Part I. Rulings — Internal Revenue Bulletin 2001-42

connection with a distribution of property made by a corporation with respect to its stock. A notice of proposed rulemaking cross-referencing the temporary regulations (REG–106791–00, 2001–6 I.R.B. 521) was published in the Federal Regis- ter for the same day (66 FR 748). No public hearing was requested or held.

No written comments responding to the notice were received. This document adopts, without substantive change, final regulations with respect to the notice of proposed rulemaking.

Effective Date

The regulations apply generally to distributions occurring after January 4, 2001. The regulations also apply to distributions occurring on or prior to January 4, 2001, if the distribution is made as part of a transaction described in, or substantially similar to, the transaction in Notice 99–59 (1999–2 C.B. 761), including transactions designed to reduce gain. Under section 7805(b)(3), the Secretary may provide that any regulation may take effect or apply retroactively to prevent abuse. These regulations are being applied retroactively to prevent the abuse described in Notice 99–59. No inference should be drawn regarding the tax treatment of distributions not covered by these regulations.

Special Analyses

It has been determined that this Treasury decision 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 final regulations do not have a significant economic impact on a substantial number of small entities. These final regulations under section 301 address distributions by corporations in which liabilities are assumed by the shareholders or in which the distributed property is subject to liabilities. These final regulations provide that the amount of a distribution under section 301 will be reduced by the amount of any liability that is treated as assumed by the distributee within the meaning of section 357(d).

These regulations apply to persons receiving distributions of property in

Section 62.—Adjusted Gross Income Defined

26 CFR 1.62–2: Reimbursements and other expense allowance arrangements.

Rules are set forth under which reimbursement or other expense allowance arrangement for the cost of lodging, meal, and incidental expenses or meal and incidental expenses incurred by an employee while traveling away from home will satisfy the requirement of § 62(c) of the Code as to substantiation of the amount of the expense. See Rev. Proc. 2001–47, page 332.

Section 162.—Trade or Business Expenses

26 CFR 1.162–17: Reporting and substantiation of certain business expenses of employees.

Rules are set forth for substantiating the amount of a deduction or an expense for lodging, meal, and incidental expenses or meal and incidental expenses incurred while traveling away from home. See Rev. Proc. 2001–47, page 332.

Section 267.—Losses, Expenses, and Interest With Respect to Transactions Between Related Taxpayers

26 CFR 1.267(a)–1: Deductions disallowed.

When a payor provides a per diem allowance to an employee who is a related party, the rules set forth for the deemed substantiation to the payor of the amount of the employee’s ordinary and necessary business expenses for lodging, meal, and incidental expenses incurred while traveling away from home do not apply. See Rev. Proc. 2001–47, page 332.

Section 274.—Disallowance of Certain Entertainment, etc., Expenses

26 CFR 1.274–5: Substantiation requirements.

Rules are set forth for an optional method for substantiating the amount of ordinary and necessary business expenses of an employee for lodging, meal, and incidental expenses or meal and incidental expenses incurred while traveling away from home when a payor provides a per diem allowance under a reimbursement or other expense allowance arrangement to pay for such expenses. Rules are also set forth for an optional method for employees and selfemployed individuals to use in computing the deductible costs of business meal and incidental ex

penses paid or incurred while traveling away from home. See Rev. Proc. 2001–47, page 332.

Section 301.—Distributions of Property

26 CFR 1.301-1: Rules applicable with respect to distributions of money and other property.

T.D. 8964

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Liabilities Assumed in Certain Corporate Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations relating to the assumption of liabilities in certain corporate transactions under section 301 of the Internal Revenue Code. These final regulations affect corporations and their shareholders. Changes to the applicable law were made by the Miscellaneous Trade and Technical Corrections Act of 1999.

DATES: Effective Date : These regulations are effective September 27, 2001.

Applicability Date : For dates of applicability, see the Effective Date portion of the preamble under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Douglas Bates (202) 622-7550 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background and Explanation of Provisions

Changes to the applicable law were made by the Miscellaneous Trade and Technical Corrections Act of 1999, Public Law 106-36 (113 Stat. 127). On January 4, 2001, temporary regulations (T.D. 8924, 2001–6 I.R.B. 489) were published in the Federal Register (66 FR 723) under section 301 of the Internal Revenue Code, relating to liabilities assumed in

October 15, 2001 320 2001–42 I.R.B.

which the property is subject to a liability, or in which liabilities are assumed by the distributee. These regulations, however, will affect only those persons described in the preceding sentence that would have, but for the regulations, considered liabilities to have been assumed in circumstances other that those described in section 357(d). Therefore, most businesses will not be affected by the final regulations in any given year. 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 Code, the notice of proposed rulemaking accompanying these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

Drafting Information

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

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * * Section 1.301–1 also issued under 26 U.S.C. 357(d)(3). * * *

Par. 2. Section 1.301–1 is amended by revising paragraph (g) to read as follows:

§1.301–1 Rules applicable with respect to distributions of money and other property.

(g) Reduction for liabilities - - (1) Gen- eral rule . For the purpose of section 301, no reduction shall be made for the amount of any liability, unless the liability is assumed by the shareholder within the meaning of section 357(d).

(2) No reduction below zero . Any reduction pursuant to paragraph (g)(1) of

this section shall not cause the amount of the distribution to be reduced below zero.

(3) Effective dates - (i) In general . This paragraph (g) applies to distributions occurring after January 4, 2001.

