P a rt I. Rulings — Internal Revenue Bulletin 1997-43

definitions of securities lending transactions and sale-repurchase transactions are provided in §§1.861–2(a)(7) and 1.861–3(a)(6) of the regulations. T h e s e provisions define a substitute payment as a payment made to the transferor of a security of an amount equal to any distributions of dividends or interest which the owner of the transferred security would normally receive. The regulations also provide that substitute interest or dividend payments have the same character as interest or dividend income, respectively, for purposes of applying sections 864(c)(4)(B), 871, 881, 894, 4948(a) and the withholding provisions under chapter 3 of the Internal Revenue Code.

Scope of regulation

Some commentators questioned whether a sale-repurchase transaction is considered a transaction that is substantially similar to a securities lending transaction for purposes of the proposed regulations. They noted that most sale-repurchase transactions contractually permit the purchaser to deal freely with the underlying securities, specifying only that substantially identical securities be returned on the repurchase date. In such cases the purchaser must also make substitute payments to the seller. The final regulations clarify that substitute payments made in a sale-repurchase transaction are sourced and characterized in the same manner that substitute payments are sourced and characterized in securities lending transactions.

The final regulations only address the tax treatment of substitute payments received by the transferor in securities lending or sale-repurchase transactions. T h e regulations do not address the treatment of fees or interest paid to the transferee in such transactions. For example, the transparency rule does not extend to characterize the interest component of the repurchase price of a sale-repurchase agreement, which is treated as interest and sourced under the general source rules for interest contained in sections 861 and 862. See Rev. Rul. 74-27 (1974–1 C.B. 24); Rev. Rul. 77–59 (1977–1 C.B. 196); Nebraska Department of Revenue v. Loewenstein, 115 S. Ct. 557 (1994).

In response to comments, the final regulations apply for purposes of determin

Section 861.—Income From Sources Within the United States

26 CFR 1.861–2: Interest.

T.D. 8735

D E PA RTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Certain Payments Made Pursuant to a Securities Lending Transaction

A G E N C Y: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

S U M M A RY: This document contains final Income Tax Regulations relating to the taxation of certain payments made pursuant to a cross-border securities lending transaction. These regulations provide guidance concerning the source, character, and income tax treaty treatment of such payments and affect United States payors and recipients and foreign payors and recipients.

D ATES: These regulations are eff e c t i v e October 14, 1997.

Applicability: These regulations are applicable to payments made after November 13, 1997.

FOR FURTHER INFORMATION CONTACT: Ramon Camacho or Paul Epstein at (202) 622-3870 (not a toll-free number) of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, NW., Wa s h i n g t o n, DC 20224.

SUPPLEMENTARYINFORMATION:

Background

On January 9, 1992, the IRS published proposed amendments (INTL–106–89) to the Income Tax Regulations (26 CFR part

under sections 861, 871, 881, 894, and 1441 of the Internal Revenue Code of 1986 (Code) in the Federal Register (57

FR 860). A public hearing was scheduled but was subsequently cancelled because no one requested to testify. However, several written comments were received. After consideration of all of the comments, the regulations proposed by INTL–106–89 are adopted by this Tr e asury decision, as modified.

Explanation of Provisions

I. The 1992 Proposed Regulations

On January 9, 1992, the Internal Revenue Service (IRS) issued proposed regulations that provided guidance on the source and character of substitute payments made in cross-border securities lending transactions. In general, the regulations proposed to source substitute payments by reference to the source of the payments (dividend or interest) for which they substitute. In addition, the regulations proposed to characterize substitute payments under a transparency rule. Under the transparency rule, substitute payments are treated as having the same character as the dividend or interest income for which they substitute.

Under the proposed regulations, the source rule applies for all purposes of the Code in cross-border securities lending transactions. In contrast, the transparency rule addressing the character of substitute payments applies only for purposes of determining the tax liability under sections 871 and 881 and nonresident alien withholding under chapter 3 of the Code and for treaty purposes. Generally, public comments welcomed the transparency rule because it eliminated unjustifiable tax biases between similar economic investments. After considering all the public comments, the proposed regulations are adopted as final regulations by this Tr e asury decision, substantially as proposed.

II. The Final Regulations

General rule

The final regulations, like the proposed regulations, provide that a substitute payment made with respect to a securities lending or sale-repurchase transaction is sourced using the general rules governing the source of interest or dividend income contained in sections 861 and 862. T h e

October 27, 1997 4 1997–43 I.R.B.

treaty purposes in the manner proposed in 1992 also is amply provided in section 7701(l), which was enacted after these comments were received. Section 7701(l) provides a broad grant of authority to issue regulations recharacterizing multiple party financing arrangements to prevent the avoidance of any tax.

