[Federal Register Volume 59, Number 198 (Friday, October 14, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-25403]


[[Page Unknown]]

[Federal Register: October 14, 1994]


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DEPARTMENT OF THE TREASURY
26 CFR Part 1

[INTL-0064-93]
RIN 1545-AS40

 

Conduit Arrangements Regulations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to 
conduit financing arrangements issued under the authority granted by 
section 7701(l). The proposed regulations apply to persons engaging in 
multiple-party financing arrangements and are necessary in order to 
determine which of those arrangements should be recharacterized under 
section 7701(l). This document also provides notice of a public hearing 
on these proposed regulations.

DATES: Written comments, requests to speak and outlines of topics to be 
discussed at the public hearing scheduled for December 16, 1994, must 
be received by December 13, 1994.

ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (INTL-0064-93), room 
5228, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. In the alternative, submissions may be hand 
delivered between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R 
(INTL-0064-93), Courier's Desk, Internal Revenue Service, 1111 
Constitution Ave. NW, Washington, DC. The public hearing will be held 
in the IRS Auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations Richard L. 
Chewning, Ramon Camacho, or Elissa Shendalman (202) 622-3870, 
concerning submissions and the hearing, Christina Vasquez, (202) 622-
7782 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act (44 U.S.C. 
3504(h)). Comments on the collections of information should be sent to 
the Office of Management and Budget, Attn: Desk Officer for the 
Department of Treasury, Office of Information and Regulatory Affairs, 
Washington, DC 20503, with copies to the Internal Revenue Service, 
Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC 20224.
    The collections of information are in Secs. 1.881-4(c), 1.6038-2, 
1.6038A-2, and 1.6038A-3. The information is required by the IRS so 
that a district director can determine whether a financing arrangement 
is subject to recharacterization under Sec. 1.881-3. The data will be 
used by the IRS and taxpayers to verify that the proper amount of tax 
is withheld. The likely respondents are withholding agents and foreign 
investors.
    Estimated total annual recordkeeping burden: 10,000 hours.
    Estimated average annual burden per taxpayer: 10 hours.
    Estimated number of recordkeepers: 1,000.
    Estimated total annual reporting burden: 3,000 hours.
    Estimated average burden per respondent: 3 hours.
    Estimated number of respondents: 1,000.
    Estimated frequency of responses: Annually.

Background

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) under Secs. 1.871-1, 1.881-0, 1.881-3, 
1.881-4, 1.1441-3, 1.1441-7, 1.6038-2, 1.6038A-2, 1.6038A-3 and 
1.7701(l)-1 that are issued under the authority granted by section 
7701(l). Section 7701(l) was enacted as part of the Omnibus Budget 
Reconciliation Act of 1993 (Pub.L. 103-66). These proposed regulations 
provide guidance with regard to conduit financing arrangements.

Explanation of Provisions

    Section 7701(l) authorizes the Secretary to ``prescribe regulations 
recharacterizing any multiple-party financing transaction as a 
transaction directly among any 2 or more of such parties where the 
Secretary determines that such recharacterization is appropriate to 
prevent avoidance of any tax imposed by this title.'' Pursuant to this 
authority, these regulations provide rules that permit the district 
director to disregard, for purposes of sections 871, 881, 1441 and 
1442, the participation of one or more persons in a conduit financing 
arrangement.

