Td 8611

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
articles. That is, when manufactured
articles qualifying for drawback are
commingled with nonqualifying articles
after the former are manufactured by a
drawback claimant, substitution under
the law is not authorized. In such
situations, identification of merchandise
or articles for drawback purposes by
accounting procedures must be revenue
neutral or favorable to the Government
and the accounting procedures should
be consistent with the criteria for such
accounting procedures described above.
Comment: The drawback law does not
require any method of identifying
fungible duty-paid imported materials
which may be commingled in storage
with other foreign or domestic
materials; rather, the law delegates
authority to the Secretary of the
Treasury to prescribe appropriate
accounting methods by regulation.
Response: Section 1313(l) of the
drawback law provides that the
allowance of drawback shall be subject
to compliance with such rules and
regulations as the Secretary of the
Treasury shall prescribe. Under this
authority, the agency has already
prescribed, inter alia, a regulation
governing the use of accounting
methods (see, 19 CFR 191.22(c)). As
stated above, the final interpretative
ruling articulates Customs position that
in situations where the law does not
specifically authorize substitution,
identification of merchandise or articles
for drawback purposes by appropriate
accounting procedures should be
consistent with the criteria for such
accounting procedures described above.
Comment: The higher-to-lower
accounting method promotes
administrative efficiency because it
allows Customs to verify drawback
claims without inquiring as to the order
of withdrawal from commingled
inventory.
Response: The drawback statute
contains specific time limits (see e.g.,
sections 1313 (i), (b), (c), (j), (p)). Any
verification by Customs of whether a
drawback claimant has complied with
the drawback law and the regulations
issued thereunder must include
verification that the statutory timelimits were met.
Comment: If Customs decides to
revoke C.S.D. 84–82 and proscribe the
use of higher-to-lower accounting for
drawback, Customs should specify a
‘‘cut-off’’ date for use of the higher-tolower method. Customs should delay
the effective date for this change in
position because the drawback public
may have relied on this ruling in
establishing its inventory methods for
drawback. One commenter suggests an
implementation period of 3 years.

Response: Customs is delaying the
effective date of the amendment of T.D.
84–49 and the revocation of C.S.D. 84–
82 for 90 days after the publication of
this document, the maximum delay
provided for in the Customs Regulations
for a modification or revocation of a
ruling (see 19 CFR 177.9). Customs
notes that, in regard to manufacturing
drawback, a drawback claimant which
relied on C.S.D. 84–82 should be able to
document such reliance in its drawback
rate (i.e., in order to be paid
manufacturing drawback, a claimant
must have an approved drawback rate
(see 19 CFR 191.23 and the general
drawback rate for section 1313(a) (T.D.
81–234), as well as the sample drawback
proposal for section 1313(b) provided
for in 19 CFR 191.21(c), the latter of
which contains specific sections in
which the claimant is instructed to
describe its inventory procedures)). In
such instances (i.e., when a claimant is
operating under a drawback rate which
specifically provides for higher-to-lower
accounting), drawback claimants may
continue to use higher-to-lower
accounting procedures, as provided for
in their drawback rates, until their rates
are modified, and notice of the
modification is sent to the rate holders.
Conclusion
For the reasons given in the June 28,
1994, Federal Register notice, and
following careful consideration of the
comments received and further review
of the matter, Customs is taking the
actions described in the June 28, 1994,
Federal Register notice. That is:
1. T.D. 84–49 is amended to permit
the accounting for withdrawals from
inventory of exports and drawback
deliveries on a FIFO basis. The order of
such withdrawals will continue to be:
first exports, then drawback deliveries,
after which domestic shipments will be
accounted for on a FIFO basis.
2. C.S.D. 84–82 is revoked.
This amendment of T.D. 84–49 and
the revocation of C.S.D. 84–82 will be
effective to drawback entries or claims
properly filed with Customs on or after
90 days from the date of publication in
the Federal Register. Drawback
claimants operating under properly
approved drawback rates under 19 CFR
191.23 may continue to claim drawback
using higher-to-lower accounting
procedures, as provided for in C.S.D.
84–82, if the drawback rates under
which they are operating specifically
provide for the use of such procedures,
until such rates are modified, and notice

40997

of such modification is sent to the rate
holders.
Michael H. Lane,
Acting Commissioner of Customs.
Approved: July 6, 1995.
John P. Simpson,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 95–19911 Filed 8–10–95; 8:45 am]
BILLING CODE 4820–02–P

Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8611]
RIN 1545–AS40

Conduit Arrangements Regulations
Internal Revenue Service (IRS),
Treasury.
ACTION: Final regulations.
AGENCY:

This document contains final
regulations relating to conduit financing
arrangements issued under the authority
granted by section 7701(l). The final
regulations apply to persons engaging in
multiple-party financing arrangements.
The final regulations are necessary to
determine whether such arrangements
should be recharacterized under section
7701(l).
EFFECTIVE DATE: The regulations are
effective September 11, 1995.
FOR FURTHER INFORMATION CONTACT:
Elissa J. Shendalman of the Office of the
Associate Chief Counsel (International),
(202) 622–3870 (not a toll-free number).
SUMMARY:

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act
The collection of information
contained in these final regulations has
been reviewed and approved by the
Office of Management and Budget for
review in accordance with the
Paperwork Reduction Act (44 U.S.C.
3504(h)) under control number 1545–
1440. The estimated annual burden per
recordkeeper is 10 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, PC:FP,
Washington, DC 20224, and to the
Office of Management and Budget, Attn:
Desk Officer for the Department of
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503.
Background
On August 10, 1993, Congress enacted
section 7701(l) of the Internal Revenue
Code (Code), which authorizes the

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Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

Secretary to ‘‘prescribe regulations
recharacterizing any multiple-party
financing transaction as a transaction
directly among any 2 or more parties
where such recharacterization is
necessary to prevent avoidance of any
tax imposed by [title 26].’’ The
legislative history to section 7701(l)
noted with approval a series of tax court
and IRS pronouncements that used
‘‘substance over form’’ principles to
recharacterize conduit financing
arrangements, but stated that the
Secretary was not bound by the
principles of these pronouncements in
developing regulations.
On October 14, 1994, the IRS
published a notice of proposed
rulemaking in the Federal Register (59
FR 52110) under section 7701(l) of the
Code. These proposed regulations
permit the district director to disregard
the participation of one or more
intermediate entities in a conduit
financing arrangement for purposes of
sections 871, 881, 1441, and 1442.
Written comments responding to the
notice were received, and a public
hearing was held on December 16, 1994.
After considering the written comments
received and the statements made at the
hearing, the IRS and Treasury adopt the
proposed regulation as revised by this
Treasury decision.
Explanation of Provisions and
Summary of Significant Comments
A. Overview of Provisions
The final regulations make few
substantive changes to the proposed
regulations. Most changes are in the
nature of refinements to, and
clarifications of, the principles in the
proposed regulations. It should be noted
that the IRS and Treasury will continue
to monitor conduit financing
arrangements in the context of sections
871, 881, 1441 and 1442 after the
publication of these final regulations. If
the rules announced herein do not
sufficiently address the avoidance of
these taxes, the IRS and Treasury will
consider modifying or supplementing
these rules as they find necessary.
Section 1.881–3(a)(2) of the final
regulations provides definitions of
certain terms used throughout the
regulations. A financing arrangement is
defined as a series of transactions by
which one person (the financing entity)
advances money or other property, or
grants rights to use property, and
another person (the financed entity)
receives money or other property, or the
right to use property, if the advance and
receipt are effected through one or more
other persons (intermediate entities) and
there are financing transactions linking

the financing entity, each of the
intermediate entities, and the financed
entity. The final regulations supplement
this basic rule with an anti-abuse rule
that allows the IRS to treat related
persons as a single entity where a
taxpayer interposes a related person in
an arrangement that would otherwise
qualify as a financing arrangement to
circumvent the application of the
conduit rules.
A financing transaction includes a
debt instrument, lease or license. In
addition, an equity instrument may
qualify as a financing transaction if the
equity has certain debt-like
characteristics. The term financing
transaction also includes any other
advance of money or property pursuant
to which the transferee is obligated to
repay or return a substantial portion of
the money or other property advanced
or the equivalent in value.
Section 1.881–3(a)(3)(i) authorizes the
district director to determine that an
intermediate entity is a conduit entity
under the rules set forth in § 1.881–
3(a)(4). Section 1.881–3(a)(3)(ii)
describes the effects of conduit
treatment. Section 1.881–3(a)(3)(ii)(B)
generally provides that the character of
the payments made under the
recharacterized transaction (i.e. interest,
rents, etc.) is determined by reference to
the character of the payments made to
the financing entity. However, if the
financing transaction to which the
financing entity is a party gives rise to
a type of payment that would not be
deductible if paid by the financed entity
(e.g., dividends, as determined under
U.S. tax principles), the character of the
payments is not affected by the
recharacterization.
Section 1.881–3(a)(3)(ii)(E) provides
that a financing entity that is unrelated
to both the intermediate entity and the
financed entity is not liable for the tax
imposed by section 881 unless it knows
or has reason to know of a conduit
financing arrangement. Moreover, the
final regulations create a presumption
that an unrelated financing entity does
not know or have reason to know of a
conduit financing arrangement where
the intermediate entity that is a party to
the financing transaction with the
financing entity is engaged in a
substantial trade or business.
Section 1.881–3(a)(4) provides the
standards for determining whether an
intermediate entity is a conduit entity
for purposes of section 881. If an
intermediate entity is related to either
the financing entity or the financed
entity, the intermediate entity will be a
conduit entity only if (i) the
participation of the intermediate entity
in the financing arrangement reduces

the U.S. withholding tax that otherwise
would have been imposed, and (ii) the
participation of the intermediate entity
in the financing arrangement is
pursuant to a plan one of the principal
purposes of which is the avoidance of
the withholding tax.
If a financing arrangement involves
multiple intermediate entities, § 1.881–
3(a)(4)(ii)(A) provides that the district
director will determine whether each of
the intermediate entities is a conduit
entity. The factors, presumptions, and
other rules in the regulations generally
state how they should be applied in the
case of multiple intermediate entities.
The regulations state that, if no such
rule is provided, the district director
should apply principles consistent with
the standards described above. Section
1.881–3(a)(4)(ii)(B) provides a general
anti-abuse rule that allows the district
director to treat related intermediate
entities as a single intermediate entity if
he determines that one of the principal
purposes for the involvement of
multiple intermediate entities in the
financing arrangement is to prevent the
characterization of an intermediate
entity as a conduit entity, to reduce the
portion of a payment that is subject to
withholding tax or otherwise to
circumvent the provisions of this
section. The district director’s
determination is to be based upon all of
the facts and circumstances, including,
but not limited to, the factors indicating
whether the intermediate entity’s
participation in a financing arrangement
is pursuant to a tax avoidance plan.
Section 1.881–3(b) provides that the
district director will weigh all available
evidence regarding the purposes for the
intermediate entity’s participation in the
financing arrangement. Moreover,
§ 1.881–3(b)(3) provides a presumption
that a tax avoidance plan does not exist
where an intermediate entity that is
related to either the financing entity or
the financed entity performs significant
financing activities with respect to the
financing transactions making up the
financing arrangement.
In the case of an intermediate entity
that is not related to either the financing
entity or the financed entity, the
intermediate entity will not be a conduit
entity unless the requirements
applicable to related parties are met
(that is, there is a reduction in the tax
imposed by section 881 and a tax
avoidance plan) and, in addition, the
intermediate entity would not have
participated in the financing
arrangement on substantially the same
terms but for the fact that the financing
entity advanced money or property to
(or entered into a lease or license with)
the intermediate entity. See § 1.881–

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
3(a)(4)(i)(C). Under § 1.881–3(c)(2), the
district director may presume that the
intermediate entity would not have
participated in the financing
arrangement on substantially the same
terms but for the financing transaction
between the financing entity and the
intermediate entity if another person
has provided a guarantee of the financed
entity’s obligation to the intermediate
entity. The term guarantee includes, but
is not limited to, a right of offset
between the two financing transactions
to which the intermediate entity is a
party.
Once the district director has
disregarded the participation of a
conduit entity in a conduit financing
arrangement, § 1.881–3(d)(1)(i) provides
that a portion of each payment made by
the financed entity is recharacterized as
a payment directly between the
financed entity and the financing entity.
If the aggregate principal amount of the
financing transaction(s) to which the
financed entity is a party is less than or
equal to the aggregate principal amount
of the financing transaction(s) linking
any of the parties to the financing
arrangement, the entire amount of the
payment by the financed entity shall be
recharacterized. If the aggregate
principal amount of the financing
transaction(s) to which the financed
entity is a party is greater than the
aggregate principal amount of the
financing transaction(s) linking any of
the parties to the financing arrangement,
then the recharacterized portion shall be
determined by multiplying the payment
by a fraction the numerator of which is
equal to the lowest aggregate principal
amount of the financing transaction(s)
linking any of the parties to the
financing arrangement and the
denominator of which is the aggregate
principal amount of the financing
transaction(s) to which the financed
entity is a party.
Under § 1.881–3(d)(1)(ii)(A), the
principal amount of a financing
transaction generally equals the amount
of money, or the fair market value of
other property, advanced, or subject to
a lease or license, valued at the time of
the financing transaction. However, in
the case of a financing arrangement
where the same property is advanced, or
rights granted from the financing entity
through the intermediate entity (or
entities) to the financed entity, the
property is valued on the date of the last
financing arrangement. This rule is
intended to minimize the distortive
effect of currency or other market
fluctuations when there is a time lag
between financing transactions. In
addition, the principal amount of
certain types of financing transactions is

subject to adjustment. Sections 1.881–
3(d)(1)(ii) (B) through (D) provide more
detailed guidance regarding how these
general rules are applied to different
types of financing transactions.
Section 1.881–4 uses the general
recordkeeping requirements under
section 6001 to require a financed entity
or any other person to keep records
relevant to determining whether such
person is a party to a financing
arrangement and whether that financing
arrangement may be recharacterized
under § 1.881–3. Corporations that
otherwise would report certain
information on total annual payments to
related parties pursuant to sections
6038(a) and 6038A(a) must also
maintain such records where the
corporation knows or has reason to
know that such transactions are part of
a financing arrangement. Specifically,
the final regulations require the entity to
retain all records relating to the
circumstances surrounding its
participation in the financing
transactions and financing
arrangements, including minutes of
board of directors meetings and board
resolutions and materials from
investment advisors regarding the
structuring of the transaction.
Under § 1.1441–7(d), any person that
is a withholding agent for purposes of
section 1441 with respect to the
transaction (whether the financed entity
or an intermediate entity that is treated
as an agent of the financing entity) must
withhold in accordance with the
recharacterization if it knows or has
reason to know that the financing
arrangement is a conduit financing
arrangement. The final regulations
provide examples of how the ‘‘knows or
has reason to know’’ standard, which
generally applies to all withholding
agents, is to be applied in this context.
B. Discussion of Significant Comments
Significant comments that relate to
the application of the proposed
regulation and the responses to them,
including an explanation of the
revisions made to the final regulation,
are summarized below. Technical or
drafting comments that have been
reflected in the final regulations
generally are not discussed.
1. General Approach
As described above, the final
regulations adopt the general ‘‘tax
avoidance’’ standard of the proposed
regulations. Several commentators
criticized the proposed regulations for
setting forth new standards for the
recharacterization of conduit
transactions. They argued that the
rulings that preceded these regulations

