[Title 26 CFR 1.936-10]
[Code of Federal Regulations (annual edition) - April 1, 2002 Edition]
[Title 26 - INTERNAL REVENUE]
[Chapter I - INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY]
[Subchapter A - INCOME TAX (CONTINUED)]
[Part 1 - INCOME TAXES]
[Sec. 1.936-10 - Qualified investments.]
[From the U.S. Government Printing Office]


26INTERNAL REVENUE102002-04-012002-04-01false1.936-10Sec. 1.936-10INTERNAL REVENUEINTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURYINCOME TAX (CONTINUED)INCOME TAXES
Sec. 1.936-10  Qualified investments.

    (a) In general. [Reserved]
    (b) Qualified investments in Puerto Rico. [Reserved]
    (c) Qualified investment in certain Caribbean Basin countries--(1) 
General rule.

[[Page 182]]

An investment of qualified funds described in this section shall be 
treated as a qualified investment of funds for use in Puerto Rico if the 
funds are used for a qualified investment in a qualified Caribbean Basin 
country. A qualified investment in a qualified Caribbean Basin country 
is a loan of qualified funds by a qualified financial institution 
(described in paragraph (c)(3) of this section) directly to a qualified 
recipient (described in paragraph (c)(9) of this section) or indirectly 
through a single financial intermediary for investment in active busines 
assets (as defined in paragraph (c)(4) of this section) in a qualified 
Caribbean Basin country (described in paragraph (c)(10)(ii) of this 
section) or for investment in development projects (as defined in 
paragraph (c)(5) of this section) in a qualified Caribbean Basin 
country, provided--
    (i) The investment is authorized, prior to disbursement of the 
funds, by the Commissioner of Financial Institutions of Puerto Rico (or 
his delegate) pursuant to regulations issued by such Commissioner; and
    (ii) The agreement, certification, and due diligency requirements 
under paragraphs (c)(11), (12), and (13) of this section are met.

A loan by a qualified financial institution shall not be disqualified 
merely because the loan transaction is processed by the central bank of 
issue of the country into which the loan is made pursuant to, and solely 
for purposes of complying with, the exchange control laws or regulations 
of such country. Further, a loan by a qualified financial institution 
shall not be disqualified merely because the loan is acquired by another 
person, provided such other person is also a qualified financial 
institution.
    (2) Termination of qualification--(i) In general. An investment 
that, at any time after having met the requirements for a qualified 
investment in a qualified Caribbean Basin country under the terms of 
this paragraph (c), fails to meet any of the conditions enumerated in 
this paragraph (c) shall no longer be considered a qualified investment 
in a qualified Caribbean Basin country from the time of such failure, 
unless the investment satisfies the requirements for a timely cure 
described in paragraph (c)(2)(ii) of this section. Such a failure 
includes, but is not limited to, the occurrence of any of the following 
events:
    (A) Active business assets cease to qualify as such;
    (B) Proceeds from the investment are diverted for the financing of 
assets, projects, or operations that are not active business assets or 
development projects or are not the assests or the project of the 
qualified recipient;
    (C) The holder of the qualified recipient's obligation is not a 
qualified financial institution;
    (D) The qualified recipient's qualified business activity ceases to 
qualify as such; or
    (E) The qualified Caribbean Basin country ceases to be a country 
described in paragraph (c)(10)(ii) of this section.
    (ii) Timely cure--(A) In general. A timely cure shall be considered 
to have been made if the event or events that cause disqualification of 
the investment are corrected within a reasonable period of time. For 
purposes of this section, a reasonable period of time shall not exceed 
60 days after such event or events come to the attention of the 
qualified recipient or the qualified financial institution or should 
have some to their attention by the exercise of reasonable diligence.
    (B) Due diligence requirements. A time cure of a failure to comply 
with the due diligence requirements of paragraphs (c)(11), (12), and 
(13) of this section shall be considered to be made if the failure to 
comply is due to reasonable cause and, upon request of the Commissioner 
of Financial Institutions of Puerto Rico (or his delegate) or of the 
Assistant Commissioner (International) (or his authorized 
representative), the qualified financial institution (and its trustee or 
agent), if any), the financial intermediary, or the qualified recipient 
establishes to the satisfaction of the Commissioner of Financial 
Institutions of Puerto Rico (or his delegate) or of the Assistant 
Commissioner (International) (or his authorized representative) that it 
has exercised due diligence in ensuring that the funds were property 
disbursed to a qualified recipient and applied by or on

[[Page 183]]

behalf of such qualified recipient to uses that qualify the investment 
as an investment in qualified business assets or a development project 
under the provisions of this paragraph (c).
    (iii) Assumption of qualified recipient's obligation. An investment 
shall not cease to qualify merely because the qualified recipient's 
obligation to the qualified financial institution (or to a financial 
intermediary, if any) is assumed by another person, provided such other 
person assumes the qualified recipient's agreement and certification 
requirements under paragraph (c)(11)(i) of this section and is either--
    (A) A qualified recipient on the date of assumption, in which case 
such person shall be treated for purposes of this section as the 
original qualified recipient and shall be subject to all the 
requirements of this section for continued qualification of the loan as 
a qualified investment in a qualified Caribbean Basin country; or
    (B) An international organization, the principal purpose of which is 
to foster economic development in developing countries and which is 
described in section 1 of the International Organizations Immunities Act 
(22 U.S.C. 288), if the assumption of the obligation is pursuant to a 
bona fide guarantee agreement.
    (3) Qualified financial institution--(i) General rule. For purposes 
of section 936(d)(4)(A) and this section, a qualified financial 
institution includes only--
    (A) A banking, financing, or similar business defined in Sec. 1.864-
4(c)(5)(i) that is an eligible institution described in paragraph 
(c)(3)(ii) of this section, but not including branches of such 
institution outside of Puerto Rico;
    (B) A single-purpose entity described in paragraph (c)(3)(iii) of 
this section;
    (C) The Government Development Bank for Puerto Rico;
    (D) The Puerto Rico Economic Development Bank; and
    (E) Such other entity as may be determined by the Commissioner by 
Revenue Procedure or other guidance published in the Internal Revenue 
Bulletin.
    (ii) Eligible institution. An eligible institution means an 
institution--
    (A) That is an entity organized under the laws of the Commonwealth 
of Puerto Rico or is the Puerto Rican branch of an entity organized 
under the laws of another jurisdiction, if such entity is engaged in a 
banking, financing, or similar business defined in Sec. 1.864-
4(c)(5)(i), and
    (B) That is licensed as an eligible institution under Regulation No. 
3582 (or any successor regulation) issued by the Commissioner of 
Financial Institutions of Puerto Rico (hereinafter ``Puerto Rican 
Regulation No. 3582'').
    (iii) Single-purpose entity. A single-purpose entity is an entity 
that meets all of the following conditions:
    (A) The entity is organized under the laws of the Commonwealth of 
Puerto Rico and is a corporation, a partnership or a trust, which 
conducts substantially all of its activities in Puerto Rico.
    (B) The sole purpose of the entity is to use qualified funds from 
possessions corporations to make one or more qualified investments in a 
qualified Caribbean Basin country and the entity actually uses such 
funds only for such purpose.
    (C) In the case of an entity that is a trust, one of the trustees is 
a qualified financial institution described in paragraph (c)(3)(i) of 
this section.
    (D) The entity is licensed as an eligible institution under Puerto 
Rican Regulation No. 3582 (or any successor regulation).
    (E) Any temporary investment by the entity for its own account of 
funds received from a possessions corporation, and the income from the 
investment thereof, and any temporary investment by the entity for its 
own account of principal and interest paid by a borrower to the entity, 
and the income from the investment thereof, are limited to investments 
in eligible activities, as described in section 6.2.4 of Puerto Rican 
Regulation No. 3582, as in effect on September 22, 1989.
    (4) Investments in active business assets--(i) In general. For 
purposes of section 936(d)(4)(A)(i)(I) and this section and subject to 
the provisions of paragraph (c)(8) of this section, a loan qualifies as 
an investment in active business assets if--
    (A) The amounts disbursed to a qualified recipient under the loan or 
bond issue are promptly applied (as defined