(ii) Retroactive application . This paragraph (g) also applies to distributions made on or before January 4, 2001, if the distribution is made as part of a transaction described in, or substantially similar to, the transaction in Notice 99–59 (1999–2 C.B. 761), including transactions designed to reduce gain (see § 601.601(d)(2) of this chapter). For rules for distributions on or before January 4, 2001 (other than distributions on or before that date to which this paragraph (g) applies), see rules in effect on January 4, 2001 (see §1.301–1(g) as contained in 26 CFR Part 1 revised April 1, 2001).

§ 1.301–1T [Removed]

Par. 3. Section 1.301–1T is removed.

Robert E. Wenzel, Deputy Commissioner

of Internal Revenue.

Approved September 17, 2001.

Mark Weinberger, Assistant Secretary of the Treasury for Tax Policy .

(Filed by the Office of the Federal Register on September 26, 2001, 8:45 a.m., and published in the issue of the Federal Register for September 27, 2001, 66 F.R. 49278)

Section 368(a)(1)(A).—Definitions Relating to Corporate Reorganizations

26 CFR 1.368–1: Purpose and scope of exception of reorganization exchanges.

Step transaction. Under the facts presented, if, pursuant to an integrated plan, a newly formed wholly owned subsidiary of an acquiring corporation merges into a target corporation, followed by the merger of the target corporation into the acquiring corporation, the transaction is treated as a single statutory merger of the target corporation into the acquiring corporation that qualifies as a reorganization under section 368(a)(1)(A).

Rev. Rul. 2001–46

ISSUE

Under the facts described below, what is the proper tax treatment if, pursuant to an integrated plan, a newly formed wholly owned subsidiary of an acquiring corporation merges into a target corporation, followed by the merger of the target corporation into the acquiring corporation?

FACTS

Situation (1). Corporation X owns all the stock of Corporation Y, a newly formed wholly owned subsidiary. Pursuant to an integrated plan, X acquires all of the stock of Corporation T, an unrelated corporation, in a statutory merger of Y into T (the “Acquisition Merger”), with T surviving. In the Acquisition Merger, the T shareholders exchange their T stock for consideration, 70 percent of which is X voting stock and 30 percent of which is cash. Following the Acquisition Merger and as part of the plan, T merges into X in a statutory merger (the “Upstream Merger”). Assume that, absent some prohibition against the application of the step transaction doctrine, the step transaction doctrine would apply to treat the Acquisition Merger and the Upstream Merger as a single integrated acquisition by X of all the assets of T. Also assume that the single integrated transaction would satisfy the nonstatutory requirements of a reorganization under § 368(a) of the Internal Revenue Code.

Situation (2). The facts are the same as in Situation (1) except that in the Acquisition Merger the T shareholders receive solely X voting stock in exchange for their T stock, so that the Acquisition Merger, if viewed independently of the Upstream Merger, would qualify as a reorganization under § 368(a)(1)(A) by reason of § 368(a)(2)(E).

LAW

Section 338(a) provides that if a corporation makes a qualified stock purchase and makes an election under that section, then the target corporation (i) shall be treated as having sold all of its assets at the close of the acquisition date at fair market value and (ii) shall be treated as a new corporation which purchased all of

2001–42 I.R.B. 321 October 15, 2001

its assets as of the beginning of the day after the acquisition date. Section 338(d)(3) defines a qualified stock purchase as any transaction or series of transactions in which stock (meeting the requirements of § 1504(a)(2)) of one corporation is acquired by another corporation by purchase during a 12-month acquisition period. Section 338(h)(3) defines a purchase generally as any acquisition of stock, but excludes acquisitions of stock in exchanges to which § 351, § 354, § 355, or § 356 applies.

Rev. Rul. 90–95 (1990–2 C.B. 67) (Situation 2), holds that the merger of a newly formed wholly owned domestic subsidiary into a target corporation with the target corporation shareholders receiving solely cash in exchange for their stock, immediately followed by the merger of the target corporation into the domestic parent of the merged subsidiary, will be treated as a qualified stock purchase of the target corporation followed by a § 332 liquidation of the target corporation. As a result, the parent’s basis in the target corporation’s assets will be the same as the basis of the assets in the target corporation’s hands. The ruling explains that even though “the step-transaction doctrine is properly applied to disregard the existence of the [merged subsidiary],” so that the first step is treated as a stock purchase, the acquisition of the target corporation’s stock is accorded independent significance from the subsequent liquidation of the target corporation and, therefore, is treated as a qualified stock purchase regardless of whether a § 338 election is made.

Section 1.338–3(d) of the Income Tax Regulations incorporates the approach of Rev. Rul. 90–95 into the regulations by requiring the purchasing corporation (or a member of its affiliated group) to treat certain asset transfers following a qualified stock purchase (where no § 338 election is made) independently of the qualified stock purchase. In the example in § 1.338–3(d)(5), the purchase for cash of 85 percent of the stock of a target corporation, followed by the merger of the target corporation into a wholly owned subsidiary of the purchasing corporation, is treated (other than by certain minority shareholders) as a qualified stock purchase of the stock of the target corporation followed by a § 368 reorganization of the

target corporation into the subsidiary. As a result, the subsidiary’s basis in the target corporation’s assets is the same as the basis of the assets in the target corporation’s hands.

Section 368(a)(1)(A) defines the term “reorganization” as a statutory merger or consolidation. Section 368(a)(2)(E) provides that a transaction otherwise qualifying under § 368(a)(1)(A) shall not be disqualified by reason of the fact that stock of a corporation (controlling corporation), which before the merger was in control of the merged corporation, is used in the transaction if (i) after the transaction, the corporation surviving the merger holds substantially all of its properties and the properties of the merged corporation, and (ii) in the transaction, former shareholders of the surviving corporation exchange, for an amount of voting stock of the controlling corporation, an amount of stock in the surviving corporation which constitutes control of such corporation.

