[Federal Register Volume 62, Number 198 (Tuesday, October 14, 1997)]
[Proposed Rules]
[Pages 53503-53504]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-26000]



  Federal Register / Vol. 62, No. 198 / Tuesday, October 14, 1997 / 
Proposed Rules  

[[Page 53503]]



DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-114000-97]
RIN-1545-AV41


Withholding on Interest in the Case of Sales of Obligations 
Between Interest Payment Dates

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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SUMMARY: This notice of proposed rulemaking provides guidance regarding 
the obligation to withhold on interest paid with respect to obligations 
in the case of the sale of obligations between interest payment dates. 
These regulations would affect United States and foreign withholding 
agents and recipients. This document also provides notice of a public 
hearing on these proposed regulations.

DATES: Comments and outlines of oral comments to be presented at the 
public hearing scheduled for January 26, 1998, at 10 a.m. must be 
received by January 5, 1998.

ADDRESSES: Send submission to: CC:DOM:CORP:R (REG-114000-97), room 
5226, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington DC 20224. Submissions may be hand delivered between the 
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-114000-97), Courier 
desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington DC. Alternatively, taxpayers may submit comments 
electronically via the internet by selecting the ``Tax Regs'' option on 
the IRS Home Page, or by submitting comments directly to the IRS 
internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html. The hearing scheduled for January 26, 1998, will be held 
in the Commissioner's Conference Room, room 3313, Internal Revenue 
Service, 1111 Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Lilo 
Hester at (202) 622-3840 (not a toll-free number); concerning 
submissions and the hearing, Evangelista Lee, (202) 622-7180 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    In this issue of the Federal Register, the IRS and Treasury are 
publishing final withholding and reporting regulations under chapter 3 
of the Internal Revenue Code (Code) and other sections of the Code. 
Section 1.1441-3(b)(2) of the final regulations provides that no 
withholding is required upon interest accrued on the date of a sale of 
debt obligations when the sale occurs between two interest payment 
dates, even though the amount is treated as interest under Sec. 1.61-7 
(c) or (d) and is subject to tax under section 871 or 881. In contrast, 
Sec. 1.1441-2(b)(3) of the final regulations provides that withholding 
is required on amounts of original issue discount in the event of a 
sale of an original issue discount obligation or a payment on such an 
obligation, subject to certain exceptions. The IRS and Treasury believe 
that, in view of these provisions, the exemption from withholding on 
non-OID amounts is no longer justified. A withholding agent that pays 
amounts to a foreign person in connection with the sale of an 
obligation between interest payments dates is in the same position as a 
withholding agent that pays amounts to a foreign person in connection 
with the sale of an original issue discount obligation. The withholding 
exemption for sale of debt obligations between interest payment dates 
provides an easy avenue for the avoidance of the documentation 
requirements imposed under sections 871(h) and 881(c) for purposes of 
qualifying interest on registered debt obligations as portfolio 
interest. For this reason, and in order to create parity with the tax 
treatment of original issue discount obligations under chapter 3 of the 
Code, it is no longer appropriate to continue this exemption.
    Under Sec. 1.1441-2(b)(3), a withholding agent must withhold on an 
amount of original issue discount to the extent that it has actual 
knowledge of the proportion of the amount of the payment that is 
taxable to the beneficial owner under section 871(a)(1)(C) or 
881(a)(3)(A). A withholding agent has actual knowledge if it knows how 
long the beneficial owner has held the obligation, the terms of the 
obligation, and the extent to which the beneficial owner purchased the 
obligation at a premium. A withholding agent is treated as having 
knowledge if the information is reasonably available. Special rules are 
provided for withholding agents with which the beneficial owner does 
not maintain a direct account relationship. Further, the regulations 
under Sec. 1.1441-2(b)(3) dealing with original issue discount provide 
that, in the case of an obligation that would qualify as portfolio 
interest if documentation were provided to the withholding agent, 
withholding is required on the entire amount of stated interest, if 
any, and original issue discounts, if no such documentation is 
provided, irrespective of whether the withholding agent has knowledge 
of the portion of the payment representing taxable original issue 
discount. For this purpose, the withholding agent may rely upon the IRS 
List of Original issue Discount Instruments contained in IRS 
Publication 1212 (available from the IRS Distribution Centers).
    In response to comments, the provisions in Sec. 1.1441-3(b)(1) are 
proposed to be modified to reduce the amount upon which withholding is 
required. No obligation to withhold is imposed under current law on the 
payment of stated interest on an obligation that was purchased between 
interest payment dates. Under Sec. 1.61-7(c), interest received on the 
interest payment date is treated as a return of basis to the extent it 
represents accrued unpaid interest as of the date of purchase as 
reflected in the new holder's basis for the obligation. Therefore, when 
the new holder receives a payment of the stated interest, the holder s 
tax liability is limited to the amount of interest accrued after the 
date of purchase (subject to additional adjustments reflecting possible 
acquisition premiums or market discounts). Because of the difficulty 
for a withholding agent to determine the amount accrued to the holder 
and other adjustments affecting the actual amount taxable to the 
holder, withholding on the entire amount of stated interest is required 
under the current withholding regulations under Sec. 1.1441-3(b)(1).
    Commentators have asked that the withholding agent be permitted to 
withhold on the amount that it knows is taxable. The final withholding 
regulations did not modify the proposed regulations on this point 
because the Treasury and IRS consider that withholding on the entire 
amount is justified if withholding on sales of obligations between 
interest payment dates is not required. However, because these proposed 
regulations require withholding, the regulations permit a withholding 
agent to adjust the amount of withholding at the time of payment of 
stated interest to account for earlier withholding.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in EO 12866. Therefore, 
a regulatory assessment is not required. It also has been determined 
that section 553(b) of the Administrative Procedure Act (5

