Part I. Rulings — Internal Revenue Bulletin 2002-14

Section 42.—Low-Income Housing Credit

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

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

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

Under what conditions will the Internal Revenue Service consider a request for a ruling that an undivided interest in rental real property (other than a mineral property as defined in § 614) is not an interest in a business entity within the meaning of § 301.7701–3 of the Procedure and Administration Regulations? See Rev. Proc. 2002–22, page 733.

Section 280G.—Golden Parachute Payments

Federal short-term, mid-term, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 382.—Limitation on Net Operating Loss Carryforwards and Certain Built-In Losses Following Ownership Change

The adjusted applicable federal long-term rate is set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 412.—Minimum Funding Standards

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 467.—Certain Payments for the Use of Property or Services

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 468.—Special Rules for Mining and Solid Waste Reclamation and Closing Costs

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 482.—Allocation of Income and Deductions Among Taxpayers

Federal short-term, mid-term, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 483.—Interest on Certain Deferred Payments

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 511.—Imposition of Tax on Unrelated Business Income of Charitable, etc., Organizations

26 CFR 1.511–1: Imposition and rates of tax.

Section 512.—Unrelated Business Taxable Income

26 CFR 1.512(a)–1: Definition.

Section 642.—Special Rules for Credits and Deductions

Federal short-term, mid-term, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 707.—Transactions Between Partner and Partnership

26 CFR 1.707–1: Transactions between partner and partnership.

Section 761.—Terms Defined

26 CFR 1.761–1: Terms defined.

Section 807.—Rules for Certain Reserves

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

2002–14 I.R.B. 706 April 8, 2002

rial in the administration of any Internal Revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

This document contains amendments to 26 CFR Part 1 under section 1221 of the Internal Revenue Code (Code). Prior to amendment in 1999, section 1221 generally defined a capital asset as property held by the taxpayer other than: (1) Stock in trade or other types of assets includible in inventory; (2) property used in a trade or business that is real property or property subject to depreciation; (3) certain copyrights (or similar property); (4) accounts or notes receivable acquired in the ordinary course of a trade or business; and (5) U.S. government publications.

In 1994, the IRS published in the Fed- eral Register (T.D. 8555, 1994–2 C.B. 180 [59 FR 36360]) final Treasury regulations under section 1221 providing for ordinary character treatment for certain business hedges. The regulations generally apply to transactions that reduce risk with respect to ordinary property, ordinary obligations, and borrowings of the taxpayer and that meet certain identification requirements. (§ 1.1221–2). In 1996, the IRS published in the Federal Regis- ter (T.D. 8653, 1996–1 C.B. 67 [61 FR 517]) final regulations on the character and timing of gain or loss from hedging transactions entered into by members of a consolidated group. In this preamble, the final regulations published in 1994 and 1996 are referred to collectively as the Treasury regulations.

On December 17, 1999, section 1221 was amended by section 532 of the Ticket to Work and Work Incentives Improvement Act of 1999 (113 Stat 1860) to provide ordinary gain or loss treatment for hedging transactions and consumable supplies. Section 1221(a)(7) provides ordinary treatment for hedging transactions that are clearly identified as such before the close of the day on which they were acquired, originated, or entered into.

The statute defines a hedging transaction as a transaction entered into by the taxpayer in the normal course of business primarily to manage risk of interest rate, price changes, or currency fluctuations with respect to ordinary property, ordinary obligations, or borrowings of the

Section 846.—Discounted Unpaid Losses Defined

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 856.—Definition of Real Estate Investment Trust

26 CFR 1.856–1: Definition of real estate invest- ment trust.

Section 1031.—Exchange of Property Held For Productive Use or Investment

26 CFR 1.1031(a)–1: Property held for productive use in trade or business or for investment.

Section 1221.—Capital Asset Defined

26 CFR 1.1221–2: Hedging transactions.

T.D. 8985

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

Hedging Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations relating to the character of gain or loss from hedging transactions.

The regulations reflect changes to the law made by the Ticket to Work and Work Incentives Improvement Act of 1999. The regulations affect businesses entering into hedging transactions.

DATES: Effective Date : These regulations are effective March 20, 2002.

Applicability Dates : For dates of applicability of these regulations, see the discussion in the Dates of Applicability paragraph in the Supplementary Information portion of the preamble.

FOR FURTHER INFORMATION CONTACT: Elizabeth Handler, (202) 622– 3930 or Viva Hammer at (202) 622–0869 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545–1480. Some responses to these collections of information are mandatory, and others are required to obtain the benefit of the separate-entity election.

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

The estimated annual burden per respondent or recordkeeper varies from .1 to 40 hours, depending on individual circumstances, with an estimated average of 5.9 hours. 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 Officer, W:CAR: MP:FP:S, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503. Books or records relating to a collection of information must be retained as long as their contents may become mate

April 8, 2002 707 2002–14 I.R.B.

taxpayer. Sections 1221(b)(2)(A)(i) and (ii). The statutory definition of hedging transaction also includes transactions to manage such other risks as the Secretary may prescribe in regulations. Section 1221(b)(2)(A)(iii). Further, the statute grants the Secretary the authority to provide regulations to address the treatment of nonidentified or improperly identified hedging transactions, and hedging transactions involving related parties (sections 1221(b)(2)(B) and (b)(3), respectively). The statutory hedging provisions are effective for transactions entered into on or after December 17, 1999. Congress intended that the hedging rules be the exclusive means through which the gains and losses from hedging transactions are treated as ordinary. S. Rep. No. 201, 106th Cong., 1st Sess. 25 (1999). Section 1221(a)(8) provides that supplies of a type regularly consumed by the taxpayer in the ordinary course of a taxpayer’s trade or business are not capital assets. That provision is effective for supplies held or acquired on or after December 17, 1999.

A notice of proposed rulemaking (REG–107047–00, 2001–14 I.R.B. 1002) was published in the Federal Register (66 FR 4738) on January 18, 2001. On May 16, 2001, the IRS held a public hearing on the proposed regulations. Written comments responding to the notice of proposed rulemaking were also received. In response to these comments, the proposed regulations were modified and as so modified are adopted as final regulations. The principal changes to the proposed regulations are discussed below.

Explanation of Provisions

Coordination with International Provisions of the Code

The provisions of these regulations generally apply to determine the character of gain or loss from transactions that are also subject to various international provisions of the Code. Paragraph (a)(4) of the regulations, however, provides that the character of gain or loss on section 988 transactions is not determined under these regulations because gain or loss on those transactions is ordinary under section 988(a)(1). In addition, no implication is intended as to what constitutes “risk management” or “managing risk” for pur

poses of proposed or final regulations under section 482.

Paragraph (a)(4) of the proposed regulations provided that the definition of a hedging transaction under § 1.1221–2(b) of the proposed regulations would apply for purposes of certain other international provisions of the Code only to the extent provided in regulations issued under those provisions. Technical changes have been made in the final regulations to eliminate references to proposed regulations as well as Code sections for which the relevant regulations have not been issued in final form. Subsequent regulations will specify the extent to which the rules relating to hedging transactions that are contained in § 1.1221–2 will be applicable for purposes of those other regulations and related Code sections.

Risk Management Standard

Several commentators noted that the proposed regulations used risk reduction as the operating standard to implement the risk management definition of hedging introduced by section 1221(b)(2)(A). These commentators found that risk reduction is too narrow a standard to encompass the intent of Congress which defined hedges to include transactions that manage risk of interest rate, price changes or currency fluctuations. They urged the IRS and Treasury to adopt a broader definition of hedging to reflect Congress’ intent. With one exception, the commentators did not suggest a definition of risk management.

In response to these comments, the final regulations have been restructured to implement the risk management standard. No definition of risk management is provided, but instead, the rules characterize a variety of classes of transactions as hedging transactions because they manage risk. Risk reducing transactions still qualify as one class of hedging transactions, but there are also others. In addition, specific provision is made for the recognition of additional types of qualifying risk management transactions through published guidance or private letter rulings. Under the final regulations, as under the proposed regulations, transactions entered into for speculative purposes will not qualify as hedging transactions. See S. Rep. No. 201, 106th Cong., 1st Sess. 24 (1999).

Application on the Basis of Separate Business Units

The proposed regulations provided that a taxpayer has risk of a particular type only if it is at risk when all of its operations are considered. That is, risk must exist on a “macro” basis. For this purpose, under the proposed regulations, a taxpayer has to show that hedges of particular assets or liabilities, or groups of assets or liabilities, are reasonably expected to reduce the overall risk of the taxpayer’s operations.

Commentators pointed out that this entity-based approach to hedging is no longer uniform business practice. Instead, businesses often conduct risk management on a business unit by business unit basis. In response to these comments, the final regulations permit the determination of whether a transaction manages risk to be made on a business unit basis provided that the business unit is within a single entity or consolidated return group that adopts the single-entity approach. An example was added to the final regulations in which for one taxpayer, the determination of whether hedging activities reduce risk is made at the business unit level. In the example, the conduct of risk management activities within separate business units is undertaken as part of a program to reduce the overall risk of the taxpayer’s operations.

Fixed-to-floating Interest Rate Hedges

Paragraph (c)(1) of the proposed regulations recognized that a transaction that economically converts an interest rate or price from a fixed rate or price to a floating rate or price may manage risk. Commentators suggested that the rule in the proposed regulations provides insufficient guidance in that it states only that fixedto-floating interest rate or price hedges may be hedging transactions. In response to these comments, the regulations have been restructured to separately address interest rate hedges and price hedges.

Commentators suggested that in the case of interest rate conversions, a taxpayer may choose to convert from a floating to a fixed rate to fix the amount payable on the obligation. However, a taxpayer could also elect to convert from a fixed to a floating rate to insure that the value of the liability remained relatively

2002–14 I.R.B. 708 April 8, 2002

“Gap” Hedges

The status of so-called gap hedges was not separately addressed in the proposed regulations and is not covered in the final regulations. Insurance companies, for example, sometimes hedge the gap between their liabilities and the assets that fund them. Under the final regulations, a hedge of those assets would not qualify as a hedging transaction if the assets are capital assets. Whether a gap hedge qualifies as a liability hedge is a question of fact and depends on whether it is more closely associated with the liabilities than with the assets.

