[Federal Register Volume 59, Number 184 (Friday, September 23, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-99999]


[[Page Unknown]]

[Federal Register: September 23, 1994]


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DEPARTMENT OF THE TREASURY
Internal Revenue Service

26 CFR Part 1

 

Determination of Taxable Income in Specific Situations

CFR Correction

    In Title 26 of the Code of Federal Regulations, part 1, 
Sec. Sec. 1.441 to 1.500, revised as of April 1, 1994, on page 475, a 
portion of paragraph (a)(1)(iii)(E)(3), Example (ii) through paragraph 
(a)(4) Example 3 of Sec. 1.482-2T was inadvertently omitted and as 
corrected should read as follows:


Sec. 1.482-2T  Determination of taxable income in specific situations 
(temporary).

* * * * *

    (ii) Average collection period. X's total sales within the same 
product group to unrelated persons within country Z for the period 
are $6,200,000. The average receivables balance for the period is 
$2,805,430 ($33,665,160/12). The average collection period in whole 
days is determined as follows: 

                                                                        
                                         $6,200,000                     
  Receivables turnover rate      =   ------------------   =       2.21  
                                         $2,805,430                     
                                                                        


                                                                        
                                          365                           
  Average collection period      =   ------------   =      165.16 days, 
                                         2.21                           
                                                                        

rounded to the nearest whole day=165 days.
    (iii) Interest-free period. Accordingly, for intercompany trade 
receivables incurred by X during Y's 1988 calendar taxable year 
attributable to the purchase of property from Y for resale to 
unrelated persons located in country Z and included in the product 
group, X may use an interest-free period of 175 days (165 days in 
the average collection period plus 10 days, but not in excess of a 
maximum of 183 days). All other intercompany trade receivables 
incurred by X are subject to the interest-free periods described in 
paragraphs (a)(1)(iii) (B), (C), or (D), whichever are applicable. 
If X makes sales in other foreign countries in addition to country Z 
or makes sales of property in more than one product group in any 
foreign country, separate computations of X's average collection 
period, by product group within each country, are required in order 
for X and Y to determine an interest-free period for such product 
groups in such foreign countries under this paragraph 
(a)(1)(iii)(E).

    (iv) Payment; book entries. (A) Except as otherwise provided in 
this paragraph (a)(1)(iv), in determining the period of time for which 
an amount owed by one member of the group to another member is 
outstanding, payments or other credits to an account are considered to 
be applied against the earliest amount outstanding, that is, payments 
or credits are applied against amounts in a first-in, first-out (FIFO) 
order. Thus, tracing payments to individual intercompany trade 
receivables is generally not required in order to determine whether a 
particular intercompany trade receivable has been paid within the 
applicable interest-free period determined under paragraph (a)(1)(iii) 
of this section. The application of this paragraph (a)(1)(iv)(A) may be 
illustrated by the following example:

    Example--(i) Facts. X and Y are members of a group of controlled 
entities within the meaning of section 482. Assume that the balance 
of intercompany trade receivables owed by X to Y on June 1 is $100, 
and that all of the $100 balance represents amounts incurred by X to 
Y during the month of May. During the month of June X incurs an 
additional $200 of intercompany trade receivables to Y. Assume that 
on July 15, $60 is properly credited against X's intercompany 
account to Y, and that $240 is properly credited against the 
intercompany account on August 31. Assume that under paragraph 
(a)(1)(iii)(B) of this section interest must be charged on X's 
intercompany trade receivables to Y beginning with the first day of 
the third calendar month following the month the intercompany trade 
receivables arise, and that no alternative interest-free period 
applies. Thus, the interest-free period for intercompany trade 
receivables incurred during the month of May ends on July 31, and 
the interest-free period for intercompany trade receivables incurred 
during the month of June ends on August 31.
    (ii) Application of payments. Using a FIFO payment order, the 
aggregate payments of $300 are applied first to the opening June 
balance, and then to the additional amounts incurred during the 
month of June. With respect to X's June opening balance of $100, no 
interest is required to be accrued on $60 of such balance paid by X 
on July 15, because such portion was paid within its interest-free 
period. Interest for 31 days, from August 1 to August 31 inclusive, 
is required to be accrued on the $40 portion of the opening balance 
not paid until August 31. No interest is required to be accrued on 
the $200 of intercompany trade receivables X incurred to Y during 
June because the $240 credited on August 31, after eliminating the 
$40 of indebtedness remaining from periods before June, also 
eliminated the $20 incurred by X during June prior to the end of the 
interest-free period for that amount. The amount of interest 
incurred by X to Y on the $40 amount during August creates bona fide 
indebtedness between controlled entities and is subject to the 
provisions of paragraph (a)(1)(iii)(A) of this section without 
regard to any of the exceptions contained in paragraphs (a)(1)(iii) 
(B) through (E) of this section.