Section 1.881-3

1. Definitions
    Section 1.881-3(a)(2) provides definitions of certain terms used 
throughout the regulations. A ``financing arrangement'' generally means 
two or more financing transactions pursuant to which one person (the 
financing entity) advances money or other property to another person 
(the intermediate entity) and the intermediate entity advances money or 
other property to a third person (the financed entity). The term also 
includes two or more financing transactions that achieve substantially 
the same result through any other series of steps (e.g., a loan from a 
foreign person to a U.S. person, followed by an assignment of the loan 
by the foreign person to another person in exchange for a note issued 
by the assignee).
    A ``financing transaction'' generally means any advance of money or 
other property in exchange for debt; any advance of money or other 
property in exchange for certain types of stock or a similar interest 
in a partnership or trust; any lease or license; any other advance of 
money or other 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); and any transaction by which a 
person becomes a party to an existing financing transaction. An advance 
of money or other property in exchange for stock will be considered a 
financing transaction only if the issuer or holder of the stock has 
rights, or there are arrangements in place, that are intended to ensure 
that payments on the instrument will be made as contemplated. 
Therefore, an exchange for common stock or ordinary perpetual preferred 
stock will not be included. However, an exchange for certain 
instruments, such as dividend-linked notes or other perpetual 
subordinated debt (which, though denominated as debt, are treated as 
equity under U.S. tax principles), will be included if those 
instruments provide for normal creditors' rights, such as the right, 
arising upon a default on a payment, to enforce the payment through a 
legal proceeding or to cause the liquidation of the issuer. The IRS 
solicits comments on the definition of a financing transaction.
    A ``conduit entity'' means an intermediate entity whose 
participation in a financing arrangement is disregarded pursuant to 
Sec. 1.881-3.
    The regulations also define the terms ``guarantee'' and 
``related,'' which are discussed elsewhere in this preamble.
    The IRS and the Treasury recognize the potential overlap of these 
regulations with the proposed regulations governing securities lending 
issued under sections 861, 871, 881, 894 and 1441, published in the 
issue of the Federal Register for January 9, 1992, 57 F.R. 860. In 
connection with the finalization of the proposed regulations concerning 
securities lending and these regulations, guidance will be provided 
coordinating the two sets of regulations.
2. Authority of District Director
    Section 1.881-3(a)(3) authorizes the district director to treat an 
intermediate entity as a conduit entity if the financing arrangement 
satisfies the standard for conduit treatment set forth in Sec. 1.881-
3(a)(4). The district director's exercise of this authority will be 
subject to judicial review under an ``abuse of discretion'' standard.
    In applying the standard for conduit treatment, the district 
director has the authority to determine which financing transactions 
comprise the financing arrangement and which persons are parties to the 
financing arrangement. For example, if an intermediate entity borrows 
$100 from a related person and $100 from an unrelated person, and in 
turn lends $100 to a U.S. person, the district director may determine 
based on the facts, whether the financing arrangement is among the U.S. 
borrower, the intermediate entity and the related person or the U.S. 
borrower, the intermediate entity and the unrelated person.
3. Standard for Conduit Treatment
    Section 1.881-3(a)(4) provides the standard to be applied by the 
district director in determining whether an intermediate entity is 
disregarded for purposes of section 881. The standard depends upon the 
relationship of the parties in the financing arrangement. If the 
intermediate entity is related to the financing entity or the financed 
entity, the financing arrangement will be subject to recharacterization 
if two conditions are satisfied: (i) The participation of the 
intermediate entity in the financing arrangement reduces the tax 
imposed by section 881; and (ii) the participation of the intermediate 
entity in the financing arrangement is pursuant to a tax avoidance 
plan, which is defined in Sec. 1.881-3(c)(1) as a plan one of the 
principal purposes of which is the avoidance of tax imposed by section 
881. The definition of the term ``related'' contained in Sec. 1.881-
3(a)(2)(v), with certain exceptions, is consistent with the definition 
of related party (and the related attribution rules) in Sec. 1.6038A-1 
(d) and (e).
    If the intermediate entity is unrelated to both the financing 
entity and the financed entity, the financing arrangement will be 
subject to recharacterization if the two conditions described above are 
satisfied 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 engaged in the 
financing transaction with the intermediate entity. Section 1.881-3(b) 
provides that, if the financing entity guarantees the liability of the 
financed entity to the intermediate entity, it will be presumed that 
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. A taxpayer may rebut this presumption by producing 
clear and convincing evidence to the contrary.
    Section 1.881-3(a)(2)(iv) defines a ``guarantee'' as 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 regulations 
further provide that the term is to be interpreted in accordance with 
the definition of guarantee in section 163(j)(6)(D)(iii).
    Section 1.881-3(a)(4)(ii)(A) provides that the district director 
may apply principles consistent with the general recharacterization 
standard described above in cases involving multiple intermediate 
entities. Section 1.881-3(a)(4)(ii)(B) contains a special rule that 
applies 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. In such 
a case, the district director may treat the related persons as a single 
intermediate entity if he or she determines based upon all the facts 
and circumstances that the avoidance of the application of Sec. 1.881-3 
is one of the principal purposes for the structuring of the financing 
transactions. That paragraph also permits the district director to 
apply similar principles if a financing transaction exists between 
related persons, but one of the principal purposes for the existence of 
the financing transaction is to prevent the district director from 
treating the related persons as a single intermediate entity.
4. Determination of Existence of Tax Avoidance Plan
    Section 1.881-3(c) contains rules for determining whether 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 tax imposed by section 881 (tax avoidance plan). This 
determination is to be based upon all of the facts and circumstances. 
In this regard, the only relevant purposes are those pertaining to the 
participation of the intermediate entity in the financing arrangement, 
not those pertaining to the existence of the financing arrangement in 
general. Moreover, the fact that an intermediate entity is a resident 
of a country that has a 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 application of these regulations 
only to an intermediate entity whose participation is pursuant to a 
plan ensures that these regulations apply only to transactions that are 
related to each other through the taxpayer's intention to secure, in an 
artificial manner, exemptions or reductions of withholding tax that 
would not otherwise be available given the economic substance of its 
transactions.
    Section 1.881-3(c)(2) lists several nonexclusive factors that are 
relevant to the determination of whether the intermediate entity's 
participation is pursuant to a tax avoidance plan. 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).
    Section 1.881-3(c)(3) provides that 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 the financing entity or the financed entity and 
the intermediate entity performs significant financing activities, as 
defined, with respect to the financing transactions forming part of the 
financing arrangement to which it is a party. The district director may 
rebut the presumption by establishing that the participation of the 
intermediate entity in the financing arrangement is pursuant to a tax 
avoidance plan. The IRS solicits comments on the significant financing 
activity presumption.
    Section 1.881-3(c)(4) provides a set of special rules applicable in 
cases where the financing entity is unrelated to the intermediate 
entity (or entities) and the financed entity. Section 1.881-3(c)(4)(i) 
provides that, in such cases, if the intermediate entity (or, in the 
case of multiple intermediate entities, the intermediate entity that 
has engaged in a financing transaction with the financed entity) is 
actively engaged in a substantial trade or business (other than the 
business of making or managing investments, except pursuant to a 
banking, insurance, financing or similar trade or business, the income 
from which is earned predominantly in transactions with unrelated 
persons), it will be presumed that the participation of the 
intermediate entity in the financing arrangement is not pursuant to a 
tax avoidance plan. This presumption may be rebutted if the district 
director establishes that the participation of the intermediate entity 
in the financing arrangement is pursuant to such a plan.
    Section 1.881-3(c)(4)(ii) provides that, in any case where a 
financing entity is unrelated to the financed entity and the 
intermediate entity (or entities), the financing entity will not be 
liable for tax under section 881 pursuant to these regulations unless 