Identification Requirement

A rule has been added specifying additional information that must be provided for a transaction that counteracts a hedging transaction.

Dates of Applicability

The regulations generally apply to all transactions entered into on or after March 20, 2002. However, the IRS will not challenge any transaction entered into on or after December 17, 1999, and before March 20, 2002, that satisfies the provisions of either § 1.1221–2 of REG– 107047–00 (2001–14 I.R.B. 1002), published in the Federal Register (66 FR 4738) on January 18, 2001, or the provisions of this final regulation.

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 the collection of information in these regulations will not have a significant economic impact on a substantial number of small entities. This certification is based upon the fact that very few small businesses enter into hedging transactions due to their cost and complexity. Further, those small businesses that hedge enter into very few hedging transactions because hedging transactions are costly, complex, and require constant monitoring and a sophisticated understanding of the capital markets. Therefore, a Regulatory Flexibility Analysis under the Regulatory

constant. In response to these comments, the final regulations provide that a transaction that converts an interest rate from a fixed rate to a floating rate or from a floating rate to a fixed rate manages risk. With respect to fixed-to-floating price hedges, the final regulations adopt the proposed rules without change.

Transactions Not Entered into Primarily to Manage Risk

Paragraph (c)(3) of the proposed regulations provided that the purchase or sale of certain assets will not qualify as a hedging transaction if the assets are not acquired primarily to manage risk. This rule was illustrated by the example of a taxpayer that has an interest rate risk from a floating rate borrowing and that acquires debt instruments bearing a comparable floating interest rate. Although the taxpayer’s interest rate risk from the floating rate borrowing may be reduced by the purchase of the floating rate debt instruments, the proposed regulations provided that the acquisition of the debt instruments is not made primarily to reduce risk and, therefore, is not a hedging transaction.

The IRS and Treasury understand that some employers may invest in assets (such as shares of a mutual fund) that are used as a reference investment for purposes of computing their liability to employees under a nonqualified deferred compensation plan. A question may arise whether such an investment may constitute a hedging transaction and, if so, whether income from the investment may be deferred by the employer until payments of deferred compensation are made to employees. See § 1.446–4(b); but compare Albertson’s, Inc. v. Commissioner, 42 F.3d 537 (9th Cir. 1994).

The rule in the proposed regulations is based on § 1.1221–2(c)(1)(vii). The rule has been restated in the final regulations to refer specifically to investments in debt instruments, equity securities, and annuity contracts so as to provide greater certainty in its application. For this purpose certain transactions in instruments that are not themselves debt instruments may include a debt investment. See, e.g., § 1.446–3(g)(4). Further, the final regulations provide that the IRS may identify by future published guidance specified transactions that are determined not to be

entered into primarily to manage risk. An example has been added to the final regulations to illustrate that an investment in mutual fund shares in the case described in the preceding paragraph does not qualify as a hedging transaction. A similar example is added with respect to an investment in an annuity contract.

Hedging Risks Other Than Interest Rate or Price Changes, or Currency Fluctuations

Paragraph (c)(8) of the proposed regulations provided that the Commissioner may, by published guidance, provide that hedging transactions include transactions entered into to manage risks other than interest rate or price changes, or currency fluctuations.

The notice of proposed rulemaking solicited comments regarding the expansion of the definition of hedging transactions to include transactions that manage risks other than interest rate or price changes, or currency fluctuations with respect to ordinary property, ordinary obligations or borrowings of the taxpayer. Some comments were received in response to that request. Because the comments described hedging transactions that related to the general operating results of a business (such as gross sales) rather than specific ordinary property, ordinary obligations or borrowings of the taxpayer, the implementation of rules respecting such hedges would present a number of issues not easily dealt with by the rules contained in the final regulations. Thus, the expansion of the scope of operation of the hedging rules is not being proposed at this time, so as not to delay the publication of guidance on the matters that are covered by the final regulations. However, the IRS is continuing to consider whether to expand the definition of hedging transactions to cover hedges of such other risks. The IRS and Treasury invite comments on the types of risks that should be covered, including specific examples of derivative transactions that may be incorporated into future guidance, as well as the appropriate timing of inclusion of gains and losses with respect to such transactions. Send submissions to: CC:ITA:RU (REG–107047–00), room 5226, Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, DC 20044.

April 8, 2002 709 2002–14 I.R.B.

Paragraph 1. The authority citation for part 1 is amended by revising the entry for §1.1221–2 to read as follows:

Authority: 26 U.S.C. 7805 - - Section 1.1221–2 also issued under 26 U.S.C. 1221(b)(2)(A)(iii), (b)(2)(B), and (b)(3); 1502 and 6001. - - Par. 2. In the list below, for each location indicated in the left column, remove the language in the middle column from that section, and add the language in the right column.

Flexibility Act (5 U.S.C. chapter 6) is not required. 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

The principal author of these regulations is Elizabeth Handler, Office of the Associate Chief Counsel (Financial Insti

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

- - - -

Adoption of Amendments to the Regulations

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

PART 1—INCOME TAXES

Affected section Remove Add 1.446–4(d)(2), first sentence 1.1221–2(e) 1.1221–2(f) 1.446–4(d)(2), last sentence 1.1221–2(e)(2) 1.1221–2(f)(2) 1.446–4(d)(3), first sentence 1.1221–2(e) 1.1221–2(f)

1.446–4(d)(3), last sentence 1.1221–2(a)(4)(i) 1.1221–2(a)(4)

1.446–4(e)(7), first sentence 1.1221–2(c)(2) 1.1221–2(d)(4)

1.446–4(e)(9)(ii), first sentence 1.1221–2(d)(2) 1.1221–2(e)(2)

1.446–4(e)(9)(ii), last sentence 1.1221–2(d)(2)(ii) 1.1221–2(e)(2)(ii)

1.475(b)–1(d)(2) 1.1221–2(e) 1.1221–2(f)

1.954–2(a)(4)(ii)(A), first sentence 1.1221–2(a) through (c) 1.1221–2(a) through (d)

1.954–2(a)(4)(ii)(B), first sentence 1.1221–2(e) 1.1221–2(f)

1.954–2(g)(2)(ii)(B)(2), last sentence 1.1221–2(c)(7) 1.1221–2(c)(3)

1.954–2(g)(3)(i)(B), last sentence 1.1221–2(c)(7) 1.1221–2(c)(3)

1.1256(e)–1(b), first and last sentences 1.1221–2(e)(1) 1.1221–2(f)(1)

1.1256(e)–1(c), first sentence 1.1221–2(e)(1) 1.1221–2(f)(1)

1.1256(e)–1(c), last sentence paragraph (f)(1)(ii) of § 1.1221–2 1.1221–2(g)(1)(ii)

ing transaction is any transaction that a taxpayer enters into in the normal course of the taxpayer’s trade or business primarily—

(1) To manage risk of price changes or currency fluctuations with respect to ordinary property (as defined in paragraph (c)(2) of this section) that is held or to be held by the taxpayer;

(2) To manage risk of interest rate or price changes or currency fluctuations with respect to borrowings made or to be made, or ordinary obligations incurred or to be incurred, by the taxpayer; or

(3) To manage such other risks as the Secretary may prescribe in regulations (see paragraph (d)(6) of this section).

(c) General rules —(1) Normal course . Solely for purposes of paragraph (b) of this section, if a transaction is entered into in furtherance of a taxpayer’s trade or business, the transaction is entered into

Par. 3. Section 1.1221–2 is revised to read as follows:

§ 1.1221–2 Hedging transactions.

(a) Treatment of hedging transact- ions —(1) In general . This section governs the treatment of hedging transactions under section 1221(a)(7). Except as provided in paragraph (g)(2) of this section, the term capital asset does not include property that is part of a hedging transaction (as defined in paragraph (b) of this section).

(2) Short sales and options . This section also governs the character of gain or loss from a short sale or option that is part of a hedging transaction. Except as provided in paragraph (g)(2) of this section, gain or loss on a short sale or option that is part of a hedging transaction (as

defined in paragraph (b) of this section) is ordinary income or loss.

(3) Exclusivity . If a transaction is not a hedging transaction as defined in paragraph (b) of this section, gain or loss from the transaction is not made ordinary on the grounds that property involved in the transaction is a surrogate for a noncapital asset, that the transaction serves as insurance against a business risk, that the transaction serves a hedging function, or that the transaction serves a similar function or purpose.

(4) Coordination with section 988 . This section does not apply to determine the character of gain or loss realized on a section 988 transaction as defined in section 988(c)(1) or realized with respect to any qualified fund as defined in section 988(c)(1)(E)(iii). (b) Hedging transaction defined . Section 1221(b)(2)(A) provides that a hedg

2002–14 I.R.B. 710 April 8, 2002

in the normal course of the taxpayer’s trade or business. This rule includes managing risks relating to the expansion of an existing business or the acquisition of a new trade or business.

(2) Ordinary property and obligations . Property is ordinary property to a taxpayer only if a sale or exchange of the property by the taxpayer could not produce capital gain or loss under any circumstances. Thus, for example, property used in a trade or business within the meaning of section 1231(b) (determined without regard to the holding period specified in that section) is not ordinary property. An obligation is an ordinary obligation if performance or termination of the obligation by the taxpayer could not produce capital gain or loss. For purposes of this paragraph (c)(2), the term termination has the same meaning as it does in section 1234A.

(3) Hedging an aggregate risk . The term hedging transaction includes a transaction that manages an aggregate risk of interest rate changes, price changes, and/or currency fluctuations only if all of the risk, or all but a de minimis amount of the risk, is with respect to ordinary property, ordinary obligations, or borrowings.

(4) Managing risk —(i) In general . Whether a transaction manages a taxpayer’s risk is determined based on all of the facts and circumstances surrounding the taxpayer’s business and the transaction. Whether a transaction manages a taxpayer’s risk may be determined on a business unit by business unit basis (for example by treating particular groups of activities, including the assets and liabilities attributable to those activities, as separate business units), provided that the business unit is within a single entity or consolidated return group that adopts the singleentity approach. A taxpayer’s hedging strategies and policies as reflected in the taxpayer’s minutes or other records are evidence of whether particular transactions were entered into primarily to manage the taxpayer’s risk.