40999

required matching cash flows from the
financed entity to the conduit entity and
from the conduit entity to the financing
entity. Some commentators argued that,
because in their view the regulations
adopt new standards, the regulations
should only be effective for transactions
entered into after the enactment of
section 7701(l), while others argued that
the regulations should only apply to
transactions entered into after the
publication of the final regulations.
Finally, some commentators suggested
that the regulations constituted an
override of our treaty obligations and
might therefore be invalid.
The IRS and Treasury believe that
pre-section 7701(l) conduit rulings
rested on a taxpayer having a tax
avoidance purpose for structuring its
transactions. The fact that an
intermediate entity received and paid
matching, or nearly matching, cash
flows was evidence that the
participation of the intermediate entity
in the transaction did not serve a
business purpose. Nevertheless, the fact
that cash flows were not matched did
not mean that the transaction had a
business purpose.
The final regulations generally apply
to payments made by financed entities
after the date which is 30 days after the
date of publication of the regulations
because the IRS and Treasury believe
that the regulations reflect existing
conduit principles. Moreover, even if
the regulations had adopted a new
standard, it would be inappropriate to
grandfather transactions that admittedly
had a tax avoidance purpose. The final
regulations do not apply to interest
payments covered by section 127(g)(3)
of the Tax Reform Act of 1984, and to
interest payments with respect to other
debt obligations issued prior to October
15, 1984 (whether or not such debt was
issued by a Netherlands Antilles
corporation). Prior law continues to
apply with respect to payments on any
such debt instruments.
As noted in the preamble to the
proposed regulations, the IRS and
Treasury believe that these regulations
supplement, but do not conflict with,
the limitation on benefits articles in tax
treaties. They do so by determining
which person is the beneficial owner of
income with respect to a particular
financing arrangement. Because the
financing entity is the beneficial owner
of the income, it is entitled to claim the
benefits of any income tax treaty to
which it is entitled to reduce the
amount of tax imposed by section 881
on that income. The conduit entity, as
an agent of the financing entity, cannot
claim the benefits of a treaty to reduce
the amount of tax due under section 881

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Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

with respect to payments made
pursuant to the financing arrangement.
2. Discretion given to District Director
a. Determination of whether conduit
entity’s participation will be
disregarded. Because the proposed
regulations utilize a tax avoidance test
that depends on the facts and
circumstances, discretion is given to the
district director to determine whether
the participation of an intermediate
entity had as one of its principal
purposes the avoidance of U.S.
withholding tax. Among other things,
the district director may determine the
composition of the financing
arrangement and the number of parties
to the financing arrangement.
Some commentators criticized this
grant of discretion because they claimed
that the regulations provide insufficient
guidance regarding what factors the
district director should take into
account. Several commentators
proposed adding presumptions, making
certain existing presumptions
irrebuttable or otherwise providing
bright-line tests. One commentator
suggested that the district director’s
discretion to determine the parties to a
financing arrangement should be
limited to the extent necessary to ensure
that a taxpayer could prove that a
different party that was entitled to treaty
benefits was the real financing entity.
Finally, another commentator suggested
that the determination whether an
intermediate entity’s participation will
be disregarded should be subject to
review by a central control board in the
National Office of the IRS.
Because the final regulations retain
the facts and circumstances test used in
the proposed regulations, the final
regulations do not significantly reduce
the district director’s discretion. As
discussed below, it was not considered
necessary to add additional factors
because the objective list of factors is
not exclusive. The final regulations do,
however, provide more guidance
regarding the tax avoidance purpose test
by adding several more examples. In
addition, the final regulations modify
the factor relating to whether there has
been a significant reduction in tax to
allow the taxpayer to produce evidence
that there was not a reduction in tax
because the entity that was the ultimate
source of funds also was entitled to
treaty benefits. See § 1.881–3(b)(2)(i).
The final regulations do not adopt the
suggestion that the district director’s
discretion be subject to review at the
National Office level. The final
regulations, like the proposed
regulations, provide that the
determination of whether a tax

avoidance plan exists is based on all of
the facts and circumstances surrounding
the intermediate entity’s participation in
the financing arrangement. The IRS and
Treasury believe that such a
determination would best be made at
the local level.
b. Judicial standard of review.
Because the district director is granted
discretion by the regulations, his
determinations generally will be
reviewed by the court under an abuse of
discretion standard. Commentators
suggested that the district director’s
determination that an intermediate
entity’s participation should be
disregarded should be reviewed by the
court under this standard. One
commentator instead suggested that
courts review a district director’s
determination using a de novo standard
of review. Another suggested that the
IRS should be afforded only its normal
presumption of correctness. The final
regulations do not adopt these
suggestions because they are
fundamentally inconsistent with the
grant of discretion to the district
director.
3. Definitions
a. Financing transaction, in general.
Commentators pointed out that
thedefinition of financing transaction in
the proposed regulations encompassed
transactions that clearly were not meant
to be covered by the proposed
regulations. For example, under the
proposed regulations, a foreign parent
that contributed an existing note from
its domestic subsidiary to a foreign
subsidiary in exchange for common
stock of the subsidiary that did not have
any debt-like features nevertheless
would be treated as a financing entity
because the foreign parent had made an
advance of property (the note) pursuant
to which the foreign subsidiary had
‘‘become a party to an existing financing
transaction’’.
The definitions of financing
transaction and financing arrangement
have been redrafted to address these
concerns. See § 1.881–3(a)(2) (i) and (ii).
The effect of the new definitions is to
take a ‘‘snapshot’’ after all the
transactions are in place to determine
whether there is a financing
arrangement.
b. Equity. Commentators noted that
the proposed regulations were
inconsistent in their treatment of how a
controlling interest in a corporation,
either before or after a default, affected
whether an equity arrangement was a
financing transaction. In addition,
commentators requested that the final
regulations explicitly exempt ‘‘common
stock’’ and ‘‘ordinary preferred stock’’

from treatment as financing
transactions.
In response to the first of these
comments and in a general attempt to
clarify the types of equity instruments
that are financing transactions, the final
regulations revise the definition of
financing transaction with respect to
equity. See § 1.881–3(a)(2)(ii) (A)(2) and
(B). The new definition provides that
the right to elect the majority of the
board of directors will not, in and of
itself, cause an equity instrument to be
a financing arrangement. See § 1.881–
3(a)(2)(ii)(B)(2)(i).
As to the second suggestion, the final
regulations do not create a separate
exception from the definition of
financing transaction for ‘‘common
stock’’ or ‘‘ordinary perpetual preferred
stock.’’ Whether a transaction
constitutes a financing transaction
depends upon the terms of the
transaction, not simply on the label
attached to the transaction. Moreover,
because these terms are not themselves
well-defined in either the Code or
common law, the IRS and Treasury
believe that excluding these categories
of instruments would lead to disputes as
to whether a particular instrument is
‘‘common stock’’ or, if not, whether it is
‘‘ordinary’’ perpetual preferred stock.
c. Guarantees. Commentators asked
that final regulations explicitly provide
that guarantees are exempted from
treatment as financing transactions. The
IRS and Treasury believe that the new
definition of financing transaction,
which does not treat becoming a party
to a financing transaction as itself a
financing transaction, clarifies that a
guarantee is not a financing transaction.
Moreover, the final regulations add an
example to eliminate any doubt in this
regard. See § 1.881–3(e) Example 1.
d. Leases and licenses. The proposed
regulations provide that leases and
licenses are financing transactions.
Some commentators suggested that the
regulations not include leases and
licenses in the definition of financing
transaction or that the IRS reserve on
the subject of leases until it had more
time to study the matter.
Other commentators proposed that
certain types of leases, for instance
short-term leases and leveraged leases,
be excluded from the definition of
financing transaction. The
commentators pointed out that certain
leveraged leases would be subject to
recharacterization under the proposed
regulations even though, in substance,
the financing arrangement is the
equivalent of a loan from a financing
entity entitled to a zero rate of
withholding on interest. Under § 1.881–
3(d)(2) of the proposed regulations,

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
which provides that the nature of the
recharacterized payments is determined
by reference to the transaction to which
the financed entity is a party, the
participation of the intermediate entity
in a leveraged lease would substantially
reduce the tax imposed under section
881 if the treaty between the United
States and the country in which the
lender was organized allowed
withholding on rental payments.
Because all of the negative factors of
§ 1.881–3(c)(2) and the ‘‘but-for’’ test of
§ 1.881–3(b) of the proposed regulations
are met in a standard leveraged lease,
this reduction in tax would allow the
district director to recharacterize the
financing arrangement as a conduit
financing arrangement.
The IRS and Treasury believe that all
leases and licenses, of whatever
duration, can be used by taxpayers to
structure a conduit financing
arrangement. Accordingly, the final
regulations continue to include leases
and licenses in the definition of
financing transaction. See § 1.881–
3(a)(2)(ii)(A)(3). However, the final
regulations change the character rule in
the case of deductible payments. In
those cases, the character of the
payments under the recharacterized
transaction is determined by reference
to the financing transaction to which the
financing entity is a party. As a result,
under the final regulations, a leveraged
lease generally will not be
recharacterized as a conduit
arrangement if the ultimate lender
would be entitled to an exemption from
withholding tax on interest received
from the financed entity, even if rental
payments made by the financed entity
to the financing entity would have been
subject to withholding tax.
e. Related. As noted above, it is more
difficult for an intermediate entity to be
a conduit entity if it is not related to
either the financing entity or the
financed entity. The definition of
persons who are related to another
person generally follows the definition
used in section 6038A. One
commentator suggested that the final
regulations eliminate the constructive
ownership rule of section 267(c)(3) from
the definition of related. The same
commentator further suggested that a
person under common control within
the meaning of section 482 should not
be a related person for purposes of this
regulation.
The IRS and Treasury believe that the
term related should be broadly defined
to ensure that the additional protection
from recharacterization provided by the
so-called ‘‘but for’’ test flows only to
those entities that are not under the
effective control of either the financing

or the financed entity. Accordingly, the
final regulations retain the definition of
related provided in the proposed
regulations. See § 1.881–3(a)(2)(v).
4. Factors Indicating the Presence or
Absence of a Tax Avoidance Plan
a. In general. The proposed
regulations provide that whether the
participation of the intermediary in the
financing arrangement is pursuant to a
tax avoidance plan is determined based
on all the relevant facts and
circumstances. In addition, the
proposed regulations provide a list of
some of the factors that will be taken
into account: the extent of the reduction
in tax; the liquidity of the intermediate
entity; the timing of the transactions;
and, in the case of related entities, the
nature of the business(es) of such
entities.
Commentators asked that the final
regulations adopt a number of
additional factors. For example,
commentators asked that the
dissimilarity of cash flows or of
financing transactions making up the
financing arrangement constitute a
positive factor (i.e., a factor that
evidences the absence of a tax
avoidance plan). Commentators also
suggested that the positive factors
include the fact that income was subject
to net tax in the United States or in a
foreign jurisdiction or, alternatively,
that the transaction reduced other U.S.
or foreign taxes more than it reduced the
U.S. withholding tax (indicating that the
purpose of the transaction was to avoid
taxes other than the tax imposed by
section 881).
The factors proposed by
commentators generally relate to the
issue of whether there were purposes,
other than the avoidance of the tax
imposed by section 881, for the
participation of the intermediate entity
in the financing arrangement. The final
regulations do not add factors relating to
purposes for the participation of an
intermediate entity in a financing
arrangement. However, § 1.881–3(b)(1)
of the final regulations addresses the
issue by clarifying that the district
director will consider all available
evidence regarding the purposes for the
participation of the intermediate entity.
b. Factor relating to a complementary
or integrated business. One of the
factors listed in the proposed
regulations is whether, if the
intermediate entity is related to the
financed entity, the two parties enter
into a financing transaction to finance a
trade or business actively engaged in by
the financed entity that forms a part of,
or is complementary to, a substantial
trade or business actively engaged in by

41001

the intermediate entity. One
commentator expressed uncertainty as
to the policy behind this factor.
The intent of this factor was to take
into account the fact that related
corporations engaged in integrated
businesses may enter into many
financing transactions in the course of
conducting those businesses, the vast
majority of which have no tax avoidance
purpose. Accordingly, § 1.881–
3(b)(2)(iv) of the final regulations
clarifies that the district director will
take into account whether a transaction
is entered into in the ordinary course of
integrated or complementary trades or
businesses in determining whether there
is a tax avoidance plan. In addition, the
factor is broadened so as to apply not
only to transactions between the
intermediate entity and the financed
entity but to transactions between any
two parties to the financing arrangement
that are related to each other.
5. Presumption Regarding Significant
Financing Activities
The proposed regulations provide
that, in the case of an intermediate
entity that is related to either the
financing entity or the financed entity,
a presumption of no tax avoidance
arises where the intermediate entity
performs significant financing activities
for such entities. Among other things,
the provision required employees of the
intermediate entity (other than an
intermediate entity that earned ‘‘active
rents’’ or ‘‘active royalties’’) to manage
‘‘business risks’’ arising from the
transaction on an ongoing basis. The
proposed regulations provide an
example showing that, if there are no
such business risks because the
intermediate entity has hedged itself
fully at the time it entered into the
financing transactions, the entity is not
described in the provision.
One commentator criticized the
articulation of the significant financing
activities presumption in the proposed
regulations on the grounds that the test
should be solely whether the
participation of the intermediate entity
produces (or could be expected to
produce) efficiency savings through a
reduction in overhead costs and the
ability to hedge the group’s positions on
a net basis. Another commentator
proposed extending the presumption for
significant financing activities to
intermediate entities that are unrelated
to both the financed entity and the
financing entity.
As to the first comment, the IRS and
Treasury agree that there is not a
sufficient business purpose for the
centralization of financing activities of a
group of related corporations in a single

41002

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

corporation unless the taxpayer
anticipates efficiency savings. Although
the prospect of such savings in general
may establish a business purpose for the
establishment of the subsidiary, it does
not prevent the subsidiary from acting
as a conduit with respect to any
particular financing arrangement. This
is demonstrated by the hedging example
described above, the rationale for which
is that either the financed entity or the
financing entity could have entered into
the long-term hedge so there is no
economic justification for the
participation of the intermediate entity
in the particular financing arrangement.
The IRS and Treasury believe that an
affiliate that is not taking a continuing
active role in coordinating and
managing a financing transaction should
not be entitled to the presumption that
its participation is not pursuant to a tax
avoidance plan.
As to the suggestion of extending the
significant financing activities
presumption to unrelated parties, the
IRS and Treasury believe that this
extension would be inconsistent with
the purpose of the presumption. The
significant financing presumption
recognizes that there are legitimate
business reasons for conducting
financing activities through a
centralized financing and hedging
subsidiary. The decision to have an
unrelated intermediate entity participate
in a financing transaction is based on
different considerations, including the
regulatory effects of such transactions
and the interests of the shareholders of
the unrelated intermediary. These
considerations are addressed by
providing that such entities will not be
conduit entities unless they satisfy the
‘‘but for’’ test. The final regulations do
not extend the significant financing
activities presumption to unrelated
parties.
Accordingly, the requirements for the
significant financing activities
presumption in § 1.881–3(b)(3) of the
final regulations are generally the same
as those in the proposed regulations.
However, the final regulations do add a
requirement that the participation of the
intermediate entity generate efficiency
savings, and change the term business
risks to market risks (to differentiate the
risks of currency and interest rate
movements from other, primarily credit,
risks). In addition, one of the examples
that illustrates the significant financing
activities presumption has been revised
to indicate that a finance subsidiary may
be managing market risks even in the
case of a fully-hedged transaction if the
intermediate entity routinely terminates
such long term arrangements when it

finds cheaper hedging alternatives. See
§ 1.881–3(e) Example 22.
6. ‘‘But for’’ Test
a. In general. Under the proposed
regulations, if the intermediate entity is
not related to either the financing entity
or the financed entity, the financing
arrangement will not be recharacterized
unless the intermediate entity would
not have participated in the financing
arrangement on substantially the same
terms ‘‘but for’’ the fact that the
financing entity advanced money or
property to (or entered into a lease or
license with) the intermediate entity.
Commentators asked for clarification
regarding what it means for terms to be
not substantially the same. One
commentator proposed using the
standards for material modifications
under section 1001.
The IRS and Treasury believe that an
attempt to set forth a comprehensive
system of bright-line rules like those
suggested by commentators would add
unnecessary complexity to the
regulation, given its anti-abuse purpose.
Accordingly, the final regulations make
no change to the proposed regulations
in this regard.
b. Presumption where financing entity
guarantees the liability of the financed
entity. Under the proposed regulations,
it is presumed that the intermediate
entity would not have participated in
the financing arrangement on
substantially the same terms if, in
addition to entering into a financing
transaction with the intermediate entity,
the financing entity guarantees the
financed entity’s liabilities under its
financing transaction with the
intermediate entity. A taxpayer may
rebut this presumption by producing
clear and convincing evidence that the
intermediate entity would have
participated in the financing
arrangement on substantially the same
terms even if the financing entity had
not entered into a financing transaction
with the intermediate entity.
Several commentators asked for
clarification of this presumption. Some
commentators suggested that the
existence of a guarantee makes the
existence of the financing transaction
between the financing entity and the
intermediate entity irrelevant to the
determination of whether the
intermediate entity would have
participated in the financing
arrangement on substantially the same
terms. Another commentator proposed
eliminating the ‘‘clear and convincing
evidence’’ standard on the grounds that
it is too difficult an evidentiary burden
for the taxpayer to overcome.