In this regard, the legislative history provides that “the committee seeks to bolster the Tr e a s u r y ’s ability to prevent unwarranted avoidance of tax through multiple-party financial engineering as well as to provide a mechanism for issuing additional guidance to taxpayers entering into financial transactions.” See H.R. Rep. No. 103–111, 103rd Cong., 1st Sess. 729 (1993). The committee also made clear that this authority was not limited to the types of back-to-back loan transactions addressed in prior rulings. See Rev. Rul. 84–152 (1984–2 C.B. 381); Rev. Rul. 84–153 (1984–2 C.B. 383); Rev. Rul. 87–89 (1987–2 C.B. 195). Section 7701(l) in fact has been applied to a broad range of financial transactions. See, e.g., Prop. Regs. §1.7701(l)–2 (treatment of obligation-shifting transactions); and Notice 97–21 (IRB 1997–11, March 17, 1997), (tax avoidance using self-amortizing investments in conduit financing entities).

The 1992 proposed regulation under section 894 provided that where an income tax convention refers to United States law, the relevant law is the section or sections of the Internal Revenue Code and regulations thereunder governing the tax which is the subject of the provision. Some commentators have suggested that the proposed securities lending regulations would be invalid for purposes of characterizing dividends that are specifically defined by treaties. However, under conduit principles and additional authority to characterize payments pursuant to section 7701(l), the regulations adopted under §1.894–1(c) address the identity of the owner of dividend and interest income for treaty purposes as opposed to the character of the payments received under varying treaty definitions. These regulations therefore are consistent with the g o v e r n m e n t ’s authority under treaties to determine the identity of the beneficial owner of income.

Special Analyses

It has been determined that this Tr e a

ing the source of substitute payments, regardless of whether the recipient of the income is U.S. or foreign. When source is determined under these regulations, it applies for all purposes of the Code (e.g., foreign tax credit limitations under sections 904 and 906). However, with respect to the characterization of substitute payments, the IRS and Treasury believe that it is appropriate, and more consistent with existing guidance regarding the treatment of substitute payments, to apply the transparency rule only with respect to foreign taxpayers and only for limited purposes. A c c o r d i n g l y, the transparency rule applies to determine character only for certain purposes of sections 864, 871, 881, 894, 4948(a) and chapter 3 of the Code. For example, under this rule, substitute payments to a foreign person with respect to stocks and securities that, absent the securities lending transaction, would give rise to foreign source eff e ctively connected income in the hands of such person, will retain their character as dividend or interest income for purposes of determining whether the income is effectively connected to the U.S. trade or business of such person.

The transparency rule does not apply, h o w e v e r, to characterize the U.S. source income of U.S. trades or businesses of foreign taxpayers. A c c o r d i n g l y, U.S. source effectively connected income of foreign taxpayers and U.S. source income of U.S. taxpayers will be treated the same. In this regard, the final regulations do not a ffect existing guidance applicable to both U.S. and foreign taxpayers concerning the characterization of substitute payments for purposes of other sections not specifically identified in these final regulations. See, e.g., Rev. Rul. 60–177 (1960–1 C.B. 9), (substitute payments are ineligible for the dividends received deduction under section 243); Rev. Rul. 80–135 (1980–1 C.B. 18), (substitute payments are ineligible for the tax-exemption on state and local bonds under section 103).

Because the transparency rule does not apply for purposes of sections 901 and 903, nothing in the final regulations affects the determination required under §1.901–2(f) concerning the identity of the person by whom a foreign tax is considered paid for purposes of sections 901 and 903.

Substitute payments on portfolio debt instruments

Under the final regulations, substitute interest payments made with respect to a debt instrument, the interest on which qualifies as portfolio interest under section 871(h) or section 881(c) in the hands of the lender, is characterized as portfolio interest if, in the case of an obligation in registered form, the lender provides the withholding agent with a beneficial owner withholding certificate or documentary evidence in accordance with §1.871–14(c) and no exception from the portfolio interest exemption applies. For example, if a bank lends securities in a transaction that the facts and circumstances indicate in substance is an extension of credit pursuant to a loan agreement in the ordinary course of the bank’s trade or business, the substitute payment may be characterized as interest which would not qualify as portfolio interest under section 881(c)(3)(A).

Tax treaties

Some commentators noted that the transparency rule adversely affects foreign taxpayers that might otherwise rely on a different characterization of substitute payments in order to claim benefits under certain income tax treaties. T h e transparency rule would eliminate these benefits in a number of cases. T h o s e commentators questioned the government’s authority to issue regulations that would characterize substitute payments as dividend or interest income in light of U.S. income tax treaty provisions.

The IRS and Treasury believe that the transparency rule in general is properly issued pursuant to the general grant of authority under section 7805 because it eliminates opportunities for abuse that arise from a rule that would characterize substitute payments in a manner different from the treatment of the underlying payment. A transparency approach provides uniform results for economically similar investments.

M o r e o v e r, the IRS and Treasury believe that, in the absence of a transparency rule, many taxpayers would use securities lending transactions in order to avoid tax under tax treaties or under the Code. For this reason, authority to characterize substitute payments for Code and

1997–43 I.R.B. 5 October 27, 1997

adding a sentence at the end of paragraph (a)(1); adding paragraph (a)(6); and removing the first sentence of paragraph (d) and adding three sentences in its place to read as follows:

§1.861–3 Dividends.

(a) * * * (1) * * * See also paragraph (a)(6) of this section for special rules concerning substitute dividend payments received pursuant to a securities lending transaction.