(ii) Limitation of risk management transactions to those specifically described . Except as otherwise determined by published guidance or by private letter ruling, a transaction that is not treated as a hedging transaction under paragraph (d) does not manage risk. Moreover, a transaction undertaken for

speculative purposes will not be treated as a hedging transaction.

(d) Transactions that manage risk (1) Risk reduction transactions —(i) In general . A transaction that is entered into to reduce a taxpayer’s risk, manages a taxpayer’s risk.

(ii) Micro and macro hedges —(A) In general . A taxpayer generally has risk of a particular type only if it is at risk when all of its operations are considered. Nonetheless, a hedge of a particular asset or liability generally will be respected as reducing risk if it reduces the risk attributable to the asset or liability and if it is reasonably expected to reduce the overall risk of the taxpayer’s operations. If a taxpayer hedges particular assets or liabilities, or groups of assets or liabilities, and the hedges are undertaken as part of a program that, as a whole, is reasonably expected to reduce the overall risk of the taxpayer’s operations, the taxpayer generally does not have to demonstrate that each hedge that was entered into pursuant to the program reduces its overall risk.

(B) Example . The following example illustrates the rules stated in paragraph (d)(1)(ii)(A) of this section:

Example . Corporation X manages its business operations by treating particular groups of activities, including the assets and liabilities attributable to those assets, as separate business units. A separate set of books and records is maintained with respect to the activities, assets and liabilities of separate business unit y . As part of a risk management program that Corporation X reasonably expects to reduce the overall risks of its business operations, Corporation X enters into hedges to reduce the risks of separate business unit y . Corporation X may demonstrate that the hedges reduce risk by taking into account only the activities, assets and liabilities of business unit y .

(iii) Written options . A written option may reduce risk. For example, in appropriate circumstances, a written call option with respect to assets held by a taxpayer or a written put option with respect to assets to be acquired by a taxpayer may be a hedging transaction. See also paragraph (d)(3) of this section.

(iv) Fixed-to-floating price hedges . Under the principles of paragraph (d)(1)(ii)(A) of this section, a transaction that economically converts a price from a fixed price to a floating price may reduce risk. For example, a taxpayer with a fixed cost for its inventory may be at risk if the price at which the inventory can be sold varies with a particular factor. Thus, for such a taxpayer a transaction that con

verts its fixed price to a floating price may be a hedging transaction.

(2) Interest rate conversions . A transaction that economically converts an interest rate from a fixed rate to a floating rate or that converts an interest rate from a floating rate to a fixed rate manages risk.

(3) Transactions that counteract hedg- ing transactions . If a transaction is entered into primarily to offset all or any part of the risk management effected by one or more hedging transactions, the transaction is a hedging transaction. For example, if a written option is used to reduce or eliminate the risk reduction obtained from another position such as a purchased option, then it may be a hedging transaction.

(4) Recycling . A taxpayer may enter into a hedging transaction by using a position that was a hedge of one asset or liability as a hedge of another asset or liability (recycling).

(5) Transactions not entered into pri- marily to manage risk —(i) Rule . Except as otherwise determined in published guidance or private letter ruling, the purchase or sale of a debt instrument, an equity security, or an annuity contract is not a hedging transaction even if the transaction limits or reduces the taxpayer’s risk with respect to ordinary property, borrowings, or ordinary obligations. In addition, the Commissioner may determine in published guidance that other transactions are not hedging transactions.

(ii) Examples . The following examples illustrate the rule stated in paragraph (d)(5)(i) of this section:

Example 1 . Taxpayer borrows money and agrees to pay a floating rate of interest. Taxpayer purchases debt instruments that bear a comparable floating rate. Although taxpayer’s interest rate risk from the floating rate borrowing may be reduced by the purchase of the debt instruments, the acquisition of the debt instruments is not a hedging transaction, because the transaction is not entered into primarily to manage the taxpayer’s risk.

Example 2 . Taxpayer undertakes obligations to pay compensation in the future. The amount of the future compensation payments is adjusted as if amounts were invested in a specified mutual fund and were increased or decreased by the earnings, gains and losses that would result from such an investment. Taxpayer invests funds in the shares of the mutual fund. Although the investment in shares of the mutual fund reduces the taxpayer’s risk of fluctuation in the amount of its obligation to employees, the investment was not made primarily to manage the taxpayer’s risk. Accordingly, the transaction is not a hedging transaction.

April 8, 2002 711 2002–14 I.R.B.

is to be effective. The election must be signed by the common parent and filed with the group’s Federal income tax return for the taxable year that includes the first date for which the election is to apply. The election applies to all transactions entered into on or after the date so indicated. The election may be revoked only with the consent of the Commissioner.

(3) Definitions . For definitions of consolidated group, divisions of a single corporation, group, intercompany transactions, and member, see section 1502 and the regulations thereunder.

(4) Examples . General Facts . In these examples, O and H are members of the same consolidated group. O ’s business operations give rise to interest rate risk “ A,” which O wishes to hedge. O enters into an intercompany transaction with H that transfers the risk to H . O ’s position in the intercompany transaction is “ B,” and H ’s position in the transaction is “ C .” H enters into position “ D ” with a third party to reduce the interest rate risk it has with respect to its position C . D would be a hedging transaction with respect to risk A if O ’s risk A were H ’s risk. The following examples illustrate this paragraph (e):

Example 1 . Single-entity treatment —(i) General rule . Under paragraph (e)(1) of this section, O ’s risk A is treated as H ’s risk, and therefore D is a hedging transaction with respect to risk A . Thus, the character of D is determined under the rules of this section, and the income, deduction, gain, or loss from D must be accounted for under a method of accounting that satisfies § 1.446–4. The intercompany transaction B-C is not a hedging transaction and is taken into account under § 1.1502–13.

(ii) Identification . D must be identified as a hedging transaction under paragraph (f)(1) of this section, and A must be identified as the hedged item under paragraph (f)(2) of this section. Under paragraph (f)(5) of this section, the identification of A as the hedged item can be accomplished by identifying the positions in the intercompany transaction as hedges or hedged items, as appropriate. Thus, substantially contemporaneous with entering into D, H may identify C as the hedged item and O may identify B as a hedge and A as the hedged item.

Example 2 . Separate-entity election; counter- party that does not mark to market . In addition to the General Facts stated above, assume that the group makes a separate-entity election under paragraph (e)(2) of this section. If H does not mark C to market under its method of accounting, then B is not a hedging transaction, and the B-C intercompany transaction is taken into account under the rules of section 1502. D is not a hedging transaction with respect to A, but D may be a hedging transaction with respect to C if C is ordinary property or an ordinary obligation and if the other requirements of paragraph (b) of this section are met. If D is not part of a hedging transaction, then D may be part of a straddle for purposes of section 1092.

Example 3 . Taxpayer provides a nonqualified retirement plan for employees that is structured like a defined contribution plan. Based on a schedule that takes into account an employee’s monthly salary and years of service with the taxpayer, the taxpayer makes monthly credits to an account for each employee. Each employee may designate that the account will be treated as if it were used to pay premiums on a variable annuity contract issued by the M insurance company with a value that reflects a specified investment option. M offers a number of investment options for its variable annuity contracts. Taxpayer invests funds in M company variable annuity contracts that parallel the investment options selected by the employees. The investment is not made primarily to manage the taxpayer’s risk and is not a hedging transaction.

(6) Hedges of other risks . The Commissioner may, by published guidance, determine that hedging transactions include transactions entered into to manage risks other than interest rate or price changes, or currency fluctuations.

(7) Miscellaneous provision —(i) Ex- tent of risk management . A taxpayer may hedge all or any portion of its risk for all or any part of the period during which it is exposed to the risk.

(ii) Number of transactions . The fact that a taxpayer frequently enters into and terminates positions (even if done on a daily or more frequent basis) is not relevant to whether these transactions are hedging transactions. Thus, for example, a taxpayer hedging the risk associated with an asset or liability may frequently establish and terminate positions that hedge that risk, depending on the extent the taxpayer wishes to be hedged. Similarly, if a taxpayer maintains its level of risk exposure by entering into and terminating a large number of transactions in a single day, its transactions may nonetheless qualify as hedging transactions.

(e) Hedging by members of a consoli- dated group —(1) General rule: single- entity approach . For purposes of this section, the risk of one member of a consolidated group is treated as the risk of the other members as if all of the members of the group were divisions of a single corporation. For example, if any member of a consolidated group hedges the risk of another member of the group by entering into a transaction with a third party, that transaction may potentially qualify as a hedging transaction. Conversely, intercompany transactions are not hedging transactions because, when con

sidered as transactions between divisions of a single corporation, they do not manage the risk of that single corporation.

(2) Separate-entity election . In lieu of the single-entity approach specified in paragraph (e)(1) of this section, a consolidated group may elect separate-entity treatment of its hedging transactions. If a group makes this separate-entity election, the following rules apply:

(i) Risk of one member not risk of other members . Notwithstanding paragraph (e)(1) of this section, the risk of one member is not treated as the risk of other members.

(ii) Intercompany transactions . An intercompany transaction is a hedging transaction (an intercompany hedging transaction) with respect to a member of a consolidated group if and only if it meets the following requirements—

(A) The position of the member in the intercompany transaction would qualify as a hedging transaction with respect to the member (taking into account paragraph (e)(2)(i) of this section) if the member had entered into the transaction with an unrelated party; and

(B) The position of the other member (the marking member) in the transaction is marked to market under the marking member’s method of accounting.

(iii) Treatment of intercompany hedg- ing transactions . An intercompany hedging transaction (that is, a transaction that meets the requirements of paragraphs (e)(2)(ii)(A) and (B) of this section) is subject to the following rules—

(A) The character and timing rules of § 1.1502–13 do not apply to the income, deduction, gain, or loss from the intercompany hedging transaction; and

(B) Except as provided in paragraph (g)(3) of this section, the character of the marking member’s gain or loss from the transaction is ordinary.