    (B) Notwithstanding the first-in, first-out payment application 
rule described in paragraph (a)(1)(iv)(A) of this section, the taxpayer 
may apply payments or credits against amounts owed in some other order 
on its books in accordance with an agreement or understanding of the 
related parties if the taxpayer can demonstrate that either it or 
others in its industry, as a regular trade practice, enter into such 
agreements or understandings in the case of similar balances with 
unrelated parties.
    (2) Arm's length interest rate--(i) In general. For purposes of 
section 482 and paragraph (a) of this section, an arm's length rate of 
interest shall be a rate of interest which was charged, or would have 
been charged, at the time the indebtedness arose, in independent 
transactions with or between unrelated parties under similar 
circumstances. All relevant factors shall be considered, including the 
principal amount and duration of the loan, the security involved, the 
credit standing of the borrower, and the interest rate prevailing at 
the situs of the lender or creditor for comparable loans between 
unrelated parties.
    (ii) Funds obtained at situs of borrower. Notwithstanding the other 
provisions of paragraph (a)(2) of this section, if the loan or advance 
represents the proceeds of a loan obtained by the lender at the situs 
of the borrower, the arm's length rate for any taxable year shall be 
equal to the rate actually paid by the lender increased by an amount 
which reflects the costs or deductions incurred by the lender in 
borrowing such amounts and making such loans, unless the taxpayer 
establishes a more appropriate rate under the standards set forth in 
paragraph (a)(2)(i) of this section.
    (iii) Safe haven interest rates for certain loans and advances made 
after May 8, 1986--(A) Applicability--(1) General rule. Except as 
otherwise provided in paragraph (a)(2) of this section, paragraph 
(a)(2)(iii)(B) of this section applies with respect to the rate of 
interest charged and to the amount of interest paid or accrued in any 
taxable year--
    (i) Under a term loan or advance between members of a group of 
controlled entities where (except as provided in paragraph 
(a)(2)(iii)(A)(2)(ii)) of this section the loan or advance is entered 
into after May 8, 1986, and
    (ii) After May 8, 1986, under a demand loan or advance between such 
controlled entities.
    (2) Grandfather rule for existing loans. The safe haven rates 
prescribed in paragraph (a)(2)(iii)(B) of this section shall not apply, 
and the safe haven rates prescribed in 26 CFR Sec. 1.482-2(a)(2)(iii) 
(revised as of April 1, 1985) shall apply to--
    (i) Term loans or advances made before May 9, 1986, and
    (ii) Term loans or advances made before August 7, 1986, pursuant to 
a binding written contract entered into before May 9, 1986.
    (B) Safe haven interest rate based on applicable Federal rate. 
Except as otherwise provided in this paragraph (a)(2), in the case of a 
loan or advance between members of a group of controlled entities, an 
arm's length rate of interest referred to in paragraph (a)(2)(i) of 
this section shall be for purposes of Chapter 1 of the Code--
    (1) The rate of interest actually charged if that rate is--
    (i) Not less than 100 percent of the applicable Federal rate (the 
``lower limit''), and
    (ii) Not greater than 130 percent of the applicable Federal rate 
(the ``upper limit'), or
    (2) If either no interest is charged or if the rate of interest 
charged is less than the lower limit, then an arm's length rate of 
interest shall be equal to the lower limit, compounded semiannually, or
    (3) If the rate of interest charged is greater than the upper 
limit, then an arm's length rate of interest shall be equal to the 
upper limit, compounded semiannually,