The presumption regarding
guarantees originated in Rev. Rul. 87–89
(1987–2 C.B. 195), which articulated the
‘‘but for’’ test in substantially the same
terms as adopted in the final
regulations. Rev. Rul. 87–89 provided
that a statutory or contractual right of
offset is presumptive evidence that the
unrelated intermediary would not have
participated in the financing
arrangement on substantially the same
terms without the financing transaction
from the financing entity. The proposed
regulations extend the presumption to
all guarantees in order to prevent
taxpayers from using forms of credit
support other than the right of offset to
avoid this presumption. The final
regulations retain this rule. See § 1.881–
3(c)(2).
The final regulations also retain the
‘‘clear and convincing evidence’’
standard. The taxpayer always must
overcome the presumption of
correctness in favor of the government
by a preponderance of the evidence.
Therefore, in order for this additional
presumption to have any effect, it is
necessary to raise the evidentiary
standard. In addition, this standard of
proof is not unreasonable, because an
intermediate entity that is unrelated to
the financing entity and the financed
entity and that proves, by clear and
convincing evidence, that it would have
entered into the financing arrangement
on substantially the same terms will
avoid recharacterization as a conduit
entity even though its participation in
the financing arrangement is pursuant to
a tax avoidance plan.
7. Multiple Intermediate Entities
a. In general. The proposed
regulations provide guidance as to how
some but not all of the operative
provisions and presumptions apply to
multiple intermediate entities. Several
commentators asked that the final
regulations clarify the manner in which
the operative rules apply in the case of
multiple intermediate entities. The final
regulations provide additional guidance
in the relevant operative rules and
presumptions. In addition, the final
regulations modify the example in the
proposed regulations relating to
multiple intermediate entities to clarify
how some of these provisions and
presumptions apply. See § 1.881–3(e)
Example 8.
b. Special rule for related persons.
Section 1.881–3(a)(4)(ii)(B) of the
proposed regulations allows the district
director to treat related persons as a
single intermediate entity if he
determines that one of the principal
purposes for the structuring of a
transaction was the avoidance of the

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
application of the conduit financing
arrangement rules. Several
commentators suggested that the final
regulations eliminate this section. One
commentator suggested that the rule be
limited to situations where one related
corporation made an equity investment
in another. Another believed that the
IRS and Treasury should ‘‘wait and see’’
whether such a rule was really
necessary to prevent taxpayers from
circumventing the conduit financing
arrangement rules.
The IRS and Treasury believe that an
anti-abuse rule is necessary to prevent
the circumvention of these rules
through manipulation of the definition
of financing arrangement. Accordingly,
§ 1.881–3(a)(2)(i)(B) of the final
regulations retains the related party
anti-abuse rule. Moreover, the final
regulations include another more
general anti-abuse rule that allows the
district director to treat related
intermediate entities as a single
intermediate entity if he determines that
one of the principal purposes for the
involvement of multiple intermediate
entities in the financing arrangement is
to prevent the characterization of an
entity as a conduit, to reduce the
portion of a payment that is subject to
withholding tax or otherwise to
circumvent any other provision of this
section. See § 1.881–3(a)(4)(ii)(B). This
rule prevents a taxpayer from
structuring a financing transaction with
a small principal amount to reduce the
amount of the recharacterized payment,
and thus replaces the second half of the
rule set forth in proposed regulation
§ 1.881–3(a)(4)(ii)(B). This rule is
illustrated in § 1.881–3(e) Example 7.
8. Principal Amount
The proposed regulations provide that
the principal amount of a financing
transaction shall be determined on the
basis of all of the facts and
circumstances. Under the proposed
regulations, the principal amount
generally equals the amount of money,
or the fair market value of other
property (determined as of the time that
the financing transaction is entered
into), advanced in the financing
transaction. The principal amount of a
financing transaction is subject to
adjustments, as appropriate.
Some commentators asked for
clarification regarding whether
adjustments would be made to the
principal amount of a financing
transaction to take account of
amortization or depreciation. Another
commentator suggested that the final
regulations provide that calculations be
performed in the functional currency of

the intermediate entity in order to
isolate currency fluctuations.
The final regulations provide that
adjustments for depreciation and
amortization are made when calculating
the principal amount of a leasing or
licensing financing transaction. See
§ 1.881–3(d)(1)(ii)(A).
Although the IRS and Treasury agree
that the effect of currency fluctuations
should be minimized, they believe that
determining the principal amount in the
functional currency of the intermediate
entity would not always yield the
correct result. Accordingly, the final
regulations eliminate currency and
market fluctuations to the extent
possible by providing that, when the
same property has been advanced by the
financing entity and received by the
financed entity, the determination of the
principal amount is made as of the date
the last financing transaction is entered
into. See § 1.881–3(d)(1)(ii)(A). An
example has been added to demonstrate
how this rule applies to transactions in
currencies other than the U.S. dollar.
See § 1.881–3(e) Example 25.
9. Correlative Adjustments
The proposed regulations do not
provide for correlative adjustments in
the case of the district director’s
recharacterization of a financing
arrangement as a transaction directly
between a financing entity and a
financed entity.
Commentators have requested that
taxpayers be allowed to make
correlative adjustments if their
transactions are recharacterized.
Commentators generally would not,
however, allow the IRS to make
correlative adjustments where such
adjustments would result in greater tax
liability.
The final regulations, like the
proposed regulations, do not provide for
correlative adjustments. The IRS and
Treasury agree with commentators that
it is not appropriate to use regulations
that are intended to prevent the
avoidance of tax under section 881 to
recharacterize transactions for purposes
of other code sections. Accordingly,
taxpayers should not be able to use
these regulations to make correlative
adjustments to their tax returns.
10. Recordkeeping and Reporting
Requirements
The proposed regulations require
corporations that would otherwise
report certain information on total
annual payments to related parties
pursuant to sections 6038(a) and
6038A(a) to report such information on
a transaction-by-transaction basis where
the corporation knows or has reason to

41003

know that such transactions are part of
a financing arrangement. In addition,
the proposed regulations require a
financed entity or any other person to
keep records relevant to determining
whether such person is a party to a
financing arrangement that is subject to
recharacterization as part of their
general recordkeeping requirements
under section 6001.
Commentators criticized the reporting
requirements imposed by the proposed
regulation as unduly burdensome in
that they would require reporting of all
financing arrangements and not simply
those subject to recharacterization as
conduit financing arrangements.
Moreover, they pointed out that,
because the regulations only would
require reporting of those transactions to
which the financed entity is a party, the
information reported would not be of
significant value. The reported
information would not be sufficient to
allow the IRS to connect the reported
financing transaction to the other
financing transactions making up a
financing arrangement.
The final regulations eliminate the
reporting requirements provided in the
proposed regulations and provide more
specific guidance as to the type of
records affected entities must retain.
The recordkeeping requirements of
§ 1.881–4 have been revised to
incorporate all of the information that
entities would have had to report under
the proposed regulations. In addition,
the final regulations require the entity to
retain all records relating to the
circumstances surrounding its
participation in the financing
transactions and financing
arrangements, including minutes of
board of directors meetings and board
resolutions and materials from
investment advisors regarding the
structuring of the transaction. See
§ 1.881–4(c)(2).
11. Withholding Obligations
Under the proposed regulations, a
person that is otherwise a withholding
agent is required to withhold tax under
section 1441 or section 1442 in
accordance with the recharacterization
of a financing arrangement if the person
knows or has reason to know that the
financing arrangement is subject to
recharacterization under sections 871 or
881. Commentators asked for additional
guidance regarding the application of
the ‘‘know or have reason to know’’
standard in the context of conduit
financing arrangements. The final
regulations include several examples
regarding the circumstances in which a
financed entity does and does not have

41004

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

reason to know of the existence of a
conduit financing arrangement.
C. Status of Revenue Rulings
The proposed regulations did not
address the status of the existing
revenue rulings relating to conduit
arrangements. Commentators have
asked for guidance regarding their
status.
Concurrent with the publication of
these regulations, the IRS is issuing a
revenue ruling modifying the existing
rulings. The revenue ruling limits the
application of the old revenue rulings in
the context of withholding tax to
payments made before the effective date
of the final regulations and to other
provisions not covered by the conduit
regulations.
Special Analyses
It has been determined that this
Treasury decision is not a significant
regulatory action as defined in EO
12866. Therefore, a regulatory
assessment is not required. It is hereby
certified that these regulations will not
have a significant economic impact on
a substantial number of small entities.
Accordingly, a regulatory flexibility
analysis is not required. This
certification is based on the information
that follows. These regulations affect
entities engaged in cross-border
multiple-party financing arrangements.
It is assumed that a substantial number
of small entities will not engage in such
financing arrangements. Pursuant to
section 7805(f) of the Internal Revenue
Code, the notice of proposed rulemaking
preceding these regulations was
submitted to the Small Business
Administration for comment on its
impact on small businesses.
Drafting Information: The principal author
of these regulations is Elissa J. Shendalman,
Office of the Associate Chief Counsel
(International). However, other personnel
from the IRS and the Treasury Department
participated in their development.

List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Adoption of Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by removing the

entry for ‘‘Sections 1.6038A–1 through
1.6038A–7’’ and adding entries in
numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.871–1 also issued under 26
U.S.C. 7701(l). * * *
Section 1.881–3 also issued under 26
U.S.C. 7701(l).
Section 1.881–4 also issued under 26
U.S.C. 7701(l). * * *
Section 1.1441–3 also issued under 26
U.S.C. 7701(l). * * *
Section 1.1441–7 also issued under 26
U.S.C. 7701(l). * * *
Section 1.6038A–1 also issued under 26
U.S.C. 6038A.
Section 1.6038A–2 also issued under 26
U.S.C. 6038A.
Section 1.6038A–3 also issued under 26
U.S.C. 6038A and 7701(l).
Section 1.6038A–4 also issued under 26
U.S.C. 6038A.
Section 1.6038A–5 also issued under 26
U.S.C. 6038A.
Section 1.6038A–6 also issued under 26
U.S.C. 6038A.
Section 1.6038A–7 also issued under 26
U.S.C. 6038A. * * *
Section 1.7701(l)–1 also issued under 26
U.S.C. 7701(l). * * *

Par. 2. In § 1.871–1, paragraph (b)(7)
is added to read as follows:
§ 1.871–1 Classification and manner of
taxing alien individuals.

*

*
*
*
*
(b) * * *
(7) Conduit financing arrangements.
For rules regarding conduit financing
arrangements, see §§ 1.881–3 and 1.881–
4.
*
*
*
*
*
Par. 3. Sections 1.881–0, 1.881–3 and
1.881–4 are added to read as follows:
§ 1.881–0

Table of contents.

This section lists the major headings
for §§ 1.881–1 through 1.881–4.
§ 1.881–1 Manner of Taxing Foreign
Corporations
(a) Classes of foreign corporations.
(b) Manner of taxing.
(1) Foreign corporations not engaged in
U.S. business.
(2) Foreign corporations engaged in U.S.
business.
(c) Meaning of terms.
(d) Rules applicable to foreign insurance
companies.
(1) Corporations qualifying under
subchapter L.
(2) Corporations not qualifying under
subchapter L.
(e) Other provisions applicable to foreign
corporations.
(1) Accumulated earnings tax.
(2) Personal holding company tax.
(3) Foreign personal holding companies.
(4) Controlled foreign corporations.
(i) Subpart F income and increase of
earnings invested in U.S. property.
(ii) Certain accumulations of earnings and
profits.

(5) Changes in tax rate.
(6) Consolidated returns.
(7) Adjustment of tax of certain foreign
corporations.
(f) Effective date.
§ 1.881–2 Taxation of Foreign Corporations
Not Engaged in U.S. Business
(a) Imposition of tax.
(b) Fixed or determinable annual or
periodical income.
(c) Other income and gains.
(1) Items subject to tax.
(2) Determination of amount of gain.
(d) Credits against tax.
(e) Effective date.
§ 1.881–3 Conduit Financing Arrangements
(a) General rules and definitions.
(1) Purpose and scope.
(2) Definitions.
(i) Financing arrangement.
(A) In general.
(B) Special rule for related parties.
(ii) Financing transaction.
(A) In general.
(B) Limitation on inclusion of stock or
similar interests.
(iii) Conduit entity.
(iv) Conduit financing arrangement.
(v) Related.
(3) Disregard of participation of conduit
entity.
(i) Authority of district director.
(ii) Effect of disregarding conduit entity.
(A) In general.
(B) Character of payments made by the
financed entity.
(C) Effect of income tax treaties.
(D) Effect on withholding tax.
(E) Special rule for a financing entity that
is unrelated to both intermediate entity and
financed entity.
(iii) Limitation on taxpayers’s use of this
section.
(4) Standard for treatment as a conduit
entity.
(i) In general.
(ii) Multiple intermediate entities.
(A) In general.
(B) Special rule for related persons.
(b) Determination of whether participation
of intermediate entity is pursuant to a tax
avoidance plan.
(1) In general.
(2) Factors taken into account in
determining the presence or absence of a tax
avoidance purpose.
(i) Significant reduction in tax.
(ii) Ability to make the advance.
(iii) Time period between financing
transactions.
(iv) Financing transactions in the ordinary
course of business.
(3) Presumption if significant financing
activities performed by a related intermediate
entity.
(i) General rule.
(ii) Significant financing activities.
(A) Active rents or royalties.
(B) Active risk management.
(c) Determination of whether an unrelated
intermediate entity would not have
participated in financing arrangement on
substantially same terms.
(1) In general.

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
(2) Effect of guarantee.
(i) In general.
(ii) Definition of guarantee.
(d) Determination of amount of tax
liability.
(1) Amount of payment subject to
recharacterization.
(i) In general.
(ii) Determination of principal amount.
(A) In general.
(B) Debt instruments and certain stock.
(C) Partnership and trust interests.
(D) Leases and licenses.
(2) Rate of tax.
(e) Examples.
(f) Effective date.
§ 1.881–4 Recordkeeping Requirements
Concerning Conduit Financing Arrangements
(a) Scope.
(b) Recordkeeping requirements.
(1) In general.
(2) Application of sections 6038 and
6038A.
(c) Records to be maintained.
(1) In general.
(2) Additional documents.
(3) Effect of record maintenance
requirement.
(d) Effective date.
§ 1.881–3

Conduit financing arrangements.

