[Federal Register Volume 65, Number 25 (Monday, February 7, 2000)]
[Proposed Rules]
[Pages 5807-5828]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-1896]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[REG-100276-97; REG-122450-98]
RIN 1545-AV59; RIN 1545-AW98


Financial Asset Securitization Investment Trusts; Real Estate 
Mortgage Investment Conduits

AGENCY:  Internal Revenue Service (IRS), Treasury.

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

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SUMMARY:  This document contains proposed regulations relating to 
financial asset securitization investment trusts (FASITs). This action 
is necessary because of changes to the applicable tax law made by the 
Small Business Job Protection Act of 1996. The proposed regulations 
affect FASITs and their investors. This document also contains proposed 
regulations relating to real estate mortgage investment conduits 
(REMICs). This document provides notice of a public hearing on the 
proposed regulations.

DATES:  Written comments must be received by May 8, 2000. Outlines of 
topics to be discussed at the public hearing scheduled for May 15, 2000 
at 10 a.m., must be received by April 24, 2000.

ADDRESSES:  Send submissions to CC:DOM:CORP:R (REG-100276-97 and REG-
122450-98), room 5226, Internal Revenue Service, POB 7604, Ben Franklin 
Station, Washington, DC 20044. Submissions may be hand delivered Monday 
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R 
(REG-100276-97), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW, Washington, DC. Alternatively, taxpayers may 
submit comments via the Internet by selecting the ``Tax Regs'' option 
of the IRS Home Page or by submitting them directly to the IRS Internet 
site at http://www.irs.gov/tax__regs/regslist.html. The public hearing 
will be held in Room 2615, 1111 Constitution Avenue, NW., Washington, 
DC.

FOR FURTHER INFORMATION CONTACT:  Concerning the proposed regulations 
other than issues relating specifically to cross border transactions, 
David L. Meyer at (202) 622-3960 (not a toll-free number) and for 
issues relating specifically to cross border transactions, Rebecca 
Rosenberg or Milton Cahn at (202) 622-3870 (not a toll-free number); 
concerning submissions of comments, the hearing, and/or to be placed on 
the building access list to attend the hearing, Guy Traynor at (202) 
622-7180 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in this notice of proposed 
rulemaking has been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collection of information should be 
sent to the Office of Management and Budget, Attn: Desk Officer for the 
Department of the Treasury, Office of Information and Regulatory 
Affairs, Washington, DC 20503, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC 
20224. Comments on the collection of information should be received by 
April 7, 2000.
    Comments are specifically requested concerning:
    Whether the proposed collection of information is necessary for the 
proper performance of the functions of the Internal Revenue Service, 
including whether the collection will have a practical utility;
    The accuracy of the estimated burden associated with the proposed 
collection of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collection of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or startup costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The collection of information is in Sec. 1.860H-1(b)(2) and 
Sec. 1.860H-6(e). This information is required to permit qualified 
entities to elect to become a Financial Asset Securitization Investment 
Trust and to ensure the holder of the ownership interest in a FASIT 
properly reports the FASIT's items of income, gain, deduction, loss, 
and credit. This information will be used to properly administer the 
provisions of part V of subchapter M of the Code. The collection of 
information is mandatory. The likely respondents are business or other 
for-profit institutions.
    Estimated total annual reporting and/or record keeping burden: 750 
hours.
    Estimated average annual burden hours per respondent and/or record-
keeper: 5 hours.
    Estimated number of respondents and/or record-keepers: 150.
    Estimated annual frequency of responses: one annually.
    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.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax information are confidential, as required by 26 U.S.C. 6103.

Background

    Section 1621(a) of the Small Business Job Protection Act of 1996, 
Public Law 104-188, 110 Stat. 1755 (August 20, 1996) (the Act) amended 
the Internal Revenue Code (Code) by adding part V (sections 860H 
through 860L) (the FASIT provisions) to subchapter M of chapter 1. Part 
V, which is effective September 1, 1997, authorizes a securitization 
vehicle called a Financial Asset Securitization Investment Trust 
(FASIT). FASITs are meant to facilitate the securitization of debt 
instruments, including non-mortgage and mortgage debt instruments.
    A solicitation for comments was published in the Federal Register 
for November 4, 1996 (61 FR 56647). The comments received both raised 
and helped resolve significant issues. The IRS and Treasury request 
comments on these proposed regulations generally, and specifically 
request suggestions on how they may be revised to be more easily 
understood.

Explanation of Provisions

In General

    A FASIT is a qualified arrangement that elects FASIT treatment and 
meets certain requirements concerning the

[[Page 5808]]

composition of its assets and the interests it issues to investors. A 
qualified arrangement can be a corporation (other than a regulated 
investment company (RIC) as defined in section 851(a)), partnership, 
trust, or segregated pool of assets.
    A FASIT may issue one or more classes of regular interests, which 
are treated as debt for all purposes of the Code. In addition, each 
FASIT must have a single ownership interest, which must be held 
entirely by a non-exempt domestic C corporation (other than a RIC, real 
estate investment trust (REIT), real estate mortgage investment conduit 
(REMIC), or subchapter T cooperative).
    A FASIT is not subject to income tax. Instead, the tax items of the 
FASIT are included in the taxable income of the holder of the ownership 
interest (the Owner). The Owner, (and in some circumstances a person 
related to the Owner) must recognize gain (if any) when property is 
either transferred to the FASIT or supports the regular interests.
    Congress enacted the FASIT provisions to facilitate the 
securitization of revolving, non-mortgage debt obligations. An anti-
abuse rule incorporated in these proposed regulations is designed to 
ensure that FASITs are used in a manner that is consistent with this 
intent and not to create opportunities for tax planning that would not 
exist but for the enactment of the FASIT provisions and these proposed 
regulations.

Rules Applicable to the FASIT

Administrative Provisions

1. Background
    The administrative provisions have three objectives: (1) ensuring 
accurate and timely reporting of the FASIT's tax items, (2) ensuring 
compliance by the FASIT with the operating and qualification rules, and 
(3) reducing administrative burdens on FASIT interest holders and the 
IRS.
2. FASIT Election
    The proposed regulations provide that a FASIT election is made by 
attaching a statement to the Owner's Federal income tax return for the 
taxable year that includes the startup day. No particular form is 
presently required, but the statement must be specified as a FASIT 
election, and must identify the arrangement for which the election is 
made. The IRS and Treasury want to ensure that the persons most 
affected by a FASIT election have agreed to make the election. 
Therefore, if the electing arrangement is an entity, the election 
statement must be signed by the person who would sign the entity's 
return in the absence of the FASIT election. If the electing 
arrangement is a segregated pool of assets, the election statement must 
be signed by each person that owns the assets in the pool for Federal 
income tax purposes immediately before the startup day.
3. Treatment of FASIT Under Subtitle F
    None of the FASIT provisions addresses how a FASIT is treated under 
subtitle F (Procedure and Administration), which governs matters such 
as returns, penalties, tax payments, and assessments. One rule 
considered was to make a FASIT's subtitle F treatment depend on the 
classification of the electing arrangement. Thus, for example, if a 
partnership makes a FASIT election, the FASIT is a partnership for 
purposes of subtitle F. Rather than adopt this approach, which leads to 
several different administrative regimes for FASITs, the proposed 
regulations treat each FASIT as a branch or division of its Owner for 
purposes of subtitle F. Because an Owner must always be a domestic C 
corporation, this solution results in uniform treatment.
    The proposed regulations also make the Owner responsible for 
reporting interest income with respect to the regular interests which 
are treated for reporting purposes as collateralized debt obligations 
(CDOs).

Relationship of a FASIT to the Owner

    The FASIT provisions do not provide a general rule defining the 
relationship between a FASIT and its Owner for non-FASIT Federal income 
tax purposes. The nature of this relationship may be relevant in 
determining the Federal income tax consequences of a number of 
transactions entered into with a FASIT. For example, it is necessary to 
know the extent to which transactions with a FASIT are treated as 
transactions with the Owner in determining how the portfolio interest 
exception applies and whether a change in the Owner of the FASIT 
results in a realization event for holders of the FASIT regular 
interests.
    The IRS and Treasury considered proposing a general rule to 
characterize the FASIT's relationship to its Owner for all non-FASIT 
Federal income tax purposes. Among the alternatives evaluated were (1) 
treating the FASIT as an entity separate from the Owner; (2) treating 
the FASIT as a branch of the Owner; and (3) treating the FASIT as an 
entity for some purposes and as a branch for others.
    Each alternative has some underpinning in the statutory scheme. For 
example, in determining the Owner's taxable income, the FASIT 
provisions treat a FASIT's assets, liabilities, and tax items as the 
assets, liabilities, and tax items of the Owner. This supports treating 
a FASIT as a branch of the Owner. However, the restrictions on what 
kind of assets may be held and what type of investor interests may be 
issued apply to the FASIT alone and favor treating a FASIT as a 
separate entity.
    The IRS and Treasury have decided it is better to resolve the 
nature of the FASIT's relationship with the Owner on an issue-by-issue 
basis rather than by adopting a single general rule. A few situations 
(for example, the treatment of a FASIT under subtitle F and the 
treatment of a FASIT under the portfolio interest rules) are addressed 
in these proposed regulations. The IRS and Treasury welcome additional 
comments on whether and how additional rules should detail the FASIT's 
relationship with the Owner for non-FASIT Federal income tax purposes.

Assets That May Be Held by a FASIT (Permitted Assets)

1. Background
    Except during a brief formation period, substantially all of a 
FASIT's assets must consist of permitted assets. Permitted assets 
include cash and cash equivalents, debt instruments (and rights to 
acquire debt instruments), foreclosure property, interest and currency 
hedges (and rights to acquire interest and currency hedges), guarantees 
(and rights to acquire guarantees), regular interests in other FASITs, 
and regular interests in REMICs. The FASIT provisions generally do not 
allow a FASIT to hold debt instruments issued by the Owner (or a 
related person).
    Several commentators requested guidance on whether certain assets 
qualified as permitted assets. Other comments focused on the 
prohibition on Owner debt. In particular, the commentators requested 
guidance on the extent to which an Owner may guarantee assets or enter 
into a permitted hedge with the FASIT without violating the prohibition 
on Owner debt.
2. ``Substantially All''
    The FASIT provisions require substantially all of a FASIT's assets 
to be permitted assets. Under the proposed regulations, a FASIT meets 
this test if the aggregate adjusted basis of its assets other than 
permitted assets is less than one percent of the aggregate adjusted 
basis of all its assets.
    The proposed rule is patterned after a safe harbor rule applicable 
to REMICs.

[[Page 5809]]

The proposed regulations do not incorporate a provision in the REMIC 
safe harbor that allows a qualified entity that fails the REMIC safe 
harbor to otherwise demonstrate that it does not own more than a de 
minimis amount of non-qualified assets. This provision does not appear 
necessary because a FASIT, unlike a REMIC, can acquire additional 
permitted assets if it is in danger of failing the substantially all 
test.
3. Cash and Cash Equivalents
    The FASIT provisions treat cash and cash equivalents as permitted 
assets. The proposed regulations generally define the phrase cash and 
cash equivalents to mean functional currency. Investment quality debt 
instruments that are close to maturity are also cash and cash 
equivalents because of their perceived liquidity.
    In response to some commentators, the proposed regulations provide 
that cash and cash equivalents include shares in U.S.-dollar-
denominated money market mutual funds. Although such shares are 
technically stock, money market mutual funds are practical investments 
for cash balances pending either distribution to regular interest 
holders or reinvestment in new debt instruments. The IRS and Treasury, 
therefore, believe it is appropriate to allow FASITs to hold these 
investments.
4. Debt Instruments in General
    Under the FASIT provisions, a debt instrument must satisfy two 
criteria to be a permitted asset. First, it has to be a debt instrument 
as defined in section 1275(a)(1) of the Code, which means it has to be 
a bond, debenture, note or certificate, or other evidence of 
indebtedness. Second, interest payments (if any) must be made in the 
manner prescribed for REMIC regular interests. Interest payments on 
REMIC regular interests must be based on a fixed or variable rate (as 
allowed in regulations), or must consist of a specified portion of the 
interest payments on the underlying mortgages held by the REMIC. This 
means that under the FASIT provisions, interest payments on a debt 
instrument held by a FASIT must also be payable at a fixed or variable 
rate, or consist of a specified portion of the interest payments on 
some underlying debt instrument.
    The proposed regulations enumerate the types of debt instruments 
that meet this standard and therefore qualify as permitted assets. In 
general, a FASIT may hold fixed-rate debt instruments, specified 
floating-rate debt instruments, inflation-indexed debt instruments, and 
credit card receivables. In response to comments received, the proposed 
regulations also clarify that a FASIT may generally hold beneficial 
interests in, or coupon and principal strips created from, these 
instruments.
    One commentator requested that the proposed regulations 
specifically allow FASITs to hold debt instruments that provide for 
prepayment penalties. The commentator's concern was that prepayment 
penalties might be viewed as contingent payments that are not fixed or 
variable interest payments within the meaning of the FASIT provisions. 
The proposed regulations accommodate this concern by including in the 
list of permitted debt instruments, debt instruments to which 
Sec. 1.1272-1(c) (relating to debt instruments that provide for 
alternate payment schedules) applies. These rules generally accommodate 
prepayment penalties.
    To prevent a FASIT from indirectly holding equity-like or other 
non-debt interests, the proposed regulations disqualify any debt 
instrument that can be converted into, or the value of which is based 
on, anything other than a permitted debt instrument. Impermissible debt 
instruments include, for example, a debt instrument convertible into 
stock and a debt instrument the interest payments on which vary based 
on the spot price of oil. The proposed regulations also do not permit a 
FASIT to hold debt instruments that, when acquired by the FASIT, are in 
default due to any payment delinquency unless the Owner reasonably 
expects the obligor to cure the default (including the payment of any 
interest and penalties) within 90 days of the date the instrument is 
acquired by the FASIT. The concern is that a distressed debt instrument 
may take on the characteristics of equity because the FASIT (and in 
turn the regular interest holders): (1) may have to look to the 
obligor's general assets for payment of the instrument, (2) may not 
receive full payment of the instrument, and (3) may not receive any 
payment until the satisfaction of claims held by the obligor's other 
creditors.
5. Participation Interests
    One commentator requested guidance on whether a participation 
interest in a pool of revolving loans would be considered a permitted 
asset. The commentator pointed out that a participation interest can be 
based either on a fixed percentage of assets in the pool or on a fixed 
dollar amount of assets in the pool.
    The proposed regulations do not specifically address participation 
interests. It does not appear that guidance is needed concerning 
participation interests that are based on a fixed percentage of assets. 
If a FASIT owns a fixed-percentage participation interest, as the 
outstanding principal balance of the pool rises and falls, the FASIT 
may be required to pay additional amounts or entitled to receive 
distributions to maintain its fixed percentage ownership in the pool. 
As long as the distributions are paid in cash (or in the form of an 
otherwise permitted asset), the FASIT's fixed-percentage interest 
should be considered a fixed-percentage interest in each of the debt 
instruments in the pool. Thus, the FASIT's fixed-percentage 
participation interest should qualify as a permitted debt instrument to 
the extent the underlying debt instruments are themselves permitted 
assets.
    The result under the FASIT provisions is less clear in cases where 
the participation interest is based on a fixed dollar amount of assets 
in a pool. In this case, each change in the outstanding balance of the 
pool would trigger a corresponding change in the FASIT's percentage 
ownership of the pool. When the size of the pool increases, the FASIT 
could be viewed as exchanging an interest in each asset in the old pool 
for a lower percentage interest in each asset in the new pool. This 
exchange might constitute an impermissible asset disposition. In some 
cases, this disposition could result in the imposition of the 
prohibited transaction tax.
    While the problem with fixed-dollar participation interests might 
be resolved by treating a pool as a single asset, a rule specifically 
allowing a FASIT to hold participation interests may be used as a means 
of inappropriately avoiding other rules. The IRS and Treasury welcome 
additional comments on whether and how the need for a FASIT to hold 
fixed-dollar amount participation interests can be accommodated.
6. Debt Instruments Issued by the Owner
    To ensure that the holders of the regular interests are looking 
primarily to the FASIT, and not the Owner, for payment, the FASIT 
provisions generally prohibit a FASIT from holding debt instruments 
issued either by the Owner or a person related to the Owner 
(collectively, Owner debt). An exception is made for cash equivalents 
and other instruments specified by regulation.
    Under the proposed regulations, Owner debt means more than just 
debt instruments issued by the Owner. It includes an obligation of the 
Owner embedded in another instrument, a third party debt instrument the

