[Federal Register Volume 63, Number 191 (Friday, October 2, 1998)]
[Rules and Regulations]
[Pages 52971-52983]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-26475]



[[Page 52971]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8785]
RIN 1545-AU70


Classification of Certain Transactions Involving Computer 
Programs

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains regulations relating to the tax 
treatment of certain transactions involving the transfer of computer 
programs. The regulations provide rules for classifying such 
transactions as sales or licenses of copyright rights, sales or leases 
of copyrighted articles, or the provision of services, or of know-how, 
under certain provisions of the Internal Revenue Code and tax treaties. 
These regulations are necessary to give taxpayers guidance on the 
taxation of computer program transactions. These regulations affect 
taxpayers engaging in certain transactions involving computer programs.

DATES: Effective date. These regulations are effective October 2, 1998.
    Applicability date. These regulations apply to transactions 
occurring pursuant to contracts entered into on or after December 1, 
1998. Taxpayers may elect to apply this section to transactions 
occurring pursuant to contracts entered into in taxable years ending on 
or after October 2, 1998. Taxpayers may also elect to apply this 
section to transactions occurring in taxable years ending on or after 
October 2, 1998 pursuant to contracts entered into before October 2, 
1998, provided the taxpayer would not be required under this section to 
change its method of accounting, or the taxpayer would be required to 
change its method of accounting but the resulting section 481 
adjustment would be zero.

FOR FURTHER INFORMATION CONTACT: Anne Shelburne, (202) 622-3880 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information in this final rule has been reviewed 
and, pending receipt and evaluation of public comments, approved by the 
Office of Management and Budget (OMB) under the Paperwork Reduction Act 
(44 U.S.C. 3507) and assigned control number 1545-1594. An agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless the collection of information displays 
a valid control number assigned by OMB.
    The collection of information in this regulation is in Sec. 1.861-
18(k) of the regulations. This information is required to permit 
taxpayers to obtain an automatic change in method of accounting. This 
information will be used to enable the IRS to determine if taxpayers 
were entitled to an automatic change in method of accounting. The 
likely respondents are organizations.
    Comments concerning the collection of information should be 
directed to OMB, Attention: Desk Officer for the Department of the 
Treasury, Office of Information and Regulatory Affairs, Washington, DC 
20503, with copies to the Internal Revenue Service, Attn: IRS Reports 
Clearance Officer, OP:FS:FP, Washington, DC 20224. Any such comments 
should be submitted not later than December 1, 1998. Comments are 
specifically requested concerning:
    Whether the collection of information is necessary for the proper 
performance of the functions of the IRS, including whether the 
information will have practical utility;
    The accuracy of the estimated burden associated with the collection 
of information (see below);
    How to enhance the quality, utility, and clarity of the information 
collected;
    How to minimize the burden of complying with the collection of 
information, including the application of automated collection 
techniques or other forms of information technology; and estimates of 
capital or start-up costs and costs of operation, maintenance, and 
purchase of services to provide information.
    The burden per respondent is reflected in the burden of Form 3115.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains final regulations to be added to the Income 
Tax Regulations (26 CFR part 1) under section 861 of the Internal 
Revenue Code (Code). These regulations clarify the treatment under 
certain provisions of the Code and tax treaties of income from 
transactions involving computer programs.
    On November 13, 1996, proposed regulations [REG-251520-96] were 
published in the Federal Register (61 FR 58152). The IRS received 
written comments on the proposed regulations and held a public hearing 
on March 19, 1997. Having considered the comments and the statements 
made at the hearing, the IRS and Treasury Department adopt the proposed 
regulations as modified by thisTreasury decision. The comments and 
revisions are discussed below.

I. The Proposed Regulations

    The proposed regulations clarify certain rules for classifying 
transactions involving computer programs. The regulations generally 
require that a transaction involving a computer program be treated as 
being within one of four possible categories: (1) Transfer of copyright 
rights, (2) Transfer of a copyrighted article, (3) Provision of 
services relating to development or modification of a computer program, 
or (4) provision of know-how relating to computer programming 
techniques.
    The regulations distinguish between transfers of copyright rights 
and transfers of copyrighted articles based on the type of rights 
transferred to the transferee. They recognize that computer programs 
are subject to copyright protection under bothU.S. and foreign 
copyright law. See the Copyright Act of 1976, as amended (17 U.S.C. 101 
et. seq.); see also, EC Directive on Legal Protection of Computer 
Programs, Council Directive 91-250,1991 J.O. (L 122), and the Berne 
Convention for the CapitalProtection of Literary and Artistic Works, 25 
U.S.T. 1341 (ParisText, July 24, 1971). Copyright law grants certain 
exclusive rights to a copyright owner. The regulations classify a 
transaction as the transfer of a copyright right if the transferee 
acquires one or more of the copyright rights identified in Sec. 1.861-
18(c)(2) of the proposed regulations. If the transferee acquires a copy 
of a computer program but does not acquire any of the rights identified 
in Sec. 1.861-18(c)(2), the regulations classify the transaction as the 
transfer of a copyrighted article.
    The proposed regulations further classify transfers of copyright 
rights as either a sale or a license of copyright rights. The proposed 
regulations require that this classification be made by examining 
whether, taking into account all facts and circumstances, all 
substantial rights in the copyright have passed to the transferee. The 
proposed regulations also require that transfers of copyrighted 
articles be further classified as either a sale or a lease of a 
copyrighted article. This classification is made by examining whether 
the benefits and burdens of ownership of the copyrighted article have 
passed to the transferee.

[[Page 52972]]

    The specific rules of the proposed regulations are based on certain 
key principles: that the special features of computer programs should 
be recognized and that functionally equivalent transactions should be 
treated similarly. The regulations are also based on the principle that 
copyright law should be a factor in classifying transactions for tax 
purposes, but should not be determinative.
    Finally, the proposed regulations contain 18 examples illustrating 
the rules.

II. Comments and Final Regulations

1. Scope and Application of the Regulations

a. General Scope
    The proposed regulations classify transactions in computer programs 
for certain international provisions of the Code. A number of comments 
addressed two types of issues involving the scope of the regulations: 
the treatment of computer programs under other tax provisions of the 
Code and the application of the principles of the proposed regulations 
to products other than computer programs.
    As to the treatment of computer programs under other Code sections, 
comments were mixed. Several commentators requested that Treasury 
expand the scope of the final regulations to apply the regulations' 
principles for all U.S. tax purposes. Other commentators, however, 
urged caution, stating that issues raised under other Code sections 
should be resolved only by legislation or by revising the regulations 
under those other sections. Most commentators recommended applying the 
regulations for tax accounting purposes.
    Some commentators requested that Treasury specifically address the 
relevance of the regulations in a specific context. For example, some 
commentators requested that the regulations clarify how the principles 
apply in determining the consequences of computer program transactions 
under tax treaties.
    After consideration of these comments, the final regulations retain 
the scope of the proposed regulations. However, Treasury and the IRS 
are considering whether the principles of these regulations should 
apply to other tax provisions of the Code.
    These regulations are intended to apply for purposes of applying 
and interpreting U.S. tax treaties. United States tax treaties provide 
that terms not defined in the treaty are defined by reference to 
domestic law. See e.g., U.S. Model Income Tax Convention of September 
20, 1996, Article 3(2).
    The second group of comments generally addressed expanding the 
scope of the regulations to apply to transactions in other types of 
digitized information. The proposed regulations are limited to 
classifying transactions in computer programs. Section 1.861-18(a)(3) 
of the proposed regulations defines a computer program as ``* * * a set 
of statements or instructions to be used directly or indirectly in a 
computer in order to bring about a certain result.'' The definition 
includes any data base or similar item only ``* * * if the data base or 
similar item is incidental to the operation of the computer program.'' 
Commentators expressed differing views as to how to define computer 
programs. Several commentators recommended that the definition be 
expanded to include data bases and content provided as part of the 
transaction. They note that advances in technology now permit 
significant amounts of content, that are not merely incidental, to be 
included in even inexpensive mass-marketed programs. Some commentators 
recommended that the definition be expanded to include data bases or 
similar items even if not incidental, while some stated that data base 
products containing only a de minimis amount of software programming to 
facilitate access to the data should be excluded from the definition.
    Several commentators requested that Treasury expand the regulations 
more generally, by applying the same or analogous principles in 
determining the tax consequences of transactions involving copyright 
rights and copyrighted articles to entertainment products, or to other 
digitized information.
    The suggestions to expand the scope of the regulations, either by 
expanding the definition of computer programs or by applying the 
regulations to other types of digitized information, were not adopted. 
Instead, the final regulations generally retain the definition of 
computer programs found in the proposed regulations. It is intended 
that a computer program includes any media, user manuals or 
documentation, or similar items (in addition to data bases) if 
incidental to and routinely transferred along with the computer 
program. Treasury and the IRS are not aware of specific instances where 
the failure to expand the definition of computer program would result 
in inappropriate consequences to taxpayers for the portion of the 
transaction not governed by these regulations. Treasury and the IRS 
invite comments on this point.
    The regulations also continue to apply only to cross-border 
transactions involving computer programs because Treasury and the IRS 
believe that such transactions raise the most pressing need for 
guidance. Treasury and the IRS may consider whether to apply the 
principles of these regulations to all transactions in digitized 
information as part of a separate guidance project.
b. Relationship with Section 482
    Numerous commentators requested clarification regarding the 
application of the regulations for purposes of section 482, requesting 
that transactions in copyright rights be treated as transactions in 
intangibles and transactions in copyrighted articles be treated as 
transactions in tangible property, even if delivered electronically.
    This suggestion has not been adopted. Treasury and the IRS intend 
to further consider this issue and may provide additional guidance in 
the future. See generally, Sec. 1.482-3(f).
c. Source of Income
    Several commentators requested that Treasury provide explicit 
guidance in final regulations on how to source income arising from 
transactions in computer programs. Generally, under the current rules, 
the source of income from sales of property depends to varying extents 
upon both the type of property and, for inventory property, the place 
of sale, with the place of sale generally determined by the place where 
title to the property passes. See Sec. 1.861-7(c). Several commentators 
requested clarification of which source rule applies to various 
transactions in computer programs. The commentators also pointed out 
that the place of sale can be problematic when dealing with sales of 
computer programs, in part because typical license agreements do not 
refer to a transfer of property, and in part because an electronic 
transfer is generally not accompanied by the usual indicia of the 
transfer of title. Several commentators suggested that the place of 
sale should be deemed to be the location of the customer, or the place 
where the customer first obtains the opportunity to install the program 
onto its computer.
    In response to comments, the final regulations provide specific 
source rules. The regulations provide that income from transactions 
that are classified as sales or exchanges of copyrighted articles will 
be sourced under sections 861(a)(6), 862(a)(6), 863, 865(a), 865(b), 
865(c), or 865(e), as appropriate. Income derived from the sale or 
exchange of a copyright right

