**DESCRIPTION OF PROVISIONSIN H.R. 4738**

**Scheduled for Markup**

**before the**

**House Committee on Ways and Means**

**on**

**October 9, 1998**

**Prepared by the Staff**

**of the**

**JOINT COMMITTEE ON TAXATION**

**October 9, 1998**

**JCX-66-98**

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**CONTENTS**

**INTRODUCTION**

**I.	EXTENSION OF EXPIRING PROVISIONS**

	A.	Extension of Research Tax Credit		

	B.	Extension of the Work Opportunity Tax Credit		

	C.	Extend the Deduction Provided for Contributions of Appreciated Stock		to Private Foundations; Public Inspection of Private Foundation	Annual Returns		

		1.	Extend the deduction for contributions of appreciated stock to private	foundations		

		2.	Public inspection of private foundation annual returns		

	D.	Exceptions under Subpart F for Certain Active Financing Income		

	E.	Extension of the Generalized System of Preferences		

	F.	Permanent Extension of Income Averaging for Farmers		

	G.	Disclosure of Return Information to Department of Education in Connection	With Income Contingent Loans		

**II.	OTHER PROVISIONS**

	A.	Comprehensive Study of Recovery Periods and Depreciation Methods	Under Section 168		

	B.	Farm Production Flexibility Contract Payments		

	C.	Increase Deduction for Health Insurance Expenses of Self-Employed		Individuals		

	D.	Increase State Volume Limits on Private Activity Tax-Exempt Bonds		

	E.	Modification of Individual Estimated Tax Safe Harbors		

**III.	REVENUE OFFSET PROVISIONS**

	A.	Treatment of Certain Deductible Liquidating Distributions of Regulated Investment Companies and Real Estate Investment Trusts		

	B.	Add Vaccines Against Rotavirus Gastroenteritis to the List of Taxable		Vaccines		

	C.	Clarify and Expand Mathematical Error Procedures		

	D.	Restrict 10-Year Net Operating Loss Carryback Rules for Specified		Liability Losses		

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**INTRODUCTION**

	The House Committee on Ways and Means has scheduled a markup on October 9, 1998,on the provisions of H.R. 4738, introduced by Chairman Bill Archer on October 8, 1998.

	This document,(1) prepared by the staff of the Joint Committee on Taxation, describes theproposals contained in the H.R. 4738.(2)  Part I of this document contains the expiring provisionproposals, Part II contains other proposals, and Part III contains revenue offset proposals.

	A separate document (JCX-68-98) provides estimates of the budget effects of the taxproposals.

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**I.  EXTENSION OF EXPIRING PROVISIONS**

**A.  Extension of Research Tax Credit**

**Present Law**

**General rule**

	Section 41 provides for a research tax credit equal to 20 percent of the amount by which ataxpayer's qualified research expenditures for a taxable year exceeded its base amount for thatyear. The research tax credit expired and generally does not apply to amounts paid or incurredafter June 30, 1998.

	A 20-percent research tax credit also applied to the excess of (1) 100 percent of corporatecash expenditures (including grants or contributions) paid for basic research conducted byuniversities (and certain nonprofit scientific research organizations) over (2) the sum of (a) thegreater of two minimum basic research floors plus (b) an amount reflecting any decrease innonresearch giving to universities by the corporation as compared to such giving during afixed-base period, as adjusted for inflation. This separate credit computation is commonlyreferred to as the "university basic research credit" (see sec. 41(e)).

**Computation of allowable credit**

	Except for certain university basic research payments made by corporations, the researchtax credit applies only to the extent that the taxpayer's qualified research expenditures for thecurrent taxable year exceed its base amount. The base amount for the current year generally iscomputed by multiplying the taxpayer's "fixed-base percentage" by the average amount of thetaxpayer's gross receipts for the four preceding years. If a taxpayer both incurred qualifiedresearch expenditures and had gross receipts during each of at least three years from 1984through 1988, then its "fixed-base percentage" is the ratio that its total qualified researchexpenditures for the 1984-1988 period bears to its total gross receipts for that period (subject to amaximum ratio of .16). All other taxpayers (so-called "start-up firms") are assigned a fixed-basepercentage of 3 percent.(3)

	In computing the credit, a taxpayer's base amount may not be less than 50 percent of itscurrent-year qualified research expenditures.

**Alternative incremental research credit regime**

	Taxpayers are allowed to elect an alternative incremental research credit regime. If ataxpayer elects to be subject to this alternative regime, the taxpayer is assigned a three-tieredfixed-base percentage (that is lower than the fixed-base percentage otherwise applicable underpresent law) and the credit rate likewise is reduced. Under the alternative credit regime, a creditrate of 1.65 percent applies to the extent that a taxpayer's current-year research expenses exceed abase amount computed by using a fixed-base percentage of 1 percent (i.e., the base amountequals 1 percent of the taxpayer's average gross receipts for the four preceding years) but do notexceed a base amount computed by using a fixed-base percentage of 1.5 percent. A credit rate of2.2 percent applies to the extent that a taxpayer's current-year research expenses exceed a baseamount computed by using a fixed-base percentage of 1.5 percent but do not exceed a baseamount computed by using a fixed-base percentage of 2 percent. A credit rate of 2.75 percentapplies to the extent that a taxpayer's current-year research expenses exceed a base amountcomputed by using a fixed-base percentage of 2 percent.  An election to be subject to thisalternative incremental credit regime may be made for any taxable year beginning after June 30,1996, and such an election applies to that taxable year and all subsequent years (in the event thatthe credit subsequently is extended by Congress) unless revoked with the consent of theSecretary of the Treasury.

**Eligible expenditures**

	Qualified research expenditures eligible for the research tax credit consist of: (1)"in-house" expenses of the taxpayer for wages and supplies attributable to qualified research; (2)certain time-sharing costs for computer use in qualified research; and (3) 65 percent of amountspaid by the taxpayer for qualified research conducted on the taxpayer's behalf (so-called "contractresearch expenses").(4)

	To be eligible for the credit, the research must not only satisfy the requirements ofpresent-law section 174 but must be undertaken for the purpose of discovering information that istechnological in nature, the application of which is intended to be useful in the development of anew or improved business component of the taxpayer, and must pertain to functional aspects,performance, reliability, or quality of a business component.

	Expenditures attributable to research that is conducted outside the United States do notenter into the credit computation.  In addition, the credit is not available for research in the socialsciences, arts, or humanities, nor is it available for research to the extent funded by any grant,contract, or otherwise by another person (or governmental entity).

**Relation to deduction**

	Deductions allowed to a taxpayer under section 174 (or any other section) are reduced byan amount equal to 100 percent of the taxpayer's research tax credit determined for the taxableyear.  Taxpayers may alternatively elect to claim a reduced research tax credit amount undersection 41 in lieu of reducing deductions otherwise allowed (sec. 280C(c)(3)).

**Description of Proposal**

	The research tax credit would be extended for 18 months--i.e., generally, for the periodJuly 1, 1998, through December 31, 1999.

**Effective Date**

	Extension of the research credit would be effective for qualified research expenditurespaid or incurred during the period July 1, 1998, through December 31, 1999.

**B.  Extension of the Work Opportunity Tax Credit**

**Present Law**

	The work opportunity tax credit is available on an elective basis for employers hiringindividuals from one or more of  eight targeted groups. The eight targeted groups are:  (1) families eligible to receive benefits under the Title IV-A Temporary Assistance for NeedyFamilies Program (the successor to the Aid to Families with Dependent Children Program); (2)high-risk youth; (3) qualified ex-felons; (4) vocational rehabilitation referrals; (5) qualifiedsummer youth employees; (6) qualified veterans; (7) families receiving food stamps; and (8)persons receiving certain Supplemental Security Income (SSI) benefits.

	The credit generally is equal to 40 percent (25 percent for employment of 400 hours orless) of qualified wages. Qualified wages consist of wages attributable to service rendered by amember of a targeted group during the 1-year period beginning with the day the individualbegins work for the employer.  For a vocational rehabilitation referral, however, the periodbegins on the day the individual begins work for the employer on or after the beginning of theindividual's vocational rehabilitation plan.

	Generally, no more than $6,000 of wages during the first year of employment is permittedto be taken into account with respect to any individual. Thus, the maximum credit per individualis $2,400. With respect to qualified summer youth employees, the maximum credit is 40 percentof up to $3,000 of qualified first-year wages, for a maximum credit of $1,200.

	In general, an individual is not to be treated as a member of a targeted group unless:(1) on or before the day the individual begins work for the employer, the employer received inwriting a certification from the designated local agency that the individual is a member of aspecific targeted group; or (2) on or before the day the individual is offered work with theemployer, a prescreening notice is completed with respect to that individual by the employer andwithin 21 days after the individual begins work for the employer, the employer submits suchnotice, signed by the employer and the individual under penalties of perjury, to the designatedlocal agency as part of a written request for certification. The prescreening notice will contain theinformation provided to the employer by the individual that forms the basis of the employer'sbelief that the individual is a member of a targeted group.

	No credit is allowed for wages paid unless the eligible individual is employed by theemployer for at least 120 hours.  The credit percentage is 25 percent for employment of 400hours or less, assuming that the minimum employment period is satisfied with respect to thatemployee.  For employment of more than 400 hours, the credit percentage is 40 percent.

	The credit is effective for wages paid or incurred to a qualified individual who beganwork for an employer before July 1, 1998.

**Description of Proposal**

	The proposal would extend the work opportunity tax credit through December 31, 1999.

**Effective Date**

	The proposal would be effective for wages paid or incurred to a qualified individual whobegins work for an employer on or after July 1, 1998, and before January 1, 2000.

**C.  Extend the Deduction Provided for Contributions of Appreciated Stock to PrivateFoundations; Public Inspection of Private Foundation Annual Returns**

**1.  Extend the deduction provided for contributions of appreciated stock to privatefoundations**

**Present Law**

	In computing taxable income, a taxpayer who itemizes deductions generally is allowed todeduct the fair market value of property contributed to a charitable organization.(5)  However, inthe case of a charitable contribution of short-term gain, inventory, or other ordinary incomeproperty, the amount of the deduction generally is limited to the taxpayer's basis in the property. In the case of a charitable contribution of tangible personal property, the deduction is limited tothe taxpayer's basis in such property if the use by the recipient charitable organization isunrelated to the organization's tax-exempt purpose.

	In cases involving contributions to a private foundation (other than certain privateoperating foundations), the amount of the deduction is limited to the taxpayer's basis in theproperty.  However, under a special rule contained in section 170(e)(5), taxpayers are allowed adeduction equal to the fair market value of "qualified appreciated stock" contributed to a privatefoundation prior to July 1, 1998.  Qualified appreciated stock is defined as publicly traded stockwhich is capital gain property.  The fair-market-value deduction for qualified appreciated stockdonations applies only to the extent that total donations made by the donor to private foundationsof stock in a particular corporation did not exceed 10 percent of the outstanding stock of thatcorporation.  For this purpose, an individual is treated as making all contributions that were madeby any member of the individual's family.