[[Page 5810]]

performance of which is contingent on the performance of Owner debt, 
and any partial interest in Owner debt such as a principal or coupon 
strip. Similarly, a debt instrument guaranteed by an Owner is treated 
as Owner debt, if at the time the FASIT acquires the debt instrument, 
the Owner is in substance the primary obligor of the debt instrument. 
See Rev. Rul. 97-3 (1997-1 C.B. 9).
    Cash equivalents of the Owner, which are permitted under the FASIT 
provisions, are limited by the proposed regulations to short-term 
investment quality debt instruments that are acquired to temporarily 
invest cash pending either distribution to the FASIT interest holders 
or re-investment in other permitted assets.
    One commentator noted that under the FASIT provisions, it is 
unclear whether the Owner of two or more FASITs may use regular 
interests from one FASIT to fund another of its FASITs. If regular 
interests are considered debt of the Owner, then, technically, the 
regular interests held by the second FASIT would be impermissible Owner 
debt. The commentator noted that this form of tiering arrangement is 
commonly used in REMICs and should be available for use with FASITs. In 
response to this comment, the proposed regulations allow this type of 
tiering arrangement. As discussed below, however, tiered FASITs may not 
be used to achieve benefits that could not be obtained without the 
FASIT provisions.
7. Foreclosure Property
    The FASIT provisions allow a FASIT to hold an asset (foreclosure 
property) acquired upon the default or imminent default of a permitted 
debt instrument. The FASIT provisions generally allow a FASIT to retain 
foreclosure property for a designated grace period of approximately 
three to four years. After the grace period, a 100-percent tax is 
imposed on any net income derived from the foreclosure property, 
including income from its operation or disposition.
    In some cases, the property acquired upon foreclosure may 
independently qualify as another type of permitted asset. Under the 
proposed regulations, the FASIT may retain this type of foreclosure 
property beyond the grace period. If the FASIT retains the property 
beyond the grace period, the property loses its status as foreclosure 
property at the end of the grace period.
    At this point, the proposed regulations require the Owner to 
recognize gain, if any, on the property as if it had been contributed 
to the FASIT at the close of the grace period. In addition, after the 
grace period, the property can no longer qualify for the foreclosure 
exception to the prohibited transaction rules.
8. Contracts or Agreements in the Nature of a Line of Credit
    A FASIT may generally hold as a permitted asset a contract or 
agreement in the nature of a line of credit as long as the FASIT does 
not originate the contract or agreement.
9. Guarantees and Hedges
    Under the FASIT provisions, a contract may qualify as a permitted 
asset if it is a permitted hedge or guarantee. The FASIT provisions 
impose two requirements on permitted hedges and guarantees. First, the 
contract must be an interest rate or foreign currency notional 
principal contract, letter of credit, insurance, guarantee against 
defaults, or other similar instrument. Second, the contract must be 
reasonably required to guarantee or hedge against the FASIT's risks 
associated with being the obligor on the interests that the FASIT has 
issued. Several commentators asked for guidance on the scope of this 
rule.
    The proposed regulations provide guidance as to what constitutes a 
permitted hedge or guarantee. Rather than focus on the type of 
contract, the proposed regulations focus on its intended function. 
Under the proposed regulations, a contract is a permitted hedge or 
guarantee if the contract is reasonably required to offset differences 
that specified risk factors may cause between the amount or timing of 
the cash flows on a FASIT's assets and the amount or timing of the cash 
flows on the FASIT's regular interests. The specified risk factors are 
(1) fluctuations in market interest rates, (2) fluctuations in currency 
exchange rates, (3) the credit quality of the FASIT's assets and 
regular interests, and (4) the receipt of payments on the FASIT's 
assets earlier or later than originally anticipated.
    Several commentators requested that the proposed regulations list 
specific types of hedges and guarantees that qualify as permitted 
assets. Because the proposed regulations define permitted assets and 
guarantees in terms of their function, the proposed regulations do not 
include this type of list. Out of a concern that hedges could be used 
to effect the economic equivalent of a transfer of non-permitted assets 
to the FASIT, the proposed regulations prohibit a hedge or guarantee 
from referencing certain assets and indices. In particular, a hedge is 
not a permitted hedge if it references an asset other than a permitted 
asset or if it references an index, economic indicator or financial 
average that is not widely disseminated and designed to correlate 
closely with changes in one or more of the four specified risk factors.
    One commentator requested that the proposed regulations permit the 
incidental hedging of assets allocable to ownership interests. The 
commentator suggested that, as a practical matter, an Owner may desire 
to hedge all of the FASIT's assets inside the FASIT even though the 
FASIT securitizes less than all of the assets. The proposed regulations 
accommodate this concern by allowing the FASIT to hedge assets held (or 
to be held) and liabilities issued (or to be issued). Thus, under the 
proposed regulations, an Owner can hedge assets inside a FASIT that 
currently relate to the ownership interest if the assets are being held 
inside the FASIT because the Owner intends for them to support FASIT 
regular interests in the future.
    The proposed regulations provide special rules for hedges and 
guarantees entered into with the Owner or a related party. These rules 
generally allow a FASIT to enter into a hedge (other than a credit 
hedge) with the Owner (or a related party) if two conditions are met. 
First, the Owner (or related party) must be a dealer with respect to 
that type of hedging contract. Second, the Owner must maintain records 
establishing that the hedge contract was entered into at arm's length. 
In addition, the special rules provide that an Owner (or a related 
party) may issue a guarantee to a FASIT if the Owner can demonstrate 
that, immediately after the guarantee is issued, less than three 
percent of the value of the FASIT's assets are attributable to Owner 
guarantees.
    Finally, the usefulness of a hedge is diminished if the tax 
character of the hedge (as an ordinary or capital asset) does not match 
the tax character of the hedged item. Absent a special rule, disposing 
of a FASIT hedge could generate capital loss even though the associated 
assets and liabilities of the FASIT generate ordinary income and 
deductions. To alleviate this character mismatch, the proposed 
regulations treat a permitted hedge as an ordinary asset.

Prohibited Transactions

1. Background
    The FASIT provisions restrict the types of transactions in which a 
FASIT may engage through the imposition of a prohibited transactions 
tax. The tax is equal to 100 percent of the income a FASIT realizes 
from a prohibited

[[Page 5811]]

transaction. The four categories of prohibited transactions set out in 
the FASIT provisions include the receipt of any income from a loan 
originated by the FASIT and the receipt of gains from the FASIT's 
disposition of its assets.
2. Loan Origination
    Commentators expressed considerable concern over the lack of 
statutory guidance on determining whether a debt instrument held by a 
FASIT has been originated by the FASIT. Commentators noted that debt 
instruments originated through the Owner's business activities might be 
deemed to be originated by the FASIT thereby exposing the FASIT to 
liability for the prohibited transactions tax on any income realized on 
the instrument.
    The proposed regulations contain five safe harbors to limit the 
scope of the prohibited transaction rules as they relate to loan 
origination. Under the first safe harbor, a FASIT is not considered to 
have originated a loan if the FASIT acquires the loan from an 
established securities market.
    Under the second safe harbor, a FASIT is not considered to have 
originated a loan if the FASIT acquires the loan more than a year after 
the loan was created.
    Under the third safe harbor, a FASIT is not considered to have 
originated a loan if the FASIT acquires the loan from a person that 
regularly originates similar loans in the ordinary course of its trade 
or business. Importantly, this third safe harbor extends to 
transactions entered into with the Owner (or a related party). As a 
result, a FASIT that acquires credit card receivables from its Owner 
(or a related party), or creates new receivables from issuances made on 
accounts held by the FASIT will not be considered to have originated 
the receivables to the extent the Owner (or related party) originates 
similar loans in the ordinary course of its business.
    The fourth safe harbor provides that the FASIT will not be treated 
as originating any new loan it may receive from the same obligor in 
exchange for the obligor's original loan in the context of a workout.
    Finally, a FASIT will not be treated as having originated a debt 
instrument when it makes a loan pursuant to a contract or agreement in 
the nature of a line of credit the FASIT is permitted to hold.
3. Substitution or Distribution of Debt Instruments
    The FASIT provisions generally impose a prohibited transaction tax 
on the distribution of debt instruments to the Owner. An exception to 
this rule exists for distributions to the Owner so long as the 
principal purpose of the distribution is not the recognition of gain 
that is due to changes in market conditions while the FASIT held the 
debt instrument. This rule effectively allows an Owner to reduce over-
collateralization so long as the reduction is not designed to obtain a 
character advantage. Absent this rule, in times of falling market 
interest rates, an Owner could inappropriately generate capital gain 
and economically offsetting ordinary loss by disposing of distributed 
appreciated debt instruments while having the FASIT dispose of related 
hedges. To clarify the application of the distribution rule, the 
proposed regulations deem a distribution of a debt instrument to be 
carried out principally to recognize gain if the Owner (or a related 
person) sells the substituted or distributed debt instrument at a gain 
within 180 days of the substitution or distribution. In this case, the 
distribution will be a prohibited transaction subject to the 100-
percent tax.

Consequences of FASIT Cessation

    Under the FASIT provisions, the Commissioner may consent to the 
intended cessation of a FASIT and may grant conditional relief in the 
case of an inadvertent cessation. There are, however, no comprehensive 
rules describing the consequences of a cessation. The proposed 
regulations, therefore, detail how a cessation affects the FASIT, the 
underlying arrangement that made the FASIT election, the Owner, and the 
regular interest holders. These rules apply unless a cessation is 
carried out with the Commissioner's consent, in which case the consent 
document controls.
    Under the proposed regulations the Owner is treated as disposing of 
the FASIT's assets for their fair market value in a prohibited 
transaction. Gain, if any, on this deemed distribution is subject to 
the prohibited transactions tax. Any loss is disallowed. The Owner is 
also treated as satisfying the regular interests for an amount equal to 
the lesser of the adjusted issue price or fair market value of the 
regular interests. This deemed satisfaction will result in cancellation 
of indebtedness income in cases where the aggregate fair market value 
of the assets is less than the aggregate adjusted issue price of the 
regular interests. The underlying arrangement is no longer treated as a 
FASIT and generally is prohibited from making a new FASIT election. In 
addition, the underlying arrangement is treated as holding the assets 
of the terminated FASIT and is classified (for example, as a 
corporation or partnership) under general tax principles. Finally, the 
regular interest holders are treated as exchanging their FASIT regular 
interests for new interests in the underlying arrangement. These new 
interests are classified under general tax principles, and the deemed 
exchange of the regular interests for the new interests may require the 
regular interest holders to recognize gain or loss.

Rules Applicable to Owner

    Under the FASIT provisions, an Owner generally determines its 
taxable income by including the gains, losses, income and deductions of 
the FASIT and by treating the assets and liabilities of the FASIT as 
its own. In addition, the Owner must also follow special rules 
concerning the FASIT's tax-exempt income, prohibited transactions and 
method of accounting for debt instruments. Few comments were received 
concerning these provisions.
    Under the special rule concerning the method of accounting for debt 
instruments, a FASIT must use the constant yield method in determining 
all interest, acquisition discount, original issue discount (OID), 
market discount, and premium deductions or adjustments. To ensure that 
the Owner uses a constant yield method for all interest and interest-
like items, the proposed regulations require the Owner to compute the 
amount of interest income and premium offset accruing on debt 
instruments held in a FASIT under the methodology described in 
Sec. 1.1272-3(c).
    One commentator noted that the FASIT provisions speak in terms of 
determining the Owner's taxable income, and that taxable income, which 
the Code defines as gross income minus deductions, makes no reference 
to credits. The proposed regulations, therefore, clarify the extent to 
which an Owner, in determining its tax, may claim the FASIT's credits. 
In general, the Owner may claim a credit for taxes paid or deemed paid 
by the FASIT in the same manner and to the same extent as if the FASIT 
were an unincorporated branch of the Owner. As discussed below, the 
allowance of a foreign tax credit is subject to the anti-abuse 
provisions of this regulation, and other relevant authorities including 
case law and the potential application of IRS Notice 98-5 (1998-3 
I.R.B. 49).
    Because the Owner includes the FASIT's tax items in determining its 
credits and taxable income, the proposed regulations make the Owner 
(rather than the FASIT) responsible for reporting those items on its 
Federal

[[Page 5812]]

income tax return. The Owner is required to attach a separate statement 
to its income tax return detailing these items. No specific form is 
required.