(a) General rules and definitions—(1)
Purpose and scope. Pursuant to the
authority of section 7701(l), this section
provides rules that permit the district
director to disregard, for purposes of
section 881, the participation of one or
more intermediate entities in a
financing arrangement where such
entities are acting as conduit entities.
For purposes of this section, any
reference to tax imposed under section
881 includes, except as otherwise
provided and as the context may
require, a reference to tax imposed
under sections 871 or 884(f)(1)(A) or
required to be withheld under section
1441 or 1442. See § 1.881–4 for
recordkeeping requirements concerning
financing arrangements. See §§ 1.1441–
3(j) and 1.1441–7(d) for withholding
rules applicable to conduit financing
arrangements.
(2) Definitions. The following
definitions apply for purposes of this
section and §§ 1.881–4, 1.1441–3(j) and
1.1441–7(d).
(i) Financing arrangement—(A) In
general. Financing arrangement means a
series of transactions by which one
person (the financing entity) advances
money or other property, or grants rights
to use property, and another person (the
financed entity) receives money or other
property, or rights to use property, if the
advance and receipt are effected through
one or more other persons (intermediate
entities) and, except in cases to which
paragraph (a)(2)(i)(B) of this section
applies, there are financing transactions
linking the financing entity, each of the

intermediate entities, and the financed
entity. A transfer of money or other
property in satisfaction of a repayment
obligation is not an advance of money
or other property. A financing
arrangement exists regardless of the
order in which the transactions are
entered into, but only for the period
during which all of the financing
transactions coexist. See Examples 1, 2,
and 3 of paragraph (e) of this section for
illustrations of the term financing
arrangement.
(B) Special rule for related parties. If
two (or more) financing transactions
involving two (or more) related persons
would form part of a financing
arrangement but for the absence of a
financing transaction between the
related persons, the district director may
treat the related persons as a single
intermediate entity if he determines that
one of the principal purposes for the
structure of the financing transactions is
to prevent the characterization of such
arrangement as a financing arrangement.
This determination shall be based upon
all of the facts and circumstances,
including, without limitation, the
factors set forth in paragraph (b)(2) of
this section. See Examples 4 and 5 of
paragraph (e) of this section for
illustrations of this paragraph
(a)(2)(i)(B).
(ii) Financing transaction—(A) In
general. Financing transaction means—
(1) Debt;
(2) Stock in a corporation (or a similar
interest in a partnership or trust) that
meets the requirements of paragraph
(a)(2)(ii)(B) of this section;
(3) Any lease or license; or
(4) Any other transaction (including
an interest in a trust described in
sections 671 through 679) pursuant to
which a person makes an advance of
money or other property or grants rights
to use property to a transferee who is
obligated to repay or return a substantial
portion of the money or other property
advanced, or the equivalent in value.
This paragraph (a)(2)(ii)(A)(4) shall not
apply to the posting of collateral unless
the collateral consists of cash or the
person holding the collateral is
permitted to reduce the collateral to
cash (through a transfer, grant of a
security interest or similar transaction)
prior to default on the financing
transaction secured by the collateral.
(B) Limitation on inclusion of stock or
similar interests—(1) In general. Stock
in a corporation (or a similar interest in
a partnership or trust) will constitute a
financing transaction only if one of the
following conditions is satisfied—
(i) The issuer is required to redeem
the stock or similar interest at a
specified time or the holder has the

41005

right to require the issuer to redeem the
stock or similar interest or to make any
other payment with respect to the stock
or similar interest;
(ii) The issuer has the right to redeem
the stock or similar interest, but only if,
based on all of the facts and
circumstances as of the issue date,
redemption pursuant to that right is
more likely than not to occur; or
(iii) The owner of the stock or similar
interest has the right to require a person
related to the issuer (or any other person
who is acting pursuant to a plan or
arrangement with the issuer) to acquire
the stock or similar interest or make a
payment with respect to the stock or
similar interest.
(2) Rules of special application—(i)
Existence of a right. For purposes of this
paragraph (a)(2)(ii)(B), a person will be
considered to have a right to cause a
redemption or payment if the person
has the right (other than rights arising,
in the ordinary course, between the date
that a payment is declared and the date
that a payment is made) to enforce the
payment through a legal proceeding or
to cause the issuer to be liquidated if it
fails to redeem the interest or to make
a payment. A person will not be
considered to have a right to force a
redemption or a payment if the right is
derived solely from ownership of a
controlling interest in the issuer in cases
where the control does not arise from a
default or similar contingency under the
instrument. The person is considered to
have such a right if the person has the
right as of the issue date or, as of the
issue date, it is more likely than not that
the person will receive such a right,
whether through the occurrence of a
contingency or otherwise.
(ii) Restrictions on payment. The fact
that the issuer does not have the legally
available funds to redeem the stock or
similar interest, or that the payments are
to be made in a blocked currency, will
not affect the determinations made
pursuant to this paragraph (a)(2)(ii)(B).
(iii) Conduit entity means an
intermediate entity whose participation
in the financing arrangement may be
disregarded in whole or in part pursuant
to this section, whether or not the
district director has made a
determination that the intermediate
entity should be disregarded under
paragraph (a)(3)(i) of this section.
(iv) Conduit financing arrangement
means a financing arrangement that is
effected through one or more conduit
entities.
(v) Related means related within the
meaning of sections 267(b) or 707(b)(1),
or controlled within the meaning of
section 482, and the regulations under
those sections. For purposes of

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determining whether a person is related
to another person, the constructive
ownership rules of section 318 shall
apply, and the attribution rules of
section 267(c) also shall apply to the
extent they attribute ownership to
persons to whom section 318 does not
attribute ownership.
(3) Disregard of participation of
conduit entity—(i) Authority of district
director. The district director may
determine that the participation of a
conduit entity in a conduit financing
arrangement should be disregarded for
purposes of section 881. For this
purpose, an intermediate entity will
constitute a conduit entity if it meets the
standards of paragraph (a)(4) of this
section. The district director has
discretion to determine the manner in
which the standards of paragraph (a)(4)
of this section apply, including the
financing transactions and parties
composing the financing arrangement.
(ii) Effect of disregarding conduit
entity—(A) In general. If the district
director determines that the
participation of a conduit entity in a
financing arrangement should be
disregarded, the financing arrangement
is recharacterized as a transaction
directly between the remaining parties
to the financing arrangement (in most
cases, the financed entity and the
financing entity) for purposes of section
881. To the extent that a disregarded
conduit entity actually receives or
makes payments pursuant to a conduit
financing arrangement, it is treated as an
agent of the financing entity. Except as
otherwise provided, the
recharacterization of the conduit
financing arrangement also applies for
purposes of sections 871, 884(f)(1)(A),
1441, and 1442 and other procedural
provisions relating to those sections.
This recharacterization will not
otherwise affect a taxpayer’s Federal
income tax liability under any
substantive provisions of the Internal
Revenue Code. Thus, for example, the
recharacterization generally applies for
purposes of section 1461, in order to
impose liability on a withholding agent
who fails to withhold as required under
§ 1.1441–3(j), but not for purposes of
§ 1.882–5.
(B) Character of payments made by
the financed entity. If the participation
of a conduit financing arrangement is
disregarded under this paragraph (a)(3),
payments made by the financed entity
generally shall be characterized by
reference to the character (e.g., interest
or rent) of the payments made to the
financing entity. However, if the
financing transaction to which the
financing entity is a party is a
transaction described in paragraph

(a)(2)(ii)(A)(2) or (4) of this section that
gives rise to payments that would not be
deductible if paid by the financed
entity, the character of the payments
made by the financed entity will not be
affected by the disregard of the
participation of a conduit entity. The
characterization provided by this
paragraph (a)(3)(ii)(B) does not,
however, extend to qualification of a
payment for any exemption from
withholding tax under the Internal
Revenue Code or a provision of any
applicable tax treaty if such
qualification depends on the terms of, or
other similar facts or circumstances
relating to, the financing transaction to
which the financing entity is a party
that do not apply to the financing
transaction to which the financed entity
is a party. Thus, for example, payments
made by a financed entity that is not a
bank cannot qualify for the exemption
provided by section 881(i) of the Code
even if the loan between the financed
entity and the conduit entity is a bank
deposit.
(C) Effect of income tax treaties.
Where the participation of a conduit
entity in a conduit financing
arrangement is disregarded pursuant to
this section, it is disregarded for all
purposes of section 881, including for
purposes of applying any relevant
income tax treaties. Accordingly, the
conduit entity may not claim the
benefits of a tax treaty between its
country of residence and the United
States to reduce the amount of tax due
under section 881 with respect to
payments made pursuant to the conduit
financing arrangement. The financing
entity may, however, claim the benefits
of any income tax treaty under which it
is entitled to benefits in order to reduce
the rate of tax on payments made
pursuant to the conduit financing
arrangement that are recharacterized in
accordance with paragraph (a)(3)(ii)(B)
of this section.
(D) Effect on withholding tax. For the
effect of recharacterization on
withholding obligations, see §§ 1.1441–
3(j) and 1.1441–7(d).
(E) Special rule for a financing entity
that is unrelated to both intermediate
entity and financed entity—(1) Liability
of financing entity. Notwithstanding the
fact that a financing arrangement is a
conduit financing arrangement, a
financing entity that is unrelated to the
financed entity and the conduit entity
(or entities) shall not itself be liable for
tax under section 881 unless the
financing entity knows or has reason to
know that the financing arrangement is
a conduit financing arrangement. But
see § 1.1441–3(j) for the withholding
agent’s withholding obligations.

(2) Financing entity’s knowledge—(i)
In general. A financing entity knows or
has reason to know that the financing
arrangement is a conduit financing
arrangement only if the financing entity
knows or has reason to know of facts
sufficient to establish that the financing
arrangement is a conduit financing
arrangement, including facts sufficient
to establish that the participation of the
intermediate entity in the financing
arrangement is pursuant to a tax
avoidance plan. A person that knows
only of the financing transactions that
comprise the financing arrangement will
not be considered to know or have
reason to know of facts sufficient to
establish that the financing arrangement
is a conduit financing arrangement.
(ii) Presumption regarding financing
entity’s knowledge. It shall be presumed
that the financing entity does not know
or have reason to know that the
financing arrangement is a conduit
financing arrangement if the financing
entity is unrelated to all other parties to
the financing arrangement and the
financing entity establishes that the
intermediate entity who is a party to the
financing transaction with the financing
entity is actively engaged in a
substantial trade or business. An
intermediate entity will not be
considered to be engaged in a trade or
business if its business is making or
managing investments, unless the
intermediate entity is actively engaged
in a banking, insurance, financing or
similar trade or business and such
business consists predominantly of
transactions with customers who are not
related persons. An intermediate
entity’s trade or business is substantial
if it is reasonable for the financing entity
to expect that the intermediate entity
will be able to make payments under the
financing transaction out of the cash
flow of that trade or business. This
presumption may be rebutted if the
district director establishes that the
financing entity knew or had reason to
know that the financing arrangement is
a conduit financing arrangement. See
Example 6 of paragraph (e) of this
section for an illustration of the rules of
this paragraph (a)(3)(ii)(E).
(iii) Limitation on taxpayer’s use of
this section. A taxpayer may not apply
this section to reduce the amount of its
Federal income tax liability by
disregarding the form of its financing
transactions for Federal income tax
purposes or by compelling the district
director to do so. See, however,
paragraph (b)(2)(i) of this section for
rules regarding the taxpayer’s ability to
show that the participation of one or
more intermediate entities results in no
significant reduction in tax.

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
(4) Standard for treatment as a
conduit entity—(i) In general. An
intermediate entity is a conduit entity
with respect to a financing arrangement
if—
(A) The participation of the
intermediate entity (or entities) in the
financing arrangement reduces the tax
imposed by section 881 (determined by
comparing the aggregate tax imposed
under section 881 on payments made on
financing transactions making up the
financing arrangement with the tax that
would have been imposed under
paragraph (d) of this section);
(B) The participation of the
intermediate entity in the financing
arrangement is pursuant to a tax
avoidance plan; and
(C) Either—
(1) The intermediate entity is related
to the financing entity or the financed
entity; or
(2) The intermediate entity would not
have participated in the financing
arrangement on substantially the same
terms but for the fact that the financing
entity engaged in the financing
transaction with the intermediate entity.
(ii) Multiple intermediate entities—
(A) In general. If a financing
arrangement involves multiple
intermediate entities, the district
director will determine whether each of
the intermediate entities is a conduit
entity. The district director will make
the determination by applying the
special rules for multiple intermediate
entities provided in this section or, if no
special rules are provided, applying
principles consistent with those of
paragraph (a)(4)(i) of this section to each
of the intermediate entities in the
financing arrangement.
(B) Special rule for related persons.
The district director may treat related
intermediate entities as a single
intermediate entity if he determines that
one of the principal purposes for the
involvement of multiple intermediate
entities in the financing arrangement is
to prevent the characterization of an
intermediate entity as a conduit entity,
to reduce the portion of a payment that
is subject to withholding tax or
otherwise to circumvent the provisions
of this section. This determination shall
be based upon all of the facts and
circumstances, including, but not
limited to, the factors set forth in
paragraph (b)(2) of this section. If a
district director determines that related
persons are to be treated as a single
intermediate entity, financing
transactions between such related
parties that are part of the conduit
financing arrangement shall be
disregarded for purposes of applying
this section. See Examples 7 and 8 of

paragraph (e) of this section for
illustrations of the rules of this
paragraph (a)(4)(ii).
(b) Determination of whether
participation of intermediate entity is
pursuant to a tax avoidance plan—(1)
In general. A tax avoidance plan is a
plan one of the principal purposes of
which is the avoidance of tax imposed
by section 881. Avoidance of the tax
imposed by section 881 may be one of
the principal purposes for such a plan
even though it is outweighed by other
purposes (taken together or separately).
In this regard, the only relevant
purposes are those pertaining to the
participation of the intermediate entity
in the financing arrangement and not
those pertaining to the existence of a
financing arrangement as a whole. The
plan may be formal or informal, written
or oral, and may involve any one or
more of the parties to the financing
arrangement. The plan must be in
existence no later than the last date that
any of the financing transactions
comprising the financing arrangement is
entered into. The district director may
infer the existence of a tax avoidance
plan from the facts and circumstances.
In determining whether there is a tax
avoidance plan, the district director will
weigh all relevant evidence regarding
the purposes for the intermediate
entity’s participation in the financing
arrangement. See Examples 11 and 12 of
paragraph (e) of this section for
illustrations of the rule of this paragraph
(b)(1).
(2) Factors taken into account in
determining the presence or absence of
a tax avoidance purpose. The factors
described in paragraphs (b)(2)(i) through
(iv) of this section are among the facts
and circumstances taken into account in
determining whether the participation
of an intermediate entity in a financing
arrangement has as one of its principal
purposes the avoidance of tax imposed
by section 881.
(i) Significant reduction in tax. The
district director will consider whether
the participation of the intermediate
entity (or entities) in the financing
arrangement significantly reduces the
tax that otherwise would have been
imposed under section 881. The fact
that an intermediate entity is a resident
of a country that has an income tax
treaty with the United States that
significantly reduces the tax that
otherwise would have been imposed
under section 881 is not sufficient, by
itself, to establish the existence of a tax
avoidance plan. The determination of
whether the participation of an
intermediate entity significantly reduces
the tax generally is made by comparing
the aggregate tax imposed under section

41007

881 on payments made on financing
transactions making up the financing
arrangement with the tax that would be
imposed under paragraph (d) of this
section. However, the taxpayer is not
barred from presenting evidence that the
financing entity, as determined by the
district director, was itself an
intermediate entity and another entity
should be treated as the financing entity
for purposes of applying this test. A
reduction in the absolute amount of tax
may be significant even if the reduction
in rate is not. A reduction in the amount
of tax may be significant if the reduction
is large in absolute terms or in relative
terms. See Examples 13, 14 and 15 of
paragraph (e) of this section for
illustrations of this factor.
(ii) Ability to make the advance. The
district director will consider whether
the intermediate entity had sufficient
available money or other property of its
own to have made the advance to the
financed entity without the advance of
money or other property to it by the
financing entity (or in the case of
multiple intermediate entities, whether
each of the intermediate entities had
sufficient available money or other
property of its own to have made the
advance to either the financed entity or
another intermediate entity without the
advance of money or other property to
it by either the financing entity or
another intermediate entity).
(iii) Time period between financing
transactions. The district director will
consider the length of the period of time
that separates the advances of money or
other property, or the grants of rights to
use property, by the financing entity to
the intermediate entity (in the case of
multiple intermediate entities, from one
intermediate entity to another), and
ultimately by the intermediate entity to
the financed entity. A short period of
time is evidence of the existence of a tax
avoidance plan while a long period of
time is evidence that there is not a tax
avoidance plan. See Example 16 of
paragraph (e) of this section for an
illustration of this factor.
(iv) Financing transactions in the
ordinary course of business. If the
parties to the financing transaction are
related, the district director will
consider whether the financing
transaction occurs in the ordinary
course of the active conduct of
complementary or integrated trades or
businesses engaged in by these entities.
The fact that a financing transaction is
described in this paragraph (b)(2)(iv) is
evidence that the participation of the
parties to that transaction in the
financing arrangement is not pursuant
to a tax avoidance plan. A loan will not
be considered to occur in the ordinary