[[Page 52973]]

will be sourced under sections 865(a), 865(c), 865(d), 865(e), or 
865(h), as appropriate. Income derived from either the leasing of a 
computer program or the licensing of copyright rights in a computer 
program will be sourced under section 861(a)(4) or section 862(a)(4), 
as appropriate. As to the issue of determining the place of sale under 
the title passage rule of Sec. 1.861-7(c), the parties in many cases 
can agree on where title passes for sales of inventory property 
generally. Consistent with the overall policy of the regulations, 
income from electronic transfers of computer programs that constitute 
inventory property, classified as sales of copyrighted articles, will 
be sourced under similar principles.

2. Relevance of Foreign Law

    Several commentators requested that Treasury clarify that 
classification of a transaction involving computer programs for U.S. 
tax purposes does not depend on foreign copyright law. In addition, one 
commentator requested that the regulations explicitly state that the 
terms used in the regulations, although taken from copyright law, will 
be interpreted in a manner consistent with the purposes of the 
regulations and Internal Revenue Code. In certain cases, terms taken 
from copyright law are specifically defined in the regulations so as to 
properly implement the regulations' underlying policy. Unless 
specifically defined in the regulations, legal standards taken from 
copyright law are intended to be given the same interpretation as under 
U.S. copyright law. Factual predicates for application of those 
standards, however, may be provided by referring to foreign copyright 
law. For example, if it were necessary to determine whether the 
transferee had acquired the right to create a derivative work based on 
a computer program protected under French copyright law, the facts of 
the case, i.e. the rights that the transferee may exercise, are 
determined under French law and the agreement between the parties. 
However, whether or not the transferee's rights constitute the right to 
create a derivative work for purposes of this regulation is determined 
by comparing those rights created under French law and the agreement 
between the parties to the U.S. law definition of the right to create a 
derivative work.
    In addition, commentators requested clarification that the 
determination of whether a foreign tax imposed on transactions in 
computer programs is a compulsory payment, eligible for a foreign tax 
credit, is not affected by these regulations. Treasury believes 
clarification is unnecessary. These regulations do not in any way 
modify the requirement of Sec. 1.901-2(e)(5) that substantive and 
procedural provisions of foreign law (including applicable tax 
treaties) determine the taxpayer's liability under foreign law for tax 
and thus whether an amount paid is a compulsory payment. Moreover, the 
regulations under section 904 recognize that a creditable foreign tax 
may be imposed on an item of income that is taxed at a different time 
or in a different manner in a foreign country than in the United 
States. See Sec. 1.904-6(a)(1).

3. Copyright Rights

    The proposed regulations, in Sec. 1.861-18(c)(2), describe four 
copyright rights: (i) the right to make copies for distribution to the 
public, (ii) the right to prepare derivative programs, (iii) the right 
to make a public performance of the program, and (iv) the right to 
publicly display the program. If a transfer of a computer program 
results in a transferee acquiring any one or more of the four listed 
rights, the regulations classify the transaction as a transfer of a 
copyright right. Although the commentators agreed that the right to 
make copies for distribution to the public is properly included, they 
made a number of comments regarding the three other copyright rights.
a. Derivative Programs
    Commentators stated that final regulations should clarify the right 
to prepare derivative programs. They recommended that the regulations 
more specifically describe the circumstances resulting in the transfer 
of such a copyright right.
    Some commentators recommended that a transfer of the right to 
prepare a derivative program should not be treated as the transfer of a 
copyright right unless it is coupled with the right to distribute the 
derivative program to the public. That change, they say, would make the 
right more consistent with the right to reproduce copies, which results 
in the transfer of a copyright right only if it is coupled with the 
right to distribute to the public.
    The final regulations do not adopt this recommendation. Although 
the final regulations disregard the de minimis right to make a 
derivative work, a substantial right to make a derivative work is 
appropriately treated as the transfer of a copyright right, regardless 
of whether it is coupled with the right to distribute to the public. 
The regulations generally follow copyright law in this respect. 
Although the right to make copies constitutes the transfer of a 
copyright right only if coupled with the right to distribute to the 
public, the regulations treat the right to make copies differently from 
the other copyright rights because of the unique characteristics of 
computer programs, including the ease by which computer programs can be 
copied.
    Another set of comments requests clarification of the effect of the 
transfer of programs that permit the user to distribute certain 
ancillary programs in conjunction with works created using the 
underlying program, or to incorporate certain program elements into new 
programs created using the underlying program. For example, certain 
programs, such as software development tools, permit the transferee to 
distribute certain ancillary programs or include certain segments of 
computer code in new programs created by the transferee using the 
development program. Similarly, transferees of computer programs are 
sometimes granted access to the program's source code in order to 
permit the transferee to correct minor errors or incompatibilities in 
the program.
    Under the proposed regulations, the transfer of a software 
development tool or the grant of the right to correct minor errors by 
modifying the source code might constitute the right to create a 
derivative computer program, resulting in the transfer of a copyright 
right. Commentators argued, however, that in both cases, the overall 
character of the transaction was analogous to the transfer of a 
copyrighted article. Several commentators recommended that where 
limited portions of a development tool are included in an application 
program, the inclusion should be considered de minimis, and the 
resulting application program not treated as a derivative program of 
the program development tool.
    In addition, several commentators recommended that where no 
independent value attaches to exploitation of the right to prepare 
derivative computer programs, such right should be treated as de 
minimis, and not considered in classifying the transaction.
    In response to these comments, the final regulations provide in 
paragraph (c)(1)(ii) that the de minimis transfer of a copyright right 
will not be taken into account in determining whether a transaction is 
considered the transfer solely of a copyrighted article. Example 17 
clarifies that the right to use software development tools to create an 
insubstantial component of a new program constitutes such a de minimis 
copyright right. Example 18 clarifies that the right to modify the 
source code to correct minor errors and make minor

[[Page 52974]]

adaptations to a computer program also constitutes a de minimis 
copyright right.
    However, the final regulations do not provide that where no 
independent value attaches to the exploitation of the right to prepare 
derivative computer programs, such right must be treated as de minimis. 
Treasury and the IRS believe that in most cases where no independent 
value attaches to the grant of the right to prepare derivative computer 
programs, the right is de minimis. However, this may not be true in all 
cases and, therefore, this comment has not been adopted.
b. Public Performance and Display
    Several commentators urged Treasury to reserve in final regulations 
on two of the copyright rights, the right to make a public performance 
and the right to public display of the copyrighted work. Several 
commentators recommended that, if Treasury elects not to reserve, a 
transaction involving either right should result in treatment as a 
transfer of a copyright right only if the transfer is for commercial 
exploitation rather than for internal use.
    Commentators also requested clarification of these rights in the 
entertainment area. They recommended the regulations state that the 
right to publicly perform or display the computer program should not be 
considered the transfer of a copyright right if the performance or 
display is limited to the advertisement of a copyrighted article, and 
does not permit the public display of the entire article.
    These suggestions have not been adopted. However, Treasury and the 
IRS recognize that the definition of these rights in the context of 
computer programs is still developing, and in the future it may be 
necessary to revisit this issue. At the present time, Treasury and the 
IRS believe it is appropriate to continue to follow copyright law as to 
these rights. In many cases, however, the transfer of a right for 
public display or performance of a computer program, such as marketing 
or advertising the program, to the extent it constitutes the transfer 
of a copyright right, would be considered a de minimis grant of a 
copyright right under Sec. 1.861-18(c)(1)(ii) of the final regulations, 
so that the transaction would not result in the transfer of a copyright 
right.
c. Definition of to the Public
    The proposed regulations list the right to make copies for 
distribution to the public as one of the four copyright rights. 
Commentators recommended that the regulations clarify the meaning of 
``to the public.'' They recommended the definition exclude distribution 
to a related party, with related party defined to ensure that transfers 
to a non-controlled joint venture would not be considered distribution 
to the public. They also recommended that distribution to identified 
distributees not be considered distribution to the public.
    Commentators also recommended the regulations state that 
distribution to the public does not mean distribution to employees. In 
addition, they urge Treasury to make explicit that internal 
distribution includes distribution to many employees, including 
employees of affiliates, at multiple locations.
    In light of these comments, the final regulations provide in new 
paragraph (g)(3) that distribution to the public does not include 
distribution to a related person, which is defined for purposes of the 
regulation as a person who bears a relationship to the transferee 
specified in section 267(b)(3), (10), (11), or (12), or section 
707(b)(1)(B), with ``10 percent'' substituted for ``50 percent.'' The 
term also excludes distribution to certain identified persons or to 
those with a legal relationship to the original transferee. The number 
of employees or independent contractors who are permitted to use the 
program in performance of services for the transferee is not relevant. 
The examples have also been amended to clarify that the number of 
permitted users, which includes employees of the transferee, within the 
group of related persons is not taken into account in determining 
whether the transferee has the right to distribute copies of the 
program to the public. See e.g., paragraph (h), Example 11.