(iv) Making and revoking the election . Unless the Commissioner otherwise prescribes, the election described in this paragraph (e)(2) must be made in a separate statement saying “[Insert Name and Employer Identification Number of Common Parent] HEREBY ELECTS THE APPLICATION OF SECTION 1.1221– 2(e)(2) (THE SEPARATE-ENTITY APPROACH).” The statement must also indicate the date as of which the election

2002–14 I.R.B. 712 April 8, 2002

and the expected interest provisions. If the hedge is for less than the entire expected issue price of the debt or the full expected term of the debt, the identification must also include the amount or the term being hedged. The identification may indicate a range of dates, terms, and amounts, rather than specific dates, terms, or amounts. For example, a taxpayer might identify a transaction as hedging the yield on an anticipated issuance of fixed rate debt during the second half of its fiscal year, with the anticipated amount of the debt between $75 million and $125 million, and an anticipated term of approximately 20 to 30 years.

(iv) Hedges of aggregate risk —(A) Required identification . If a transaction hedges aggregate risk as described in paragraph (c)(3) of this section, the identification under paragraph (f)(2) of this section must include a description of the risk being hedged and of the hedging program under which the hedging transaction was entered. This requirement may be met by placing in the taxpayer’s records a description of the hedging program and by establishing a system under which individual transactions can be identified as being entered into pursuant to the program.

(B) Description of hedging program . A description of a hedging program must include an identification of the type of risk being hedged, a description of the type of items giving rise to the risk being aggregated, and sufficient additional information to demonstrate that the program is designed to reduce aggregate risk of the type identified. If the program contains controls on speculation (for example, position limits), the description of the hedging program must also explain how the controls are established, communicated, and implemented.

Example 3 . Separate-entity election; counter- party that marks to market . The facts are the same as in Example 2 above, except that H marks C to market under its method of accounting. Also assume that B would be a hedging transaction with respect to risk A if O had entered into that transaction with an unrelated party. Thus, for O, the B-C transaction is an intercompany hedging transaction with respect to O ’s risk A, the character and timing rules of § 1.1502–13 do not apply to the B-C transaction, and H ’s income, deduction, gain, or loss from C is ordinary. However, other attributes of the items from the B-C transaction are determined under § 1.1502–13. D is a hedging transaction with respect to C if it meets the requirements of paragraph (b) of this section.

(f) Identification and recordkeeping (1) Same-day identification of hedging transactions . Under section 1221(a)(7), a taxpayer that enters into a hedging transaction (including recycling an existing hedging transaction) must clearly identify it as a hedging transaction before the close of the day on which the taxpayer acquired, originated, or entered into the transaction (or recycled the existing hedging transaction).

(2) Substantially contemporaneous identification of hedged item —(i) Content of the identification . A taxpayer that enters into a hedging transaction must identify the item, items, or aggregate risk being hedged. Identification of an item being hedged generally involves identifying a transaction that creates risk, and the type of risk that the transaction creates. For example, if a taxpayer is hedging the price risk with respect to its June purchases of corn inventory, the transaction being hedged is the June purchase of corn and the risk is price movements in the market where the taxpayer buys its corn. For additional rules concerning the content of this identification, see paragraph (f)(3) of this section.

(ii) Timing of the identification . The identification required by this paragraph (f)(2) must be made substantially contem

poraneously with entering into the hedging transaction. An identification is not substantially contemporaneous if it is made more than 35 days after entering into the hedging transaction.

(3) Identification requirements for cer- tain hedging transactions . In the case of the hedging transactions described in this paragraph (f)(3), the identification under paragraph (f)(2) of this section must include the information specified.

(i) Anticipatory asset hedges . If the hedging transaction relates to the anticipated acquisition of assets by the taxpayer, the identification must include the expected date or dates of acquisition and the amounts expected to be acquired.

(ii) Inventory hedges . If the hedging transaction relates to the purchase or sale of inventory by the taxpayer, the identification is made by specifying the type or class of inventory to which the transaction relates. If the hedging transaction relates to specific purchases or sales, the identification must also include the expected dates of the purchases or sales and the amounts to be purchased or sold.

(iii) Hedges of debt of the taxpayer (A) Existing debt . If the hedging transaction relates to accruals or payments under an issue of existing debt of the taxpayer, the identification must specify the issue and, if the hedge is for less than the full issue price or the full term of the debt, the amount of the issue price and the term covered by the hedge.

(B) Debt to be issued . If the hedging transaction relates to the expected issuance of debt by the taxpayer or to accruals or payments under debt that is expected to be issued by the taxpayer, the identification must specify the following information: the expected date of issuance of the debt; the expected maturity or maturities; the total expected issue price;

April 8, 2002 713 2002–14 I.R.B.

(v) Transactions that counteract hedg- ing transactions . If the hedging transaction is described in paragraph (d)(3) of this section, the description of the hedging transaction must include an identification of the risk management transaction that is being offset and the original underlying hedged item.

(4) Manner of identification and records to be retained —(i) Inclusion of identification in tax records . The identification required by this paragraph (f) must be made on, and retained as part of, the taxpayer’s books and records.

(ii) Presence of identification must be unambiguous . The presence of an identification for purposes of this paragraph (f) must be unambiguous. The identification of a hedging transaction for financial accounting or regulatory purposes does not satisfy this requirement unless the taxpayer’s books and records indicate that the identification is also being made for tax purposes. The taxpayer may indicate that individual hedging transactions, or a class or classes of hedging transactions, that are identified for financial accounting or regulatory purposes are also being identified as hedging transactions for purposes of this section.

(iii) Manner of identification . The taxpayer may separately and explicitly make each identification, or, so long as paragraph (f)(4)(ii) of this section is satisfied, the taxpayer may establish a system pursuant to which the identification is indicated by the type of transaction or by the manner in which the transaction is consummated or recorded. An identification under this system is made at the later of the time that the system is established or the time that the transaction satisfies the terms of the system by being entered, or by being consummated or recorded, in the designated fashion.

(iv) Principles of paragraph (f)(4)(iii) of this section illustrated . Paragraphs (f)(4)(iv)(A) through (C) of this section illustrate the principles of paragraph (f)(4)(iii) of this section and assume that the other requirements of this paragraph (f) are satisfied.

(A) A taxpayer can make an identification by designating a hedging transaction for (or placing it in) an account that has been identified as containing only hedges of a specified item (or of specified items or specified aggregate risk).

(B) A taxpayer can make an identification by including and retaining in its books and records a statement that designates all future transactions in a specified derivative product as hedges of a specified item, items, or aggregate risk.

(C) A taxpayer can make an identification by designating a certain mark, a certain form, or a certain legend as meaning that a transaction is a hedge of a specified item (or of specified items or a specified aggregate risk). Identification can be made by placing the designated mark on a record of the transaction (for example, trading ticket, purchase order, or trade confirmation) or by using the designated form or a record that contains the designated legend.

(5) Identification of hedges involving members of the same consolidated group —(i) General rule: single-entity approach . A member of a consolidated group must satisfy the requirements of this paragraph (f) as if all of the members of the group were divisions of a single corporation. Thus, the member entering into the hedging transaction with a third party must identify the hedging transaction under paragraph (f)(1) of this section. Under paragraph (f)(2) of this section, that member must also identify the item, items, or aggregate risk that is being hedged, even if the item, items, or aggregate risk relates primarily or entirely to other members of the group. If the members of a group use intercompany transactions to transfer risk within the group, the requirements of paragraph (f)(2) of this section may be met by identifying the intercompany transactions, and the risks hedged by the intercompany transactions, as hedges or hedged items, as appropriate. Because identification of the intercompany transaction as a hedge serves solely to identify the hedged item, the identification is timely if made within the period required by paragraph (f)(2) of this section. For example, if a member transfers risk in an intercompany transaction, it may identify under the rules of this paragraph (f) both its position in that transaction and the item, items, or aggregate risk being hedged. The member that hedges the risk outside the group may identify under the rules of this paragraph (f) both its position with the third party and its position in the intercompany transaction.

Paragraph (e)(4) Example 1 of this section illustrates this identification.

(ii) Rule for consolidated groups mak- ing the separate-entity election . If a consolidated group makes the separate-entity election under paragraph (e)(2) of this section, each member of the group must satisfy the requirements of this paragraph (f) as though it were not a member of a consolidated group.

(6) Consistency with section 1256(e)(2) . Any identification for purposes of section 1256(e)(2) is also an identification for purposes of paragraph (f)(1) of this section.

(g) Effect of identification and non- identification —(1) Transactions identi- fied —(i) In general . If a taxpayer identifies a transaction as a hedging transaction for purposes of paragraph (f)(1) of this section, the identification is binding with respect to gain, whether or not all of the requirements of paragraph (f) of this section are satisfied. Thus, gain from that transaction is ordinary income. If the transaction is not in fact a hedging transaction described in paragraph (b) of this section, however, paragraphs (a)(1) and (2) of this section do not apply and the character of loss is determined without reference to whether the transaction is a surrogate for a noncapital asset, serves as insurance against a business risk, serves a hedging function, or serves a similar function or purpose. Thus, the taxpayer’s identification of the transaction as a hedging transaction does not itself make loss from the transaction ordinary.

(ii) Inadvertent identification . Notwithstanding paragraph (g)(1)(i) of this section, if the taxpayer identifies a transaction as a hedging transaction for purposes of paragraph (f) of this section, the character of the gain is determined as if the transaction had not been identified as a hedging transaction if—

(A) The transaction is not a hedging transaction (as defined in paragraph (b) of this section);

(B) The identification of the transaction as a hedging transaction was due to inadvertent error; and

(C) All of the taxpayer’s transactions in all open years are being treated on either original or, if necessary, amended returns in a manner consistent with the principles of this section.

2002–14 I.R.B. 714 April 8, 2002

(2) Transactions not identified —(i) In general . Except as provided in paragraphs (g)(2)(ii) and (iii) of this section, the absence of an identification that satisfies the requirements of paragraph (f)(1) of this section is binding and establishes that a transaction is not a hedging transaction. Thus, subject to the exceptions, the rules of paragraphs (a)(1) and (2) of this section do not apply, and the character of gain or loss is determined without reference to whether the transaction is a surrogate for a noncapital asset, serves as insurance against a business risk, serves a hedging function, or serves a similar function or purpose.