(6) Substitute dividend payments. A substitute dividend payment is a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to a dividend distribution which the owner of the transferred security is entitled to receive during the term of the transaction. A securities lending transaction is a transfer of one or more securities that is described in section 1058(a) or a substantially similar transaction. A sale-repurchase transaction is an agreement under which a person transfers a security in exchange for cash and simultaneously agrees to receive substantially identical securities from the transferee in the future in exchange for cash. A substitute dividend payment shall be sourced in the same manner as the distributions with respect to the transferred security for purposes of this section and §1.862–1. See also §§1.864–5(b)(2)(iii), 1.871–7(b)(2) and 1.881–2(b)(2) for the character of such payments and §1.894–1(c) for the application of tax treaties to these transactions.

(d) * * * Except as otherwise provided in this paragraph this section applies with respect to dividends received or accrued after December 31, 1966. Paragraph (a)(5) of this section applies to certain dividends from a DISC or former DISC in taxable years ending after December 31, 1971. Paragraph (a)(6) of this section is applicable to payments made after November 13, 1997. * * *

Par. 4. Section 1.864–5 is amended by redesignating paragraph (b)(2)(ii) as paragraph (b)(2)(iii) and adding new paragraph (b)(2)(ii) to read as follows:

sury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It is hereby certified that these regulations will not have a significant economic impact on a substantial number of small entities. A c c o r d i n g l y, a regulatory flexibility analysis is not required. This certification is based on the information that follows. These regulations affect entities engaged in cross-border multipleparty financing arrangements. These regulations affect the tax treatment of substitute payments made with respect to stocks and debt securities. The primary participants who engage in cross-border multiple party financing arrangements of this type are large regulated commercial banks and brokerage firms. In addition, comments received in response to the notice of proposed rulemaking were from law associations, other associations that represent large regulated financial companies or from individuals. A c c o r d i n g l y, Treasury and IRS do not believe that a substantial number of small entities engages in cross-border multiple party financing arrangements of the type covered by these regulations. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Small Business Administration for comment on its impact on small business.

Drafting Information

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

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * * Section 1.861–2 also issued under 26 U.S.C. 863(a). Section 1.861–3 also issued under 26

U.S.C. 863(a). * * * Section 1.864–5 also issued under 26 U.S.C. 7701(l). * * * Section 1.871–7 also issued under 26 U.S.C. 7701(l). * * * Section 1.881–2 also issued under 26 U.S.C. 7701(l). * * * Section 1.894–1 also issued under 26 U.S.C. 7701(l). * * *

Par. 2. Section 1.861–2 is amended by adding a sentence at the end of paragraph (a)(1); adding paragraph (a)(7); and revising paragraph (e) to read as follows:

§1.861–2 Interest.

(a) * * * (1) * * * See paragraph (a)(7) of this section for special rules concerning substitute interest paid or accrued pursuant to a securities lending transaction.

(7) A substitute interest payment is a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to an interest payment which the owner of the transferred security is entitled to receive during the term of the transaction. A securities lending transaction is a transfer of one or more securities that is described in section 1058(a) or a substantially similar transaction. A s a l e repurchase transaction is an agreement under which a person transfers a security in exchange for cash and simultaneously agrees to receive substantially identical securities from the transferee in the future in exchange for cash. A substitute interest payment shall be sourced in the same manner as the interest accruing on the transferred security for purposes of this section and §1.862–1. See also §§1.864–5(b)(2)(iii), 1.871–7(b)(2), 1.881–2(b)(2) and for the character of such payments and §1.894–1(c) for the application tax treaties to these transactions.

(e) Effective dates. Except as otherwise provided, this section applies with respect to taxable years beginning after December 31, 1966. For corresponding rules applicable to taxable years beginning before January 1, 1967, (see 26 CFR part 1 revised April 1, 1971). Paragraph (a)(7) of this section is applicable to payments made after November 13, 1997.

Par. 3. Section 1.861–3 is amended by

October 27, 1997 6 1997–43 I.R.B.

to the terms of the transferred security. S i m i l a r l y, for purposes of this section, a substitute dividend payment (as defined in §1.861–3(a)(6)) received by a foreign person pursuant to a securities lending transaction or a sale-repurchase transaction (as defined in §1.861–2(a)(7)) shall have the same character as a distribution received with respect to the transferred security. Where, pursuant to a securities lending transaction or a sale-repurchase transaction, a foreign person transfers to another person a security the interest on which would qualify as portfolio interest under section 881(c) in the hands of the lender, substitute interest payments made with respect to the transferred security will be treated as portfolio interest, provided that in the case of interest on an obligation in registered form (as defined in §1.871–14(c)(1)(i)), the transferor complies with the documentation requirement described in §1.871–14(c)(1)(ii)(C) with respect to the payment of substitute interest and none of the exceptions to the portfolio interest exemption in sections 881(c)(3) and (4) apply. See also §§1.871–7(b)(2) and 1.894–1(c).

(e) * * * Except as otherwise provide in this paragraph, this section applies for taxable years beginning after December 31, 1966. Paragraph (b)(2) of this section is applicable to payments made after November 13, 1997. * * *

Par. 7. Section 1.894–1 is amended by revising paragraph (c) and adding paragraph (d) to read as follows:

§1.894–1 Income affected by treaty.