Gain Recognition on Property Transferred to a FASIT

1. Background
    The FASIT provisions require Owners (or, in some cases, related 
persons) to include in income gain (but not loss) realized on the 
transfer of assets to a FASIT. In general, the amount of gain (if any) 
that must be included is equal to the value of the transferred asset 
over its adjusted basis in the transferor's hands. In addition, the 
FASIT provisions require gain (if any) to be recognized on assets the 
Owner holds outside of the FASIT but which nonetheless support FASIT 
regular interests. Significant comments were received regarding the 
gain recognition rule. In particular, comments were received on the 
method of valuing property, the scope of the support rule, and the need 
for a gain deferral rule.
2. Related-Person Gain Recognition Rule
    The IRS and Treasury have determined that the gain recognition rule 
of the FASIT provisions could be circumvented when a related person 
transfers property to a FASIT. Because the FASIT provisions do not 
require that the related person be a taxable C corporation (or even 
that the related person be subject to U.S. tax), the intended 
corporate-level tax on gain could be avoided by having non-corporate or 
foreign related persons make asset transfers. In this case, the FASIT 
provisions could be interpreted as allocating gain to the related 
person and the economically offsetting losses (usually in the form of 
premium offset) to the Owner. This misallocation of gain, if allowed, 
would frustrate the purpose of the gain recognition rule.
    The IRS and Treasury considered two ways to address this issue in 
developing these proposed regulations. One approach would have required 
any contribution from a related party to the FASIT to be taxed as if it 
were a deemed sale to the Owner followed by a contribution to the 
FASIT. This rule would conform the treatment of related person 
contributions with the treatment of contributions from unrelated 
persons under section 860I(a)(2). This rule would also ensure that gain 
upon contribution would be allocated to the taxpayer entitled to the 
subsequently occurring offsetting economic loss, namely, the Owner. A 
second approach was to develop regulations that would limit related 
person treatment to taxable, domestic C corporations and ensure that 
the misallocation of gain (in the related person) and associated loss 
(in the Owner) would not produce unwarranted tax benefits.
    The proposed regulations adopt the first approach. Under the 
proposed regulations, transactions between a related person and the 
FASIT are treated as transactions between the related person and the 
Owner followed by transactions between the Owner and the FASIT. This 
rule, however, does not apply in all cases. Transfers of publicly 
traded property by related persons are unlikely to be abusive. The rule 
in the proposed regulations, therefore, only applies if the related 
person transfers property not traded on an established securities 
market. Thus, for example, the rule applies to a transfer of consumer 
receivables, but not to a transfer of Treasury bills.
3. Determination of Value for Gain Recognition Purposes
    a. In general. To determine value for purposes of applying the gain 
recognition rules, the FASIT provisions divide property into two 
categories: (1) debt instruments not traded on an established 
securities market, and (2) all other property. The value of debt 
instruments not traded on an established securities market is 
determined by a special statutory rule. The value of all other property 
(which includes debt instruments that are traded on an established 
securities market) is fair market value.
    Under the special rule, the value of a debt instrument not traded 
on an established securities market is the sum of the reasonably 
expected cash flows on the instrument, discounted using semiannual 
compounding at a rate equal to 120 percent of the applicable federal 
rate (AFR).
    The intent behind the special valuation rule is uncertain. The 
legislative history of the FASIT provisions indicates the rule was 
meant to be a simple and mechanical formula that, by its nature, would 
not produce accurate results in every case. Specifically, the 
legislative history states that the value of an asset is determined by 
the special valuation rule even if a different value would be 
determined by applying a willing buyer/willing seller standard. See 
H.R. Rept.104-737, 104th Cong. 2d Sess., 327 (1996). At the same time, 
by applying a fair market value standard to all other assets (including 
market-traded debt), Congress showed a clear preference for using 
actual fair market value whenever it can be determined with reasonable 
accuracy.
    Several commentators made suggestions on how to interpret the 
legislative intent behind the special valuation rule. In general, the 
commentators were concerned that implementing the rule without 
modification would in many cases generate tax gains far in excess of 
economic gains. Because the commentators viewed this overvaluation as a 
substantial impediment to the use of FASITs, they asked that the 
proposed regulations narrow as much as possible the debt instruments 
subject to the special valuation rule.
    The proposed regulations attempt to reconcile the legislative 
intent and the commentators' concerns in a consistent and principled 
manner. The policy justification for the special valuation rule is 
strongest where it is difficult, if not impossible, to separate the 
value of a debt instrument from the value of the Owner's business 
relationship with the debtor. For example, the value of credit card 
receivables may be inferred if the receivables are placed in trust and 
used to create new debt instruments that are sold to the public at a 
disclosed price. In this case, however, the implied price necessarily 
includes both the value of the receivables and the value of the 
transferor's implicit or explicit promise to replace the receivables as 
they mature. Because there is no objective, easily administrable method 
for allocating the portion of the price allocable to the receivable (as 
opposed to the portion allocable to the transferor's ongoing business), 
the special valuation rule seems appropriate in this context.
    By contrast, the policy justification for the special valuation 
rule is weakest in cases where the fair market value of the debt 
instrument can be easily established. For example, if a FASIT purchases 
a pool of non-market-traded securities for cash in a transaction where 
the FASIT maintains no continuing relationship with the seller, there 
appears to be no reason to distrust the value as determined by an 
actual arm's length bargaining.
    Consistent with this understanding of the purpose behind the 
special valuation rule, the proposed regulations take a broad view of 
what constitutes an established securities market. In addition, the 
regulations clearly delineate whether property is subject to the 
special rule and provide a number of exceptions from the special rule.
    b. Traded on an established securities market. The proposed 
regulations define the term traded on an established securities market 
by reference to Sec. 1.1273-2(f)(2) through (4) of the OID

[[Page 5813]]

regulations. The proposed regulations also give the Commissioner the 
power to determine that debt instruments not meeting the standards of 
the OID regulations are nevertheless traded on an established 
securities market. Under the cross-reference to the OID regulations, 
debt is considered traded on an established securities market if (1) it 
is listed on certain specified securities exchanges or on certain 
interdealer quotation systems, (2) it is traded on a board of trade or 
interbank market, or (3) it appears on a quotation medium that provides 
a reasonable basis to determine fair market value by disseminating 
either recent price quotations or actual prices of recent sales 
transactions.
    The proposed regulations do not cross-reference Sec. 1.1273-2(f)(5) 
of the OID regulations. Consequently, debt is not considered traded on 
an established securities market if it is merely readily quotable 
within the meaning of Sec. 1.1273-2(f)(5). The IRS and Treasury do not 
expect this omission to have a significant impact because, under a 
special exception (the spot purchase rule, discussed below) the 
proposed regulations value non-publicly traded debt instruments at 
their cost if a FASIT acquires them in (or soon after) an arm's length 
cash purchase.
    According to one commentator, bank loans and private placement 
loans, which are typically made to small and medium sized businesses, 
are readily quotable within the meaning of Sec. 1.1273-5(f)(5) but 
would not otherwise be considered as traded on an established 
securities market. The commentator stated there would be commercial 
interest in securitizing these loans through FASITs but for application 
of the special valuation rule. Although the proposed regulations do not 
adopt the readily quotable standard, the IRS and Treasury believe bank 
and private placement loans will be securitized in transactions 
qualifying for the spot purchase exception. Nevertheless, comments are 
requested on whether the readily quotable standard is still necessary.
    c. Exceptions for debt not traded on an established securities 
market. The proposed regulations except from the special valuation rule 
certain beneficial and stripped interests. Under this exception, a 
certificate representing beneficial ownership of debt instruments 
constitutes beneficial ownership of debt instruments traded on an 
established securities market if either the certificate or all of the 
underlying debt instruments are traded on an established securities 
market. Similarly, a stripped bond or stripped coupon represents debt 
traded on an established securities market, if either the strip or the 
underlying debt instrument is traded on an established securities 
market. Because fair market value is easily determined in these 
circumstances, there appears to be little reason to apply the special 
valuation rule.
    Finally, the proposed regulations provide an exception for certain 
debt instruments that are contemporaneously purchased and transferred 
to the FASIT (the spot purchase rule). Under this provision, the value 
of a debt instrument is its cost to the Owner if four conditions are 
met: (1) the debt instrument is purchased from an unrelated person in 
an arm's length transaction, (2) the debt instrument is acquired for 
cash, (3) the price of the debt instrument is fixed no more than 15 
days before the date of the purchase, and (4) the debt instrument is 
transferred to the FASIT no more than 15 days after the date of the 
purchase.
    d. Debt instruments not traded on an established securities market. 
As discussed above, the special valuation rule values a debt instrument 
by discounting the reasonably expected cash flows on the instrument. 
The proposed regulations require that the determination of reasonably 
expected cash flows be commercially reasonable. The proposed 
regulations also permit reasonable assumptions concerning credit risk, 
early repayments, and loan servicing costs to be taken into account. 
Additional rules discourage the use of assumptions known to be 
inaccurate.
    One safeguard is a consistency test. Even though a debt instrument 
may not be traded on an established securities market, a person 
securitizing the debt instrument may make certain public 
representations about the debt instrument, such as in a prospectus or 
an offering memorandum. The consistency test prevents the use of one 
set of assumptions for tax purposes and the use of another set for 
different purposes. Specifically, all assumptions used in determining 
reasonably expected cash flows (for purposes of the FASIT valuation 
rule) must be no less favorable than the assumptions underlying the 
representations made to any of the following groups in the prescribed 
order: investors, rating agencies, or governmental agencies. For 
example, if one default rate is assumed to value debt instruments in a 
prospectus, a higher default rate cannot be assumed to value the debt 
instruments for purposes of the gain recognition provisions. Even if no 
representations concerning value are made to investors, rating 
agencies, or governmental agencies, the assumptions made for purposes 
of the gain recognition provisions must still be consistent with any 
applicable industry customs and standards. To encourage adherence to 
the consistency test, the Commissioner may determine reasonably 
expected cash flows without making any adjustment if the assumption 
made with respect to that adjustment (for example, assumed credit 
risks) fails the consistency test or is otherwise unreasonable.
    In addition to the consistency test, the proposed regulations place 
a ceiling on projected loan servicing costs. Specifically, the amount 
of loan servicing costs projected may not exceed the lesser of (1) the 
amount the FASIT agrees to pay the Owner (or a related person) for 
servicing all, or a portion, of the loans held by the FASIT, or (2) the 
amount a third party would reasonably pay for the servicing of 
identical loans.
    e. Special valuation rule for guarantees. Because a guarantee 
usually is not a debt instrument, any gain recognized on transferring a 
guarantee to a FASIT would be determined using the guarantee's fair 
market value absent a special rule. Nevertheless, if a guarantee 
relates solely to non-traded debt instruments, the proposed regulations 
allow taxpayers to value the guarantee and the debt instruments 
together. Under this rule, the reasonably expected payments on the 
guarantee are treated as part of the reasonably expected payments on 
the debt instruments to which the guarantee relates.
4. Property Held Outside a FASIT Supporting FASIT Regular Interests
    An Owner (or a person related to the Owner) must recognize gain on 
any property the Owner or related person holds outside the FASIT that 
supports the regular interests. In addition, property held by the Owner 
or related person that supports regular interests is treated as held by 
the FASIT for all purposes of the FASIT provisions. By treating support 
property as transferred to and held by a FASIT, the support rules 
discourage taxpayers from trying to avoid the gain-on-transfer rules 
and ensure that FASIT income includes the income from all FASIT 
property.
    Commentators asked for a clear and narrow definition of support 
property. They suggested limiting the support rule to situations in 
which the arrangement with the regular interest holders indicates that 
assets held outside the FASIT would have been transferred to the FASIT 
but for the gain recognition rules. Under this view, support property

[[Page 5814]]

includes: (1) subordinated interests in debt instruments contributed to 
the FASIT, (2) property securing an Owner's guarantee, and (3) 
contribution agreements that allow the FASIT to purchase a debt 
instrument for an amount significantly below its fair market value. 
Several commentators argued that unless a narrow view of support is 
adopted, the support rule threatens to subject to the gain recognition 
rule all property held by an Owner whenever the Owner guarantees a 
regular interest or has any kind of continuing relationship with the 
FASIT.
    Consistent with the comments received, the proposed regulations 
narrowly define support property. Under the proposed regulations, 
property generally is support property if the Owner (or a related 
person): (1) Identifies the property as providing security for a 
regular interest, (2) sets aside the property for transfer to the FASIT 
under a contribution agreement, or (3) holds an interest in the 
property that is subordinate to the FASIT's interest in the property. 
This last situation can arise, for example, if the Owner holds the 
junior interests in a pool of debt instruments while the FASIT holds 
the senior interests.
5. Deferral of Gain Recognition
    Although gain must ordinarily be recognized as soon as property is 
transferred, the FASIT provisions authorize regulations under which 
gain on transferred property is deferred until the transferred property 
supports regular interests. Several commentators specifically requested 
a gain deferral system and one explained in detail how a gain deferral 
system could be applied to a constantly revolving pool of assets.
    The proposed regulations do not provide a general gain deferral 
system. After carefully considering the issues involved, the IRS and 
Treasury have determined that gain deferral rules must build on rules 
for accounting for pooled debt instruments. The IRS and Treasury 
anticipate providing rules for pooled debt instrument in future 
guidance, and at that time expect to revisit the FASIT gain deferral 
rules.
    Although the proposed regulations do not provide rules for gain 
deferral generally, rules permitting gain deferral for pre-effective 
date FASITs have been developed consistent with the requirements of the 
Act. The IRS and the Treasury request comments on whether and how the 
gain deferral system for pre-effective date FASITs may be modified to 
accommodate a general gain deferral system.

Ownership Interests and Consolidated Groups

    By statute, to qualify as a FASIT, an arrangement must have one 
(and only one) ownership interest, and that ownership interest must be 
held by one (and only one) eligible corporation. Congress, however, 
anticipated that Treasury would ``issue guidance on how the ownership 
rule would apply to cases in which the entity that owns the FASIT joins 
in the filing of a consolidated return with other members of the group 
that wish to hold an ownership interest in the FASIT.'' See H.R. Conf. 
Rep. No. 737, 104th Cong., 2d Sess. 329 (1996).
    Commentators urged the IRS and Treasury to issue guidance that 
would change the statutory rule and permit members of a consolidated 
group to jointly hold a FASIT ownership interest. In studying the 
issue, however, the IRS and Treasury became concerned about how such 
guidance would continue to satisfy those general principles of the 
consolidated return regulations that preclude the shifting of stock 
basis, income, or loss. The IRS and Treasury considered different 
models that would permit members of a consolidated group to jointly 
hold (or enjoy the benefits of jointly holding) a FASIT ownership 
interest, but none of these were found to adequately address the 
government's concerns without adding administrative complexity for both 
the IRS and taxpayers. Moreover, the IRS and Treasury are not convinced 
the level of potential attribute shifting should be disregarded or 
addressed through an anti-abuse rule or would be so minor that 
disregarding it would be appropriate. Therefore, the proposed 
regulations do not provide rules permitting members of a consolidated 
group to jointly hold ownership interests in a FASIT. The IRS and 
Treasury invite the submission of additional comments that would 
address these concerns.