[[Page 184]]

in paragraphs (c)(6) and (7) of this section) by (or on behalf of) the 
qualified recipient solely for capital expenditures for the 
construction, rehabilitation (including demolition associated 
therewith), improvement, or upgrading of qualified assets described in 
paragraphs (c)(4)(ii)(A), (B), (E), and (F) of this section, for the 
acquisition of qualified assets described in paragraphs (c)(4)(ii)(B), 
(C), (E), and (F) of this section, for the expenditures described in 
paragraphs (c)(4)(ii)(D), (E), and (F) of this section, and, if 
applicable, for the financing of incidental expenditures described in 
paragraph (c)(4)(iii) of this section;
    (B) The qualified recipient owns the assets for United States income 
tax purposes and uses them in a qualified business activity (as defined 
in paragraph (c)(4)(iv)); and
    (C) The requirements of paragraph (c)(6) of this section (regarding 
temporary investments and time periods within which the funds must be 
invested) and of paragraph (c)(7) of this section (regarding the 
refinancing of existing funding and the time periods within which 
funding for investments must be secured) are satisfied.
    (ii) Definition of qualified assets. For purposes of this paragraph 
(c), qualified assets mean--
    (A) Real property;
    (B) Tangible personal property (such as furniture, machinery, or 
equipment) that is not property described in section 1221(1) and that is 
either new property or property which at no time during the period 
specified in paragraph (c)(4)(v) of this section was used in a business 
activity in the qualified Caribbean Basin country in which the property 
is to be used;
    (C) Rights to intangible property that is a patent, invention, 
formula, process, design, pattern, know-how, or similar item, or rights 
under a franchise agreement, provided that such rights--
    (1) Were not at any time during the period specified in paragraph 
(c)(4)(v) of this section used in a business activity in the qualified 
Caribbean Basin country in which the rights are to be used,
    (2) Are not rights the use of which gives rise, or would give rise 
if used, to United States source income, and
    (3) Are not rights acquired by the qualified recipient from a person 
related (within the meaning of section 267(b), using ``10 percent'' 
instead of ``50 percent'' in the places where it appears) to the 
qualified recipient;
    (D) Exploration and development expenditures incurred by a qualified 
recipient for the purpose of ascertaining the existence, location, 
extent or quality of any deposit of ore, oil, gas, or other mineral in a 
qualified Caribbean Basin country, as well as for purposes of developing 
such deposit (within the meaning of section 616 of the Code and the 
regulations thereunder);
    (E) Living plants and animals (other than crops, plants, and animals 
that are acquired primarily to hold as inventory by the qualified 
recipient for resale in the ordinary course of trade or business) 
acquired in connection with a farming business (as defined in 
Sec. 1.263-1T(c)(4)(i)), expenditures of a preparatory nature to prepare 
the land or area for farming (such as planting trees, drilling wells, 
clearing brush, leveling land, laying pipes, building roads, 
constructing tanks and reservoirs), expenditures for soil and water 
conservation of a type described in section 175(c)(1), and expenditures 
of a development nature incurred in connection with, and during, the 
preproductive period of property produced in a farming business (as 
defined in Sec. 1.263-1T(c)(4)(ii));
    (F) Other assets or expenditures that are not described in 
paragraphs (c)(4)(ii)(A) through (E) of this section and that the 
Commissioner may, by Revenue Procedure or other guidance published in 
the Internal Revenue Bulletin or by ruling issued to a qualified 
financial institution or qualified recipient upon its request, determine 
to be qualified assets.
    (iii) Incidental expenditures. An amount in addition to the loan 
proceeds borrowed to make an investment in active business assets shall 
be considered an investment in active business assets if such amount is 
applied to finance expenditures that are incidental to making the 
investment in active business assets, provided such