(c) Substitute interest and dividend p a y m e n t s . The provisions of an income tax convention dealing with interest or dividends paid to or derived by a foreign person include substitute interest or dividend payments that have the same character as interest or dividends under §1.864–5(b)(2)(ii), 1.871–7(b)(2) or 1.881–2(b)(2). The provisions of this paragraph (c) shall apply for purposes of securities lending transactions or sale-repurchase transactions as defined in §1.861–2(a)(7) and §1.861–3(a)(6).

(d) Effective dates . Paragraphs (a) and (b) of this section apply for taxable years

§1.864–5 Foreign source income effectively connected with U.S. business.

(b) * * * (2) * * * (ii) Substitute payments. For purposes of this paragraph (b)(2), a substitute interest payment (as defined in §1.861–2(a)(7)) received by a foreign person subject to tax under this paragraph (b) pursuant to a securities lending transaction or a sale-repurchase transaction (as defined in §1.861–2(a)(7)) with respect to a security (as defined in §1.864–6(b)(2)(ii)(c)) shall have the same character as interest income paid or accrued with respect to the terms of the transferred security. Similarly, for purposes of this paragraph (b)(2), a substitute dividend payment (as defined in §1.861–3(a)(6)) received by a foreign person pursuant to a securities lending transaction or a sale-repurchase transaction (as defined in §1.861–3(a)(6)) with respect to a stock shall have the same character as a distribution received with respect to the transferred security. T h i s paragraph (b)(2)(ii) is applicable to payments made after November 13, 1997.

Par. 5. Section 1.871–7 is amended by redesignating the text of paragraph (b) as paragraph (b)(1); adding a paragraph heading for newly designated paragraph (b)(1); adding paragraph (b)(2); and removing the first sentence of paragraph (f) and adding two sentences in its place to read as follows:

§1.871–7 Taxation of nonresident alien individuals not engaged in U.S. business.

(b) Fixed or determinable annual or pe - riodical income —(1) General rule. * * *

(2) Substitute payments. For purposes of this section, a substitute interest payment (as defined in §1.861–2(a)(7)) received by a foreign person pursuant to a securities lending transaction or a sale-repurchase transaction (as defined in §1.861–2(a)(7)) shall have the same character as interest income paid or accrued with respect to the terms of the transferred s e c u r i t y. Similarly, for purposes of this

section, a substitute dividend payment (as defined in §1.861–3(a)(6)) received by a foreign person pursuant to a securities lending transaction or a sale-repurchase transaction (as defined in §1.861–3(a)(6)) shall have the same character as a distribution received with respect to the transferred security. Where, pursuant to a securities lending transaction or a sale-repurchase transaction, a foreign person transfers to another person a security the interest on which would qualify as portfolio interest under section 871(h) in the hands of the lender, substitute interest payments made with respect to the transferred security will be treated as portfolio interest, provided that in the case of interest on an obligation in registered form (as defined in §1.871–14(c)(1)(i)), the transferor complies with the documentation requirement described in §1.871–14(c) (1)(ii)(C) with respect to the payment of the substitute interest and none of the exceptions to the portfolio interest exemption in sections 871(h)(3) and (4) apply. See also §§1.861–2(b)(2) and 1.894–1(c).

(f) * * * Except as otherwise provided in this paragraph, this section shall apply for taxable years beginning after December 31, 1966. Paragraph (b)(2) of this section is applicable to payments made after November 13, 1997. * * *

Par. 6. Section 1.881–2 is amended by redesignating the text of paragraph (b) as paragraph (b)(1); adding a paragraph heading for newly designated paragraph (b)(1); adding a paragraph (b)(2); and removing the first sentence of paragraph (e) and adding two sentences in its place to read as follows:

§1.881–2 Taxation of foreign corporations not engaged in U.S. business.

(b) Fixed or determinable annual or pe - riodical income—(1) General ru l e . - * *

1997–43 I.R.B. 7 October 27, 1997

beginning after December 31, 1966. For corresponding rules applicable to taxable years beginning before January 1, 1967, (see 26 CFR part 1 revised April 1, 1971). Paragraph (c) of this section is applicable to payments made after November 13, 1997.

§1.7701(l)–1 [Amended]

P a r. 10. Section 1.7701(l)–1 is amended as follows:

Paragraph (a) is amended by removing the paragraph designation (a) and the heading.
Paragraph (b) is removed.

reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1 5 4 5 – 1126. Responses to these collections of information are mandatory.

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

The estimated annual burden per respondent varies from 1/2 hour to 3 hours, depending on individual circumstances, with an estimated average of 1 hour.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Off i c e r, T: F P, Wa s hington, DC 20224, and to the Office of Management and Budget, Attn: Desk O fficer for the Department of the Tr e as u r y, Office of Information and Regulatory Affairs, Washington, DC 20503.