Transfers of Ownership Interests

    The proposed regulations ignore the transfer of an ownership 
interest if the transfer is accomplished to impede the assessment or 
collection of tax. A transfer is accomplished to impede the assessment 
or collection of tax if the transferor knows, or should know, that the 
transferee would be unwilling or unable to pay some or all of the tax 
arising from holding the ownership interest. A safe harbor, 
incorporated through a cross-reference to comparable rules regarding 
transfers of REMIC residual interests, is available to Owner-
transferors who conduct a reasonable investigation of the transferee's 
financial condition. As explained under the caption PROPOSED AMENDMENT 
TO REMIC REGULATIONS in this preamble, the REMIC safe harbor 
incorporated by the FASIT rules has been modified.

Rules Applicable to Regular Interest Holders

    The FASIT provisions treat a regular interest as a debt instrument 
for all purposes of the Code and require the holder to account for 
gross income with respect to the regular interest under an accrual 
method.
    Few comments were made with respect to FASIT regular interests. One 
commentator suggested a rule that would prevent the holder of a debt 
instrument from recognizing a loss on, or changing the tax consequences 
of, the debt instrument by transferring it to a FASIT in exchange for 
an identical or similar FASIT regular interest. No such rule is adopted 
by the proposed regulations because the IRS and Treasury believe this 
type of transaction is adequately addressed by the wash sales rules of 
the Code and the FASIT anti-abuse rule described later. Similarly, the 
proposed regulations have adopted no special rules concerning the 
consequences of modifying regular interests, because the IRS and 
Treasury believe these issues are adequately addressed under existing 
principles of Federal tax law.

Special Rules

Anti-Abuse Rule

    The proposed regulations contain an anti-abuse rule patterned after 
the anti-abuse rule in the partnership regulations issued under 
subchapter K. The FASIT anti-abuse rule evaluates transactions against 
the underlying purpose of the FASIT provisions, which is to promote the 
spreading of credit risk on debt instruments by facilitating the 
securitization of debt instruments. If a FASIT is formed or used to 
achieve a tax result inconsistent with this purpose, the Commissioner 
may take remedial action, including disregarding the FASIT election, 
reallocating items of income, deductions and credits, recharacterizing 
regular interests, and redesignating the holder of the ownership 
interest. Whether a FASIT is formed or used to achieve a tax result 
that is inconsistent with the FASIT provisions is a question of fact. 
In addition to applying the specific anti-abuse rule included in these 
proposed regulations, the IRS and Treasury will also continue to apply 
other statutory, administrative, and judicial anti-abuse provisions, 
such as the judicial

[[Page 5815]]

doctrines of economic substance and substance over form, to 
transactions and structures involving FASITs. For example, see the 
principles of Notice 98-5 (1998-3 I.R.B. 49), regarding foreign tax 
credits.
    Although regular interests in a FASIT may be held in a tiered FASIT 
structure and treated by each FASIT as permitted assets, the tiering of 
FASITs may not be used for double or multiple counting of the FASIT 
gross income or gross assets for other purposes of the Code in a manner 
that would be inconsistent with the intent of the FASIT provisions. In 
this regard, the IRS and Treasury consider the recognition of interest 
expense paid and the corresponding interest income received by the same 
Owner to be inconsistent with the intent of the provisions. 
Accordingly, such Owner-created attributes must be disregarded because 
a taxpayer may not enter into a transaction with itself. For example, 
the gross income and gross assets from the tiering of FASITs may not be 
taken into account more than once for purposes of testing whether an 
Owner is an 80/20 company under section 861, or for purposes of 
determining the relative domestic and foreign source gross assets of 
the Owner or the Owner's affiliated group in applying the interest 
expense allocation rules proposed here under section 864(e).

International Provisions

Prohibition of Foreign FASITS and Segregated Pools Subject to Foreign 
Tax

    It appears that taxpayers may attempt to exploit differences in the 
characterization of a FASIT or the interests in a FASIT under U.S. law 
and relevant foreign law to produce inappropriate tax avoidance 
(including by producing a non-economic allocation of foreign taxes to 
the holder of the FASIT ownership interest). To minimize this 
possibility, the proposed regulations provide that a foreign entity 
(including but not limited to a foreign corporation or a foreign 
partnership) may not be a qualified arrangement. In addition, a 
qualified arrangement may not be a domestic entity or a segregated pool 
of identified assets any of the income of which is subject to tax on a 
net basis by a foreign country. The IRS and Treasury intend that the 
imposition of foreign tax on a net basis with respect to the assets and 
liabilities of a FASIT will disqualify a FASIT election without regard 
to whether the segregated pool of assets is actually held through a 
U.S. or foreign office or fixed place of business. In addition, a 
preexisting qualified FASIT may cease to be a FASIT prospectively by 
being subjected to foreign net taxation for the first time in a later 
year as a result of newly conducted foreign activities. It is not 
necessary that actual foreign tax be imposed for an arrangement to be 
considered subject to foreign net taxation.
    The IRS and Treasury request comments regarding whether there may 
be circumstances in which legitimate (non-tax) business reasons justify 
allowing a FASIT election to be made by a foreign entity, or an entity 
the income of which is subject to net foreign taxation, or on behalf of 
a segregated pool which may be subject to net foreign taxation.

Prohibition on Foreign FASITs and Segregated Pools Subject to Foreign 
Tax

    The IRS and Treasury are also concerned that taxpayers may attempt 
to use FASITs to produce non-economic allocations of foreign 
withholding taxes to the holder of the FASIT ownership interest. The 
IRS and Treasury believe that such transactions may be facilitated by 
the ease with which an Owner can acquire publicly-traded debt that is 
subject to foreign withholding tax. In addition, prohibiting a FASIT 
from holding publicly-traded debt subject to a foreign withholding tax 
should not unduly interfere with legitimate securitizations of debt 
held by an Owner. Accordingly, the proposed regulations provide that 
the definition of permitted debt instruments does not include debt 
instruments traded on an established securities market if such debt 
instruments are subject to foreign withholding tax. The IRS and 
Treasury request comments concerning whether the scope of this rule is 
adequate to address potentially abusive transactions and whether 
legitimate (non-tax) business reasons may justify the use of a FASIT to 
hold foreign debt that is traded on an established securities market 
and is subject to a foreign withholding tax.

Avoidance of U.S. Withholding Tax

    The IRS and Treasury are also concerned that FASITs may be used by 
foreign resident taxpayers to avoid U.S. withholding taxes that would 
otherwise be imposed on direct cross-border financing to a foreign 
person's U.S. subsidiary. In particular, the IRS and Treasury are aware 
that foreign taxpayers may attempt to use FASITs to convert interest 
that would be disqualified from the portfolio interest exemption under 
sections 871(h)(3), 881(c)(3)(B), and 881(c)(3)(C) (concerning interest 
paid to a 10 percent shareholder and interest paid to a controlled 
foreign corporation from a related person) into interest that qualifies 
as portfolio interest. To prevent such avoidance, the proposed 
regulations provide that interest paid or accrued to a foreign holder 
of a FASIT regular interest will not qualify as portfolio interest 
under sections 871(h)(3) and 881(c)(3) to the extent that the FASIT 
receives or accrues interest from an obligor who is a U.S. resident 
taxpayer (the related obligor) if (1) the foreign holder is a 10 
percent shareholder (within the meaning of Section 871(h)(3)) of the 
related obligor or (2) the foreign holder is a controlled foreign 
corporation and the related obligor is a related person (within the 
meaning of section 864(d)(4)) with respect to the foreign holder. For 
these purposes, the related obligor is defined as a conduit debtor who 
is treated as paying interest directly to the 10 percent shareholder or 
the controlled foreign corporation for purposes of sections 871, 881, 
1441 and 1442. This rule characterizes all interest of the foreign 
regular interest holder as non-portfolio interest if the FASIT receives 
or accrues an equal or greater amount of interest from the related 
obligor.
    Further, the IRS and Treasury request comments concerning whether 
FASIT regular interests, REMIC regular interests, and pass through 
certificates should be treated in a consistent manner for purposes of 
applying U.S. withholding tax rules.
    The IRS and Treasury intend to issue regulations that will provide 
that the FASIT and its Owner are withholding agents in respect of 
payments made to foreign regular interest holders.
    The IRS and Treasury solicit comments with respect to circumstances 
in which the FASIT and its Owner may be unaware of a possible 
relationship between foreign regular interest holders and the related 
obligors of the debt instruments held by the FASIT or other 
circumstances under which it would be inappropriate to treat payments 
to a regular interest holder as payments directly from a conduit 
debtor. It is anticipated that these regulations will provide that the 
FASIT and its Owner will not be responsible for withholding amounts 
paid to the foreign regular interest holders in the above circumstances 
unless the FASIT or its Owner knows, or has reason to know, that the 
foreign regular interest holder is a 10 percent shareholder of the 
related obligor or is a controlled foreign corporation considered to be 
receiving interest from a related person. It is expected that these 
regulations will further provide that the FASIT and its Owner shall be 
presumed to know that

[[Page 5816]]

these circumstances exist if the foreign regular interest holder owns 
10 percent or more of the total value of the FASIT's regular interests 
and the debt of the related obligor accounts for 10 percent or more of 
the total value of the FASIT's assets.

Earnings Stripping and Original Issue Discount

    The IRS and Treasury are also aware that regular interests in 
FASITs may be used by foreign residents to avoid other consequences 
that might apply to cross-border related-party payments. The IRS and 
Treasury are concerned that taxpayers may attempt to use FASITs to 
avoid the deferrals on deductibility imposed by sections 163(e)(3) on 
OID owing to related foreign persons and 163(j) on net interest expense 
that is otherwise treated as disqualified under the earnings stripping 
rules.
    Similar to the rules adopted for portfolio indebtedness purposes, 
the proposed regulations treat a U.S. resident taxpayer who is an 
obligor to a FASIT as a conduit debtor to the extent a related person 
(within the meaning of section 267(b) or 707(b)(1)) who would not be 
subject to tax on a direct payment by the U.S. obligor receives 
interest with respect to a regular interest in the FASIT. In such 
circumstances, the earnings stripping provisions will apply to treat 
interest paid by a U.S. corporation or a U.S. trade or business of a 
foreign corporation on an obligation held by a FASIT as disqualified 
interest for purposes of section 163(j). Similarly, the conduit debtor 
rule also operates to treat OID accrued to a FASIT by a domestic party 
as deferred to the extent a related foreign person (as defined in 
section 163(e)(3)(B)) receives interest with respect to a regular 
interest of the FASIT. These rules apply to payments and accruals made 
during the same period the regular interest in the FASIT is held by the 
10 percent shareholder or foreign related party.

No Correlative Adjustments to FASIT

    The FASIT and its Owner are not entitled to any correlative 
adjustments for amounts that are treated as directly paid by a conduit 
debtor and treated as directly received by or accrued to a related 
party. Accordingly, all interest paid or accrued by the conduit debtor 
to the FASIT must be taken into account by the Owner in determining its 
own taxable income. This treatment is consistent with Treasury's 
general approach, already adopted in conduit financing regulations, to 
preventing withholding tax avoidance. TD 8611, 1995-2 C.B. 286, 293.

Interest Expense Allocation

    For purposes of applying the interest expense allocation rules to 
the Owner under section 864(e) and the regulations thereunder, new 
proposed regulations provide that all interest expense from all FASITs 
that is treated as incurred by any Owner or by any other Owner that is 
a member of the same affiliated group of which the Owner is a member is 
directly allocated solely to all income from all FASITs of such Owners. 
The directly allocated interest expense is treated as directly related 
to all activities and assets of all the Owner's FASITs and is 
apportioned between domestic and foreign source FASIT gross income by 
applying the general asset method to the FASIT's assets. The proposed 
interest allocation rules also extend the existing asset adjustment 
rules under the asset method in Sec. 1.861-9T(g), which reduce assets 
to reflect the principal amount of indebtedness outstanding relating to 
the interest which is directly allocated. The rules of Sec. 1.861-
10T(d)(2) are also made applicable. In addition, the new proposed 
interest allocation rules are the exclusive method for the direct 
allocation of FASIT interest expense. The IRS and Treasury are not 
aware of any situations in which the direct allocation rules of the 
existing temporary regulations would apply to any items of FASIT income 
and interest expense. Comments are solicited in this regard.
    The rules apply to interest expense with respect to any FASIT as of 
that FASIT's startup day and throughout the entire period that the 
arrangement continues to qualify as a FASIT. The rules provide the 
Commissioner with discretion to continue to directly allocate interest 
expense with respect to a ceased FASIT to FASIT income if the 
Commissioner determines that a principle purpose for terminating the 
FASIT was to affect the interest allocation.
    The IRS and Treasury believe that directly allocating FASIT 
interest expense solely to FASIT gross income is an administrable and 
appropriate way to limit distortions (favorable or unfavorable as the 
case may be) to a taxpayer's overall allocation of interest expense for 
foreign tax credit purposes. It is recognized, however, that the new 
proposed direct allocation rules may enable certain interest expense 
allocation planning that may create distortions that would not occur 
under existing interest allocation rules. To address these concerns, 
the IRS and Treasury are considering whether to adopt rules in final 
regulations that limit the extent to which the direct allocation rules 
may apply, including rules regarding the amount of variance between the 
direct allocation and combined asset allocation rules that is 
appropriate. Comments are solicited on this issue.