**Description of Proposal**

	The proposal would extend permanently the special rule contained in section 170(e)(5).

**Effective Date
	The provision would be effective for contributions of qualified appreciated stock toprivate foundations made on or after July 1, 1998.

**2.  Public inspection of private foundation annual returns**

**Present Law
	Tax-exempt organizations (other than churches and certain small organizations) arerequired to file an annual information return (Form 990) with the Internal Revenue Service("IRS"), setting forth the organization's items of gross income and expenses attributable to suchincome, disbursements for tax-exempt purposes, plus certain other information for the taxableyear.

	Private foundations are required to make the current year's annual information return(Form 990-PF) available for public inspection at the foundation's principal office during regularbusiness hours (sec. 6104(d)).  Such return must be made available for inspection by any citizenon request made within 180 days after the date of publication of notice of its availability.  Noticemust be published, not later than the day the return is required to be filed, in a newspaper havinggeneral circulation in the county in which the principal office of the foundation is located.  Thenotice must state that the annual return is available for public inspection by any citizen whorequests it, and must state the address and telephone number of the private foundation's principaloffice and the name of its principal manager.

	Tax-exempt organizations (other than private foundations) that are required to file a Form990, including public charities, are required to allow public inspection at the organization'sprincipal office (and certain regional or district offices) of their Forms 990 for the three mostrecent taxable years (sec. 6104(e)).

	The Taxpayer Bill of Rights 2 imposed additional public inspection requirements on tax-exempt organizations.  All tax-exempt organizations, except private foundations, will be requiredto comply with requests made in person or in writing by individuals who seek a copy of theorganization's Form 990 for any of the organization's three most recent taxable years.  Upon sucha request, the organization is required to supply copies without charge other than a reasonable feefor reproduction and mailing costs.  If the request for copies is made in person, then theorganization must immediately provide such copies.  If the request for copies is made in writing,then copies must be provided within 30 days.  In addition, all tax-exempt organizations,including private foundations, will be required to comply in the same manner with requests madein person or in writing by individuals who seek a copy of the organization's application forrecognition of tax-exempt status and certain related documents.  However, an organization maybe relieved of its obligation to provide copies if, in accordance with regulations to bepromulgated by the Secretary of Treasury, (1) the organization has made the requesteddocuments widely available or (2) the Secretary of the Treasury determined, upon application bythe organization, that the organization was subject to a harassment campaign such that a waiverof the obligation to provide copies would be in the public interest.  These additional publicinspection provisions apply to requests made no earlier than 60 days after the date on which theTreasury Department publishes regulations defining when requested documents have been madewidely available or when a request is part of a harassment campaign.(6)  While proposed regulations have been issued, final regulations have notbeen published; therefore, the provision is not yet in effect.(7)

	Upon written request to the IRS, members of the general public also are permitted toinspect annual information returns of tax-exempt organizations and applications for recognitionof tax-exempt status (and related documents) at the National Office of the IRS in Washington,D.C.  A person making such a written request is notified by the IRS when the material isavailable for inspection at the National Office, where notes may be taken of the material open forinspection, photographs taken with the person's own equipment, or copies of such materialobtained from the IRS for a fee (Treas. Reg. secs. 301.6104(a)-6 and 301.6104(b)-1).

**Description of Proposal**

	Under the proposal, private foundations would be subject to the public inspectionrequirements  that currently apply to public charities and all other tax-exempt organizations thatfile annual information returns.  Accordingly, private foundations would be required to complywith requests from individuals who seek a copy of the foundation's annual information return forany of the foundation's three most recent taxable years.  Private foundations would no longer besubject to the publication requirements of section 6104(d).

**Effective Date**

	The additional public inspection provisions would apply to requests made after the laterof: (1)  the date which is 60 days after the date on which the Treasury Department publishesregulations defining when requested documents have been made widely available or when arequest is part of a harassment campaign, or (2) December 31, 1998.  The repeal of the present-law publication requirement would apply only to those returns the due date for filing of which ison or after the date the public inspection requirements become effective.

**D.  Exceptions Under Subpart F for Certain Active Financing Income**

**Present Law**

**In general**

	Under the subpart F rules, certain U.S. shareholders of a controlled foreign corporation("CFC") are subject to U.S. tax currently on certain income earned by the CFC, whether or notsuch income is distributed to the shareholders. The income subject to current inclusion under thesubpart F rules includes, among other things, "foreign personal holding company income" andinsurance income. The U.S. 10-percent shareholders of a CFC also are subject to currentinclusion with respect to their shares of the CFC's foreign base company services income (i.e.,income derived from services performed for a related person outside the country in which theCFC is organized).

	Foreign personal holding company income generally consists of the following:  (1)dividends, interest, royalties, rents and annuities; (2) net gains from the sale or exchange of (a)property that gives rise to the preceding types of income, (b) property that does not give rise toincome, and (c) interests in trusts, partnerships, and REMICs; (3) net gains from commoditiestransactions; (4) net gains from foreign currency transactions; (5) income that is equivalent tointerest; (6) income from notional principal contracts; and (7) payments in lieu of dividends.

	Insurance income subject to current inclusion under the subpart F rules includes anyincome of a CFC attributable to the issuing or reinsuring of any insurance or annuity contract inconnection with risks located in a country other than the CFC's country of organization. SubpartF insurance income also includes income attributable to an insurance contract in connection withrisks located within the CFC's country of organization, as the result of an arrangement underwhich another corporation receives a substantially equal amount of consideration for insurance ofother-country risks. Investment income of a CFC that is allocable to any insurance or annuitycontract related to risks located outside the CFC's country of organization is taxable as subpart Finsurance income (Prop. Treas. Reg. sec. 1.953-1(a)).

	Temporary exceptions from foreign personal holding company income and foreign basecompany services income apply for subpart F purposes for certain income that is derived in theactive conduct of a banking, financing, insurance, or similar business.(8) These exceptions(described below) are applicable only for taxable years beginning in 1998.

**Income from the active conduct of a banking, financing, or similar business**

	A temporary exception from foreign personal holding company income applies to incomethat is derived in the active conduct of a banking, financing, or similar business by a CFC that ispredominantly engaged in the active conduct of such business. For this purpose, income derivedin the active conduct of a banking, financing, or similar business generally is determined underthe principles applicable in determining financial services income for foreign tax credit limitationpurposes. However, in the case of a corporation that is engaged in the active conduct of abanking or securities business, the income that is eligible for this exception is determined underthe principles applicable in determining the income which is treated as nonpassive income forpurposes of the passive foreign investment company provisions. In this regard, the income of acorporation engaged in the active conduct of a banking or securities business that is eligible forthis exception is the income that is treated as nonpassive under the regulations proposed undersection 1296(b) (as in effect prior to the enactment of the Taxpayer Relief Act of 1997). SeeProp. Treas. Reg. secs. 1.1296-4 and 1.1296-6. The Secretary of the Treasury is directed toprescribe regulations applying look-through treatment in characterizing for this purposedividends, interest, income equivalent to interest, rents and royalties from related persons.

	For purposes of the temporary exception, a corporation is considered to be predominantlyengaged in the active conduct of a banking, financing, or similar business if it is engaged in theactive conduct of a banking or securities business or is a qualified bank affiliate or qualifiedsecurities affiliate. In this regard, a corporation is considered to be engaged in the active conductof a banking or securities business if the corporation would be treated as so engaged under theregulations proposed under prior law section 1296(b) (as in effect prior to the enactment of theTaxpayer Relief Act of 1997); qualified bank affiliates and qualified securities affiliates are asdetermined under such proposed regulations. See Prop. Treas. Reg. secs. 1.1296-4 and 1.1296-6.

	Alternatively, a corporation is considered to be engaged in the active conduct of abanking, financing, or similar business if more than 70 percent of its gross income is derivedfrom such business from transactions with unrelated persons located within the country under thelaws of which the corporation is created or organized. For this purpose, income derived by aqualified business unit ("QBU") of a corporation from transactions with unrelated personslocated in the country in which the QBU maintains its principal office and conducts substantialbusiness activity is treated as derived by the corporation from transactions with unrelated personslocated within the country in which the corporation is created or organized. A person other than anatural person is considered to be located within the country in which it maintains an officethrough which it engages in a trade or business and by which the transaction is effected. Anatural person is treated as located within the country in which such person is physically locatedwhen such person enters into the transaction.

**Income from the active conduct of an insurance business**

	A temporary exception from foreign personal holding company income applies forcertain investment income of a qualifying insurance company with respect to risks located withinthe CFC's country of creation or organization. These rules differ from the rules of section 953 ofthe Code, which determines the subpart F inclusions of a U.S. shareholder relating to insuranceincome of a CFC. Such insurance income under section 953 generally is computed in accordancewith the rules of subchapter L of the Code.

	A temporary exception applies for income (received from a person other than a relatedperson) from investments made by a qualifying insurance company of its reserves or 80 percentof its unearned premiums. For this purpose, in the case of contracts regulated in the country inwhich sold as property, casualty or health insurance contracts, unearned premiums and reservesare defined as unearned premiums and reserves for losses incurred determined using the methodsand interest rates that would be used if the qualifying insurance company were subject to taxunder subchapter L of the Code. Thus, for this purpose, unearned premiums are determined inaccordance with section 832(b)(4), and reserves for losses incurred are determined in accordancewith section 832(b)(5) and 846 of the Code (as well as any other rules applicable to a U.S.property and casualty insurance company with respect to such amounts).

	In the case of a contract regulated in the country in which sold as a life insurance orannuity contract, the following three alternative rules for determining reserves apply. Any one ofthe three rules can be elected with respect to a particular line of business.

	First, reserves for such contracts can be determined generally under the rules applicableto domestic life insurance companies under subchapter L of the Code, using the methods therespecified, but substituting for the interest rates in Code section 807(d)(2)(B) an interest ratedetermined for the country in which the qualifying insurance company was created or organized,calculated in the same manner as the mid-term applicable Federal interest rate ("AFR") (withinthe meaning of section 1274(d)).

	Second, the reserves for such contracts can be determined using a preliminary termforeign reserve method, except that the interest rate to be used is the interest rate determined forthe country in which the qualifying insurance company was created or organized, calculated inthe same manner as the mid-term AFR. If a qualifying insurance company uses such apreliminary term method with respect to contracts insuring risks located in the country in whichthe company is created or organized, then such method is the method that applies for purposes ofthis election.

	Third, reserves for such contracts can be determined to be equal to the net surrender valueof the contract (as defined in section 807(e)(1)(A)).

	In no event can the reserve for any contract at any time exceed the foreign statementreserve for the contract, reduced by any catastrophe or deficiency reserve. This rule applieswhether the contract is regulated as a property, casualty, health, life insurance, annuity or anyother type of contract.