(ii) Inadvertent error . If a taxpayer does not make an identification that satisfies the requirements of paragraph (f) of this section, the taxpayer may treat gain or loss from the transaction as ordinary income or loss under paragraph (a)(1) or (2) of this section if—

(A) The transaction is a hedging transaction (as defined in paragraph (b) of this section);

(B) The failure to identify the transaction was due to inadvertent error; and

(C) All of the taxpayer’s hedging transactions in all open years are being treated on either original or, if necessary, amended returns as provided in paragraphs (a)(1) and (2) of this section.

(iii) Anti-abuse rule . If a taxpayer does not make an identification that satisfies all the requirements of paragraph (f) of this section but the taxpayer has no reasonable grounds for treating the transaction as other than a hedging transaction, then gain from the transaction is ordinary. The reasonableness of the taxpayer’s failure to identify a transaction is determined by taking into consideration not only the requirements of paragraph (b) of this section but also the taxpayer’s treatment of the transaction for financial accounting or

CFR part or section where identified and described

other purposes and the taxpayer’s identification of similar transactions as hedging transactions.

(3) Transactions by members of a con- solidated group —(i) Single-entity app- roach . If a consolidated group is under the general rule of paragraph (e)(1) of this section (the single-entity approach), the rules of this paragraph (g) apply only to transactions that are not intercompany transactions.

(ii) Separate-entity election . If a consolidated group has made the election under paragraph (e)(2) of this section, then, in addition to the rules of paragraphs (g)(1) and (2) of this section, the following rules apply:

(A) If an intercompany transaction is identified as a hedging transaction but does not meet the requirements of paragraphs (e)(2)(ii)(A) and (B) of this section, then, notwithstanding any contrary provision in § 1.1502–13, each party to the transaction is subject to the rules of paragraph (g)(1) of this section with respect to the transaction as though it had incorrectly identified its position in the transaction as a hedging transaction.

(B) If a transaction meets the requirements of paragraphs (e)(2)(ii)(A) and (B) of this section but the transaction is not identified as a hedging transaction, each party to the transaction is subject to the rules of paragraph (g)(2) of this section. (Because the transaction is an intercompany hedging transaction, the character and timing rules of § 1.1502–13 do not apply. See paragraph (e)(2)(iii)(A) of this section.)

(h) Effective date . The rules of this section apply to transactions entered into on or after March 20, 2002.

Par. 4. Section 1.1256(e)–1 is revised to read as follows:

§ 1.1256(e)–1 Identification of hedging transactions .

(a) Identification and recordkeeping requirements . Under section 1256(e)(2), a taxpayer that enters into a hedging transaction must identify the transaction as a hedging transaction before the close of the day on which the taxpayer enters into the transaction.

(b) Requirements for identification . The identification of a hedging transaction for purposes of section 1256(e)(2) must satisfy the requirements of § 1.1221–2(f)(1). Solely for purposes of section 1256(f)(1), however, an identification that does not satisfy all of the requirements of § 1.1221–2(f)(1) is nevertheless treated as an identification under section 1256(e)(2).

(c) Consistency with § 1.1221–2 . Any identification for purposes of § 1.1221– 2(f)(1) is also an identification for purposes of this section. If a taxpayer satisfies the requirements of § 1.1221– 2(f)(1)(ii), the transaction is treated as if it were not identified as a hedging transaction for purposes of section 1256(e)(2).

(d) Effective date . The rules of this section apply to transactions entered into on or after March 20, 2002.

PART 602—OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 5. The authority citation for part 602 continues to read as follows: Authority: 26 U.S.C. 7805. Par. 6. In § 602.101, paragraph (b) is amended by removing the entries for “1.1221–2,” “1.1221–2(d)(2)(iv),” “1.1221–2(e)(5),” “1.1221–2(g)(5)(ii),” “1.1221–2(g)(6)(ii),” “1.1221– 2(g)(6)(iii),” and “1.1221–2T(c)” and adding an entry in numerical order to the table to read as follows:

§ 602.101 OMB Control numbers .

- - - (b) - -

Current OMB

control No.

1.1221–2................................................................................................................................................................... 1545–1480

April 8, 2002 715 2002–14 I.R.B.

Robert E. Wenzel, Deputy Commissioner of

Internal Revenue .

Federal rates; adjusted federal rates; adjusted federal long-term rate and the long-term exempt rate . For purposes of sections 382, 1274, 1288, and other sections of the Code, tables set forth the rates for April 2002.

Rev. Rul. 2002–17

This revenue ruling provides various prescribed rates for federal income tax purposes for April 2002 (the current month). Table 1 contains the short-term, mid-term, and long-term applicable federal rates (AFR) for the current month for purposes of section 1274(d) of the Internal Revenue Code. Table 2 contains the short-term, mid-term, and long-term adjusted applicable federal rates (adjusted AFR) for the current month for purposes of section 1288(b). Table 3 sets forth the adjusted federal long-term rate and the long-term tax-exempt rate described in section 382(f). Table 4 contains the appropriate percentages for determining the low-income housing credit described in section 42(b)(2) for buildings placed in service during the current month. Finally, Table 5 contains the federal rate for determining the present value of an annuity, an interest for life or for a term of years, or a remainder or a reversionary interest for purposes of section 7520.

Approved March 14, 2002.

Mark Weinberger, Assistant Secretary of the Treasury .

(Filed by the Office of the Federal Register on March 15, 2002, 8:54 a.m., and published in the issue of the Federal Register for March 20, 2002, 67 F.R. 12863)

Section 1274.—Determin- ation of Issue Price in the Case of Certain Debt Instruments Issued for Property

(Also sections 42, 280G, 382, 412, 467, 468, 482, 483, 642, 807, 846, 1288, 7520, 7872.)

Applicable Federal Rates (AFR) for April 2002

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-Term

AFR 2.88% 2.86% 2.85% 2.84%

110% AFR 3.17% 3.15% 3.14% 3.13%

120% AFR 3.46% 3.43% 3.42% 3.41%

130% AFR 3.75% 3.72% 3.70% 3.69%

Mid-Term

AFR 4.65% 4.60% 4.57% 4.56% 110% AFR 5.12% 5.06% 5.03% 5.01%

120% AFR 5.60% 5.52% 5.48% 5.46% 130% AFR 6.07% 5.98% 5.94% 5.91% 150% AFR 7.02% 6.90% 6.84% 6.80%

175% AFR 8.21% 8.05% 7.97% 7.92%

Long-Term

AFR 5.62% 5.54% 5.50% 5.48% 110% AFR 6.18% 6.09% 6.04% 6.01%

120% AFR 6.76% 6.65% 6.60% 6.56% 130% AFR 7.33% 7.20% 7.14% 7.09%

2002–14 I.R.B. 716 April 8, 2002

REV. RUL. 2002–17 TABLE 2

Adjusted AFR for April 2002

Period for Compounding

Annual Semiannual Quarterly Monthly

Short-term adjusted AFR 2.08% 2.07% 2.06% 2.06%

Mid-term adjusted AFR 3.52% 3.49% 3.47% 3.46%

Long-term adjusted AFR 4.87% 4.81% 4.78% 4.76%

REV. RUL. 2002–17 TABLE 3

Rates Under Section 382 for April 2002

Adjusted federal long-term rate for the current month 4.87%

Long-term tax-exempt rate for ownership changes during the current month (the highest of the adjusted federal long-term rates for the current month and the prior two months.) 5.01%

REV. RUL. 2002–17 TABLE 4

Appropriate Percentages Under Section 42(b)(2) for April 2002

Appropriate percentage for the 70% present value low-income housing credit 8.20%

Appropriate percentage for the 30% present value low-income housing credit 3.51%

April 8, 2002 717 2002–14 I.R.B.

REV. RUL. 2002–17 TABLE 5

Rate Under Section 7520 for April 2002

Applicable federal rate for determining the present value of an annuity, an interest for life or a term of years, or a remainder or reversionary interest 5.6%

ambiguity that can be resolved by applying the canon that statutes are to be construed liberally in favor of Indians with ambiguous provisions interpreted to their benefit. Rejecting their argument reduces the chapter 35 phrase to surplusage, but there is no other reasonable reading of the statute. Pp. 3–4.

(b) The statute’s language is too strong to give the chapter 35 reference independent operative effect. The unambiguous language outside the parenthetical says without qualification that the subsection applies to “provisions . . . concerning the reporting and withholding of taxes”; and the language inside the parenthetical, prefaced with the word “including,” literally says the same, since to “include” means to “contain.” The use of parentheses emphasizes the fact that that which is within is meant simply to be illustrative. To give the chapter 35 reference independent operative effect would require seriously rewriting the rest of the statute. One would have to read “including” to mean what it does not mean, namely, “including. . . and.” To read the language outside the parenthetical as if it referred to (1) Code provisions concerning tax reporting and withholding and (2) those “concerning . . . wagering operations” would be far too convoluted to believe Congress intended it. There is no reason to think Congress intended to sweep within the subsection’s scope every Code provision concerning wagering. The subject matter at issue - tax exemption - also counsels against accepting the Tribes’ interpretation. This Court can find no comparable instance in which Congress

Section 1288.—Treatment of Original Issue Discounts on Tax-Exempt Obligations

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 1361.—S Corporation Defined

26 CFR 1.1361–1: S Corporation defined.

Section 4401.—Imposition of Tax

Ct. D. 2073

SUPREME COURT OF THE

UNITED STATES

No. 00–507

CHICKASAW NATION v . UNITED

STATES

Syllabus

The Indian Gaming Regulatory Act (Gaming Act) provides, as relevant here, that Internal Revenue Code (Code) provisions “(including [Secs.] 1441, 3402(q), 6041, and 6050I, and chapter 35 . . . ) concerning the reporting and withholding of taxes” with respect to gambling operations shall apply to Indian tribes in the same way as they apply to States. 25 U.S.C. Sec. 2719(d)(i). Chapter 35 imposes taxes from which it exempts certain state-controlled gambling activities, but says nothing about tax reporting or withholding . Petitioners, the Choctaw and Chickasaw Nations, claim that the Gaming Act subsection’s explicit parenthetical reference exempts them from paying those chapter 35 taxes from which the States are exempt. Rejecting that claim, the Tenth Circuit held that the subsection applies only to Code provisions concerning tax withholding and reporting.