the financing entity knows or has reason to know that the financing 
arrangement is subject to recharacterization under Sec. 1.881-3(a)(3). 
Section 1.881-3(c)(4)(ii) does not relieve the section 881 liability 
for purposes of determining whether any person is liable for 
withholding tax pursuant to Sec. 1.1441-3(j) or whether any party to a 
financing arrangement is entitled to a refund of tax actually withheld 
by a withholding agent pursuant to section 1441. Accordingly, if the 
requirements of Sec. 1.881-3(a)(4) are satisfied, the financed entity 
is required to pay withholding tax without regard to the knowledge of 
the financing entity and no party to the financing arrangement is 
entitled to a refund (except to the extent the amount withheld exceeds 
the amount determined under section 881).
    A person is not considered to have reason to know that the 
financing arrangement is subject to recharacterization if the person 
knows of the financing transactions that comprise the financing 
arrangement but does not know or have reason to know of facts 
sufficient to establish that the intermediate entity's participation 
was pursuant to a tax avoidance plan. The IRS solicits comments on the 
treatment of unrelated financing entities.
5. Determination of Amount of Tax Liability
    Section 1.881-3(d) provides rules for determining the portion of 
each payment made by a financed entity that is recharacterized under 
Sec. 1.881-3(a)(3). The recharacterized portion is proportionate to a 
ratio of the principal amounts of the financing transactions that 
comprise the financing arrangement. This ratio measures the proportion 
of money or other property advanced by the financing entity to the 
intermediate entity that is considered to flow through to the financed 
entity.
    If a financing arrangement involves multiple conduit entities, the 
ratio is based upon a comparison of the smallest financing transaction 
between a conduit entity and a party other than the financed entity, 
and the financing transaction involving the financed entity. Thus, if 
pursuant to a financing arrangement, A lends $500 to B, B lends $300 to 
C, and C lends $350 to D, and B and C are conduit entities, the ratio 
equals $300/$350 (assuming at the time of the payment from the financed 
entity to the conduit entity the principal amounts have not changed). 
This rule does not apply, however, in a case where the district 
director treats related persons as a single intermediate entity under 
Sec. 1.881-3(a)(4)(ii)(B).
    Section 1.881-3(d)(1)(iii) provides that the principal amount of a 
financing transaction will be determined on the basis of all of the 
facts and circumstances. The principal amount generally will equal 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. In the case of a debt instrument 
or stock, the fair market value of the property advanced will be 
considered to equal the issue price unless the fair market value 
differs materially from the issue price. The principal amount of a 
financing transaction will be subject to adjustments, as appropriate. 
The IRS solicits comments on the definition of principal amount.
    Section 1.881-3(d)(2) provides that payments made by a financed 
entity pursuant to a financing arrangement that is recharacterized 
under Sec. 1.881-3(a)(3) are subject to tax at the rate applicable to 
payments made directly to the financing entity. Thus, the rate of tax 
will be affected by whether an income tax treaty is in existence 
between the United States and the country in which the financing entity 
is a resident. However, special withholding rules apply under 
Sec. 1.1441-3(j).
6. Interaction With Treaties
    These regulations are intended to provide anti-abuse rules that 
supplement, but do not conflict with, the limitation on benefits 
articles in U.S. income tax treaties. Treaty limitation on benefits 
articles commonly limit the tax benefits of the treaty to those 
residents of the other contracting state that have a substantial 
business nexus with, or otherwise have a significant business purpose 
for residing in, the other contracting state. These articles generally 
provide objective, bright-line rules for determining whether an entity 
has a sufficient nexus to the contracting state to be treated as a 
resident for treaty purposes. It has been recognized that contracting 
states may supplement these rules by transactionally-based domestic 
anti-abuse rules, including rules under which a particular transaction 
may be recast, in accordance with the substance of the transaction. 
These regulations, which reflect common law substance over form 
principles as applied to conduit financing arrangements, complement the 
limitation on benefits provisions of income tax treaties and are not 
precluded by the inclusion of such provisions, just as those provisions 
have not overridden the applicability of existing anti-conduit rulings 
such as Rev. Rul. 84-152, 1984-2 C.B. 381, Rev. Rul. 84-153, 1984-2 
C.B. 383, and Rev. Rul. 87-89, 1987-1 C.B. 195.
    Accordingly, Sec. 1.881-3(d)(3) provides that a financing 
arrangement may be recharacterized under Sec. 1.881-3 regardless of 
whether the conduit entity is a resident of a country that has an 
income tax treaty with the United States. Thus, the treaty applicable 
to determine the amount of tax due under section 881, if any, will be 
based upon the substance of the financing arrangement.
7. Alternative Approach Not Adopted
    In formulating these regulations, the IRS and the Treasury 
considered several alternative standards for recharacterizing a 
financing arrangement. For example, consideration was given to a test 
that would measure the similarity of the cash flows of the financing 
transactions that comprise the financing arrangement, with respect to 
both the advance and repayment of funds. This test was rejected 
principally for the following reasons. First, the delineation of cash 
flows considered characteristic of a conduit arrangement would be 
inherently arbitrary. In a substantial number of cases, the application 
of the test would produce results that were either overinclusive or 
underinclusive. Second, such a test could be circumvented, particularly 
with respect to cash flows on repayment. Related parties have 
particular flexibility to structure the terms of their financing 
transactions to satisfy a bright-line test. Unrelated parties may have 
less flexibility. However, in either case, parties could alter the 
financial consequences of holding an asset or liability with particular 
cash flows through the use of derivative financial instruments.
    Although the regulations do not adopt a bright-line cash flow test, 
Sec. 1.881-3(c)(2) (i)(C) and (ii)(B) provides that the timing of the 
advances of money or other property to the intermediate entity and the 
financed entity pursuant to the financing arrangement is a factor 
relevant to whether the intermediate entity's participation is pursuant 
to a tax avoidance plan. The regulations do not set forth as a factor 
the similarity of the repayment terms of the financing transactions. 
This is because of concerns about the extent to which the similarity of 
repayment terms is a useful indication of a tax avoidance plan. The IRS 
solicits comments on this point.
8. Equity Investments
    The legislative history to section 7701(l) authorizes the issuance 
of regulations that apply to financing arrangements involving equity 
investments. These regulations, however, generally do not include 
investments in common stock (or investments in ordinary perpetual 
preferred stock) in the definition of financing transaction principally 
for the following reasons. First, because a corporation has no legal 
obligation to make distributions with respect to its common stock, 
inclusion of ordinary common stock in the definition of financing 
transaction could add significant uncertainty and complexity to the 
application of the regulations. Second, there are substantial questions 
about the extent to which common stock and ordinary perpetual preferred 
stock can be used in a conduit financing arrangement to avoid U.S. 
withholding tax. Nevertheless, the IRS and the Treasury remain 
concerned about the potential for abuse with respect to such equity 
investments and will monitor developments in this area. If the IRS and 
the Treasury determine that taxpayers are structuring conduit financing 
arrangements with such stock to avoid U.S. withholding tax, these 
regulations may be extended to cover such stock.
9. Guarantees
    The legislative history to section 7701(l) authorizes the issuance 
of regulations that apply to financing arrangements involving debt 
guarantees. These regulations, however, generally do not treat debt 
guarantees as a financing transaction as defined in Sec. 1.881-
3(a)(2)(ii). Nevertheless, the IRS and the Treasury remain concerned 
about the potential for abuse with respect to debt guarantees and will 
monitor developments in this area. If the IRS and the Treasury 
determine that taxpayers are structuring conduit financing arrangements 
with debt guarantees to avoid U.S. withholding tax, these regulations 
may be extended to cover debt guarantees.
10. Collateral Consequences of Recharacterization
    These regulations do not provide that a financing arrangement 
recharacterized for purposes of sections 871, 881, 1441 or 1442 is also 
recharacterized for purposes of other Code sections. The IRS and the 
Treasury are considering, however, the circumstances under which the 
recharacterization should be extended to other Code sections. The IRS 
solicits comments on this point.
11. Use of Regulations by Taxpayers
    Section 1.881-3(a)(3) provides that a taxpayer may not apply 
Sec. 1.881-3 to reduce its tax liability. However, a taxpayer may 
comply with the provisions of Sec. 1.881-3 in order to avoid the 
imposition of interest and penalties.