	A temporary exception from foreign personal holding company income also applies forincome from investment of assets equal to: (1) one-third of premiums earned during the taxableyear on insurance contracts regulated in the country in which sold as property, casualty, or healthinsurance contracts; and (2) the greater of 10 percent of reserves, or, in the case of a qualifyinginsurance company that is a startup company, $10 million. For this purpose, a startup company isa company (including any predecessor) that has not been engaged in the active conduct of aninsurance business for more than 5 years. In general, the 5-year period commences when theforeign company first is engaged in the active conduct of an insurance business. If the foreigncompany was formed before being acquired by the U.S. shareholder, the 5-year periodcommences when the acquired company first was engaged in the active conduct of an insurancebusiness. In the event of the acquisition of a book of business from another company through anassumption or indemnity reinsurance transaction, the 5-year period commences when theacquiring company first engaged in the active conduct of an insurance business, except that ifmore than a substantial part (e.g., 80 percent) of the business of the ceding company is acquired,then the 5-year period commences when the ceding company first engaged in the active conductof an insurance business. Reinsurance transactions among related persons may not be used tomultiply the number of 5-year periods.

	Under rules prescribed by the Secretary, income is allocated to contracts as follows. Inthe case of contracts that are separate account-type contracts (including variable contracts notmeeting the requirements of sec. 817), only the income specifically allocable to such contractsare taken into account. In the case of other contracts, income not specifically allocable isallocated ratably among such contracts.

	A qualifying insurance company is defined as any entity which: (1) is regulated as aninsurance company under the laws of the country in which it is incorporated; (2) derives at least50 percent of its net written premiums from the insurance or reinsurance of risks situated withinits country of incorporation; and (3) is engaged in the active conduct of an insurance businessand would be subject to tax under subchapter L if it were a domestic corporation.

	The temporary exceptions do not apply to investment income (includable in the incomeof a U.S. shareholder of a CFC pursuant to sec. 953) allocable to contracts that insure relatedparty risks or risks located in a country other than the country in which the qualifying insurancecompany is created or organized.

**Anti-abuse rule**

	An anti-abuse rule applies for purposes of these temporary exceptions. For purposes ofapplying these exceptions, items with respect to a transaction or series of transactions aredisregarded if one of the principal purposes of the transaction or transactions is to qualify incomeor gain for these exceptions, including any change in the method of computing reserves or anyother transaction or transactions one of the principal purposes of which is the acceleration ordeferral of any item in order to claim the benefits of these exceptions.

**Foreign base company services income**

	A temporary exception from foreign base company services income applies for incomederived from services performed in connection with the active conduct of a banking, financing,insurance or similar business by a CFC that is predominantly engaged in the active conduct ofsuch business or is a qualifying insurance company.

**Description of Proposal**

**In general**

	The proposal would extend and modify the present-law temporary exceptions fromsubpart F for income that is derived in the active conduct of a banking, financing, or similarbusiness or in the conduct of an insurance business. These exceptions (as modified) would beapplicable only for taxable years beginning in 1999.

	With respect to income derived in the active conduct of a banking, financing, or similarbusiness, the proposal differs from the present-law temporary exceptions in the followingsignificant respects. First, the proposal would require a CFC to conduct substantial activity withrespect to its business in order to qualify for the exceptions. Second, the proposal would addcertain nexus requirements which would require that income which is derived by a CFC or QBUfrom transactions with customers would be eligible for the exceptions if, among other things,substantially all of the activities in connection with such transactions are conducted directly bythe CFC or QBU in its home country, and such income is treated as earned by the CFC or QBUin its home country for purposes of such country's tax laws. Third, the proposal would modifythe tests for determining whether a CFC is predominantly engaged in the active conduct of abanking, financing, or similar business, including modifications for income derived from alending or finance business. Fourth, the proposal would extend the exceptions to income derivedfrom certain cross border transactions, provided that certain requirements are met.  Fifth, thedetermination of where a customer is treated as located would be made under rules prescribed bythe Secretary of the Treasury. Finally, the look-through rule that was included in the present-lawprovision for purposes of determining the income eligible for the exceptions would beeliminated.

	In the case of insurance, the proposal differs from present law in the following significantrespects. In addition to the exception for certain income of a qualifying insurance company withrespect to risks located within the CFC's country of creation or organization that is providedunder present law, the proposal would provide additional exceptions. First, the proposal wouldprovide temporary exceptions from insurance income and from foreign personal holdingcompany income for certain income of a qualifying branch of a qualifying insurance companywith respect to risks located within the home country of the branch, provided certainrequirements are met under each of the exceptions.  Further, the proposal would add additionaltemporary exceptions from insurance income and from foreign personal holding companyincome for certain income of certain CFCs or branches with respect to risks located in anycountry other than the United States, provided that the requirements for these exceptions are met.

**Income from the active conduct of a banking, financing, or similar business**

Substantial activity requirement

	The proposal would modify the exceptions from subpart F for income derived in theactive conduct of a banking, financing, or similar business by, among other things, incorporatinga substantial activity requirement. Under the proposal, the subpart F exceptions would apply to aCFC that is an eligible controlled foreign corporation (an "eligible CFC").  An eligible CFCwould be defined as a CFC which is predominantly engaged in the active conduct of a banking,financing, or similar business, but only if it conducts substantial activity with respect to suchbusiness.

	Whether a CFC would be considered to conduct substantial activity with respect to abanking, financing, or similar business would be determined under all the facts andcircumstances. It would be intended that as part of this facts and circumstances analysis indetermining whether the activities conducted by the CFC are substantial, all relevant factorswould be taken into account, including the overall size of the CFC, the amount of its revenuesand expenses, the number of its employees, the ratio of its revenues per employee, the amount ofproperty it owns, and the nature, size, and relative significance of the applicable activitiesconducted by the CFC. Under the proposal, the Secretary would be granted the authority toprescribe regulations to carry out the purposes of these exceptions. It would be intended that suchauthority would include the authority to prescribe rules relating to whether a CFC (or, asrelevant, a QBU) would be considered to conduct substantial activity.

	It also would be intended that as part of this facts and circumstances analysis, a CFCwould be required to conduct substantially all of the activities necessary for the generation ofincome with respect to the business, which generally would include the following:
- 	initial solicitation of customers (including vendors);
- 	advising customers on financial needs, including funding and financial products; 
- 	providing financial and technical advice to customers; 
- 	designing or tailoring financial products to customers' needs;
- 	negotiating terms with customers;
- performing credit analysis on customers and evaluating noncredit risks;
- 	providing related services to customers;
- 	making loans, entering into leases, extending credit or entering into othertransactions with customers that generate income that would be consideredderived in the active conduct of a banking, financing, or similar business;
- 	collecting from customers;
- 	performing remarketing activities (including sales) following termination oftransactions with customers;
- 	responding to customers' failure to satisfy their obligations under transactions,including enforcement or renegotiation of terms, liquidation of collateral,foreclosure, and/or institution of litigation; and
- 	holding collateral for transactions with customers.

It would be intended that the performance of back-office functions (including accounting forincome or loss, recordkeeping, and routine communicating with customers) not be taken intoaccount in determining whether the substantial activity requirement would be satisfied. It alsowould be intended that the relevant activities of the business may be modified by Treasuryregulation to take into account future changes in the operations of these businesses.

	In general, the substantial activity requirement would be applied based on the activities ofthe CFC as a whole, including the activities of any QBUs of the CFC. In determining whether thesubstantial activity requirement would be satisfied, activities performed in the country in whichthe CFC is incorporated (or in the country in which the QBU has its principal office) byemployees of a related person of the CFC would be taken into account, but only to the extent thatthe related person is compensated on an arm's-length basis for the services of such employeesand such compensation is includible in the related person's income in such country for purposesof such country's income tax laws. For this purpose, a related person would have the meaningprovided in section 954(d)(3), substituting "at least 80 percent" for "more than 50 percent." Itwould be intended that the activities of such a related person would not again be taken intoaccount in determining whether another CFC or QBU (e.g., the related person) satisfies thesubstantial activity requirement.

	Predominantly engaged requirement

	The proposal also would modify the rules for determining whether a CFC ispredominantly engaged in the active conduct of a banking, financing, or similar business.Alternative rules would apply for this purpose.

Banking or securities business.--The proposal would modify the present-law applicationof the banking or securities business tests for determining whether a CFC is predominantlyengaged in the active conduct of a banking, financing or similar business. Under the proposal, aCFC would be considered to be predominantly engaged in the active conduct of a banking,financing, or similar business if it is engaged in the active conduct of a banking business and isan institution licensed to do business as a bank in the United States (or is any other corporationnot so licensed which is specified in regulations). In addition, a CFC would be considered to bepredominantly engaged in the active conduct of a banking, financing, or similar business if it isengaged in the active conduct of a securities business and is registered as a securities broker ordealer under applicable U.S. securities laws (or is any other corporation not so registered whichis specified in regulations). It generally would be intended that these requirements for the activeconduct of a banking or securities business be interpreted in the manner provided in theregulations proposed under prior law section 1296(b) (as in effect prior to the enactment of theTaxpayer Relief Act of 1997). See Prop. Treas. Reg. secs. 1.1296-4 and 1.1296-6.  Specifically,it would be intended that these requirements would include the requirements for foreign banksunder Prop. Treas. Reg. sec. 1.1296-4 as currently drafted. However, it would not be intendedthat these requirements be considered to be satisfied by a CFC merely because it is a qualifiedbank affiliate or a qualified securities affiliate within the meaning of the proposed regulationsunder former section 1296(b).

Lending or finance business.--The proposal would modify the present-law 70 percent testfor determining whether a CFC is predominantly engaged in the active conduct of a banking,financing, or similar business. Under the proposal, a CFC would be considered to bepredominantly engaged in the active conduct of such business if more than 70 percent of its grossincome is derived directly from the active and regular conduct of a lending or finance businessfrom transactions with customers which are unrelated persons. For this purpose, it would beintended that transactions with customers located in the United States not be taken into accountin determining whether the 70-percent test would be satisfied.

	For this purpose, a CFC would be considered to be engaged in a lending or financebusiness if it is engaged in the business of:

	(1)	making loans;

	(2)	purchasing or discounting accounts receivable, notes (including loans), or installmentobligations;

	(3)	engaging in leasing (including entering into leases and purchasing, servicing anddisposing of leases and leased assets);

	(4)	issuing letters of credit and providing guarantees;

	(5)	providing charge and credit card services; or

	(6)	rendering services or making facilities available in connection with the foregoingactivities carried on by the corporation rendering such services or facilities, or byanother corporation which is a member of the same affiliated group.

For this purpose, whether two corporations are affiliated would be determined by reference tosection 1504 with one modification: the exclusion for foreign corporations would be disregarded.

	Whether any portion of a CFC's gross income is derived directly from the active andregular conduct of a lending or finance business would be determined under all the facts andcircumstances. Under the proposal, the Secretary would be granted the authority to prescriberegulations to carry out the purposes of these exceptions. It would be intended that such authoritywould include the authority to prescribe rules relating to this determination.