4. Definition of Copyrighted Article

    The comments on this issue fell into two categories. One group of 
comments recommended that final regulations clarify the consequences of 
transferring a de minimis copyright right along with the transfer of a 
copyrighted article. The proposed regulations state in Sec. 1.861-
18(c)(1)(ii) that if a person acquires a copy of a computer program but 
does not acquire any of the four copyright rights, the transfer is 
classified as a transfer of a copyrighted article. Several commentators 
requested that the regulations clarify the statement to say that if the 
transfer includes only a de minimis copyright right, the transfer is 
classified as a transfer of a copyrighted article. As discussed above, 
in response, the final regulations provide that if the transfer 
includes only a de minimis copyright right, the transfer is classified 
as a transfer of a copyrighted article.
    The second category of comments concerned the definition of a 
copyrighted article. Section 1.861-18(c)(3) defines a copyrighted 
article as a copy of a computer program from which the work can be 
perceived, reproduced, or otherwise communicated, either directly or 
with the aid of a machine or device. Several commentators recommended 
the regulations be modified to say that the copy of the program need 
not be fixed in a tangible medium, and thus electronically transferred 
copies also constitute copyrighted articles.
    Treasury and the IRS believe that the regulations clearly indicate 
that electronically transferred copies also constitute the transfer of 
a copyrighted article. Section 1.861-18(g)(2) of the final regulations 
continues to provide that the physical or electronic medium used to 
effectuate a transfer of a computer program shall not be taken into 
account. Also, the examples contained in the regulations, including 
paragraph (h), Examples 2, 3, and 4, specifically conclude that the 
electronic transfer of software can constitute the transfer of 
copyrighted articles.
    One commentator suggested that the words ``carrier medium'' should 
be substituted for the words ``the magnetic medium of a floppy disk'' 
because computer programs may be distributed on a non-magnetic medium, 
such as a CD-ROM. This comment has been adopted in Sec. 1.861-18(c)(3) 
of the final regulations.

5. Further classification of a copyright right as a sale or license

    In classifying a copyright right as a sale or license, the proposed 
regulations look to whether, considering all the facts and 
circumstances, all substantial rights in a copyright right are 
transferred. Commentators raised a number of issues regarding the all 
substantial rights test, commenting on the effect of exclusivity, term 
of transfer, geographic area, and time and manner of payment.
    Several commentators stated that exclusivity is the most important 
factor in determining whether all substantial rights have been 
transferred. They pointed out that two examples, Examples 5 and 6, 
discuss other factors, the term of the transfer and a transfer in a 
limited geographic area, in addition to exclusivity, and requested that 
the regulations explicitly state that exclusivity is the most important 
factor. One commentator suggested that the term of the transfer may not 
be relevant since the useful life of the program may be shorter than 
originally believed due to technological advances.
    The final regulations do not incorporate these comments. The

[[Page 52975]]

regulations were not intended to change the generally applicable ``all 
substantial rights'' test used in determining whether a transfer of an 
intangible, including copyright rights, is a sale of the intangible or 
a license of the intangible.
    Another fact mentioned in the examples is the manner of payment. 
Several commentators stated that the term over which payments are made 
should be irrelevant in characterizing the transaction, and requested 
that this be made explicit. Although the regulations are not intended 
to depart from what is the generally applicable rule on this issue, 
this comment has been reflected in paragraph (h), Example 5 of the 
final regulations, thus clarifying that the payment term is irrelevant 
on the facts of this example.
    Several commentators pointed out that, in determining whether all 
substantial rights are transferred, the regulations state the 
principles of section 1222 and section 1235 shall apply. They seek 
clarification that section 1222, not section 1235, applies to transfers 
of copyrights, with section 1235 only applying to qualifying transfers 
of patents.
    Although section 1235 by its terms only applies to patent 
transfers, the proposed regulations state that ``the principles of 
sections 1222 and 1235'' (emphasis added) shall apply. Treasury and the 
IRS believe that the all substantial rights test in the regulations 
under section 1235, although a safe harbor under that section, 
nevertheless reflects the all substantial rights test arising from case 
law generally, and is, therefore, an appropriate standard that may be 
applied. However, in applying the all substantial rights test to 
transactions in computer programs under these regulations, relevant 
case law, other than that specifically addressing section 1235 or 
section 1222, may also be applied, and the final regulations clarify 
this point.

6. Further Classification of a Copyrighted Article as a Sale or Lease

a. Lease Character for Copyrighted Articles
    The proposed regulations treat a non-sale transfer of a copy of a 
computer program as a lease. Some commentators urged Treasury to 
reconsider its decision to adopt lease characterization for 
transactions that traditionally have been characterized as licenses. 
They submitted that the change creates confusion, is inconsistent with 
established commercial practice, and implies that all lease 
transactions involve tangible property. One commentator asked the IRS 
to clarify that the regulation is not intended to produce any 
differences in income tax consequences by treating a transfer of a 
program as a lease instead of a license.
    These comments have not been adopted. Treasury and the IRS continue 
to believe that lease characterization is correct for non-sale 
transfers of copies of computer programs. Any income tax consequences 
from such characterization under these regulations will result from 
application of generally applicable tax law to the leasing transaction.
b. Benefits and Burdens Test
    In determining whether the transfer of a copyrighted article 
results in a sale, or instead as a lease generating rental income, the 
proposed regulations look to whether, based on the facts and 
circumstances, the benefits and burdens of ownership are transferred. 
One commentator stated that this test is not helpful here, and proposed 
an economic substance test instead, focusing on the right to use a 
computer program as the economically valuable right. Under that 
standard, a copyrighted article would be considered sold if transferred 
with the right to use it indefinitely.
    Other commentators, however, believed that the existing authorities 
applying the benefits and burdens test provide the correct analytical 
approach for distinguishing a sale from a lease of a copyrighted 
article.
    The final regulations preserve the benefits and burdens test, and 
are not intended to change the generally applicable benefits and 
burdens test.

7. Related Parties

    The examples to the proposed regulations state that they assume the 
parties are unrelated. Several commentators requested that final 
regulations clarify the treatment of related parties under the 
regulations. They state that the regulations should apply to related 
and unrelated parties in the same way, and that Treasury should specify 
any particular concerns.
    In response to these comments, the examples to the final 
regulations do not contain an assumption that the parties are 
unrelated. The regulations are intended to apply to related and 
unrelated parties in the same manner. The relationship between the 
parties does not affect the character of the transaction, with the 
exception of special rules regarding definition of the term 
``distribution to the public.'' Of course, if the parties are related 
for purposes of section 482, that section may apply to determine the 
proper amount of consideration for the transfer.

8. Services and Know-How

    Some commentators suggested that final regulations clarify the 
relevancy of the distinction between the provision of services and the 
provision of know-how. This suggestion has not been incorporated in the 
final regulations. The purpose of the regulations is only to 
characterize transactions involving computer programs. Once the 
character of the transaction is determined under the regulations, the 
taxation of the income arising from the transaction is determined under 
other Code sections. Thus, the relevance of the distinction between 
services and know-how must be determined under other Code sections. 
Compare sections 861(a)(3) and 862(a)(3), looking to place of 
performance in sourcing income from services, with sections 861(a)(4) 
and 862(a)(4), sourcing income derived from the transfer of certain 
know-how based on where the know-how is used. The distinction between 
services and know-how may also be relevant under income tax treaties. 
Compare Convention Between the United States of America and Japan for 
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion 
with Respect to Taxes on Income, Article 8 (Business Profits) and 
Article 14 (Royalties).
    Some commentators suggested the final regulations eliminate the 
requirement in paragraph (e) of the proposed regulations, requiring 
that know-how not be copyrightable as a prerequisite to being treated 
as know-how for purposes of this section. This comment has been adopted 
to eliminate any inference that only orally transmitted information 
could be classified as know-how. The final regulations, however, add 
two other requirements. Know-how is of the type covered by these 
regulations only if the information is information relating to computer 
programming techniques, is furnished under conditions preventing 
unauthorized disclosure, specifically contracted for between the 
parties, and is considered property subject to trade secret protection. 
Know-how is considered a property interest under applicable law, and 
only if the know-how is specifically contracted for between the 
parties. These additional requirements should help clarify the 
definition of know-how described in these regulations.

9. Mixed Transactions

    The proposed regulations state that if a transaction in a computer 
program consists of transactions in more than one category listed in 
Sec. 1.861-18(b)(1), the transactions, unless de minimis, will

[[Page 52976]]

be treated as separate transactions, with the rules applied separately 
to each. Several commentators requested further guidance on how to 
treat transactions that include payments for updates, support, 
consulting, education, and training. They pointed out that in many 
cases, the extent to which such transactions or services will be 
required by the transferee are unknown at the time of the initial 
contract. They asked that regulations clarify the factors that will 
sustain an allocation where these various options are made available, 
or that Treasury consider bundling rules.
    These comments have not been adopted. These regulations are limited 
to characterizing transactions relating to computer programs, and are 
not intended to provide rules for allocating income arising from mixed 
transactions. Mixed transactions occur in many circumstances outside of 
transactions involving computer programs. Whether income arising from a 
mixed transaction, involving computer programs or otherwise, must be 
allocated to its separate components under generally applicable 
principles of taxation, and the method by which such income is 
allocated to the transaction's components, must be determined under 
other Code sections.