[[Page 185]]

amount is disbursed at or about the same time the proceeds for making 
the investment in active business assets are disbursed. For purposes of 
this section, expenditures incidental to an investment in active 
business assets include only the following items:
    (A) A reasonable amount of costs (other than the cost of credit 
enhancement or bond insurance premiums) associated with arranging the 
financing of an investment in active business assets, not to exceed 3.5 
percent of the proceeds of the loan or bond issue.
    (B) A reasonable amount of installation costs and other reasonable 
costs associated with placing an active business asset in service in the 
qualified business activity.
    (C) An amount not in excess of 10 percent of the total amount of 
investment in qualified assets to finance the acquisition of inventory, 
and other working capital requirements, but if an investment is in 
connection with a manufacturing or farming business, the percentage 
limitation shall be 50 percent rather than 10 percent provided the 
excess over the 10 percent limitation is used to finance inventory 
property. For purposes of this paragraph (c), whether a business is a 
manufacturing business shall be determined under principles similar to 
those described in section 954(d)(1)(A) and the regulations thereunder; 
whether a business is a farming business shall be determined under 
Sec. 1.263-1T(c)(4)(i).
    (D) An amount not in excess of 5 percent of the sum of the 
investment in active business assets and the costs described in 
paragraphs (c)(4)(iii)(A), (B), and (C) of this section for the 
refinancing of an existing debt of the qualified recipient if such 
refinancing is incidental to an investment in active business assets. 
For this purpose, the replacement of an existing loan arrangement shall 
not be considered the refinancing of an existing indebtedness to the 
extent that the funds under such loan arrangement have not yet been 
disbursed to the qualified recipient.
    (iv) Qualified business activity. A qualified business activity is a 
lawful industrial or commercial activity that is conducted as an active 
trade or business (under principles similar to those described in 
Sec. 1.367(a)-2T(b) (2) and (3)) in a qualified Caribbean Basin country. 
A trade or business for purposes of this paragraph (c)(4)(iv) is any 
business activity meeting the principles of section 367 of the Code and 
described in Divisions A through I (excluding group 43 in Division E 
(relating to the United States Postal Service) and groups 84 (relating 
to museums, art galleries, and botanical and zoological gardens), 86 
(relating to membership organizations), and 88 (relating to private 
households in Division I) of the 1987 Standard Industrial Classification 
Manual issued by the Executive Office of the President, Office of 
Management and Budget, or in the comparable provisions of any successor 
Standard Industrial Classification Manual that is adopted by the 
Commissioner of Internal Revenue in a notice, regulation, or other 
document published in the Internal Revenue Cumulative Bulletin.
    (v) Period of use. The period referred to in paragraphs 
(c)(4)(ii)(B) and (C) of this section shall be a five year period 
preceding the date of acquisition with the loan proceeds, if the date of 
acquisition is on or before May 13, 1991. If the date of acquisition is 
after May 13, 1991, then the period specified in this paragraph 
(c)(4)(v) shall be three years preceding the date of acquisition with 
the loan proceeds.
    (5) Investments in development projects--(i) In general. Subject to 
the provisions of paragraph (c)(8) of this section, this paragraph 
(c)(5)(i) describes the requirements in order for a loan by a qualified 
financial institution to qualify as an investment in a development 
project for purposes of section 936(d)(4)(A)(i)(II) and for this 
section.
    (A) The amounts disbursed under the loan or bond issue must be 
promptly applied (as defined in paragraphs (c)(6) and (7) of this 
section) by (or on behalf of) the qualified recipient solely for one or 
more investments described in paragraph (c)(4)(i)(A) of this section and 
in any land, buildings, or other property functionally related and 
subordinate to a facility described in paragraph (c)(5)(ii) of this 
section (determined under principles similar to those described in 
Sec. 1.103-8(a)(3)), for use

[[Page 186]]

(under principles similar to those described in Sec. 1.367(a)-2T(b)(5)) 
in connection with one or more activities described in paragraph 
(c)(5)(i)(B) of this section.
    (B) The activities referred to in paragraph (c)(5)(i)(A) of this 
section are--
    (1) A development project described in paragraph (c)(5)(ii) of this 
section in a qualified Caribbean Basin country; or
    (2) The performance in a qualified Caribbean Basin country of a non-
commercial governmental function described in paragraph (c)(5)(iv) of 
this section;
    (C) The qualified recipient must own the assets for United States 
income tax purposes;
    (D) The requirements of paragraph (c)(6) of this section (regarding 
temporary investments and time periods within which the funds must be 
invested) and of paragraph (c)(7) of this section (regarding the 
refinancing of existing funding and time periods within which funding 
for investments must be secured) must be satisfied.
    (ii) Development project. For purposes of this paragraph (c), a 
development project is one or more facilities in a qualified Caribbean 
Basin country that support economic development in that country and that 
satisfy the public use requirement of paragraph (c)(5)(iii) of this 
section. Examples of facilities that may meet the public use requirement 
include, but are not limited to--
    (A) Transportation systems and equipment, including sea, surface, 
and air, such as roads, railways, air terminals, runways, harbor 
facilities, and ships and aircraft;
    (B) Communications facilities;
    (C) Training and education facilities related to qualified business 
activities;
    (D) Industrial parks, including necessary support facilities such as 
roads; transmission lines for water, gas, electricity, and sewage; 
docks; plant sites preparations; power generation; sewage disposal; and 
water treatment;
    (E) Sports facilities;
    (F) Convention or trade show facilities;
    (G) Sewage, solid waste, water, and electric facilities;
    (H) Housing projects pursuant to a government program designed to 
provide affordable housing to low or moderate income families, based 
upon local standards; and
    (I) Hydroelectric generating facilities.
    (iii) Public use requirement. To satisfy the public use requirement 
in paragraph (c)(5)(ii) of this section, a facility must serve or be 
available on a regular basis for general public use, as contrasted with 
similar types of facilities which are constructed for the exclusive use 
of a limited number of persons as determined under principles similar to 
those described in Sec. 1.103-8(a)(2).
    (iv) Non-commercial governmental functions. For purposes of 
paragraph (c)(5)(i)(B) of this section, the term ``non-commercial 
governmental functions'' refers to activities that, under U.S. 
standards, are not customarily attributable to or carried on by private 
enterprises for profit and are performed for the general public with 
respect to the common welfare or which relate to the administration of 
some phase of government. For example, the operation of libraries, toll 
bridges, or local transportation services, and activities substantially 
equivalent to those carried out by the Federal Aviation Authority, 
Interstate Commerce Commission, or United States Postal Service, are 
considered non-commercial governmental functions. For purposes of this 
section, non-commercial government functions shall not include military 
activities.
    (v) [Reserved]
    (6) Prompt application of borrowed proceeds. This paragraph (c)(6) 
provides rules for determining whether amounts disbursed to a qualified 
recipient by a qualified financial institution (or a financial 
intermediary) shall be considered to have been promptly applied for the 
purpose of paragraphs (c)(4)(i)(A) and (c)(5)(i)(A) of this section.
    (i) In general. Except as otherwise provided in paragraphs 
(c)(6)(ii) and (c)(7)(iii)(B) of this section, amounts disbursed to a 
qualified recipient by a qualified financial institution (or a financial 
intermediary) shall be considered to have been promptly applied for the 
purpose of paragraphs (c)(4)(i)(A) and (c)(5)(i)(A) of this section if 
the amounts are fully expended for any of the purposes described in 
paragraphs (c)(4)(i)(A) or (c)(5)(i)(A) of this section