Qualified banking or financing income exempt from subpart F

In general.--If a CFC would be treated as an eligible CFC (i.e., it satisfies the substantialactivity and predominantly engaged requirements), the subpart F exceptions would apply toqualified banking or financing income of such corporation. Qualified banking or financingincome would be defined as income which is derived in the active conduct of a banking,financing, or similar business by an eligible CFC or a QBU of such CFC if: (1) the income isderived from transactions with customers not located in the United States, (2) substantially all ofthe activities in connection with such transactions are conducted directly by the corporation orunit in its home country, and (3) the income is treated as earned by such corporation or unit in itshome country for purposes of such country's tax laws. For this purpose, income would beconsidered to be earned by a CFC or a QBU in its home country if such income is sourced andallocable to such CFC or QBU in its home country for purposes of such country's tax laws. Inaddition, for this purpose, activities would be considered to be conducted by a CFC or QBU ifsuch activities are performed by employees of the CFC or QBU. Except as provided byregulations, a CFC's home country would be defined as its country of creation or organization,and a QBU's home country would be defined as the country in which the unit maintains itsprincipal office. Moreover, income derived from transactions with customers would apply onlyto transactions with customers acting in their capacity as such.

	For this purpose, it would be intended that income derived by an eligible CFC or QBU ofsuch CFC from the following types of activities be considered to be income derived in the activeconduct of a banking, financing, or similar business (provided that the other requirements forthese exceptions are satisfied):

	(1)	regularly making personal, mortgage, industrial, or other loans in the ordinarycourse of the corporation's trade or business;

	(2)	factoring evidences of indebtedness for customers;

	(3)	purchasing, selling, discounting, or negotiating for customers notes, drafts, checks,bills of exchange, acceptances, or other evidences of indebtedness;

	(4)	issuing letters of credit and negotiating drafts drawn thereunder for customers;

	(5)	performing trust services, including as a fiduciary, agent, or custodian, forcustomers, provided such trust activities are not performed in connection withservices provided by a dealer in stock, securities or similar financial instruments;

	(6)	arranging foreign exchange transactions (including any section 988 transactionwithin the meaning of section 988(c)(1)) for, or engaging in foreign exchangetransactions with, customers;

	(7)	arranging interest rate or currency futures, forwards, options or notional principalcontracts for, or entering into such transactions with, customers;

	(8)	underwriting issues of stock, debt instruments or other securities under best effortsor firm commitment agreements for customers;

	(9)	engaging in leasing (including entering into leases and purchasing, servicing anddisposing of leases and leased assets);

	(10)	providing charge and credit card services for customers or factoring receivablesobtained in the course of providing such services;

	(11)	providing traveler's check and money order services for customers;

	(12)	providing correspondent bank services for customers;

	(13)	providing paying agency and collection agency services for customers;

	(14)	maintaining restricted reserves (including money or securities) in a segregatedaccount in order to satisfy a capital or reserve requirement imposed by a localbanking or securities regulatory authority;

	(15)	engaging in hedging activities directly related to another activity described herein;

	(16)	repackaging mortgages and other financial assets into securities and servicingactivities with respect to such assets (including the accrual of interest incidental tosuch activity);

	(17)	engaging in financing activities typically provided in the ordinary course by aninvestment bank, such as project financing provided in connection with constructionprojects, structured finance (including the extension of a loan and the sale ofparticipations or interests in the loan to other financial institutions or investors), andleasing activities to the extent incidental to such financing activities;

	(18)	providing financial or investment advisory services, investment managementservices, fiduciary services, or custodial services;

	(19)	purchasing or selling stock, debt instruments, interest rate or currency futures orother securities or derivative financial products (including notional principalcontracts) from or to customers and holding stock, debt instruments and othersecurities as inventory for sale to customers, unless the relevant securities orderivative financial products are not held in a dealer capacity;

	(20)	effecting transactions in securities for customers as a securities broker; and

	(21)	any other activity that the Secretary of the Treasury determines to be a financingactivity conducted by active corporations in the ordinary course of their business.

	Qualified banking or financing income of an eligible CFC or QBU of such CFC would bedetermined separately for the CFC and each QBU, taking into account, in the case of an eligibleCFC, only items of income, gain, deduction, loss or other items, as well as activities, of suchCFC that are not properly allocable to any QBUs. Similarly, in the case of a QBU, qualifiedbanking or financing income would be determined by taking into account such applicable items(e.g., income and activities) that are properly allocable to such QBU. Under the proposal, theSecretary would be granted the authority to prescribe regulations to carry out the purposes ofthese exceptions. It would be intended that such authority would include the authority toprescribe rules for properly allocating items and activities among branches or units of a CFC, andbetween the CFC and its branches or units.

Income from local customer transactions.--If the requirements above are satisfied, theexceptions would apply to income that is derived from transactions with customers located in theCFC's home country. In addition, the exceptions would apply to income that is derived by aQBU of an eligible CFC from transactions with customers located in the QBU's home country.

	For example, assume that a CFC is incorporated in the United Kingdom and hasoperations in France that constitute a QBU. Also assume that the activities of the U.K. CFC'shead office together with the activities of the French QBU satisfy the substantial activityrequirement. Under the proposal, income derived by the U.K. CFC from transactions withcustomers in the United Kingdom would be eligible for the exceptions if substantially all of theactivities in connection with the transaction are performed in the United Kingdom by employeesof the U.K. CFC, and the income is treated as earned by the U.K. CFC in the United Kingdomfor U.K. income tax purposes. In addition, income derived by the French QBU from transactionswith customers in France would be eligible for the exceptions if substantially all of the activitiesin connection with the transactions are performed in France by employees of the French QBU,and the income is treated as earned by the French QBU in France for French income taxpurposes.

Income from cross border transactions.--If the requirements above are satisfied, theexceptions also would apply to income from certain cross border transactions, but only if ahigher standard with respect to the substantial activity requirement is satisfied. Under theproposal, income derived by a CFC from transactions with customers not located in the CFC'shome country or the United States would be eligible for the exceptions if the CFC conductssubstantial activity with respect to a banking, financing, or similar business in its home country.In addition, income derived by a QBU of an eligible CFC from transactions with customers notlocated in the QBU's home country or the United States would be eligible for the exceptions, butonly if the QBU conducts substantial activity with respect to such a business in its home country.For this purpose, the substantial activity requirement would be applied by looking only at theactivities of the applicable CFC or QBU on a stand-alone basis. Thus, income derived by a QBUfrom transactions with customers not located in its home country (or in the United States) wouldbe eligible for the exceptions if the activities of the QBU itself constitute substantial activities(provided that the other requirements are satisfied).

	Consider again the U.K. CFC and the French QBU. If the head office of the U.K. CFCderives income from a transaction with a customer in Germany, the income would be eligible forthe exceptions if the activities of the CFC itself (without regard to those of the French QBU)satisfy the substantial activity requirement. Alternatively, if the French QBU derives incomefrom a transaction with a German customer, the income would be eligible for the exceptions ifthe activities of the French QBU itself satisfy the substantial activity requirement.

Home country requirement for income earned with respect to a lending or financebusiness.--In the case of a lending or finance business, in addition to the requirements describedabove, the proposal would include an additional requirement to qualify for the exceptions in thecase of income earned by a CFC which qualifies as an eligible CFC by satisfying thepredominantly engaged requirement for an active lending or finance business. For such aneligible CFC, income derived by such CFC would be eligible for the exceptions only if suchCFC derives more than 30 percent of its gross income directly from the active and regularconduct of a lending or finance business from transactions with customers that are unrelatedpersons and that are located within the CFC's home country (the "home country" requirement).In addition, income derived by a QBU of such an eligible CFC would be eligible for theexceptions only if such QBU derives more than 30 percent of its gross income directly from theactive and regular conduct of a lending or finance business from transactions with customers thatare unrelated persons and that are located within the QBU's home country. For this purpose, itwould be intended that transactions with customers located in the United States not be taken intoaccount.

	The home country requirement would be applied on a stand-alone basis to the particularCFC or QBU.  Thus, the 30-percent gross income test would take into account only the grossincome of a particular CFC (without regard to the income of its QBUs) from transactions with itshome-country unrelated customers.  Similarly, in the case of a QBU, there would be taken intoaccount the gross income of the particular QBU (without regard to the income of the CFC orother QBUs) from transactions with its home-country unrelated customers. Accordingly, if morethan 70 percent of the CFC's gross income is derived directly from the active and regularconduct of a lending or finance business from transactions with unrelated customers, and one ofthe CFC's QBUs satisfies the home country requirement but another QBU does not satisfy suchrequirement, income derived by the QBU that satisfies the home country requirement would beeligible for the exceptions from subpart F (provided that the other requirements are satisfied), butincome derived by the other QBU would not be eligible for the exceptions.

Coordination with other rules.--The proposal would provide that the exceptions undersection 954(h) for income derived in the active conduct of a banking, financing, or similarbusiness would not apply to income described in the dealer exception under section954(c)(2)(C)(ii) (described below) for a dealer in securities which is an eligible CFC that satisfiesthe predominantly engaged requirement for a securities business.

	In addition, it would be expected that the Treasury Department and the Internal RevenueService would issue timely guidance to make conforming changes to existing regulations in orderto reflect the exceptions under section 954(h).

**Exception for securities dealers**

	The proposal would provide an additional exception from foreign personal holdingcompany income for certain income derived by a securities dealer within the meaning of section475 (the so-called "dealer exception"). The dealer exception would apply to interest or dividends(or equivalent amounts described in sec. 954(c)(1)(E) or (G)) from any transaction (including ahedging transaction or a transaction consisting of a deposit of collateral or margin described insec. 956(c)(2)(J)) entered into in the ordinary course of the dealer's trade or business as such asecurities dealer, but only if the income is attributable to activities of the dealer in the country inwhich the dealer is created or organized (or, in the case of a QBU of the dealer, is attributable toactivities of the QBU in the country in which the QBU both maintains its principal office andconducts substantial business activity). For this purpose, income would be considered to beattributable to activities of the dealer in its country of incorporation (or to a QBU in the countryin which the QBU both maintains its principal office and conducts substantial business activity),if such income is attributable to activities performed in such country by employees of the dealer(or QBU), and such income is treated as earned in such country by the dealer (or QBU) forpurposes of such country's tax laws. For this purpose, income would be considered to be earnedin the country in which the dealer is created or organized (or, in the case of a QBU, in thecountry in which the QBU both maintains its principal office and conducts substantial businessactivity), if such income is sourced and allocable to such dealer (or QBU) in such country forpurposes of such country's tax laws. It would be intended that the dealer exception not apply toincome from transactions with persons located in the United States with respect to U.S.securities.  Thus, it would be intended that the exception from current inclusion under subpart Ffor income earned by dealers in securities not apply to activities that would otherwise beconducted in the United States. In addition, it would be intended that the dealer exception wouldapply to interest paid by customers to the dealer on margin loans in connection with sales ofsecurities (provided that the other requirements of the provision are satisfied).