10. Shrink Wrap License

    Several commentators stated that the reference to the term shrink 
wrap license in the proposed regulations should be deleted, because the 
reference can be misinterpreted as ascribing some legal significance to 
the term. They suggested a more general reference to a user agreement 
or a user license. In response to these comments, the final regulations 
now indicate in Example 1 that the term shrink-wrap license is merely 
illustrative. The regulations' analysis is based on the terms of the 
agreement between the parties, and on the nature and extent of the 
rights transferred, not the means of packaging or distributing the 
computer program. In particular, the use of the term shrink-wrap 
license in the proposed regulations was not intended to create an 
inference that the regulations apply only to mass-marketed software.

11. Pre-Effective Date Transactions

    The proposed regulations draw no inference for transactions prior 
to the regulations' effective date. One commentator recommended that 
the regulations permit taxpayers to elect retroactive application of 
the regulations. Another commentator requested a statement that a 
taxpayer's prior treatment of a transaction would be respected as long 
as it is reasonably supportable. Another commentator recommended the 
IRS remedy double tax problems for transactions prior to the effective 
date.
    The final regulations apply to transactions occurring pursuant to 
contracts entered into on or after the effective date of the 
regulations. A special transition rule permits taxpayers to elect to 
apply the regulations to transactions occurring pursuant to contracts 
entered into in taxable years ending on or after the date of 
publication of this document in the Federal Register. Taxpayers may 
also elect to apply this section to transactions occurring in taxable 
years ending on or after the date of publication of this document in 
the Federal Register, for contracts entered into before the date of 
publication of this document in the Federal Register, provided the 
taxpayer would not be required under this section to change its method 
of accounting, or the taxpayer would be required to change its method 
of accounting but the resulting section 481 adjustment would be zero.
    With regard to double taxation, taxpayers who believe they are 
subject to double taxation may pursue competent authority relief.

12. Accounting Method Changes

    Commentators suggested that the IRS issue, simultaneously with the 
issuance of the final regulations, a revenue procedure permitting an 
automatic change of accounting to allow taxpayers to apply the 
principles of these regulations for purposes of accounting for prepaid 
income under software maintenance agreements. Different rules apply 
depending on whether the income from such agreements is considered to 
be derived from the sale of goods or the performance of services. 
Compare, Sec. 1.451-5 (sale of goods) and Rev. Proc. 71-21 (1971-2 CB 
549) (performance of services).
    In response to comments, the final regulations grant taxpayers 
consent to change their method of accounting if necessary to conform 
the classification of transactions with these regulations, where the 
taxpayer elects one of the transtion rules in paragraph (i)(2) of the 
regulations. To obtain automatic consent to change a method of 
accounting, the regulations direct taxpayers to file Form 3115 with 
their returns and send a copy to the national office.

13. Reverse Engineering and Decompilation

    One commentator stated that the right to reverse engineer (or 
decompile) a computer program (i.e., the right to reconstruct the 
source code from the object code) should be irrelevant in classifying 
transactions in computer programs, and that references to that right 
should be eliminated from the examples.
    This comment has not been adopted. The decompilation of a computer 
program can result in the creation of a derivative work. Under the 
regulations, the right to create a derivative work is a copyright 
right. Therefore, whether the transferee is prohibited from reverse 
engineering a computer program could be relevant in determining if a 
copyrighted article has been transferred.

14. Effect of Practices Used to Control Piracy

    One commentator suggested that certain practices used to control 
software piracy, such as a requirement that the transferee annually 
contact the transferor and pay an annual fee, be disregarded in 
determining whether a transaction results in a sale or lease of a 
computer program.
    This comment has not been adopted. Such a transaction must be 
analyzed under the benefits and burdens test, taking into account all 
the facts and circumstances. Under that test, the requirement that the 
transferee contact the transferor and pay an annual fee might not 
result in lease characterization, if other significant benefits and 
burdens of ownership pass to the transferee.

15. Definition of Computer

    One commentator urged Treasury to adopt a flexible definition of 
the term computer. However, the final regulations do not define 
computer. The definition of software used in the regulations is based 
on the definition in the Copyright Act. The Copyright Act does not 
define the term computer.

16. Comments (not otherwise addressed above) Regarding Specific 
Examples

a. Paragraph (h), Examples 6 and 7
    Commentators requested that, given the ease of reproduction, the 
distinction between paragraph (h), Examples 6 and 7 should be removed. 
This comment has not been adopted. Although computer programs can be 
easily reproduced, a fact which the regulations recognize, there is 
still an important commercial and legal distinction between persons who 
are granted the right to make copies of a program for distribution and 
persons who do not have that right.
b. Example 6
    In response to comments, the final regulations make clear that the 
party exercising reproduction rights can

[[Page 52977]]

exercise that right indirectly by contracting out the reproduction 
function.
c. Example 8
    In response to a comment, Example 8 has been clarified to indicate 
that the right to make back-up copies of the program, or the fact that 
a back-up copy of the program is transferred on a disk, is irrelevant 
to classification.
d. Example 9
    In response to a comment, paragraph (h), Example 9 is clarified to 
indicate that the mechanics of copying a computer program are 
irrelevant.
e. Example 10
    Some commentators suggested that in the case of so-called 
enterprise licenses, the fact the transferee can use the program at 
multiple locations should not affect the character of the transaction 
as the sale of copyrighted articles. This comment has been adopted, and 
paragraph (h), Example 10(ii)(C) of the final regulations has been 
amended accordingly.
f. Examples 12 and 13
    Some commentators suggested adding examples to illustrate so-called 
software maintenance or subscription agreements. Paragraph (h), 
Examples 12 and 13 of the proposed regulations, however, were intended 
to illustrate such agreements, and, in response to comments, these 
examples have been modified in the final regulations. Generally, the 
provision of an updated program pursuant to a maintenance agreement is 
intended to be treated as the transfer of a copyrighted article. 
However, this may not always be the case, and maintenance agreements 
must be analyzed in the same way as other transactions under the 
regulations.
g. Example 15
    A commentator suggested that the example's use of a derivative 
computer program adds complexity, and recommends the example be 
redrafted to purely illustrate services. This comment has been adopted 
and the example has been revised accordingly.
h. Additional Examples.
    Commentators suggested additional examples. The final regulations 
add additional examples where clarification was believed necessary.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in EO 12866. Therefore, a 
regulatory assessment is not required.
    It is hereby certified that the collection of information contained 
in these regulations will not have a significant economic impact on a 
substantial number of small entities. This certification is based on 
the fact that the rules of this section impact taxpayers who engage in 
international transactions in computer programs, and therefore the 
rules will impact very few small entities. Moreover, in those few 
instances where the rules of this section impact small entities, the 
economic impact of the collection of information on such small entities 
is not likely to be significant because it merely requires a copy of 
the Form 3115 to be filed with the National Office. Accordingly, a 
regulatory flexibility analysis is not required under the Regulatory 
Flexibility Act (5 U.S.C. chapter 6).
    Pursuant to section 7805(f) of the Internal Revenue Code, the 
notice of proposed rulemaking preceding these regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business.

Drafting information

    The principal author of these regulations is Anne Shelburne, of the 
Office of Associate Chief Counsel (International), IRS. However, other 
personnel from the IRS and Treasury Department participated in their 
development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

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

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

    Par. 2. Section 1.861-18 is added to read as follows:


Sec. 1.861-18  Classification of transactions involving computer 
programs.

    (a) General--(1) Scope. This section provides rules for classifying 
transactions relating to computer programs for purposes of subchapter N 
of chapter 1 of the Internal Revenue Code, sections 367, 404A, 482, 
551, 679, 1059A, chapter 3, chapter 5, sections 842 and 845 (to the 
extent involving a foreign person), and transfers to foreign trusts not 
covered by section 679.
    (2) Categories of transactions. This section generally requires 
that such transactions be treated as being solely within one of four 
categories (described in paragraph (b)(1) of this section) and provides 
certain rules for categorizing such transactions. In the case of a 
transfer of a copyright right, this section provides rules for 
determining whether the transaction should be classified as either a 
sale or exchange, or a license generating royalty income. In the case 
of a transfer of a copyrighted article, this section provides rules for 
determining whether the transaction should be classified as either a 
sale or exchange, or a lease generating rental income.
    (3) Computer program. For purposes of this section, a computer 
program is a set of statements or instructions to be used directly or 
indirectly in a computer in order to bring about a certain result. For 
purposes of this paragraph (a)(3), a computer program includes any 
media, user manuals, documentation, data base or similar item if the 
media, user manuals, documentation, data base or similar item is 
incidental to the operation of the computer program.
    (b) Categories of transactions--(1) General. Except as provided in 
paragraph (b)(2) of this section, a transaction involving the transfer 
of a computer program, or the provision of services or of know-how with 
respect to a computer program (collectively, a transfer of a computer 
program) is treated as being solely one of the following--
    (i) A transfer of a copyright right in the computer program;
    (ii) A transfer of a copy of the computer program (a copyrighted 
article);
    (iii) The provision of services for the development or modification 
of the computer program; or
    (iv) The provision of know-how relating to computer programming 
techniques.
    (2) Transactions consisting of more than one category. Any 
transaction involving computer programs which consists of more than one 
of the transactions described in paragraph (b)(1) of this section shall 
be treated as separate transactions, with the appropriate provisions of 
this section being applied to each such transaction. However, any 
transaction that is de minimis, taking into account the overall 
transaction and the surrounding facts and circumstances, shall not be 
treated as a separate transaction, but as part of another transaction.