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

Background

On April 27, 1992, a notice of proposed rulemaking was published in the Federal R e g i s t e r (57 F.R. 15272) proposing amendments to the final Regulations on Procedure and Administration (26 CFR 3 0 1 . 6 114–1), published in the F e d e r a l R e g i s t e r on March 14, 1990 (55 F. R . 9438) and on July 12, 1990 (55 F. R . 28608). The proposed amendments related to §301.6114–1(b) and (c) and §301.7701(b)–7(c)(2). No written comments responding to the notice were received. No public hearing was requested or held. The proposed amendments are adopted without change by this Treasury decision. This Treasury decision also includes modifications to §§1.6038–2(j), 1.6046–1(g), 301.6114–1(d), 301.7701 (b)–3(b)(3) and (4), 301.7701(b)–7(c)(1) and 301.7701(b)–8(b)(1) and (2).

Explanation of Provisions

Section 301.6114–1(b) is amended by adding paragraph (b)(8) to provide that

Michael P. Dolan, Acting Commissioner of

Internal Revenue.

is defined in § 4261(e)(1)(B) of the Internal Revenue Code, for purposes of computing the tax on air transportation. See Announcement 97–107, page 25.

Section 6114.—Tre a t y - B a s e d R e t u rn Positions

26 CFR 301.6114–1: Treaty-based return positions.

T.D. 8733

D E PA RTMENT OF THE TREASURY Internal Revenue Service 26 CFR Parts 1, 301 and 602

Treaty-Based Return Positions

A G E N C Y: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

S U M M A RY: This document contains final regulations under section 6114 of the Internal Revenue Code of 1986 providing that reporting is specifically required if the residency of an individual is determined under a treaty and apart from the Code. The IRS concluded, in the process of completing the regulations under section 7701(b), that the rules of section 6 114 should apply to individuals determining their residency under a treaty. These final regulations are necessary to implement the section 6114 rules to individuals determining their residency under a treaty. Also contained in this document are final regulations relating to section 7701(b) and conforming changes to regulations under sections 6038 and 6046.

EFFECTIVE DATE: These regulations are effective December 15, 1997.

FOR FURTHER INFORMATION CONTACT: David A. Juster, telephone (202622-3850) (not a toll-free number), regarding sections 6114 and 7701(b) and Carl M. Cooper, telephone (202-6223840) (not a toll-free number) regarding sections 6038 and 6046, both of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, IRS.

SUPPLEMENTARYINFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been

Approved August 28, 1997.

Donald C. Lubick, Acting Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on October 6, 1997, 8:45 a.m., and published in the issue of the Federal Register for October 14, 1997, 62 F.R. 53498)

Section 1362.—Election; Revocation; Termination.

26 CFR 1.1362–6: Elections and consents.

If a taxpayer applies for late S corporation election relief under §1362(b)(5) of the Internal Revenue Code under Rev. Proc. 97–48, who must file the consent to apply for late S corporation election relief? See Rev. Proc. 97–48, page 19.

Section 1502.—Regulations

26 CFR 1.1502–13: Intercompany transactions.

This revenue procedure provides guidance for requesting consent under §1.1502–13(e)(3) to treat certain intercompany transactions on a separate entity basis, to revoke such consent, or to change from the unauthorized use of separate entity reporting to single entity reporting. This revenue procedure cross-references Rev. Proc. 97–27 and modifies and supersedes Rev. Proc. 82–36. See Rev. Proc. 97–49, page 22.

Section 4261.—Imposition of Tax

26 CFR 49.4261–1: Imposition of tax; in general.

This announcement corrects Rev. Proc. 97–46, which provides a list of “rural airports” as that term

October 27, 1997 8 1997–43 I.R.B.

reporting is required under section 611 4 where residency of an individual is determined under a treaty and apart from the Internal Revenue Code (Code). The regulations provide, however, that reporting is waived for an individual if payments or income items reportable by reason of paragraph (b)(8) do not exceed $100,000 in the aggregate. Section 301.6114–1(d) currently provides that when reporting is required under section 6114, a taxpayer must furnish as an attachment to his or her return a written statement with the information as set forth in paragraph (d). Section 301.7701(b)–7(b) currently provides that a dual resident taxpayer who claims a treaty benefit as a nonresident of the United States must file a statement in the form required by paragraph (c) of that section. Section 301.6114–1(d) is now amended to provide that, when reporting is required under section 6114, a taxpayer must furnish, as an attachment to his or her return, a fully completed Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) or appropriate successor form. Section 301.7701(b)–7(c)(1) is amended to provide that the written statement required to be furnished under paragraph (b) of that section, as an attachment to a dual resident taxpayer’s return, must be in the form of a fully completed Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) or appropriate successor form. Form 8833 was developed to provide standardized reporting of the information currently required by §§301.6114–1(d) and 301.7701(b)–7(c). In an effort to provide standardized reporting of the information currently required to be reported, under §301.7701(b)–8(b), by taxpayers claiming the closer connection exception and exempt individuals and individuals with a medical condition, the Service has developed Form 8840 (Closer Connection Exception Statement) and Form 8843 (Statement for Exempt Individuals and Individuals with a Medical Condition). A c c o r d i n g l y, §301.7701(b)–8(b)(1) is amended to provide that the statement filed by alien individuals claiming the closer connection exception, described in §301.7701(b)–2, must be in the form of a fully completed Form 8840 or appropriate successor form. Section 301.7701(b)–8(b)(2) is

amended to provide that the statement filed by exempt individuals and individuals with a medical condition, described in §301.7701(b)–3, must be in the form of a fully completed Form 8843 or appropriate successor form.