Pre-Effective Date FASITs

    Section 1691(e) of the Small Business Job Protection Act of 1996 
(the Act) provides special transition rules for securitization entities 
in existence on August 31, 1997. Under these rules, the Owner of a pre-
effective date FASIT may defer the recognition of FASIT gain on assets 
attributable to pre-FASIT interests. For purposes of this rule, a pre-
effective date FASIT is a FASIT the underlying arrangement of which was 
in existence on August 31, 1997. A pre-FASIT interest is an interest in 
the underlying arrangement that was outstanding on the FASIT startup 
date and that is considered debt under general tax principles.
    The proposed regulations provide a safe-harbor method of accounting 
that allows the separation of FASIT gain attributable to pre-FASIT 
interests, and other FASIT gain. Basically, the safe-harbor method has 
three steps. Under the first step, the Owner groups the assets of the 
FASIT into pools. To ensure that each pool can be marked to market 
using a valuation methodology appropriate for its constituent assets, 
the proposed regulations provide that no pool may contain assets of 
more than one of the following three types: (1) assets that are valued 
under the special valuation rule and that have FASIT gain on the first 
day they are held by the FASIT, (2) assets that are valued under 
general fair market value principles and that have FASIT gain on the 
first day they are held by the FASIT, and (3) assets that do not have 
FASIT gain on the first day they are held by the FASIT.
    Under the second step, the Owner periodically computes for each 
pool the difference between the income determined under a mark-to-
market system (using the appropriate FASIT valuation methodology) and 
the income determined under an accrual system. This difference is 
referred to as FASIT gain (or loss) and is essentially a measure of the 
gain (or loss) from the pool that is attributable to the operation of 
the FASIT gain recognition rules. These rules require gain to be 
determined at the pool level when assets are contributed to a FASIT, 
and implicitly allow this gain to be reversed out (as deductions in the 
nature of premium offset) as the assets in the pool mature. In periods 
in which net contributions are made to the pool, the

[[Page 5817]]

calculation generally will produce FASIT gain. In periods in which the 
pool decreases in size or duration, the calculation generally will 
produce FASIT loss. This FASIT loss is, in effect, a recapture of 
previously determined FASIT gain. Over the entire life of a pool, the 
aggregate FASIT gain (or loss) will be zero; the FASIT valuation rules 
do not create lifetime net income.
    Under the third step, the Owner determines the proper amount of 
FASIT gain (or loss) to recognize during the current period. To 
determine this amount, the Owner first calculates the total amount of 
FASIT gain as of the last day of the current period. The Owner then 
reduces this amount to exclude the percentage of the FASIT gain that is 
attributable to pre-FASIT interests outstanding on the last day of the 
period. This reduced amount represents the cumulative amount of FASIT 
gain the Owner should recognize by the end of the current period. 
Finally, to adjust for amounts recognized in previous periods, the 
Owner subtracts from this amount the cumulative amount of FASIT gain 
that the Owner had recognized at the end of the previous period. The 
difference is the amount of FASIT gain (or loss) to be recognized in 
the current period.
    Owners of pre-effective date FASITs that presently use a gain 
deferral methodology that differs from the safe harbor method described 
above may adopt the safe-harbor method. The IRS and Treasury request 
comments on whether guidance is needed on how this change of method may 
be accomplished.

Proposed Amendment to REMIC Regulations

    Final regulations governing REMICs, issued in 1992, contain rules 
governing the transfer of noneconomic REMIC residual interests. In 
general, a transfer of a noneconomic residual interest is disregarded 
for all tax purposes if a significant purpose of the transfer is to 
enable the transferor to impede the assessment or collection of tax. A 
purpose to impede the assessment or collection of tax (a wrongful 
purpose) exists if the transferor, at the time of the transfer, either 
knew or should have known that the transferee would be unwilling or 
unable to pay taxes due on its share of the REMIC's taxable income.
    Under a safe harbor, the transferor of a REMIC residual interest is 
presumed not to have a wrongful purpose if two requirements are 
satisfied. First, the transferor must conduct a reasonable 
investigation of the transferee's financial condition. Second, the 
transferor must secure a representation from the transferee to the 
effect that the transferee understands the tax obligations associated 
with holding a residual interest and intends to pay those taxes.
    The IRS and Treasury are concerned that some transferors of 
residual interests claim they satisfy the safe harbor even in 
situations where the economics of the transfer clearly indicate the 
transferee is unwilling or unable to pay the tax associated with 
holding the interest. The proposed regulations, therefore, would 
clarify the safe harbor. The proposal explains that the safe harbor is 
unavailable unless the present value of the anticipated tax liabilities 
associated with holding the residual interest does not exceed the sum 
of: (1) the present value of any consideration given to the transferee 
to acquire the interest; (2) the present value of the expected future 
distributions on the interest; and (3) the present value of the 
anticipated tax savings associated with holding the interest as the 
REMIC generates losses. No inference is intended regarding whether any 
existing transactions satisfy the substantive requirements of this safe 
harbor before the clarification made by this amendment.

Proposed Effective Date

    In general, the proposed regulations including the proposed 
amendments to the interest expense allocation regulations are proposed 
to apply on the date final regulations are filed with the Federal 
Register. The portion of the proposed regulations containing the anti-
abuse rule and the portion of the proposed regulations allowing the 
deferral of gain on assets held by a pre-effective date FASIT are 
proposed to apply on February 4, 2000. The proposed amendment to the 
REMIC regulations is proposed to apply to all transfers occurring after 
the date final regulations concerning the amendment are published in 
the Federal Register.

Special Analyses

    It is hereby certified that these proposed regulations will not 
have a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that it is unlikely 
that a substantial number of small entities will hold FASIT ownership 
interests. Therefore, a Regulatory Flexibility Analysis under the 
Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. It has 
been determined that this Treasury decision is not a significant 
regulatory action as defined in Executive Order 12866. Therefore, a 
regulatory assessment is not required. Pursuant to section 7805(f) of 
the Internal Revenue Code, these proposed regulations will be submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on their impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) that are submitted timely to the IRS. All 
comments will be available for public inspection and copying.
    A public hearing has been scheduled for May 15, 2000, beginning at 
10 a.m. in Room 2615 of the Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th Street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble. The rules of 26 CFR 601.601(a)(3) 
apply to the hearing. Persons who wish to present oral comments at the 
hearing must submit written comments and an outline of the topics to be 
discussed and the time to be devoted to each topic (signed original and 
eight (8) copies) by April 24, 2000. A period of 10 minutes will be 
allotted to each person for making comments. An agenda showing the 
scheduling of the speakers will be prepared after the deadline for 
receiving outlines has passed. Copies of the agenda will be available 
free of charge at the hearing.

Drafting Information

    The principal author of these proposed regulations is David L. 
Meyer, Office of Assistant Chief Counsel (Financial Institutions and 
Products), 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 record keeping requirements.

26 CFR Part 602

    Reporting and record keeping requirements.

[[Page 5818]]

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for 1.861-10(e) and adding entries in numerical 
order to read as follows:

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

    Section 1.860H-1 also issued under 26 U.S.C. 860L(h).
    Section 1.860H-2 also issued under 26 U.S.C. 860L(h).
    Section 1.860H-3 also issued under 26 U.S.C. 860L(h) and 
860L(f).
    Section 1.860H-4 also issued under 26 U.S.C. 860L(h).
    Section 1.860H-5 also issued under 26 U.S.C. 860L(h) and 
7701(l).
    Section 1.860I-1 also issued under 26 U.S.C. 860L(h) and 
860I(c).
    Section 1.860I-2 also issued under 26 U.S.C. 860L(h).
    Section 1.860J-1 also issued under 26 U.S.C. 860L(h).
    Section 1.860K-1 also issued under 26 U.S.C. 860L(h).
    Section 1.860L-1 also issued under 26 U.S.C. 860L(h).
    Section 1.860L-2 also issued under 26 U.S.C. 860L(h).
    Section 1.860L-3 also issued under 26 U.S.C. 860L(h).
    Section 1.860L-4 also issued under 26 U.S.C. 860L(h). * * *
    Section 1.861-9 also issued under 26 U.S.C. 864(e)(7).
    Section 1.861-10 also issued under 26 U.S.C 863(a), 26 U.S.C. 
864(e)(7), 26 U.S.C. 865(i), and 26 U.S.C. 7701(f). * * *

    Par. 2. Section 1.860E-1 is amended by:
    1. Revising paragraph (c)(4).
    2. Adding paragraphs (c)(5) and (c)(6).
    The addition and revision read as follows:


Sec. 1.860E-1  Treatment of taxable income of a residual interest 
holder in excess of daily accruals.

* * * * *
    (c) * * *
    (4) Safe harbor for establishing lack of improper knowledge. A 
transferor is presumed not to have improper knowledge if--
    (i) The transferor conducted, at the time of the transfer, a 
reasonable investigation of the financial condition of the transferee 
and, as a result of the investigation, the transferor found that the 
transferee had historically paid its debts as they came due and found 
no significant evidence to indicate that the transferee will not 
continue to pay its debts as they come due in the future;
    (ii) The transferee represents to the transferor that it 
understands that, as the holder of the noneconomic residual interest, 
the transferee may incur tax liabilities in excess of any cash flows 
generated by the interest and that the transferee intends to pay taxes 
associated with holding residual interest as they become due; and
    (iii) The present value of the anticipated tax liabilities 
associated with holding the residual interest does not exceed the sum 
of--
    (A) The present value of any consideration given to the transferee 
to acquire the interest;
    (B) The present value of the expected future distributions on the 
interest; and
    (C) The present value of the anticipated tax savings associated 
with holding the interest as the REMIC generates losses.
    (5) Computational assumptions. The following rules apply for 
purposes of paragraph (c)(4)(iii) of this section:
    (i) The transferee is assumed to pay tax at a rate equal to the 
highest rate of tax specified in section 11(b)(1); and
    (ii) Present values are computed using a discount rate equal to the 
applicable Federal rate prescribed by section 1274(d) compounded 
semiannually (a lower discount rate may be used if the transferee can 
demonstrate that it regularly borrows, in the course of its trade or 
business, substantial funds at such lower rate from unrelated third 
parties).
    (6) Effective date. Paragraphs (c)(4) and (5) of this section are 
applicable on February 4, 2000.
    Par. 3. Sections 1.860H-0 through 1.860L-4 are added to read as 
follows:

Sec. 1.860H-0  Table of contents.

    This section lists captions that appear in Secs. 1.860H-1 
through 1.860L-4.

Sec. 1.860H-1  FASIT defined, FASIT election, other definitions.

(a) FASIT defined.
(b) FASIT election.
(1) Person that makes the election.
(2) Form of election.
(3) Time for filing election.
(4) Contents of election.
(5) Required signatures.
(6) Special rules regarding startup day.
(c) General definitions.
(1) Owner.
(2) Transfer.

Sec. 1.860H-2  Assets permitted to be held by a FASIT.

(a) Substantially all.
(b) Permitted debt instrument.
(1) In general.
(2) Special rules for short-term debt instruments issued by the 
Owner or related person.
(3) Exceptions.
(c) Cash and cash equivalents.
(d) Hedges and guarantees.
(1) In general.
(2) Referencing other than permitted assets.
(3) Association with particular assets or regular interests.
(4) Creating an investment prohibited.
(e) Hedges and guarantees issued by Owner (or related person).
(1) Hedges.
(2) Guarantees.
(f) Foreclosure property.
(g) Special rule for contracts or agreements in the nature of a line 
of credit.
(h) Contracts to acquire hedges or debt instruments.

Sec. 1.860H-3  Cessation of a FASIT.

(a) In general.
(b) Time of cessation.
(c) Consequences of cessation.
(d) Disregarding inadvertent failures to remain qualified.

Sec. 1.860H-4  Regular interests in general.

(a) Issue price of regular interests.
(1) Regular interests not issued for property.
(2) Regular interests issued for property.
(b) Special rules for high-yield regular interests.
(1) High-yield interests held by a securities dealer.
(2) High-yield interests held by a pass-thru.

Sec. 1.860H-5  Foreign resident holders of regular interests.

(a) Look-through to underlying FASIT debt.
(b) Conduit debtor.
(c) Limitation.
(d) Cross-references.

Sec. 1.860H-6  Taxation of Owner, Owner's reporting requirements, 
transfers of ownership interest.

(a) In general.
(b) Constant yield method to apply.
(c) Method of accounting for, and character of, hedges.
(d) Coordination with mark to market provisions.
(1) No mark to market accounting.
(2) Transfer of a mark to market asset to a FASIT.
(e) Owner's annual reporting requirements.
(f) Treatment of FASIT under subtitle F of Title 26 U.S.C.
(g) Transfer of ownership interest.
(1) In general.
(2) Safe harbor for establishing lack of improper knowledge.

Sec. 1.860I-1  Gain recognition on property transferred to FASIT or 
supporting FASIT regular interests.

(a) In general.
(b) Support property defined.
(c) Time of gain determination and recognition.
(d) Gain deferral election. [Reserved]
(e) Amount of gain.
(f) Record keeping requirements.
(g) Special rule applicable to property of related persons.

Sec. 1.860I-2  Value of property.

(a) Special valuation rule.
(b) Traded on an established securities market.
(c) Reasonably expected payments.
(1) In general.
(2) Consistency requirements.
(3) Servicing costs.

[[Page 5819]]

(4) Nonconforming or unreasonable assumptions.
(d) Special rules.
(1) Beneficial ownership interests.
(2) Stripped interests.
(3) Contemporaneous purchase and transfer of debt instruments.
(4) Guarantees.
(e) Definitions.

Sec. 1.860J-1  Non-FASIT losses not to offset certain FASIT inclusions.

(a) In general.
(b) Special rule for holders of multiple ownership interests.
(c) Related persons.
(1) Taxable income.
(2) Effect on net operating loss.
(3) Coordination with minimum tax.

Sec. 1.860L-1  Prohibited transactions.

(a) Loan origination.
(1) In general.
(2) Acquisitions presumed not to be loan origination.
(3) Activities presumed to be loan origination.
(4) Loan workouts.
(b) Origination of a contract or agreement in the nature of a line 
of credit.
(1) In general.
(2) Activities presumed to be origination.
(3) Debt instruments issued under contracts or agreements in the 
nature of a line of credit.
(c) Disposition of debt instruments.
(d) Exclusion of prohibited transactions tax to dispositions of 
hedges.

Sec. 1.860L-2  Anti-abuse rule.

(a) Intent of FASIT provisions.
(b) Application of FASIT provisions.
(c) Facts and circumstances analysis.

Sec. 1.860L-3  Transition rule for pre-effective date FASITs.

(a) Scope.
(1) Pre-effective date FASIT defined.
(2) Pre-FASIT interest defined.
(3) FASIT gain defined.
(b) Election to defer gain.
(c) Safe harbor method.
(d) Example
(e) Election to apply gain deferral retroactively
(f) Effective date.

Sec. 1.860L-4  Effective date.


Sec. 1.860H-1  FASIT defined, FASIT election, other definitions.

