Part I. Rulings — Internal Revenue Bulletin 2007-31

Section 83.—Property Transferred in Connection With Performance of Services

26 CFR 1.83–3: Meaning and use of certain terms.

Post-grant restrictions. This ruling sets forth the tax consequences under section 83 of the Code when restrictions are imposed on substantially vested stock causing that stock to become substantially nonvested. The ruling holds that if the imposition of such restrictions occurs in the absence of an exchange of stock, the substantially nonvested stock is not subject to section 83. However, if the substantially vested stock is exchanged for substantially nonvested stock, the substantially nonvested stock is subject to section 83.

Rev. Rul. 2007–49

ISSUES

Is there a transfer of substantially nonvested stock subject to § 83 of the Internal Revenue Code where restrictions imposed on substantially vested stock cause the substantially vested stock to become substantially nonvested?
Is there a transfer of substantially nonvested stock subject to § 83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a reorganization described in § 368(a)?
Is there a transfer of substantially nonvested stock subject to § 83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a taxable stock acquisition?

FACTS

Investors form Corporation X in 2004, by contributing $1,000 each to Corporation X in exchange for 100 shares of Corporation X stock. In exchange for Individual A’s agreement to perform services for Corporation X, Corporation X issues 100 shares of its stock to A. The fair market value of the Corporation X stock on that date is $10 per share. The shares of Corporation X stock transferred to A are

“substantially vested” within the meaning of § 1.83–3(b) of the Income Tax Regulations.

For the 2004 taxable year, the amount included in A’s income under § 83(a) is $1,000 (the fair market value of the stock ($10 x 100 shares) less the amount paid ($0)). A’s basis in the stock is $1,000.

Situation 1 . In connection with its plan to start a new business venture, Corporation X seeks financing from Investor M on July 9, 2007. Investor M agrees to invest funds in Corporation X in exchange for a specified number of shares and the further requirement that A agree to subject A’s shares to a restriction that will cause the stock to be “substantially nonvested” within the meaning of § 1.83–3(b). Under this restriction, if the employment of A with Corporation X terminates before July 9, 2009, A must sell the shares to Corporation X in exchange for the lesser of $150 per share (the fair market value of Corporation X stock on July 9, 2007) or the fair market value at the time of forfeiture. In addition, the shares are nontransferable before that date. A remains employed with Corporation X, and on July 9, 2009, the fair market value of Corporation X stock is $250 per share.

Situation 2 . Corporation Y, a corporation unrelated to Corporation X, agrees to acquire all of the stock of Corporation X. Accordingly, on August 9, 2010, Corporation Y causes Corporation Z (a newly formed wholly-owned subsidiary of Corporation Y) to merge into Corporation X in a transaction that qualifies as a reorganization described in § 368(a). In the merger, the shareholders of Corporation X receive solely Corporation Y voting stock in exchange for their Corporation X stock. The fair market value of the Corporation X stock on August 9, 2010, is $310 per share.

In the merger, A’s 100 shares of substantially vested Corporation X stock are exchanged for 100 shares of Corporation Y stock subject to a restriction that will cause the stock to be “substantially nonvested” within the meaning of § 1.83–3(b). Under this restriction, if A’s employment with Corporation X is terminated for any reason before August 9, 2013, A must sell the substantially nonvested Corporation Y

shares to Corporation Y in exchange for the lesser of $310 per share (the fair market value of the shares on August 9, 2010) or the fair market value at the time of forfeiture. In addition, the shares are nontransferable before that date. No other shareholder of Corporation X receives Corporation Y stock subject to a restriction.

A timely files an election under § 83(b) with respect to the substantially nonvested Corporation Y stock A receives in the merger.

A continues to be employed by Corporation X until August 9, 2013 at which time the fair market value of the stock is $500. A sells the stock on October 31, 2014 when the fair market value of the stock is $550 per share.

Situation 3 . Assume the same facts as in Situation 2 except that in the merger half of the Corporation X stock is exchanged for cash and half is exchanged for Corporation Y stock, the transaction is fully taxable, and all of A’s Corporation X stock is exchanged for Corporation Y stock.