Sections 3121(b)(19), 3306(c)(19) and 3231(e)(1) of the Code provide that “J” class visa holders (teachers and trainees) are exempt from FICA, FUTA and Railroad Retirement Act taxes, respectively. Section 320 of the Social Security Independence and Program Improvements Act of 1994, Public Law 103–296 (108 Stat. 1464), extends the FICA, FUTAand Railroad Retirement Act tax exemptions and certain other tax rules to “Q” class visa holders (participants in international cultural exchange programs). A c c o r d i n g l y, conforming changes have been made to §301.7701(b)–3(b)(3) and (4) to reflect the revisions in the Code to the definitions of a teacher or trainee and s t u d e n t c o ntained in section 7701(b)(5).

Section 301.7701(b)–7(c)(2), adopted as proposed, provides that, for purposes of stating the approximate amount of subpart F income to be included in the statement required to be furnished under paragraph (b) of that section by a dual resident taxpayer who is a shareholder in a c o n t rolled foreign corporation (as defined in section 957 or section 953(c)), the approximate amount of income may be based on the audited foreign financial statements of the CFC if there are no other United States shareholders in that CFC. Parallel rules with respect to information reporting under sections 6038 and 6046 are added in §§1.6038–2(j)(2)(ii) and 1.6046–1(g). Under these rules, a taxpayer who claims a treaty benefit as a nonresident of the United States, but who is a United States person for purposes of the information reporting requirements of sections 6038 or 6046, may satisfy certain information reporting requirements by filing the audited foreign financial statements of the foreign corporation with respect to which the information reporting is required. However, these rules apply only if the taxpayer is the sole United States person for purposes of the information reporting requirements with respect to the foreign corporation. If there are other United States persons for those purposes, then the taxpayer must report the information required by the

regulations in the form and manner generally prescribed.

Special Analyses

It has been determined that this Tr e asury decision is not a significant regulatory action as defined in EO 12866. Therefore, a regulatory assessment is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the notice of proposed rulemaking preceding the regulations was issued prior to March 29, 1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Drafting Information

Various personnel from the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, IRS and the Treasury Department participated in developing the regulations.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1, 301 and 602 are 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 1.6038-2 is amended by:

Redesignating paragraph (j)(2)(ii) as paragraph (j)(2)(iii).
Adding new paragraph (j)(2)(ii) to read as follows:

§1.6038–2 Information returns required of United States persons with respect to annual accounting periods of certain foreign corporations beginning after December 31, 1962.

(j) * * * (2) * * *

1997–43 I.R.B. 9 October 27, 1997

ual if payments or income items otherwise reportable under this section (other than by reason of paragraph (b)(8) of this section), received by the individual during the course of the taxable year do not exceed $10,000 in the aggregate or, in the case of payments or income items reportable only by reason of paragraph (b)(8) of this section, do not exceed $100,000 in the aggregate.

(3) Reporting with respect to payments or income items the treatment of which is mandated by the terms of a closing agreement with the Internal Revenue Service, and that would otherwise be subject to the reporting requirements of this section, is also waived.

(4) If a partnership, trust, or estate that has the taxpayer as a partner or beneficiary discloses on its information return a position for which reporting is otherwise required by the taxpayer, the taxpayer (partner or beneficiary) is then excused from disclosing that position on a return.

(5) This section does not apply to a withholding agent with respect to the performance of its withholding functions.

(d) Information to be re p o rt e d - ( 1 ) Returns due after December 15, 1997 . When reporting is required under this section for a return relating to a taxable year for which the due date (without extensions) is after December 15 1997, the taxpayer must furnish, in accordance with paragraph (a) of this section, as an attachment to the return, a fully completed Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) or appropriate successor form. (2) Earlier returns . For returns relating to taxable years for which the due date for filing returns (without extensions) is on or before December 15, 1997, the taxpayer must furnish information in accordance with paragraph (d) of this section in e ffect prior to December 15, 1997 (see § 3 0 1 . 6 114–1(d) as contained in 26 CFR part 301, revised April 1, 1997).

(3) In general —(i) Permanent estab - l i s h m e n t . For purposes of determining the nature and amount (or reasonable estimate thereof) of gross receipts, if a taxpayer takes a position that it does not have a permanent establishment or a fixed base in the United States and properly discloses that position, it need not separately report its payment of actual or deemed dividends or interest exempt from tax by

(ii) If an individual who is a United States person required to furnish information with respect to a foreign corporation under section 6038 is entitled under a treaty to be treated as a nonresident of the United States, and if the individual claims this treaty benefit, and if there are no other United States persons that are required to furnish information under section 6038 with respect to the foreign corporation, then the individual may satisfy the requirements of paragraphs (f)(10), ( f ) ( 11), (g), and (h) of this section by filing the audited foreign financial statements of the foreign corporation with the individu a l ’s return required under section 6038.