unless the taxpayer establishes a more appropriate compound rate of 
interest under paragraph (a)(2)(i) of this section. However, if the 
compound rate of interest actually charged is greater than the upper 
limit and less than the rate determined under paragraph (a)(2)(i) of 
this section, or if the compound rate actually charged is less than the 
lower limit and greater than the rate determined under paragraph 
(a)(2)(i) of this section, then the compound rate actually charged 
shall be deemed to be an arm's length rate under paragraph (a)(2)(i) of 
this section. In the case of any sale-leaseback described in section 
1274(e), the lower limit shall be 110 percent of the applicable Federal 
rate, compounded semiannually.
    (C) Applicable Federal rate. For purposes of paragraph 
(a)(2)(iii)(B) of this section, the term ``applicable Federal rate'' 
means, in the case of a loan or advance to which this section applies 
and having a term of--
    (1) Not over 3 years, the Federal short-term rate.
    (2) Over 3 years but not over 9 years, the Federal mid-term rate, 
or
    (3) Over 9 years, the Federal long-term rate,

as determined under section 1274(d) in effect on the date such loan or 
advance is made. In the case of any sale or exchange between controlled 
entities, the lower limit shall be the lowest of the applicable Federal 
rates in effect for any month in the 3-calendar-month period ending 
with the first calendar month in which there is a binding written 
contract in effect for such sale or exchange (the ``lowest 3-month 
rate'', as defined in section 1274(d)(2)). In the case of a demand loan 
or advance to which this section applies, the ``applicable Federal 
rate'' means the Federal short-term rate determined under section 
1274(d) (determined without regard to the lowest 3-month short-term 
rate determined under section 1274(d)(2)) in effect for each day on 
which any amount of such loan or advance (including unpaid accrued 
interest determined under paragraph (a)(2) of this section) is 
outstanding.
    (D) Lender in business of making loans.  If the lender in a loan or 
advance transaction to which paragraph (a)(2) of this section applies 
is regularly engaged in the trade or business or making loans or 
advances to unrelated parties, the safe haven rates prescribed in 
paragraph (a)(2)(iii)(B) of this section shall not apply, and the arm's 
length interest rate to be used shall be determined under the standards 
described in paragraph (a)(2)(i) of this section, including reference 
to the interest rates charged in such trade or business by the lender 
on loans or advances of a similar type made to unrelated parties at and 
about the time the loan or advance to which paragraph (a)(2) of this 
section applies was made.
    (E) Foreign currency loans. The safe haven interest rates 
prescribed in paragraph (a)(2)(iii)(B) of this section do not apply to 
any loan or advance the principal or interest of which is expressed in 
a currency other than U.S. dollars.
    (3) Coordination with interest adjustments required under certain 
other Code sections. If the stated rate of interest on the stated 
principal amount of a loan or advance between controlled entities is 
subject to adjustment under section 482 and is also subject to 
adjustment under any other section of the Code (for example, section 
467, 483, 1274 or 7872), section 482 and paragraph (a) of this section 
may be applied to such loan or advance in addition to such other Code 
section. After the enactment of the Tax Reform Act of 1984, Pub. L. 98-
369, and the enactment of Pub. L. 99-121, such other Code sections 
include sections 467, 483, 1274 and 7872. The order in which the 
different provisions shall be applied is as follows:
    (i) First, the substance of the transaction shall be determined; 
for this purpose, all the relevant facts and circumstances shall be 
considered and any law or rule of law (assignment of income, step 
transaction, etc.) may apply. Only the rate of interest with respect to 
the stated principal amount of the bona fide indebtedness (within the 
meaning of paragraph (a)(1) of this section), if any, shall be subject 
to adjustment under section 482, paragraph (a) of this section, and any 
other Code section.
    (ii) Second, the other Code section shall be applied to the loan or 
advance to determine whether any amount other than stated interest is 
to be treated as interest, and if so, to determine such amount 
according to the provisions of such other Code section.
    (iii) Third, whether or not the other Code section applies to 
adjust the amounts treated as interest under such loan or advance, 
section 482 and paragraph (a) of this section may then be applied by 
the district director to determine whether the rate of interest charged 
on the loan or advance, as adjusted by any other Code section, is 
greater or less than an arm's length rate of interest, and if so, to 
make appropriate allocations to reflect an arm's length rate of 
interest.
    (iv) Fourth, section 482 and paragraphs (b) through (e) of this 
section, if applicable, may be applied by the district director to make 
any appropriate allocations, other than an interest rate adjustment, to 
reflect an arm's length transaction based upon the principal amount of 
the loan or advance and the interest rate as adjusted under paragraph 
(a)(3) (i), (ii) or (iii) of this section. For example, assume that two 
commonly controlled taxpayers enter into a deferred payment sale of 
tangible property and no interest is provided, and assume also that 
section 483 is applied to treat a portion of the stated sales price as 
interest, thereby reducing the stated sales price. If after this 
recharacterization of a portion of the stated sales price as interest, 
the recomputed sales price does not reflect an arm's length sales price 
under the principles of paragraph (e) of this section, the district 
director may make other appropriate allocations (other than an interest 
rate adjustment) to reflect an arm's length sales price.
    (4) Examples. The principles of paragraph (a)(3) of this section 
may be illustrated by the following examples:

    Example (1). An individual, A, transfers $20,000 to a 
corporation controlled by A in exchange for the corporation's note 
which bears adequate stated interest. The district director 
recharacterizes the transaction as a contribution to the capital of 
the corporation in exchange for preferred stock. Under paragraph 
(a)(3)(i) of this section, section 1.482-2(a) does not apply to the 
transaction because there is no bona fide indebtedness.
    Example (2). B, an individual, is an employee of Z corporation, 
and is also the controlling shareholder of Z. Z makes a term loan of 
$15,000 to B at a rate of interest that is less than the applicable 
Federal rate. In this instance the other operative Code section is 
section 7872. Under section 7872(b), the difference between the 
amount loaned and the present value of all payments due under the 
loan using a discount rate equal to 100 percent of the applicable 
Federal rate is treated as an amount of cash transferred from the 
corporation to B and the loan is treated as having original issue 
discount equal to such amount. Under paragraph (a)(3)(iii) of this 
section, section 482 and paragraph (a) of this section may also be 
applied by the district director to determine if the rate of 
interest charged on this $15,000 loan (100 percent of the AFR, 
compounded semiannually, as adjusted by section 7872) is an arm's 
length rate of interest. Because the rate of interest on the loan, 
as adjusted by section 7872, is within the safe haven range of 100-
130 percent of the AFR, compounded semiannually, no further interest 
rate adjustments under section 482 and paragraph (a) of this section 
will be made to this loan.
    Example (3). The facts are the same as in example (2) except 
that the amount lent by Z to B is 9,000, and that amount is the 
aggregate outstanding amount of loans between Z and B. Under the 
$10,000 de minimis exception of section 7872(c)(3), no adjustment 
for interest will be made to this $9,000 loan under section 7872. 
Under paragraph (a)(3)(iii) of this section, the district director 
may apply section 482 and paragraph (a) of this section to this 
$9,000 loan to determine whether the rate of interest charged is 
less than an arm's length rate of interest, and if so, to make 
appropriate allocations to reflect an arm's length rate of interest.
* * * * *
[FR Doc. 94-99999 Filed 9-22-94; 8:45 am]
BILLING CODE 1505-01-D