LAW

Section 83, provides that if, in connection with the performance of services, property is transferred to any person other than the service recipient, the excess of the fair market value of the property (determined without regard to any restriction other than a restriction which by its terms will never lapse), on the first day that the rights to the property are either transferable or not subject to a substantial risk of forfeiture, over the amount paid for the property is included in the service provider’s gross income for the first taxable year in which the rights to the property are either transferable or not subject to a substantial risk of forfeiture.

Section 1.83–3(f) provides that property transferred to an employee or independent contractor (or beneficiary thereof) in recognition of the performance of, or the refraining from performance of, services is considered transferred in connection with the performance of services within the meaning of § 83. However, the existence of other persons entitled to buy stock on the same terms and conditions as an

2007–31 I.R.B. 237 July 30, 2007

ANALYSIS — Situation 2

In Situation 2, A receives 100 shares of Corporation Y stock with an exchanged basis of $1,000 in the tax-free reorganization. Because the substantially vested Corporation X stock is exchanged for stock that is subjected to a restriction causing the shares to be “substantially nonvested,” the substantially nonvested shares are treated as having been transferred in connection with the performance of services, and thus, are subject to § 83. As a result of the § 83(b) election, A becomes the owner of those shares.

The “amount paid” for the stock under § 83 on the transfer of the substantially nonvested shares is the fair market value of the substantially vested Corporation X stock exchanged for the substantially nonvested Corporation Y stock ($31,000) on the exchange date, August 9, 2010. On A’s election under § 83(b), $31,000 is treated as the amount paid for the Corporation Y stock for purposes of applying § 83. On A’s return for the 2010 taxable year, A does not report any taxable income from the transfer of the Corporation Y stock under the § 83(b) election because the fair market value of the stock less the amount paid is $0. A does not include any amount in compensation income in the 2013 taxable year when the stock becomes substantially vested because of the prior § 83(b) election. A’s basis in the Corporation Y stock continues to be $1,000. Upon the sale of the shares in 2014, A recognizes capital gain of $54,000, the amount by which $55,000 ($550, the fair market value of the stock, x 100 shares) exceeds A’s $1,000 basis in the shares.

ANALYSIS — Situation 3

In Situation 3, A holds substantially vested Corporation X stock with a basis of $1,000 at the time of the merger. A exchanges that substantially vested Corporation X stock for substantially nonvested Corporation Y stock with a fair market value of $310 per share in a taxable transaction. Because A disposed of the substantially vested Corporation X stock in exchange for substantially nonvested Corporation Y stock in an exchange to which § 1001 applies, A recognizes capital gain on the disposition of the Corporation X stock in the amount of $30,000 ($31,000

employee, whether pursuant to a public or private offering, may indicate that in such circumstances a transfer to the employee is not in recognition of the performance of, or the refraining from performance of, services.

Subjecting stock to a restriction that will cause it to be “substantially nonvested” (within the meaning of § 1.83–3(b)) indicates that the property is transferred in connection with the performance of services even if the employee pays fair value for the stock. See Alves v. Commissioner, 734 F.2d 478 (9th Cir. 1984), aff’g 79 T.C. 864 (1982). Section 1.83–1(a)(1) provides that property transferred in connection with the performance of services is not taxable under § 83(a) until it has been transferred (as defined in § 1.83–3(a)) to an employee or independent contractor and becomes substantially vested (as defined in § 1.83–3(b)) in such person. Until such property becomes substantially vested, the transferor is regarded as the owner of the property, and any income from such property received by the employee or independent contractor (or beneficiary thereof) or the right to the use of such property by the employee or independent contractor constitutes additional compensation and must be included in the gross income of such employee or independent contractor for the taxable year in which such income is received or such use is made available.

Section 83(b) provides that any person who has performed services in connection with which property is transferred to any person may elect to include in gross income, for the taxable year in which such property is transferred, the excess of the fair market value of such property at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount paid for such property.