In Rev. Rul. 67–274 (1967–2 C.B. 141), Corporation Y acquires all of the stock of Corporation X in exchange for some of the voting stock of Y and, thereafter, X completely liquidates into Y. The ruling holds that because the two steps are parts of a plan of reorganization, they cannot be considered independently of each other. Thus, the steps do not qualify as a reorganization under § 368(a)(1)(B) followed by a liquidation under § 332, but instead qualify as an acquisition of X’s assets in a reorganization under § 368(a)(1)(C).

ANALYSIS

Situation (1) Because of the amount of cash consideration paid to the T shareholders, the Acquisition Merger could not qualify as a reorganization under § 368(a)(1)(A) and § 368(a)(2)(E). If the Acquisition Merger and the Upstream Merger in Situation (1) were treated as separate from each other, as were the steps in Situation (2) of Rev. Rul. 90–95, the Acquisition Merger would be treated as a stock acquisition that is a qualified stock purchase, because the stock is not acquired in a § 354 or § 356 exchange. The Upstream Merger would qualify as a liquidation under § 332.

However, if the approach reflected in Rev. Rul. 67–274 were applied to Situation (1), the transaction would be treated as an integrated acquisition of T’s

assets by X in a single statutory merger (without a preliminary stock acquisition). Accordingly, unless the policies underlying § 338 dictate otherwise, the integrated asset acquisition in Situation (1) is properly treated as a statutory merger of T into X that qualifies as a reorganization under § 368(a)(1)(A). See King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969) (in a case that predated § 338, the court applied the step transaction doctrine to treat the acquisition of the stock of a target corporation followed by the merger of the target corporation into the acquiring corporation as a reorganization under § 368(a)(1)(A)); J.E. Seagram Corp. v. Commissioner, 104 T.C. 75 (1995) (same). Therefore, it is necessary to determine whether the approach reflected in Rev. Rul. 90–95 applies where the step transaction doctrine would otherwise apply to treat the transaction as an asset acquisition that qualifies as a reorganization under § 368(a).

Rev. Rul. 90–95 and § 1.338–3(d) reject the approach reflected in Rev. Rul. 67–274 where the application of that approach would treat the purchase of a target corporation’s stock without a § 338 election followed by the liquidation or merger of the target corporation as the purchase of the target corporation’s assets resulting in a cost basis in the assets under § 1012. The rejection of step integration in Rev. Rul. 90–95 and § 1.338–3(d) is based on Congressional intent that § 338 “replace any nonstatutory treatment of a stock purchase as an asset purchase under the Kimbell-Diamond doctrine.” H.R. Rep. No. 760, 97 ^th Cong., 2d Sess. 536 (1982), 1982–2 C.B. 600, 632. (In Kim- bell-Diamond Milling Co. v. Commis- sioner, 14 T.C. 74, aff’d per curiam, 187 F.2d 718 (1951), cert. denied, 342 U.S. 827 (1951), the court held that the purchase of the stock of a target corporation for the purpose of obtaining its assets through a prompt liquidation should be treated by the purchaser as a purchase of the target corporation’s assets with the purchaser receiving a cost basis in the assets.) Rev. Rul. 90–95 and § 1.338–3(d) treat the acquisition of the stock of the target corporation as a qualified stock purchase followed by a separate carryover basis transaction in order to preclude any nonstatutory treatment of the steps as an integrated asset purchase.

October 15, 2001 322 2001–42 I.R.B.

The policy underlying § 338 is not violated by treating Situation (1) as a single statutory merger of T into X because such treatment results in a transaction that qualifies as a reorganization under § 368(a) (1)(A) in which X acquires the assets of T with a carryover basis under § 362, and does not result in a cost basis for those assets under § 1012. Thus, in Situation (1), the step transaction doctrine applies to treat the Acquisition Merger and the Upstream Merger not as a stock acquisition that is a qualified stock purchase followed by a § 332 liquidation, but instead as an acquisition of T’s assets through a single statutory merger of T into X that qualifies as a reorganization under § 368(a)(1)(A). Accordingly, a § 338 election may not be made in such a situation.

Situation (2) Situation (2) differs from Situation (1) only in that the Acquisition Merger, if viewed independently of the Upstream Merger, would qualify as a reorganization under § 368(a)(1)(A) by reason of § 368(a) (2)(E). This difference does not change the result from that in Situation (1). The transaction is treated as a single statutory merger of T into X that qualifies as a reorganization under § 368(a)(1)(A) without regard to § 368(a)(2)(E).

HOLDING

Under the facts presented, if, pursuant to an integrated plan, a newly formed wholly owned subsidiary of an acquiring corporation merges into a target corporation, followed by the merger of the target corporation into the acquiring corporation, the transaction is treated as a single statutory merger of the target corporation into the acquiring corporation that qualifies as a reorganization under § 368(a)(1)(A).

APPLICATION

Pursuant to § 7805(b)(8), the Service will not apply the principles of this revenue ruling to challenge a taxpayer’s position with respect to the treatment of a multi-step transaction, one step of which,

viewed independently, is a qualified stock purchase if:

(1) a timely (including extensions) and valid (without regard to whether there was a qualified stock purchase under the principles of this revenue ruling) election under § 338(h)(10) or § 338(g) (Election) is or was filed with respect to the acquisition of the stock of the target corporation; and

(a) the acquisition date for the target corporation is on or before September 24, 2001; or (b) the acquisition of stock of the target corporation meeting the requirements of § 1504(a)(2) by the purchasing corporation is pursuant to a written agreement that (subject to customary conditions) is binding on September 24, 2001, and at all times thereafter until the acquisition date; and

(3) such taxpayer does not take a position for U.S. tax purposes that is inconsistent with the treatment of the acquisition as a qualified stock purchase with respect to which the Election was made.