P a r. 3. In §1.6046–1, paragraph (g) is amended by adding a sentence at the end to read as follows:

§1.6046–1 Returns as to organization or reorganization of foreign corporations and as to acquisitions of their stock, on or after January 1, 1963.

(g) * * * If an individual who is a United States person required to make a return with respect to a foreign corporation under section 6046 is entitled under a treaty to be treated as a nonresident of the United States, and if the individual claims this treaty benefit, and if there are no other United States persons that are required to furnish information under section 6046 with respect to the foreign corporation, then the individual may satisfy the requirements of paragraphs (b)(10), (11) and (12), (c)(3)(ii)(d), and (g) of this section by filing the audited foreign financial statements of the foreign corporation with the individual’s return required under section 6046.

PART 301—PROCEDURE AND ADMINISTRATION

P a r. 4. The authority citation for part 301 continues to read in part as follows: Authority: 26 U.S.C. 7805 * * * Section 301.6114–1 also issued under 26 U.S.C. 6114; * * *

Par. 5. Section 301.6114–1 is amended by:

Removing the language “(c)(1)” in paragraph (b)(4) introductory text and

adding “(c)(1)(i)” in its place.

Removing the language “(c)(1)” in paragraph (b)(5) introductory text and adding “(c)(1)(i)” in its place.
Removing the language”(c)(4)” in paragraph (b)(6) and adding “(c)(1)(iv)” in its place.
Removing the language “or” at the end of paragraph (b)(6).
Removing the period at the end of paragraph (b)(7) and adding “; or” in its place.
Adding a paragraph (b)(8).
Paragraphs (c)(1) through (c)(6) are redesignated as paragraphs (c)(1)(i) through (c)(1)(vi), respectively.
Paragraphs (c)(7) introductory text, (c)(7)(i), (c)(7)(ii), and (c)(7)(iii) are redesignated as paragraphs (c)(1)(vii) introductory text, (c)(1)(vii)(A), (c)(1)(vii)(B) and (c)(1)(vii)(C), respectively.
The introductory text of paragraph (c) is redesignated as the introductory text of paragraph (c)(1).
Revising newly designated paragraph (c)(1)(ii).
Removing the concluding text immediately following newly designated paragraph (c)(1)(vii)(C).
Adding paragraphs (c)(2), (c)(3), (c)(4) and (c)(5).
Revising paragraph (d). The additions and revisions read as follows:

§301.6114–1 Treaty-based return positions.

(b) * * * (8) For returns relating to taxable years for which the due date for filing returns (without extensions) is after December 15, 1997, that residency of an individual is determined under a treaty and apart from the Internal Revenue Code.

(ii) For returns relating to taxable years for which the due date for filing returns (without extensions) is on or before December 15, 1997, that residency of an individual is determined under a treaty and apart from the Internal Revenue Code.

(2) Reporting is waived for an individ

October 27, 1997 10 1997–43 I.R.B.

reason of a treaty (or any liability for tax imposed by reason of section 884).

(ii) Single income item . For purposes of the statement of facts relied upon to support each separate Treaty-Based Return Position taken, a taxpayer may treat payments or income items of the same type (e.g., interest items) received from the same ultimate payor (e.g., the obligor on a note) as a single separate payment or income item.

(iii) F o reign source effectively con - nected income . If a taxpayer takes the return position that, under the treaty, income that would be income eff e c t i v e l y connected with a U.S. trade or business is not subject to U.S. taxation because it is income treated as derived from sources outside the United States, the taxpayer may treat payments or income items of the same type (e.g., interest items) as a single separate payment or income item.

(iv) Sales or services income . Income from separate sales or services, whether or not made or preformed by an agent (independent or dependent), to different U.S. customers on behalf of a foreign corporation not having a permanent establishment in the United States may be treated as a single payment or income item.

(v) Foreign insurers or reinsurers. For purposes of reporting by foreign insurers or reinsurers, as described in paragraph (c)(1)(vii)(B) of this section, such reporting must separately set forth premiums paid with respect to casualty insurance and indemnity bonds (subject to section 4371(1)); life insurance, sickness and accident policies, and annuity contracts (subject to section 4371(2)); and reinsurance (subject to section 4371(3)). All premiums paid with respect to each of these three categories may be treated as a single payment or income item within that category. For reports first due before May 1, 1991, the report may disclose, for each of the three categories, the total amount of premiums derived by the foreign insurer or reinsurer in U.S. dollars (even if a portion of these premiums relate to risks that are not U.S. situs). Reasonable estimates of the amounts required to be disclosed will satisfy these reporting requirements.

P a r. 6. Section 301.7701(b)–0 is amended in the contents listing by:

Adding entries for §301.7701(b)–7,

paragraphs (c)(1)(i) and (c)(1)(ii).

§301.7701(b)–0 Outline of regulation provision for section 7701(b)–1 through (b)–9.

§301.7701(b)–7 Coordination with income tax treaties.

§301.7701(b)–8 Procedural rules.

(b) * * * (1) * * * (i) Returns due after December 15, 1997. (ii) Earlier returns. (2) * * * (i) Returns due after December 15, 1997 . (ii) Earlier returns .