    (a) FASIT defined--(1) A FASIT is a qualified arrangement (as 
defined in paragraph (a)(2) of this section) that meets the 
requirements of section 860L(a)(1) and the FASIT regulations (as 
defined in paragraph (c) of this section). A qualified arrangement 
fails to meet the requirements of section 860L(a)(1) unless it has one 
and only one ownership interest and that ownership interest is held by 
one and only one eligible corporation (as defined in section 
860L(a)(2)).
    (2) Except as provided in paragraph (a)(3) of this section, a 
qualified arrangement is an arrangement that is either--
    (i) An entity (other than a regulated investment company as defined 
in section 851(a)); or
    (ii) A segregated pool of assets if--
    (A) The initial assets of the pool are clearly identified, such as 
through an indenture; and
    (B) Changes in the assets of the pool are clearly identified, such 
as through instruments of conveyance or release.
    (3) Notwithstanding paragraph (a)(2) of this section, a qualified 
arrangement does not include--
    (i) An entity created or organized under the law of a foreign 
country or a possession of the United States;
    (ii) An entity any of the income of which is or ever has been 
subject to net tax by a foreign country or a possession of the United 
States; or
    (iii) A segregated pool of assets any of the income of which at any 
time is subject to net tax by a foreign country or a possession of the 
United States.
    (b) FASIT election--(1) Person that makes the election. For a 
qualified arrangement to be a FASIT an eligible corporation (as defined 
in section 860L(a)(2)) must make the election required under section 
860L(a)(1)(A).
    (i) If the qualified arrangement is an entity described in 
paragraph (a)(2)(i) of this section, the eligible corporation making 
the election must hold one or more interests in the entity, and one of 
those interests must be the interest designated as the FASIT's 
ownership interest.
    (ii) If the qualified arrangement is a segregated pool of assets 
described in paragraph (a)(2)(ii) of this section, the eligible 
corporation making the election must be the first taxpayer to be 
treated as the Owner of the resulting FASIT.
    (2) Form of election. Unless the Commissioner prescribes otherwise, 
a FASIT election is made by means of a statement attached to the 
Federal income tax return of the eligible corporation making the 
election.
    (3) Time for filing election. The statement referred to in 
paragraph (b)(2) of this section must be attached to a timely filed 
(including extensions) original Federal income tax return for the 
eligible corporation's taxable year in which the FASIT's startup day 
occurs. An election may not be made on an amended return.
    (4) Contents of election. The statement referred to in paragraph 
(b)(2) of this section must include--
    (i) For other than a segregated pool of assets, the name, address, 
and taxpayer identification number of the arrangement (if one was 
issued prior to the making of the election);
    (ii) For a segregated pool of assets, the following information--
    (A) The name, address, and taxpayer identification number of the 
person or persons holding legal title to the pool of assets;
    (B) The name, address, and taxpayer identification number of the 
person or persons that, immediately before the startup day, are 
considered to own the pool for Federal income tax purposes; and
    (C) Information describing the origin of the pool (including the 
caption and date of execution of any instruments of indenture or 
similar documents that govern the pool);
    (iii) The startup day; and
    (iv) The name and title of all persons signing the statement.
    (5) Required signatures. The statement referred to in paragraph 
(b)(2) of this section must be signed by the authorized person, 
described in this paragraph (b)(5).
    (i) For other than a segregated pool of assets, the authorized 
person is any person authorized to sign the qualified arrangement's 
Federal income tax return in the absence of a FASIT election. For 
example, if a qualified arrangement is a corporation or trust under 
applicable state law, an authorized person is a corporate officer or 
trustee, respectively.
    (ii) For a segregated pool of assets, the authorized person is each 
person who, for Federal income tax purposes, owns the assets of the 
pool immediately before the earlier of the date on which--
    (A) An outstanding interest in the pool is designated as a regular 
or ownership interest in a FASIT; or
    (B) The pool issues an interest designated at the time of issuance 
as a regular or ownership interest in a FASIT.
    (6) Special rule regarding startup day. The startup day must be a 
day on which the eligible corporation making the election is described 
in paragraph (b)(1)(i) or (ii) of this section.
    (c) General definitions. For purposes of the regulations issued 
under part V of subchapter M of chapter 1 of subtitle A of the Internal 
Revenue Code (the FASIT regulations)--
    (1) Owner means the eligible corporation that holds the interest 
described in section 860L(b)(2);
    (2) Transfer includes a sale, contribution, endorsement, or other 
conveyance of a legal or beneficial interest in property.


Sec. 1.860H-2  Assets permitted to be held by a FASIT.

    (a) Substantially all. For purposes of section 860L(a)(1)(D), 
substantially all of the assets held by a FASIT consist of

[[Page 5820]]

permitted assets if the total adjusted bases of the permitted assets is 
more than 99 percent of the total adjusted bases of all the assets held 
by the FASIT, including those assets deemed to be held under section 
860I(b)(2).
    (b) Permitted debt instrument--(1) In general. Except as otherwise 
provided, a debt instrument is described in section 860L(c)(1)(B) only 
if it is a permitted debt instrument. For purposes of the FASIT 
regulations, a permitted debt instrument is--
    (i) A fixed rate debt instrument, including a debt instrument 
having more than one payment schedule for which a single yield can be 
determined under Sec. 1.1272-1(c) or (d);
    (ii) A variable rate debt instrument within the meaning of 
Sec. 1.1275-5 if the debt instrument provides for interest at a 
qualified floating rate within the meaning of Sec. 1.1275-5(b);
    (iii) A REMIC regular interest;
    (iv) A FASIT regular interest (including a FASIT regular interest 
issued by anotherFASIT in which the Owner (or a related person) holds 
an ownership interest);
    (v) An inflation-indexed debt instrument as defined in Sec. 1.1275-
7;
    (vi) Any receivable generated through an extension of credit under 
a revolving credit agreement (such as a credit card account);
    (vii) A stripped bond or stripped coupon (as defined in section 
1286(e)(2) and (3)), if the debt instrument from which the stripped 
bond or stripped coupon is created is described in paragraphs (b)(1)(i) 
through (vi) of this section; and
    (viii) A certificate of trust representing a beneficial ownership 
interest in a debt instrument described in paragraphs (b)(1)(i) through 
(vii) of this section.
    (2) Special rules for short-term debt instruments issued by the 
Owner or related person. Notwithstanding section 860L(c)(2) and 
paragraph (b)(3)(iii) of this section, a debt instrument issued by the 
Owner (or a related person) is a permitted debt instrument if it--
    (i) Is described in paragraph (b)(1)(i) or (ii) of this section;
    (ii) Has an original stated maturity of 270 days or less;
    (iii) Is rated at least investment quality by a nationally 
recognized statistical rating organization that is not a related person 
of the issuer; and (
    iv) Is acquired to temporarily invest cash awaiting either 
reinvestment in permitted assets not described in this paragraph 
(b)(2), or distribution to the Owner or holders of one or more FASIT 
regular interests.
    (3) Exceptions. Notwithstanding paragraph (b)(1) of this section, 
the following debt instruments are not permitted assets.
    (i) Equity-linked debt instrument. A debt instrument is not a 
permitted asset if the debt instrument contains a provision that 
permits the instrument to be converted into, or exchanged for, any 
legal or beneficial ownership interest in any asset other than a 
permitted debt instrument (such as a debt instrument that is 
exchangeable for an interest in a partnership). Similarly, a debt 
instrument is not a permitted asset if the debt instrument contains a 
provision under which one or more payments on the instrument are 
determined by reference to, or are contingent upon, the value of any 
asset other than a permitted debt instrument (such as a debt instrument 
containing a provision under which one or more payments on the 
instrument are determined by reference to, or are contingent upon, the 
value of stock).
    (ii) Defaulted debt instrument. A debt instrument is not a 
permitted asset if, on the date the debt instrument is acquired by the 
FASIT, the debt instrument is in default due to the debtor's failure to 
have timely made one or more of the payments owed on the debt 
instrument and the Owner has no reasonable expectation that all 
delinquent payments on the debt instrument, including any interest and 
penalties thereon, will be fully paid on or before the date that is 90 
days after the date the instrument is first held by the FASIT.
    (iii) Owner debt. A debt instrument is not a permitted asset if the 
debt instrument is issued by the Owner (or a related person) and the 
debt instrument does not qualify as a permitted debt instrument under 
paragraphs (b)(1)(iv) or (2) of this section.
    (iv) Certain Owner-guaranteed debt. A debt instrument is not a 
permitted asset if the debt instrument is guaranteed by the Owner (or a 
related person) and, based on all of the facts and circumstances 
existing at the time the guarantee is given, or at the time the FASIT 
acquires the guaranteed debt instrument the Owner (or a related person) 
is, in substance, the primary obligor on the debt instrument. For this 
purpose, a guarantee includes any promise to pay in the case of the 
default or imminent default of any debt instrument.
    (v) Debt instrument linked to the Owner's credit. A debt instrument 
that is issued by a person other than the Owner (or a related person) 
is not a permitted asset if the timing or amount of payments on the 
instrument are determined by reference to, or are contingent on, the 
timing or amount of payments made on a debt instrument issued by the 
Owner (or a related person).
    (vi) Partial interests in non-permitted debt instruments. A debt 
instrument is not a permitted asset if the debt instrument is a partial 
interest such a stripped bond or stripped coupon (as defined in section 
1286(e)) in a debt instrument described in paragraphs (b)(3)(i) through 
(v) of this section.
    (vii) Certain Foreign Debt Subject to Withholding Tax. A debt 
instrument is not a permitted asset if the debt instrument is traded on 
an established securities market (within the meaning of Sec. 1.860I-2) 
and interest on the debt instrument is subject to any tax determined on 
a gross basis (such as a withholding tax) other than a tax which is in 
the nature of a prepayment of a tax imposed on a net basis.
    (c) Cash and cash equivalents. For purposes of section 
860L(c)(1)(A) and the FASIT regulations, the term cash and cash 
equivalents means--
    (1) The United States dollar;
    (2) A currency other than the United States dollar if the currency 
is received as payment on a permitted asset described in Sec. 1.860H-2, 
or the currency is required by the FASIT to make a payment on a regular 
interest issued by the FASIT according to the terms of the regular 
interest;
    (3) A debt instrument if it--
    (i) Is described--
    (A) In paragraphs (b)(1)(i), (ii), or (v) of this section, or
    (B) In paragraph (b)(vii) of this section if it is created from an 
instrument described in paragraphs (b)(1)(i), (ii), or (v) of this 
section;
    (ii) Has a remaining maturity of 270 days or less; and
    (iii) Is rated at least investment quality by a nationally 
recognized statistical rating organization that is not a related person 
to the issuer; and
    (4) Shares in a U.S.-dollar-denominated money market fund (as 
defined in 17 CFR 270.2a-7).
    (d) Hedges and guarantees--(1) In general. Subject to the rules in 
paragraphs (d)(2) through (4) of this section, a hedge or guarantee 
contract is described in section 860L(c)(1)(D) (a permitted hedge) only 
if the hedge or guarantee contract is reasonably required to offset any 
differences that any risk factor may cause between the amount or timing 
of the receipts on assets the FASIT holds (or expects to hold) and the 
amount or timing of the payments on the regular interests the FASIT has 
issued (or expects to issue). For purposes of this paragraph (d), the 
risk factors are--

[[Page 5821]]

    (i) Fluctuations in market interest rates;
    (ii) Fluctuations in currency exchange rates;
    (iii) The credit quality of, or default on, the FASIT's assets or 
debt instruments underlying the FASIT's assets; and
    (iv) The receipt of payments on the FASIT's assets earlier or later 
than originally anticipated.
    (2) Referencing other than permitted assets. A hedge or guarantee 
contract is not a permitted hedge if it references an asset other than 
a permitted asset or if it references an index, economic indicator, or 
financial average, that is not both widely disseminated and designed to 
correlate closely with changes in one or more of the risk factors 
described in paragraphs (d)(1)(i) through (iv) of this section.
    (3) Association with particular assets or regular interests. A 
hedge or guarantee contract need not be associated with any of the 
FASIT's assets or regular interests, or any group of its assets or 
regular interests, if the hedge or guarantee contract offsets the 
differences described in paragraph (d)(1) of this section.
    (4) Creating an investment prohibited. A hedge or guarantee 
contract is not a permitted hedge if at the time the hedge or guarantee 
is entered into, it in substance creates an investment in the FASIT.
    (e) Hedges and guarantees issued by Owner (or related person)--(1) 
Hedges. A hedge contract issued by the Owner (or a related person) is a 
permitted asset only if--
    (i) The contract is a permitted hedge other than a guarantee 
contract;
    (ii) The Owner (or the related person) regularly provides, offers, 
or sells substantially similar contracts in the ordinary course of its 
trade or business;
    (iii) On the date the contract is acquired by the FASIT (and on any 
later date that it is substantially modified) its terms are consistent 
with the terms that would apply in the case of an arm's length 
transaction between unrelated parties; and
    (iv) The Owner maintains records that--
    (A) Show the terms of the contract are consistent with the terms 
that would apply in the case of an arm's length transaction between 
unrelated parties; and
    (B) Explain how the Owner (or related person) determined the 
consideration for the contract.
    (2) Guarantees. A guarantee contract issued by the Owner (or a 
related person) is a permitted asset only if--
    (i) The contract is a permitted hedge and satisfies paragraphs 
(e)(1)(iii) and (iv) of this section;
    (ii) The contract is a credit enhancement contract under 
Sec. 1.860G-2(c); and
    (iii) Immediately after the contract is acquired by the FASIT (and 
on any later date that it is substantially modified), the value 
(determined under section 860I and Sec. 1.860I-2) of all the FASIT's 
guarantee contracts issued by the Owner (and related persons) is less 
than 3 percent of the value (determined under section 860I and 
Sec. 1.860I-2) of all the FASIT's assets.
    (f) Foreclosure property. Property acquired in connection with the 
default or imminent default of a debt instrument held by a FASIT may 
qualify both as foreclosure property under section 860L(c)(1)(C) and as 
another type of permitted asset under section 860L(c)(1). If 
foreclosure property qualifies as another type of permitted asset, the 
FASIT may hold the property beyond the grace period prescribed for 
foreclosure property under section 860L(c)(3). In this case, 
immediately after the grace period ends, the taxpayer must recognize 
gain, if any, as if the property had been contributed by the Owner to 
the FASIT on that date. See Sec. 1.860I-1(a)(1)(iii). In addition, 
after the close of the grace period, disposition of the property is 
subject to the prohibited transactions tax imposed under section 
860L(e) without the benefit of the exception for foreclosure property.
    (g) Special rule for contracts or agreements in the nature of a 
line of credit. For purposes of section 860L(c)(1), the term permitted 
asset includes a lender's position in a contract or agreement in the 
nature of a line of credit (other than a contract or agreement that is 
originated by the FASIT). Such a contract or agreement is not subject 
to the rules of section 860I(a) at the time the contract or agreement 
is transferred to the FASIT. Extensions of credit under the contract or 
agreement are subject to the rules of section 860I(a) at the time the 
extension is made. See section 860I(d)(2). To determine whether a 
contract or agreement is originated by a FASIT, see Sec. 1.860L-1.
    (h) Contracts to acquire hedges or debt instruments. A contract is 
not described in section 860L(c)(1)(E) if it is an agreement under 
which the Owner (or a related person) agrees to transfer permitted 
hedges or permitted debt instruments to a FASIT for less than --
    (1) Fair market value, in the case of hedges or debt instruments 
traded on an established securities market (as defined in Sec. 1.860I-
2); or
    (2) Ninety percent of their value, as determined under section 
860I(d)(1)(A) and the FASIT regulations, in the case of debt 
instruments not traded on an established securities market.