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course of the active conduct of
complementary or integrated trades or
businesses unless the loan is a trade
receivable or the parties to the
transaction are actively engaged in a
banking, insurance, financing or similar
trade or business and such business
consists predominantly of transactions
with customers who are not related
persons. See Example 17 of paragraph
(e) of this section for an illustration of
this factor.
(3) Presumption if significant
financing activities performed by a
related intermediate entity—(i) General
rule. It shall be presumed that the
participation of an intermediate entity
(or entities) in a financing arrangement
is not pursuant to a tax avoidance plan
if the intermediate entity is related to
either or both the financing entity or the
financed entity and the intermediate
entity performs significant financing
activities with respect to the financing
transactions forming part of the
financing arrangement to which it is a
party. This presumption may be
rebutted if the district director
establishes that the participation of the
intermediate entity in the financing
arrangement is pursuant to a tax
avoidance plan. See Examples 21, 22
and 23 of paragraph (e) of this section
for illustrations of this presumption.
(ii) Significant financing activities.
For purposes of this paragraph (b)(3), an
intermediate entity performs significant
financing activities with respect to such
financing transactions only if the
financing transactions satisfy the
requirements of either paragraph
(b)(3)(ii)(A) or (B) of this section.
(A) Active rents or royalties. An
intermediate entity performs significant
financing activities with respect to
leases or licenses if rents or royalties
earned with respect to such leases or
licenses are derived in the active
conduct of a trade or business within
the meaning of section 954(c)(2)(A), to
be applied by substituting the term
intermediate entity for the term
controlled foreign corporation.
(B) Active risk management—(1) In
general. An intermediate entity is
considered to perform significant
financing activities with respect to
financing transactions only if officers
and employees of the intermediate
entity participate actively and
materially in arranging the intermediate
entity’s participation in such financing
transactions (other than financing
transactions described in paragraph
(b)(3)(ii)(B)(3) of this section) and
perform the business activity and risk
management activities described in
paragraph (b)(3)(ii)(B)(2) of this section
with respect to such financing

transactions, and the participation of the
intermediate entity in the financing
transactions produces (or reasonably
can be expected to produce) efficiency
savings by reducing transaction costs
and overhead and other fixed costs.
(2) Business activity and risk
management requirements. An
intermediate entity will be considered
to perform significant financing
activities only if, within the country in
which the intermediate entity is
organized (or, if different, within the
country with respect to which the
intermediate entity is claiming the
benefits of a tax treaty), its officers and
employees—
(i) Exercise management over, and
actively conduct, the day-to-day
operations of the intermediate entity.
Such operations must consist of a
substantial trade or business or the
supervision, administration and
financing for a substantial group of
related persons; and
(ii) Actively manage, on an ongoing
basis, material market risks arising from
such financing transactions as an
integral part of the management of the
intermediate entity’s financial and
capital requirements (including
management of risks of currency and
interest rate fluctuations) and
management of the intermediate entity’s
short-term investments of working
capital by entering into transactions
with unrelated persons.
(3) Special rule for trade receivables
and payables entered into in the
ordinary course of business. If the
activities of the intermediate entity
consist in whole or in part of cash
management for a controlled group of
which the intermediate entity is a
member, then employees of the
intermediate entity need not have
participated in arranging any such
financing transactions that arise in the
ordinary course of a substantial trade or
business of either the financed entity or
the financing entity. Officers or
employees of the financing entity or
financed entity, however, must have
participated actively and materially in
arranging the transaction that gave rise
to the trade receivable or trade payable.
Cash management includes the
operation of a sweep account whereby
the intermediate entity nets
intercompany trade payables and
receivables arising from transactions
among the other members of the
controlled group and between members
of the controlled group and unrelated
persons.
(4) Activities of officers and
employees of related persons. Except as
provided in paragraph (b)(3)(ii)(B)(3) of
this section, in applying this paragraph

(b)(3)(ii)(B), the activities of an officer or
employee of an intermediate entity will
not constitute significant financing
activities if any officer or employee of
a related person participated materially
in any of the activities described in this
paragraph, other than to approve any
guarantee of a financing transaction or
to exercise general supervision and
control over the policies of the
intermediate entity.
(c) Determination of whether an
unrelated intermediate entity would not
have participated in financing
arrangement on substantially the same
terms—(1) In general. The
determination of whether an
intermediate entity would not have
participated in a financing arrangement
on substantially the same terms but for
the financing transaction between the
financing entity and the intermediate
entity shall be based upon all of the
facts and circumstances.
(2) Effect of guarantee—(i) In general.
The district director may presume that
the intermediate entity would not have
participated in the financing
arrangement on substantially the same
terms if there is a guarantee of the
financed entity’s liability to the
intermediate entity (or in the case of
multiple intermediate entities, a
guarantee of the intermediate entity’s
liability to the intermediate entity that
advanced money or property, or granted
rights to use other property). However,
a guarantee that was neither in existence
nor contemplated on the last date that
any of the financing transactions
comprising the financing arrangement is
entered into does not give rise to this
presumption. A taxpayer may rebut this
presumption by producing clear and
convincing evidence that the
intermediate entity would have
participated in the financing transaction
with the financed entity on substantially
the same terms even if the financing
entity had not entered into a financing
transaction with the intermediate entity.
(ii) Definition of guarantee. For the
purposes of this paragraph (c)(2), a
guarantee is any arrangement under
which a person, directly or indirectly,
assures, on a conditional or
unconditional basis, the payment of
another person’s obligation with respect
to a financing transaction. The term
shall be interpreted in accordance with
the definition of the term in section
163(j)(6)(D)(iii).
(d) Determination of amount of tax
liability—(1) Amount of payment
subject to recharacterization—(i) In
general. If a financing arrangement is a
conduit financing arrangement, a
portion of each payment made by the
financed entity with respect to the

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
financing transactions that comprise the
conduit financing arrangement shall be
recharacterized as a transaction directly
between the financed entity and the
financing entity. If the aggregate
principal amount of the financing
transaction(s) to which the financed
entity is a party is less than or equal to
the aggregate principal amount of the
financing transaction(s) linking any of
the parties to the financing arrangement,
the entire amount of the payment shall
be so recharacterized. If the aggregate
principal amount of the financing
transaction(s) to which the financed
entity is a party is greater than the
aggregate principal amount of the
financing transaction(s) linking any of
the parties to the financing arrangement,
then the recharacterized portion shall be
determined by multiplying the payment
by a fraction the numerator of which is
equal to the lowest aggregate principal
amount of the financing transaction(s)
linking any of the parties to the
financing arrangement (other than
financing transactions that are
disregarded pursuant to paragraphs
(a)(2)(i)(B) and (a)(4)(ii)(B) of this
section) and the denominator of which
is the aggregate principal amount of the
financing transaction(s) to which the
financed entity is a party. In the case of
financing transactions the principal
amount of which is subject to
adjustment, the fraction shall be
determined using the average
outstanding principal amounts for the
period to which the payment relates.
The average principal amount may be
computed using any method applied
consistently that reflects with
reasonable accuracy the amount
outstanding for the period. See Example
24 of paragraph (e) of this section for an
illustration of the calculation of the
amount of tax liability.
(ii) Determination of principal
amount—(A) In general. Unless
otherwise provided in this paragraph
(d)(1)(ii), the principal amount equals
the amount of money advanced, or the
fair market value of other property
advanced or subject to a lease or license,
in the financing transaction. In general,
fair market value is calculated in U.S.
dollars as of the close of business on the
day on which the financing transaction
is entered into. However, if the property
advanced, or the right to use property
granted, by the financing entity is the
same as the property or rights received
by the financed entity, the fair market
value of the property or right shall be
determined as of the close of business
on the last date that any of the financing
transactions comprising the financing
arrangement is entered into. In the case

of fungible property, property of the
same type shall be considered to be the
same property. See Example 25 of
paragraph (e) for an illustration of the
calculation of the principal amount in
the case of financing transactions
involving fungible property. The
principal amount of a financing
transaction shall be subject to
adjustments, as set forth in this
paragraph (d)(1)(ii).
(B) Debt instruments and certain
stock. In the case of a debt instrument
or of stock that is subject to the current
inclusion rules of sections 305(c)(3) or
(e), the principal amount generally will
be equal to the issue price. However, if
the fair market value on the issue date
differs materially from the issue price,
the fair market value of the debt
instrument shall be used in lieu of the
instrument’s issue price. Appropriate
adjustments will be made for accruals of
original issue discount and repayments
of principal (including accrued original
issue discount).
(C) Partnership and trust interests. In
the case of a partnership interest or an
interest in a trust, the principal amount
is equal to the fair market value of the
money or property contributed to the
partnership or trust in return for that
partnership or trust interest.
(D) Leases or licenses. In the case of
a lease or license, the principal amount
is equal to the fair market value of the
property subject to the lease or license
on the date on which the lease or
license is entered into. The principal
amount shall be adjusted for
depreciation or amortization, calculated
on a basis that accurately reflects the
anticipated decline in the value of the
property over its life.
(2) Rate of tax. The rate at which tax
is imposed under section 881 on the
portion of the payment that is
recharacterized pursuant to paragraph
(d)(1) of this section is determined by
reference to the nature of the
recharacterized transaction, as
determined under paragraphs
(a)(3)(ii)(B) and (C) of this section.
(e) Examples. The following examples
illustrate this section. For purposes of
these examples, unless otherwise
indicated, it is assumed that FP, a
corporation organized in country N,
owns all of the stock of FS, a
corporation organized in country T, and
DS, a corporation organized in the
United States. Country T, but not
country N, has an income tax treaty
with the United States. The treaty
exempts interest, rents and royalties
paid by a resident of one state (the
source state) to a resident of the other
state from tax in the source state.

41009

Example 1. Financing arrangement. (i) On
January 1, 1996, BK, a bank organized in
country T, lends $1,000,000 to DS in
exchange for a note issued by DS. FP
guarantees to BK that DS will satisfy its
repayment obligation on the loan. There are
no other transactions between FP and BK.
(ii) BK’s loan to DS is a financing
transaction within the meaning of paragraph
(a)(2)(ii)(A)(1) of this section. FP’s guarantee
of DS’s repayment obligation is not a
financing transaction as described in
paragraphs (a)(2)(ii)(A)(1) through (4) of this
section. Therefore, these transactions do not
constitute a financing arrangement as defined
in paragraph (a)(2)(i) of this section.
Example 2. Financing arrangement. (i) On
January 1, 1996, FP lends $1,000,000 to DS
in exchange for a note issued by DS. On
January 1, 1997, FP assigns the DS note to FS
in exchange for a note issued by FS. After
receiving notice of the assignment, DS remits
payments due under its note to FS.
(ii) The DS note held by FS and the FS note
held by FP are financing transactions within
the meaning of paragraph (a)(2)(ii)(A)(1) of
this section, and together constitute a
financing arrangement within the meaning of
paragraph (a)(2)(i) of this section.
Example 3. Financing arrangement. (i) On
December 1, 1994 FP creates a special
purposes subsidiary, FS. On that date FP
capitalizes FS with $1,000,000 in cash and
$10,000,000 in debt from BK, a Country N
bank. On January 1, 1995, C, a U.S. person,
purchases an automobile from DS in return
for an installment note. On August 1, 1995,
DS sells a number of installment notes,
including C’s, to FS in exchange for
$10,000,000. DS continues to service the
installment notes for FS.
(ii) The C installment note now held by FS
(as well as all of the other installment notes
now held by FS) and the FS note held by BK
are financing transactions within the
meaning of paragraph (a)(2)(ii)(A)(1) of this
section, and together constitute a financing
arrangement within the meaning of
paragraph (a)(2)(i) of this section.
Example 4. Related persons treated as a
single intermediate entity. (i) On January 1,
1996, FP deposits $1,000,000 with BK, a bank
that is organized in country N and is
unrelated to FP and its subsidiaries. M, a
corporation also organized in country N, is
wholly-owned by the sole shareholder of BK
but is not a bank within the meaning of
section 881(c)(3)(A). On July 1, 1996, M lends
$1,000,000 to DS in exchange for a note
maturing on July 1, 2006. The note is in
registered form within the meaning of section
881(c)(2)(B)(i) and DS has received from M
the statement required by section
881(c)(2)(B)(ii). One of the principal purposes
for the absence of a financing transaction
between BK and M is the avoidance of the
application of this section.
(ii) The transactions described above
would form a financing arrangement but for
the absence of a financing transaction
between BK and M. However, because one of
the principal purposes for the structuring of
these financing transactions is to prevent
characterization of such arrangement as a
financing arrangement, the district director
may treat the financing transactions between

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FP and BK, and between M and DS as a
financing arrangement under paragraphs
(a)(2)(i)(B) of this section. In such a case, BK
and M would be considered a single
intermediate entity for purposes of this
section. See also paragraph (a)(4)(ii)(B) of this
section for the authority to treat BK and M
as a single intermediate entity.
Example 5. Related persons treated as a
single intermediate entity. (i) On January 1,
1995, FP lends $10,000,000 to FS in
exchange for a 10-year note that pays interest
annually at a rate of 8 percent per annum. On
January 2, 1995, FS contributes $10,000,000
to FS2, a wholly-owned subsidiary of FS
organized in country T, in exchange for
common stock of FS2. On January 1, 1996,
FS2 lends $10,000,000 to DS in exchange for
an 8-year note that pays interest annually at
a rate of 10 percent per annum. FS is a
holding company whose most significant
asset is the stock of FS2. Throughout the
period that the FP–FS loan is outstanding, FS
causes FS2 to make distributions to FS, most
of which are used to make interest and
principal payments on the FP–FS loan.
Without the distributions from FS2, FS
would not have had the funds with which to
make payments on the FP–FS loan. One of
the principal purposes for the absence of a
financing transaction between FS and FS2 is
the avoidance of the application of this
section.
(ii) The conditions of paragraph (a)(4)(i)(A)
of this section would be satisfied with
respect to the financing transactions between
FP, FS, FS2 and DS but for the absence of
a financing transaction between FS and FS2.
However, because one of the principal
purposes for the structuring of these
financing transactions is to prevent
characterization of an entity as a conduit, the
district director may treat the financing
transactions between FP and FS, and
between FS2 and DS as a financing
arrangement. See paragraph (a)(4)(ii)(B) of
this section. In such a case, FS and FS2
would be considered a single intermediate
entity for purposes of this section. See also
paragraph (a)(2)(i)(B) of this section for the
authority to treat FS and FS2 as a single
intermediate entity.
Example 6. Presumption with respect to
unrelated financing entity. (i) FP is a
corporation organized in country T that is
actively engaged in a substantial
manufacturing business. FP has a revolving
credit facility with a syndicate of banks, none
of which is related to FP and FP’s
subsidiaries, which provides that FP may
borrow up to a maximum of $100,000,000 at
a time. The revolving credit facility provides
that DS and certain other subsidiaries of FP
may borrow directly from the syndicate at the
same interest rates as FP, but each subsidiary
is required to indemnify the syndicate banks
for any withholding taxes imposed on
interest payments by the country in which
the subsidiary is organized. BK, a bank that
is organized in country N, is the agent for the
syndicate. Some of the syndicate banks are
organized in country N, but others are
residents of country O, a country that has an
income tax treaty with the United States
which allows the United States to impose a
tax on interest at a maximum rate of 10