[[Page 53504]]

U.S.C. chapter 5) does not apply to these regulations, and because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any comments that are submitted timely 
to the IRS. All comments will be available for public inspection and 
copying.
    A public hearing has been scheduled for January 26, 1998, at 10 
a.m. in the Commissioner's Conference Room, room 3313, Internal Revenue 
Building, 1111 Constitution Ave, NW., Washington DC. Because of access 
restrictions, visitors will not be admitted beyond the Internal Revenue 
Building lobby more than 15 minutes before the hearing starts.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit comments and an outline of the topics to be discussed and the 
time to be devoted to each topic by January 5, 1998.
    A period of 10 minutes will be allotted to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority for part 1 continues to read in part as 
follows:

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

    Par. 2. In Sec. 1.1441-3, paragraph (b) is revised to read as 
follows:


Sec. 1.1441-3  Determination of amount to be withheld.

* * * * *
    (b) Withholding on payments on certain obligations--(1) Withholding 
at time of payment of interest. When making a payment on an interest-
bearing obligation, a withholding agent must withhold under 
Sec. 1.1441-1 upon the gross amount of stated interest payable on the 
interest payment date, regardless of whether the payment constitutes a 
return of capital or the payment of income within the meaning of 
section 61, unless the withholding agent has knowledge of the actual 
amount of interest paid. For this purpose, the withholding agent may 
rely on information provided by the issuer (or its paying agent), on a 
representation from the beneficial owner, or on information that the 
withholding agent has in its records. To the extent an amount was 
withheld on an amount of capital rather than interest, see rules for 
adjustments, refunds, or credits under Sec. 1.1441-1(b)(8).
    (2) No withholding between interest payment dates--(i) General 
rule. A withholding agent is not required to withhold under 
Sec. 1.1441-1 upon interest accrued on the date of a sale of debt 
obligations when that sale occurs between two interest payment dates 
(even though the amount is treated as interest under Sec. 1.61-7(c) or 
(d) and is subject to tax under section 871(a) or 881(a)), unless the 
withholding agent has knowledge of the amount paid as interest. For 
purposes of this paragraph (b)(2)(i), a withholding agent is treated as 
having knowledge in the same manner as a withholding agent has 
knowledge for purposes of Sec. 1.1441-2(b)(3)(ii), dealing with 
withholding on original issue discount. In addition, notwithstanding 
lack of knowledge (within the meaning of Sec. 1.1441-2(b)(3)(ii)), 
withholding is required on the entire amount of stated interest paid 
with respect to the obligation as determined as of the date of original 
issue if the withholding agent, pursuant to the provisions in 
Sec. 1.1441-1(b)(3), treats the payment as made to a foreign payee 
because it cannot associate the payment with required documentation and 
the amount would qualify as portfolio interest. See Sec. 1.1441-1(b)(8) 
for adjustments to any amount that has been overwithheld as a result of 
this provision.
    (ii) Applicable rules. Any exemption from withholding pursuant to 
paragraph (b)(2)(i) of this section applies without a requirement that 
documentation be furnished to the withholding agent. However, 
documentation may have to be furnished for purposes of the information 
reporting provisions under section 6049 and backup withholding under 
section 3406. See Sec. 1.6045-1(c) for reporting requirements by 
brokers with respect to sale proceeds. Any exemption from withholding 
under paragraph (b)(2)(i) of this section is not a determination that 
the accrued interest is not fixed or determinable annual or periodical 
income. See Sec. 1.61-7(c) regarding the character of payments received 
by the acquirer of an obligation subsequent to such acquisition (that 
is, as a return of capital or interest accrued after the acquisition).
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
[FR Doc. 97-26000 Filed 10-6-97; 8:45 am]
BILLING CODE 4830-01-P