Further, the Service and the Treasury are considering whether to issue regulations that would reflect the general principles of this revenue ruling, but would allow taxpayers to make a valid election under § 338(h)(10) with respect to a step of a multi-step transaction that, viewed independently, is a qualified stock purchase if such step is pursuant to a written agreement that requires, or permits the purchasing corporation to cause, a § 338(h)(10) election in respect of such step to be made. The Service and the Treasury request comments regarding the adoption of such an approach.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 67–274 is amplified and Rev. Rul. 90–95 is distinguished.

DRAFTING INFORMATION

The principal authors of this revenue ruling are Reginald Mombrun and Joseph

(2) either

M. Calianno of the Office of the Associate Chief Counsel (Corporate). For further information regarding this revenue ruling, contact Mr. Mombrun at (202) 622-7750 (not a toll-free call) or Mr. Calianno at (202) 622-7930 (not a toll-free call).

Section 472.—Last-in, First-out Inventories

26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes; department stores. The August 2001 Bureau of Labor Statistics price indexes are accepted for use by department stores employing the retail inventory and last-in, first-out inventory methods for valuing inventories for tax years ended on, or with reference to, August 31, 2001.

Rev. Rul. 2001–45

The following Department Store Inventory Price Indexes for August 2001 were issued by the Bureau of Labor Statistics. The indexes are accepted by the Internal Revenue Service, under § 1.472–1(k) of the Income Tax Regulations and Rev. Proc. 86–46 (1986–2 C.B. 739), for appropriate application to inventories of department stores employing the retail inventory and last-in, first-out inventory methods for tax years ended on, or with reference to, August 31, 2001.

The Department Store Inventory Price Indexes are prepared on a national basis and include (a) 23 major groups of departments, (b) three special combinations of the major groups - soft goods, durable goods, and miscellaneous goods, and (c) a store total, which covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

2001–42 I.R.B. 323 October 15, 2001

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS

(January 1941 = 100, unless otherwise noted)

Percent Change Groups Aug. Aug. from Aug. 2000 2000 2001 to Aug. 2001 ¹

Piece Goods - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 509.2 485.7 –4.6
Domestics and Draperies- - - - - - - - - - - - - - - - - - - - - - - - 617.9 591.8 –4.2
Women’s and Children’s Shoes- - - - - - - - - - - - - - - - - - - - 618.3 655.4 6.0
Men’s Shoe - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 913.2 856.4 –6.2
Infants’ Wear - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 619.8 609.5 –1.7
Women’s Underwear - - - - - - - - - - - - - - - - - - - - - - - - - - 570.2 567.5 –0.5
Women’s Hosiery- - - - - - - - - - - - - - - - - - - - - - - - - - - - - 334.7 354.8 6.0
Women’s and Girls’Accessories - - - - - - - - - - - - - - - - - - - 532.0 547.2 2.9
Women’s Outerwear and Girls’ Wear - - - - - - - - - - - - - - - - 370.5 361.6 –2.4
Men’s Clothing - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 605.4 579.2 –4.3
Men’s Furnishings - - - - - - - - - - - - - - - - - - - - - - - - - - - - 612.9 583.9 –4.7
Boys’ Clothing and Furnishings - - - - - - - - - - - - - - - - - - - 473.0 469.2 –0.8
Jewelry - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 936.5 936.3 0.0
Notions - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 785.9 793.0 0.9
Toilet Articles and Drugs- - - - - - - - - - - - - - - - - - - - - - - - 971.0 969.9 –0.1
Furniture and Bedding - - - - - - - - - - - - - - - - - - - - - - - - - 687.9 633.9 –7.8
Floor Coverings- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 603.2 623.8 3.4
Housewares - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 778.5 767.6 –1.4
Major Appliances- - - - - - - - - - - - - - - - - - - - - - - - - - - - - 230.9 226.9 –1.7
Radio and Television - - - - - - - - - - - - - - - - - - - - - - - - - - 58.8 53.4 –9.2
Recreation and Education ² - - - - - - - - - - - - - - - - - - - - - - - 92.2 89.3 –3.1
Home Improvements ² - - - - - - - - - - - - - - - - - - - - - - - - - - 129.2 125.8 –2.6
Auto Accessories ² - - - - - - - - - - - - - - - - - - - - - - - - - - - - 106.2 109.4 3.0

Groups 1 – 15: Soft Goods - - - - - - - - - - - - - - - - - - - - - - - - 585.3 575.5 –1.7

Groups 16 – 20: Durable Goods- - - - - - - - - - - - - - - - - - - - - - 437.2 421.8 –3.5

Groups 21 – 23: Misc. Goods ² - - - - - - - - - - - - - - - - - - - - - - - 99.8 98.2 –1.6

Store Total ³ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 529.7 518.8 –2.1

1 Absence of a minus sign before the percentage change in this column signifies a price increase. 2 Indexes on a January 1986=100 base. 3 The store total index covers all departments, including some not listed separately, except for the following: candy, food, liquor, tobacco, and contract departments.

DRAFTING INFORMATION

The principal author of this revenue ruling is Michael Burkom of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue ruling, contact Mr. Burkom at (202) 622-4930 (not a toll-free call).

Section 872. — Gross Income

(Also sections 883, 894.) 26 CFR 1.872–2: Exclusions from gross income of nonresident alien individuals. (Also 26 CFR 1.883–1.)