Section 1.881-4

    Section 1.881-4 provides rules for the furnishing of information 
and the maintenance of records concerning financing arrangements to 
which Sec. 1.881-3 applies.
    Section 1.881-4(b) provides that a financed entity that is a 
reporting corporation within the meaning of section 6038A(a) and the 
regulations under that section, or that is required to report pursuant 
to section 6038(a) and the regulations under that section, must comply 
with certain reporting requirements with respect to any financing 
transaction to which the financed entity is a party that it knows or 
has reason to know forms a part of a financing arrangement described in 
Sec. 1.881-3(a)(4) (determined without regard to the tax avoidance 
purpose rule of Sec. 1.881-3(a)(4)(i)(B)). This rule applies only if a 
person with respect to which the financed entity is required to report 
under sections 6038 or 6038A is a party to that financing arrangement.
    Section 1.881-4(c) provides that a financed entity or any other 
person subject to the general recordkeeping requirements of section 
6001, or the recordkeeping requirements of Sec. 1.6038A-3, must keep 
the permanent books of account or records, as required by section 6001 
or Sec. 1.6038A-3, that may be relevant to the determination of whether 
the financing arrangement is subject to recharacterization under 
Sec. 1.881-3.

Section 1.1441-3(j)

    Section 1.1441-3(j) provides that a financed entity or other person 
required to withhold tax under section 1441 with respect to a financing 
arrangement subject to recharacterization under Sec. 1.871-1(b)(7) or 
1.881-3(a)(3), is required to withhold in accordance with the 
recharacterization on the portion of each payment subject to 
recharacterization, as determined by Sec. 1.881-3(d).

Section 1.1441-7

    Section 1.1441-7(d) provides that a person is required to withhold 
tax under section 1441 in accordance with the recharacterization of a 
financing arrangement under Sec. 1.881-3(a)(3) if the person knows or 
has reason to know that the financing arrangement is subject to 
recharacterization under those sections and the person otherwise is a 
withholding agent with respect to the financing arrangement. The 
``knows or has reason to know'' standard is the standard that generally 
applies to withholding agents presented with a claim for treaty 
benefits. See, e.g., Rev. Rul. 85-4, 1985-1 C.B. 294, 295; Rev. Rul. 
76-224, 1976-1 C.B. 268, 269. A person is not considered to have reason 
to know that a financing arrangement is subject to recharacterization 
under Sec. 1.881-3(a)(3) if the person knows of the financing 
transactions that comprise the financing arrangement but does not know 
or have reason to know of facts sufficient to establish that the 
intermediate entity's participation was pursuant to a tax avoidance 
plan. The IRS solicits comments on the standard applicable to 
withholding agents.

Proposed Effective Date

    Sections 1.881-3, 1.881-4, 1.1441-3(j) and 1.1441-7(d) are proposed 
to be effective for payments made after the date which is 30 days after 
publication of final regulations in the Federal Register. This 
regulation shall not apply with respect to interest payments made by 
United States corporations to Netherlands Antilles corporations in 
connection with debt obligations issued prior to October 15, 1984 (see 
Rev. Rul. 85-163, 1985-2 C.B. 349) and payments of interest covered by 
section 127(g)(3) of the Tax Reform Act of 1984.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5 U.S.C. 
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do 
not apply to these regulations, and, therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for Friday, December 16, 1994, 
at 10 a.m., in the Internal Revenue Service Auditorium, 7400 corridor. 
Because of access restrictions, visitors will not be admitted beyond 
the Internal Revenue Building lobby more than 15 minutes before the 
hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons that wish to present oral comments at the hearing must 
submit written comments and submit an outline of the topics to be 
discussed and the time to be devoted to each topic (signed original and 
eight (8) copies) by December 13, 1994.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

    Several persons from the Office of Chief Counsel and the Treasury 
Department participated in developing these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendment to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for Secs. 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 1.6038-2 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 and 7701(l).
    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 Sec. 1.871-1, paragraph (b)(7) is added to read as 
follows:


Sec. 1.871-1  Classification and manner of taxing alien individuals.