Held : Section 2719(d)(i) does not exempt tribes from paying the gamblingrelated taxes that chapter 35 imposes. Pp. 3–11. (a) The subsection’s language outside the parenthetical says that the subsection applies to Code provisions concerning reporting and withholding, and the other four parenthetical references arguably concern reporting and withholding. The Tribes nonetheless claim that the subsection’s explicit parenthetical reference to chapter 35 expands the Gaming Act’s scope beyond reporting and withholding provisions - to the tax-imposing provisions that chapter 35 contains - and at the very least gives the subsection an

CERTIORARI TO THE UNITED

STATES COURT OF APPEALS FOR THE TENTH

CIRCUIT November 27, 2001*

*Together with Choctaw Nation of Oklahoma v. United States (see this Court’s Rule 12.4), also on certiorari to the same court.

2002–14 I.R.B. 718 April 8, 2002

legislated an exemption through a parenthetical numerical cross-reference. Since the more plausible role for the parenthetical to play in this subsection is that of providing an illustrative list of examples, common sense suggests that “chapter 35” is simply a bad example that Congress included inadvertently, a drafting mistake. Pp. 4–6.

(c) The Gaming Act’s legislative history on balance supports this Court’s conclusion. And the canons of interpretation to which the Tribes point - that every clause and word of a statute should be given effect and that statutes are to be construed liberally in favor of the Indians with ambiguous provisions interpreted to their benefit - do not determine how to read this statute. First, the canons are guides that need not be conclusive. Cir- cuit City Stores, Inc. v. Adams, 532 U.S. 105, 115. To accept these canons as conclusive here would produce an interpretation that the Court firmly believes would conflict with congressional intent. Second, specific canons are often countered by some maxim pointing in a different direction. Ibid . The canon requiring a court to give effect to each word “if possible” is sometimes offset by the canon permitting a court to reject words as mere surplusage if inadvertently inserted or if repugnant to the rest of the statute. Moreover, the pro-Indian canon is offset by the canon warning against interpreting federal statutes as providing tax exemptions unless the exemptions are clearly expressed. Given the individualized nature of this Court’s previous cases, one cannot say that the pro-Indian canon is inevitably stronger, particularly where the interpretation of a congressional statute rather than an Indian treaty is at issue. Pp. 6–11. 208 F.3d 871 (first judgment); 210 F.3d 389 (second judgment), affirmed.

BREYER, J., delivered the opinion of the Court, in which REHNQUIST, C. J., and STEVENS, KENNEDY, and GINSBURG, JJ., joined, and in all but Part II-B of which SCALIA and THOMAS, JJ., joined. O’CONNOR, J., filed a dissenting opinion, in which SOUTER, J., joined.

SUPREME COURT OF THE

UNITED STATES

No. 00–507

CHICKASAW NATION, PETITIONER v . UNITED STATES

CHOCTAW NATION OF OKLAHOMA, PETITIONER v .

UNITED STATES

ON WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR THE TENTH

CIRCUIT

November 27, 2001

JUSTICE BREYER delivered the opinion of the Court.*

In these cases, we must decide whether a particular subsection in the Indian Gaming Regulatory Act, 102 Stat. 2467–2486, 25 U.S.C. Secs. 2701–2721 (1994 ed.), exempts tribes from paying the gamblingrelated taxes that chapter 35 of the Internal Revenue Code imposes - taxes that States need not pay. We hold that it does not create such an exemption.

I The relevant Indian Gaming Regulatory Act (Gaming Act) subsection, as codified in 25 U.S.C. Sec. 2719(d)(i), reads as follows:

“The provisions of [the Internal Revenue Code of 1986] (including sections 1441, 3402(q), 6041, and 6050I, and chapter 35 of such Code) concerning the reporting and withholding of taxes with respect to the winnings from gaming or wagering operations shall apply to Indian gaming operations conducted pursuant to this chapter, or under a TribalState compact entered into under section 2710(d)(3) of this title that is in effect, in the same manner as such provisions apply to State gaming and wagering operations.” The subsection says that Internal Revenue Code provisions that “concer[n] the reporting and withholding of taxes” with respect to gambling operations shall apply to Indian tribes in the same way as

they apply to States. The subsection also says in its parenthetical that those provisions “includ[e]” Internal Revenue Code “chapter 35.” Chapter 35, however, says nothing about the reporting or the with- holding of taxes. Rather, that chapter simply imposes taxes - excise taxes and occupational taxes related to gambling from which it exempts certain statecontrolled gambling activities. See, e.g., 26 U.S.C. Sec. 4401(a) (1994 ed.) (imposing 0.25% excise tax on each wager); Sec. 4411 (imposing $50 occupational tax on each individual engaged in wagering business); Sec. 4402(3) (exempting state-operated gambling operations, such as lotteries).

In this lawsuit two Native American Indian Tribes, the Choctaw and Chickasaw Nations, claim that the Gaming Act subsection exempts them from paying those chapter 35 taxes from which States are exempt. Brief for Petitioners 34–36. They rest their claim upon the subsection’s explicit parenthetical reference to chapter 35. The Tenth Circuit rejected their claim on the ground that the subsection, despite its parenthetical reference, applies only to Code provisions that concern the “reporting and withholding of taxes.” 208 F.3d 871, 883–884 (2000); see also 210 F.3d 389 (2000). The Court of Appeals for the Federal Circuit, however, reached the opposite conclusion. Little Six, Inc. v. United States, 210 F.3d 1361, 1366 (2000). We granted certiorari in order to resolve the conflict. We agree with the Tenth Circuit.

II The Tribes’ basic argument rests upon the subsection’s explicit reference to “chapter 35” — contained in a parenthetical that refers to four other Internal Revenue Code provisions as well. The subsection’s language outside the parenthetical says that the subsection applies to those Internal Revenue Code provisions that concern “reporting and withholding.” The other four parenthetical references are to provisions that concern, or at least arguably concern, reporting and withholding. See 26 U.S.C. Sec. 1441 (withholding of taxes for nonresident alien); Sec. 3402(q) (withholding of

*JUSTICE SCALIA and JUSTICE THOMAS join all but Part II-B of this opinion.

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taxes from certain gambling winnings); 26 U.S.C. Sec. 6041 (reporting by businesses of payments, including payments of gambling winnings, to others); Sec. 6050I (reporting by businesses of large cash receipts, arguably applicable to certain gambling winnings or receipts).

But what about chapter 35? The Tribes correctly point out that chapter 35 has nothing to do with “reporting and withholding.” Brief for Petitioners 28–29. They add that the reference must serve some purpose, and the only purpose that the Tribes can find is that of expanding the scope of the Gaming Act’s subsection beyond reporting and withholding provisions - to the tax-imposing provisions that chapter 35 does contain. The Gaming Act therefore must exempt them (like States) from those tax payment requirements. The Tribes add that at least the reference to chapter 35 makes the subsection ambiguous. And they ask us to resolve the ambiguity by applying a special Indian-related interpretative canon, namely, “‘statutes are to be construed liberally in favor of the Indians’ with ambiguous provisions interpreted to their benefit.” Brief for Petitioners 13 (quoting Montana v. Blackfeet Tribe, 471 U.S. 759, 766 (1985)). We cannot accept the Tribes’ claim. We agree with the Tribes that rejecting their argument reduces the phrase “(including . . . chapter 35) . . .” to surplusage. Nonetheless we can find no other reasonable reading of the statute.

The language of the statute is too strong to bend as the Tribes would wish

i.e., so that it gives the chapter 35 reference independent operative effect. For one thing, the language outside the parenthetical is unambiguous. It says without qualification that the subsection applies to “provisions . . . concerning the reporting and withholding of taxes.” And the language inside the parenthetical, prefaced with the word “including,” literally says the same. To “include” is to “contain” or “comprise as part of a whole.” Webster’s Ninth New Collegiate Dictionary 609 (1985). In this instance, that which “contains” the parenthetical references - the “whole” of which the references are “parts” - is the phrase “provisions . . . concerning the reporting and withholding

of taxes. . . .” The use of parentheses emphasizes the fact that that which is within is meant simply to be illustrative, hence redundant — a circumstance underscored by the lack of any suggestion that Congress intended the illustrative list to be complete. Cf. 26 U.S.C. Sec. 3406 (backup withholding provision not mentioned in parenthetical).

Nor can one give the chapter 35 reference independent operative effect without seriously rewriting the language of the rest of the statute. One would have to read the word “including” to mean what it does not mean, namely, “including . . . and.” One would have to read the statute as if, for example, it placed “chapter 35” outside the parenthetical and said “provisions of the . . . Code including chapter 35 and also provisions . . . concerning the reporting and withholding of taxes. . . .” Or, one would have to read the language as if it said “provisions of the . . . Code . . . concerning the taxation and the reporting and withholding of taxes. . . .” We mention this latter possibility because the congressional bill that became the law before us once did read that way. But when the bill left committee, it contained not the emphasized words (“the taxation and”) but the cross-reference to chapter 35. We recognize the Tribes’ claim (made here for the first time) that one could avoid rewriting the statute by reading the language outside the parenthetical as if it referred to two kinds of “provisions of the . . . Code”: first those “concerning the reporting and withholding of taxes with respect to the winnings from gaming,” and, second, those “concerning . . . wagering operations.” See Reply Brief for Petitioners 8–10. The subsection’s grammar literally permits this reading. But that reading, even if ultimately comprehensible, is far too convoluted to believe Congress intended it. Nor is there any reason to think Congress intended to sweep within the subsection’s scope every Internal Revenue Code provision concerning wagering - a result that this unnatural reading would accomplish.

The subject matter at issue also counsels against accepting the Tribes’ interpretation. That subject matter is tax exemption. When Congress enacts a tax exemption, it ordinarily does so explicitly. We can find no comparable instance

in which Congress legislated an exemption through an inexplicit numerical cross-reference - especially a crossreference that might easily escape notice.