This revenue ruling updates the list of countries that grant a reciprocal exemp

tion for income from the international operation of ships or aircraft to U.S. persons for purposes of sections 872(b) and 883 of the Code.

Rev. Rul. 2001–48

PURPOSE

The purpose of this revenue ruling is to assist foreign persons who derive income from the international operation of ships or aircraft in determining whether such income is exempt from U.S. taxation under section 872(b) or 883(a) of the Internal Revenue Code of 1986, by providing a current list of countries that grant United States persons equivalent exemptions from tax for various categories of

income from the international operation of ships and aircraft. This revenue ruling modifies and supersedes Rev. Rul. 89–42 (1989–1 C.B. 234), as supplemented by Rev. Rul. 97–31 (1997–2 C.B. 77).

Section 872(b) of the Code provides that gross income shall not include income from the international operation of a ship or ships or aircraft, and such income shall be exempt from U.S. Federal income taxation, if the income is derived by an individual resident of a foreign country, and such foreign country grants an equivalent exemption to individual residents of the United States. Section 883(a) provides a similar exemption for such income derived by corporations organized in a foreign country that grants

October 15, 2001 324 2001–42 I.R.B.

an equivalent exemption to corporations organized in the United States. For purposes of sections 872(b) and 883(a), a foreign country may grant an equivalent exemption from tax through an exchange of diplomatic notes or other agreement, by not imposing a tax on income from the international operation of ships or aircraft, or by a decree or specific statutory exemption.

Part A of Table I provides a list of the countries that grant exemptions through diplomatic notes exchanged with the United States.

Part B of Table I provides a list of the countries for which the Service has determined, upon examination of their domestic law, that an equivalent exemption is granted by statute or decree, or by not imposing a tax on income from the international operation of ships or aircraft. This determination is made on a countryby-country basis and relies upon information submitted to the Internal Revenue Service by the foreign country regarding the foreign law in effect at the time of the submission. The date of the Service’s review is reflected in the first column of Part B of Table I. Since its initial review, the Service has not attempted to determine whether any of the foreign laws of the countries listed in Part B of Table I have been amended or repealed. Therefore, taxpayers should independently verify the accuracy of the information in Part B of Table I at such time that a determination is relevant.

Part B of Table I does not represent an exclusive list of countries the domestic law of which provides an equivalent exemption. Other countries that have not submitted the information necessary for the Service to make a determination also may grant an equivalent exemption. In those cases, an individual resident of, or a corporation organized in, such a foreign country may be treated as a resident of, or a corporation organized in, a foreign country that grants an equivalent exemption, even though the foreign country is not included in Part B of Table I. Consistent with past practice, the Service will entertain a request from a foreign government to determine whether the domestic law of the country provides an equivalent exemption. Accordingly, taxpayers may seek to have the relevant foreign government request a determination

that the particular country qualifies as an equivalent-exemption jurisdiction.

Table II provides a list of countries that grant an exemption under the shipping and aircraft article or capital gains article of an income tax convention to which the United States is a party. Table II is provided to assist a foreign corporation organized in one of the countries listed in Table I in demonstrating that it also meets the ownership requirements of section 883(c). In general, a foreign corporation can demonstrate that it meets the ownership requirements of section 883(c) if the corporation can show that more than 50 percent of the value of the stock of the corporation is owned by individuals who are residents of countries that grant an equivalent exemption to corporations organized in the United States. For the sole purpose of determining if an individual shareholder’s country of residence grants an equivalent exemption for purposes of section 883(c), a foreign country will also be considered to grant an equivalent exemption if it grants such an exemption through an income tax convention with the United States.

Accordingly, Table II is relevant only in determining whether a shareholder of a foreign corporation seeking an exemption from tax under section 883 is a shareholder that qualifies under section 883(c)(1) because the shareholder’s country of residence grants an equivalent exemption under an income tax convention with the United States. Table II is not relevant in determining whether a nonresident alien individual or a foreign corporation itself is eligible to claim an exemption under section 872(b) or 883(a), respectively.

Table II includes a summary of the requirements for the exemption, such as whether the exemption is based solely on residence, or, as in the case of certain older income tax conventions, the exemption has an additional requirement of documentation or registration. Table II does not set forth other benefits relating to a shipping or an air transport business that may be provided under articles covering business profits, rentals and royalties, and other income because such benefits are not relevant for purposes of section 883(c). These Tables are intended only as a summary. The full text of any relevant diplomatic note, foreign law, or income

tax convention should be consulted. It may be necessary to consult the technical explanation of an income tax convention, including any protocol thereto, any agreement, or any diplomatic note accompanying a convention, to determine the items of income exempted. Income tax conventions and diplomatic notes are published in the Cumulative Bulletin and Internal Revenue Bulletins. These Tables will continue to be updated periodically.

CHANGES TO REV. RUL. 97–31

The changes to the table published in Rev. Rul. 89–42, as supplemented by Rev. Rul. 97–31, are summarized below.

The table in the prior rulings has been reorganized to clarify the limited relevance of Part I of that table, relating to treaties, as discussed above. Accordingly, in this revenue ruling Part II of the prior table (diplomatic notes) has become Part A of Table I; Part III (domestic law) of the prior table has become Part B of Table I; and Part I of the prior table (treaties) has become Table II.

In Part A of Table I, Bahrain, Ethiopia, Saudi Arabia, and the United Arab Emirates have been added to the list of countries that have exchanged diplomatic notes with the United States. Although a diplomatic note was signed with Bolivia in November 1987, that note required ratification by the Bolivian Government to enter into force. The diplomatic note was ratified on March 24, 1999, and officially became effective upon publication in the official Gazette on March 31, 1999, for income earned after that date. Therefore, Bolivia also has been added to the list.