percent. It is reasonable for BK and the
syndicate banks to have determined that FP
will be able to meet its payment obligations
on a maximum principal amount of
$100,000,000 out of the cash flow of its
manufacturing business. At various times
throughout 1995, FP borrows under the
revolving credit facility until the outstanding
principal amount reaches the maximum
amount of $100,000,000. On December 31,
1995, FP receives $100,000,000 from a public
offering of its equity. On January 1, 1996, FP
pays BK $90,000,000 to reduce the
outstanding principal amount under the
revolving credit facility and lends
$10,000,000 to DS. FP would have repaid the
entire principal amount, and DS would have
borrowed directly from the syndicate, but for
the fact that DS did not want to incur the
U.S. withholding tax that would have
applied to payments made directly by DS to
the syndicate banks.
(ii) Pursuant to paragraph (a)(3)(ii)(E)(1) of
this section, even though the financing
arrangement is a conduit financing
arrangement (because the financing
arrangement meets the standards for
recharacterization in paragraph (a)(4)(i)), BK
and the other syndicate banks have no
section 881 liability unless they know or
have reason to know that the financing
arrangement is a conduit financing
arrangement. Moreover, pursuant to
paragraph (a)(3)(ii)(E)(2)(ii) of this section,
BK and the syndicate banks are presumed not
to know that the financing arrangement is a
conduit financing arrangement. The
syndicate banks are unrelated to both FP and
DS, and FP is actively engaged in a
substantial trade or business—that is, the
cash flow from FP’s manufacturing business
is sufficient for the banks to expect that FP
will be able to make the payments required
under the financing transaction. See
§ 1.1441–3(j) for the withholding obligations
of the withholding agents.
Example 7. Multiple intermediate
entities—special rule for related persons. (i)
On January 1, 1995, FP lends $10,000,000 to
FS in exchange for a 10-year note that pays
interest annually at a rate of 8 percent per
annum. On January 2, 1995, FS contributes
$9,900,000 to FS2, a wholly-owned
subsidiary of FS organized in country T, in
exchange for common stock and lends
$100,000 to FS2. On January 1, 1996, FS2
lends $10,000,000 to DS in exchange for an
8-year note that pays interest annually at a
rate of 10 percent per annum. FS is a holding
company that has no significant assets other
than the stock of FS2. Throughout the period
that the FP–FS loan is outstanding, FS causes
FS2 to make distributions to FS, most of
which are used to make interest and
principal payments on the FP–FS loan.
Without the distributions from FS2, FS
would not have had the funds with which to
make payments on the FP–FS loan. One of
the principal purposes for structuring the
transactions between FS and FS2 as
primarily a contribution of capital is to
reduce the amount of the payment that
would be recharacterized under paragraph
(d) of this section.
(ii) Pursuant to paragraph (a)(4)(ii)(B) of
this section, the district director may treat FS

and FS2 as a single intermediate entity for
purposes of this section since one of the
principal purposes for the participation of
multiple intermediate entities is to reduce
the amount of the tax liability on any
recharacterized payment by inserting a
financing transaction with a low principal
amount.
Example 8. Multiple intermediate entities.
(i) On January 1, 1995, FP deposits
$1,000,000 with BK, a bank that is organized
in country T and is unrelated to FP and its
subsidiaries, FS and DS. On January 1, 1996,
at a time when the FP–BK deposit is still
outstanding, BK lends $500,000 to BK2, a
bank that is wholly-owned by BK and is
organized in country T. On the same date,
BK2 lends $500,000 to FS. On July 1, 1996,
FS lends $500,000 to DS. FP pledges its
deposit with BK to BK2 in support of FS’
obligation to repay the BK2 loan. FS’, BK’s
and BK2’s participation in the financing
arrangement is pursuant to a tax avoidance
plan.
(ii) The conditions of paragraphs
(a)(4)(i)(A) and (B) of this section are satisfied
because the participation of BK, BK2 and FS
in the financing arrangement reduces the tax
imposed by section 881, and FS’, BK’s and
BK2’s participation in the financing
arrangement is pursuant to a tax avoidance
plan. However, since BK and BK2 are
unrelated to FP and DS, under paragraph
(a)(4)(i)(C)(2) of this section, BK and BK2 will
be treated as conduit entities only if BK and
BK2 would not have participated in the
financing arrangement on substantially the
same terms but for the financing transaction
between FP and BK.
(iii) It is presumed that BK2 would not
have participated in the financing
arrangement on substantially the same terms
but for the BK–BK2 financing transaction
because FP’s pledge of an asset in support of
FS’ obligation to repay the BK2 loan is a
guarantee within the meaning of paragraph
(c)(2)(ii) of this section. If the taxpayer does
not rebut this presumption by clear and
convincing evidence, then BK2 will be a
conduit entity.
(iv) Because BK and BK2 are related
intermediate entities, the district director
must determine whether one of the principal
purposes for the involvement of multiple
intermediate entities was to prevent
characterization of an entity as a conduit
entity. In making this determination, the
district director may consider the fact that
the involvement of two related intermediate
entities prevents the presumption regarding
guarantees from applying to BK. In the
absence of evidence showing a business
purpose for the involvement of both BK and
BK2, the district director may treat BK and
BK2 as a single intermediate entity for
purposes of determining whether they would
have participated in the financing
arrangement on substantially the same terms
but for the financing transaction between FP
and BK. The presumption that applies to BK2
therefore will apply to BK. If the taxpayer
does not rebut this presumption by clear and
convincing evidence, then BK will be a
conduit entity.
Example 9. Reduction of tax. (i) On
February 1, 1995, FP issues debt to the public

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
that would satisfy the requirements of section
871(h)(2)(A) (relating to obligations that are
not in registered form) if issued by a U.S.
person. FP lends the proceeds of the debt
offering to DS in exchange for a note.
(ii) The debt issued by FP and the DS note
are financing transactions within the
meaning of paragraph (a)(2)(ii)(A)(1) of this
section and together constitute a financing
arrangement within the meaning of
paragraph (a)(2)(i) of this section. The
holders of the FP debt are the financing
entities, FP is the intermediate entity and DS
is the financed entity. Because interest
payments on the debt issued by FP would not
have been subject to withholding tax if the
debt had been issued by DS, there is no
reduction in tax under paragraph (a)(4)(i)(A)
of this section. Accordingly, FP is not a
conduit entity.
Example 10. Reduction of tax. (i) On
January 1, 1995, FP licenses to FS the rights
to use a patent in the United States to
manufacture product A. FS agrees to pay FP
a fixed amount in royalties each year under
the license. On January 1, 1996, FS
sublicenses to DS the rights to use the patent
in the United States. Under the sublicense,
DS agrees to pay FS royalties based upon the
units of product A manufactured by DS each
year. Although the formula for computing the
amount of royalties paid by DS to FS differs
from the formula for computing the amount
of royalties paid by FS to FP, each represents
an arm’s length rate.
(ii) Although the royalties paid by DS to FS
are exempt from U.S. withholding tax, the
royalty payments between FS and FP are
income from U.S. sources under section
861(a)(4) subject to the 30 percent gross tax
imposed by § 1.881–2(b) and subject to
withholding under § 1.1441–2(a). Because the
rate of tax imposed on royalties paid by FS
to FP is the same as the rate that would have
been imposed on royalties paid by DS to FP,
the participation of FS in the FP–FS–DS
financing arrangement does not reduce the
tax imposed by section 881 within the
meaning of paragraph (a)(4)(i)(A) of this
section. Accordingly, FP is not a conduit
entity.
Example 11. A principal purpose. (i) On
January 1, 1995, FS lends $10,000,000 to DS
in exchange for a 10-year note that pays
interest annually at a rate of 8 percent per
annum. As was intended at the time of the
loan from FS to DS, on July 1, 1995, FP
makes an interest-free demand loan of
$10,000,000 to FS. A principal purpose for
FS’ participation in the FP–FS–DS financing
arrangement is that FS generally coordinates
the financing for all of FP’s subsidiaries
(although FS does not engage in significant
financing activities with respect to such
financing transactions). However, another
principal purpose for FS’ participation is to
allow the parties to benefit from the lower
withholding tax rate provided under the
income tax treaty between country T and the
United States.
(ii) The financing arrangement satisfies the
tax avoidance purpose requirement of
paragraph (a)(4)(i)(B) of this section because
FS participated in the financing arrangement
pursuant to a plan one of the principal
purposes of which is to allow the parties to
benefit from the country T-U.S. treaty.

Example 12. A principal purpose. (i) DX is
a U.S. corporation that intends to purchase
property to use in its manufacturing
business. FX is a partnership organized in
country N that is owned in equal parts by
LC1 and LC2, leasing companies that are
unrelated to DX. BK, a bank organized in
country N and unrelated to DX, LC1 and LC2,
lends $100,000,000 to FX to enable FX to
purchase the property. On the same day, FX
purchases the property and engages in a
transaction with DX which is treated as a
lease of the property for country N tax
purposes but a loan for U.S. tax purposes.
Accordingly, DX is treated as the owner of
the property for U.S. tax purposes. The
parties comply with the requirements of
section 881(c) with respect to the debt
obligation of DX to FX. FX and DX structured
these transactions in this manner so that LC1
and LC2 would be entitled to accelerated
depreciation deductions with respect to the
property in country N and DX would be
entitled to accelerated depreciation
deductions in the United States. None of the
parties would have participated in the
transaction if the payments made by DX were
subject to U.S. withholding tax.
(ii) The loan from BK to FX and from FX
to DX are financing transactions and, together
constitute a financing arrangement. The
participation of FX in the financing
arrangement reduces the tax imposed by
section 881 because payments made to FX,
but not BK, qualify for the portfolio interest
exemption of section 881(c) because BK is a
bank making an extension of credit in the
ordinary course of its trade or business
within the meaning of section 881(c)(3)(A).
Moreover, because DX borrowed the money
from FX instead of borrowing the money
directly from BK to avoid the tax imposed by
section 881, one of the principal purposes of
the participation of FX was to avoid that tax
(even though another principal purpose of
the participation of FX was to allow LC1 and
LC2 to take advantage of accelerated
depreciation deductions in country N).
Assuming that FX would not have
participated in the financing arrangement on
substantially the same terms but for the fact
that BK loaned it $100,000,000, FX is a
conduit entity and the financing arrangement
is a conduit financing arrangement.
Example 13. Significant reduction of tax.
(i) FS owns all of the stock of FS1, which also
is a resident of country T. FS1 owns all of
the stock of DS. On January 1, 1995, FP
contributes $10,000,000 to the capital of FS
in return for perpetual preferred stock. On
July 1, 1995, FS lends $10,000,000 to FS1. On
January 1, 1996, FS1 lends $10,000,000 to
DS. Under the terms of the country T-U.S.
income tax treaty, a country T resident is not
entitled to the reduced withholding rate on
interest income provided by the treaty if the
resident is entitled to specified tax benefits
under country T law. Although FS1 may
deduct interest paid on the loan from FS,
these deductions are not pursuant to any
special tax benefits provided by country T
law. However, FS qualifies for one of the
enumerated tax benefits pursuant to which it
may deduct dividends paid with respect to
the stock held by FP. Therefore, if FS had
made a loan directly to DS, FS would not

41011

have been entitled to the benefits of the
country T-U.S. tax treaty with respect to
payments it received from DS, and such
payments would have been subject to tax
under section 881 at a 30 percent rate.
(ii) The FS–FS1 loan and the FS1–DS loan
are financing transactions within the
meaning of paragraph (a)(2)(ii)(A)(1) of this
section and together constitute a financing
arrangement within the meaning of
paragraph (a)(2)(i) of this section. Pursuant to
paragraph (b)(2)(i) of this section, the
significant reduction in tax resulting from the
participation of FS1 in the financing
arrangement is evidence that the
participation of FS1 in the financing
arrangement is pursuant to a tax avoidance
plan. However, other facts relevant to the
presence of such a plan must also be taken
into account.
Example 14. Significant reduction of tax.
(i) FP owns 90 percent of the voting stock of
FX, an unlimited liability company organized
in country T. The other 10 percent of the
common stock of FX is owned by FP1, a
subsidiary of FP that is organized in country
N. Although FX is a partnership for U.S. tax
purposes, FX is entitled to the benefits of the
U.S.-country T income tax treaty because FX
is subject to tax in country T as a resident
corporation. On January 1, 1996, FP
contributes $10,000,000 to FX in exchange
for an instrument denominated as preferred
stock that pays a dividend of 7 percent and
that must be redeemed by FX in seven years.
For U.S. tax purposes, the preferred stock is
a partnership interest. On July 1, 1996, FX
makes a loan of $10,000,000 to DS in
exchange for a 7-year note paying interest at
6 percent.
(ii) Because FX is required to redeem the
partnership interest at a specified time, the
partnership interest constitutes a financing
transaction within the meaning of paragraph
(a)(2)(ii)(A)(2) of this section. Moreover,
because the FX-DS note is a financing
transaction within the meaning of paragraph
(a)(2)(ii)(A)(1) of this section, together the
transactions constitute a financing
arrangement within the meaning of (a)(2)(i) of
this section. Payments of interest made
directly by DS to FP and FP1 would not be
eligible for the portfolio interest exemption
and would not be entitled to a reduction in
withholding tax pursuant to a tax treaty.
Therefore, there is a significant reduction in
tax resulting from the participation of FX in
the financing arrangement, which is evidence
that the participation of FX in the financing
arrangement is pursuant to a tax avoidance
plan. However, other facts relevant to the
existence of such a plan must also be taken
into account.
Example 15. Significant reduction of tax.
(i) FP owns a 10 percent interest in the
profits and capital of FX, a partnership
organized in country N. The other 90 percent
interest in FX is owned by G, an unrelated
corporation that is organized in country T.
FX is not engaged in business in the United
States. On January 1, 1996, FP contributes
$10,000,000 to FX in exchange for an
instrument documented as perpetual
subordinated debt that provides for quarterly
interest payments at 9 percent per annum.
Under the terms of the instrument, payments

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on the perpetual subordinated debt do not
otherwise affect the allocation of income
between the partners. FP has the right to
require the liquidation of FX if FX fails to
make an interest payment. For U.S. tax
purposes, the perpetual subordinated debt is
treated as a partnership interest in FX and
the payments on the perpetual subordinated
debt constitute guaranteed payments within
the meaning of section 707(c). On July 1,
1996, FX makes a loan of $10,000,000 to DS
in exchange for a 7-year note paying interest
at 8 percent per annum.
(ii) Because FP has the effective right to
force payment of the ‘‘interest’’ on the
perpetual subordinated debt, the instrument
constitutes a financing transaction within the
meaning of paragraph (a)(2)(ii)(A)(2) of this
section. Moreover, because the note between
FX and DS is a financing transaction within
the meaning of paragraph (a)(2)(ii)(A)(1) of
this section, together the transactions are a
financing arrangement within the meaning of
(a)(2)(i) of this section. Without regard to this
section, 90 percent of each interest payment
received by FX would be treated as exempt
from U.S. withholding tax because it is
beneficially owned by G, while 10 percent
would be subject to a 30 percent withholding
tax because beneficially owned by FP. If FP
held directly the note issued by DS, 100
percent of the interest payments on the note
would have been subject to the 30 percent
withholding tax. The significant reduction in
the tax imposed by section 881 resulting from
the participation of FX in the financing
arrangement is evidence that the
participation of FX in the financing
arrangement is pursuant to a tax avoidance
plan. However, other facts relevant to the
presence of such a plan must also be taken
into account.
Example 16. Time period between
transactions. (i) On January 1, 1995, FP lends
$10,000,000 to FS in exchange for a 10-year
note that pays no interest annually. When the
note matures, FS is obligated to pay
$24,000,000 to FP. On January 1, 1996, FS
lends $10,000,000 to DS in exchange for a 10year note that pays interest annually at a rate
of 10 percent per annum.
(ii) The FS note held by FP and the DS note
held by FS are financing transactions within
the meaning of paragraph (a)(2)(ii)(A)(1) of
this section and together constitute a
financing arrangement within the meaning of
(a)(2)(i) of this section. Pursuant to paragraph
(b)(2)(iii) of this section, the short period of
time (twelve months) between the loan by FP
to FS and the loan by FS to DS is evidence
that the participation of FS in the financing
arrangement is pursuant to a tax avoidance
plan. However, other facts relevant to the
presence of such a plan must also be taken
into account.
Example 17. Financing transactions in the
ordinary course of business. (i) FP is a
holding company. FS is actively engaged in
country T in the business of manufacturing
and selling product A. DS manufactures
product B, a principal component in which
is product A. FS’ business activity is
substantial. On January 1, 1995, FP lends
$100,000,000 to FS to finance FS’ business
operations. On January 1, 1996, FS ships
$30,000,000 of product A to DS. In return, FS