P a r. 7. Section 301.7701(b)3 is amended by revising paragraphs (b)(3) and (b)(4) to read as follows:

§301.7701(b)–3 Days of presence in the United States that are excluded for purposes of section 7701(b).

(b) * * * (3) Teacher or trainee . A teacher or trainee includes any individual (and that i n d i v i d u a l ’s immediate family), other than a student, who is admitted temporarily to the United States as a nonimmigrant under section 101(a)(15)(J) (relating to

Removing the language “[Reserved]” in the entry for §301.7701(b)–7, paragraph (c)(2).
Adding entries for §301.7701(b)–8, paragraphs (b)(1)(i), (b)(1)(ii), (b)(2)(i) and (b)(2)(ii).

The additions read as follows:

the admission of teachers and trainees into the United States) or section 101(a)(15)(Q) (relating to the admission of participants in international cultural exchange programs) of the Immigration and Nationality Act (8 U.S.C. 1101(a)(15)(J), (Q)) and who substantially complies with the requirements of being admitted.

(4) Student . A student is any individual (and that individual’s immediate family) who is admitted temporarily to the United States as a nonimmigrant under section 101(a)(15)(F) or (M) (relating to the admission of students into the United States) or as a student under section 101(a)(15)(J) (relating to the admission of teachers and trainees into the United States) or section 101(a)(15)(Q) (relating to the admission of participants in international cultural exchange programs) of the Immigration and Nationality Act (8 U.S.C. 1101(a)(15)(F), (J), (M), (Q)) who substantially complies with the requirements of being admitted. For rules concerning taxation of certain nonresident students or trainees, see section 871 (c) and §1.871–9(a) of this chapter.

P a r. 8. Section 301.7701(b)–7 is amended by:

Revising paragraph (c)(1).
Adding text for paragraph (c)(2). The revision and addition read as follows:

§301.7701(b)–7 Coordination with income tax treaties.

(c) * * * (1) In general —(i) Returns due after December 15, 1997 . The statement filed by an individual described in paragraph (a)(1) of this section, for a return relating to a taxable year for which the due date (without extensions) is after December 15, 1997, must be in the form of a fully completed Form 8833 (TreatyBased Return Position Disclosure Under Section 6114 or 7701(b)) or appropriate successor form. See section 6114 and § 3 0 1 . 6 114–1 for rules relating to other treaty-based return positions taken by the same taxpayer.

(ii) Earlier returns. For returns relating to taxable years for which the due date for filing returns (without extensions) is on or before December 15, 1997, the

1997–43 I.R.B. 11 October 27, 1997

amended by adding an entry in numerical order to the table and revising the entry for 301.7701(b)–7 to read as follows:

§602.101 OMB Control numbers.

CFR part or section Current OMB where identified and control No. described

301.6114–1 1545–1126

301.7701(b)–7 1545–0089 1545–1126

Michael P. Dolan, Acting Commissioner of

Internal Revenue.

Approved August 28, 1997.

Donald C. Lubick, Acting Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on October 6, 1997, 8:45 a.m., and published in the issue of the Federal Register for October 14, 1997, 62 F.R. 53384)

statement filed by the individual described in paragraph (a)(1) of this section must contain the information in accordance with paragraph (c)(1) of this section in effect prior to December 15, 1997 (see §301.7701(b)–7(c)(1) as contained in 26 CFR part 301, revised April 1, 1997). (2) C o n t rolled foreign corporation shareholders . If the taxpayer who claims a treaty benefit as a nonresident of the United States is a United States shareholder in a controlled foreign corporation (CFC), as defined in section 957 or section 953(c), and there are no other United States shareholders in that CFC, then for purposes of paragraph (c)(1) of this section, the approximate amount of subpart F income (as defined in section 952) that would have been included in the taxpayer’s income may be determined based on the audited foreign financial statements of the CFC.

P a r. 9. Section 301.7701(b)–8 is amended by revising paragraphs (b)(1) and (b)(2) to read as follows:

§301.7701(b)–8 Procedural rules.

(b) * * * (1) Closer connection exception - ( i ) Returns due after December 15, 1997 . The statement filed by an individual described in paragraph (a)(1) of this section, for a return relating to a taxable year for which the due date (without extensions) is after December 15, 1997, must be in the form of a fully completed Form 8840 (Closer Connection Exception Statement) or appropriate successor form.

(ii) Earlier returns . For returns relating to taxable years for which the due date for filing returns (without extensions) is on or before December 15, 1997, the statement filed by the individual described in paragraph (a)(1) of this section must contain the information in accordance with paragraph (b)(1) of this section in effect prior to December 15, 1997 (see §301.7701(b)–8(b)(1) as contained in 26 CFR Part 301, revised April 1, 1997). (2) Exempt individuals and individuals with a medical condition —(i) R e t u r n s due after December 15, 1997 . The statement filed by an individual described in paragraph (a)(2) of this section, for a return relating to a taxable year for which the due date (without extensions) is after December 15, 1997, must be in the form of a fully completed Form 8843 (Statement for Exempt Individuals and Individuals with a Medical Condition) or appropriate successor form.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 10. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 11. In §602.101, paragraph (c) is

October 27, 1997 12 1997–43 I.R.B.