In Part B of Table I, Aruba, Peru (with respect to aircraft), and the Republic of Surinam have been added to the list of countries whose domestic law has been determined to provide an equivalent exemption.

In Table II, the following countries have been added to the list of countries that provide an exemption under an income tax convention: Estonia, Latvia, Lithuania, Slovenia, South Africa, Thailand, Turkey, the Ukraine, and Venezuela. The following countries have entered into new income tax conventions with the United States that supersede prior income tax conventions reported in Rev. Rul. 97–31: Austria, Denmark, Ireland, Luxembourg, and Switzerland.

2001–42 I.R.B. 325 October 15, 2001

TO CLAIM AN EXEMPTION

Taxpayers claiming an exemption from U.S. Federal income tax under section 872(b) of the Code must file a return on Form 1040NR ( U.S. Income Tax Return of a Nonresident Alien ). Taxpayers claiming an exemption from U.S. Federal income tax under section 883 must file a return on Form 1120F ( U.S. Income Tax

Return of a Foreign Corporation ). Both must comply with the relevant provisions of section 8 of Rev. Proc. 91–12 (1991–1 C.B. 473).

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 97–31 and Rev. Rul. 89–42 are modified and superseded.

TABLE I

DRAFTING INFORMATION

The principal author of this revenue ruling is Patricia A. Bray of the Office of Associate Chief Counsel (International). For information regarding this revenue ruling, contact Ms. Bray at (202) 6223880 (not a toll-free call).

Countries Currently Granting Equivalent Exemptions For

Income From The International Operation of

Ships and Aircraft

PART A - EXCHANGE OF NOTES ¹

TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Opera- Full Bare- Con- Capital ting Rental Boat tainer Gains ³

Countries Cumulative Bulletin Income (Time Rental Rental ³

and Or Internal Revenue or voy- Territories Bulletin Citation age char- ter)

Argentina 1988-1 C.B. 456 X X X X X

Bahamas 1988-1 C.B. 458 X X X X -

Bahrain 2000-46 I.R.B. 475 X X X X X

Belgium 1988-1 C.B. 459 X X - X -

Bolivia ⁴ 1988-1 C.B. 460 X X X X -

Chile ⁵ 1991-1 C.B. 304 X X X ³ X -

Colombia 1988-1 C.B. 461 X X X X -

Cyprus 1989-2 C.B. 332 X X X X -

Denmark 1988-1 C.B. 462 X X X X -

El Salvador ⁵ 1988-1 C.B. 463 X X X X X

Ethiopia 1999-1 C.B. 1134 X X X X X

Fiji 1996-2 C.B. 202 X X X X X

Finland 1989-2 C.B. 334 X X X X -

Greece 1988-2 C.B. 366 X X X X -

Hong Kong ^6/7 1995-1 C.B. 228 X X X X X

India 1990-2 C.B. 316 X X X ³ X X

Isle of Man ⁶ 1990-2 C.B. 317 X X X X X

Japan 1990-2 C.B. 318 X X X X -

Jordan 1996-2 C.B. 202 X X X X -

Liberia 1988-1 C.B. 463 X X X X X

Luxembourg 1996-2 C.B. 203 X X X X -

Malaysia 1990-2 C.B. 319 X X X ³ X X

October 15, 2001 326 2001–42 I.R.B.

TABLE I—Continued

Countries Currently Granting Equivalent Exemptions For

Income From The International Operation of

Ships and Aircraft

PART A - EXCHANGE OF NOTES ¹

TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Opera- Full Bare- Con- Capital ting Rental Boat tainer Gains ³

Countries Cumulative Bulletin Income (Time Rental Rental ³

and Or Internal Revenue or voy- Territories Bulletin Citation age char- ter)

Malta 1997-1 C.B. 314 X X X X X

Marshall Islands 1990-2 C.B. 321 X X X X X

Norway 1991-1 C.B. 304 X X X X X

Pakistan ⁶ 1991-1 C.B. 305 X ⁸ - - - -

Panama 1988-2 C.B. 366 X X X X -

Peru ⁶ 1989-2 C.B. 335 X X X ³ X -

Saudi Arabia ⁹ 2000-22 I.R.B. 1126 X X X X X

St. Vincent & Grenadines 1989-2 C.B. 336 X X X X -

Singapore 1990-2 C.B. 323 X X X X -

Sweden 1988-1 C.B. 466 X X X ³ X -

Taiwan 1989-2 C.B. 337 X X X X -

United Arab Emirates 1998-2 C.B. 528 X X X X X

Venezuela 1988-1 C.B. 467 X X X ³ X X

PART B - DOMESTIC LAW

TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Opera- Full Bare- Con- Capital Date ting Rental Boat tainer Gains ³

Countries Foreign Income (Time Rental Rental ³

and Law or voy- Territories Reviewed age char- ter)

Antigua & Barbuda ⁶ NOV 1991 X X X X X

Aruba JUNE 1999 X X X X -

Barbados OCT 1989 X X X X X

Bermuda NOV 1988 X X X X X

Brazil ¹⁰ DEC 1988 X X X ³ X -

Bulgaria FEB 1989 X X X X X

Cayman Islands ¹¹ JAN 1987 X X X X X

Chile ⁶ OCT 1988 X X X X X

Ecuador ^6/12 DEC 1989 X X X ³ X X

Israel FEB 1991 X X X X X

2001–42 I.R.B. 327 October 15, 2001

TABLE I—Continued

Countries Currently Granting Equivalent Exemptions For

Income From The International Operation of

Ships and Aircraft

PART B - DOMESTIC LAW—Continued

TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Opera- Full Bare- Con- Capital Date ting Rental Boat tainer Gains ³