**Insurance income**

In general

	The proposal would provide a temporary exception to insurance income under section953.  For purposes of the exception to insurance income, reserves for an exempt insurance orannuity contract would be determined in the same manner as under the temporary exception,described below, for foreign personal holding company income relating to certain insurancecontracts (sec. 954(i), as added by the proposal).  For purposes of these provisions, reserveswould be intended to include discounted unpaid losses or losses incurred, as appropriate, forproperty and casualty contracts.

Operation of the exception

	The proposal would provide an exception from insurance income for income derived by aqualifying insurance company that is attributable to the issuing (or reinsuring) of an exemptcontract by the qualifying insurance company or a qualifying insurance company branch of sucha company, and that is treated as earned by the company or branch in that company's, orbranch's, home country for purposes of that country's tax laws.  The exception from insuranceincome would not apply to income attributable to the issuing (or reinsuring) of an exemptcontract as the result of any arrangement whereby another corporation receives a substantiallyequal amount of premiums or other consideration in respect of issuing (or reinsuring a contractthat is not an exempt contract).  An exempt contract would be an insurance or annuity contractissued or reinsured by a qualifying insurance company or qualified insurance company branch inconnection with property in, liability arising out of activity in, or the lives or health of residentsof, a country other than the United States.

	No contract would be treated as an exempt contract unless the qualifying insurancecompany or branch derives more than 30 percent of its net written premiums from exemptcontracts (determined without regard to this sentence) covering applicable home country risks,and with respect to which no policyholder, insured, annuitant, or beneficiary is a related person(within the meaning of sec. 954(d)(3)).  Applicable home country risks would be risks inconnection with property in, liability arising out of activity in, or the lives or health of residentsof, the home country of the qualifying insurance company or branch, as the case may be. In allcases, the 30-percent test would be applied on a unit-by-unit basis.  Accordingly, income derivedby a qualifying insurance company branch of a CFC would qualify only if such branch alonesatisfies the 30-percent test (without regard to the net written premiums of any other branch). Income derived by the CFC would qualify only if the CFC alone satisfies the 30-percent testwithout regard to the net written premiums of any other unit or branch of the CFC.

	When determinations under the proposal are made separately with respect to a qualifyinginsurance company and its qualifying insurance company branch or branches, then in the case ofthe qualifying insurance company, only income, gain, or loss and activities of the company notproperly allocable or attributable to any qualifying insurance company branch would be takeninto account. In the case of a qualifying insurance company branch, only income, gain, or lossand activities of the branch that are properly allocable or attributable to it would be taken intoaccount. Under the proposal, the Secretary would be granted the authority to carry out thepurposes of these exceptions.  It would be intended that such authority would include theauthority to prescribe rules for properly allocating items and activities among branches or unitsof a CFC, and among the CFC and its branches or units.

	The home country of a CFC would be the country in which the CFC is created ororganized.  The home country of a qualified business unit that is a qualifying insurance companybranch of a qualifying insurance company would mean the country in which the principal officeof such unit is located and in which such unit is licensed, authorized, or regulated by theapplicable insurance regulatory body to sell insurance, reinsurance or annuity contracts topersons other than related persons (within the meaning of sec. 954(d)(3)) in that country.

Qualifying insurance company

	A qualifying insurance company would be a CFC that meets the following requirements,which would be intended to distinguish firms that have a real business nexus with a foreigncountry or countries from firms that do not.  The first requirement would be that the CFC besubject to regulation as an insurance (or reinsurance) company by its home country, and that theCFC be licensed, authorized, or regulated by the applicable insurance regulatory body for itshome country to sell insurance, reinsurance, or annuity contracts to persons other than relatedpersons (within the meaning of section 954(d)(3)) in its home country.

	The second requirement would be that the CFC derive more than 50 percent of itsaggregate net written premiums from the insurance or reinsurance by the CFC (on an aggregatebasis, including qualifying insurance company branches) covering applicable home country risks(as described above) of the CFC or branch, as the case may be.  For purposes of this rule, if a policyholder, insured, annuitant, or beneficiary is a related person, then the contract would betreated as not covering home country risks.  A related person would have the meaning set forth insection 954(d)(3). In the case of a qualifying insurance company branch, premiums would betaken into account under this second requirement only to the extent that the premiums would betreated as earned by the branch in its home country for purposes of that country's tax laws.

	The 50-percent test would apply on an aggregate basis.  For example, assume that aGerman CFC has a branch in France and a branch in Italy.  Assume that $50 of net writtenpremiums are properly allocable to the Italian branch, $100 of net written premiums are properlyallocable to the French branch, and $100 of net written premiums are properly allocable to theCFC in Germany.  For the Italian branch, assume $20 of the $50, or 40 percent, is from homecountry risks.  For the French branch, assume that $80 of the $100, or 80 percent, is from homecountry risks.  For the CFC in Germany, assume that $60 of the $100, or 60 percent, is fromhome country risks.  Taking into account the respective amounts and percentages, the CFCwould have 64 percent of its net written premiums from home country risks on an aggregatebasis.

	The third requirement would be that the CFC be engaged in the insurance business andthat it would be subject to tax under subchapter L if it were a domestic corporation.  A CFCwould be considered to be engaged in the insurance business, within the meaning of thisproposal, if it operates in a manner consistent with the operation of other bona fide commercialinsurance companies that sell insurance products to unrelated parties in its home country, andconducts managerial activities in that country with respect to the major functions of the insurancebusiness.  A factor, among others, that could be considered in determining whether it conductsmanagerial activities in its home country with respect to the major functions of the insurancebusiness may be whether in its home country it exercises key decision making in determiningbusiness strategy with respect to the major functions of the insurance business.  For purposes ofthe requirement that the CFC be engaged in the insurance business, activities performed in thehome country of the CFC by employees of the CFC and of a related person would be taken intoaccount, to the extent that the related person is compensated on an arm's-length basis for theservices of such employees and such compensation is includible in the related person's income insuch country for purposes of that country's tax laws.  For this purpose, a related person wouldhave the meaning provided in section 954(d)(3), substituting "at least 80 percent" for "more than50 percent."  In determining whether a CFC would be engaged in the insurance business, forexample, an entity that is not engaged in regular and continuous transactions with persons thatare not related persons (as described in the anti-abuse rules) would not be considered as engagedin the insurance business.

Qualifying insurance company branch

	A qualifying insurance company branch would be a qualified business unit of a CFC thatmeets two requirements.  A qualified business unit would mean any separate and clearlyidentified unit of a trade or business of a taxpayer which maintains separate books and records(within the meaning of sec. 989(a)).  The first requirement would be that the unit be licensed,authorized, or regulated by the applicable insurance regulatory body for its home country to sellinsurance, reinsurance or annuity contracts to persons other than related persons (within themeaning of sec. 954(d)(3)) in that country. It would be intended that the applicable insuranceregulatory body be the regulatory body that has the authority to license, authorize, or regulatewith respect to the insurance business in the country where the branch is located and a branchthat is regulated by such a body be considered to be regulated in the country where the branch islocated.  The second requirement would be that the CFC (of which the branch is a unit) be aqualifying insurance company, taking the unit into account for purposes of the applicable tests(above) as if it were a qualifying insurance company branch.

Additional requirements in the case of cross border risks

	The proposal would impose additional requirements with respect to any contract thatcovers cross border risks (that is, risks other than applicable home country risks), due to theincreased concern about mobility of income in cross border business. A contract issued by aqualifying insurance company or qualifying insurance company branch that covers risks otherthan applicable home country risks would not be treated as an exempt contract unless suchcompany or branch, as the case may be, (1) conducts substantial activity in its home country withrespect to the insurance business, and (2) performs in its home country substantially all of theactivities necessary to give rise to the income generated by the contract.

	Whether a CFC or unit thereof would be considered to perform in its home countrysubstantial activities with respect to the insurance business would be determined under all thefacts and circumstances. It would be intended that as part of this facts and circumstances analysisin determining whether the activities conducted by the CFC or unit are substantial, all relevantfactors would be taken into account, including the overall size of the CFC or unit, the amount ofits revenues and expenses, the number of its employees, the ratio of its revenues per employee,the amount of property it owns, and the nature, size and relative significance of the applicableactivities conducted by the CFC or unit.  Under the proposal, the Secretary would be granted theauthority to carry out the purposes of these exceptions.  It would be intended that such authoritywould include the authority to prescribe regulations relating to whether a CFC or unit would beconsidered to conduct substantial activity.

	It also would be intended that as part of this facts and circumstances analysis, a CFC orunit would be required to conduct substantially all of the activities necessary for the generationof income with respect to the insurance business. Such activities of an insurance businessgenerally would depend on the line of business, and could include:

- designing or tailoring insurance products to meet market or customer requirements;
- 	performing actuarial analysis with respect to insurance products;
- determining investment options for separate account-type products;
- 	performing underwriting functions with respect to insurance products;
- performing analysis for purposes of risk assessment;
- 	performing analysis for purposes of setting premium rates;
- 	performing analysis for purposes of calculating reserves;
- 	performing claims management and adjustment functions;
- 	developing marketing strategies, advertising and other public image activities;
- 	making (or arranging for) sales to customers;
- 	maintaining reserves and surplus (other than excess surplus);
- 	making (or arranging for) investments; and
- 	collecting from customers.

It further would be intended that the performance of back-office functions (including accountingfor income or loss, recordkeeping, and routine communicating with customers) not be taken intoaccount in determining whether the substantial activity requirement would be satisfied. It alsowould be intended that the relevant activities of the business may be modified by Treasuryregulation to take into account the actual operation of lines of insurance business and futurechanges in the operation of lines of insurance business.

	It further would be intended that activities performed in the CFC's or unit's home countryby employees of a related person (within the meaning of sec. 954(d)(3), substituting "at least 80percent" for "more than 50 percent") be taken into account, to the extent that the related person iscompensated on an arm's-length basis for the services of such employees and such compensationis includible in the related person's income in that country for purposes of such country's taxlaws. It also would be intended that the activities of such a related person would not again betaken into account in determining whether another CFC or unit (e.g., the related person) satisfiesthe substantial activity requirement.

	In addition, with respect to a contract issued by a qualifying insurance company orqualifying insurance company branch that covers risks other than applicable home country risks,the qualifying insurance company or qualifying insurance company branch would be required toperform in its home country substantially all of the activities necessary to give rise to the incomegenerated by the contract. 

**Foreign personal holding company income with respect to insurance**

	The proposal would provide a temporary exception from foreign personal holdingcompany income for certain investment income derived by a qualifying insurance company andby certain qualifying insurance company branches.

	The exception would apply to income (received from a person other than a relatedperson) from investments made by a qualifying insurance company or qualifying insurancecompany branch of its reserves allocable to exempt contracts or 80 percent of its unearnedpremiums from exempt contracts.  For this purpose, an exempt contract would have the meaningprovided under the proposal.