[[Page 52978]]

    (c) Transfers involving copyright rights and copyrighted articles--
(1) Classification--(i) Transfers treated as transfers of copyright 
rights. A transfer of a computer program is classified as a transfer of 
a copyright right if, as a result of the transaction, a person acquires 
any one or more of the rights described in paragraphs (c)(2)(i) through 
(iv) of this section. Whether the transaction is treated as being 
solely the transfer of a copyright right or is treated as separate 
transactions is determined pursuant to paragraph (b)(1) and (b)(2) of 
this section. For example, if a person receives a disk containing a 
copy of a computer program which enables it to exercise, in relation to 
that program, a non-de minimis right described in paragraphs (c)(2)(i) 
through (iv) of this section (and the transaction does not involve, or 
involves only a de minimis provision of services as described in 
paragraph (d) of this section or of know-how as described in paragraph 
(e) of this section), then, under paragraph (b)(2) of this section, the 
transfer is classified solely as a transfer of a copyright right.
    (ii) Transfers treated solely as transfers of copyrighted articles. 
If a person acquires a copy of a computer program but does not acquire 
any of the rights described in paragraphs (c)(2)(i) through (iv) of 
this section (or only acquires a de minimis grant of such rights), and 
the transaction does not involve, or involves only a de minimis, 
provision of services as described in paragraph (d) of this section or 
of know-how as described in paragraph (e) of this section, the transfer 
of the copy of the computer program is classified solely as a transfer 
of a copyrighted article.
    (2) Copyright rights. The copyright rights referred to in paragraph 
(c)(1) of this section are as follows--
    (i) The right to make copies of the computer program for purposes 
of distribution to the public by sale or other transfer of ownership, 
or by rental, lease or lending;
    (ii) The right to prepare derivative computer programs based upon 
the copyrighted computer program;
    (iii) The right to make a public performance of the computer 
program; or
    (iv) The right to publicly display the computer program.
    (3) Copyrighted article. A copyrighted article includes a copy of a 
computer program from which the work can be perceived, reproduced, or 
otherwise communicated, either directly or with the aid of a machine or 
device. The copy of the program may be fixed in the magnetic medium of 
a floppy disk, or in the main memory or hard drive of a computer, or in 
any other medium.
    (d) Provision of services. The determination of whether a 
transaction involving a newly developed or modified computer program is 
treated as either the provision of services or another transaction 
described in paragraph (b)(1) of this section is based on all the facts 
and circumstances of the transaction, including, as appropriate, the 
intent of the parties (as evidenced by their agreement and conduct) as 
to which party is to own the copyright rights in the computer program 
and how the risks of loss are allocated between the parties.
    (e) Provision of know-how. The provision of information with 
respect to a computer program will be treated as the provision of know-
how for purposes of this section only if the information is--
    (1) Information relating to computer programming techniques;
    (2) Furnished under conditions preventing unauthorized disclosure, 
specifically contracted for between the parties; and
    (3) Considered property subject to trade secret protection.
    (f) Further classification of transfers involving copyright rights 
and copyrighted articles--(1) Transfers of copyright rights. The 
determination of whether a transfer of a copyright right is a sale or 
exchange of property is made on the basis of whether, taking into 
account all facts and circumstances, there has been a transfer of all 
substantial rights in the copyright. A transaction that does not 
constitute a sale or exchange because not all substantial rights have 
been transferred will be classified as a license generating royalty 
income. For this purpose, the principles of sections 1222 and 1235 may 
be applied. Income derived from the sale or exchange of a copyright 
right will be sourced under section 865(a), (c), (d), (e), or (h), as 
appropriate. Income derived from the licensing of a copyright right 
will be sourced under section 861(a)(4) or 862(a)(4), as appropriate.
    (2) Transfers of copyrighted articles. The determination of whether 
a transfer of a copyrighted article is a sale or exchange is made on 
the basis of whether, taking into account all facts and circumstances, 
the benefits and burdens of ownership have been transferred. A 
transaction that does not constitute a sale or exchange because 
insufficient benefits and burdens of ownership of the copyrighted 
article have been transferred, such that a person other than the 
transferee is properly treated as the owner of the copyrighted article, 
will be classified as a lease generating rental income. Income from 
transactions that are classified as sales or exchanges of copyrighted 
articles will be sourced under sections 861(a)(6), 862(a)(6), 863, 
865(a), (b), (c), or (e), as appropriate. Income derived from the 
leasing of a copyrighted article will be sourced under section 
861(a)(4) or section 862(a)(4), as appropriate.
    (3) Special circumstances of computer programs. In connection with 
determinations under this paragraph (f), consideration must be given as 
appropriate to the special characteristics of computer programs in 
transactions that take advantage of these characteristics (such as the 
ability to make perfect copies at minimal cost). For example, a 
transaction in which a person acquires a copy of a computer program on 
disk subject to a requirement that the disk be destroyed after a 
specified period is generally the equivalent of a transaction subject 
to a requirement that the disk be returned after such period. 
Similarly, a transaction in which the program deactivates itself after 
a specified period is generally the equivalent of returning the copy.
    (g) Rules of operation--(1) Term applied to transaction by parties. 
Neither the form adopted by the parties to a transaction, nor the 
classification of the transaction under copyright law, shall be 
determinative. Therefore, for example, if there is a transfer of a 
computer program on a single disk for a one-time payment with 
restrictions on transfer and reverse engineering, which the parties 
characterize as a license (including, but not limited to, agreements 
commonly referred to as shrink-wrap licenses), application of the rules 
of paragraphs (c) and (f) of this section may nevertheless result in 
the transaction being classified as the sale of a copyrighted article.
    (2) Means of transfer not to be taken into account. The rules of 
this section shall be applied irrespective of the physical or 
electronic or other medium used to effectuate a transfer of a computer 
program.
    (3) To the public--(i) In general. For purposes of paragraph 
(c)(2)(i) of this section, a transferee of a computer program shall not 
be considered to have the right to distribute copies of the program to 
the public if it is permitted to distribute copies of the software to 
only either a related person, or to identified persons who may be 
identified by either name or by legal relationship to the original 
transferee. For purposes of this subparagraph, a related person is a 
person who bears a relationship to the transferee specified in section 
267(b)(3), (10), (11), or (12), or section 707(b)(1)(B). In applying

[[Page 52979]]