As we have said, the more plausible role for the parenthetical to play in this subsection is that of providing an illustrative list of examples. So considered, “chapter 35” is simply a bad example an example that Congress included inadvertently. The presence of a bad example in a statute does not warrant rewriting the remainder of the statute’s language. Nor does it necessarily mean that the statute is ambiguous, i.e., “capable of being understood in two or more possible senses or ways.” Webster’s Ninth New Collegiate Dictionary 77 (1985). Indeed, in ordinary life, we would understand an analogous instruction - say, “Test drive some cars, including Plymouth, Nissan, Chevrolet, Ford, and Kitchenaid” - not as creating ambiguity, but as reflecting a mistake. Here too, in context, common sense suggests that the cross-reference is simply a drafting mistake, a failure to delete an inappropriate cross-reference in the bill that Congress later enacted into law. Cf. Little Six, Inc. v. United States, 229 F.3d 1383, 1385 (CA Fed. 2000) (Dyk, J., dissenting from denial of rehearing en banc) (“The language of the provision has all the earmarks of a simple mistake in legislative drafting”).

The Gaming Act’s legislative history on balance supports our conclusion. The subsection as it appeared in the original Senate bill applied both to taxation and to reporting and withholding. It read as follows:

“Provisions of the Internal Revenue Code . . . concerning the taxation and the reporting and withholding of taxes with respect to gambling or wagering operations shall apply to Indian gaming operations . . . the same as they apply to State operations,” S. 555, 100th Cong., 1st Sess., 37 (1987). With the “taxation” language present, it would have made sense to include chapter 35, which concerns taxation, in a parenthetical that included other provisions that concern reporting and withholding. But the Senate committee deleted the taxation language. Why did it permit the

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cross-reference to chapter 35 to remain? Committee documents do not say.

The Tribes argue that the committee intentionally left it in the statute in order to serve as a substitute for the word “taxation.” An amicus tries to support this view by pointing to a tribal representative’s testimony that certain Tribes were “opposed to any indication where Internal Revenue would be collecting taxes from the tribal bingo operations.” Hearings on S. 555 and S. 1303 before the Senate Select Committee on Indian Affairs, 100th Cong., 1st Sess., 109 (1987) (statement of Lionel John, Executive Director of United South and Eastern Tribes). Other Tribes thought the “taxation” language too “vague,” preferring a clear statement “that the Internal Revenue Service is not being granted authority to tax tribes.” Id., at 433, 435 (statement of Charles W. Blackwell, Representative of the American Indian Tribal Government and Policy Consultants, Inc.).

Substitution of “chapter 35” for the word “taxation,” however, could not have served the tribal witnesses purposes, for doing so took from the bill the very words that made clear the tribes would not be taxed and substituted language that made it more likely they would be taxed. Nor can we believe that anyone seeking to grant a tax exemption would intentionally substitute a confusion-generating numerical cross-reference, see Part A, supra, for pre-existing language that unambiguously carried out that objective. It is far easier to believe that the drafters, having included the entire parenthetical while the word “taxation” was still part of the bill, unintentionally failed to remove what had become a superfluous numerical cross-reference—particularly since the tax-knowledgeable Senate Finance Committee never received the opportunity to examine the bill. Cf. S. Doc. No. 100–1, Senate Manual, 30 (1987) (proposed legislation concerning revenue measures shall be referred to the Committee on Finance).

Finally, the Tribes point to a letter written by one of the Gaming Act’s authors, stating that “by including reference to Chapter 35,” Congress intended “that the tax treatment of wagers conducted by tribal governments be the same as that for wagers conducted by state governments under Chapter 35.” App. to Pet.

for Cert. 113a. This letter, however, was written after the event. It expresses the views of only one member of the committee. And it makes no effort to explain the critical legislative circumstance, namely, the elimination of the word “taxation” from the bill. The letter may express the Senator’s interpretive preference, but that preference cannot overcome the language of the statute and the related considerations we have discussed. See Heintz v. Jenkins, 514 U.S. 291, 298 (1995) (A “statement [made] not during the legislative process, but after the statute became law . . . is not a statement upon which other legislators might have relied in voting for or against the Act, but it simply represents the views of one informed person on an issue about which others may (or may not) have thought differently”). Cf. New York Telephone Co. v. New York State Dept. of Labor, 440 U.S. 519, 564, n. 18 (1979) (Powell, J., dissenting) (“The comments . . . of a single Congressman, delivered long after the original passage of the [act at issue], are of no aid in determining congressional intent . . .”).

In sum, to adopt the Tribes’ interpretation would read back into the Act the very word “taxation” that the Senate committee deleted. We ordinarily will not assume that Congress intended “‘to enact statutory language that it has earlier discarded in favor of other language.’” INS v. Cardoza-Fonseca, 480 U.S. 421, 443 (1987) (quoting Nachman Corp. v. Pen- sion Benefit Guaranty Corporation, 446 U.S. 359, 392–393 (1980)); Gulf Oil Corp. v. Copp Paving Co., 419 U.S. 186, 200 (1974) (same); Mescalero Apache Tribe v. Jones, 411 U.S. 145, 157 (1973) (same). There is no special reason for doing so here.

The Tribes point to canons of interpretation that favor their position. The Court has often said that “‘every clause and word of a statute’” should, “‘if possible,’” be given “‘effect.’” United States v. Menasche, 348 U.S. 528, 538–539 (1955) (quoting Montclair v. Ramsdell, 107 U.S. 147, 152 (1883)). The Tribes point out that our interpretation deprives the words “chapter 35” of any effect. The Court has also said that “statutes are to be construed liberally in favor of the Indians with ambiguous provisions interpreted to their

benefit.” Montana v. Blackfeet Tribe, 471 U.S. at 766; South Carolina v. Catawba Tribe, Inc., 476 U.S. 498, 520 (1986) (Blackmun, J., dissenting). The Tribes point out that our interpretation is not to the Indians’ benefit.

Nonetheless, these canons do not determine how to read this statute. For one thing, canons are not mandatory rules. They are guides that “need not be conclusive.” Circuit City Stores, Inc. v. Adams, 532 U.S. 105, 115 (2001). They are designed to help judges determine the Legislature’s intent as embodied in particular statutory language. And other circumstances evidencing congressional intent can overcome their force. In this instance, to accept as conclusive the canons on which the Tribes rely would produce an interpretation that we conclude would conflict with the intent embodied in the statute Congress wrote. Cf. Cho- teau v. Burnet, 283 U.S. 691 (1931) (upholding taxation where congressional intent reasonably clear); Superintendent of Five Civilized Tribes v. Commissioner, 295 U.S. 418 (1935) (same); Mescalero Apache Tribe v. Jones, supra (same). In light of the considerations discussed earlier, we cannot say that the statute is “fairly capable” of two interpretations, cf. Montana v. Blackfeet Tribe, supra, at 766, nor that the Tribes’ interpretation is fairly “possible.”

Specific canons “are often countered . . . by some maxim pointing in a different direction.” Circuit City Stores, Inc. v. Adams, supra, at 115. The canon requiring a court to give effect to each word “ if possible ” is sometimes offset by the canon that permits a court to reject words “as surplusage” if “inadvertently inserted or if repugnant to the rest of the statute . . . .” K. Llewellyn, The Common Law Tradition 525 (1960). And the latter canon has particular force here where the surplus words consist simply of a numerical cross-reference in a parenthetical. Cf. Cabell Huntington Hospital, Inc. v. Shalala, 101 F.3d 984, 990 (CA4 1996) (“A parenthetical is, after all, a parenthetical, and it cannot be used to overcome the operative terms of the statute”).

Moreover, the canon that assumes Congress intends its statutes to benefit the tribes is offset by the canon that warns us against interpreting federal statutes as

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ing chapter 35, a Code provision that relates to gambling operations generally, but not to the reporting and withholding of gambling winnings. Ibid .

One of these two changes must have been made in error. There is no reason to assume, however, that it must have been the latter. It is equally likely that Congress intended Sec. 2719(d) to apply chapter 35 to the Nations, but adopted too restrictive a general characterization of the applicable sections.

The Court can do no more than speculate that the bill’s drafters included the parenthetical while the original restriction was in place and failed to remove it when that restriction was altered. See ante, at 7. Both the inclusion of the parenthetical and the alteration of the restriction occurred in the Senate committee, S. Rep. No. 100–446 (1988), and there is no way to determine the order in which they were adopted. If the parenthetical was added after the restriction, one could just as easily characterize the restriction as an unintentional holdover from a previous version of the bill.

True, reading the statute to grant the Nations the exemption requires the section’s reference to the “reporting and withholding of taxes with respect to the winnings” from gaming operations to sustain a meaning the words themselves cannot bear. But the Court’s reading of the statute fares no better: It requires excising from Sec. 2719(d) Congress’ explicit reference to chapter 35. This goes beyond treating statutory language as mere surplusage. See Potter v. United States, 155 U.S. 438, 446 (1894) (the presence of statutory language “cannot be regarded as mere surplusage; it means something”); cf. ante, at 3. Surplusage is redundant statutory language, Babbitt v. Sweet Home Chapter, Communities for Great Ore., 515 U.S. 687, 697–698 (1995); W. Popkin, Materials on Legislation: Political Language and the Political Process 214 (3d ed. 2001) - the Court’s reading negates language that undeniably bears separate meaning. This is not a step to be undertaken lightly.

Both approaches, therefore, require rewriting the statute, see ante, at 4. Neither of these rewritings is necessarily more “serious” than the other: At most, each involves doing no more than reversing a change made in committee. Cf. ante, at 4–5.

providing tax exemptions unless those exemptions are clearly expressed. See United States v. Wells Fargo Bank, 485 U.S. 351, 354 (1988) (“[E]xemptions from taxation . . . must be unambiguously proved”); Squire v. Capoeman, 351 U.S. 1, 6 (1956) (“[T]o be valid, exemptions to tax laws should be clearly expressed”); United States Trust Co. v. Helvering, 307 U.S. 57, 60 (1939) (“Exemptions from taxation do not rest upon implication”). Nor can one say that the pro-Indian canon is inevitably stronger - particularly where the interpretation of a congressional statute, rather than an Indian treaty, is at issue. Cf. post, at 7. This Court’s earlier cases are too individualized, involving too many different kinds of legal circumstances, to warrant any such assessment about the two canons’ relative strength. Compare, e.g., Choate v. Trapp, 224 U.S. 665, 675–676 (1912) (interpreting statement in treaty-related Indian land patents that land is “nontaxable” as creating property right invalidating later congressional effort to tax); Squire, supra, at 3 (Indian canon offsetting tax canon when related statutory provision and history make clear that language freeing Indian land “‘of all charge or incumbrance whatsoever’” includes tax); McClanahan v. Arizona Tax Comm’n, 411 U.S. 164, 174 (1973) (state tax violates principle of Indian sovereignty embodied in treaty), with Mescalero, supra (relying on tax canon to find Indians taxable); Choteau, supra language makes clear no exemption); Five Tribes, supra (same).