[[Page 187]]

no later than six months from the date of such disbursement and any 
temporary investment of such funds by the qualified recipient during 
such period complies with the rules of paragraph (c)(6)(iii)(A) of this 
section. Where the amounts disbursed are bond proceeds described in 
paragraph (c)(6)(iv)(A) of this section, the six-month period shall 
begin on the date of issuance of the bonds. In the event the qualified 
financial institution (or financial intermediary) invests any part of 
the bond proceeds before disbursement of those proceeds to the qualified 
recipient, all earnings from any such investment shall be paid to the 
qualified recipient or applied for its benefit.
    (ii) Special rules for long term projects financed out of bond 
proceeds. In the case of a long term project described in paragraph 
(c)(6)(iv)(B) of this section that is financed out of bond proceeds, the 
six-month period described in paragraph (c)(6)(i) of this section shall 
be extended with respect to the amount of bond proceeds used to fund the 
project for such reasonable period of time as shall be necessary until 
completion of the project or until beginning of production (in the case 
of a farming business), but, in any event, not to exceed three years 
from the date of issuance of the bonds, and only if--
    (A) The project that is financed out of bond proceeds was identified 
as of the date of issue;
    (B) A construction and expenditure plan certified by an independent 
expert (such as an engineer, an architect, or a farming expert) is filed 
with, and approved by, the Commissioner of Financial Institutions of 
Puerto Rico (or his delegate) prior to the date of issue, which makes a 
reasonable estimate, as of the date of filing of the plan, of the 
amounts and uses of the bond proceeds and the time of completion or 
production, and includes a schedule of progress payments until such 
time;
    (C) The terms of the construction and expenditure plan are disclosed 
in the public offering memorandum, private placement memorandum, or 
similar document prepared for information or disclosure purposes in 
relation to the issuance of bonds; and
    (D) Any temporary investment of the bond proceeds complies with the 
rules of paragraph (c)(6)(iii)(A) and (B) of this section.
    (iii) Temporary investments--(A) During six-month period. During the 
six-month period described in paragraph (c)(6)(i) of this section, 
during the first six months of the period described in paragraph 
(c)(6)(ii) of this section, and during the 30-day period described in 
paragraph (c)(7)(iii)(A) of this section, loan proceeds disbursed to a 
qualified recipient, bond proceeds, and income from the investment 
thereof, may be held in unrestricted yield investments, provided such 
yield reflects normal market yield for such type of investments and 
provided the income from such investments, if any, is or would be 
sourced either in Puerto Rico or in a country in which the investment in 
active business assets or development project is to be made.
    (B) During other periods. During any other period, any temporary 
investment of bond proceeds, and of income from such investments, shall 
be limited to investments in eligible activities. For purposes of this 
paragraph (c)(6)(iii)(B), the term ``eligible activities'' shall mean 
those investments described in section 6.2.4 of Puerto Rican Regulation 
No. 3582, as in effect on September 22, 1989.
    (iv) Definitions--(A) Bond proceeds. For purposes of this paragraph 
(c), bond proceeds shall mean the proceeds from the issuance of 
obligations by way of a public offering or a private placement by a 
qualified financial institution for investment in active business assets 
or a development project that has been identified at the time of issue 
and is described in a public offering memorandum, private placement 
memorandum, or similar document prepared for information or disclosure 
purposes in relation to the issuance of the bonds.
    (B) Long term project. For purposes of this section, the term long 
term project means--
    (1) A project, whether or not under a contract, for the 
construction, rehabilitation, improvement, upgrading, or production of 
qualified assets, or for expenditures, described in paragraph (c)(4)(ii) 
of this section (other than paragraph (c)(4)(ii)(C) of this section),

[[Page 188]]

which is reasonably expected to require more than 12 months to complete; 
or
    (2) The production of property in a farming business referred to in 
paragraph (c)(4)(ii)(E) of this section, which is reasonably expected to 
require a preproductive period in excess of 12 months.
    (7) Financing of previously incurred costs. Loan or bond proceeds 
which are disbursed after a qualified recipient has paid or incurred 
part or all of the costs of acquiring active business assets or 
investing in a development project shall be considered to have been 
applied for such purposes only as provided in this paragraph (c)(7).
    (i) Replacement of temporary non-section 936 financing of a 
qualified investment. This paragraph (c)(7)(i) prescribes the maximum 
time limits within which temporary non-section 936 financing of 
qualified investments may be replaced with section 936 funds without 
being considered a prohibited refinancing transaction. This paragraph 
(c)(7)(i) applies to the refinancing of costs incurred with respect to 
investments that, at the time the costs were first incurred, were either 
qualified investments in a qualified Caribbean Basin country or were 
investments by a qualified recipient in active business assets or a 
development project in a qualified Caribbean Basin country. This 
paragraph (c)(7)(i) applies also to the refinancing of costs incurred 
with respect to any other investment. However, in the latter case, the 
amount of costs that may be refinanced with section 936 funds is limited 
to the amount of costs that are incurred with respect to the investment 
after the investment becomes a qualified investment in a qualified 
Caribbean Basin country. For purposes of this paragraph (c)(7)(i), the 
time when costs are incurred shall be determined under principles 
similar to those applicable under section 461(h) dealing with the 
economic performance test for the accrual of deductible liabilities. 
This paragraph (c)(7)(i) applies only to the situations described in 
this paragraph (c)(7)(i).
    (A) In the case of an investment in active business assets or a 
development project, a loan shall be a qualified investment for purposes 
of this paragraph (c) if the loan proceeds are disbursed, or the 
obligations are issued, no later than six months after the date on which 
the qualified recipient takes possession of the asset or the facility 
or, if earlier, places the asset or the facility in service. However, in 
the case of a small project described in paragraph (c)(8)(v) of this 
section, the six-month period shall be one year.
    (B) In the case of an investment in active business assets or a 
development project that is part of a long term project described in 
paragraph (c)(6)(iv)(B) of this section, a loan shall also be a 
qualified investment for purposes of this paragraph (c) if the loan 
proceeds are disbursed, or the obligations are issued, no later than six 
months after completion of the project or, in the case of a farming 
business, after the beginning of production, and in any event, no later 
than three years after the date on which the first payment is made 
toward the eligible costs of the project. The amount of the qualified 
investment may not exceed the sum of--
    (1) The eligible costs relating to investments described in 
paragraph (c)(4)(i)(A) in the case of an investment in active business 
assets, or the eligible costs relating to investments described in 
paragraph (c)(5)(i) of this section in the case of a development 
project, but only to the extent of the costs that are incurred after the 
date described in paragraph (c)(7)(i)(D) of this section, and
    (2) The portion of unpaid interest that would be required to be 
capitalized under U.S. tax rules and that accrued on prior temporary 
non-section 936 financing from the date described in paragraph 
(c)(7)(i)(D) of this section through the date the section 936 loan 
proceeds are disbursed or the section 936 obligations are issued.
    (C) In order to qualify for the special rules of this paragraph 
(c)(7)(i), a plan must be filed with the Commissioner of Financial 
Institutions of Puerto Rico (or his delegate) stating the qualified 
recipient's intention to refinance the costs of the long term project 
with section funds.
    (D) The date referred to in paragraph (c)(7)(i)(B) (1) and (2) of 
this section is a date that is the later of--