	In the case of exempt contracts that are property, casualty, or health insurance contracts,unearned premiums and reserves would mean unearned premiums and reserves for lossesincurred determined using the methods and interest rates that would be used if the qualifyinginsurance company or qualifying insurance company branch were subject to tax under subchapterL of the Code, with certain modifications. For this purpose, unearned premiums and lossesincurred would be determined in accordance with section 832(b) and 846 of the Code (as well asany other rules applicable to a U.S. property and casualty insurance company with respect tosuch amounts).  However, in applying these rules, there would be substituted for the applicableFederal interest rate the interest rate determined for the functional currency of the company orbranch and which (except as provided by the Treasury Secretary) would be calculated in thesame manner as the Federal mid-term rate under section 1274(d).  In addition, there would besubstituted for the loss payment pattern under section 846 the appropriate foreign loss paymentpattern determined by the Treasury Secretary for the line of business.  In the case of healthinsurance contracts, it would be intended that appropriate foreign mortality and morbidity tablesbe used for this purpose. In the case of disability contracts (other than credit disability) which aresubject to section 846(f)(6)(A), it would be intended that mortality and morbidity tablesreasonably reflect appropriate experience and foreign mortality and morbidity factors.

	In the case of an exempt contract that is a life insurance or annuity contract, reserves forsuch contracts would be determined as follows.  The reserves would equal the greater of: (1) thenet surrender value of the contract (as defined in section 807(e)(1)(A)), including in the case ofpension plan contracts; or (2) the amount determined by applying the tax reserve method thatwould apply if the qualifying insurance company were subject to tax under Subchapter L of theCode, with the following modifications.  First, there would be substituted for the applicableFederal interest rate an interest rate determined for the functional currency of the qualifyinginsurance company's home country, calculated (except as provided by the Treasury Secretary inorder to address insufficient data and similar problems) in the same manner as the mid-termapplicable Federal interest rate ("AFR") (within the meaning of section 1274(d)).  Second, therewould be substituted for the prevailing State assumed rate the highest assumed interest ratepermitted to be used for purposes of determining statement reserves in the foreign country for thecontract.  Third, in lieu of U.S. mortality and morbidity tables, there would be applied mortalityand morbidity tables that reasonably reflect the current mortality and morbidity risks in theforeign country.  Fourth, the Treasury Secretary may provide that the interest rate and mortalityand morbidity tables of a qualifying insurance company may be used for one or more of itsbranches when appropriate.

	In no event would the reserve for any contract at any time exceed the foreign statementreserve for the contract, reduced by any catastrophe, equalization, or deficiency reserve or anysimilar reserve.  In the case of a contract that is a property, casualty, or health insurance contract,it would be intended that this limitation would apply with respect to unpaid losses by line ofbusiness (similar to sec. 846(a)(3)). These rules would apply whether the contract is regulated asa property, casualty, health, life insurance, annuity, or any other type of contract.

	The proposal also would provide an exception from foreign personal holding companyincome for income from investment of assets equal to (1) one-third of premiums earned duringthe taxable year on exempt contracts regulated in the country in which sold as property, casualty,or health insurance contracts, and (2) 10 percent of reserves (determined for purposes of theproposal) for contracts regulated in the country in which sold as life insurance or annuitycontracts.  In no event would the exception from foreign personal holding company incomeapply to investment income with respect to excess surplus.

	To prevent the shifting of relatively high-yielding assets to generate investment incomethat qualifies under this temporary exception, the proposal would provide that, except asprovided by the Treasury Secretary, income would be allocated to contracts as follows.  In thecase of a separate account-type contract (including a variable contract not meeting therequirements of section 817), the income credited under the contract would be allocable only tothat contract.  Income not so allocated generally would be allocated ratably among all contractsthat are not separate account-type contracts, subject to the anti-abuse rules (described below).

**Other definitions and anti-abuse rules relating to insurance**

	The proposal would provide that the present-law statutory definition of a life insurancecontract (under secs. 7702 or 101(f)), as well as the distribution on death requirement of section72(s) and the diversification requirement of section 817(h), would not apply for purposes ofdetermining reserves for a life insurance or annuity contract under sections 953 and 954 of theCode, provided that neither the policyholders, the insureds or annuitants, nor the beneficiarieswith respect to the contract are U.S. persons.

	The proposal would provide a rule coordinating the exception to insurance income withthe present-law special rule for certain captive insurance companies (sec. 953(c)).  Under thecoordination rule, the scope of the present-law rule that related party insurance income is treatedas subpart F income would be retained.  The exception under the proposal from the definition ofinsurance income would not include income derived from exempt contracts that cover risks otherthan applicable home country risks, for purposes of the rules of section 953(c).

	The anti-abuse rules applicable under the subpart F exceptions provided in section 954(h)(other than sec. 954(h)(7)(B)) (as added by the proposal) would apply to these exceptions forinsurance.  In addition, the proposal would provide anti-abuse rules applicable under theexceptions from subpart F income relating to insurance.

	The proposal would provide that there shall be disregarded any item of income, gain,loss, or deduction of, or derived from, an entity which is not engaged in regular and continuoustransactions with persons that are not related persons.  This rule would be intended, for example,to address the use of fronting companies or similar entities (that are not engaged in regular andcontinuous transactions with persons that are not related persons) to reinsure risks in a manner tocause a CFC or branch to qualify as a qualifying insurance company or qualifying insurancecompany branch by meeting percentage requirements with respect to home country risks that itwould not otherwise meet.

	The proposal would provide that there shall be disregarded any change in the method ofcomputing reserves or any other transaction or transactions one of the principal purposes ofwhich is the acceleration or deferral of any item in order to claim the benefits of theseexceptions.

	The proposal also would provide that a contract is not treated as an exempt contract (asdescribed above), if any policyholder, insured or annuitant, or beneficiary is a resident of theUnited States, the contract was marketed to the U.S. resident, and was written to cover a riskoutside the United States.

	The proposal also would provide that a contract is not treated as an exempt contract, if thecontract covers risks located both within and outside the United States, and the qualifyinginsurance company or branch does not maintain such records, and file such reports, with respectto the contract as the Treasury Secretary requires.  It would be intended that documentation thatis contemporaneous with the issuance of the contract be maintained by the qualifying insurancecompany or branch.

	The proposal also would provide that the Treasury Secretary may prescribe rules for theallocation of contracts (and income from contracts) among two or more qualifying insurancecompany branches of a qualifying insurance company in order to clearly reflect the income ofsuch branches.

	The proposal also would provide that premiums from a contract would be treated as notcovering home country risks (and are treated as covering risks other than home country risks) forpurposes of the tests for 30 percent and 50 percent, respectively, of net written premiums if thecontract reinsures a contract issued or reinsured by a related person (within the meaning of sec.954(d)(3)).

	The proposal also would provide that the Treasury Secretary may prescribe regulations asmay be necessary or appropriate to carry out the purposes of the exceptions from insuranceincome and foreign personal holding company income provided under sections 953(e) and 954(i)(as added by the proposal).

**Other anti-abuse rules**

	The proposal generally includes the anti-abuse rules of the present-law provision, withcertain further refinements. Under the proposal, the anti-abuse rules would provide that itemswith respect to a transaction or series of transactions would be disregarded if one of the principalpurposes of the transaction or transactions is to qualify income or gain for these exceptions,including any transaction or a series of transactions a principal purpose of which is theacceleration or deferral of any item in order to claim the benefits of these exceptions. In addition,the anti-abuse rules would provide that items of an entity which is not engaged in regular andcontinuous transactions with customers which are not related persons would be disregarded.Moreover, items with respect to a transaction or series of transactions would be disregarded ifone of the principal purposes of the transaction or transactions is to qualify income or gain forthese exceptions, including utilizing or doing business with: (1) one or more entities in order tosatisfy any home country requirement, or (2) a special purpose entity or arrangement, including asecuritization or financing arrangement or any similar entity or arrangement. Finally, the anti-abuse rules would provide that a related person, officer, director, or employee with respect to anyCFC (or QBU) which otherwise would be treated as a customer of such corporation or unit withrespect to any transaction would not be treated as a customer, if a principal purpose of suchtransaction is to satisfy any requirement for these exceptions. 

**Sale of assets of an active financing business**

	The proposal would include a modification to address the treatment of sales of assets ofan active financing business. In general, foreign personal holding company income includes netgains from the sale or exchange of property that gives rise to dividends, interest, royalties, rents,or annuities. The proposal would provide an exception from this rule for income that qualifies forthe exception from subpart F for income derived in the active conduct of a banking, financing, orsimilar business. Under the proposal, foreign personal holding company income would notinclude net gains from the sale or exchange of property that gives rise to dividends, interest,royalties, rents, or annuities if such property gives rise to income not treated as foreign personalholding company income for the taxable year by reason of the exceptions under section 954(h) or(i) (as added by the proposal) for income derived in the active conduct of a banking, financing, orsimilar business or in the conduct of an insurance business. It would be intended that thisexception would apply only to the extent that, prior to its disposition, the property was held togenerate or generated income which qualifies for the exceptions under section 954(h) or (i) (andsuch property was not so held for a principal purpose of taking advantage of this exception).

**Exceptions from foreign base company services income**

	The present-law provision includes a corresponding exception from foreign basecompany services income for income derived by a CFC from the performance of services that aredirectly related to a transaction entered into by the CFC that gives rise to income that is eligiblefor these exceptions from subpart F. Under the proposal, foreign base company services incomewould not include income that is not treated as foreign personal holding company income byreason of the exceptions under section 954(h) or 954(i) or the securities dealer exception undersection 954(c)(2)(C)(ii), or treated as exempt insurance income by reason of section 953(e) (asadded by the proposal).

**Other matters**

	Nothing in this provision is intended to alter the Treasury Department's agreement, asreflected in Notice 98-35, not to finalize regulations regarding so-called hybrid entities prior toJanuary 1, 2000, in order to allow Congress the opportunity to fully consider the tax policy issuesinvolved.

**Effective Date**

	The proposal would apply only to taxable years of foreign corporations beginning in1999, and to taxable years of U.S. shareholders with or within which such taxable years offoreign corporations end.

**E.  Extension of the Generalized System of Preferences**

**Present Law**

	Title V of the Trade Act of 1974, as amended, grants authority to the President to provideduty-free treatment on imports of certain articles from beneficiary developing countries subjectto certain conditions and limitations.  To qualify for GSP privileges, each beneficiary country issubject to various mandatory and discretionary eligibility criteria.  Import sensitive products areineligible for GSP.  The GSP program, which is designed to promote development through traderather than traditional aid programs, expired after June 30, 1998.

**Description of Proposal**

	The proposal would reauthorize the GSP program to terminate after December 31, 1999. Refunds would be authorized, upon request of the importer, for duties paid between July 1, 1998,and the date of enactment of the bill.

**Effective Date**

	The proposal would be effective for duties paid on or after July 1, 1998, and beforeJanuary 1, 2000.

**F.  Permanent Extension of Income Averaging for Farmers**

**Present Law**

	The 1997 Act included a provision that allows individuals engaged in the trade orbusiness of farming an election to calculate their current year regular income tax liability byaveraging, over the prior three-year period, all or a portion of their taxable income attributable tothe farming business.