Consequently, the canons here cannot make the difference for which the Tribes argue. We conclude that the judgments of the Tenth Circuit must be affirmed.

It is so ordered.

SUPREME COURT OF THE

UNITED STATES

No. 00–507

CHICKASAW NATION, PETITIONER v . UNITED STATES

CHOCTAW NATION OF OKLAHOMA, PETITIONER v .

UNITED STATES

ON WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS FOR THE TENTH

CIRCUIT

November 27, 2001

JUSTICE O’CONNOR, with whom JUSTICE SOUTER joins, dissenting.

The Court today holds that 25 U.S.C. Sec. 2719(d) (1994 ed.) clearly and unambiguously fails to give Indian Nations (Nations) the exemption from federal wagering excise and related occupational taxes enjoyed by the States. Because I believe Sec. 2719(d) is subject to more than one interpretation, and because “statutes are to be construed liberally in favor of the Indians, with ambiguous provisions interpreted to their benefit,” Montana v. Blackfeet Tribe, 471 U.S. 759, 766 (1985), I respectfully dissent.

I agree with the Court that Sec. 2719(d) incorporates an error in drafting. I disagree, however, that the section’s reference to chapter 35 is necessarily that error.

As originally proposed in the Senate, the bill that became the Indian Gaming Regulatory Act (IGRA) would have applied all gambling and wageringrelated sections of the Internal Revenue Code to the Nations in the same manner as the States:

“Provisions of the Internal Revenue Code of 1986, concerning the taxation and the reporting and withholding of taxes with respect to gambling or wagering operations shall apply to Indian gaming operations conducted pursuant to this Act the same as they apply to State operations.” S. 555, 100th Cong., 1st Sess., 37 (1987). The Senate Indian Affairs Committee altered the language of this bill in two contradictory ways. It restricted the applicable Code sections to those relating to the “reporting and withholding of taxes with respect to the winnings” from gaming operations. 25 U.S.C. Sec. 2719(d). It also added a parenthetical listing specific Code sections to be applied to the Nations in the same manner as the States, includ

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The Court argues that because the reference to chapter 35 occurs in a parenthetical, negating this language does less damage to the statute than concluding that the restrictive language outside the parenthetical is too narrowly drawn. I am aware of no generally accepted canon of statutory construction favoring language outside of parentheses to language within them, see, e.g., W. Eskridge, P. Frickey, & E. Garrett, Legislation and Statutory Interpretation, App. C (2000) (listing canons), nor do I think it wise for the Court to adopt one today. The importance of statutory language depends not on its punctuation, but on its meaning. See United States Nat. Bank of Ore. v. Inde- pendent Ins. Agents of America, Inc., 508 U.S. 439, 454 (1993) (“[A] purported plain-meaning analysis based only on punctuation is necessarily incomplete and runs the risk of distorting a statute’s true meaning”).

The fact that the parenthetical is illustrative does not change the analysis: If Congress’ illustration does not match its general description, there is as much reason to question the description as the illustration. Where another general description is possible - and was in fact part of the bill at an earlier stage - Congress’ choice of an example that matches the earlier description is at least ambiguous. Moreover, as Sec. 2719(d)’s parenthetical specifically lists statutory sections to be applied to the Nations, one might in fact conclude that the doctrine that the specific governs the general, Crawford Fitting Co. v. J. T. Gibbons, Inc., 482 U.S. 437, 445 (1987), makes this specific parenthetical even more significant than the general restriction that follows.

Nor is negating Congress’ clear reference to chapter 35 required by the policy behind the statute. If anything, congressional policy weighs in favor of the Nations. Congress’ central purpose in enacting IGRA was “to provide a statutory basis for the operation of gaming by Indian tribes as a means of promoting tribal economic development, selfsufficiency, and strong tribal governments.” Sec. 2702(1). Exempting Nations from federal gaming taxation in the same manner as States preserves the Nations’ sovereignty and avoids giving state gaming a competitive advantage that would

interfere with the Nations’ ability to raise revenue in this manner.

II Because nothing in the text, legislative history, or underlying policies of Sec. 2719(d) clearly resolves the contradiction inherent in the section, it is appropriate to turn to canons of statutory construction. The Nations urge the Court to rely upon the Indian canon, that “statutes are to be construed liberally in favor of the Indians, with ambiguous provisions interpreted to their benefit,” Montana v. Blackfeet Tribe, 471 U.S., at 766, as a basis for deciding that the error in Sec. 2719(d) lies in the restriction of the subclass, not in the specific listing of chapter 35. “[R]ooted in the unique trust relationship between the United States and the Indians,” County of Oneida v. Oneida Indian Nation of N.Y., 470 U.S. 226, 247 (1985), the Indian canon presumes congressional intent to assist its wards to overcome the disadvantages our country has placed upon them. Consistent with this purpose, the Indian canon applies to statutes as well as treaties: The form of the enactment does not change the presumption that Congress generally intends to benefit the Nations. Montana v. Blackfeet Tribe, supra; County of Yakima v. Confederated Tribes and Bands of Yakima Nation, 502 U.S. 251 (1992). In this case, because Congress has chosen gaming as a means of enabling the Nations to achieve selfsufficiency, the Indian canon rightly dictates that Congress should be presumed to have intended the Nations to receive more, rather than less, revenue from this enterprise.

Of course, the Indian canon is not the only canon with potential applicability in this case. Also relevant is the taxation principle, that exemptions from taxation must be clearly expressed. United States Trust Co. v. Helvering, 307 U.S. 57, 60 (1939); see also ante, at 10. These canons pull in opposite directions, the former favoring the Nations’ preferred reading, and the latter favoring the Government’s.

This Court has repeatedly held that, when these two canons conflict, the Indian canon predominates. In Choate v. Trapp, 224 U.S. 665 (1912), a State attempted to rely on the taxation principle to argue that a treaty provision making land granted to Indians nontaxable was merely a bounty, capable of being with

drawn at any time. The Court acknowledged the taxation principle, responding:

“But in the Government’s dealings with the Indians, the rule is exactly the contrary. The construction, instead of being strict, is liberal; doubtful expressions, instead of being resolved in favor of the United States, are to be resolved in favor of [Indian nations.] Id., at 674–675. In Squire v. Capoeman, 351 U.S. 1, 3 (1956), the Federal Government had conveyed land to the Nations “‘free of all charge or encumbrance whatsoever.’” Although this phrase did not expressly mention nontaxability, the Court held that the language “might well be sufficient to include taxation,” id., at 7. Invoking the Indian canon, id., at 6–7, we found the Nations exempt.

Likewise, in McClanahan v. Arizona Tax Comm’n, 411 U.S. 164 (1973), this Court inferred an exemption from state taxation of property inside reservations from a treaty reserving lands for the exclusive use and occupancy of the Nations. In doing so, the Court noted that: “It is true, of course, that exemptions from tax laws should, as a general rule, be clearly expressed. But we have in the past construed language far more ambiguous than this as providing a tax exemption for Indians.” Id., at 176 (citing Squire, supra, at 6).

As the purpose behind the Indian canon is the same regardless of the form of enactment, supra, at 5, there is no reason to alter the Indian canon’s relative strength where a statute rather than a treaty is involved. Cf. ante, at 10. The primacy of the Indian canon over the taxation principle should not be surprising, as this Court has also held that the general presumption supporting the legality of executive action must yield to the Indian canon, a “counterpresumption specific” to Indians. Minnesota v. Mille Lacs Band of Chippewa Indians, 526 U.S. 172, 194, n. 5 (1999). This Court has failed to apply the Indian canon to extend tax exemptions to the Nations only when nothing in the language of the underlying statute or treaty suggests the Nations should be exempted. The Cherokee Tobacco, 11 Wall. 616, 618–620 (1871) (finding no exemption for the Nations from language imposing

April 8, 2002 723 2002–14 I.R.B.

Faced with the unhappy choice of determining which part of a flawed statutory section is in error, I would thus rely upon the long-established Indian canon of construction and adopt the reading most favorable to the Nations.

Section 7520.—Valuation Tables

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page 716.

Section 7872.—Treatment of Loans With Below-Market Interest Rates

The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month of April 2002. See Rev. Rul. 2002–17, page716.

taxes on certain “‘articles produced anywhere within the exterior boundaries of the United States’”); Choteau v. Burnet, 283 U.S. 691, 693–694 (1931) (finding no exemption in provisions “subject[ing] the income of ‘every individual’ to tax,” including “income ‘from any source whatever’”); Superintendent of Five Civi- lized Tribes v. Commissioner, 295 U.S. 418 (1935) (same); Mescalero Apache Tribe v. Jones, 411 U.S. 145, 155 (1973) (refusing to exempt the Nations from taxes on land use income based on language that “[o]n its face . . . exempts land and rights in land, not income derived from its use”). Mescalero also went further, suggesting that because of the taxation principle, the Court would refuse to find such an exemption absent “clear statutory guidance.” Id., at 156. Mescale- ro’s formulation is admittedly in tension with the Court’s precedents giving the Indian canon primacy over the taxation principle where statutory language is ambiguous. As Mescalero was decided on the same day as one of those very prece

dents, the unanimous decision in McClanahan v. Arizona Tax Comm’n, supra, however, it cannot have intended to alter the Court’s established practice.

Section 2719(d) provides an even more persuasive case for application of the Indian canon than any of our precedents. Here, the Court is not being asked to create out of vague language a tax exemption not specifically provided for in the statute. Instead, the Nations simply ask the Court to use the Indian canon as a tiebreaker between two equally plausible (or, in this case, equally implausible) constructions of a troubled statute, one which specifically makes chapter 35’s tax exemption applicable to the Nations, and one which specifically does not. Breaking interpretive ties is one of the least controversial uses of any canon of statutory construction. See Eskridge, Frickey, & Garrett, Legislation and Statutory Interpretation, at 341 (“The weakest kind of substantive canon operates merely as a tiebreaker at the end of the interpretive analysis”).

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