[[Page 189]]

    (1) The date the plan described in paragraph (c)(7)(i)(C) is filed, 
or
    (2) The date the investment becomes a qualified investment by a 
qualified recipient in active business assets or a development project 
in a qualified Caribbean Basin country.
    (ii) Refinancing of section 936 financing. A section 936 loan or 
bond issue used to finance a qualified investment described in paragraph 
(c)(1) of this section may be refinanced with section 936 funds through 
a new loan or bond issue to the extent of the remaining principal 
balance on such existing qualified financing, increased by the amount of 
unpaid interest accrued through the date the new loan proceeds are 
disbursed or the new obligations are issued and that would be required 
to be capitalized under U.S. tax rules.
    (iii) Prompt application of borrowed proceeds--(A) In general. In 
the case of a loan or bond issue described in paragraph (c)(7)(i) or 
(ii) of this section, the rules of paragraph (c)(6) of this section 
shall apply but the six-month period described in paragraph (c)(6)(i) of 
this section shall be limited to 30 days from the date of disbursement 
of loan proceeds to the qualified recipient or from the date of issuance 
in the case of a bond issue.
    (B) Special rules for long term projects financed out of bond 
proceeds. In the case of a long term project described in paragraph 
(c)(6)(iv)(B) of this section that is financed out of bond proceeds, the 
30-day period described in paragraph (c)(7)(iii)(A) of this section 
shall be extended with respect to the amount of bond proceeds used for 
the permanent financing of the long term project for such reasonable 
period of time as shall be necessary until completion of the project or 
beginning of production (in the case of a farming business), but, in any 
event, not to exceed three years from the date of issuance of the bonds. 
For purposes of this paragraph (c)(7)(iii)(B), the period of time shall 
be considered reasonable only if--
    (1) A construction and expenditure plan certified by an independent 
expert (such as an engineer, an architect, or a farming expert) is filed 
with, and approved by, the Commissioner of Financial Institutions of 
Puerto Rico (or his delegate) prior to the date of issue, which makes a 
reasonable estimate, as of the date of issue, of the amounts and uses of 
the bond proceeds and the time of completion or production, and includes 
a schedule of progress payments until such time; and
    (2) The terms of the construction and expenditure plan are disclosed 
in the public offering memorandum, private placement memorandum, or 
similar document prepared for information or disclosure purposes in 
relation to the bond issue.
    (8) Miscellaneous operating rules--(i) Sale and leaseback. An asset 
that is acquired and leased back to the person from whom acquired does 
not constitute an investment in an active business asset or an 
investment in a development project.
    (ii) Use of asset in qualified business activity. For purposes of 
paragraph (c)(4)(i)(B), an asset shall be considered used or held for 
use in a qualified business activity if it is used or held for use in 
such activity under principles similar to those described in 
Sec. 1.367(a)-2T(b)(5), or a successor provision.
    (iii) Definition of capital expenditures. For purposes of this 
paragraph (c), capital expenditures mean those expenditures described in 
section 263(a) of the Code (without regard to paragraphs (A) through (G) 
of section 263(a)(1)), and those costs required to be capitalized under 
section 263A with respect to property described in section 263A(b)(1), 
relating to self-constructed assets.
    (iv) Loans through certain financial intermediaries. A loan by a 
qualified financial institution shall not be disqualified from being an 
investment in active business assets or in a development project merely 
because the proceeds are first lent to a financial intermediary (as 
defined in paragraph (c)(8)(iv)(H) of this section) which, in turn, on-
lends the proceeds directly to a qualified recipient, provided the 
requirements of this paragraph (c)(8)(iv) are satisfied.
    (A) The loan to the qualified recipient must satisfy the 
requirements of paragraph (c)(4)(i) of this section in the case of an 
investment in active business assets, or of paragraph (c)(5)(i) of this 
section in the case of an investment in a development project.

[[Page 190]]