	Under the provision, a taxpayer (1) designates all or a portion of the current year incomefrom the farming business as "elected farm income," (2) allocates one-third of the "elected farmincome" to each of the prior three taxable years, and (3) determines the current year regularincome tax liability by determining the sum of (a) his or her current year income tax liability(without the elected farm income) plus (b) the increases in the income tax liability for each of thethree prior taxable years by taking into account the allocable share of the elected farm income forthose years.

	The provision does not apply for purposes of the self-employment tax or the alternativeminimum tax.  The provision is effective for taxable years beginning after December 31, 1997,and before January 1, 2001.

**Description of Proposal**

	The proposal would make permanent the income averaging provision for farmers.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 2000.

**G.  Disclosure of Return Information to Department of Education in Connection with Income Contingent Loans**

**Present and Prior Law
	Under section 6103(l)(13) of the Code, the Secretary of Treasury was authorized todisclose to the Department of Education certain return information with respect to any taxpayerwho has received an "applicable student loan."  An "applicable student loan" is any loan madeunder (1) part D of title IV of the Higher Education Act of 1965 or  (2) parts B or E of title IV ofthe Higher Education Act of 1965 which is in default and has been assigned to the Department ofEducation, if the loan repayment amounts are based in whole or in part on the taxpayer's income. The Secretary is permitted to disclose only taxpayer identity information and the adjusted grossincome of the taxpayer.  The Department of Education may use the information only to establishthe appropriate income contingent repayment amount for an applicable student loan.

	The disclosure authority under section 6103(l)(13) terminated with respect to requestsmade after September 30, 1998.

**Description of Proposal**

	The proposal would reinstate the disclosure authority under section 6103(l)(13) withrespect to requests made after the date of enactment and before October 1, 2003.

**Effective Date**

	The disclosure authority under section 6103(l)(13) would apply to requests made after thedate of enactment, and before October 1, 2003.

**II.  OTHER PROVISIONS**

**A.  Comprehensive Study of Recovery Periods and Depreciation Methods Under Section 168**

**Present Law**

	A taxpayer is allowed to deduct a reasonable allowance for the exhaustion, wear and tear,and obsolescence of property that is used a trade or business or is held for the production ofincome.  For most tangible personal and real property placed in service after 1986, the amount ofthe deductible allowance is determined under section 168 using the applicable recovery period,the applicable depreciation method, and the applicable convention specified in section 168.

	For some types of assets, the applicable recovery period of an asset is provided in section168.  In other cases, the recovery period of an asset is determined by reference to its class life. The class life of an asset may be provided by section 168, or may be determined with regard tothe list of class lives provided by the Treasury that was in effect on November 9, 1990.  TheTreasury Department is required to monitor and analyze actual experience with respect to alldepreciable assets.

	The applicable depreciation method determines the rate at which the cost of the propertyis recovered.  In general, the applicable depreciation method specified in section 168 varies withthe recovery period of the property.  For property with a recovery period of 10 years or less, theapplicable method is the 200 percent declining balance method, switching to straight-line in thefirst year in which that method yields a larger allowance.  The 150 percent declining balance,(switching to straight-line) is the applicable method for property with a recovery period of 15 or20 years, as well as for all property used in the trade or business of farming.  The straight-linemethod must be used for property with a longer recovery period, as well as for certain specifiedtypes of property.

	The applicable convention determines the point of time during the year that the propertyis considered placed in service.  Applicable conventions specified in section 168 include the mid-year, the mid-quarter and the mid-month conventions.

**Description of Proposal**

	The Secretary of the Treasury (or his delegate) would be directed to conduct acomprehensive study of the recovery periods and depreciation methods under section 168 of theCode, and to provide recommendations for determining such periods and methods in a morerational manner.

**Effective Date**

	The Secretary of the Treasury (or his delegate) would be directed to submit the results ofthe study and recommendations to the House Ways and Means and Senate Finance Committeesby March 31, 2000.

**B.  Farm Production Flexibility Contract Payments**

**Present law**

	A taxpayer is generally required to include an item in income no later than the time of itsactual or constructive receipt, unless such amount is properly accounted for in a different periodunder the taxpayer's method of accounting.  If a taxpayer has an unrestricted right to demand thepayment of an amount, the taxpayer is in constructive receipt of that amount whether or not thetaxpayer makes the demand and actually receives the payment.

	The Federal Agriculture Improvement and Reform Act of 1996 (the "FAIR Act")provides for production flexibility contracts between certain eligible owners and producers andthe Secretary of Agriculture.  These contracts generally cover crop years from 1996 through2002.  Annual payments are made under such contracts at specific times during the Federalgovernment's fiscal year.  Section 112(d)(2) of the FAIR Act provides that one-half of eachannual payment is to be made on either December 15 or January 15 of the fiscal year, at theoption of the recipient.(9)  This option to receive the payment on December 15 potentially resultsin the constructive receipt (and thus potential inclusion in income) of one-half of the annualpayment at that time, even if the option to receive the amount on January 15 is elected.

	The remaining one-half of the annual payment must be made no later than September 30of the fiscal year. The Emergency Farm Financial Relief Act of 1998 added section 112(d)(3) tothe FAIR Act which provides that all payments for fiscal year 1999 are to be paid at such time ortimes during fiscal year 1999 as the recipient may specify.  Thus, the one-half of the annualamount that would otherwise be required to be paid no later than September 30, 1999 can bespecified for payment in calendar year 1998. This potentially results in the constructive receipt(and thus required inclusion in taxable income) of such amounts in calendar year 1998, whetheror not the amounts are actually received or the right to their receipt is fixed.

**Description of Proposal**

	The time a production flexibility contract payment under the FAIR Act is properlyincludible in income would be determined without regard to the options granted by section112(d)(2) (allowing receipt of one-half of the annual payment on either December 15 or January15 of the fiscal year) or section 112(d)(3) (allowing the acceleration of all payments for fiscalyear 1999) of that Act.

**Effective Date**

	The proposal would be effective for production flexibility contract payments made underthe FAIR Act in taxable years ending after December 31, 1995.

**C.  Increase Deduction for Health Insurance Expenses of Self-Employed Individuals**

**Present Law**

	Under present law, self-employed individuals are entitled to deduct a portion of theamount paid for health insurance for the self-employed individual and the individual's spouse anddependents.  The deduction for health insurance expenses of self-employed individuals is notavailable for any month in which the taxpayer is eligible to participate in a subsidized health planmaintained by the employer of the taxpayer or the taxpayer's spouse.  The deduction is availablein the case of self insurance as well as commercial insurance.  The self-insured plan must in factbe insurance (e.g., there must be appropriate risk shifting) and not merely a reimbursementarrangement.

	The portion of health insurance expenses of self-employed individuals that is deductibleis 45 percent for taxable years beginning in 1998 and 1999, 50 percent for taxable yearsbeginning in 2000 and 2001, 60 percent for taxable years beginning in 2002, 80 percent fortaxable years beginning in 2003, 2004, and 2005, 90 percent for taxable years beginning in 2006,and 100 percent for taxable years beginning in 2007 and thereafter.

	Under present law, employees can exclude from income 100 percent of employer-provided health insurance.

**Description of Proposal**

	The proposal would increase the deduction for health insurance of self-employedindividuals to 75 percent for taxable years beginning in 2002 and to 100 percent for taxable yearsbeginning in 2003 and thereafter.

**Effective Date**

	The proposal would be effective for taxable years beginning after December 31, 2001.

**D.  Increase State Volume Limits on Private Activity Tax-Exempt Bonds**

**Present Law**

	Interest on bonds issued by States and local governments is excluded from income if theproceeds of the bonds are used to finance activities conducted and paid for by the governmentalunits (Code sec. 103).  Interest on bonds issued by these governmental units to finance activitiescarried out and paid for by private persons ("private activity bonds") is taxable unless theactivities are specified in the Internal Revenue Code.  Private activity bonds on which interestmay be tax-exempt include bonds for privately operated transportation facilities (airports, docksand wharves, mass transit, and high speed rail facilities), privately owned and/or providedmunicipal services (water, sewer, solid waste disposal, and certain electric and heating facilities),economic development (small manufacturing facilities and redevelopment in economicallydepressed areas), and certain social programs (low-income rental housing, qualified mortgagebonds, student loan bonds, and exempt activities of charitable organizations described in Codesec. 501(c)(3)).

	The volume of tax-exempt private activity bonds that States and local governments mayissue for most of these purposes in each calendar year is limited by State-wide volume limits. The current annual volume limits are $50 per resident of the State or $150 million if greater.  Thevolume limits do not apply to private activity bonds to finance airports, docks and wharves,certain governmentally owned, but privately operated solid waste disposal facilities, certain highspeed rail facilities, and to certain types of private activity tax-exempt bonds that are subject toother limits on their volume (qualified veterans' mortgage bonds and certain "new"empowerment zone and enterprise community bonds).

**Description of Proposal**

	The proposal would increase the present-law annual State private activity bond volumelimits to $75 per resident of each State or $225 million (if greater) beginning in calendar year2007. The increase would be phased-in as follows, beginning in calendar year 2003:**Calendar Year****Volume Limit**2003$55 per resident ($165 million if greater)2004$60 per resident ($180 million if greater)2005$65 per resident ($195 million if greater)2006$70 per resident ($210 million if greater)
**Effective Date

	The volume limit increases  would be effective beginning in calendar year 2003.

**E.  Modification of Individual Estimated Tax Safe Harbors**

**Present Law**

	Under present law, an individual taxpayer generally is subject to an addition to tax forany underpayment of estimated tax.  An individual generally does not have an underpayment ofestimated tax if he or she makes timely estimated tax payments at least equal to: (1) 100 percentof the tax shown on the return of the individual for the preceding year (the "100 percent of lastyear's liability safe harbor") or (2) 90 percent of the tax shown on the return for the current year. The 100 percent of last year's liability safe harbor is generally modified to be a 110 percent oflast year's liability safe harbor for any individual with an AGI of more than $150,000 as shownon the return for the preceding taxable year, except that it is 105 percent of last year's liability fortaxable years beginning in 1999, 2000, and 2001, and 112 percent of last year's liability fortaxable years beginning in 2002.  If a married individual files a separate return for the year forwhich an estimated tax installment payment was due, the $150,000 amount becomes $75,000.

**Description of Proposal**

	For taxable years beginning in 2000 and 2001, the 105 percent of last year's liability safeharbor for any individual with an AGI of more than $150,000 as shown on the return for thepreceding taxable year would be a 106 percent of last year's liability safe harbor.

**Effective Date**

	The proposal would be effective for taxable years beginning in 2000 and 2001.