Sec. 1.860H-3  Cessation of a FASIT.

    (a) In general. An arrangement ceases to be a FASIT if it revokes 
its election with the consent of the Commissioner or if it fails to 
qualify as a FASIT and the Commissioner does not determine the failure 
to be inadvertent.
    (b) Time of cessation. An arrangement ceases to be a FASIT at the 
close of the day designated by the Commissioner in the consent to 
revoke, or if there is no consent to revoke or determination of 
inadvertence, at the close of the day on which the arrangement 
initially fails to qualify as a FASIT.
    (c) Consequences of cessation. Except as otherwise determined by 
the Commissioner, the consequences of cessation are as follows:
    (1) The FASIT and the underlying arrangement. The arrangement that 
made the FASIT election (the underlying arrangement) is no longer a 
FASIT and cannot re-elect FASIT treatment without the Commissioner's 
approval. Immediately after the cessation, the arrangement's 
classification (for example, as a partnership or corporation) is 
determined under general principles of Federal income tax law. 
Immediately after the cessation, the arrangement holds the FASIT's 
assets with a fair market value basis. Any election the Owner made 
(other than the FASIT election), and any method of accounting the Owner 
adopted with respect to those assets, binds the underlying arrangement 
as if the underlying arrangement itself had made the election or 
adopted the method of accounting. If the underlying arrangement is a 
segregated pool of assets, the person holding legal title to the pool 
is responsible for complying with any tax filing or reporting 
requirements arising from the pool's operation.
    (2) The Owner. (i) The Owner is treated as exchanging the assets of 
the FASIT for an amount equal to their value (as determined under 
Sec. 1.860I-2). Gain realized on the exchange is treated as gain from a 
prohibited transaction and the Owner is subject to the tax imposed by 
860L without exception. Loss, if any, is disallowed. The determination 
of gain or loss on assets for purposes of this paragraph is made on an 
asset-by-asset basis.
    (ii) The Owner must recognize cancellation of indebtedness income 
in an amount equal to the adjusted issue

[[Page 5822]]

price of the regular interests outstanding immediately before the 
cessation over the fair market value of those interests immediately 
before the cessation. This determination is made on a regular interest 
by regular interest basis. The Owner cannot take any deduction for 
acquisition premium.
    (iii) If, after the cessation, the Owner has a continuing economic 
interest in the assets, the characterization of this economic interest 
(for example, as stock or a partnership interest) is determined under 
general principles of Federal income tax law. If the Owner has a 
continuing economic interest in the assets immediately after cessation, 
the Owner holds the interest with a fair market value basis.
    (3) The regular interest holders. Holders of the regular interests 
are treated as exchanging their regular interests for interests in the 
underlying arrangement. Interests in the underlying arrangement are 
classified (for example, as debt or equity) under general principles of 
Federal income tax law. Gain must be recognized if a regular interest 
is exchanged either for an interest not classified as debt or for an 
interest classified as debt that differs materially either in kind or 
extent. No loss may be recognized on the exchange. The basis of an 
interest in the underlying arrangement equals the basis in the regular 
interest exchanged for it, increased by any gain recognized on the 
exchange under this paragraph (c)(3).
    (d) Disregarding inadvertent failures to remain qualified--(1) If a 
qualified arrangement that ceases to be a FASIT meets the requirements 
of paragraph (d)(2) of this section, then the Commissioner may either--
    (i) Deem the qualified arrangement as continuing to be a FASIT 
notwithstanding the cessation; or
    (ii) Allow the qualified arrangement to re-elect FASIT status after 
cessation notwithstanding the prohibition in section 860L(a)(4) .
    (2) The requirements of this paragraph are satisfied if --
    (i) The Commissioner determines that the cessation was inadvertent;
    (ii) No later than a reasonable time after the discovery of the 
event resulting in the cessation, steps are taken so that all of the 
requirements for a FASIT are satisfied; and
    (iii) The qualified arrangement and each person holding an interest 
in the qualified arrangement at any time during the period the 
qualified arrangement failed to qualify as a FASIT agree to make such 
adjustments (consistent with the treatment of the qualified arrangement 
as a FASIT or the treatment of the Owner as a C corporation) as the 
Commissioner may require with respect to such period.


Sec. 1.860H-4  Regular interests in general.

    (a) Issue price of regular interests--(1) Regular interests not 
issued for property. The issue price of a FASIT regular interest not 
issued for property is determined under section 1273(b).
    (2) Regular interests issued for property. Notwithstanding sections 
1273 and 1274 and the regulations thereunder, the issue price of a 
FASIT regular interest issued for property is the fair market value of 
the regular interest determined as of the issue date.
    (b) Special rules for high-yield regular interests--(1) High-yield 
interests held by a securities dealer--(i) Due date of tax imposed on 
securities dealer under section 860K(d). The excise tax imposed under 
section 860K(d) (treatment of high-yield interest held by a securities 
dealer that is not an eligible corporation) must be paid on or before 
the due date of the securities dealer's Federal income tax return for 
the earlier of the taxable year in which the securities dealer--
    (A) Ceases to be a dealer in securities; or
    (B) Commences holding the high-yield interest for investment.
    (ii) [Reserved]
    (2) High-yield interests held by a pass-thru--(i) Nature and due 
date of tax imposed under section 860K(e). The tax imposed under 
section 860K(e) (treatment of high-yield interest held by a pass-thru 
entity) is an excise tax which must be paid on or before the due date 
of the pass-thru entity's Federal income tax return for the taxable 
year in which the pass-thru entity issues the debt or equity interest 
described in section 860K(e).
    (ii) Pass-thru entity includes REMIC. For purposes of section 
860K(e), a pass-thru entity includes a real estate mortgage investment 
conduit (REMIC) as defined in section 860D.


Sec. 1.860H-5  Foreign resident holders of regular interests.

    (a) Look-through to underlying FASIT debt. If, during the same 
period, a foreign resident holds (either directly or through a vehicle 
which itself is not subject to the Federal income tax such as a 
partnership or trust) a regular interest in a FASIT and a conduit 
debtor (as defined in paragraph (b) of this section) pays or accrues 
interest on a debt instrument held by the FASIT, then any interest 
received or accrued by the foreign resident with respect to the regular 
interest during that period is treated as received or accrued from the 
conduit debtor. This rule applies to both the foreign resident holder 
of the FASIT regular interest and the conduit debtor for all purposes 
of subtitle A and the regulations thereunder.
    (b) Conduit debtor. A debtor is a conduit debtor if the debtor is a 
U.S. resident taxpayer or a foreign resident taxpayer to which interest 
expense paid or accrued with respect to the debt held by the FASIT is 
treated as paid or accrued by a U.S. trade or business of the foreign 
taxpayer under section 884(f)(1)(A), and the foreign resident holder 
described in paragraph (a) of this section--
    (1) Is a 10-percent shareholder of the debtor (within the meaning 
of section 871(h)(3)(B));
    (2) Is a controlled foreign corporation, but only if the debtor is 
a related person (within the meaning of section 864(d)(4)) with respect 
to the controlled foreign corporation; or
    (3) Is related to the debtor (within the meaning of section 267(b) 
or 707(b)(1)).
    (c) Limitation. The amount of income treated under paragraph (a) of 
this section as received from a conduit debtor is the lesser of--
    (1) The income received or accrued by the foreign resident holder 
with respect to the FASIT regular interest; or
    (2) The amount paid or accrued by the conduit debtor with respect 
to the debt instrument held by the FASIT.
    (d) Cross references. For the treatment of related-party interest 
accrued to foreign related persons, see sections 163(e)(3), 163(j), 
871(h)(3), 881(c)(3)(B), and 881(c)(3)(C).


Sec. 1.860H-6  Taxation of Owner, Owner's reporting requirements, 
transfers of ownership interest.

    (a) In general. For purposes of determining an Owner's credits and 
taxable income, all assets, liabilities, and items of income, gain, 
deduction, loss, and credit of the FASIT are treated as assets, 
liabilities, and such items of the Owner.
    (b) Constant yield method to apply. The income from each debt 
instrument a FASIT holds is determined by applying the constant yield 
method (including the rules of section 1272(a)(6)) described in 
Sec. 1.1272-3(c).
    (c) Method of accounting for, and character of, hedges. The method 
of accounting used for a permitted hedge (as described in Sec. 1.860H-
2(e)) must clearly reflect income and otherwise comply with the rules 
of Sec. 1.446-4 (whether or not the permitted hedge instrument is part 
of a hedging transaction as defined in Sec. 1.1221-2(b)). The character 
of any gain or loss realized on a permitted hedge (as described in 
Sec. 1.860H-2(e)) is ordinary.

[[Page 5823]]

    (d) Coordination with mark-to market provisions--(1) No mark to 
market accounting. Mark to market accounting does not apply to any 
asset (other than a non-permitted asset) while it is held, or deemed 
held, by a FASIT.
    (2) Transfer of a mark to market asset to a FASIT. If an Owner 
transfers a permitted asset to a FASIT and the asset would have been 
marked to market if the taxable year had ended immediately before the 
transfer (for example, an asset accounted for under section 475(a)), 
then immediately before the transfer, the Owner must mark the asset to 
market and take gain or loss into account as if the taxable year had 
ended at that point. See Sec. 1.475(b)-1(b)(4). If the asset is a debt 
instrument that is valued under the special valuation rule of 
Sec. 1.860I-2(a), then immediately after the asset is marked to market 
under this paragraph (d)(2), the asset is also valued under 
Sec. 1.860I-2(a), and any additional gain is taken into account under 
section 860I. The latter gain, but not any mark to market gain, is 
subject to section 860J.
    (e) Owner's annual reporting requirements. Unless the Commissioner 
otherwise prescribes, specified information regarding the FASIT must be 
reported by means of a separate statement, attached by the Owner to its 
income tax return for the taxable year that includes the reporting 
period. The reporting period is the period in the Owner's taxable year 
during which the Owner holds the ownership interest in the FASIT. 
Unless the Commissioner otherwise requires, the statement must set 
forth--
    (1) The name, address, and taxpayer identification number (if any) 
of the FASIT and any other information necessary to establish the 
identity of the FASIT for which the statement is being filed;
    (2) If the ownership interest was acquired from another person 
during the Owner's taxable year, the date on which it was acquired, and 
the name and address of the person from which it was acquired;
    (3) If the ownership interest was transferred by the Owner during 
the Owner's taxable year, the date on which it was transferred, the 
name and address of the person to which it was transferred, and whether 
such person is described in section 860L(a)(2);
    (4) If any regular interests are issued during the reporting 
period, a description of the prepayment and reinvestment assumptions 
that are made pursuant to section 1272(a)(6) and any regulations 
thereunder, including a statement supporting the selection of the 
prepayment assumption;
    (5) The FASIT's items (taken into account during the reporting 
period) of income, gain, loss, deduction and credit from permitted 
transactions, and separately stated, the FASIT's items (taken into 
account during the reporting period) of income, gain, loss, deduction 
and credit from prohibited transactions;
    (6) Information detailing the extent to which the items described 
in paragraph (f)(5) of this section consist of interest accrued that, 
but for section 860H(b)(4), is exempt from the taxes imposed under 
subtitle A of 26 U.S.C.; and
    (7) If a qualified arrangement ceases to be a FASIT during a 
reporting period (including at the close of a reporting period), 
information disclosing--
    (i) The effective date of the cessation;
    (ii) A description of how the cessation occurred; and
    (iii) A statement regarding whether the arrangement will continue 
after cessation and, if so, the continuing arrangement's name, address, 
and taxpayer identification number.
    (f) Treatment of FASIT under subtitle F of Title 26 U.S.C. For 
purposes of subtitle F (Procedure and Administration)--
    (1) A FASIT is treated as a branch or division of the Owner;
    (2) The Owner is treated as the issuer of the regular interests; 
and
    (3) The regular interests are treated as collateralized debt 
obligations as defined in Sec. 1.6049-7(d)(2).
    (g) Transfer of ownership interest--(1) In general. If, at the time 
of any transfer of the ownership interest, the Owner knew or should 
have known that the transferee would be unwilling or unable to pay some 
or all of the tax arising from the application of section 860H(b), then 
the transfer is disregarded for all Federal tax purposes.
    (2) Safe harbor for establishing lack of improper knowledge. A 
transfer will not be disregarded under paragraph (g)(1) of this section 
if the rules of Sec. 1.860E-1(c)(4) (safe harbor for establishing lack 
of improper knowledge on the transfer of a non-economic REMIC residual 
interest) are satisfied with respect to the FASIT ownership interest.


Sec. 1.860I-1  Gain recognition on property transferred to FASIT or 
supporting FASIT regular interests.