Section 1.83–2(a) provides, in part, that the fact that the transferee has paid full value for the property transferred, realizing no bargain element in the transaction, does not preclude the use of the election under § 83(b). If this election is made, the substantial vesting rules of § 83(a) and the regulations thereunder do not apply with respect to such property. Thus, with respect to such property, the excess (if any) of the fair market value of the property

at the time of transfer (determined without regard to any restriction other than a restriction which by its terms will never lapse) over the amount (if any) paid for such property is includible in gross income as compensation at the time of transfer, and no compensation will be includible in gross income when such property becomes substantially vested. An employee who makes an election under § 83(b) is considered to be the owner of the property. See Rev. Rul. 83–22, 1983–1 C.B. 17.

Section 1001(a) provides that the gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis provided in § 1011 for determining gain, and the loss is the excess of the adjusted basis provided in such section for determining loss over the amount realized.

Section 1001(b) provides that the amount realized from the sale or other disposition of the property is the sum of any money received plus the fair market value of the property (other than money) received.

Section 1001(c) provides, except as otherwise provided in Subtitle A, the entire amount of the gain or loss, determined under section 1001, on the sale or exchange of the property shall be recognized.

Section 1.83–3(g) provides that for purposes of § 83 and its regulations, the term “amount paid” refers to the value of any money or property paid for the transfer of property to which § 83 applies.

ANALYSIS — Situation 1

In Situation 1, in connection with the new investment, the substantially vested shares of Corporation X stock owned by A are subjected to a restriction causing them to be “substantially nonvested”. Because the substantially vested shares of Corporation X stock are already owned by A for purposes of § 83, there is no “transfer” under § 83. Thus, the imposition of new restrictions on the substantially vested shares has no effect for purposes of § 83.

When the substantially nonvested Corporation X stock becomes substantially vested on July 9, 2009, A does not recognize compensation income under § 83(a). A’s basis in the stock continues to be $1,000.

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fair market value of substantially nonvested Corporation Y stock ($310 per share x 100 shares) less $1,000 basis in the Corporation X stock). A’s basis in the Corporation Y stock is $31,000.

Because the substantially vested Corporation X stock is exchanged for Corporation Y stock that is subjected to a restriction causing the shares to be “substantially nonvested,” the substantially nonvested shares are treated as having been transferred in connection with the performance of services, and thus, are subject to § 83.

As in Situation 2, the “amount paid” for the stock under § 83 is $31,000. When A makes an election under § 83(b) with respect to the Corporation Y stock, A does not report any additional amount of income for the 2010 taxable year as a result of such election because the fair market value of the stock less the amount paid for the stock is $0. A does not include any amount in compensation income in the 2013 taxable year when the stock becomes substantially vested because of the prior § 83(b) election. A’s basis in the Corporation Y stock continues to be $31,000. On the sale of the 100 shares in 2014, A will recognize capital gain of $24,000, the amount by which $55,000 ($550, the sale price, x 100 shares) exceeds A’s $31,000 basis in the shares.

If A had not made an election under § 83(b) with respect to the Corporation Y stock, when the stock becomes substantially vested on August 9, 2013, A would include $19,000 in gross income as compensation under § 83(a). This is the amount by which the fair market value of 100 Corporation Y shares ($50,000 or $500 per share) exceeds the amount paid for those shares ($31,000). Consequently, A’s basis in the Corporation Y stock would be increased by $19,000 to $50,000. See § 1.83–4(b). On the sale of the 100 shares, A would recognize capital gain of $5,000, the amount by which $55,000 ($550, the sale price, x 100 shares) exceeds A’s basis of $50,000 in the shares.

HOLDINGS

There is not a transfer of substantially nonvested stock subject to § 83 where restrictions imposed on substantially vested stock cause the substantially vested stock to become substantially nonvested.
There is a transfer of substantially nonvested stock subject to § 83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a reorganization described in § 368(a).
There is a transfer of substantially nonvested stock subject to § 83 where a service provider exchanges substantially vested stock for substantially nonvested stock in a taxable stock acquisition.

DRAFTING INFORMATION

The principal author of this revenue ruling is Jean Casey of the Office of Division Counsel/Associate Chief Counsel (Tax Exempt & Government Entities). However, other personnel from the IRS and Treasury Department participated in its development. For further information regarding this revenue ruling, contact Ms. Casey at (202) 622–6030 (not a toll-free call). For further information regarding issues with respect to subchapter C, contact Ms. Jean Brenner at (202) 622–7790 (not a toll-free number).