    (B) The qualified recipient and the active business assets or 
development project in which the proceeds are to be invested must be 
identified prior to disbursement of any part of the proceeds by the 
qualified financial institution to the financial intermediary.
    (C) The effective interest rate charged by the qualified financial 
institution to the financial intermediary must not exceed the average 
interest rate paid by the qualified financial institution with respect 
to its eligible funds, increased by such number of basis points as is 
required to provide reasonable compensation to the qualified financial 
institution for services performed and risks assumed with respect to the 
loan to the financial intermediary that are not ordinarily required to 
be performed or assumed with respect to a deposit, loan, repurchase 
agreement or other transfer of eligible funds with another qualified 
financial institution. The average interest rate shall be the average 
rate, determined on a daily basis, paid by the qualified financial 
institution on its eligible funds over the most recent quarter preceding 
the date on which the rate on the loan to the financial intermediary is 
committed.
    (D) The effective interest rate charged by the financial 
intermediary to the qualified recipient must not exceed the effective 
interest rate charged to the financial intermediary by the qualified 
financial institution, increased by such number of basis points as is 
required to provide reasonable compensation to the financial 
intermediary for services performed and risks assumed with respect to 
the loan to the qualified recipient.
    (E) The financial intermediary must borrow from the qualified 
financial institution under substantially the same terms as it lends to 
the qualified recipient. In particular, both loans must have 
disbursement terms, repayment schedules and maturity dates for interest 
and principal amounts such that the financial intermediary does not 
retain for more than 48 hours any of the funds disbursed by the 
qualified financial institution nor any of the funds paid by the 
qualified recipient in repayment of principal or interest on the loan.
    (F) The financial institution and the financial intermediary must 
agree to comply with the due diligence requirements described in 
paragraphs (c)(11), (12), and (13) of this section;
    (G) The time periods and temporary investments rules in paragraphs 
(c)(6) and (7) of this section must be complied with; and
    (H) For purposes of this paragraph (c), the financial intermediary 
must be--
    (1) An active trade or business which a person maintains in a 
qualified Caribbean Basin country and which consists of a banking, 
financing or similar business as defined in Sec. 1.864-4(c)(5)(i) (other 
than a central bank of issue); or
    (2) A public international organization, the principal purpose of 
which is to foster economic development in developing countries and 
which is described in section 1 of the International Organizations 
Immunities Act (22 U.S.C. 288).

For purposes of paragraphs (c)(8)(iv)(C) and (D) of this section, the 
determination of whether compensation is reasonable shall be made in 
relation to normal commercial practices for comparable transactions 
carrying a similar degree of commercial, currency and political risk. 
Reasonable credit enhancement fees and other reasonable fees and amounts 
charged to the financial intermediary or the qualified recipient with 
respect to the loan transaction in addition to interest shall be added 
to the interest cost in determining the effective interest rate.
    (v) Small project. For purposes of this paragraph (c), a small 
project shall be a project (including the acquisition of an asset) for 
which the total amount of section 936 funds used for its financing does 
not exceed $1,000,000 in the aggregate, or such other amount as the 
Commissioner may publish, from time to time, in the Internal Revenue 
Bulletin.
    (9) Qualified recipient. For purposes of this section, a qualified 
recipient is any person described in paragraph (c)(9)(i) or (ii) of this 
section. The term ``person'' means a person described in section 
7701(a)(1) or a government (within the meaning of Sec. 1.892-2T(a)(1)) 
of a qualified Caribbean Basin country.

[[Page 191]]

    (i) In the case of an investment described in paragraph (c)(4) of 
this section (relating to investments in active business assets), a 
qualified recipient is a person that carries on a qualified business 
activity in a qualified Caribbean Basin country, and complies with the 
agreement and certification requirements described in paragraph 
(c)(11)(i) of this section at all times during the period in which the 
investment remains outstanding.
    (ii) In the case of an investment described in pargraph (c)(5) of 
this section (relating to investments in development projects), a 
qualified recipient is the borrower (including a person empowered by the 
borrower to authorize expenditures for the investment in the development 
project) that has authority to comply, and complies, with the agreement 
and certification requirements described in paragraph (c)(11)(i) of this 
section at all times during the period in which the investment remains 
outstanding.
    (10) Investments in a qualified Caribbean Basin country--(i) Rules 
for determining the place of an investment. The rules of this paragraph 
(c)(10)(i) shall apply to determine the extent to which an investment in 
an active business asset or a development project will be considered 
made in qualified Caribbean Basin Country.
    (A) An investment in real property is considered made in the 
qualified Caribbean Basin country in which the real property is located.
    (B) Except as otherwise provided in this paragraph (c)(10)(i)(B), an 
investment in tangible personal property is considered made in a 
qualified Caribbean Basin Country so long as the tangible personal 
property is predominantly used in that country. Whether property is used 
predominantly in a qualified Caribbean Basin country shall be determined 
under principles similar to those described in Sec. 1.48-1(g)(1), 
(g)(2)(ii), (g)(2)(iv), (g)(2)(vi), (g)(2)(viii), and (g)(2)(x) 
(relating to investment tax credits for property used outside the United 
States) as in effect on December 31, 1985. A vessel, container, or 
aircraft shall be considered for use predominantly in a qualified 
Caribbean Basin country in any year if it is used for transport to and 
from such country with some degree of frequency during that year and at 
least 30 percent of the income from the use of such vessel, container or 
aircraft for that year is sourced in such country under principles 
similar to those described in section 863(c)(1) and (2) (relating to 
source rules for certain transportation income). Cables and pipelines 
which are premanently installed as part of a communication or 
transportation system between a qualified Caribbean Basin country and 
another country or among several countries which include a qualified 
Caribbean Basin country shall be considered used in a qualified 
Caribbean Basin country to the extent of 50 percent of the portion of 
the facility that directly links the qualified country to another 
country or to a hub, unless it is established by notice or other 
guidance published in the Internal Revenue Bulletin or by ruling issued 
to a qualified institution or qualified recipient upon request that it 
is appropriate to attribute a greater portion of the cost of the 
facility to the qualified Caribbean Basin country.
    (C) An investment in rights to intangible property is considered 
made in a qualified Caribbean Basin country to the extent such rights 
are used in that country. Where rights to intangible property are used 
shall be determined under principles similar to those described in 
Sec. 1.954-2T(b)(3)(vii) or a successor provision.
    (ii) Qualified Caribbean Basin country. For purposes of this 
section, the term ``qualified Caribbean Basin country'' means any 
beneficiary country (within the meaning of section 212(a)(1)(A) of the 
Caribbean Basin Economic Recovery Act, Public Law 98-67 (Aug. 5, 1983), 
97 Stat. 384, 19 U.S.C. 2702(a)(1)(A)), which meets the requirements of 
section 274(h)(6)(A)(i) and (ii) and the U.S. Virgin Islands, and 
includes the territorial waters and continental shelf thereof.
    (11) Agreements and certifications by qualified recipients and 
financial intermediaries--(i) In general. In order for an investment to 
be considered a qualified investment under section 936(d)(4) and 
paragraph (c)(1) of this section, a qualified recipient must certify to 
the qualified financial institution (or to the financial intermediary, 
if the loan is