section 267(b), 267(f), 707(b)(1)(B), or 1563(a), ``10 percent'' shall 
be substituted for ``50 percent.''
    (ii) Use by individuals. The number of employees of a transferee of 
a computer program who are permitted to use the program in connection 
with their employment is not relevant for purposes of this paragraph 
(g)(3). In addition, the number of individuals with a contractual 
agreement to provide services to the transferee of a computer program 
who are permitted to use the program in connection with the performance 
of those services is not relevant for purposes of this paragraph 
(g)(3).
    (h) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. (i) Facts. Corp A, a U.S. corporation, owns the 
copyright in a computer program, Program X. It copies Program X onto 
disks. The disks are placed in boxes covered with a wrapper on which 
is printed what is generally referred to as a shrink-wrap license. 
The license is stated to be perpetual. Under the license no reverse 
engineering, decompilation, or disassembly of the computer program 
is permitted. The transferee receives, first, the right to use the 
program on two of its own computers (for example, a laptop and a 
desktop) provided that only one copy is in use at any one time, and, 
second, the right to make one copy of the program on each machine as 
an essential step in the utilization of the program. The transferee 
is permitted by the shrink-wrap license to sell the copy so long as 
it destroys any other copies it has made and imposes the same terms 
and conditions of the license on the purchaser of its copy. These 
disks are made available for sale to the general public in Country 
Z. In return for valuable consideration, P, a Country Z resident, 
receives one such disk.
    (ii) Analysis. (A) Under paragraph (g)(1) of this section, the 
label license is not determinative. None of the copyright rights 
described in paragraph (c)(2) of this section have been transferred 
in this transaction. P has received a copy of the program, however, 
and, therefore, under paragraph (c)(1)(ii) of this section, P has 
acquired solely a copyrighted article.
    (B) Taking into account all of the facts and circumstances, P is 
properly treated as the owner of a copyrighted article. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of a 
copyrighted article rather than the grant of a lease.
    Example 2. (i) Facts. The facts are the same as those in Example 
1, except that instead of selling disks, Corp A, the U.S. 
corporation, decides to make Program X available, for a fee, on a 
World Wide Web home page on the Internet. P, the Country Z resident, 
in return for payment made to Corp A, downloads Program X (via 
modem) onto the hard drive of his computer. As part of the 
electronic communication, P signifies his assent to a license 
agreement with terms identical to those in Example 1, except that in 
this case P may make a back-up copy of the program on to a disk.
    (ii) Analysis. (A) None of the copyright rights described in 
paragraph (c)(2) of this section have passed to P. Although P did 
not buy a physical copy of the disk with the program on it, 
paragraph (g)(2) of this section provides that the means of 
transferring the program is irrelevant. Therefore, P has acquired a 
copyrighted article.
    (B) As in Example 1, P is properly treated as the owner of a 
copyrighted article. Therefore, under paragraph (f)(2) of this 
section, there has been a sale of a copyrighted article rather than 
the grant of a lease.
    Example 3. (i) Facts. The facts are the same as those in Example 
1, except that Corp A only allows P, the Country Z resident, to use 
Program X for one week. At the end of that week, P must return the 
disk with Program X on it to Corp A. P must also destroy any copies 
made of Program X. If P wishes to use Program X for a further period 
he must enter into a new agreement to use the program for an 
additional charge.
    (ii) Analysis. (A) Under paragraph (c)(2) of this section, P has 
received no copyright rights. Because P has received a copy of the 
program under paragraph (c)(1)(ii) of this section, he has, 
therefore, received a copyrighted article.
    (B) Taking into account all of the facts and circumstances, P is 
not properly treated as the owner of a copyrighted article. 
Therefore, under paragraph (f)(2) of this section, there has been a 
lease of a copyrighted article rather than a sale. Taking into 
account the special characteristics of computer programs as provided 
in paragraph (f)(3) of this section, the result would be the same if 
P were required to destroy the disk at the end of the one week 
period instead of returning it since Corp A can make additional 
copies of the program at minimal cost.
    Example 4. (i) Facts. The facts are the same as those in Example 
2, where P, the Country Z resident, receives Program X from Corp A's 
home page on the Internet, except that P may only use Program X for 
a period of one week at the end of which an electronic lock is 
activated and the program can no longer be accessed. Thereafter, if 
P wishes to use Program X, it must return to the home page and pay 
Corp A to send an electronic key to reactivate the program for 
another week.
    (ii) Analysis. (A) As in Example 3, under paragraph (c)(2) of 
this section, P has not received any copyright rights. P has 
received a copy of the program, and under paragraph (g)(2) of this 
section, the means of transmission is irrelevant. P has, therefore, 
under paragraph (c)(1)(ii) of this section, received a copyrighted 
article.
    (B) As in Example 3, P is not properly treated as the owner of a 
copyrighted article. Therefore, under paragraph (f)(2) of this 
section, there has been a lease of a copyrighted article rather than 
a sale. While P does retain Program X on its computer at the end of 
the one week period, as a legal matter P no longer has the right to 
use the program (without further payment) and, indeed, cannot use 
the program without the electronic key. Functionally, Program X is 
no longer on the hard drive of P's computer. Instead, the hard drive 
contains only a series of numbers which no longer perform the 
function of Program X. Although in Example 3, P was required to 
physically return the disk, taking into account the special 
characteristics of computer programs as provided in paragraph (f)(3) 
of this section, the result in this Example 4 is the same as in 
Example 3.
    Example 5. (i) Facts. Corp A, a U.S. corporation, transfers a 
disk containing Program X to Corp B, a Country Z corporation, and 
grants Corp B an exclusive license for the remaining term of the 
copyright to copy and distribute an unlimited number of copies of 
Program X in the geographic area of Country Z, prepare derivative 
works based upon Program X, make public performances of Program X, 
and publicly display Program X. Corp B will pay Corp A a royalty of 
$y a year for three years, which is the expected period during which 
Program X will have commercially exploitable value.
    (ii) Analysis. (A) Although Corp A has transferred a disk with a 
copy of Program X on it to Corp B, under paragraph (c)(1)(i) of this 
section because this transfer is accompanied by a copyright right 
identified in paragraph (c)(2)(i) of this section, this transaction 
is a transfer solely of copyright rights, not of copyrighted 
articles. For purposes of paragraph (b)(2) of this section, the disk 
containing a copy of Program X is a de minimis component of the 
transaction.
    (B) Applying the all substantial rights test under paragraph 
(f)(1) of this section, Corp A will be treated as having sold 
copyright rights to Corp B. Corp B has acquired all of the copyright 
rights in Program X, has received the right to use them exclusively 
within Country Z, and has received the rights for the remaining life 
of the copyright in Program X. The fact the payments cease before 
the copyright term expires is not controlling. Under paragraph 
(g)(1) of this section, the fact that the agreement is labelled a 
license is not controlling (nor is the fact that Corp A receives a 
sum labelled a royalty). (The result in this case would be the same 
if the copy of Program X to be used for the purposes of reproduction 
were transmitted electronically to Corp B, as a result of the 
application of the rule of paragraph (g)(2) of this section.)
    Example 6. (i) Facts. Corp A, a U.S. corporation, transfers a 
disk containing Program X to Corp B, a Country Z corporation, and 
grants Corp B the non exclusive right to reproduce (either directly 
or by contracting with either Corp A or another person to do so) and 
distribute for sale to the public an unlimited number of disks at 
its factory in Country Z in return for a payment related to the 
number of disks copied and sold. The term of the agreement is two 
years, which is less than the remaining life of the copyright.
    (ii) Analysis. (A) As in Example 5, the transfer of the disk 
containing the copy of the program does not constitute the transfer 
of a copyrighted article under paragraph (c)(1) of this section 
because Corp B has also acquired a copyright right under paragraph 
(c)(2)(i) of this section, the right to reproduce and distribute to 
the public. For purposes of paragraph (b)(2) of this section, the 
disk

[[Page 52980]]

containing Program X is a de minimis component of the transaction.
    (B) Taking into account all of the facts and circumstances, 
there has been a license of Program X to Corp B, and the payments 
made by Corp B are royalties. Under paragraph (f)(1) of this 
section, there has not been a transfer of all substantial rights in 
the copyright to Program X because Corp A has the right to enter 
into other licenses with respect to the copyright of Program X, 
including licenses in Country Z (or even to sell that copyright, 
subject to Corp B's interest). Corp B has acquired no right itself 
to license the copyright rights in Program X. Finally, the term of 
the license is for less than the remaining life of the copyright in 
Program X.
    Example 7. (i) Facts. Corp C, a distributor in Country Z, enters 
into an agreement with Corp A, a U.S. corporation, to purchase as 
many copies of Program X on disk as it may from time-to-time 
request. Corp C will then sell these disks to retailers. The disks 
are shipped in boxes covered by shrink-wrap licenses (identical to 
the license described in Example 1).
    (ii) Analysis. (A) Corp C has not acquired any copyright rights 
under paragraph (c)(2) of this section with respect to Program X. It 
has acquired individual copies of Program X, which it may sell to 
others. The use of the term license is not dispositive under 
paragraph (g)(1) of this section. Under paragraph (c)(1)(ii) of this 
section, Corp C has acquired copyrighted articles.
    (B) Taking into account all of the facts and circumstances, Corp 
C is properly treated as the owner of copyrighted articles. 
Therefore, under paragraph (f)(2) of this section, there has been a 
sale of copyrighted articles.
    Example 8. (i) Facts. Corp A, a U.S. corporation, transfers a 
disk containing Program X to Corp D, a foreign corporation engaged 
in the manufacture and sale of personal computers in Country Z. Corp 
A grants Corp D the non-exclusive right to copy Program X onto the 
hard drive of an unlimited number of computers, which Corp D 
manufactures, and to distribute those copies (on the hard drive) to 
the public. The term of the agreement is two years, which is less 
than the remaining life of the copyright in Program X. Corp D pays 
Corp A an amount based on the number of copies of Program X it loads 
on to computers.
    (ii) Analysis. The analysis is the same as in Example 6. Under 
paragraph (c)(2)(i) of this section, Corp D has acquired a copyright 
right enabling it to exploit Program X by copying it on to the hard 
drives of the computers that it manufactures and then sells. For 
purposes of paragraph (b)(2) of this section, the disk containing 
Program X is a de minimis component of the transaction. Taking into 
account all of the facts and circumstances, Corp D has not, however, 
acquired all substantial rights in the copyright to Program X (for 
example, the term of the agreement is less than the remaining life 
of the copyright). Under paragraph (f)(1) of this section, this 
transaction is, therefore, a license of Program X to Corp D rather 
than a sale and the payments made by Corp D are royalties. (The 
result would be the same if Corp D included with the computers it 
sells an archival copy of Program X on a floppy disk.)
    Example 9. (i) Facts. The facts are the same as in Example 8, 
except that Corp D, the Country Z corporation, receives physical 
disks. The disks are shipped in boxes covered by shrink-wrap 
licenses (identical to the licenses described in Example 1). The 
terms of these licenses do not permit Corp D to make additional 
copies of Program X. Corp D uses each individual disk only once to 
load a single copy of Program X onto each separate computer. Corp D 
transfers the disk with the computer when it is sold.
    (ii) Analysis. (A) As in Example 7 (unlike Example 8) no 
copyright right identified in paragraph (c)(2) of this section has 
been transferred. Corp D acquires the disks without the right to 
reproduce and distribute publicly further copies of Program X. This 
is therefore the transfer of copyrighted articles under paragraph 
(c)(1)(ii) of this section.
    (B) Taking into account all of the facts and circumstances, Corp 
D is properly treated as the owner of copyrighted articles. 
Therefore, under paragraph (f)(2) of this section, the transaction 
is classified as the sale of a copyrighted article. (The result 
would be the same if Corp D used a single physical disk to copy 
Program X onto each computer, and transferred an unopened box 
containing Program X with each computer, if Corp D were not 
permitted to copy Program X onto more computers than the number of 
individual copies purchased.)
    Example 10. (i) Facts. Corp A, a U.S. corporation, transfers a 
disk containing Program X to Corp E, a Country Z corporation, and 
grants Corp E the right to load Program X onto 50 individual 
workstations for use only by Corp E employees at one location in 
return for a one-time per-user fee (generally referred to as a site 
license or enterprise license). If additional workstations are 
subsequently introduced, Program X may be loaded onto those machines 
for additional one-time per-user fees. The license which grants the 
rights to operate Program X on 50 workstations also prohibits Corp E 
from selling the disk (or any of the 50 copies) or reverse 
engineering the program. The term of the license is stated to be 
perpetual.
    (ii) Analysis. (A) The grant of a right to copy, unaccompanied 
by the right to distribute those copies to the public, is not the 
transfer of a copyright right under paragraph (c)(2) of this 
section. Therefore, under paragraph (c)(1)(ii) of this section, this 
transaction is a transfer of copyrighted articles (50 copies of 
Program X).
    (B) Taking into account all of the facts and circumstances, P is 
properly treated as the owner of copyrighted articles. Therefore, 
under paragraph (f)(2) of this section, there has been a sale of 
copyrighted articles rather than the grant of a lease. 
Notwithstanding the restriction on sale, other factors such as, for 
example, the risk of loss and the right to use the copies in 
perpetuity outweigh, in this case, the restrictions placed on the 
right of alienation.
    (C) The result would be the same if Corp E were permitted to 
copy Program X onto an unlimited number of workstations used by 
employees of either Corp E or corporations that had a relationship 
to Corp E specified in paragraph (g)(3) of this section.
    Example 11. (i) Facts. The facts are the same as in Example 10, 
except that Corp E, the Country Z corporation, acquires the right to 
make Program X available to workstation users who are Corp E 
employees by way of a local area network (LAN). The number of users 
that can use Program X on the LAN at any one time is limited to 50. 
Corp E pays a one-time fee for the right to have up to 50 employees 
use the program at the same time.
    (ii) Analysis. Under paragraph (g)(2) of this section the mode 
of utilization is irrelevant. Therefore, as in Example 10, under 
paragraph (c)(2) of this section, no copyright right has been 
transferred, and, thus, under paragraph (c)(1)(ii) of this section, 
this transaction will be classified as the transfer of a copyrighted 
article. Under the benefits and burdens test of paragraph (f)(2) of 
this section, this transaction is a sale of copyrighted articles. 
The result would be the same if an unlimited number of Corp E 
employees were permitted to use Program X on the LAN or if Corp E 
were permitted to copy Program X onto LANs maintained by 
corporations that had a relationship to Corp E specified in 
paragraph (g)(3) of this section.
    Example 12. (i) Facts. The facts are the same as in Example 11, 
except that Corp E pays a monthly fee to Corp A, the U.S. 
corporation, calculated with reference to the permitted maximum 
number of users (which can be changed) and the computing power of 
Corp E's server. In return for this monthly fee, Corp E receives the 
right to receive upgrades of Program X when they become available. 
The agreement may be terminated by either party at the end of any 
month. When the disk containing the upgrade is received, Corp E must 
return the disk containing the earlier version of Program X to Corp 
A. If the contract is terminated, Corp E must delete (or otherwise 
destroy) all copies made of the current version of Program X. The 
agreement also requires Corp A to provide technical support to Corp 
E but the agreement does not allocate the monthly fee between the 
right to receive upgrades of Program X and the technical support 
services. The amount of technical support that Corp A will provide 
to Corp E is not foreseeable at the time the contract is entered 
into but is expected to be de minimis. The agreement specifically 
provides that Corp E has not thereby been granted an option to 
purchase Program X.
    (ii) Analysis. (A) Corp E has received no copyright rights under 
paragraph (c)(2) of this section. Corp A has not provided any 
services described in paragraph (d) of this section. Based on all 
the facts and circumstances of the transaction, Corp A has provided 
de minimis technical services to Corp E. Therefore, under paragraph 
(c)(1)(ii) of this section, the transaction is a transfer of a 
copyrighted article.
    (B) Taking into account all facts and circumstances, under the 
benefits and burdens test Corp E is not properly treated as the 
owner of the copyrighted article. Corp E does not receive the right 
to use Program X in perpetuity, but only for so long as it continues 
to make payments. Corp E does not have the right to purchase Program 
X on