creates an interest-bearing account receivable
on its books. FS’ shipment is in the ordinary
course of the active conduct of its trade or
business (which is complementary to DS’
trade or business.)
(ii) The loan from FP to FS and the
accounts receivable opened by FS for a
payment owed by DS are financing
transactions within the meaning of paragraph
(a)(2)(ii)(A)(1) of this section and together
constitute a financing arrangement within the
meaning of paragraph (a)(2)(i) of this section.
Pursuant to paragraph (b)(2)(iv) of this
section, the fact that DS’ liability to FS is
created in the ordinary course of the active
conduct of DS’ trade or business that is
complementary to a business actively
engaged in by DS is evidence that the
participation of FS in the financing
arrangement is not pursuant to a tax
avoidance plan. However, other facts relevant
to the presence of such a plan must also be
taken into account.
Example 18. Tax avoidance plan—other
factors. (i) On February 1, 1995, FP issues
debt in Country N that is in registered form
within the meaning of section 881(c)(3)(A).
The FP debt would satisfy the requirements
of section 881(c) if the debt were issued by
a U.S. person and the withholding agent
received the certification required by section
871(h)(2)(B)(ii). The purchasers of the debt
are financial institutions and there is no
reason to believe that they would not furnish
Forms W–8. On March 1, 1995, FP lends a
portion of the proceeds of the offering to DS.
(ii) The FP debt and the loan to DS are
financing transactions within the meaning of
paragraph (a)(2)(ii)(A)(1) of this section and
together constitute a financing arrangement
within the meaning of paragraph (a)(2)(i) of
this section. The owners of the FP debt are
the financing entities, FP is the intermediate
entity and DS is the financed entity. Interest
payments on the debt issued by FP would be
subject to withholding tax if the debt were
issued by DS, unless DS received all
necessary Forms W–8. Therefore, the
participation of FP in the financing
arrangement potentially reduces the tax
imposed by section 881(a). However, because
it is reasonable to assume that the purchasers
of the FP debt would have provided
certifications in order to avoid the
withholding tax imposed by section 881,
there is not a tax avoidance plan.
Accordingly, FP is not a conduit entity.
Example 19. Tax avoidance plan—other
factors. (i) Over a period of years, FP has
maintained a deposit with BK, a bank
organized in the United States, that is
unrelated to FP and its subsidiaries. FP often
sells goods and purchases raw materials in
the United States. FP opened the bank
account with BK in order to facilitate this
business and the amounts it maintains in the
account are reasonably related to its dollardenominated working capital needs. On
January 1, 1995, BK lends $5,000,000 to DS.
After the loan is made, the balance in FP’s
bank account remains within a range
appropriate to meet FP’s working capital
needs.
(ii) FP’s deposit with BK and BK’s loan to
DS are financing transactions within the
meaning of paragraph (a)(2)(ii)(A)(1) of this

section and together constitute a financing
arrangement within the meaning of
paragraph (a)(2)(i) of this section. Pursuant to
section 881(i), interest paid by BK to FP with
respect to the bank deposit is exempt from
withholding tax. Interest paid directly by DS
to FP would not be exempt from withholding
tax under section 881(i) and therefore would
be subject to a 30% withholding tax.
Accordingly, there is a significant reduction
in the tax imposed by section 881, which is
evidence of the existence of a tax avoidance
plan. See paragraph (b)(2)(i) of this section.
However, the district director also will
consider the fact that FP historically has
maintained an account with BK to meet its
working capital needs and that, prior to and
after BK’s loan to DS, the balance within the
account remains within a range appropriate
to meet those business needs as evidence that
the participation of BK in the FP–BK–DS
financing arrangement is not pursuant to a
tax avoidance plan. In determining the
presence or absence of a tax avoidance plan,
all relevant facts will be taken into account.
Example 20. Tax avoidance plan—other
factors. (i) Assume the same facts as in
Example 19, except that on January 1, 2000,
FP’s deposit with BK substantially exceeds
FP’s expected working capital needs and on
January 2, 2000, BK lends additional funds
to DS. Assume also that BK’s loan to DS
provides BK with a right of offset against FP’s
deposit. Finally, assume that FP would have
lent the funds to DS directly but for the
imposition of the withholding tax on
payments made directly to FP by DS.
(ii) As in Example 19, the transactions in
paragraph (i) of this Example 20 are a
financing arrangement within the meaning of
paragraph (a)(2)(i) and the participation of
the BK reduces the section 881 tax. In this
case, the presence of funds substantially in
excess of FP’s working capital needs and the
fact that FP would have been willing to lend
funds directly to DS if not for the
withholding tax are evidence that the
participation of BK in the FP-BK-FS
financing arrangement is pursuant to a tax
avoidance plan. However, other facts relevant
to the presence of such a plan must also be
taken into account. Even if the district
director determines that the participation of
BK in the financing arrangement is pursuant
to a tax avoidance plan, BK may not be
treated as a conduit entity unless BK would
not have participated in the financing
arrangement on substantially the same terms
in the absence of FP’s deposit with BK. BK’s
right of offset against FP’s deposit (a form of
guarantee of BK’s loan to DS) creates a
presumption that BK would not have made
the loan to DS on substantially the same
terms in the absence of FP’s deposit with BK.
If the taxpayer overcomes the presumption
by clear and convincing evidence, BK will
not be a conduit entity.
Example 21. Significant financing
activities. (i) FS is responsible for
coordinating the financing of all of the
subsidiaries of FP, which are engaged in
substantial trades or businesses and are
located in country T, country N, and the
United States. FS maintains a centralized
cash management accounting system for FP
and its subsidiaries in which it records all

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
intercompany payables and receivables; these
payables and receivables ultimately are
reduced to a single balance either due from
or owing to FS and each of FP’s subsidiaries.
FS is responsible for disbursing or receiving
any cash payments required by transactions
between its affiliates and unrelated parties.
FS must borrow any cash necessary to meet
those external obligations and invests any
excess cash for the benefit of the FP group.
FS enters into interest rate and foreign
exchange contracts as necessary to manage
the risks arising from mismatches in
incoming and outgoing cash flows. The
activities of FS are intended (and reasonably
can be expected) to reduce transaction costs
and overhead and other fixed costs. FS has
50 employees, including clerical and other
back office personnel, located in country T.
At the request of DS, on January 1, 1995, FS
pays a supplier $1,000,000 for materials
delivered to DS and charges DS an open
account receivable for this amount. On
February 3, 1995, FS reverses the account
receivable from DS to FS when DS delivers
to FP goods with a value of $1,000,000.
(ii) The accounts payable from DS to FS
and from FS to other subsidiaries of FP
constitute financing transactions within the
meaning of paragraph (a)(2)(ii)(A)(1) of this
section, and the transactions together
constitute a financing arrangement within the
meaning of paragraph (a)(2)(i) of this section.
FS’s activities constitute significant financing
activities with respect to the financing
transactions even though FS did not actively
and materially participate in arranging the
financing transactions because the financing
transactions consisted of trade receivables
and trade payables that were ordinary and
necessary to carry on the trades or businesses
of DS and the other subsidiaries of FP.
Accordingly, pursuant to paragraph (b)(3)(i)
of this section, FS’ participation in the
financing arrangement is presumed not to be
pursuant to a tax avoidance plan.
Example 22. Significant financing
activities—active risk management. (i) The
facts are the same as in Example 21, except
that, in addition to its short-term funding
needs, DS needs long-term financing to fund
an acquisition of another U.S. company; the
acquisition is scheduled to close on January
15, 1995. FS has a revolving credit agreement
with a syndicate of banks located in Country
N. On January 14, 1995, FS borrows ¥10
billion for 10 years under the revolving credit
agreement, paying yen LIBOR plus 50 basis
points on a quarterly basis. FS enters into a
currency swap with BK, an unrelated bank
that is not a member of the syndicate, under
which FS will pay BK ¥10 billion and will
receive $100 million on January 15, 1995;
these payments will be reversed on January
15, 2004. FS will pay BK U.S. dollar LIBOR
plus 50 basis points on a notional principal
amount of $100 million semi-annually and
will receive yen LIBOR plus 50 basis points
on a notional principal amount of ¥10 billion
quarterly. Upon the closing of the acquisition
on January 15, 1995, DS borrows $100
million from FS for 10 years, paying U.S.
dollar LIBOR plus 50 basis points
semiannually.
(ii) Although FS performs significant
financing activities with respect to certain

financing transactions to which it is a party,
FS does not perform significant financing
activities with respect to the financing
transactions between FS and the syndicate of
banks and between FS and DS because FS
has eliminated all material market risks
arising from those financing transactions
through its currency swap with BK.
Accordingly, the financing arrangement does
not benefit from the presumption of
paragraph (b)(3)(i) of this section and the
district director must determine whether the
participation of FS in the financing
arrangement is pursuant to a tax avoidance
plan on the basis of all the facts and
circumstances. However, if additional facts
indicated that FS reviews its currency swaps
daily to determine whether they are the most
cost efficient way of managing their currency
risk and, as a result, frequently terminates
swaps in favor of entering into more cost
efficient hedging arrangements with
unrelated parties, FS would be considered to
perform significant financing activities and
FS’ participation in the financing
arrangements would not be pursuant to a tax
avoidance plan.
Example 23. Significant financing
activities—presumption rebutted. (i) The
facts are the same as in Example 21, except
that, on January 1, 1995, FP lends to FS DM
15,000,000 (worth $10,000,000) in exchange
for a 10 year note that pays interest annually
at a rate of 5 percent per annum. Also, on
March 15, 1995, FS lends $10,000,000 to DS
in exchange for a 10-year note that pays
interest annually at a rate of 8 percent per
annum. FS would not have had sufficient
funds to make the loan to DS without the
loan from FP. FS does not enter into any
long-term hedging transaction with respect to
these financing transactions, but manages the
interest rate and currency risk arising from
the transactions on a daily, weekly or
quarterly basis by entering into forward
currency contracts.
(ii) Because FS performs significant
financing activities with respect to the
financing transactions between FS, DS and
FP, the participation of FS in the financing
arrangement is presumed not to be pursuant
to a tax avoidance plan. The district director
may rebut this presumption by establishing
that the participation of FS is pursuant to a
tax avoidance plan, based on all the facts and
circumstances. The mere fact that FS is a
resident of country T is not sufficient to
establish the existence of a tax avoidance
plan. However, the existence of a plan can be
inferred from other factors in addition to the
fact that FS is a resident of country T. For
example, the loans are made within a short
time period and FS would not have been able
to make the loan to DS without the loan from
FP.
Example 24. Determination of amount of
tax liability. (i) On January 1, 1996, FP makes
two three-year installment loans of $250,000
each to FS that pay interest at a rate of 9
percent per annum. The loans are selfamortizing with payments on each loan of
$7,950 per month. On the same date, FS
lends $1,000,000 to DS in exchange for a twoyear note that pays interest semi-annually at
a rate of 10 percent per annum, beginning on
June 30, 1996. The FS-DS loan is not self-

41013

amortizing. Assume that for the period of
January 1, 1996 through June 30, 1996, the
average principal amount of the financing
transactions between FP and FS that
comprise the financing arrangement is
$469,319. Further, assume that for the period
of July 1, 1996 through December 31, 1996,
the average principal amount of the financing
transactions between FP and FS is $393,632.
The average principal amount of the
financing transaction between FS and DS for
the same periods is $1,000,000. The district
director determines that the financing
transactions between FP and FS, and FS and
DS, are a conduit financing arrangement.
(ii) Pursuant to paragraph (d)(1)(i) of this
section, the portion of the $50,000 interest
payment made by DS to FS on June 30, 1996,
that is recharacterized as a payment to FP is
$23,450 computed as follows: ($50,000 x
$469,319/$1,000,000) = $23,450. The portion
of the interest payment made on December
31, 1996 that is recharacterized as a payment
to FP is $19,650, computed as follows:
($50,000 x $393,632/$1,000,000) = $19,650.
Furthermore, under § 1.1441–3(j), DS is liable
for withholding tax at a 30 percent rate on
the portion of the $50,000 payment to FS that
is recharacterized as a payment to FP, i.e.,
$7,035 with respect to the June 30, 1996
payment and $5,895 with respect to the
December 31, 1996 payment.
Example 25. Determination of principal
amount. (i) FP lends DM 10,000,000 to FS in
exchange for a ten year note that pays interest
semi-annually at a rate of 8 percent per
annum. Six months later, pursuant to a tax
avoidance plan, FS lends DM 5,000,000 to DS
in exchange for a 10 year note that pays
interest semi-annually at a rate of 10 percent
per annum. At the time FP make its loan to
FS, the exchange rate is DM 1.5/$1. At the
time FS makes its loan to DS the exchange
rate is DM 1.4/$1.
(ii) FP’s loan to FS and FS’ loan to DS are
financing transactions and together constitute
a financing arrangement. Furthermore,
because the participation of FS reduces the
tax imposed under section 881 and FS’
participation is pursuant to a tax avoidance
plan, the financing arrangement is a conduit
financing arrangement.
(iii) Pursuant to paragraph (d)(1)(i) of this
section, the amount subject to
recharacterization is a fraction the numerator
of which is the average principal amount
advanced from FS to DS and the denominator
of which is the average principal amount
advanced from FP to FS. Because the
property advanced in these financing
transactions is the same type of fungible
property, under paragraph (d)(1)(ii)(A) of this
section, both are valued on the date of the
last financing transaction. Accordingly, the
portion of the payments of interest that is
recharacterized is ((DM 5,000,000×DM 1.4/
$1)/(DM 10,000,000×DM 1.4/$1) or 0.5.

(f) Effective date. This section is
effective for payments made by financed
entities on or after September 11, 1995.
This section shall not apply to interest
payments covered by section 127(g)(3)
of the Tax Reform Act of 1984, and to
interest payments with respect to other
debt obligations issued prior to October

41014

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

15, 1984 (whether or not such debt was
issued by a Netherlands Antilles
corporation).
§ 1.881–4 Recordkeeping requirements
concerning conduit financing
arrangements.

(a) Scope. This section provides rules
for the maintenance of records
concerning certain financing
arrangements to which the provisions of
§ 1.881–3 apply.
(b) Recordkeeping requirements—(1)
In general. Any person subject to the
general recordkeeping requirements of
section 6001 must keep the permanent
books of account or records, as required
by section 6001, that may be relevant to
determining whether that person is a
party to a financing arrangement and
whether that financing arrangement is a
conduit financing arrangement.
(2) Application of Sections 6038 and
6038A. A financed entity that is a
reporting corporation within the
meaning of section 6038A(a) and the
regulations under that section, and any
other person that is subject to the
recordkeeping requirements of
§ 1.6038A–3, must comply with those
recordkeeping requirements with
respect to records that may be relevant
to determining whether the financed
entity is a party to a financing
arrangement and whether that financing
arrangement is a conduit financing
arrangement. Such records, including
records that a person is required to
maintain pursuant to paragraph (c) of
this section, shall be considered records
that are required to be maintained
pursuant to section 6038 or 6038A.
Accordingly, the provisions of sections
6038 and 6038A (including, without
limitation, the penalty provisions
thereof), and the regulations under those
sections, shall apply to any records
required to be maintained pursuant to
this section.
(c) Records to be maintained—(1) In
general. An entity described in
paragraph (b) of this section shall be
required to retain any records
containing the following information
concerning each financing transaction
that the entity knows or has reason to
know comprises the financing
arrangement—
(i) The nature (e.g., loan, stock, lease,
license) of each financing transaction;
(ii) The name, address, taxpayer
identification number (if any) and
country of residence of—
(A) Each person that advanced money
or other property, or granted rights to
use property;
(B) Each person that was the recipient
of the advance or rights; and

(C) Each person to whom a payment
was made pursuant to the financing
transaction (to the extent that person is
a different person than the person who
made the advance or granted the rights);
(iii) The date and amount of—
(A) Each advance of money or other
property or grant of rights; and
(B) Each payment made in return for
the advance or grant of rights;
(iv) The terms of any guarantee
provided in conjunction with a
financing transaction, including the
name of the guarantor; and
(v) In cases where one or both of the
parties to a financing transaction are
related to each other or another entity in
the financing arrangement, the manner
in which these persons are related.
(2) Additional documents. An entity
described in paragraph (b) of this
section must also retain all records
relating to the circumstances
surrounding its participation in the
financing transactions and financing
arrangements. Such documents may
include, but are not limited to—
(i) Minutes of board of directors
meetings;
(ii) Board resolutions or other
authorizations for the financing
transactions;
(iii) Private letter rulings;
(iv) Financial reports (audited or
unaudited);
(v) Notes to financial statements;
(vi) Bank statements;
(vii) Copies of wire transfers;
(viii) Offering documents;
(ix) Materials from investment
advisors, bankers and tax advisors; and
(x) Evidences of indebtedness.
(3) Effect of record maintenance
requirement. Record maintenance in
accordance with paragraph (b) of this
section generally does not require the
original creation of records that are
ordinarily not created by affected
entities. If, however, a document that is
actually created is described in this
paragraph (c), it is to be retained even
if the document is not of a type
ordinarily created by the affected entity.
(d) Effective date. This section is
effective September 11, 1995. This
section shall not apply to interest
payments covered by section 127(g)(3)
of the Tax Reform Act of 1984, and to
interest payments with respect to other
debt obligations issued prior to October
15, 1984 (whether or not such debt was
issued by a Netherlands Antilles
corporation).
Par. 4. In § 1.1441–3, the OMB
parenthetical at the end of the section is
removed and paragraph (j) is added to
read as follows:

§ 1.1441–3 Exceptions and rules of special
application.