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

26 CFR 1.382–7T: Built-in gains and losses (tempo- rary).

T.D. 9330

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Built-in Gains and Losses Under Section 382(h)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

SUMMARY: This document contains temporary regulations that apply to corporations that have undergone ownership changes within the meaning of section 382. These regulations provide guidance regarding the treatment of prepaid income

under the built-in gain provisions of section 382(h). The text of these temporary regulations also serves as the text of the proposed regulations (REG–144540–06) set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin.

DATES: Effective Date: These regulations are effective on June 14, 2007.

Applicability Date: For dates of applicability, see §1.382–7T(b).

FOR FURTHER INFORMATION CONTACT: Keith Stanley at (202) 622–7750 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

Section 382

Section 382 limits, after a more than 50 percent change in stock ownership (ownership change), the amount of a loss corporation’s taxable income for any postchange year that may be offset by prechange losses. The amount of the limitation each year is equal to the product of the fair market value of all the stock of the loss corporation immediately before the ownership change multiplied by the applicable long-term tax-exempt rate (section 382 limitation).

Section 382(h)(1)(A) provides that if the loss corporation has a net unrealized built-in gain (NUBIG), the section 382 limitation for any taxable year ending within a 5-year recognition period is increased by the recognized built-in gain (RBIG) for the taxable year, subject to the NUBIG limitation. Section 382(h)(2)(A) defines RBIG as any gain recognized during the 5-year recognition period on the disposition of any asset to the extent the loss corporation establishes that (i) it held the asset on the change date and (ii) such gain does not exceed the asset’s built-in gain on the change date. Section 382(h)(6)(A) also treats as RBIG any item of income “properly taken into account during the recognition period” if the item is “attributable to periods before the change date.”

In Notice 2003–65, 2003–2 C.B. 747, the IRS provided interim guidance regarding the identification of built-in gains and losses under section 382(h). The notice

2007–31 I.R.B. 239 July 30, 2007

The common purpose of the prepaid income deferral provisions described above is to better match the taxpayer’s income with the expenses incurred to earn that income and, as a result, to more clearly reflect the taxpayer’s income both in the year of receipt and in the year of performance.

Certain taxpayers are taking the position that prepaid income received in the period before the change date (pre-change period) but included in gross income in the recognition period is RBIG. As further explained below, the IRS and Treasury Department believe that prepaid income is attributable to the period on or after the change date (post-change period) rather than the pre-change period. Thus, treating prepaid income as RBIG is inconsistent with the purposes of section 382(h).

Explanation of Provisions

This temporary regulation provides that prepaid income is not recognized built-in gain. The term prepaid income means any amount received prior to the change date that is attributable to performance occurring on or after the change date. Examples to which the temporary regulation applies include, but are not limited to, income received prior to the change date that is deferred under section 455, §1.451–5, or Rev. Proc. 2004–34 (or any successor revenue procedure).

The IRS and Treasury Department believe that the section 382 legislative history, through the examples set forth therein, supports the position that prepaid income should not be treated as RBIG for section 382 purposes. The House and Senate Committee Reports that accompanied the enactment of section 382(h)(6)(A) both state that items of income attributable to the pre-change period include accounts receivable of a cash basis taxpayer that arose before the change date and are collected after that date, the gain on completion of a long-term contract performed by a taxpayer using the completed contract method of accounting that is attributable to the pre-change period, and the recognition of income attributable to the pre-change period pursuant to section 481 adjustments, as when the loss corporation is required to change to the accrual method. See H. Rep. No. 100–795, 46 (1988); S. Rep. No. 100–445, 48 (1988).

provides, among other things, that a loss corporation may use the 338 approach in determining the amount of its RBIG or recognized built-in loss (RBIL) for purposes of section 382(h). The 338 approach identifies items of RBIG and RBIL generally by comparing the loss corporation’s actual items of income, gain, deduction, and loss with those that would have resulted if a section 338 election had been made with respect to a hypothetical purchase of all of the outstanding stock of the loss corporation on the change date.

