumption arising from the filing of notices under section 508(b) of the Code. This listing does not indicate that the organizations have lost their status as organizations described in section 501(c)(3), eligible to receive deductible contributions.

Former Public Charities . The following organizations (which have been treated as organizations that are not private foundations described in section 509(a) of the Code) are now classified as private foundations: ACDASCO, Chicago IL Advertising Professionals of Des Moines

City, MO

Blue Springs School of Economics Inc.,

Blue Springs, MO Bonnie Lynn Acres Inc., Milwaukee, WI Canyon Ferry Limnological Institute

Inc., Helena, MT Cardiff Giant Theater Company,

Chicago, IL Cates Goodfellow Housing, St. Louis,

MO Cat Tables Inc., Lebanon, MO Change, Pontiac, IL Children, Inc., Woodward, IA Chippewa Valley Volunteer Center Inc.,

Eau Claire, WI Christian Ministries of St. Louis Inc,

Clayton, MO Christian Mission of Pignon-Pella, Pella,

IA Clayton Historical Society, Clayton, MO Coast to Coast Theatre Company LTD,

Waukegan, IL Community Support Systems Inc.,

Omaha, NE Cozad Youth Center Inc., Cozad, NE Crisis Intervention Shelter Service,

Sturgis, SD Eagles Rest Ministries, Bloomington,

MN Edina Public Schools French Immerson

Parent Organization, Edina, MN Financial Information & Service Center

Inc., Green Bay, Green Bay, WI Fresh Start Center Inc., Greenfield, WI Friends of the Sugar River Inc.,

Belleville, WI Fountain House-Milwaukee Inc.,

Milwaukee, WI Fox Cities Marathon Inc., Appleton, WI Gifts From the Heart Milwaukee Inc.,

Milwaukee, WI Gopher Golf Booster Club Inc.,

Scholarship Foundation, Des Moines, IA American Dream Corporation, Des

Lake City, MN Lambda Justice Center, Minneapolis,

Moines, IA American Variety Arts Foundation,

Detroit, MI Americas Choice Community, Clarinda,

MN Latino Sports Association of Wisconsin

Inc., Milwaukee, WI Learning Bridges Research Organization

Inc., Clayton, MO Lewis University Project Upward,

IA Am Housing, Inc., Omaha, NE Association of Active Emergency Med

Tech of Clay, Vermillion, SD Association of Disabled Americans Inc.,

Romeoville, IL Lukas Foss Cultural Centre Inc.,

Milwaukee, WI M-2 W-2 of Wisconsin Inc., Nashotah,

Poplar Bluff, MO Batavia Riverwalk Committee Inc.,

Wheaton, IL Belle Fourche Historical Preservation

Inc., Belle Fourche, SD Black Health Care Coalition, Kansas

WI Main Entrance Inc., Little Falls, MN Mankato West Booster Club, North

Mankato, MN Masterworks of Minneapolis Inc.,

Minneapolis, MN

55 1997–7 I.R.B.

Merrit Youth Hockey Association,

Sind Medical Association of North

America Inc., Milwaukee, WI Society of Noise Reductionist Inc., St.

Duluth, MN Methodist Manor of Waukegan Inc.,

Park Rapids Activities Foundation Inc.,

Minneapolis, MN Prevail-Psychiatric Reform Thru

Waukesha, WI Midwest Hip Hop Movement, Chicago,

IL Minnesota Big Dads, Stillwater, MN Minnesota Charitable Accounts Inc., St.

Park Rapids, MN Phillips Tender Loving Care,

Development Center, Chicago, IL Therapeutic Recreators for Recovery,

Paul, MN South Dakota Concrete Promotion

Association, Spearfish, SD Space West Ridge Community

Organization, Chicago, IL U.S.S. Springfield Commissioning

Committee, Springfield, IL Whiteside County AIDS Network,

Paul, MN Minnesota Czechoslovak Center,

Minneapolis, MN Minnesota Leadership Foundation,

Algonquin, IL United for Progress Outreach

Minneapolis, MN Minnesota Living Center Inc., St. Paul,

Education Visionary Action, Madison, WI Princeton Alumni Association, Inc.,

Princeton, MO Project Fresh Start, Chicago, IL Property Management Resource Center,

Chicago, IL Quality Behavioral Care, Chicago, IL Racine County Clubhouse, Inc., Racine,

MN Minnesotans for Light Rail Transit

(MNLRT), Brooklyn Park, MN Minnesota Sharp Tailed Grouse Society

WI Remedial Education Adolescents

Disadvantaged Foundation Inc., Baton Rouge, LA River Falls Educational Foundation Inc.,

Morrison, IL Women at the Court House,

Minneapolis, MN Womens Board, Chicago, IL XI Lambda Educational Foundation,

Chicago, IL Youth Enjoying Sobriety, Peoria, IL

Inc., Duluth, MN Mt. Zion Child Development Center,

River Falls, WI River Forest Boosters Association,

Milwaukee, WI Naperville Youth Football League,

Naperville, IL National Coalition of Black Amer Men

Inc., Milwaukee, WI Nels Sorensen Memorial, Minneapolis,

Chicago, IL River Valley Child Center Inc., Spring

MN New Jerusalem Ministries Inc. Green

Bay, WI North Star Focal Point Center for

Adolescents, Minneapolis, MN Northstar Stair Community Land Trust,

Green, WI Running Water Historical Society,

Yankton, SD Save Our School Inc., Streator, IL Service Personnel Support Group,

Rochester, MN Shepherds Foundation Inc., Union

Grove, WI Shoreview Historical Society,

St. Paul, MN Opera 101 Theatre Company, St. Paul,

Shoreview, MN Sian Ka An Biosphere Foundation,

MN Over and Back, Northfield, MN Ozark Mountain Center for

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 determination letter with the revised classification as to foundation status. Grantors and contributors may thereafter rely upon such ruling or determination letter as provided in section 1.509(a)–7 of the Income Tax Regulations. It is not the practice of the Service to announce such revised classification of foundation status in the Internal Revenue Bulletin.

Environmental Education, Alton, MO

Minneapolis, MN Silk for Life Project Inc., Milwaukee,

1997–7 I.R.B. 56