[[Page 52981]]

advantageous (or, indeed, any) terms once a certain amount of money 
has been paid to Corp A or a certain period of time has elapsed 
(which might indicate a sale). Once the agreement is terminated, 
Corp E will no longer possess any copies of Program X, current or 
superseded. Therefore under paragraph (f)(2) of this section there 
has been a lease of a copyrighted article.
    Example 13. (i) Facts. The facts are the same as in Example 12, 
except that, while Corp E must return copies of Program X as new 
upgrades are received, if the agreement terminates, Corp E may keep 
the latest version of Program X (although Corp E is still prohibited 
from selling or otherwise transferring any copy of Program X).
    (ii) Analysis. For the reasons stated in Example 10, paragraph 
(ii)(B), the transfer of the program will be treated as a sale of a 
copyrighted article rather than as a lease.
    Example 14. (i) Facts. Corp G, a Country Z corporation, enters 
into a contract with Corp A, a U.S. corporation, for Corp A to 
modify Program X so that it can be used at Corp G's facility in 
Country Z. Under the contract, Corp G is to acquire one copy of the 
program on a disk and the right to use the program on 5,000 
workstations. The contract requires Corp A to rewrite elements of 
Program X so that it will conform to Country Z accounting standards 
and states that Corp A retains all copyright rights in the modified 
Program X. The agreement between Corp A and Corp G is otherwise 
identical as to rights and payment terms as the agreement described 
in Example 10.
    (ii) Analysis. (A) As in Example 10, no copyright rights are 
being transferred under paragraph (c)(2) of this section. In 
addition, since no copyright rights are being transferred to Corp G, 
this transaction does not involve the provision of services by Corp 
A under paragraph (d) of this section. This transaction will be 
classified, therefore, as a transfer of copyrighted articles under 
paragraph (c)(1)(ii) of this section.
    (B) Taking into account all facts and circumstances, Corp G is 
properly treated as the owner of copyrighted articles. Therefore, 
under paragraph (f)(2) of this section, there has been the sale of a 
copyrighted article rather than the grant of a lease.
    Example 15. (i) Facts. Corp H, a Country Z corporation, enters 
into a license agreement for a new computer program. Program Q is to 
be written by Corp A, a U.S. corporation. Corp A and Corp H agree 
that Corp A is writing Program Q for Corp H and that, when Program Q 
is completed, the copyright in Program Q will belong to Corp H. Corp 
H gives instructions to Corp A programmers regarding program 
specifications. Corp H agrees to pay Corp A a fixed monthly sum 
during development of the program. If Corp H is dissatisfied with 
the development of the program, it may cancel the contract at the 
end of any month. In the event of termination, Corp A will retain 
all payments, while any procedures, techniques or copyrightable 
interests will be the property of Corp H. All of the payments are 
labelled royalties. There is no provision in the agreement for any 
continuing relationship between Corp A and Corp H, such as the 
furnishing of updates of the program, after completion of the 
modification work.
    (ii) Analysis. Taking into account all of the facts and 
circumstances, Corp A is treated as providing services to Corp H. 
Under paragraph (d) of this section, Corp A is treated as providing 
services to Corp H because Corp H bears all of the risks of loss 
associated with the development of Program Q and is the owner of all 
copyright rights in Program Q. Under paragraph (g)(1) of this 
section, the fact that the agreement is labelled a license is not 
controlling (nor is the fact that Corp A receives a sum labelled a 
royalty).
    Example 16. (i) Facts. Corp A, a U.S. corporation, and Corp I, a 
Country Z corporation, agree that a development engineer employed by 
Corp A will travel to Country Z to provide know-how relating to 
certain techniques not generally known to computer programmers, 
which will enable Corp I to more efficiently create computer 
programs. These techniques represent the product of experience 
gained by Corp A from working on many computer programming projects, 
and are furnished to Corp I under nondisclosure conditions. Such 
information is property subject to trade secret protection.
    (ii) Analysis. This transaction contains the elements of know-
how specified in paragraph (e) of this section. Therefore, this 
transaction will be treated as the provision of know-how.
    Example 17 (i) Facts. Corp A, a U.S. corporation, transfers a 
disk containing Program Y to Corp E, a Country Z corporation, in 
exchange for a single fixed payment. Program Y is a computer program 
development program, which is used to create other computer 
programs, consisting of several components, including libraries of 
reusable software components that serve as general building blocks 
in new software applications. No element of these libraries is a 
significant component of any overall new program. Because a computer 
program created with the use of Program Y will not operate unless 
the libraries are also present, the license agreement between Corp A 
and Corp E grants Corp E the right to distribute copies of the 
libraries with any program developed using Program Y. The license 
agreement is otherwise identical to the license agreement in Example 
1.
    (ii) Analysis. (A) No non-de minimis copyright rights described 
in paragraph (c)(2) of this section have passed to Corp E. For 
purposes of paragraph (b)(2) of this section, the right to 
distribute the libraries in conjunction with the programs created 
using Program Y is a de minimis component of the transaction. 
Because Corp E has received a copy of the program under paragraph 
(c)(1)(ii) of this section, it has received a copyrighted article.
    (B) Taking into account all the facts and circumstances, Corp E 
is properly treated as the owner of a copyrighted article. 
Therefore, under paragraph (f)(2) of this section, there has been 
the sale of a copyrighted article rather than the grant of a lease.
    Example 18 (i) Facts. (A) Corp A, a U.S. corporation, transfers 
a disk containing Program X to Corp E, a country Z Corporation. The 
disk contains both the object code and the source code to Program X 
and the license agreement grants Corp E the right to--
    (1) Modify the source code in order to correct minor errors and 
make minor adaptations to Program X so it will function on Corp E's 
computer; and
    (2) Recompile the modified source code.
    (B) The license does not grant Corp E the right to distribute 
the modified Program X to the public. The license is otherwise 
identical to the license agreement in Example 1.
    (ii) Analysis. (A) No non-de minimis copyright rights described 
in paragraph (c)(2) of this section have passed to Corp E. For 
purposes of paragraph (b)(2) of this section, the right to modify 
the source code and recompile the source code in order to create new 
code to correct minor errors and make minor adaptations is a de 
minimis component of the transaction. Because Corp E has received a 
copy of the program under paragraph (c)(1)(ii) of this section, it 
has received a copyrighted article.
    (B) Taking into account all the facts and circumstances, Corp E 
is properly treated as the owner of a copyrighted article. 
Therefore, under paragraph (f)(2) of this section, there has been 
the sale of a copyrighted article rather than the grant of a lease.