[[Page 192]]

made through a financial intermediary) on the date of closing of the 
loan agreement and on each anniversary date thereof, that it is a 
qualified recipient described in paragraph (c)(9) of this section. In 
addition, the qualified recipient must agree in the loan agreement with 
the qualified financial institution (or with the financial intermediary, 
if the loan is made through a financial intermediary)--
    (A) To use the funds at all times during the period the loan is 
outstanding solely for the purposes and in the manner described in 
paragraph (c)(4) of this section (regarding investment in active 
business assets) or in paragraph (c)(5) of this section (regarding 
investment in development projects);
    (B) To comply with the requirements of paragraph (c)(6) of this 
section (regarding temporary investments and time periods within which 
the funds must be invested) and paragraph (c)(7) of this section 
(regarding the refinancing of existing funding and the time periods 
within which funding for investments must be secured);
    (C) To notify the Assistant Commissioner (International), the 
qualified financial institution (or the financial intermediary, if the 
loan is made through a financial intermediary), and the Commissioner of 
Financial Institutions of Puerto Rico (or his delegate) pursuant to 
paragraph (c)(14) of this section if it no longer is a qualified 
recipient or if, for any other reason, the investment has ceased to 
qualify as a qualified investment described in paragraph (c)(1) of this 
section, promptly upon the occurrence of such disqualifying event; and
    (D) To permit examination by the office of the Assistant 
Commissioner (International) (or by the office of any District Director 
authorized by the Assistant Commissioner (International)) and the 
Commissioner of Financial Institutions of Puerto Rico (or his delegate) 
of all necessary books and records that are sufficient to verify that 
the funds were used for investments in active business assets or 
development projects in conformity with the terms of the loan agreement.
    (ii) Certification by a financial intermediary. In the case of a 
loan by a qualified financial institution to a financial intermediary, 
the financial intermediary must certify to the qualified financial 
institution (using the procedures described in paragraph (c)(11)(i) of 
this section) that it is a financial intermediary described in paragraph 
(c)(8)(iv)(H) of this section, and must furnish to the qualified 
financial institution a copy of the qualified recipient's certification 
described in paragraph (c)(11)(i) of this section and of its loan 
agreement with the qualified recipient. In addition, the financial 
intermediary must agree in the loan agreement with the qualified 
financial institution:
    (A) To comply with the requirements of paragraph (c)(8)(iv) of this 
section; and
    (B) To permit examination by the office of the Assistant 
Commissioner (International) (or by the office of any District Director 
authorized by the Assistant Commissioner (International)) and the 
Commissioner of Financial Institutions of Puerto Rico (or his delegate) 
of all its necessary books and records that are sufficient to verify 
that the funds were used in conformity with the terms of the loan 
agreements.
    (12) Certification requirements. In order for an investment to be 
considered a qualified investment under section 936(d)(4), section 
936(d)(4)(C)(i) requires that both the person in whose trade or business 
such investment is made and the financial institution certify to the 
Secretary of the Treasury and the Commissioner of Financial Institutions 
of Puerto Rico that the proceeds of the loan will be promptly used to 
acquire active business assets or to make other authorized expenditures. 
This certification requirement is satisfied as to the qualified 
financial institution, the financial intermediary (if any), and the 
qualified recipient if the qualified financial institution submits a 
certificate to both the Assistant Commissioner (International) and to 
the Commissioner of Financial Institutions of Puerto Rico (or his 
delegate) pursuant to paragraph (c)(14) of this section upon 
authorization of the investment by the Commissioner of Financial 
Institutions and, in any event, prior to the first disbursement of the 
loan proceeds to the qualified recipient or to the financial 
intermediary (if any), in

[[Page 193]]

which the qualified financial institution--
    (i) Represents that, as of the date of the certification, the 
qualified recipient and the financial intermediary (if any) have 
complied with the requirements described in paragraph (c)(11) of this 
section;
    (ii) Describes the important terms of the loan to the financial 
intermediary (if any) and to the qualified recipient, including the 
amount of the loan, the nature of the investment, the basis for its 
qualification as an investment in active business assets or a 
development project under this section, the identity of the financial 
intermediary (if any) and of the qualified recipient, the qualified 
Caribbean Basin country involved, and the nature of the collateral or 
other security used, including any guarantee;
    (iii) Agrees to permit examination by the Assistant Commissioner 
(International) (or by the office of any District Director authorized by 
the Assistant Commissioner (International)) and the Commissioner of 
Financial Institutions of Puerto Rico (or his delegate) of all its 
necessary books and records that are sufficient to verify that the funds 
were used for investments in active business assets or development 
projects in conformity with the terms of the loan agreement or 
agreements with the financial intermediary (if any) and with the 
qualified recipient; and
    (iv) In the case of a single-purpose entity that is a qualified 
financial institution, discloses the name and address of the entity's 
trustee or agent, if any, that assists the qualified financial 
institution in the performance of its due diligence requirement under 
paragraph (c) of this section, and represents that the trustee or agent 
has agreed with the qualified financial institution to permit 
examination by the Assistant Commissioner (International) (or by the 
office of any District Director authorized by the Assistant Commissioner 
(International)) and the Commissioner of Financial Institutions of 
Puerto Rico (or his delegate) of all necessary books and records of such 
trustee or agent that are sufficient to verify that the funds were used 
for investments in active business assets or development projects in 
conformity with the terms of the loan agreement or agreements with the 
financial intermediary (if any) and with the qualified recipient.
    (13) Continuing due diligence requirements. In order to maintain the 
qualification for an investment under paragraph (c)(1) of this section, 
the continuing due diligence requirements described in this paragraph 
(c)(13) must be satisfied.
    (i) Requirements of qualified recipient. A qualified recipient must-
-
    (A) Submit annually to the qualified financial institution or to the 
financial intermediary from which its qualified funds were obtained a 
copy of its most recent annual financial statement accompanied by an 
opinion of an independent accountant familiar with the financials of the 
qualified recipient disclosing the amount of the loan, the current 
outstanding balance of the loan, describing the assets financed with 
such loan and the qualified business activity in which such assets are 
used or the development project for which the loan is used, and stating 
that there are no reasons to doubt that the loan proceeds have been 
properly used and continue to be properly used, and
    (B) Act in a manner consistent with its representations and 
agreements described in paragraph (c)(11) of this section.
    (ii) Requirements of qualified financial institutions. Except as 
otherwise provided in paragraph (c)(13)(iii) of this section, a 
qualified financial institution described in paragraph (c)(3) of this 
section must maintain in its records and have available for inspection 
the documentation described in paragraph (c)(13)(ii)(A) or (B) of this 
section. In addition, the qualified financial institution is required to 
notify the Assistant Commissioner (International) and the Commissioner 
of Financial Institutions of Puerto Rico (or his delegate) pursuant to 
paragraph (c)(14) of this section upon becoming aware that a loan has 
ceased to be an investment in active business assets or a development 
project under this section. For purposes of this paragraph (c)(13)(ii), 
multiple loans for investment in a single qualified business activity or 
development project will be