Countries Foreign Income (Time Rental Rental ³

and Law or voy- Territories Reviewed age char- ter)

Netherlands OCT 1988 X X X ³ X -

Netherlands Antilles MAY 1988 X X X X X

Peru ⁵ SEPT 1995 X X X X X

Portugal ¹⁰ Ships JUNE 1989 X X X - - Aircraft FEB 1989 X X X - -

Qatar ⁵ AUG 1994 X ⁸ - - - -

Spain ¹³ DEC 1988 X X - X -

Surinam NOV 1999 X X X X X

Turkey ¹⁴ JAN 1987 X - - X -

Turks & Caicos ¹¹ FEB 1990 X X X X X

U.S. Virgin Islands OCT 1988 X X X X X

Vanuatu MAY 1987 X X X X X

TABLE II

Countries Currently Granting by Income Tax Convention

Equivalent Exemptions For Purposes of Qualifying a

Shareholder Under Section 883(c)(1) ¹⁵

BASIS FOR EXEMPTION TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Resi- Resi- Resi- Opera- Full Bare- Con- Capital dence dence dence ting Rental Boat tainer Gains Countries Based & Flag & Flag Income (Time Rental Rental and No Reci- Uni- or voy- Territories Flag procal lateral age char- ter)

Australia X X X ¹⁶ X ¹⁷ X ¹⁷ X ^3/18

Austria ¹⁹ X X X ²⁰ X ²⁰ X X

Barbados X X X ²⁰ X ²⁰ X X

Belgium X ²¹ X X ³ X ³ X ³ X ³

Canada X X X X X X

China ²²

(Peoples Republic) X X X ²⁰ X ²⁰ X X

Cyprus X X X ²⁰ X ²⁰ X X

October 15, 2001 328 2001–42 I.R.B.

TABLE II—Continued

Countries Currently Granting by Income Tax Convention

Equivalent Exemptions For Purposes of Qualifying a

Shareholder Under Section 883(c)(1) ¹⁵

BASIS FOR EXEMPTION TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Czech Republic X X X X ³ X X

Denmark ¹⁹ X X X X ²⁰ X X

Egypt X X X ³ X ³ X ³ -

Estonia ¹⁹ X X X X ³ X X

Finland X X X ³ X ³ X ²³ X

France X X X X ²⁰ X ³ X ³

Germany ²⁴ X X X - X X

Greece X X ⁸ - - - -

Hungary X X X ³ X ³ X X

Iceland X ²⁵ X X ³ X ³ X ³ X

India X X X ³ X ³ X X ^3/26

Indonesia X X X X ²⁷ X ³ X

Ireland ¹⁹ X X X X ²⁰ X X

Israel X X X ³ X ³ X ³ X ³

Italy ^28/29 X ²⁵ X X ³⁰ X ³ X X ³

Jamaica X X X ²⁰ X ²⁰ X X ³

Japan ²⁸ X ³¹ X X ³ X ³ X ³ X ³

Kazakhstan X X X X ²⁰ X X

Korea X X X ³² - X ³ -

Latvia ¹⁹ X X X X ¹⁷ X X

Lithuania ¹⁹ X X X X ¹⁷ X ³ X

Luxembourg ¹⁹ X X X X ²⁰ X X

Mexico X X X X ²³ X X

Morocco X ²¹ X ⁸ - - - X ³

Netherlands X X X ³ X ³ - X

New Zealand X X X X ³ X ³ X ¹⁸

Norway ²⁸ X X X ³² X ³ X ³ X

Pakistan ⁵ X X ⁸ - - - -

Philippines ⁶ X - - - - X ³

2001–42 I.R.B. 329 October 15, 2001

TABLE II—Continued

Countries Currently Granting by Income Tax Convention

Equivalent Exemptions For Purposes of Qualifying a

Shareholder Under Section 883(c)(1) ¹⁵

BASIS FOR EXEMPTION TYPES OF SHIPPING AND AIRCRAFT INCOME EXEMPTED ²

Poland X ²⁵ X X ³ X ³ X ³ X

Portugal X X X X ³ - X

Romania X X X ³ X ³ X ³ X

Russian Federation X X X X ²⁰ X X

Slovak Republic X X X X ³ X X

Slovenia ¹⁹ X X X X ²⁰ X X

South Africa ¹⁹ X X X X ²⁰ X X

Spain X X X X ³ X X

Sweden X X X X ³ X X

Switzerland ¹⁹ X X X ³³ X ³ - X

Thailand ¹⁹ X ⁵ X X X ³ X ³ X X ⁶ - - - - X

Trinidad & Tobago X ²⁵ X X ³ X ³ - X

Tunisia X X X ²⁰ X ²⁰ X ³ X

Turkey ¹⁹ X X X X ³ X X

Ukraine ¹⁹ X X X X ²⁰ X X ³

USSR/NIS ³⁴ X X ⁸ - - - X ³

U.K. ²⁹ X ²⁵ X X X ³ X X ³

Venezuela ¹⁹ X X X X ²⁰ X X

1 Notes signed prior to the Technical and Miscellaneous Revenue Act of 1988 will be interpreted in accordance with Technical Corrections enacted by that Act. 2 Unless otherwise footnoted, an “X” indicates full exemption whether or not there is a permanent establishment. 3 The tax exemption is available only if the income is incidental to operating income. 4 The note was ratified by the Bolivian Congress and signed by the Bolivian President. The note and exemption officially became effective upon publication in the official Gazette on March 31, 1999, for income earned after that date. 5 This exemption applies to aircraft only. 6 This exemption applies to shipping only. 7 This diplomatic note applies to Hong Kong before July 1, 1997, and pursuant to Notice 97-40 (1997-2 C.B. 287), to the Hong Kong Special Administrative Region of the People’s Republic of China on or after July 1, 1997. The note does not apply with respect to the People’s Republic of China, which will continue to be treated as a separate country for purposes of the Internal Revenue Code. 8 Operating income is not defined. 9 The note is effective for all taxable years beginning on or after January 1, 1999, and for all prior open taxable years.