Prepaid Income

Generally, a taxpayer, including an accrual method taxpayer that receives payments in advance of performance, must include the payments in gross income in the taxable year of receipt without regard to whether the required performance has occurred. In Schlude v. Commissioner, 372 U.S. 128 (1963), the Supreme Court held that advance payments for dance lessons were includable in gross income when received because the payments were nonrefundable and the services were provided on demand of the student. In American Automobile Association v. United States, 367 U.S. 687 (1961), the Supreme Court held that membership dues entitling members to emergency road assistance and tripplanning services were includable in gross income when received, even though the taxpayer’s method reflected income in accordance with generally accepted accounting principles (which generally operate to defer income recognition until the item is economically earned).

However, courts have allowed the deferral of prepaid income in limited circumstances. In Artnell Co. v. Commis- sioner, 400 F.2d 981 (7th Cir. 1968), the court held that amounts received on advance ticket sales relating to major league baseball games to be played on fixed dates in the next year could be deferred to that year. In Tampa Bay Devil Rays, Ltd. v. Commissioner, T.C. Memo 2002–248, the Tax Court held that deposits received by a new baseball franchise (Devil Rays) in 1995 and 1996 on advance season tickets for major league baseball games to be played by the Devil Rays in its first season in 1998 could be deferred until 1998, even though the deferral period was greater than a year. The Tax Court emphasized that the

games were to be played on a fixed and definite schedule in 1998 and that deferral more clearly matched the deposits with the related expenses that were incurred and deducted in 1998.

Congress, the IRS, and Treasury Department have allowed deferral of prepaid income in certain circumstances. For example, section 455 allows taxpayers that have prepaid subscription income for newspapers, magazines, and other periodicals to elect to defer such income to the taxable years during which the liability to furnish or deliver the newspaper, magazine, or periodical exists. Section 1.451–5(b)(1)(ii) allows advance payments for the sale of goods to be deferred to the year the payments are included in gross receipts under the taxpayer’s method of accounting for tax purposes (such as when the goods are shipped or delivered), unless the income is recorded earlier for purposes of the taxpayer’s financial statements. For goods that must be inventoried, the permitted deferral is further limited by §1.451–5(c)(1) to the second year following the year substantial advance payments, as defined in §1.451–5(c)(3), are received.

Revenue Procedure 71–21, 1971–2 C.B. 549, which was modified and superseded by Rev. Proc. 2004–34, 2004–1 C.B. 991, allowed accrual method taxpayers that received a payment in one taxable year for services to be performed before the end of the next succeeding taxable year to defer income inclusion until the services were performed (but no later than the end of the succeeding taxable year). The stated purpose of the Revenue Procedure was to reconcile the tax accounting treatment of such payments with the financial accounting conventions consistently used by accrual method taxpayers in the treatment of such payments. Rev. Proc. 2004–34 allows a qualifying taxpayer to defer advance payments for services (and for certain non-services and combinations of services and non-services) to the taxable year succeeding the taxable year of receipt to the extent the taxpayer establishes that the advance payments are not recognized in revenues in the taxpayer’s applicable financial statement in the taxable year of receipt; or, if the taxpayer does not have an applicable financial statement, the payment is not earned in the taxable year of receipt.

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Drafting Information

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

Availability of IRS Documents

IRS revenue rulings, procedures, and notices cited in this preamble are made available by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

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Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * * Section 1.382–7T also issued under 26 U.S.C. 382(m).* * *

Par. 2. Section 1.382–7T is added to read as follows:

§1.382–7T Built-in gains and losses (temporary).

(a) Treatment of prepaid income . For purposes of section 382(h), prepaid income is not recognized built-in gain. The term prepaid income means any amount received prior to the change date that is attributable to performance occurring on or after the change date. Examples to which this paragraph (a) will apply include, but are not limited to, income received prior to the change date that is deferred under section 455, §1.451–5, or Rev. Proc. 2004–34, 2004–1 C.B. 991 (or any successor revenue procedure) (see §601.601(d)(2) of this chapter).