**III.  REVENUE OFFSET PROVISIONS**

**A.  Treatment of Certain Deductible Liquidating Distributions of Regulated Investment Companies and Real Estate Investment Trusts**

**Present Law**

	Regulated investment companies ("RICs") and real estate investment trusts ("REITs") areallowed a deduction for dividends paid to their shareholders.  The deduction for dividends paidincludes amounts distributed in liquidation which are properly chargeable to earnings and profits,as well as, in the case of a complete liquidation occurring within 24 months after the adoption ofa plan of complete liquidation, any distribution made pursuant to such plan to the extent ofearnings and profits.  Rules that govern the receipt of dividends from RICs and REITs generallyprovide for including the amount of the dividend in the income of the shareholder receiving thedividend that was deducted by the RIC or REIT.  Generally, any shareholder realizing gain froma liquidating distribution of a RIC or REIT includes the amount of gain in the shareholder'sincome.  However, in the case of a liquidating distribution to a corporation owning 80-percent ofthe stock of the distributing corporation, a separate rule generally provides that the distribution istax-free to the parent corporation.  The parent corporation succeeds to the tax attributes,including the adjusted basis of assets, of the distributing corporation.  Under these rules, aliquidating RIC or REIT might be allowed a deduction for amounts paid to its parent corporation,without a corresponding inclusion in the income of the parent corporation, resulting in incomebeing subject to no tax.

	A RIC or REIT may designate a portion of a dividend as a capital gain dividend to theextent the RIC or REIT itself has a net capital gain, and a RIC may designate a portion of thedividend paid to a corporate shareholder as eligible for the 70-percent dividends-receiveddeduction to the extent the RIC itself received dividends from other corporations.  If certainconditions are satisfied, a RIC also is permitted to pass through to its shareholders the tax-exempt character of the RIC's net income from tax-exempt obligations through the payment of"exempt interest dividends," though no deduction is allowed for such dividends.

**Description of Proposal**

	Any amount which a liquidating RIC or REIT may take as a deduction for dividends paidwith respect to an otherwise tax-free liquidating distribution to an 80-percent corporate owner is includible in the income of the recipient corporation. The includible amount is treated as adividend received from the RIC or REIT.  The liquidating corporation may designate the amountdistributed as a capital gain dividend or, in the case of a RIC, a dividend eligible for the 70-percent dividends received deduction or an exempt interest dividend, to the extent provided bythe RIC or REIT provisions of the Code.

	The proposal does not otherwise change the tax treatment of the distribution to the parentcorporation or to the RIC or REIT.  Thus, for example, the liquidating corporation will notrecognize gain (if any) on the liquidating distribution and the recipient corporation will hold theassets at a carryover basis, even where the amount received is treated as a dividend..

**Effective Date**

	The provision is effective for distributions on or after May 22, 1998, regardless of whenthe plan of liquidation was adopted.

	No inference is intended regarding the treatment of such transactions under present law.

**B.  Add Vaccines Against Rotavirus Gastroenteritis to the List of Taxable Vaccines**

**Present Law**

	A manufacturer's excise tax is imposed at the rate of 75 cents per dose (sec. 4131) on thefollowing vaccines routinely recommended for administration to children:  diphtheria, pertussis,tetanus, measles, mumps, rubella, polio, HIB (haemophilus influenza type B),  hepatitis B, andvaricella (chicken pox).  The tax applied to any vaccine that is a combination of vaccinecomponents equals 75 cents times the number of components in the combined vaccine.

	Amounts equal to net revenues from this excise tax are deposited in the Vaccine InjuryCompensation Trust Fund to finance compensation awards under the Federal Vaccine InjuryCompensation Program for individuals who suffer certain injuries following administration ofthe taxable vaccines.  This program provides a substitute Federal "no fault" insurance system forthe State-law tort and private liability insurance systems otherwise applicable to vaccinemanufacturers.  All persons immunized after September 30, 1988, with covered vaccines mustpursue compensation under this Federal program before bringing civil tort actions under Statelaw.

**Description of Proposal**

	The proposal would add vaccines against rotavirus gastroenteritis to the list of taxablevaccines.

**Effective Date**

	The proposal would be effective for vaccine purchases after the date of enactment.  Nofloor stocks tax would be collected for amounts held for sale on that date.

**C.  Clarify and Expand Mathematical Error Procedures**

**Present Law**

**Taxpayer identification numbers ("TINs")**

	The Internal Revenue Service ("IRS") may deny a personal exemption for a taxpayer, thetaxpayer's spouse or the taxpayer's dependents if the taxpayer fails to provide a correct TIN foreach person for whom the taxpayer claims an exemption.  This TIN requirement also indirectlyaffects other tax benefits currently conditioned on a taxpayer being able to claim a personalexemption for a dependent (e.g., head-of-household filing status and the dependent care credit). Other tax benefits, including the adoption credit, the child tax credit, the Hope Scholarship creditand Lifetime Learning credit, and the earned income credit also have TIN requirements.  Formost individuals, their TIN is their Social Security Number ("SSN").  The mathematical andclerical error procedure currently applies to the omission of a correct TIN for purposes ofpersonal exemptions and all of the credits listed above except for the adoption credit.

**Mathematical or clerical errors**

	The IRS may summarily assess additional tax due as a result of a mathematical or clericalerror without sending the taxpayer a notice of deficiency and giving the taxpayer an opportunityto petition the Tax Court.  Where the IRS uses the summary assessment procedure formathematical or clerical errors, the taxpayer must be given an explanation of the asserted errorand a period of 60 days to request that the IRS abate its assessment.  The IRS may not proceed tocollect the amount of the assessment until the taxpayer has agreed to it or has allowed the 60-dayperiod for objecting to expire.  If the taxpayer files a request for abatement of the assessmentspecified in the notice, the IRS must abate the assessment.  Any reassessment of the abatedamount is subject to the ordinary deficiency procedures.  The request for abatement of theassessment is the only procedure a taxpayer may use prior to paying the assessed amount in orderto contest an assessment arising out of a mathematical or clerical error.  Once the assessment issatisfied, however, the taxpayer may file a claim for refund if he or she believes the assessmentwas made in error.

**Description of Proposal**

	For purposes of the mathematical and clerical error procedure, the proposal wouldprovide that a correct TIN is a TIN assigned by the Social Security Administration (or in certainlimited cases, the IRS) to the individual identified on the return.  The IRS would be authorized todetermine that the individual identified on the tax return corresponds in every aspect (includingname, age, date of birth, and SSN) to the individual to whom the TIN is issued.  The IRS wouldbe authorized to use the mathematical and clerical error procedure to deny eligibility for thedependent care tax credit, the child tax credit, and the earned income credit even though a correctTIN has been supplied if the IRS determines that the statutory age restrictions for eligibility forany of the respective credits is not satisfied (e.g., the TIN issued for the child claimed as the basisof the child tax credit identifies the child as over the age of 17 at the end of the taxable year).

**Effective Date**

	The proposal would be effective for taxable years ending after the date of enactment.

**D.  Restrict 10-Year Net Operating Loss Carryback Rules for Specified Liability Losses**

**Present Law**

	Under present law, that portion of a net operating loss that qualifies as a "specifiedliability loss" may be carried back 10 years rather than being limited to the general two-yearcarryback period.  A specified liability loss includes amounts allowable as a deduction withrespect to product liability, and also certain liabilities that arise under Federal or State law or outof any tort of the taxpayer.  In the case of a liability arising out of a Federal or State law, the act(or failure to act) giving rise to the liability must occur at least 3 years before the beginning ofthe taxable year.  In the case of a liability arising out of a tort, the liability must arise out of aseries of actions (or failures to act) over an extended period of time a substantial portion of whichoccurred at least three years before the beginning of the taxable year.  A specified liability losscannot exceed the amount of the net operating loss, and is only available to taxpayers that usedan accrual method of accounting throughout the period that the acts (or failures to act) occurred.

**Description of Proposal**

	Under the proposal, specified liability losses would be limited to product liability lossesand amounts allowable as a deduction (other than a deduction under sec. 468(a)(1) or sec.468A(a)) that are in satisfaction of a liability under a Federal or State law requiring thereclamation of land, decommissioning of a nuclear power plant (or any unit thereof),dismantlement of a drilling platform, remediation of environmental contamination, or a paymentunder any workers compensation act (within the meaning of sec. 461(h)(2)(C)(i)), if the act (orfailure to act) giving rise to such liability occurs at least 3 years before the beginning of thetaxable year.  As under present law, the specified liability loss (as redefined) cannot exceed theamount of the net operating loss and is only available to taxpayers that used an accrual method ofaccounting throughout the period that the act (or failure to act) giving rise to the liabilityoccurred.  No inference regarding the interpretation of the specified liability loss carryback rulesunder present law is intended.

**Effective Date**

	The proposal would be effective for net operating losses arising in taxable years endingafter the date of enactment.

1.   This document may be cited as follows: Joint Committee on Taxation, *Description ofProvisions in H.R. 4738* (JCX-66-98), October 9, 1998.  (References in this document to the"1997 Act" refer to the Taxpayer Relief Act of 1997.)
2.   A separate document provides a description of the Chairman's mark relating toproposed tax technical corrections.  (See JCX-67-98.)
3.   A special rule is designed to gradually recompute a start-up firm's fixed-basepercentage based on its actual research experience. Under this special rule, a start-up firm will beassigned a fixed-base percentage of 3 percent for each of its first five taxable years after 1993 inwhich it incurs qualified research expenditures. In the event that the research credit is extendedbeyond the scheduled expiration date, a start-up firm's fixed-based percentage for its sixththrough tenth taxable years after 1993 in which it incurs qualified research expenditures will be aphased-in ratio based on its actual research experience. For all subsequent taxable years, thetaxpayer's fixed-based percentage will be its actual ratio of qualified research expenditures togross receipts for any five years selected by the taxpayer from its fifth through tenth taxableyears after 1993 (sec. 41(c)(3)(B)). 
4.   Under a special rule, 75 percent of amounts paid to a research consortium for qualifiedresearch is treated as qualified research expenses eligible for the research credit (rather than 65percent under the general rule under sec. 41(b)(3) governing contract research expenses) if (1)such research consortium is a tax-exempt organization that is described in section 501(c)(3)(other than a private foundation) or section 501(c)(6) and is organized and operated primarily toconduct scientific research, and (2) such qualified research is conducted by the consortium onbehalf of the taxpayer and one or more persons not related to the taxpayer. 
5.   The amount of the deduction allowable for a taxable year with respect to a charitablecontribution may be reduced depending on the type of property contributed, the type ofcharitable organization to which the property is contributed, and the income of the taxpayer(secs. 170(b) and 170(e)).
6.   However, the legislative history of the provision indicates that Congress expected thatorganizations will comply voluntarily with the public inspection provisions prior to the issuanceof such final regulations.  
7.   Prop. Treas. Reg. sec. 301.6104(e)-1.
8.  The President canceled these exceptions in 1997 pursuant to the Line Item Veto Act. OnJune 25, 1998, the U.S. Supreme Court held that the cancellation procedures set forth in the LineItem Veto Act are unconstitutional. Clinton v. City of New York, 118 S. Ct. 2091 (June 25,1998).
9.  This rule applies to fiscal years after 1996.  For fiscal year 1996, this payment was to bemade not later than 30 days after the production flexibility contract was entered into.********