* * * * *
    (b) * * *
    (7) Conduit financing arrangements. For rules regarding conduit 
financing arrangements, see Secs. 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:


Sec. 1.881-0  Table of contents.

    This section lists the major headings for Secs. 1.881-1 through 
1.881-4.

Sec. 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.

Sec. 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.

Sec. 1.881-3  Conduit financing arrangements.

    (a) General rules and definitions.
    (1) Purpose and scope.
    (2) Definitions.
    (i) Financing arrangement.
    (ii) Financing transaction.
    (iii) Conduit entity.
    (iv) Guarantee.
    (v) Related.
    (vi) Tax avoidance plan.
    (3) Treatment of intermediate entity as conduit entity.
    (i) Authority of district director.
    (ii) Taxpayer's use of this section.
    (4) Standard for conduit treatment.
    (i) In general.
    (ii) Multiple intermediate entities.
    (A) In general.
    (B) Special rule for related persons.
    (b) Determination of whether intermediate entity would not have 
participated in financing arrangement on substantially same terms.
    (c) 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 plan.
    (3) Presumption if significant financing activities performed by 
a related intermediate entity.
    (i) General rule.
    (ii) Requirements.
    (4) Special rules for cases where financing entity is unrelated 
to both intermediate entity and financed entity.
    (i) Presumption of no tax avoidance.
    (ii) Liability of financing entity.
    (d) Determination of amount of tax liability.
    (1) Amount of payment subject to recharacterization.
    (i) In general.
    (ii) Multiple conduit entities.
    (iii) Determination of principal amount.
    (2) Rate of tax.
    (3) Effect of income tax treaties.
    (4) Withholding tax due.
    (e) Coordination with sections 871, 884, 1441 and 1442.
    (f) Examples.
    (g) Effective date.

Sec. 1.881-4  Reporting and recordkeeping requirements concerning 
conduit financing arrangements.

    (a) Scope.
    (b) Reporting requirements.
    (1) Persons required to report.
    (2) Reporting requirement.
    (3) Additional disclosure.
    (c) Recordkeeping requirements.
    (d) Application of sections 6038 and 6038A.
    (1) In general.
    (2) Duplication of reporting requirements.
    (e) Effective date.


Sec. 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 persons in a conduit financing 
arrangement. These rules also apply for purposes of sections 871, 1441, 
and 1442. See Sec. 1.881-4 for reporting and recordkeeping requirements 
concerning conduit financing arrangements. See Secs. 1.1441-3(j) and 
1.1441-7(d) for withholding rules applicable to conduit financing 
arrangements.
    (2) Definitions. The following definitions apply to this section 
and to Secs. 1.881-4, 1.1441-3(j) and 1.1441-7(d).
    (i) Financing arrangement means two or more financing transactions 
pursuant to which one person (the financing entity) advances money or 
other property to another person (the intermediate entity) and the 
intermediate entity advances money or other property to a third person 
(the financed entity), and, if there is more than one intermediate 
entity, there is a chain of financing transactions linking each 
intermediate entity. For this purpose, a transfer of money or other 
property in satisfaction of a repayment obligation is not an advance of 
money or other property. The term financing arrangement also includes 
two or more financing transactions that achieve substantially the same 
result through any other series of steps. A financing arrangement 
exists only for the period during which all of the financing 
transactions are coexistent. See Example 1 of paragraph (f) of this 
section for an illustration of the term financing arrangement.
    (ii) Financing transaction means--
    (A) Any advance of money or other property in exchange for debt;
    (B) Any advance of money or other property in exchange for stock 
(or a similar interest in a partnership or trust) if--
    (1) As of the issue date, the holder has the right (or, as of the 
issue date, it is more likely than not that the holder will receive the 
right) to cause the issuer to redeem the stock, or will receive such a 
right upon the occurrence of a specified event and such event is more 
likely than not to occur, or, as of the issue date, it is more likely 
than not that the stock will be redeemed as a result of an issuer's 
right to redeem the stock (assuming for all purposes of this paragraph 
(a)(2)(ii)(B)(1) that the issuer will have the legally available funds 
to redeem the stock);
    (2) The holder possesses the right (or, as of the issue date, it is 
more likely than not that the holder will obtain the right) to cause, 
directly or indirectly, the issuer to make any payment (other than a 
payment described in paragraph (a)(2)(ii)(B)(1) of this section) with 
respect to the stock (assuming for this purpose that the issuer will 
have the legally available funds to make such a payment), including the 
right, arising upon a default on a payment (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, cause the issuer to be liquidated, or elect a 
majority of the issuer's board of directors, but not including a right 
derived 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; or
    (3) Under circumstances similar to those described in paragraph 
(a)(2)(ii)(B)(1) or (2) of this section, the holder 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 make a payment with respect to the stock;
    (C) Any lease or license;
    (D) Any advance of money or other property not described in 
paragraph (a)(2)(ii)(A), (B) or (C) of this section (including an 
advance by any person to a trust described in sections 671 through 679) 
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. This paragraph (a)(2)(ii)(D) shall not apply to 
the posting of collateral unless the intermediate entity is permitted 
to reduce such 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; and
    (E) Any transaction by which a person becomes a party to an 
existing financing transaction.
    (iii) Conduit entity means an intermediate entity whose 
participation in a financing arrangement is disregarded in whole or in 
part pursuant to this section.
    (iv) Guarantee means 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). However, a 
guarantee that was neither in existence nor contemplated at the time 
the financing transaction between the intermediate entity and the 
financed entity was entered into is not a guarantee for these purposes.
    (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 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.
    (vi) Tax avoidance plan is defined in paragraph (c)(1) of this 
section.
    (3) Treatment of intermediate entity as conduit entity--(i) 
Authority of district director. For purposes of section 881, the 
district director may determine that an intermediate entity is a 
conduit entity under the standard set forth in paragraph (a)(4) of this 
section. In applying that paragraph, the district director may 
determine the composition of the financing arrangement and the number 
of parties to the financing arrangement.
    (ii) 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.
    (4) Standard for conduit treatment--(i) In general. The district 
director, in his or her discretion, may treat an intermediate entity in 
a financing arrangement as a conduit entity if--
    (A) The participation of the intermediate entity in the financing 
arrangement reduces the tax imposed by section 881;
    (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 may apply principles consistent with those of paragraph 
(a)(4)(i) of this section to the entire financing arrangement so as to 
treat two or more intermediate entities as conduit entities. For an 
illustration of this rule see Example 2 of paragraph (f) of this 
section.
    (B) Special rule for related persons. 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 or she determines 
that the avoidance of the application of this section is one of the 
principal purposes for the structuring of the financing transactions. 
This determination shall be based upon all of the facts and 
circumstances, including, without limitation, the factors set forth in 
paragraph (c)(2) of this section. The district director may apply 
similar principles if a financing transaction exists between related 
persons, but one of the principal purposes for the existence of the 
financing transaction is to prevent the district director from treating 
the related persons as a single intermediate entity. For examples 
illustrating the special rule of this paragraph, see Examples 3, 4 and 
5 of paragraph (f) of this section.
    (b) Determination of whether intermediate entity would not have 
participated in financing arrangement on substantially same terms. 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. It shall be presumed that the intermediate entity would 
not have participated in the financing arrangement on substantially the 
same terms if the financing entity guarantees the liability of the 
financed entity to the intermediate entity under that financing 
transaction. A taxpayer may rebut this presumption by producing clear 
and convincing evidence to the contrary.
    (c) 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. The plan may be formal or informal, 
written or oral, and may involve any one or more of the parties to the 
financing arrangement. It may be inferred from the facts and 
circumstances, but must be in existence no later than the last date 
that any of the financing transactions comprising the financing 
arrangement are entered into. The determination of whether the 
participation of the intermediate entity in the financing arrangement 
is pursuant to a tax avoidance plan shall be based upon all of the 
facts and circumstances relevant to the existence of a plan and to the 
purposes for the participation of the intermediate entity in the 
financing arrangement.
    (2) Factors taken into account in determining the presence or 
absence of a tax avoidance plan. Among the facts and circumstances 
taken into account in determining whether the participation of an 
intermediate entity in a financing arrangement is pursuant to a tax 
avoidance plan are--
    (i) Whether the participation of the intermediate entity in the 
financing arrangement significantly reduces the tax that otherwise 
would have been imposed under section 881 (determined by comparing the 
rate of tax imposed on payments made by the financed entity to the 
intermediate entity with the rate that would have been imposed had the 
payments been made by the financed entity to the financing entity). 
However, the fact that an intermediate entity is a resident of a 
country that has a 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;
    (ii) Whether the intermediate entity would have been able to make 
the advance of the money or other property to the financed entity 
without the advance of money or other property to it by the financing 
entity;
    (iii) The length of the period of time that separates the advances 
of money or other property by the financing entity to the intermediate 
entity and by the intermediate entity to the financed entity. A short 
period of time is indicative of a tax avoidance plan while a long 
period of time is not; and
    (iv) If the intermediate entity is related to the financed entity, 
whether the two entities 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 the intermediate entity (other than the 
business of making or managing investments, except pursuant to a 
banking, insurance, financing or similar trade or business the income 
from which is earned predominantly in transactions with unrelated 
persons). A financing transaction described in the preceding sentence 
is indicative that no tax avoidance plan exists.
    (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. For illustrations of this presumption, see Examples 12, 
13 and 14 of paragraph (f) of this section.
    (ii) Requirements. For purposes of this paragraph (c)(3), an 
intermediate entity performs significant financing activities with 
respect to such financing transactions if--
    (A) Rents or royalties earned with respect to leases or licenses 
constituting such financing transactions are derived in the active 
conduct of a trade or business within the meaning of Sec. 1.954-2T(c) 
or (d), to be applied by substituting the term intermediate entity for 
the term controlled foreign corporation; or
    (B) Officers and employees of the intermediate entity, without the 
material participation of any officer or employee of a related person, 
other than participation in the approval of any guarantee of a 
financing transaction--
    (1) Participate actively and materially in arranging the 
intermediate entity's participation in such financing transactions. 
This requirement shall not apply to a financing transaction that is the 
advance of property in exchange for a trade receivable that is ordinary 
and necessary to carrying on a substantial trade or business of either 
the financed entity or the financing entity if officers or employees of 
that entity participated actively and materially in arranging the 
financing transaction; and
    (2) 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)--
    (i) Exercise management and oversight of (and actually carry out) 
the intermediate entity's strategic business decision-making process 
and of its day-to-day operations, which must consist of a substantial 
trade or business, or supervision, administration and financing of a 
substantial group of related persons; and
    (ii) Actively manage, on an ongoing basis, material business 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.
    (4) Special rules for cases where financing entity is unrelated to 
both intermediate entity and financed entity--(i) Presumption of no tax 
avoidance. 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 financing entity is unrelated 
to the intermediate entity (or entities) and the financed entity, and 
the intermediate entity (or, in the case of multiple intermediate 
entities, the intermediate entity that has engaged in a financing 
transaction with the financing entity) is actively engaged in a 
substantial trade or business (other than the business of making or 
managing investments, except pursuant to a banking, insurance, 
financing or similar trade or business the income from which is earned 
predominantly in transactions with unrelated persons). 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. For an illustration of this 
special rule see Example 15 of paragraph (f) of this section.
    (ii) Liability of financing entity--(A) In general. Notwithstanding 
that the district director may treat an intermediate entity in a 
financing arrangement as a conduit entity under paragraph (a)(4) of 
this section, a financing entity that is unrelated to the financed 
entity and the intermediate entity (or entities) shall not be liable 
for tax under section 881 pursuant to this section unless the financing 
entity knows or has reason to know that the financing arrangement is 
subject to recharacterization under paragraph (a)(3) of this section. 
This paragraph (c)(4)(ii) shall not apply, however, for purposes of 
determining whether any person is liable for withholding tax pursuant 
to Sec. 1.1441-3(j) or whether any party to a financing arrangement is 
entitled under sections 1461 to 1464 to a refund of tax actually 
withheld by a withholding agent pursuant to section 1441. Accordingly, 
if the conditions of paragraph (a)(4) of this section are satisfied, 
the financed entity shall be required to pay withholding tax without 
regard to the knowledge of the financing entity and no party to the 
financing arrangement shall be entitled to a refund except to the 
extent the amount withheld exceeds the amount determined under section 
881 by recharacterizing the transaction and disregarding the conduit 
entity pursuant to paragraph (a)(4).
    (B) Know or have reason to know standard. The standard described in 
paragraph (c)(4)(ii)(A) shall be satisfied if the person knows or has 
reason to know those facts relevant to whether the financing 
arrangement satisfies the conditions set forth in paragraph (a)(4) of 
this section, including whether the participation of the intermediate 
entity in the financing arrangement is pursuant to a tax avoidance 
plan. A person shall not be considered to have reason to know that the 
financing arrangement is subject to recharacterization under paragraph 
(a)(3) of this section if the person knows of the financing 
transactions that comprise the financing arrangement but does not know 
or have reason to know of facts sufficient to establish that the 
participation of the intermediate entity in the financing arrangement 
was pursuant to such a plan.
    (d) Determination of amount of tax liability--(1) Amount of payment 
subject to recharacterization--(i) In general. If the district director 
treats an intermediate entity as a conduit entity pursuant to paragraph 
(a)(3) of this section, a portion of each payment made by the financed 
entity with respect to the financing transactions that comprise the 
financing arrangement shall be subject to recharacterization as a 
transaction directly between the financed entity and the financing 
entity. The recharacterized portion shall be the portion of the payment 
that is equal to the ratio (not to exceed 1:1) of the average principal 
amount of such financing transaction(s) between the conduit entity and 
the financing entity to the average principal amount of such financing 
transaction(s) between the financed entity and the conduit entity, for 
the period to which the payment made by the financed entity relates. 
The average may be computed using any method applied consistently that 
reflects with reasonable accuracy the amount outstanding for the 
period. For an illustration of the calculation of the amount of tax 
liability see Example 16 of paragraph (f) of this section.
    (ii) Multiple conduit entities. Except in the case of a financing 
arrangement described in paragraph (a)(4)(ii)(B) of this section, if a 
financing arrangement involves multiple intermediate entities that are 
treated as conduit entities, the ratio described in paragraph (d)(1)(i) 
of this section shall be based upon a comparison of the financing 
transaction between a conduit entity and a party other than the 
financed entity that has the lowest average principal amount, and the 
financing transaction involving the financed entity.
    (iii) Determination of principal amount. The principal amount of a 
financing transaction shall be determined on the basis of all of the 
facts and circumstances. The principal amount generally will equal 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. In the case of a debt instrument 
or stock, the fair market value of the property advanced will be 
considered to equal the issue price unless the fair market value 
differs materially from the issue price. The principal amount of a 
financing transaction shall be subject to adjustments, as appropriate. 
For example, in the case of an OID debt instrument that is repaid in 
installments and has an issue price equal to the fair market value of 
the property advanced, appropriate adjustments will be made for 
accruals of original issue discount and repayments of principal 
(including accrued original issue discount).
    (2) Rate of tax. If a financing arrangement is recharacterized 
under paragraph (a)(3) of this section, the payments by the financed 
entity described in section 881 shall be subject to tax at the rate 
that would have been applicable had payments been made directly to the 
financing entity. The applicable rate shall be determined by reference 
to the character of the financing transaction (e.g., loan or lease) 
between the intermediate entity and the financed entity.
    (3) Effect of income tax treaties. A financing arrangement shall be 
subject to recharacterization under this section regardless of whether 
a conduit entity is a resident of a country that has an income tax 
treaty with the United States. Accordingly, if the financing 
arrangement is recharacterized as a transaction directly between the 
financed entity and a person that is not entitled to claim the benefits 
of the income tax treaty, the treaty shall not operate to reduce the 
amount of tax due under section 881.
    (4) Withholding tax due. For withholding rules applicable to 
financing arrangements described in paragraph (a)(4) of this section, 
see Secs. 1.1441-3(j) and 1.1441-7(d).
    (e) Coordination with sections 871, 884, 1441 and 1442. For 
purposes of this section, any reference to tax imposed under section 
881 includes, as the context may require, a reference to tax imposed 
under sections 871, 884(f)(1)(A), 1441, or 1442.
    (f) 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 X, owns all of the stock of 
FS, a corporation organized in country Y, and DS, a corporation 
organized in the United States. Country Y, but not country X, 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.

    Example 1. Financing arrangement. (i) On January 1, 1995, FP 
lends $1,000,000 to DS in exchange for a note issued by DS. On 
January 1, 1996, 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) FP's loan to DS and FP's assignment of the DS note to FS 
are financing transactions within the meaning of paragraph 
(a)(2)(ii) of this section, and the transactions together constitute 
a financing arrangement within the meaning of paragraph (a)(2)(i) of 
this section. Therefore, for purposes of section 881, the district 
director may treat FS as a conduit entity if the conditions of 
paragraph (a)(4)(i) of this section are satisfied.
    Example 2. Multiple conduits. (i) On January 1, 1995, FP 
deposits $1,000,000 with BK, a bank that is organized in country Y 
and is unrelated to FP and its subsidiaries. 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 Y. On the same date, BK2 lends $500,000 to FS. On July 1, 
1996, FS lends $500,000 to DS. FP pledges its deposit 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) Since there are multiple intermediate entities, under 
paragraph (a)(4)(ii)(A) of this section, principles consistent with 
those of paragraph (a)(4)(i) of this section apply to the entire 
financing arrangement for purposes of determining whether the 
requirements of paragraph (a)(4) of this section are satisfied. 
Since BK and BK2 are unrelated to FP, FS and DS, the conditions of 
paragraph (a)(4)(i)(C)(2) of this section must be satisfied with 
respect to the financing transactions between FP, BK, BK2 and FS. 
The conditions of that paragraph are presumed under paragraph (b) of 
this section to be satisfied 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 (a)(2)(iv) of this section. Since BK 
and BK2 are related, it is not necessary that the conditions of 
paragraph (a)(4)(i)(C)(2) of this section be satisfied independently 
with respect to the financing transactions between FP, BK and BK2. 
In addition, 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. Accordingly, for 
purposes of section 881, the district director may treat FP as a 
financing entity and BK, BK2 and FS as conduit entities, and 
recharacterize the financing arrangement as a financing transaction 
directly between DS and FP.
    Example 3. Related persons treated as a single conduit entity. 
(i) On January 1, 1995, FP deposits $1,000,000 with BK, a bank that 
is organized in country X and is unrelated to FP and its 
subsidiaries. M, a corporation also organized in country X, 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, 1995, M lends 
$1,000,000 to DS in exchange for a note maturing on July 1, 2005. 
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). The conditions of paragraph (a)(4)(i) of 
this section would be satisfied with respect to the financing 
transactions between FP, BK, M and DS but for the absence of a 
financing transaction between BK and M. 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) Pursuant to paragraph (a)(4)(ii)(B) of this section, the 
district director may treat the financing transactions between FP, 
BK, M and DS as a financing arrangement for purposes of this section 
even though BK and M do not engage in a financing transaction. In 
such a case, BK and M would be considered a single intermediate 
entity for purposes of this section.
    Example 4. Related persons treated as a single conduit 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 Y, 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.
    (ii) 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.
    (iii) The conditions of paragraph (a)(4)(i) 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. 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.
    (iv) Pursuant to paragraph (a)(4)(ii)(B) of this section, the 
district director may treat the financing transactions between FP, 
FS, FS2 and DS as a financing arrangement for purposes of this 
section even though FS and FS2 do not engage in a financing 
transaction. In such a case, FS and FS2 would be considered a single 
intermediate entity for purposes of this section.
    Example 5. Related persons treated as a single conduit entity. 
Assume the same facts as in Example 4 except that FS contributes 
$9,900,000 and lends $100,000 to FS2. Pursuant to paragraph 
(a)(4)(ii)(B) of this section, the district director may treat the 
financing transactions between FP, FS, FS2 and DS as a financing 
arrangement for purposes of this section even though FS and FS2 
engage in a financing transaction since from the facts and 
circumstances the district director may determine that one of the 
principal purposes for the existence of the financing transaction is 
to prevent the district director from treating the related persons 
as a single intermediate entity. In such a case, FS and FS2 would be 
considered a single intermediate entity for purposes of this 
section.
    Example 6. Reduction of tax. (i) On January 1, 1995, FP licenses 
to FS the rights to use a patent in the U.S. 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 U.S. 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. 
The fair market value of the patent rights do not increase between 
January 1, 1995, and January 1, 1996.
    (ii) Under the country Y-U.S. income tax treaty, the royalties 
paid by DS to FS are exempt from U.S. withholding tax. However, 
pursuant to Secs. 1.881-2(b) and 1.1441-2(a), the parties withhold 
tax at a 30 percent rate on the royalties paid to FP because the 
royalties are paid in consideration for the privilege of using the 
patent in the United States, and therefore the royalties constitute 
income from U.S. sources under section 861(a)(4).
    (iii) Because the principal amount of the license between FS and 
DS is equal to or less than the principal amount of the license 
between FP and FS, the royalties paid by DS and FS represent an 
arm's length rate, and 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 is not considered to reduce the tax imposed by 
section 881 within the meaning of paragraph (a)(4)(i)(A) of this 
section.
    Example 7. A principal purpose of plan. (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 
treaty between country Y and the United States.
    (ii) The financing arrangement satisfies the tax avoidance 
purpose requirement of paragraph (a)(4)(i)(B) of this section since 
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 Y-U.S. treaty.
    Example 8. Reduction of tax. (i) FX is a wholly-owned subsidiary 
of FP and is a resident of country Y. FX owns all of the stock of 
FS1, which also is a resident of country Y. FS1 owns all of the 
stock of DX, a corporation organized in the United States. On 
January 1, 1995, FP contributes $10,000,000 to the capital of FX. On 
July 1, 1995, FX lends $10,000,000 to FS1. On January 1, 1996, FS1 
lends $10,000,000 to DX. Under the terms of the country Y-U.S. 
income tax treaty, a country Y resident is not entitled to the 
reduced withholding rate on interest income provided by the treaty 
if the resident is entitled to, even if it does not claim, special 
tax benefits under country Y law. In order to qualify for the 
reduced withholding rate on the interest it receives from DX, FS1 
does not claim the special tax benefits under country Y law. FX, 
however, obtains the special tax benefits under country Y law, which 
substantially reduces the rate of tax imposed on the interest it 
receives from FS1. Accordingly, if FX had made a loan directly to 
DX, payments of interest by DX to FX would have been subject to tax 
under section 881 at a 30 percent rate.
    (ii) Pursuant to paragraph (a)(3)(i) of this section, the 
district director may determine that the FX-FS1 loan and the FS1-DX 
loan comprise a financing arrangement. Pursuant to paragraph 
(c)(2)(i)(A) 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 9. Time period between financing 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 10-year note that pays interest 
annually at a rate of 10 percent per annum.
    (ii) Pursuant to paragraph (c)(2)(i)(C) of this section, the 
twelve-month period 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 10. Active conduct of a trade or business. (i) FP is a 
holding company. FS is actively engaged in country Y in the business 
of manufacturing and selling product A. DS manufactures product B, 
which is a principal component used by FS in the manufacture of 
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 lends $30,000,000 to DS to finance its 
manufacturing business.
    (ii) Pursuant to paragraph (c)(2)(ii)(C) of this section, the 
fact that FS makes a loan to DS in order to finance a business 
actively engaged in by DS that forms a part of, or is complementary 
to, a substantial business actively engaged in by FS 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 11. Ordinary course deposits of working capital. (i) 
Over a period of years, FP has maintained a deposit with BK, a bank 
that is organized in country Y and is unrelated to FP and its 
subsidiaries. FP has placed funds in the bank account in order to 
maintain sufficient liquidity to meet its working capital needs. On 
January 1, 1995, BK lends $5,000,000 to DS. FP guarantees to BK that 
DS will satisfy its repayment obligation on the loan. Both prior to 
and 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) The fact that FP has historically 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, is evidence that 
the participation of BK in the FP-BK-DS 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.
    (iii) Assume the same facts, except that on January 1, 2000, 
FP's deposit with BK substantially exceeds FP's expected working 
capital needs. On January 2, 2000, BK lends additional funds to DS. 
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.
    (iv) The presence of funds substantially in excess of FP's 
working capital needs and FP's willingness to lend funds directly to 
DS is 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.
    (v) In either case, the taxpayer may establish, pursuant to 
paragraph (b) of this section, that BK would have made the loan to 
DS on substantially the same terms in the absence of FP's deposit 
with BK.
    Example 12. Presumption with respect to significant financing 
activities. (i) FS has 100 employees located in country Y who are 
responsible for coordinating the financing of all of the 
subsidiaries of FP, which are engaged in a substantial trade or 
business and are located in both country Y and country X. FS 
maintains a centralized cash management accounting system for FP and 
its subsidiaries in which it records all 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. 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 in excess 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) of this section, and the 
transactions together constitute a financing arrangement within the 
meaning of paragraph (a)(2)(i) of this section. FS performs 
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 advances of property in exchange 
for trade receivables that were ordinary and necessary to carry on 
the trades or businesses of DS and the other subsidiaries of FP. 
Accordingly, pursuant to paragraph (c)(3)(i) of this section, FS's 
participation in the financing arrangement is presumed not to be 
pursuant to a tax avoidance plan.
    Example 13. Active management of material business risks. (i) 
The facts are the same as in Example 12, 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 X. 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, 1994; 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 semiannually 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 business 
risks arising from those financing transactions through its currency 
swap with BK. Accordingly, the financing arrangement does not 
benefit from the presumption of paragraph (c)(3)(i) 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.
    Example 14. A principal purpose of plan. (i) The facts are the 
same as in Example 12, except that, on January 1, 1995, FP lends to 
FS 20,000,000 deutsche marks (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 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. 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 its 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 Y 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 Y. For 
example, the loans are made on the same day and FS would not have 
been able to make the loan to DS without the loan from FP.
    Example 15. Presumption with respect to unrelated financing 
entity. (i) FP is a corporation organized in country Y that is 
actively engaged in a substantial manufacturing business. On January 
1, 1995, FP obtains a 20-year $100,000,000 loan from BK, a bank that 
is organized in country X and is unrelated to FP and its 
subsidiaries. On January 1, 1996, FP lends $10,000,000 to DS.
    (ii) Pursuant to paragraph (c)(4)(i) of this section, FP's 
participation in the financing arrangement with BK and DS is 
presumed not to be pursuant to a tax avoidance plan because BK is 
unrelated to both FP and DS, and FP is actively engaged in a 
substantial manufacturing business.
    Example 16. Calculation 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. Payments on each loan are $7,950 per month. On the same date, 
FS lends $1,000,000 to DS in exchange for a two-year note that pays 
interest semi-annually at a rate of 10 percent per annum, beginning 
on June 30, 1996. The district director determines that the 
financing transactions between FP and FS, and FS and DS, are made 
pursuant to a financing arrangement involving FP, FS and DS, that 
satisfies the conditions of paragraph (a)(4) of this section.
    (ii) 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.
    (iii) 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.
    (iv) Under Sec. 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.

    (g) Effective date. This section is effective for payments made 
after the date which is 30 days after publication of final regulations 
in the Federal Register. This section shall not apply with respect to 
interest payments made by United States corporations to Netherlands 
Antilles corporations in connection with debt obligations issued prior 
to October 15, 1984 and payments of interest covered by section 
127(g)(3) of the Tax Reform Act of 1984.


Sec. 1.881-4  Reporting and recordkeeping requirements concerning 
conduit financing arrangements.

    (a) Scope. This section provides rules for the furnishing of 
information and the maintenance of records concerning certain financing 
arrangements to which the provisions of Sec. 1.881-3 apply. This 
section also provides rules for coordinating the application of 
sections 6038 and 6038A with the application of this section.
    (b) Reporting requirements--(1) Persons required to report. A 
financed entity that is a reporting corporation within the meaning of 
section 6038A(a) and the regulations under that section, or that is 
required to report pursuant to section 6038(a) and the regulations 
under that section, shall be required to comply with the requirements 
of this paragraph (b) with respect to any financing transaction to 
which the financed entity is a party, that the financed entity knows or 
has reason to know forms a part of a financing arrangement described in 
Sec. 1.881-3(a)(4) (determined without regard to Sec. 1.881-
3(a)(4)(i)(B)). For purposes of this paragraph (b), a financed entity 
will be considered to know or have reason to know that the conditions 
of Sec. 1.881-3(a)(4)(i)(C)(2) are satisfied with respect to a 
financing arrangement if the financed entity knows or has reason to 
know that the financing entity has guaranteed the liability of the 
financed entity under the financing transaction. This paragraph (b) 
applies only if a person with respect to which the financed entity is 
required to report under sections 6038 or 6038A is a party to the 
financing arrangement.
    (2) Reporting requirement. A financed entity described in paragraph 
(b)(1) of this section shall be required to attach to the Form 5471 or 
5472, whichever is applicable, for each year in which it is a party to 
a financing transaction described in paragraph (b)(1) of this section, 
a statement setting forth the following information (rendered in the 
English language and expressed in United States currency, with 
disclosure of applicable exchange rates) concerning each financing 
transaction--
    (i) The character (e.g., loan, stock, lease, license) of the 
financing transaction;
    (ii) The name of the person that advanced money or other property 
to the financed entity in the financing transaction, and the name of 
the person (if different) to which the financed entity has made 
payments pursuant to the financing arrangement;
    (iii) The date and amount of each advance of money or other 
property to the financed entity;
    (iv) The amount of money or other property paid by the financed 
entity pursuant to the financing transaction, and the date on which 
each payment was made;
    (v) A description of any guarantee provided by the financing entity 
in connection with the financing arrangement; and
    (vi) With respect to each party to the financing arrangement that 
is related to the financed entity within the meaning of Sec. 1.881-
3(a)(2)(v)--
    (A) The name, address, taxpayer identification number, if any, and 
country of residence of the related person; and
    (B) A description of the manner in which the financed entity and 
the person are related.
    (3) Additional disclosure. A financed entity may be required to 
disclose on its Federal income tax return, or on other forms (including 
Form 5471 or Form 5472, if otherwise applicable), information 
concerning its participation in a financing arrangement described in 
paragraph (b)(1) of this section, regardless of whether the financed 
entity is required to report pursuant to paragraph (b)(1) of this 
section. Information disclosed on the return or other forms need not 
also be reported pursuant to paragraph (b)(2) of this section.
    (c) Recordkeeping requirements. A financed entity or any other 
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 whether that person is a party 
to a financing arrangement that is subject to recharacterization under 
Sec. 1.881-3. In addition, 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 Sec. 1.6038A-3, must comply with such 
recordkeeping requirements with respect to records that may be relevant 
to whether the financed entity is a party to a financing arrangement 
that is subject to recharacterization under Sec. 1.881-3.
    (d) Application of sections 6038 and 6038A--(1) In general. Any 
information that a financed entity is required to report pursuant to 
paragraph (b) of this section, or any records that any person is 
required to maintain pursuant to paragraph (c) of this section, shall 
be considered information that is required to be reported, or records 
that are required to be maintained, pursuant to sections 6038 or 6038A 
if such person is required to report information or maintain records 
concerning transactions between the financed entity and any other party 
to the financing arrangement under either section 6038 or section 
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 information 
required to be reported or records required to be maintained pursuant 
to this section.
    (2) Duplication of reporting requirements. Information that is 
required to be reported on Form 5471 by Sec. 1.6038-2(f) or on Form 
5472 by Sec. 1.6038A-2(b) need not be duplicated on the statements 
required by paragraph (b)(2) of this section. Information that is 
required to be reported about a particular financing transaction on the 
statement required by paragraph (b)(2) of this section shall not be 
considered to duplicate information required to be reported in the 
aggregate on Form 5471 or Form 5472 about more than one financing 
transaction.
    (e) Effective date. This section is effective for tax years in 
which payments described in Sec. 1.881-3 are made. This section shall 
not apply with respect to interest payments made by United States 
corporations to Netherlands Antilles corporations in connection with 
debt obligations issued prior to October 15, 1984 and payments of 
interest covered by section 127(g)(3) of the Tax Reform Act of 1984.
    Par. 4. In Sec. 1.1441-3, paragraph (j) is added to read as 
follows:


Sec. 1.1441-3  Exceptions and rules of special application.

* * * * *
    (j) Conduit financing arrangements. A financed entity or other 
person required to withhold tax under section 1441 with respect to a 
financing arrangement subject to recharacterization under Sec. 1.871-
1(b)(7) or 1.881-3(a)(3), shall be required to withhold in accordance 
with the recharacterization on the portion of each payment subject to 
recharacterization, as determined by Sec. 1.881-3(c). If the financing 
entity is entitled to the benefit of a treaty that provides a reduced 
rate of tax on a payment of the type recharacterized, the financed 
entity may withhold tax at that reduced rate if the financing entity 
complies with the procedures, if any, prescribed in the relevant 
treaty, or in regulations under section 1441. See Sec. 1.1441-7(d) 
relating to withholding tax liability of the withholding agent in 
conduit financing arrangements subject to Sec. 1.881-3. This paragraph 
(j) is effective for payments made after the date which is 30 days 
after publication of final regulations in the Federal Register. This 
section shall not apply with respect to interest payments made by 
United States corporations to Netherlands Antilles corporations in 
connection with debt obligations issued prior to October 15, 1984 and 
payments of interest covered by section 127(g)(3) of the Tax Reform Act 
of 1984.
    Par. 5. In Sec. 1.1441-7, paragraph (d) is added to read as 
follows:


Sec. 1.1441-7  General provisions relating to withholding agents.

* * * * *
    (d) Conduit financing arrangements. A person shall be required to 
withhold tax under section 1441 in accordance with the 
recharacterization of a financing arrangement under Sec. 1.871-1(b)(7) 
or 1.881-3(a)(3) if the person knows or has reason to know that the 
financing arrangement is subject to recharacterization under those 
sections and the person otherwise is a withholding agent with respect 
to the financing arrangement. This standard shall be satisfied if the 
person knows or has reason to know those facts relevant to whether the 
financing arrangement satisfies the conditions set forth in Sec. 1.881-
3(a)(4), including whether the participation of the intermediate entity 
is pursuant to a tax avoidance plan. A person shall not be considered 
to have reason to know that the financing arrangement is subject to 
recharacterization under Sec. 1.871-1(b)(7) or 1.881-3(a)(3) if the 
person knows of the financing transactions that comprise the financing 
arrangement but does not know or have reason to know facts sufficient 
to establish that the participation of the intermediate entity in the 
financing arrangement was pursuant to such a plan. This paragraph is 
effective for payments made after the date which is 30 days after 
publication of final regulations in the Federal Register. This section 
shall not apply with respect to interest payments made by United States 
corporations to Netherlands Antilles corporations in connection with 
debt obligations issued prior to October 15, 1984 and payments of 
interest covered by section 127(g)(3) of the Tax Reform Act of 1984.
    Par. 6. In Sec. 1.6038-2, paragraph (f)(12) is added to read as 
follows:


Sec. 1.6038-2  Reporting requirements for conduit financing 
arrangements.

* * * * *
    (f) * * *
    (12) Conduit financing arrangements. See Sec. 1.881-4 for 
additional information that must be reported on (or attached to) Form 
5471 relating to conduit financing arrangements.
* * * * *
    Par. 7. In Sec. 1.6038A-2, paragraph (b)(9) is added to read as 
follows:


Sec. 1.6038A-2  Requirement of return.

* * * * *
    (b) * * *
    (9) See Sec. 1.881-4 for additional information that must be 
reported on (or attached to) Form 5472 relating to conduit financing 
arrangements.
* * * * *
    Par. 8. In Sec. 1.6038A-3, paragraphs (b)(5) and (c)(2)(vii) are 
added to read as follows:


Sec. 1.6038A-3  Record maintenance.

* * * * *
    (b) * * *
    (5) Records relating to conduit financing arrangements. See 
Sec. 1.881-4 relating to conduit financing arrangements.
    (c) * * *
    (2) * * *
    (vii) Records relating to conduit financing arrangements. See 
Sec. 1.881-4 relating to conduit financing arrangements.
* * * * *
    Par. 9. Section 1.7701(l)-1 is added to read as follows:


Sec. 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)--
    (1) Sec. 1.871-1(b)(7);
    (2) Sec. 1.881-3;
    (3) Sec. 1.881-4;
    (4) Sec. 1.1441-3(j);
    (5) Sec. 1.1441-7(d);
    (6) Sec. 1.6038A-2(f)(12);
    (7) Sec. 1.6038A-2(b)(9);
    (8) Sec. 1.6038A-3(b)(5); and
    (9) Sec. 1.6038A-3(c)(2)(vii).
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-25403 Filed 10-11-94; 8:48 am]
BILLING CODE 4830-01-U