(b) Effective/Applicability date . (1) This section applies to loss corporations that have undergone an ownership change on or after June 14, 2007.

(2) The applicability of this section expires on or before June 11, 2010.

The IRS and Treasury Department believe that prepaid income is distinguishable from the income items described in the committee report examples. In each of the committee report examples, the item of income is attributable to the pre-change period because that is the period in which performance occurred and expenses were incurred to earn the income. By contrast, prepaid income is attributable to the postchange period because that is the period in which performance occurred and expenses were incurred to earn the income. Therefore, because prepaid income is attributable to the post-change period rather than the pre-change period, the IRS and Treasury Department have determined that such prepaid income should not be treated as RBIG under section 382(h).

The 338 approach described in Notice 2003–65 hereinafter will be applied consistently with this temporary regulation.

Comments

The text of these temporary regulations also serves as the text of the proposed regulations set forth in the notice of proposed rulemaking on this subject in this issue of the Bulletin. Please see the “Comments and Requests for a Public Hearing” section of the notice of proposed rulemaking for the procedures to follow in submitting comments on the proposed regulations on this subject.

In preparing comments on the proposed regulations, please consider the following. In Notice 2003–65, comments were requested regarding the different approaches, including the 338 approach, set forth for determining RBIG and RBIL under section 382(h). The IRS and Treasury Department believe the 338 approach, in most cases, will properly identify whether or not an item of income or deduction is treated as RBIG or RBIL. However, the IRS and Treasury Department are concerned that taking items of income and deduction into account separately may cause the 338 approach, in some cases, to not properly identify whether or not an item of income or deduction is treated as RBIG or RBIL. The purpose of section 382(h)(6) is to treat items of income or deduction in similar fashion to gain and loss under section 382(h)(2). However, under general tax principles, there is a fundamental difference between the treatment

of items of income or deduction and items of gain or loss. On the one hand, under section 382(h)(2), which incorporates the principles of section 1001, gain or loss on the disposition of an asset is taken into account net of the taxpayer’s basis, or investment, in the assets. In contrast, under section 382(h)(6), an item of income is generally a gross amount that is not netted and therefore not necessarily matched with the item of deduction incurred to earn the item of income.

Therefore, the IRS and Treasury Department request comments on the proposed regulations about identifying cases where taking into account items of income and deduction separately may cause the 338 approach to not properly identify whether or not an item of income or deduction is treated as RBIG or RBIL, and how the 338 approach might be adapted so that in such cases it properly identifies whether or not an item of income or deduction is treated as RBIG or RBIL.

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. These temporary regulations address situations in which taxpayers inappropriately attempt to treat deferred prepaid income as net unrealized built-in gain for purposes of increasing the amount of post-ownership change income that may be offset by pre-ownership change losses. For this reason, it has been determined pursuant to 5 U.S.C. 553(b)(B) that prior notice and public procedure are impracticable and contrary to the public interest. For the same reason, it has been determined pursuant to 5 U.S.C. 553(d)(3) that good cause exists to make these temporary regulations effective upon the date of publication. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6) refer to the Special Analyses section of the preamble to the cross-reference notice of the proposed rulemaking published in this issue of the Bulletin. Pursuant to section 7805(f) of the Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

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Associate Chief Counsel (International). However, other personnel from the IRS and Treasury Department participated in their development.

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Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for 26 CFR part 1 continues to read, in part, as follows:

Authority: 26 U.S.C. 7805 * * * Par. 2. Section 1.954–2 is amended by revising paragraphs (a)(5)(ii)(C) and (a)(5)(iii) Example 2, to read as follows:

§1.954–2 Foreign personal holding company income.

(a) * - (5) - * (ii) - * (C) A controlled foreign corporation’s distributive share of partnership income will not be excluded from foreign personal holding company income under the exception contained in section 954(i) unless the controlled foreign corporation is a qualifying insurance company, as defined in section 953(e)(3), and the income of the partnership would have been qualified insurance income, as defined in section 954(i)(2), if received by the controlled foreign corporation directly. See §1.952–1(g)(1).