[[Page 194]]

aggregated in determining what due diligence requirements apply.
    (A) In the case of a small project described in paragraph (c)(8)(v) 
of this section, the following documents must be maintained and 
available for inspection:
    (1) The loan application or other similar document;
    (2) The financial statements of the qualified recipient filed as 
part of the loan application;
    (3) The statement required by section 6.4.3(a)(iii) of Puerto Rican 
Regulation No. 3582 or any successor thereof, signed by the qualified 
recipient (or its duly authorized representative), acknowledging the 
receipt of the loan proceeds, describing the assets financed with such 
loan and the business activity in which such assets are to be used or 
the development project for which the funds will be utilized, the 
collateral to be provided for the transaction including any guarantee, 
and the basis for its qualification as a qualified recipient;
    (4) The loan documents; and
    (5) In the case of a qualified financial institution that is a 
single-purpose entity, a copy of the agreement with the entity's trustee 
or agent, if any, described in paragraph (c)(12)(iv) of this section.
    (B) In the case of a disbursement concerning a project that is not a 
small project described in paragraph (c)(8)(v) of this section, the 
following documents must be maintained and available for inspection, in 
addition to the documents required by paragraph (c)(13)(ii)(A) of this 
section:
    (1) A memorandum of credit prepared by an officer of the qualified 
financial institution (or, in the case of a single purpose entity, an 
agent of the entity or a trustee for the entity, if any) and signed by 
the officer of the qualified financial institution, containing the 
details of the investigation and review that the qualified financial 
institution, or its trustee or agent, if any, conducted in order to 
evaluate whether the investment is qualified under paragraph (c)(1) of 
this section and the opinion of the officer of the qualified financial 
institution, or the opinion of an officer of the agent of, or of the 
trustee for, the qualified financial institution, if any, that there is 
no reasonable ground for belief that the qualified funds will be 
diverted to a use that is not permitted under the provisions of this 
section; in making this investigation and review, factors that must be 
utilized are ones similar to those listed in Puerto Rico Regulation No. 
3582, section 6.4.2;
    (2) The annual financial statement of the qualified recipient; and
    (3) The written report of an officer of the qualified financial 
institution, or of an officer of an agent of, or of the trustee for, the 
qualified financial institution, if any, documenting discussions, both 
before and after the disbursement of the loan proceeds, with each 
recipient's accounting, financial and executive personnel with respect 
to the proposed and actual use of the loan proceeds and his analysis of 
the annual financial statements of the qualified recipient including an 
analysis of the statement of sources and uses of funds. After the loan 
disbursement, such discussions and review shall occur annually during 
the term of the loan. Such report shall include the conclusion that in 
such officer's opinion there is no reasonable ground for belief that the 
qualified recipient is improperly utilizing the funds.
    (iii) Requirements in the case of a financial intermediary. Where a 
qualified financial institution lends funds to a financial intermediary 
which are on-lent to a qualified recipient--
    (A) The obligation to maintain the documentation described in 
paragraph (c)(13)(ii)(A) or (B) of this section shall apply only to the 
financial intermediary and not to the qualified financial institution 
and the provisions of paragraph (c)(13)(ii)(A) or (B) of this section 
shall be read so as to impose on the financial intermediary any 
obligation imposed on the qualified financial institution.
    (B) The financial intermediary shall forward annually to the 
qualified financial institution a copy of the documentation it is 
required to maintain in its records pursuant to the provisions of this 
paragraph (c)(13)(iii) and shall notify the Assistant Commissioner 
(International), the Commissioner of Financial Institutions of Puerto 
Rico

[[Page 195]]

(or his delegate) and the qualified financial institution pursuant to 
paragraph (c)(14) of this section upon becoming aware that a loan has 
ceased to be an investment in active business assets or a development 
project under this section. The qualified financial institution must 
maintain in its records and have available for inspection the 
documentation furnished by the financial intermediary pursuant to this 
paragraph (c)(13)(iii)(B).
    (C) The qualified financial institution shall cause one of its 
officers (or one of the officers of its agent or trustee, if any) to 
prepare a written report documenting his analysis of the documentation 
furnished by the financial intermediary pursuant to paragraph 
(c)(13)(iii)(B) of this section, his discussions, both before and after 
the disbursement of the loan proceeds, with the financial intermediary's 
accounting, financial and executive personnel with respect to the 
proposed and actual use of the loan proceeds, and his analysis of the 
annual financial statements of the qualified recipient including an 
analysis of the statement of sources and uses of funds. After the loan 
disbursement, such discussions and review shall occur annually during 
the term of the loan. Such report shall include the conclusion that in 
such officer's opinion there is no reasonable ground for belief that the 
qualified recipient is improperly utilizing the funds.
    (14) Procedures for notices and certifications. Notices and 
certifications to the Assistant Commissioner (International) required 
under paragraphs (c)(11), (12) and (13) of this section shall be 
addressed to the attention of the Assistant Commissioner 
(International), Office of Taxpayer Service and Compliance, IN:C, 950 
L'Enfant Plaza South, SW., Washington, DC 20024. Notices and 
certifications to the Commissioner of Financial Institutions of Puerto 
Rico required under paragraphs (c)(11), (12), and (13) of this section 
shall be addressed as follows: Commissioner of Financial Institutions, 
GPO Box 70324, San Juan, Puerto Rico 00936.
    (15) Effective date. This paragraph (c) is effective May 13, 1991. 
It is applicable to investments by a possessions corporation in a 
financial institution that are used by a financial institution for 
investments in accordance with a specific authorization granted by the 
Commissioner of Financial Institutions of Puerto Rico (or his delegate) 
after September 22, 1989. However, the taxpayer may choose to apply 
Sec. 1.936-10T(c) for periods before June 12, 1991.

[T.D. 8350, 56 FR 21927, May 13, 1991]