    (i) Effective date--(1) General. This section applies to 
transactions occurring pursuant to contracts entered into on or after 
December 1, 1998.
    (2) Elective transition rules--(i) Contracts entered into in 
taxable years ending on or after October 2, 1998. A taxpayer may elect 
to apply this section to transactions occurring pursuant to contracts 
entered into in taxable years ending on or after October 2, 1998. A 
taxpayer that makes an election under this paragraph (i)(2)(i) must 
apply this section to all contracts entered into in taxable years 
ending on or after October 2, 1998.
    (ii) Contracts entered into before October 2, 1998. A taxpayer may 
elect to apply this section to transactions occurring in taxable years 
ending on or after October 2, 1998 pursuant to contracts entered into 
before October 2, 1998 provided the taxpayer would not be required 
under this section to change its method of accounting as a result of 
such election, or the taxpayer would be required to change its method 
of accounting but the resulting section 481(a) adjustment would be 
zero. A taxpayer that makes an election under this paragraph (i)(2)(ii) 
must apply this section to all transactions occurring in taxable years 
ending on or after October 2, 1998 pursuant to contracts entered into 
before October 2, 1998.
    (3) Manner of making election. Taxpayers may elect, under paragraph 
(i)(2)(i) or (i)(2)(ii) of this section, to apply this section, by 
treating the transactions in accordance with these regulations on their 
original tax return.
    (4) Examples. The following examples illustrate application of the 
transition

[[Page 52982]]

rule of paragraph (i)(2)(ii) of this section:

    Example 1. Corp A develops computer programs for sale to third 
parties. Corp A uses an overall accrual method of accounting and 
files its tax return on a calendar-year basis. In year 1, Corp A 
enters into a contract to deliver a computer program in that year, 
and to provide updates for each of the following four years. Under 
the contract, the computer program and the updates are priced 
separately, and Corp A is entitled to receive payments for the 
computer program and each of the updates upon delivery. Assume Corp 
A properly accounts for the contract as a contract for the provision 
of services. Corp A properly includes the payments under the 
contract in gross income in the taxable year the payments are 
received and the computer program or updates are delivered. Corp A 
properly deducts the cost of developing the computer program and 
updates when the costs are incurred. Year 3 includes October 2, 
1998. Assume under the rules of this section, the provision of 
updates would properly be accounted for as the transfer of 
copyrighted articles. If Corp A made an election under paragraph 
(i)(2)(ii) of this section, Corp A would not be required to change 
its method of accounting for income under the contract as a result 
of the election. Corp A would also not be required to change its 
method of accounting for the cost of developing the computer program 
and the updates under the contract as a result of the election. 
Therefore, under paragraph (i)(2)(ii) of this section, Corp A may 
elect to apply the provisions of this section to the updates 
provided in years 3, 4, and 5, because Corp A is not required to 
change from its accrual method of accounting for the contract as a 
result of the election.
    Example 2. Corp A develops computer programs for sale to third 
parties. Corp A uses an overall accrual method of accounting and 
files its tax return on a calendar-year basis. In year 1, Corp A 
enters into a contract to deliver a computer program and to provide 
one update the following year. Under the contract, the computer 
program and the update are priced separately, and Corp A is entitled 
to receive payment for the computer program and the update upon 
delivery of the computer program. Assume Corp A properly accounts 
for the contract as a contract for the provision of services. Corp A 
properly includes the portion of the payment relating to the 
computer program in gross income in year 1, the taxable year the 
payment is received and the program delivered. Corp A properly 
includes the portion of the payment relating to the update in gross 
income in year 2, the taxable year the update is provided, under 
Rev. Proc. 71-21, 1971-2 CB 549 (see Sec. 601.601 (d)(2) of this 
chapter). Corp A properly deducts the cost of developing the 
computer program and update when the costs are incurred. Year 2 
includes October 2, 1998. Assume under the rules of this section, 
provision of the update would properly be accounted for as the 
transfer of a copyrighted article. If Corp A made an election under 
paragraph (i)(2)(ii) of this section, Corp A would be required to 
change its method of accounting for deferring income under its 
contract as a result of the election. However, the section 481(a) 
adjustment would be zero because the portion of the payment relating 
to the update would be includible in gross income in year 2, the 
taxable year the update is provided, under both Rev. Proc. 71-21 and 
Sec. 1.451-5. Corp A would not be required to change its method of 
accounting for the cost of developing the computer program and the 
update under the contract as a result of the election. Therefore, 
under paragraph (i)(2)(ii) of this section, Corp A may elect to 
apply the provisions of this section to the update in year 2, 
because the section 481(a) adjustment resulting from the change in 
method of accounting for deferring advance payments under the 
contract is zero, and because Corp A is not required to change from 
its accrual method of accounting for the cost of developing the 
computer program and updates under the contract as a result of the 
election.
    Example 3. Assume the same facts as in Example 1 except that 
Corp A is entitled to receive payments for the computer program and 
each of the updates 30 days after delivery. Corp A properly includes 
the amounts due under the contract in gross income in the taxable 
year the computer program or updates are provided. Assume that Corp 
A properly uses the nonaccrual-experience method described in 
section 448(d)(5) and Sec. 1.448-2T to account for income on its 
contracts. If Corp A made an election under paragraph (i)(2)(ii) of 
this section, Corp A would be required to change from the 
nonaccrual-experience method for income as a result of the election, 
because the method is only available with respect to amounts to be 
received for the performance of services. Therefore, Corp A may not 
elect to apply the provisions of this section to the updates 
provided in years 3, 4, and 5, under paragraph (i)(2)(ii) of this 
section, because Corp A would be required to change from the 
nonaccrual-experience method of accounting for income on the 
contract as a result of the election.

    (j) Change in method of accounting required by this section--(1) 
Consent. A taxpayer is granted consent to change its method of 
accounting for contracts involving computer programs, to conform with 
the classification prescribed in this section. The consent is granted 
for contracts entered into on or after December 1, 1998, or in the case 
of a taxpayer making an election under paragraph (i)(2)(i) of this 
section, the consent is granted for contracts entered into in taxable 
years ending on or after October 2, 1998. In addition, a taxpayer that 
makes an election under paragraph (i)(2)(ii) of this section is granted 
consent to change its method of accounting for any contract with 
transactions subject to the election, if the taxpayer is required to 
change its method of accounting as a result of the election.
    (2) Year of change. The year of change is the taxable year that 
includes December 1, 1998, or in the case of a taxpayer making an 
election under paragraph (i)(2)(i) or (i)(2)(ii) of this section, the 
taxable year that includes October 2, 1998.
    (k) Time and manner of making change in method of accounting--(1) 
General. A taxpayer changing its method of accounting in accordance 
with this section must file a Form 3115, Application for Change in 
Method of Accounting, in duplicate. The taxpayer must type or print the 
following statement at the top of page 1 of the Form 3115: ``FILED 
UNDER TREASURY REGULATION Sec. 1.861-18.'' The original Form 3115 must 
be attached to the taxpayers original return for the year of change. A 
copy of the Form 3115 must be filed with the National Office no later 
than when the original Form 3115 is filed for the year of change.
    (2) Copy of Form 3115. The copy required by this paragraph (k)(l) 
to be sent to the national office should be sent to the Commissioner of 
Internal Revenue, Attention: CC:DOM:IT&A, P.O. Box 7604, Benjamin 
Franklin Station, Washington DC 20044 (or in the case of a designated 
private delivery service: Commissioner of Internal Revenue, Attention: 
CC:DOM:IT&A, 1111 Constitution Avenue, NW., Washington, DC 20224).
    (3) Effect of consent and Internal Revenue Service review. A change 
in method of accounting granted under this section is subject to review 
by the district director and the national office and may be modified or 
revoked in accordance with the provisions of Rev. Proc. 97-37 (1997-33 
IRB 18) (or its successors) (see Sec. 601.601(d)(2) of this chapter).

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

    Par. 4. In Sec. 602.101, paragraph (c) is amended by adding an 
entry to the table in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *

[[Page 52983]]



------------------------------------------------------------------------
                                                             Current OMB
     CFR part or section where identified and described      control No.
------------------------------------------------------------------------
*                  *                  *                  *
                  *                  *                  *
1.861-18...................................................    1545-1594
*                  *                  *                  *
                  *                  *                  *
------------------------------------------------------------------------

Michael P. Dolan,
Deputy Commissioner of Internal Revenue.
    Approved: April 1, 1998.
Donald C. Lubick,
Assistant Secretary of the Treasury.
[FR Doc. 98-26475 Filed 9-30-98; 8:45 am]
BILLING CODE 4830-01-U