(iii) * * Example 2 . D Corp, a Country F corporation, is a controlled foreign corporation within the meaning of section 957(a). D Corp is a qualifying insurance company, within the meaning of section 953(e)(3), that is engaged in the business of issuing life insurance contracts. D Corp has reserves of $100x, all of which are allocable to exempt contracts, and $10x of surplus, which is equal to 10 percent of the reserves allocable to exempt contracts. D Corp contributed the $100x of reserves and $10x of surplus to DJ Partnership in exchange for a 40-percent partnership interest. DJ Partnership is an entity organized under the laws of Country G and is treated as a partnership under the laws of Country G and Country F. DJ Partnership earns $30x of investment income during the taxable year that is received from persons who are not related persons with respect to D Corp, within the meaning of section 954(d)(3). D Corp’s distributive share of this investment income is

Kevin M. Brown, Deputy Commissioner for Services and Enforcement.

Approved June 4, 2007.

Eric Solomon, Assistant Secretary

of the Treasury.

(Filed by the Office of the Federal Register on June 13, 2007, 8:45 a.m., and published in the issue of the Federal Register for June 14, 2007, 72 F.R. 32792)

Section 954.—Foreign Base Company Income

26 CFR 1.954–2: Foreign personal holding company income.

T.D. 9326

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

Guidance Under Subpart F Relating to Partnerships

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of the temporary regulations.

SUMMARY: This document contains final regulations providing guidance under subpart F relating to partnerships. The final regulations add rules for determining whether a controlled foreign corporation’s (CFC’s) distributive share of partnership income is excluded from foreign personal holding company income under the exception contained in section 954(i). These regulations will affect CFCs that are qualified insurance companies, as defined in section 953(e)(3), that have an interest in a partnership and U.S. shareholders of such CFCs.

DATES: Effective Date: These regulations are effective July 13, 2007.

Applicability Date: For date of applicability, see §1.954–2(a)(5)(v).

FOR FURTHER INFORMATION CONTACT: Kate Y. Hwa, (202) 622–3840 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

On January 17, 2006, the IRS and the Treasury Department published in the Federal Register a notice of proposed rulemaking (REG–106418–05, 2006–1 C.B. 461 [71 FR 2496]) by cross-reference to temporary regulations (T.D. 9240, 2006–1 C.B. 454 [71 FR 2462]) (collectively, the January 2006 regulations), which provide that a CFC’s distributive share of partnership income will qualify for the exception contained in section 954(i) of the Internal Revenue Code (Code) if the CFC is a qualifying insurance company and the income of the partnership would have been qualified insurance income under section 954(i) if received by the CFC directly. Thus, whether the CFC partner’s distributive share of partnership income is qualified insurance income is determined at the CFC partner level.

The IRS and the Treasury Department received no comments responding to the January 2006 regulations and no public hearing was requested or held. Accordingly, the proposed regulations are adopted without change by this Treasury decision and the corresponding temporary regulations are removed.

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 has also been determined that section 553(b) of the Administrative Procedures Act (5 U.S.C. chapter 5) does not apply to these regulations and, because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking that preceded 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 Kate Y. Hwa of the Office of the

July 30, 2007 242 2007–31 I.R.B.

$12x. This income is treated as earned by D Corp in Country F under the tax laws of Country F and meets the definition of exempt insurance income in section 953(e)(1). This $12x of investment income would be qualified insurance income, under section 954(i)(2), if D Corp had received the income directly, because the $110x invested by D Corp in DJ Partnership is equal to D Corp’s reserves allocable to exempt contracts under section 954(i)(2)(A) and allowable surplus under section 954(i)(2)(B)(ii). Thus, D Corp’s distributive share of DJ Partnership’s income will be excluded from foreign personal holding company income under section 954(i).

§1.954–2T [REMOVED]

Par. 3. Section 1.954–2T is removed.

Kevin M. Brown, Deputy Commissioner for Services and Enforcement.

Approved July 2, 2007.

Eric Solomon, Assistant Secretary of the Treasury (Tax Policy).

(Filed by the Office of the Federal Register on July 12, 2007, 8:45 a.m., and published in the issue of the Federal Register for July 13, 2007, 72 F.R. 38474)

2007–31 I.R.B. 243 July 30, 2007