*

*
*
*
*
(j) Conduit financing arrangements—
(1) Duty to withhold. A financed entity
or other person required to withhold tax
under section 1441 with respect to a
financing arrangement that is a conduit
financing arrangement within the
meaning of § 1.881–3(a)(2)(iv) shall be
required to withhold under section 1441
as if the district director had
determined, pursuant to § 1.881–3(a)(3),
that all conduit entities that are parties
to the conduit financing arrangement
should be disregarded. The amount of
tax required to be withheld shall be
determined under § 1.881–3(d). The
withholding agent may withhold tax at
a reduced rate if the financing entity
establishes that it is entitled to the
benefit of a treaty that provides a
reduced rate of tax on a payment of the
type deemed to have been paid to the
financing entity. Section 1.881–
3(a)(3)(ii)(E) shall not apply for
purposes of determining whether any
person is required to deduct and
withhold tax pursuant to this paragraph
(j), or whether any party to a financing
arrangement is liable for failure to
withhold or entitled to a refund of tax
under sections 1441 or 1461 to 1464
(except to the extent the amount
withheld exceeds the tax liability
determined under § 1.881–3(d)). See
§ 1.1441–7(d) relating to withholding
tax liability of the withholding agent in
conduit financing arrangements subject
to § 1.881–3.
(2) Effective date. This paragraph (j) is
effective for payments made by financed
entities on or after September 11, 1995.
This paragraph shall not apply to
interest payments covered by section
127(g)(3) of the Tax Reform Act of 1984,
and to interest payments with respect to
other debt obligations issued prior to
October 15, 1984 (whether or not such
debt was issued by a Netherlands
Antilles corporation).
Par. 5. In § 1.1441–7, the OMB
parenthetical at the end of the section is
removed and paragraph (d) is added to
read as follows:

§ 1.1441–7 General provisions relating to
withholding agents.

*

*
*
*
*
(d) Conduit financing arrangements—
(1) Liability of withholding agent.
Subject to paragraph (d)(2) of this
section, any person that is required to
deduct and withhold tax under
§ 1.1441–3(j) is made liable for that tax
by section 1461. A person that is
required to deduct and withhold tax but
fails to do so is liable for the payment

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations
of the tax and any applicable penalties
and interest.
(2) Exception for withholding agents
that do not know of conduit financing
arrangement—(i) In general. A
withholding agent will not be liable
under paragraph (d)(1) of this section for
failing to deduct and withhold with
respect to a conduit financing
arrangement unless the person knows or
has reason to know that the financing
arrangement is a conduit financing
arrangement. This standard shall be
satisfied if the withholding agent knows
or has reason to know of facts sufficient
to establish that the financing
arrangement is a conduit financing
arrangement, including facts sufficient
to establish that the participation of the
intermediate entity in the financing
arrangement is pursuant to a tax
avoidance plan. A withholding agent
that knows only of the financing
transactions that comprise the financing
arrangement will not be considered to
know or have reason to know of facts
sufficient to establish that the financing
arrangement is a conduit financing
arrangement.
(ii) Examples. The following
examples illustrate the operation of
paragraph (d)(2) of this section.
Example 1. (i) DS is a U.S. subsidiary of
FP, a corporation organized in Country N, a
country that does not have an income tax
treaty with the United States. FS is a special
purpose subsidiary of FP that is incorporated
in Country T, a country that has an income
tax treaty with the United States that
prohibits the imposition of withholding tax
on payments of interest. FS is capitalized
with $10,000,000 in debt from BK, a Country
N bank, and $1,000,000 in capital from FS.
(ii) On May 1, 1995, C, a U.S. person,
purchases an automobile from DS in return
for an installment note. On July 1, 1995, DS
sells a number of installment notes,
including C’s, to FS in exchange for
$10,000,000. DS continues to service the
installment notes for FS and C is not notified
of the sale of its obligation and continues to
make payments to DS. But for the
withholding tax on payments of interest by
DS to BK, DS would have borrowed directly
from BK, pledging the installment notes as
collateral.
(iii) The C installment note is a financing
transaction, whether held by DS or by FS,
and the FS note held by BK also is a
financing transaction. After FS purchases the
installment note, and during the time the
installment note is held by FS, the
transactions constitute a financing
arrangement, within the meaning of § 1.881–
3(a)(2)(i). BK is the financing entity, FS is the
intermediate entity, and C is the financed
entity. Because the participation of FS in the
financing arrangement reduces the tax
imposed by section 881 and because there
was a tax avoidance plan, FS is a conduit
entity.
(iv) Because C does not know or have
reason to know of the tax avoidance plan

(and by extension that the financing
arrangement is a conduit financing
arrangement), C is not required to withhold
tax under section 1441. However, DS, who
knows that FS’s participation in the
financing arrangement is pursuant to a tax
avoidance plan and is a withholding agent
for purposes of section 1441, is not relieved
of its withholding responsibilities.
Example 2. Assume the same facts as in
Example, 1 except that C receives a new
payment booklet on which DS is described as
‘‘agent’’. Although C may deduce that its
installment note has been sold, without more
C has no reason to know of the existence of
a financing arrangement. Accordingly, C is
not liable for failure to withhold, although
DS still is not relieved of its withholding
responsibilities.
Example 3. (i) DC is a U.S. corporation that
is in the process of negotiating a loan of
$10,000,000 from BK1, a bank located in
Country N, a country that does not have an
income tax treaty with the United States.
Before the loan agreement is signed, DC’s tax
lawyers point out that interest on the loan
would not be subject to withholding tax if the
loan were made by BK2, a subsidiary of BK1
that is incorporated in Country T, a country
that has an income tax treaty with the United
States that prohibits the imposition of
withholding tax on payments of interest. BK1
makes a loan to BK2 to enable BK2 to make
the loan to DC. Without the loan from BK1
to BK2, BK2 would not have been able to
make the loan to DC.
(ii) The loan from BK1 to BK2 and the loan
from BK2 to DC are both financing
transactions and together constitute a
financing arrangement within the meaning of
§ 1.881–3(a)(2)(i). BK1 is the financing entity,
BK2 is the intermediate entity, and DC is the
financed entity. Because the participation of
BK2 in the financing arrangement reduces
the tax imposed by section 881 and because
there is a tax avoidance plan, BK2 is a
conduit entity.
(iii) Because DC is a party to the tax
avoidance plan (and accordingly knows of its
existence), DC must withhold tax under
section 1441. If DC does not withhold tax on
its payment of interest, BK2, a party to the
plan and a withholding agent for purposes of
section 1441, must withhold tax as required
by section 1441.
Example 4. (i) DC is a U.S. corporation that
has a long-standing banking relationship
with BK2, a U.S. subsidiary of BK1, a bank
incorporated in Country N, a country that
does not have an income tax treaty with the
United States. DC has borrowed amounts of
as much as $75,000,000 from BK2 in the past.
On January 1, 1995, DC asks to borrow
$50,000,000 from BK2. BK2 does not have
the funds available to make a loan of that
size. BK2 considers BK1 to enter into a loan
with DC but rejects this possibility because
of the additional withholding tax that would
be incurred. Accordingly, BK2 borrows the
necessary amount from BK1 with the
intention of on-lending to DC. BK1 does not
make the loan directly to DC because of the
withholding tax that would apply to
payments of interest from DC to BK1. DC
does not negotiate with BK1 and has no
reason to know that BK1 was the source of
the loan.

41015

(ii) The loan from BK2 to DC and the loan
from BK1 to BK2 are both financing
transactions and together constitute a
financing arrangement within the meaning of
§ 1.881–3(a)(2)(i). BK1 is the financing entity,
BK2 is the intermediate entity, and DC is the
financed entity. The participation of BK2 in
the financing arrangement reduces the tax
imposed by section 881. Because the
participation of BK2 in the financing
arrangement reduces the tax imposed by
section 881 and because there was a tax
avoidance plan, BK2 is a conduit entity.
(iii) Because DC does not know or have
reason to know of the tax avoidance plan
(and by extension that the financing
arrangement is a conduit financing
arrangement), DC is not required to withhold
tax under section 1441. However, BK2, who
is also a withholding agent under section
1441 and who knows that the financing
arrangement is a conduit financing
arrangement, is not relieved of its
withholding responsibilities.

(3) Effective date. This paragraph (d)
is effective for payments made by
financed entities on or after September
11, 1995. This paragraph shall not apply
to interest payments covered by section
127(g)(3) of the Tax Reform Act of 1984,
and to interest payments with respect to
other debt obligations issued prior to
October 15, 1984 (whether or not such
debt was issued by a Netherlands
Antilles corporation).
Par. 6. In § 1.6038A–3, paragraphs
(b)(5) and (c)(2)(vii) are added to read as
follows:
§ 1.6038A–3

Record maintenance.

*

*
*
*
*
(b) * * *
(5) Records relating to conduit
financing arrangements. See § 1.881–4
relating to conduit financing
arrangements.
(c) * * *
(2) * * *
(vii) Records relating to conduit
financing arrangements. See § 1.881–4
relating to conduit financing
arrangements.
*
*
*
*
*
Par. 7. Section 1.7701(l)–1 is added to
read as follows:
§ 1.7701(l)–1 Conduit financing
arrangements.

(a) Scope. Section 7701(l) authorizes
the issuance of regulations that
recharacterize any multiple-party
financing transaction as a transaction
directly among any two or more of such
parties where the Secretary determines
that such recharacterization is
appropriate to prevent avoidance of any
tax imposed by title 26 of the United
States Code.
(b) Regulations issued under authority
of section 7701(l). The following
regulations are issued under the
authority of section 7701(l)—

41016

Federal Register / Vol. 60, No. 155 / Friday, August 11, 1995 / Rules and Regulations

the delinquent debtor. These regulations
are necessary for the Department’s
participation in the IRS offset program.
The IRS offset program has proven to be
a cost-effective mechanism for
collection of delinquent debt.
EFFECTIVE DATE: These regulations are
effective September 11, 1995.
PART 602—OMB CONTROL NUMBERS
FOR FURTHER INFORMATION CONTACT:
UNDER THE PAPERWORK
Robert Barnhard, Division of Planning
REDUCTION ACT
and Internal Control, Office of Financial
Integrity, Office of the Chief Financial
Par. 8. The authority citation for part
Officer, Department of Labor, Room S–
602 continues to read as follows:
4502, 200 Constitution Avenue, NW.,
Authority: 26 U.S.C. 7805.
Washington, DC 20210, telephone
Par. 9. In § 602.101, paragraph (c) is
number 202/219–8184.
amended by adding an entry in
SUPPLEMENTARY INFORMATION: In 1992
numerical order and revising an entry to the Congress passed and the President
the table to read as follows:
signed into law the Cash Management
Improvement Act Amendments of 1992,
§ 602.101 OMB Control numbers.
which requires Federal agencies to
*
*
*
*
*
participate in the IRS income tax refund
(c) * * *
offset program. On September 15, 1994
the Department of Labor published in
Current
CFR part or section where
the Federal Register an interim rule
OMB
conidentified and described
trol No.
with request for comments
implementing the IRS income tax
refund offset program. The interim rule
*
*
*
*
*
established a new Subpart E which
1.881–4 .....................................
1545–1440
specifies the procedures the Department
of Labor will follow with regard to
*
*
*
*
*
§ 1.6038A–3 ..............................
1545–1191 referral by its constituent offices,
1545–1440 administrations and bureaus of past-due
legally enforceable debts to IRS for
*
*
*
*
*
collection by income tax refund offset.
The interim rule also established a
Margaret Milner Richardson,
new title for 29 CFR part 20: Federal
Commissioner of Internal Revenue.
Claims Collection. In addition to the
new subpart E, part 20 contains the
Approved: July 26, 1995.
Department’s regulations implementing
Leslie Samuels,
the Debt Collection Act of 1982 (DCA).
Assistant Secretary of the Treasury.
Subpart A implements the credit
[FR Doc. 95–19446 Filed 8–10–95; 8:45 am]
reporting provisions of the DCA;
BILLING CODE 4830–01–U
Subpart B, adminstrative offset; Subpart
C, assessment of interest, penalties and
administrative costs; and Subpart D,
DEPARTMENT OF LABOR
salary offset.
No comments were received in
Office of the Secretary
response to the notice of interim
rulemaking with request for comments.
29 CFR Part 20
Comments were to be submitted on or
before November 14, 1994. However,
Federal Claims Collection; Collection
two changes are made with the adoption
of Debts by Federal Income Tax
of the interim rule as final due to
Refund Offset
changes in IRS requirements for
AGENCY: Office of the Secretary, Labor.
participation in the offset program. In
§ 20.105 the specified minimum
ACTION: Final rule; interim rule adopted
amounts for individual debts and
as final with changes.
business debts otherwise eligible for
SUMMARY: The Department of Labor is
referral have been deleted. Section
completing its rulemaking to implement 10.106(b) is amended to delete reference
the requirement of the Cash
to the requirement that business debts
Management Improvement Act
be referred to a commercial credit
Amendments of 1992 that Federal
reporting agency.
agencies refer delinquent debt to the
Publication in Final
Internal Revenue Service (IRS) for
collection by offset from a Federal
The Department of Labor has
income tax refund that may be due to
determined pursuant to 5 U.S.C.
(1) § 1.871–1(b)(7);
(2) § 1.881–3;
(3) § 1.881–4;
(4) § 1.1441–3(j);
(5) § 1.1441–7(d);
(6) § 1.6038A–3(b)(5); and
(7) § 1.6038A–3(c)(2)(vii).

553(b)(B) that good cause exists for
waiving public comment on the changes
to § 20.105 and § 20.106(b) set forth in
this document. These changes merely
reflect the change or elimination of
certain IRS requirements for
participation in the offset program.
Therefore, public comment is
unnecessary.
Executive Order 12866
This final rule is not classified as a
‘‘significant rule’’ under Executive
Order 12866 on Federal regulations,
because it will not result in (1) an
annual effect on the economy of $100
million or more; (2) a major increase in
costs or prices for consumers,
individual industries, Federal, State, or
local government agencies, or
geographic regions; or (3) significant
adverse effects on competition,
employment, investment, productivity,
innovation, or on the ability of United
States-based enterprises to compete
with foreign-based enterprises in
domestic or foreign markets.
Accordingly, no regulatory impact
assessment is required.
Regulatory Flexibility Act
Because no notice of proposed
rulemaking has occurred during this
rulemaking, the requirements of the
Regulatory Flexibility Act (5 U.S.C. 601
et seq.) pertaining to regulatory analyses
do not apply.
Paperwork Reduction Act
This final rule is not subject to
Section 3504(h) of the Paperwork
Reduction Act (44 U.S.C. 3501) since it
does not contain any new information
collection requirements.
List of Subjects in 19 CFR Part 20
Government employees, Loan
programs, Credit, Administrative
practice and procedure, Claims.
Accordingly, the interim rule
amending part 20 of title 29 of the Code
of Federal Regulations which was
published at 59 FR 47249 on September
15, 1994 is adopted as a final rule with
the following changes:
PART 20—FEDERAL CLAIMS
COLLECTION
1. The authority citation for Part 20
continues to read as follows:
Authority: 31 U.S.C. 3711 et seq.; Subpart
D is also issued under 5 U.S.C. 5514; Subpart
E is also issued under 31 U.S.C. 3720A.

2. Section 20.105 is revised to read as
follows: