1310 Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8853]

RIN 1545–AV07

Recharacterizing Financing

Arrangements Involving Fast-Pay

Stock

AGENCY: Internal Revenue Service (IRS),

Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final

regulations that recharacterize, for tax

purposes, financing arrangements

involving fast-pay stock. The regulations

are necessary to prevent taxpayers from

using fast-pay stock to achieve

inappropriate tax avoidance. The

regulations affect corporations that issue

fast-pay stock, holders of fast-pay stock,

and other shareholders that may claim

tax benefits purported to result from

arrangements involving fast-pay stock.

DATES: Effective Date: February 27,

1997.

Applicability Dates: For dates of

applicability, see §§ 1.1441–10(e) and

1.7701(l)–3(g) of these regulations.

FOR FURTHER INFORMATION CONTACT:

Jonathan Zelnik, (202) 622–3920 (not a

toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information

contained in these final regulations has

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork

Reduction Act of 1995 (44 U.S.C.

3507(d)) under control number 1545–

1642. Responses to this collection of

information are mandatory.

An agency may not conduct or

sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information

displays a valid control number.

The estimated average annual burden

hours per respondent/recordkeeper: 1

hour.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and to the

Office of Management and Budget, Attn:

Desk Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503.

Books or records relating to a

collection of information must be

retained as long as their contents may

become material in the administration

of any internal revenue law. Generally,

tax returns and tax information are

confidential, as required by 26 U.S.C.

6103.

Background

On February 27, 1997, the IRS issued

Notice 97–21, 1997–1 C.B. 407, which

relates to financing arrangements

involving fast-pay stock. Among other

things, the notice informed the public

that the IRS and Treasury Department

expected to issue regulations

recharacterizing these arrangements to

prevent tax avoidance. No comments

were received in response to Notice 97–

21.

On January 6, 1999, the IRS published

in the Federal Register a notice of

proposed rulemaking (64 FR 805)

providing rules for the

recharacterization of certain fast-pay

arrangements under section 7701(l) of

the Internal Revenue Code. Because no

one requested to speak at the public

hearing, the hearing was canceled. Four

written comments responding to the

notice of proposed rulemaking were

received. The comments addressed

neither (1) the accuracy of the estimate

of the collection of information burden

nor (2) the accuracy of the IRS’s

understanding that the total number of

entities engaging in transactions affected

by these regulations is not substantial

and most are not small entities within

the meaning of the Regulatory

Flexibility Act (5 U.S.C. chapter 6).

After considering the comments, the

proposed regulations are adopted as

final regulations with some changes.

The preamble to the proposed

regulations (64 FR 805) provides a

detailed discussion of fast-pay

arrangements and the proposed

regulations.

Summary of Comments and Changes

In General

Two commentators were generally

favorable to the proposed regulations.

One considered them a reasonable

attempt to address abusive transactions.

The other viewed them as consistent

with section 7701(l), but preferred, as a

matter of tax policy, a legislative

solution. One of these commentators

also recommended narrowing the scope

of the proposed regulations, asserting

they might penalize shareholders who

do not benefit from the fast-pay

arrangement. Significantly, neither of

these commentators recommended that

the final regulations adopt a different

approach, such as the one taken in

Notice 97–21.

A third commentator criticized the

proposed regulations as inconsistent

with section 7701(l). This commentator

viewed them as addressing not a

conduit financing issue, but a tax

accounting issue, namely, that the

amount of dividend income under tax

principles can exceed the economic

income from the stock. Additionally,

this commentator believed that

regulations under section 7701(l) cannot

operate if there is no back-to-back

structure or if the corporation subject to

recharacterization holds bona fide assets

such as third-party debt. Finally, the

commentator questioned whether the

grant of regulatory authority under

section 7701(l) permits recharacterizing

transactions subject to other,

comprehensive statutory rules such as

the rules governing the transactions of

RICs and REITs.

The IRS and Treasury Department

have concluded that section 7701(l)

authorizes recharacterization of any

multiple-party financing transaction,

including a fast-pay arrangement. The

IRS and Treasury Department have also

concluded (as did the other two

commentators) that recharacterizing a

fast-pay arrangement as an arrangement

directly between the fast-pay

shareholders and the benefited

shareholders is consistent with the

legislative mandate of section 7701(l).

Thus, the final regulations retain the

approach of the proposed regulations

while making some changes to address

other comments.

Definition of Fast-Pay Stock

Under the proposed regulations, stock

is fast-pay stock if it is structured so that

dividends (as defined in section 316)

paid by the corporation with respect to

the stock are economically (in whole or

in part) a return of the holder’s

investment (as opposed to only a return

on the holder’s investment). To

determine if it is fast-pay stock, stock is

examined when issued, and, for stock

that is not fast-pay stock when issued,

when there is a significant modification

in the terms of the stock or the related

agreements or a significant change in

the relevant facts and circumstances.

Two commentators expressed concern

about the interaction of section 302 with

the definition of fast-pay stock and the

duty to retest stock. In particular, the

commentators asked whether stock that

is not fast-pay stock when issued can

become fast-pay stock solely because a

redemption of the stock is treated as a

dividend under section 302. This

conversion is possible because section

302 treats certain redemptions as

distributions of property to which

Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations 1311

section 301 applies rather than as

distributions in exchange for stock.

The commentators gave different

reasons why stock should not become

fast-pay stock solely because a

redemption is treated as a dividend.

One reason was that section 302 and the

provisions referring to it (for example,

section 1059(e)) already recharacterize

certain redemptions of stock, which

indicates Congress has determined the

appropriate tax treatment of these

transactions. Another reason was that

applying the fast-pay regulations to

arrangements involving redemptions

may have a chilling effect on common,

non-abusive transactions. Finally, it was

suggested that any changes affecting the

application of section 302 should be

accomplished by issuing new

regulations under that statute.

The IRS and Treasury Department

agree it is inappropriate to treat as a fastpay arrangement every arrangement in

which a redemption of stock produces

dividend income under section 302. The

IRS and Treasury Department, however,

conclude that eliminating all such

arrangements from the scope of the

regulations would render the

regulations meaningless. Little

difference exists between a fast-pay

arrangement resulting from redemptions

structured to be dividends and a fastpay arrangement resulting from

dividends structured to be a return of

the holder’s investment.

To balance the concerns of the

commentators and the concerns of the

IRS and Treasury Department, the final

regulations add a new rule clarifying the

effect of section 302 on the

determination of whether stock is fastpay stock. Under this rule, stock is not

fast-pay stock solely because a

redemption is treated as a dividend by

section 302 unless there is a principal

purpose of achieving the same economic

and tax effect as a fast-pay arrangement.

In this way, only those arrangements in

which redemptions are designed to

return a shareholder’s economic

investment as dividends are

recharacterized. Because the problem of

stock redemptions may be common to

many different fast-pay arrangements,

regardless of how they are structured,

the rule addressing such problem is

placed within the regulations under

section 7701(l) rather than under a

different section.

Characterization of the Financing

Instruments

Under the proposed regulations, the

fast-pay shareholders are treated as

holding financing instruments issued by

the benefited shareholders rather than

as holding the fast-pay stock. The

character of financing instruments (for

example, stock or debt) is determined

under general tax principles and

depends on all the facts and

circumstances.

All three commentators were

concerned by the failure of the proposed

regulations to classify the financing

instruments as debt. If the financing

instruments are classified as stock, the

benefited shareholders are subject to

substantially greater tax liabilities: they

must include in income all dividends

paid by the corporation that issues the

fast-pay stock, but cannot deduct

amounts deemed paid with respect to

the financing instruments. According to

the commentators, this result distorts

the benefited shareholders’ economic

income. Therefore, the regulations

should classify the financing

instruments as debt in all cases.

After careful consideration of the

comments, the IRS and Treasury

Department have decided against

characterizing the financing instruments

in the final regulations. Although debt

characterization may be appropriate in

some cases, in other cases it will be

more appropriate to characterize the

financing instruments as equity or

something else. Thus, the rule in the

proposed regulations is retained. (As

explained below, however, the final

regulations permit taxpayers, for a

limited period, to determine their

taxable income attributable to a

recharacterized fast-pay arrangement by

treating the financing instruments as

debt.)

Election to Limit Taxable Income

Attributable to a Recharacterized FastPay Arrangement for Periods Before

April 1, 2000

Because the regulations are effective

February 27, 1997 (the date Notice 97–

21 was issued to the public), the

proposed regulations permit a

shareholder of a recharacterized fast-pay

arrangement to limit, for certain taxable

years, its income from the arrangement.

Specifically, a shareholder may limit its

taxable income attributable to a

recharacterized fast-pay arrangement to

the taxable income that results if the

fast-pay arrangement is recharacterized

under Notice 97–21. This limit is

available under the proposed

regulations for taxable years ending after

the effective date of the regulations and

before the regulations are finalized. Any

amount excluded under this limit must

be included as an adjustment to taxable

income in the shareholder’s first taxable

year that includes the date the

regulations are finalized. Thus, the sole

benefit of limiting taxable income under

the proposed regulations is a timing

benefit. The preamble to the proposed

regulations found this appropriate on

the assumption that over the life of a

fast-pay arrangement a shareholder has

the same amount of taxable income

whether the fast-pay arrangement is

recharacterized under Notice 97–21 or

under the regulations.

One commentator criticized this

assumption, and, therefore, the limit

and later adjustment. In particular, the

commentator pointed out that if the

financing instruments are treated as

equity under the regulations, a benefited

shareholder would have had less taxable

income over the life of the fast-pay

arrangement under the

recharacterization of Notice 97–21 (that

is, a shareholder would have a

permanent reduction to taxable income).

Thus, the limit is without any

substantive effect because any nontiming reduction in taxable income due

to the limit is included in the year the

regulations are finalized. To rectify this

problem, the commentator asked that, if

the final regulations do not classify the

financing instruments as debt in all

cases, they should at least classify the

financing instruments as debt for the

period starting after the effective date of

the final regulations and ending before

the final regulations are published.

To address these concerns, the final

regulations adopt a different rule from

the one in the proposed regulations. As

with the proposed regulations, a

shareholder may limit its taxable

income to either the amount determined

under Notice 97–21 or the amount

determined under the regulations. For

purposes of this limit, a shareholder

may assume the financing instruments

are debt under the final regulations. A

shareholder may also make this

assumption to determine the amount of

any later adjustment to income because

of the limit. Thus, the later adjustment

will not include any permanent

reduction to taxable income a

shareholder realizes by limiting its

taxable income to the amount

determined under Notice 97–21.

The final regulations also adopt a

longer period during which

shareholders may limit their taxable

income. Under the proposed regulation,

a shareholder may limit its taxable

income for taxable years ending after

February 26, 1997, and before the date

these regulations are published as final

regulations in the Federal Register. The

final regulations permit a shareholder to

limit its taxable income for all periods

before April 1, 2000. Thus, for all

taxable years ending after February 26,

1997 and before April 1, 2000, and for

that part of a shareholder’s taxable year

before April 1, 2000, a shareholder may

1312 Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations

limit its taxable income attributable to

the fast-pay arrangement.

In permitting shareholders to

determine their taxable income under

the regulations by assuming that the

financing instruments are debt for

periods before April 1, 2000, the IRS

and Treasury Department intend no

implication regarding the proper

characterization of the financing

instruments under general tax

principles. Rather, the rule regarding the

financing instruments is intended solely

for the purpose of giving shareholders

the benefit of the recharacterization

described in Notice 97–21 for periods

before April 1, 2000.

Use of Derivatives To Avoid the

Regulations

One commentator recommended

adding an explicit rule to prevent

parties from using derivative contracts

to create a fast-pay arrangement that

escapes either the regulations or the

effect of the recharacterization rules. To

illustrate this point, the commentator

posited a simplified transaction in

which a corporation issues fast-pay

stock to one tax-exempt entity and

benefited stock to another tax-exempt

entity. The tax-exempt entity holding

the benefited stock enters into a prepaid

forward contract with a taxable person.

Under the prepaid forward contract, the

taxable person must buy the benefited

stock in the future for an amount

substantially below its expected value.

According to the commentator, unless

the taxable person is treated as owning

the benefited stock, the parties have

created a fast-pay arrangement in which

the recharacterization of the regulations

fails to prevent tax avoidance. Without

making a recommendation, the

commentator offered a number of rules

to correct this situation. (The

commentator did not discuss whether

the benefited holder would be subject to

the ‘‘debt-financing’’ rules in section

514).

The IRS and Treasury Department

have concluded that there is no present

need to modify the regulations to

address this problem. First, the tax

treatment of derivatives in general is

outside of the scope of these regulations.

Therefore, a rule specific to these

regulations would only increase the

complexity regarding the tax treatment

of derivatives. Second, and more

importantly, the IRS and Treasury

Department have concluded that under

existing law the party entitled to

purchase the benefited stock under a

prepaid forward contract such as the

one described above is the owner of the

benefited stock for federal income tax

purposes. See Rev. Rul. 82–150, 1982–

2 C.B. 110 (concluding that the holder

of a deep-in-the-money option is the

owner of the reference property).

Finally, the regulations state they are to

be interpreted in a manner consistent

with preventing the avoidance of tax.

Mechanically applying the regulations

in a manner that does not prevent tax

avoidance is clearly inconsistent with

the purpose of the regulations and the

Congressional mandate of section

7701(l).

Fast-Pay Arrangement Defined

The proposed regulations define a

fast-pay arrangement as any

arrangement in which a corporation has

outstanding for any part of its taxable

year two or more classes of stock, at

least one of which is fast-pay stock.

Some taxpayers assert that the

regulations can be avoided by creating

a fast-pay arrangement in which a

corporation issues what is nominally a

single class of shares, notwithstanding

that some of the shares are subject to a

related agreement. These taxpayers

apparently rely on the formal meaning

of ‘‘class’’ under state corporate law and

ignore the direction in the proposed

regulations to determine whether stock

is fast-pay stock based on all the facts

and circumstances.

To remove any doubt that the

regulations cover fast-pay arrangements

no matter how contrived, the IRS and

Treasury Department have simplified

the definition of ‘‘fast-pay arrangement’’

in the final regulations. Under this

definition, a fast-pay arrangement is any

arrangement in which a corporation has

fast-pay stock outstanding for any part

of its taxable year. The regulations

illustrate this point with an example.

Effective Date

These regulations apply to taxable

years ending after February 26, 1997.

Special Analyses

It has been determined that this

Treasury decision is not a significant

regulatory action as defined in

Executive Order 12866. Therefore, a

regulatory assessment is not required. It

is hereby certified that these regulations

will not have a significant economic

impact on a substantial number of small

entities. This certification is based on

the understanding of the IRS and

Treasury Department that the total

number of fast-pay arrangements is

fewer than 100, that the number of

entities engaging in transactions affected

by these regulations is not substantial

and, of those entities, few or none are

small entities within the meaning of the

Regulatory Flexibility Act (5 U.S.C.

chapter 6). Therefore, a Regulatory

Flexibility Analysis is not required.

Pursuant to section 7805(f) of the

Internal Revenue Code, the notice of

proposed rulemaking preceding these

regulations was submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comments

on its impact on small businesses.

Drafting Information

The principal authors of these

regulations are Jonathan Zelnik and

Marshall Feiring of the Office of the

Assistant Chief Counsel (Financial

Institutions & Products). However, other

personnel from the IRS and Treasury

Department participated in their

development.

List of Subjects

26 CFR Part 1

Income taxes, Reporting and

recordkeeping requirements.

26 CFR Part 602

Reporting and recordkeeping

requirements.

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an entry

in numerical order to read in part as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.7701(l)–3 also issued under

26 U.S.C. 7701(l). * * *

Par. 2. Section 1.1441–10, is added to

read as follows:

§ 1.1441–10 Withholding agents with

respect to fast-pay arrangements.

(a) In general. A corporation that

issues fast-pay stock in a fast-pay

arrangement described in § 1.7701(l)–

3(b)(1) is a withholding agent with

respect to payments made on the fastpay stock and payments deemed made

under the recharacterization rules of

§ 1.7701(l)–3. Except as provided in this

paragraph (a) or in paragraph (b) of this

section, the withholding tax rules under

section 1441 and section 1442 apply

with respect to a fast-pay arrangement

described in § 1.7701(l)–3(c)(1)(i) in

accordance with the recharacterization

rules provided in § 1.7701(l)–3(c). In all

cases, notwithstanding paragraph (b) of

this section, if at any time the

withholding agent knows or has reason

to know that the Commissioner has

exercised the discretion under either

§ 1.7701(l)–3(c)(1)(ii) to apply the

recharacterization rules of § 1.7701(l)–

Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations 1313

3(c), or § 1.7701(l)–3(d) to depart from

the recharacterization rules of

§ 1.7701(l)–3(c) for a taxpayer, the

withholding agent must withhold on

payments made (or deemed made) to

that taxpayer in accordance with the

characterization of the fast-pay

arrangement imposed by the

Commissioner under § 1.7701(l)–3.

(b) Exception. If at any time the

withholding agent knows or has reason

to know that any taxpayer entered into

a fast-pay arrangement with a principal

purpose of applying the

recharacterization rules of § 1.7701(l)–

3(c) to avoid tax under section 871(a) or

section 881, then for each payment

made or deemed made to such taxpayer

under the arrangement, the withholding

agent must withhold, under section

1441 or section 1442, the higher of—

(1) The amount of withholding that

would apply to such payment

determined under the form of the

arrangement; or

(2) The amount of withholding that

would apply to deemed payments

determined under the recharacterization

rules of § 1.7701(l)–3(c).

(c) Liability. Any person required to

deduct and withhold tax under this

section is made liable for that tax by

section 1461, and is also liable for

applicable penalties and interest for

failing to comply with section 1461.

(d) Examples. The following examples

illustrate the rules of this section:

Example 1. REIT W issues shares of fastpay stock to foreign individual A, a resident

of Country C. United States source dividends

paid to residents of C are subject to a 30

percent withholding tax. W issues all shares

of benefited stock to foreign individuals who

are residents of Country D. D’s income tax

convention with the United States reduces

the United States withholding tax on

dividends to 15 percent. Under § 1.7701(l)–

3(c), the dividends paid by W to A are

deemed to be paid by W to the benefited

shareholders. W has reason to know that A

entered into the fast-pay arrangement with a

principal purpose of using the

recharacterization rules of § 1.7701(l)–3(c) to

reduce United States withholding tax. W

must withhold at the 30 percent rate because

the amount of withholding that applies to the

payments determined under the form of the

arrangement is higher than the amount of

withholding that applies to the payments

determined under § 1.7701(l)–3(c).

Example 2. The facts are the same as in

Example 1 of this paragraph (d) except that

W does not know, or have reason to know,

that A entered into the arrangement with a

principal purpose of using the

recharacterization rules of § 1.7701(l)–3(c) to

reduce United States withholding tax.

Further, the Commissioner has not exercised

the discretion under § 1.7701(l)–3(d) to

depart from the recharacterization rules of

§ 1.7701(l)–3(c). Accordingly, W must

withhold tax at a 15 percent rate on the

dividends deemed paid to the benefited

shareholders.

(e) Effective date. This section applies

to payments made (or deemed made) on

or after January 6, 1999.

Par. 3. Section 1.7701(l)–0 is added to

read as follows:

§ 1.7701(l)–0 Table of contents.

This section lists captions that appear

in §§ 1.7701(l)–1 and 1.7701(l)–3:

§ 1.7701(l)–1 Conduit financing

arrangements.

§ 1.7701(l)–3 Recharacterizing financing

arrangements involving fast-pay stock.

(a) Purpose and scope.

(b) Definitions.

(1) Fast-pay arrangement.

(2) Fast-pay stock.

(i) Defined.

(ii) Determination.

(3) Benefited stock.

(c) Recharacterization of certain fast-pay

arrangements.

(1) Scope.

(2) Recharacterization.

(i) Relationship between benefited

shareholders and fast-pay shareholders.

(ii) Relationship between benefited

shareholders and corporation.

(iii) Relationship between fast-pay

shareholders and corporation.

(3) Other rules.

(i) Character of the financing instruments.

(ii) Multiple types of benefited stock.

(iii) Transactions affecting benefited stock.

(A) Sale of benefited stock.

(B) Transactions other than sales.

(iv) Adjustment to basis for amounts

accrued or paid in taxable years ending

before February 27, 1997.

(d) Prohibition against affirmative use of

recharacterization by taxpayers.

(e) Examples.

(f) Reporting requirement.

(1) Filing requirements.

(i) In general.

(ii) Controlled foreign corporation.

(iii) Foreign personal holding company.

(iv) Passive foreign investment company.

(2) Statement.

(g) Effective date.

(1) In general.

(2) Election to limit taxable income

attributable to a recharacterized fast-pay

arrangement for periods before April 1, 2000.

(i) Limit.

(ii) Adjustment and statement.

(iii) Examples.

(3) Rule to comply with this section.

(4) Reporting requirements.

Par. 4. Section 1.7701(l)–3 is added to

read as follows:

§ 1.7701(l)–3 Recharacterizing financing

arrangements involving fast-pay stock.

(a) Purpose and scope. This section is

intended to prevent the avoidance of tax

by persons participating in fast-pay

arrangements (as defined in paragraph

(b)(1) of this section) and should be

interpreted in a manner consistent with

this purpose. This section applies to all

fast-pay arrangements. Paragraph (c) of

this section recharacterizes certain fastpay arrangements to ensure the

participants are taxed in a manner

reflecting the economic substance of the

arrangements. Paragraph (f) of this

section imposes reporting requirements

on certain participants.

(b) Definitions—(1) Fast-pay

arrangement. A fast-pay arrangement is

any arrangement in which a corporation

has fast-pay stock outstanding for any

part of its taxable year.

(2) Fast-pay stock—(i) Defined. Stock

is fast-pay stock if it is structured so that

dividends (as defined in section 316)

paid by the corporation with respect to

the stock are economically (in whole or

in part) a return of the holder’s

investment (as opposed to only a return

on the holder’s investment). Unless

clearly demonstrated otherwise, stock is

presumed to be fast-pay stock if—

(A) It is structured to have a dividend

rate that is reasonably expected to

decline (as opposed to a dividend rate

that is reasonably expected to fluctuate

or remain constant); or

(B) It is issued for an amount that

exceeds (by more than a de minimis

amount, as determined under the

principles of § 1.1273–1(d)) the amount

at which the holder can be compelled to

dispose of the stock.

(ii) Determination. The determination

of whether stock is fast-pay stock is

based on all the facts and

circumstances, including any related

agreements such as options or forward

contracts. A related agreement includes

any direct or indirect agreement or

understanding, oral or written, between

the holder of the stock and the issuing

corporation, or between the holder of

the stock and one or more other

shareholders in the corporation. To

determine if it is fast-pay stock, stock is

examined when issued, and, for stock

that is not fast-pay stock when issued,

when there is a significant modification

in the terms of the stock or the related

agreements or a significant change in

the relevant facts and circumstances.

Stock is not fast-pay stock solely

because a redemption is treated as a

dividend as a result of section 302(d)

unless there is a principal purpose of

achieving the same economic and tax

effect as a fast-pay arrangement.

(3) Benefited stock. With respect to

any fast-pay stock, all other stock in the

corporation (including other fast-pay

stock having any significantly different

characteristics) is benefited stock.

(c) Recharacterization of certain fastpay arrangements—(1) Scope. This

paragraph (c) applies to any fast-pay

arrangement—

1314 Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations

(i) In which the corporation that has

outstanding fast-pay stock is a regulated

investment company (RIC) (as defined

in section 851) or a real estate

investment trust (REIT) (as defined in

section 856); or

(ii) If the Commissioner determines

that a principal purpose for the

structure of the fast-pay arrangement is

the avoidance of any tax imposed by the

Internal Revenue Code. Application of

this paragraph (c)(1)(ii) is at the

Commissioner’s discretion, and a

determination under this paragraph

(c)(1)(ii) applies to all parties to the fastpay arrangement, including transferees.

(2) Recharacterization. A fast-pay

arrangement described in paragraph

(c)(1) of this section is recharacterized

as an arrangement directly between the

benefited shareholders and the fast-pay

shareholders. The inception and

resulting relationships of the

recharacterized arrangement are deemed

to be as follows:

(i) Relationship between benefited

shareholders and fast-pay shareholders.

The benefited shareholders issue

financial instruments (the financing

instruments) directly to the fast-pay

shareholders in exchange for cash equal

to the fair market value of the fast-pay

stock at the time of issuance (taking into

account any related agreements). The

financing instruments have the same

terms (other than issuer) as the fast-pay

stock. Thus, for example, the timing and

amount of the payments made with

respect to the financing instruments

always match the timing and amount of

the distributions made with respect to

the fast-pay stock.

(ii) Relationship between benefited

shareholders and corporation. The

benefited shareholders contribute to the

corporation the cash they receive for

issuing the financing instruments.

Distributions made with respect to the

fast-pay stock are distributions made by

the corporation with respect to the

benefited shareholders’ benefited stock.

(iii) Relationship between fast-pay

shareholders and corporation. For

purposes of determining the

relationship between the fast-pay

shareholders and the corporation, the

fast-pay stock is ignored. The

corporation is the paying agent of the

benefited shareholders with respect to

the financing instruments.

(3) Other rules—(i) Character of the

financing instruments. The character of

a financing instrument (for example,

stock or debt) is determined under

general tax principles and depends on

all the facts and circumstances.

(ii) Multiple types of benefited stock.

If any benefited stock has any

significantly different characteristics

from any other benefited stock, the

recharacterization rules of this

paragraph (c) apply among the different

types of benefited stock as appropriate

to match the economic substance of the

fast-pay arrangement.

(iii) Transactions affecting benefited

stock—(A) Sale of benefited stock. If one

person sells benefited stock to another—

(1) In addition to any consideration

actually paid and received for the

benefited stock, the buyer is deemed to

pay and the seller is deemed to receive

the amount necessary to terminate the

seller’s position in the financing

instruments at fair market value; and

(2) The buyer is deemed to issue

financing instruments to the fast-pay

shareholders in exchange for the

amount necessary to terminate the

seller’s position in the financing

instruments.

(B) Transactions other than sales.

Except for transactions subject to

paragraph (c)(3)(iii)(A) of this section, in

the case of any transaction affecting

benefited stock, the parties to the

transaction must make appropriate

adjustments to properly take into

account the fast-pay arrangement as

characterized under paragraph (c)(2) of

this section.

(iv) Adjustment to basis for amounts

accrued or paid in taxable years ending

before February 27, 1997. In the case of

a fast-pay arrangement involving

amounts accrued or paid in taxable

years ending before February 27, 1997,

and recharacterized under this

paragraph (c), a benefited shareholder

must decrease its basis in any benefited

stock (as determined under paragraph

(c)(2)(ii) of this section) by the amount

(if any) that—

(A) Its income attributable to the

benefited stock (reduced by deductions

attributable to the financing

instruments) for taxable years ending

before February 27, 1997, computed by

recharacterizing the fast-pay

arrangement under this paragraph (c)

and by treating the financing

instruments as debt; exceeds

(B) Its income attributable to such

stock for taxable years ending before

February 27, 1997, computed without

applying the rules of this paragraph (c).

(d) Prohibition against affirmative use

of recharacterization by taxpayers. A

taxpayer may not use the rules of

paragraph (c) of this section if a

principal purpose for using such rules is

the avoidance of any tax imposed by the

Internal Revenue Code. Thus, with

respect to such taxpayer, the

Commissioner may depart from the

rules of this section and recharacterize

(for all purposes of the Internal Revenue

Code) the fast-pay arrangement in

accordance with its form or its

economic substance. For example, if a

foreign person acquires fast-pay stock in

a REIT and a principal purpose for

acquiring such stock is to reduce United

States withholding taxes by applying

the rules of paragraph (c) of this section,

the Commissioner may, for purposes of

determining the foreign person’s United

States tax consequences (including

withholding tax), depart from the rules

of paragraph (c) of this section and treat

the foreign person as holding fast-pay

stock in the REIT.

(e) Examples. The following examples

illustrate the rules of paragraph (c) of

this section:

Example 1. Decline in dividend rate—(i)

Facts. Corporation X issues 100 shares of A

Stock and 100 shares of B Stock for $1,000

per share. By its terms, a share of B Stock is

reasonably expected to pay a $110 dividend

in years 1 through 10 and a $30 dividend

each year thereafter. If X liquidates, the

holder of a share of B Stock is entitled to a

preference equal to the share’s issue price.

Otherwise, the B Stock cannot be redeemed

at either X’s or the shareholder’s option.

(ii) Analysis. When issued, the B Stock has

a dividend rate that is reasonably expected to

decline from an annual rate of 11 percent of

its issue price to an annual rate of 3 percent

of its issue price. Since the B Stock is

structured to have a declining dividend rate,

the B Stock is fast-pay stock, and the A Stock

is benefited stock.

Example 2. Issued at a premium—(i) Facts.

The facts are the same as in Example 1 of this

paragraph (e) except that a share of B Stock

is reasonably expected to pay an annual $110

dividend as long as it is outstanding, and

Corporation X has the right to redeem the B

Stock for $400 a share at the end of year 10.

(ii) Analysis. The B Stock is structured so

that the issue price of the B Stock ($1,000)

exceeds (by more than a de minimis amount)

the price at which the holder can be

compelled to dispose of the stock ($400).

Thus, the B Stock is fast-pay stock, and the

A Stock is benefited stock.

Example 3. Planned section 302(d)

redemptions—(i) Facts. Corporation L, a

subchapter C corporation, issues 220 shares

of common stock for $1,000 per share. No

other stock is authorized, but L can issue

warrants entitling the holder to acquire L

common stock for $3,000 per share until such

time as L adopts a plan of liquidation. L can

adopt a plan of liquidation if approved by 90

percent of its shareholders. Half of L’s stock

is purchased by Corporation M, and half by

Organization N, which is tax exempt. At the

time of purchase, M and N agree that for a

period of ten years L will annually redeem

(and N will tender) ten shares of stock in

exchange for $12,100 and ten warrants. It is

anticipated that, under sections 302 and 301,

the annual payment to N will be a

distribution of property that is a dividend.

(ii) Analysis. Considering all the facts and

circumstances, including the agreement

between M and N, L’s redemption of N’s

stock is undertaken with a principal purpose

of achieving the same economic and tax

Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations 1315

effect as a fast-pay arrangement. Thus, N’s

stock is fast-pay stock, M’s stock is benefited

stock, and the parties have entered into a

fast-pay arrangement. Because L is neither a

RIC nor a REIT, whether this fast-pay

arrangement is recharacterized under

paragraph (c) of this section depends on

whether the Commissioner determines,

under paragraph (c)(1)(ii) of this section, that

a principal purpose for the structure of the

fast-pay arrangement is the avoidance of any

tax imposed by the Internal Revenue Code.

Example 4. Recharacterization

illustrated—(i) Facts. On formation, REIT Y

issues 100 shares of C Stock and 100 shares

of D Stock for $1,000 per share. By its terms,

a share of D Stock is reasonably expected to

pay a $110 dividend in years 1 through 10

and a $30 dividend each year thereafter. In

years 1 through 10, persons holding a

majority of the D Stock must consent before

Y may take any action that would result in

Y liquidating or dissolving, merging or

consolidating, losing its REIT status, or

selling substantially all of its assets.

Thereafter, Y may take these actions without

consent so long as the D Stock shareholders

receive $400 in exchange for their D Stock.

(ii) Analysis. When issued, the D Stock has

a dividend rate that is reasonably expected to

decline from an annual rate of 11 percent of

its issue price to an annual rate of 3 percent

of its issue price. In addition, the $1,000

issue price of a share of D Stock exceeds the

price at which the shareholder can be

compelled to dispose of the stock ($400).

Thus, the D Stock is fast-pay stock, and the

C Stock is benefited stock. Because Y is a

REIT, the fast-pay arrangement is

recharacterized under paragraph (c) of this

section.

(iii) Recharacterization. The fast-pay

arrangement is recharacterized as follows:

(A) Under paragraph (c)(2)(i) of this

section, the C Stock shareholders are treated

as issuing financing instruments to the D

Stock shareholders in exchange for $100,000

($1,000, the fair market value of each share

of D Stock, multiplied by 100, the number of

shares).

(B) Under paragraph (c)(2)(ii) of this

section, the C Stock shareholders are treated

as contributing $200,000 to Y (the $100,000

received for the financing instruments, plus

the $100,000 actually paid for the C Stock)

in exchange for the C Stock.

(C) Under paragraph (c)(2)(ii) of this

section, each distribution with respect to the

D Stock is treated as a distribution with

respect to the C Stock.

(D) Under paragraph (c)(2)(iii) of this

section, the C Stock shareholders are treated

as making payments with respect to the

financing instruments, and Y is treated as the

paying agent of the financing instruments for

the C Stock shareholders.

Example 5. Transfer of benefited stock

illustrated—(i) Facts. The facts are the same

as in Example 4 of this paragraph (e). Near

the end of year 5, a person holding one share

of C Stock sells it for $1,300. The buyer is

unrelated to REIT Y or to any of the D Stock

shareholders. At the time of the sale, the

amount needed to terminate the seller’s

position in the financing instruments at fair

market value is $747.

(ii) Benefited shareholder’s treatment on

sale. Under paragraph (c)(3)(iii)(A) of this

section, the seller’s amount realized is $2,047

($1,300, the amount actually received, plus

$747, the amount necessary to terminate the

seller’s position in the financing instruments

at fair market value). The seller’s gain on the

sale of the common stock is $47 ($2,047, the

amount realized, minus $2,000, the seller’s

basis in the common stock). The seller has no

income or deduction with respect to

terminating its position in the financing

instruments.

(iii) Buyer’s treatment on purchase. Under

paragraph (c)(3)(iii)(A) of this section, the

buyer’s basis in the share of D Stock is $2,047

($1,300, the amount actually paid, plus $747,

the amount needed to terminate the seller’s

position in the financing instruments at fair

market value). Under paragraph (c)(3)(iii)(B)

of this section, simultaneous with the sale,

the buyer is treated as issuing financing

instruments to the fast-pay shareholders in

exchange for $747, the amount necessary to

terminate the seller’s position in the

financing instruments at fair market value.

Example 6. Fast-pay arrangement

involving amounts accrued or paid in a

taxable year ending before February 27,

1997—(i) Facts. Y is a calendar year taxpayer.

In June 1996, Y acquires shares of REIT T

benefited stock for $15,000. In December

1996, Y receives dividends of $100. Under

the recharacterization rules of paragraph

(c)(2) of this section, Y’s 1996 income

attributable to the benefited stock is $1,200,

Y’s 1996 deduction attributable to the

financing instruments is $500, and Y’s basis

in the benefited stock is $25,000.

(ii) Analysis. Under paragraph (c)(3)(iv) of

this section, Y’s basis in the benefited stock

is reduced by $600. This is the amount by

which Y’s 1996 income from the fast-pay

arrangement as recharacterized under this

section ($1,200 of income attributable to the

benefited stock less $500 of deductions

attributable to the financing instruments),

exceeds Y’s 1996 income from the fast-pay

arrangement as not recharacterized under

this section ($100 of income attributable to

the benefited stock). Thus, in 1997 when the

fast-pay arrangement is recharacterized, Y’s

basis in the benefited stock is $24,400.

(f) Reporting requirement—(1) Filing

requirements—(i) In general. A

corporation that has fast-pay stock

outstanding at any time during the

taxable year must attach the statement

described in paragraph (f)(2) of this

section to its federal income tax return

for such taxable year. This paragraph

(f)(1)(i) does not apply to a corporation

described in paragraphs (f)(1)(ii), (iii), or

(iv) of this section.

(ii) Controlled foreign corporation. In

the case of a controlled foreign

corporation (CFC), as defined in section

957, that has fast-pay stock outstanding

at any time during its taxable year

(during which time it was a CFC), each

controlling United States shareholder

(within the meaning of § 1.964–1(c)(5))

must attach the statement described in

paragraph (f)(2) of this section to the

shareholder’s Form 5471 for the CFC’s

taxable year. The provisions of section

6038 and the regulations under section

6038 apply to any statement required by

this paragraph (f)(1)(ii).

(iii) Foreign personal holding

company. In the case of a foreign

personal holding company (FPHC), as

defined in section 552, that has fast-pay

stock outstanding at any time during its

taxable year (during which time it was

a FPHC), each United States citizen or

resident who is an officer, director, or

10-percent shareholder (within the

meaning of section 6035(e)(1)) of such

FPHC must attach the statement

described in paragraph (f)(2) of this

section to his or her Form 5471 for the

FPHC’s taxable year. The provisions of

sections 6035 and 6679 and the

regulations under sections 6035 and

6679 apply to any statement required by

this paragraph (f)(1)(iii).

(iv) Passive foreign investment

company. In the case of a passive

foreign investment company (PFIC), as

defined in section 1297, that has fastpay stock outstanding at any time

during its taxable year (during which

time it was a PFIC), each shareholder

that has elected (under section 1295) to

treat the PFIC as a qualified electing

fund and knows or has reason to know

that the PFIC has outstanding fast-pay

stock must attach the statement

described in paragraph (f)(2) of this

section to the shareholder’s Form 8621

for the PFIC’s taxable year. Each

shareholder owning 10 percent or more

of the shares of the PFIC (by vote or

value) is presumed to know that the

PFIC has issued fast-pay stock. The

provisions of sections 1295(a)(2) and

1298(f) and the regulations under those

sections (including § 1.1295–1T(f)(2))

apply to any statement required by this

paragraph (f)(1)(iv).

(2) Statement. The statement required

under this paragraph (f) must say, ‘‘This

fast-pay stock disclosure statement is

required by § 1.7701(l)–3(f) of the

income tax regulations.’’ The statement

must also identify the corporation that

has outstanding fast-pay stock and must

contain the date on which the fast-pay

stock was issued, the terms of the fastpay stock, and (to the extent the filing

person knows or has reason to know

such information) the names and

taxpayer identification numbers of the

shareholders of any stock that is not

traded on an established securities

market (as described in § 1.7704–1(b)).

(g) Effective date—(1) In general.

Except as provided in paragraph (g)(4)

of this section (relating to reporting

requirements), this section applies to

taxable years ending after February 26,

1997. Thus, all amounts accrued or paid

1316 Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations

during the first taxable year ending after

February 26, 1997, are subject to this

section.

(2) Election to limit taxable income

attributable to a recharacterized fastpay arrangement for periods before

April 1, 2000—(i) Limit. For periods

before April 1, 2000, provided the

shareholder recharacterizes the fast-pay

arrangement consistently for all such

periods, a shareholder may limit its

taxable income attributable to a fast-pay

arrangement recharacterized under

paragraph (c) of this section to the

taxable income that results if the fastpay arrangement is recharacterized

under either—

(A) Notice 97–21, 1997–1 C.B. 407,

see § 601.601(d)(2) of this chapter; or

(B) Paragraph (c) of this section,

computed by assuming the financing

instruments are debt.

(ii) Adjustment and statement. A

shareholder that limits its taxable

income to the amount determined under

paragraph (g)(2)(i)(A) of this section

must include as an adjustment to

taxable income the excess, if any, of the

amount determined under paragraph

(g)(2)(i)(B) of this section, over the

amount determined under paragraph

(g)(2)(i)(A) of this section. This

adjustment to taxable income must be

made in the shareholder’s first taxable

year that includes April 1, 2000. A

shareholder to which this paragraph

(g)(2)(ii) applies must include a

statement in its books and records

identifying each fast-pay arrangement

for which an adjustment must be made

and providing the amount of the

adjustment for each such fast-pay

arrangement.

(iii) Examples. The following

examples illustrate the rules of this

paragraph (g)(2). For purposes of these

examples, assume that a shareholder

may limit its taxable income under this

paragraph (g)(2) for periods before

January 1, 2000.

Example 1. Fast-pay arrangement

recharacterized under Notice 97–21; REIT

holds third-party debt—(i) Facts. (A) REIT Y

is formed on January 1, 1997, at which time

it issues 1,000 shares of fast-pay stock and

1,000 shares of benefited stock for $100 per

share. Y and all of its shareholders are U.S.

persons and have calendar taxable years. All

shareholders of Y have elected to accrue

market discount based on a constant interest

rate, to include the market discount in

income as it accrues, and to amortize bond

premium.

(B) For years 1 through 5, the fast-pay stock

has an annual dividend rate of $17 per share

($17,000 for all fast-pay stock); in later years,

the fast-pay stock has an annual dividend

rate of $1 per share ($1,000 for all fast-pay

stock). At the end of year 5, and thereafter,

a share of fast-pay stock can be acquired by

Y in exchange for $50 ($50,000 for all fastpay stock).

(C) On the day Y is formed, it acquires a

five-year mortgage note (the note) issued by

an unrelated third party for $200,000. The

note provides for annual interest payments

on December 31 of $18,000 (a coupon interest

rate of 9.00 percent, compounded annually),

and one payment of principal at the end of

5 years. The note can be prepaid, in whole

or in part, at any time.

(ii) Recharacterization under Notice 97–

21—(A) In general. One way to recharacterize

the fast-pay arrangement under Notice 97–21

is to treat the fast-pay shareholders and the

benefited shareholders as if they jointly

purchased the note from the issuer with the

understanding that over the five-year term of

the note the benefited shareholders would

use their share of the interest to buy (on a

dollar-for-dollar basis) the fast-pay

shareholders’ portion of the note. The

benefited shareholders’ and the fast-pay

shareholders’ yearly taxable income under

Notice 97–21 can then be calculated after

determining their initial portions of the note

and whether those initial portions are

purchased at a discount or premium.

(B) Determining initial portions of the debt

instrument. The fast-pay shareholders’ and

the benefited shareholders’ initial portions of

the note can be determined by comparing the

present values of their expected cash flows.

As a group, the fast-pay shareholders expect

to receive cash flows of $135,000 (five annual

payments of $17,000, plus a final payment of

$50,000). As a group, the benefited

shareholders expect to receive cash flows of

$155,000 (five annual payments of $1,000,

plus a final payment of $150,000). Using a

discount rate equal to the yield to maturity

(as determined under § 1.1272–1(b)(1)(i)) of

the mortgage note (9.00 percent,

compounded annually), the present value of

the fast-pay shareholders’ cash flows is

$98,620, and the present value of the

benefited shareholders’ cash flows is

$101,380. Thus, the fast-pay shareholders

initially acquire 49 percent of the note at a

$1,380 premium (that is, they paid $100,000

for $98,620 of principal in the note). The

benefited shareholders initially acquire 51

percent of the note at a $1,380 discount (that

is, they paid $100,000 for $101,380 of

principal in the note). Under section 171, the

fast-pay shareholders’ premium is

amortizable based on their yield in their

initial portion of the note (8.574 percent,

compounded annually). The benefited

shareholders’ discount accrues based on the

yield in their initial portion of the note (9.353

percent, compounded annually).

(C) Taxable income under Notice 97–21—

(1) Fast-pay shareholders. Under Notice 97–

21, the fast-pay shareholders compute their

taxable income attributable to the fast-pay

arrangement for periods before January 1,

2000, by subtracting the amortizable

premium from the accrued interest on the

fast-pay shareholders’ portion of the note. For

purposes of paragraph (g)(2)(i)(A) of this

section, the fast-pay shareholders’ taxable

income as a group is as follows:

Taxable period Interest

income

Amortizable

premium

Taxable

income

1/1/97–12/31/97 ..................................................................................................................... $8,876 ($302) $8,574

1/1/98–12/31/98 ..................................................................................................................... 8,145 (293) 7,852

1/1/99–12/31/99 ..................................................................................................................... 7,348 (281) 7,067

Total ................................................................................................................................ 24,369 (876) 23,493

(2) Benefited shareholders. Under Notice

97–21, the benefited shareholders compute

their taxable income attributable to the fastpay arrangement for periods before January 1,

2000, by adding the accrued discount to the

accrued interest on the benefited

shareholders’ portion of the note. For

purposes of paragraph (g)(2)(i)(A) of this

section, the benefited shareholders’ taxable

income as a group is as follows:

Taxable period Interest

income

Amortizable

premium

Taxable

income

1/1/97–12/31/97 ..................................................................................................................... $9,124 $229 $9,353

1/1/98–12/31/98 ..................................................................................................................... 9,855 251 10,106

1/1/99–12/31/99 ..................................................................................................................... 10,652 274 10,926

Total ................................................................................................................................ 29,631 754 30,385

Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations 1317

(iii) Taxable income under the

recharacterization of this section—(A) Fastpay shareholders. Under paragraphs (c) and

(g)(2)(i)(B) of this section, the fast-pay

shareholders’ taxable income attributable to

the fast-pay arrangement for periods before

January 1, 2000, is the interest deemed paid

on the financing instruments. For purposes of

paragraph (g)(2)(i)(B) of this section, the fastpay shareholders’ taxable income as a group

is as follows:

Taxable period Taxable

income

1/1/97–12/31/97 .............................. $8,574

1/1/98–12/31/98 .............................. 7,852

1/1/99–12/31/99 .............................. 7,067

Total ............................................ 23,493

(B) Benefited shareholders. Under

paragraphs (c) and (g)(2)(i)(B) of this section,

the benefited shareholders compute their

taxable income attributable to the fast-pay

arrangement for periods before January 1,

2000, by subtracting the interest deemed paid

on the financing instruments from the

dividends actually and deemed paid on the

benefited stock. For purposes of paragraph

(g)(2)(i)(B) of this section, the benefited

shareholders’ taxable income as a group is as

follows:

Taxable period

Dividends paid

on benefited

stock

Interest paid on

financing

instruments

Taxable

income

1/1/97–12/31/97 ..................................................................................................................... $18,000 ($8,574) $9,426

1/1/98–12/31/98 ..................................................................................................................... 18,000 (7,852) 10,148

1/1/99–12/31/99 ..................................................................................................................... 18,000 (7,067) 10,933

Total ................................................................................................................................ 54,000 (23,493) 30,507

(iv) Limit on taxable income under

paragraph (g)(2)(i) of this section—(A) Fastpay shareholders. For periods before January

1, 2000, the fast-pay shareholders have the

same taxable income under the

recharacterization of Notice 97–21 and

paragraph (g)(2)(i)(A) of this section ($23,493)

as they have under the recharacterization of

paragraphs (c) and (g)(2)(i)(B) of this section

($23,493). Thus, under paragraph (g)(2)(i) of

this section, the fast-pay shareholders may

limit their taxable income attributable to the

fast-pay arrangement for periods before

January 1, 2000, to $23,493 (as a group).

(B) Benefited shareholders. For periods

before January 1, 2000, the benefited

shareholders have taxable income

attributable to the fast-pay arrangement of

$30,385 under the recharacterization of

Notice 97–21 and paragraph (g)(2)(i)(A) of

this section, and taxable income of $30,507

under the recharacterization of paragraphs (c)

and (g)(2)(i)(B) of this section. Thus, under

paragraph (g)(2)(i) of this section, the

benefited shareholders may limit their

taxable income attributable to the fast-pay

arrangement for periods before January 1,

2000, to either $30,385 (as a group) or

$30,507 (as a group).

(v) Adjustment to taxable income under

paragraph (g)(2)(ii) of this section. Under

paragraph (g)(2)(ii) of this section, any

benefited shareholder that limited its taxable

income to the amount determined under

paragraph (g)(2)(i)(A) of this section must

include as an adjustment to taxable income

the excess, if any, of the amount determined

under paragraph (g)(2)(i)(B) of this section,

over the amount determined under paragraph

(g)(2)(i)(A) of this section. If all benefited

shareholders limited their taxable income to

the amount determined under paragraph

(g)(2)(i)(A) of this section, then as a group

their adjustment to income is $122 ($30,507,

minus $30,385). Each shareholder must

include its adjustment in income for the

taxable year that includes January 1, 2000.

Example 2. REIT holds debt issued by a

benefited shareholder—(i) Facts. The facts

are the same as in Example 1 of this

paragraph (g)(2) except that corporation Z

holds 800 shares (80 percent) of the benefited

stock, and Z, instead of a third party, issues

the mortgage note acquired by Y.

(ii) Recharacterization under Notice 97–21.

Because Y holds a debt instrument issued by

Z, the fast-pay arrangement is recharacterized

under Notice 97–21 as an arrangement in

which Z issued one or more instruments

directly to the fast-pay shareholders and the

other benefited shareholders.

(A) Fast-pay shareholders. Consistent with

this recharacterization, Z is treated as issuing

a debt instrument to the fast-pay

shareholders for $100,000. The debt

instrument provides for five annual

payments of $17,000 and an additional

payment of $50,000 in year five. Thus, the

debt instrument’s yield to maturity is 8.574

percent per annum, compounded annually.

(B) Benefited shareholders. Z is also treated

as issuing a debt instrument to the other

benefited shareholders for $20,000 (200

shares multiplied by $100, or 20 percent of

the $100,000 paid to Y by the benefited

shareholders as a group). This debt

instrument provides for five annual

payments of $200 and an additional payment

of $30,000 in year five. The debt instrument’s

yield to maturity is 9.304 percent per annum,

compounded annually.

(C) Issuer’s interest expense under Notice

97–21. Under Notice 97–21, Z’s interest

expense attributable to the fast-pay

arrangement for periods before January 1,

2000, equals the interest accrued on the debt

instrument held by the fast-pay shareholders,

plus the interest accrued on the debt

instrument held by the benefited

shareholders other than Z. For purposes of

paragraph (g)(2)(i)(A) of this section, Z’s

interest expense is as follows:

Taxable period

Accrued interest

fast-pay

shareholders

Accrued

interest other

benefited

shareholders

Total interest

expense

1/1/97–12/31/97 ..................................................................................................................... ($8,574) ($1,861) ($10,435)

1/1/98–12/31/98 ..................................................................................................................... (7,852) (2,015) (9,867)

1/1/99–12/31/99 ..................................................................................................................... (7,067) (2,184) (9,251)

Total ................................................................................................................................ (23,493) (6,060) (29,553)

(iii) Recharacterization under this section.

Under paragraphs (c) and (g)(2)(i)(B) of this

section, Z’s taxable income attributable to the

fast-pay arrangement for periods before

January 1, 2000, equals Z’s share of the

dividends actually and deemed paid on the

benefited stock (80 percent of the outstanding

benefited stock), reduced by the sum of the

interest accrued on the note held by Y and

the interest accrued on the financing

instruments deemed to have been issued by

Z. For purposes of paragraph (g)(2)(i)(B) of

this section, Z’s taxable income is as follows:

1318 Federal Register / Vol. 65, No. 6 / Monday, January 10, 2000 / Rules and Regulations

Taxable period

Dividends

benefited

stock

Accrued

interest on

debt held by Y

Accrued

interest financing instrumentsTaxable

expense

1/1/97–12/31/97 ............................................................................................... $14,400 ($18,000) ($6,859) ($10,459)

1/1/98–12/31/98 ............................................................................................... 14,400 (18,000) (6,281) (9,881)

1/1/99–12/31/99 ............................................................................................... 14,400 (18,000) ( 5,654) (9,254)

Total .......................................................................................................... 43,200 (54,000) (18,794) (29,594)

(iv) Limit on taxable income under this

paragraph (g)(2). For periods before January

1, 2000, Z has a taxable loss attributable to

the fast-pay arrangement of $29,553 under

the recharacterization of Notice 97–21 and

paragraph (g)(2)(i)(A) of this section, and a

taxable loss of $29,594 under the

recharacterization of paragraphs (c) and

(g)(2)(i)(B) of this section. Thus, under

paragraph (g)(2)(i) of this section, Z may

report a taxable loss attributable to the fastpay arrangement for periods before January 1,

2000, of either $29,553 or $29,594. Under

paragraph (g)(2)(ii), Z has no adjustment to

its taxable income for its taxable year that

includes January 1, 2000.

(3) Rule to comply with this section.

To comply with this section for each

taxable year in which it failed to do so,

a taxpayer should file an amended

return. For taxable years ending before

Janaury 10, 2000, a taxpayer that has

complied with Notice 97–21, 1997–1

C.B. 407 (see § 601.601(d)(2) of this

chapter), for all such taxable years is

considered to have complied with this

section and limited its taxable income

under paragraph (g)(2)(i)(A) of this

section.

(4) Reporting requirements. The

reporting requirements of paragraph (f)

of this section apply to taxable years (of

the person required to file the

statement) ending after Janaury 10,

2000.

PART 602—OMB CONTROL NUMBERS

UNDER THE PAPERWORK

REDUCTION ACT

Par. 5. The authority citation for part

602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 6. Section 602.101(b) is amended

by adding an entry in numerical order

to the table to read as follows:

§ 602.101 OMB Control numbers.

* * * * *

(6) * * *

CFR part or section where

identified and described

Current

OMB control

No.

*****

1.7701(l)–3 ................................ 1545–1642

*****

Approved: December 10, 1999.

Jonathan Talisman,

Acting Assistant Secretary of the Treasury.

Robert Wenzel,

Deputy Commissioner of Internal Revenue.

[FR Doc. 00–114 Filed 1–7–00; 8:45 am]

BILLING CODE 4830–01–P

POSTAL SERVICE

39 CFR Part 111

Domestic Mail Manual; Miscellaneous

Amendments

AGENCY: Postal Service.

ACTION: Final rule.

SUMMARY: This document describes the

numerous amendments consolidated in

the Transmittal Letter for Issue 55 of the

Domestic Mail Manual, which is

incorporated by reference in the Code of

Federal Regulations, see 39 CFR 111.1.

These amendments reflect changes in

mail preparation requirements and other

miscellaneous rules and regulations not

previously published in the Federal

Register.

EFFECTIVE DATE: January 10, 2000.

FOR FURTHER INFORMATION CONTACT:

Anne Emmerth, (202) 268–2363.

SUPPLEMENTARY INFORMATION: The

Domestic Mail Manual (DMM),

incorporated by reference in title 39,

Code of Federal Regulations, part 111,

contains the basic standards of the U.S.

Postal Service governing its domestic

mail services, descriptions of the mail

classes and special services and

conditions governing their use, and

standards for rate eligibility and mail

preparation. The document is amended

and republished about every six

months, with each issue sequentially

numbered. Interim updates of the DMM

are posted monthly on the USPS Postal

Explorer web site (http://pe.usps.gov).

DMM Issue 55, the next printed edition,

is scheduled for release on January 10,

2000. Issue 55 will contain all changes

previously published in the Federal

Register and all changes listed below.

The following excerpt from section I010,

Summary of Changes, of the transmittal

letter for DMM Issue 55 covers the

minor changes not previously described

in interim or final rules published in the

Federal Register. Announcements of

these minor changes were first

published in various issues of the Postal

Bulletin, an official biweekly document

published by the Postal Service. In

addition, the revised table of contents of

DMM Issue 55 is presented.

Domestic Mail Manual Issue 55

Summary of Changes

A Addressing

A010.1.2 and A010.3.2 are amended

to correct information on the placement

of private mailbox numbers. Effective 6–

3–99.

A010.1.2 and A010.3.2 are amended

and A010.5.3 is added to reflect changes

to regulations relevant to mail delivery

procedures to a commercial mail

receiving agency (CMRA). Effective 4–

24–99.

A040.3.3 is amended to clarify the

standards for placement of an optional

endorsement line when used with the

exceptional address format. Effective 9–

9–99.

A950.5.4 is revised to incorporate

changes to PS Form 3553, Coding

Accuracy Support System (CASS)

Summary Report. Effective 2–11–99.

C Characteristics and Content

C010.6.2 is added to clarify standards

for items mailed in USPS-provided

Express Mail and Priority Mail

packaging. Effective 9–9–99.

C022.3.3, C023.2.2, and C023.8.5 are

revised to reflect organizational changes

for rulings and appeals authority.

Effective 8–12–99.

C023 is revised to clarify the

hazardous material standards

concerning the use of shipping papers

and the requirements for flammable and

magnetized materials. Effective 5–6–99.

C023.4.0 is revised to clarify the

standards that apply to flammable and

combustible liquids in domestic mail.

Effective 12–2–99.

C023.11.4 is amended to change the

standards that apply to dry ice in

domestic mail via surface

transportation. Effective 5–6–99.

C023.11.4 is revised to clarify the

standards that apply to dry ice in

domestic mail. Effective 11–5–98.