October 15, 2001 330 2001–42 I.R.B.

10 Brazilian and Portuguese statutes exempt only companies. 11 The country generally imposes no income tax. 12 This exemption is generally effective for all open years beginning on or after January 1, 1987. 13 The Spanish statute exempts only corporations. 14 See generally Rev. Rul. 87-18 (1987-1 C.B. 178) (explaining the application of Turkey’s domestic-law exemption). 15 Table II is relevant only in determining whether a shareholder of a foreign corporation seeking an exemption from tax under section 883 is a shareholder that qualifies under section 883(c)(1) because the shareholder’s country of residence grants an equivalent exemption under an income tax convention with the United States. Table II is not relevant in determining whether a nonresident alien individual or foreign corporation itself is eligible to claim an exemption under section 872(b) or 883(a), respectively. 16 Lessor must either regularly lease ships or aircraft on a full basis or operate them in international traffic. 17 This exemption applies if the ships or aircraft are operated in international traffic by the lessee, and the rental income is incidental to the operation of ships or aircraft in international traffic by the lessor. 18 Except to the extent depreciation has been allowed in the other country. 19 The following income tax treaties were ratified after the publication of Rev. Rul. 97-31 and are generally effective on the following dates: Austria . . . . . . . . . . . . . . . . . . . . . . January 1, 1999 Denmark . . . . . . . . . . . . . . . . . . . . . January 1, 2001 Estonia . . . . . . . . . . . . . . . . . . . . . . January 1, 2000 Ireland . . . . . . . . . . . . . . . . . . . . . . January 1, 1998 Latvia . . . . . . . . . . . . . . . . . . . . . . . January 1, 2000 Lithuania . . . . . . . . . . . . . . . . . . . . January 1, 2000 Luxembourg . . . . . . . . . . . . . . . . . . January 1, 2001 Slovenia . . . . . . . . . . . . . . . . . . . . . January 1, 2002 South Africa . . . . . . . . . . . . . . . . . . January 1, 1998 Switzerland . . . . . . . . . . . . . . . . . . . January 1, 1998 Thailand . . . . . . . . . . . . . . . . . . . . . January 1, 1998 Turkey . . . . . . . . . . . . . . . . . . . . . . January 1, 1998 Ukraine . . . . . . . . . . . . . . . . . . . . . . January 1, 2001 Venezuela . . . . . . . . . . . . . . . . . . . . January 1, 2000 The U.S.-Slovenia tax treaty entered into force on June 22, 2001. The treaty applies, with respect to taxes withheld at source, in respect of amounts paid or credited on or after September 1, 2001, and, with regard to other taxes, in respect of taxable years beginning on or after January 1, 2002. 20 This exemption applies if the ships or aircraft are operated in international traffic by the lessee, or the rental income is incidental to the operation of ships or aircraft in international traffic by the lessor. 21 In the case of aircraft only, the registration may be in the country of residence or in any country with a treaty providing a reciprocal exemption between such country and the country of residence. 22 Pursuant to Notice 97-40 (1997-2 C.B. 287), the treaty between the United States and the People’s Republic of China (China) will continue to apply only to China and will not apply to the Hong Kong Special Administrative Region of the People’s Republic of China. 23 The exemption applies except where the containers are used solely between places within the other Contracting State. 24 This treaty is effective for the eastern States of Germany (the former East Germany) from January 1, 1991. 25 Documentation or registration required for ships or aircraft of United States residents only. 26 This treaty exempts gains derived by an enterprise of a Contracting State if the ships, aircraft or containers are owned and operated by the enterprise and the income from them is taxable only in that State. 27 Income from the bareboat rental of aircraft used in international traffic is exempt. Income from the bareboat rental of ships also is exempt if the ship is operated in international traffic and if the lessee is not a resident of, or does not have a permanent establishment in, the other Contracting State. 28 See also the diplomatic notes or protocol accompanying this treaty. 29 The United States has entered into new treaties with Italy and the United Kingdom, but neither treaty has entered into force as of the date of publication of this ruling. 30 This exemption applies if the ship or aircraft is operated in international traffic or if the rental income is incidental to income from such international operation. 31 With regard to residents of Japan, the ships or aircraft need not be registered in Japan if the ships or aircraft are leased by such a resident. 32 As a result of correspondence, it was clarified that income from the international operation of ships or aircraft includes this category of income. 33 This exemption applies if the ships or aircraft are used by the lessee in international traffic. 34 The U.S. - U.S.S.R. income tax treaty signed June 20, 1973, continues to apply to the New Independent States (NIS) of Armenia, Azerbaijan, Belarus, Georgia, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, and Uzbekistan.

Section 883.—Exclusions From Gross Income

This revenue ruling updates the Table of countries that grant a reciprocal exemption for income from the international operation of ships or aircraft to U.S. persons for purposes of sections 872(b) and 883 of the Code. See Rev. Rul. 2001–48, page 324.

Section 894.—Income Affected By Treaty

2001–42 I.R.B. 331 October 15, 2001