    (a) In general--(1) Except as provided in paragraphs (a)(2) and (d) 
of this section, the Owner of a FASIT (or a related person ) must 
recognize gain (if any) on--
    (i) Property the Owner (or the related person) transfers either to 
the FASIT or its regular interest holders;
    (ii) Support property; and
    (iii) Property acquired by the FASIT as foreclosure property and 
held beyond the grace period allowed for foreclosure property.
    (2) An Owner (or a related person) does not have to recognize gain 
under section 860I or paragraph (a)(1) of this section on a transfer or 
pledge of property to a regular interest holder, if the Owner (or the 
related person) makes the transfer or pledge in a capacity other than 
as Owner (or related person), and the regular interest holder receives 
the transfer or pledge in a capacity other than regular interest 
holder.
    (b) Support property defined. Property is support property if the 
Owner (or a related person)--
    (1) Pledges the property, directly or indirectly, to pay a FASIT 
regular interest, or otherwise identifies the property as providing 
security for the payment of a FASIT regular interest;
    (2) Sets aside the property for transfer to a FASIT under any 
agreement or understanding; or
    (3) Holds an interest in the property that is subordinate to the 
FASIT's interest in the property (for example, the Owner holds 
subordinate interests in a pool of mortgages and the FASIT holds senior 
interests in the same pool).
    (c) Timing of gain determination and recognition. Gain is 
determined and recognized under paragraph (a)(1) of this section 
immediately before the property is transferred to the FASIT or becomes 
support property, or in the case of foreclosure property, on the day 
immediately following the termination of the grace period allowed for 
foreclosure property.
    (d) Gain deferral election. [Reserved]
    (e) Amount of gain. Except as provided in paragraph (f) of this 
section, the amount of gain recognized under paragraph (a)(1) of this 
section is the same as if the Owner (or the related person) had sold 
the property for its value as determined under Sec. 1.860I-2.
    (f) Recordkeeping requirements. The Owner is required to maintain 
such books and records as may be necessary or appropriate to 
demonstrate that the requirements of this section are satisfied.
    (g) Special rule applicable to property of related persons. Except 
in the case of property traded on an established securities market (as 
defined in Sec. 1.860I-2(b)), if a related person holds property that 
becomes support property, or if a related person transfers property to 
a FASIT or its regular interest holders, then for purposes of applying 
the gain recognition provisions of this section--
    (1) The related person is treated as transferring the property to 
the Owner for the property's fair market value as

[[Page 5824]]

determined under general tax principles; and
    (2) The Owner is treated as transferring the property to the FASIT 
for the property's value as determined under Sec. 1.860I-2.


Sec. 1.860I-2  Value of property.

    (a) Special valuation rule. For purposes of section 860I(d)(1)(A), 
except as provided in paragraph (c) of this section, the value of a 
debt instrument not traded on an established securities market is the 
present value of the reasonably expected payments on the instrument 
determined--
    (1) As of the date the instrument is to be valued (as described in 
Sec. 1.860I-1(c)); and
    (2) By using a discount rate equal to 120 percent of the applicable 
federal rate, compounded semi-annually, for instruments having the same 
term as the weighted average maturity of the reasonably expected 
payments on the instrument. For this purpose, the applicable federal 
rate is the rate prescribed under section 1274(d) for the period that 
includes the date the instrument is valued (as described in 
Sec. 1.860I-1(c)).
    (b) Traded on an established securities market. For purposes of 
section 860I(d)(1)(A), a debt instrument is traded on an established 
securities market if it is traded on a market described in Sec. 1.1273-
2(f) (2), (3), or (4).
    (c) Reasonably expected payments--(1) In general. Reasonably 
expected payments on an instrument must be determined in a commercially 
reasonable manner and, except as otherwise provided in this section 
(c), may take into account reasonable assumptions concerning early 
repayments, late payments, non-payments, and loan servicing costs. No 
other assumptions may be considered.
    (2) Consistency requirements. Except as provided in paragraph 
(c)(3) of this section, any assumption used in determining the 
reasonably expected payments on an instrument must be consistent with 
(and no less favorable than) the first of the following categories that 
applies--
    (i) Representations made in connection with the offering of a 
regular interest in the FASIT;
    (ii) Representations made to any nationally recognized statistical 
rating organizations;
    (iii) Representations made in any filings or registrations with any 
governmental agency with respect to the FASIT; and
    (iv) Industry customs or standards (as defined in paragraph (e) of 
this section).
    (3) Servicing costs. Notwithstanding paragraph (c)(2) of this 
section, the amount of loan servicing costs assumed may not exceed the 
lesser of--
    (i) The amount the FASIT agrees to pay the Owner for servicing the 
loans held by the FASIT if the Owner is providing the servicing; or
    (ii) The amount a third party would reasonably pay for servicing 
identical loans.
    (4) Nonconforming or unreasonable assumptions. If a taxpayer, in 
determining the expected payments on an instrument, takes into account 
an assumption that either fails to meet the requirements of paragraph 
(c)(2) or (3) of this section or is unreasonable, the Commissioner may 
determine the reasonably expected payments on the instrument without 
the assumption. Thus, for example, if a taxpayer makes an unreasonable 
assumption concerning non-payments, the Commissioner may compute 
expected payments without any adjustment for non-payments.
    (d) Special rules--(1) Beneficial ownership interests. A 
certificate representing beneficial ownership of a debt instrument, is 
deemed to represent beneficial ownership of a debt instrument traded on 
an established securities market, if either --
    (i) The certificate is traded on an established securities market; 
or
    (ii) The certificate represents ownership in a pool of assets 
composed solely of debt instruments all of which are traded on 
established securities markets.
    (2) Stripped interests. A stripped bond or stripped coupon (as 
defined in section 1286(e)) not otherwise traded on an established 
securities market is considered as being traded on an established 
securities market, if--
    (i) The underlying bond (the bond from which the stripped bond or 
stripped coupon is created) is traded on an established securities 
market; and
    (ii) The stripped bond or stripped coupon is valued using a 
commercially reasonable method based on the market value of the 
underlying bond.
    (3) Contemporaneous purchase and transfer of debt instruments--(i) 
Notwithstanding paragraph (a) of this section, the value of a debt 
instrument not traded on an established securities market is its cost 
to the Owner (or a related person) if--
    (A) The debt instrument is purchased from an unrelated person in an 
arm's length transaction in which no other property is transferred or 
services provided;
    (B) The debt instrument is acquired solely for cash;
    (C) The price of the debt instrument is fixed no more than 15 days 
before the date of purchase; and
    (D) The debt instrument is transferred to the FASIT no more than 15 
days after the date of purchase.
    (ii) For purposes of paragraph (d)(3)(i) of this section, the date 
of purchase is the earliest date on which the burdens and benefits of 
ownership of the debt instrument irrevocably pass to the Owner (or a 
related person).
    (4) Guarantees. Notwithstanding paragraph (c)(1) of this section, 
if a guarantee qualifying as a permitted hedge under this paragraph (d) 
relates solely to a debt instrument not traded on an established 
securities market and the taxpayer determines the reasonably expected 
payments on the debt instrument by including the reasonably expected 
payments on the guarantee, then the guarantee and the property need not 
be valued separately.
    (e) Definitions. For purposes of Sec. 1.860I-2--
    (1) An industry custom is any long-standing practice in use by 
entities that engage in asset securitization as part of their ordinary 
business activities; and
    (2) An industry standard is any standard that is both--
    (i) Commonly used in evaluating the expected payments on 
securitized debt instruments (or debt instruments pending 
securitization) in similar transactions; and
    (ii) Disseminated through written or electronic means by any 
independent, nationally recognized trade association or other authority 
that is recognized as competent to issue the standard.


Sec. 1.860J-1  Non-FASIT losses not to offset certain FASIT inclusions.

    (a) In general. For purposes of applying section 860J(a)(1), an 
Owner's taxable income from a FASIT includes any gains recognized by 
the Owner under Sec. 1.860I-1(a).
    (b) Special rule for holders of multiple ownership interests. For 
purposes of applying section 860J and the rules of Sec. 1.860J-1, a 
person may aggregate the net income (or loss) from all FASITs in which 
the person holds the ownership interest.
    (c) Related persons--(1) Taxable income. The taxable income of a 
related person for any taxable year is no less than the sum of--
    (i) The amounts specified in section 860J(a); plus
    (ii) Any gains recognized under Sec. 1.860I-1(a).
    (2) Effect on net operating loss. Any increase in a related 
person's taxable income attributable to paragraph (c)(1) of this 
section is disregarded--

[[Page 5825]]

    (i) In determining under section 172 the amount of the related 
person's net operating loss for the taxable year; and
    (ii) In determining the related person's taxable income for such 
taxable year for purposes of the second sentence of section 172(b)(2).
    (3) Coordination with minimum tax. For purposes of part VI of 
subchapter A of chapter 1 of subtitle A of Title 26 U.S.C., the 
alternative minimum taxable income of any related person is in no event 
less than the related person's taxable income as computed under 
paragraph (c)(1) of this section.


Sec. 1.860L-1  Prohibited transactions.

    (a) Loan origination--(1) In general. Section 860L(e) imposes a 
prohibited transactions tax on the receipt of any income derived from 
any loan originated by a FASIT. Except as provided in paragraphs (a)(2) 
and (3) of this section, whether a FASIT originates a loan for purposes 
of section 860L(e) depends on all the facts and circumstances.
    (2) Acquisitions presumed not to be loan origination. Except as 
provided in paragraph (a)(3) of this section, a FASIT is considered not 
to have originated a loan if the FASIT acquires the loan--
    (i) From an established securities market described in Sec. 1.1273-
2(f)(2), (3), or (4);
    (ii) On a date more than 12 months after the loan was issued; or
    (iii) From a person (including the Owner or a related person) that 
regularly originates similar loans (such as through a standardized 
contract) in the ordinary course of its business.
    (3) Activities presumed to be loan origination. (i) Notwithstanding 
paragraph (a)(2) of this section, a FASIT is considered to originate a 
loan if the FASIT either engages in or facilitates (other than through 
a person from whom the FASIT acquires the loan and who is described in 
paragraph (a)(2)(iii) of this section)--
    (A) Soliciting the loan, including advertising to solicit 
borrowers, accepting the loan application, or generally making any 
offer to lend funds to any person;
    (B) Evaluating an applicant's financial condition;
    (C) Negotiating or establishing any terms of the loan;
    (D) Preparing or processing any document related to negotiating or 
entering into the loan; or
    (E) Closing the loan transaction.
    (ii) For purposes of paragraph (a)(3)(i) of this section, if a 
FASIT enters into a contract to engage in purchases described in 
paragraph (a)(2)(iii) of this section, the FASIT is not treated as 
originating the loans it acquires solely because it was a party to the 
contract.
    (4) Loan workouts. If a FASIT holds a loan, the FASIT is not 
treated as originating a new loan that it receives from the same 
obligor in exchange for the old loan in the context of a workout.
    (b) Origination of a contract or agreement in the nature of a line 
of credit--(1) In general. A FASIT is presumed not to have originated a 
contract or agreement in the nature of a line of credit if the FASIT 
acquires the contract or agreement from a person (including the Owner 
or a related person) that regularly originates similar contracts or 
agreements in the ordinary course of its business.
    (2) Activities presumed to be origination. If a FASIT assumes the 
role of a lender under a contract or agreement in the nature of a line 
of credit from a person that does not regularly originate similar 
contracts or agreements in the ordinary course of its business, the 
FASIT is considered to originate the contract or agreement if, with 
respect to the contract or agreement, the FASIT engages in any of the 
activities described in paragraphs (A) through (E) of Sec. 1.860L-
1(a)(3)(i) of this section.
    (3) Debt instruments issued under contracts or agreements in the 
nature of a line of credit. If a FASIT acquires a debt instrument as a 
result of the FASIT's position as a lender under a contract or 
agreement in the nature of a line of credit, the FASIT is presumed to 
have originated the debt instrument if and only if the FASIT originated 
the related contract or agreement.
    (c) Disposition of debt instruments. Notwithstanding sections 
860L(e)(3)(B)(i) and (ii) (certain exceptions from the prohibited 
transactions tax), the distribution to the Owner of a debt instrument 
contributed by the Owner, and the transfer to the Owner of one debt 
instrument in exchange for another, are prohibited transactions, if 
within 180 days of receiving the debt instrument the Owner realizes a 
gain on the disposition of the instrument to any person, regardless of 
whether the realized gain is recognized.
    (d) Exclusion of prohibited transactions tax to dispositions of 
hedges. The rules of section 860L(e) and paragraph (b) of this section 
do not apply to the disposition of any asset described in section 
860L(c)(1)(D).


Sec. 1.860L-2  Anti-abuse rule.

    (a) Intent of FASIT provisions. Part V of subchapter M of the 
Internal Revenue Code (the FASIT provisions) is intended to promote the 
spreading of credit risk on debt instruments by facilitating the 
securitization of those debt instruments. Implicit in the intent of the 
FASIT provisions are the following requirements--
    (1) Assets to be securitized through a FASIT consist primarily of 
permitted debt instruments;
    (2) The source of principal and interest payments on a FASIT's 
regular interests is primarily the principal and interest payments on 
permitted debt instruments held by the FASIT (as opposed to receipts on 
other assets or deposits of cash); and
    (3) No FASIT provision may be used to achieve a Federal tax result 
that cannot be achieved without the provision unless the provision 
clearly contemplates that result.
    (b) Application of FASIT provisions. The FASIT provisions and the 
FASIT regulations must be applied in a manner consistent with the 
intent of the FASIT provisions as set forth in paragraph (a) of this 
section. Therefore, if a principal purpose of forming or using a FASIT 
is to achieve results inconsistent with the intent of the FASIT 
provisions and the FASIT regulations, the Commissioner may make any 
appropriate adjustments with regard to the FASIT and any arrangement or 
transaction (or series of transactions) involving the FASIT. The 
Commissioner's authority includes--
    (1) Disregarding a FASIT election;
    (2) Treating one or more assets of a FASIT as held by a person or 
persons other than the Owner;
    (3) Allocating FASIT income, loss, deductions and credits to a 
person or persons other than the Owner;
    (4) Disallowing any item of FASIT income, loss, deduction, or 
credit;
    (5) Treating the ownership interest in a FASIT as held by a person 
other than the nominal holder;
    (6) Treating a FASIT regular interest as other than a debt 
instrument; and
    (7) Treating a regular interest held by any person as having the 
same tax characteristics as one or more of the assets held by the 
FASIT.
    (c) Facts and circumstances analysis. Whether a FASIT is created or 
used for a principal purpose of achieving a result inconsistent with 
the intent of the FASIT provisions is determined based on all of the 
facts and circumstances, including a comparison of the purported 
business purpose for a transaction and the claimed tax benefits 
resulting from the transaction.
    (d) Effective date. This section is applicable on February 4, 2000.


Sec. 1.860L-3  Transition rule for pre-effective date FASITs.

    (a) Scope. This section applies if a pre-effective date FASIT has 
one or

[[Page 5826]]

more pre-FASIT interests outstanding on the startup day of the FASIT.
    (1) Pre-effective date FASIT defined. A pre-effective date FASIT is 
a FASIT whose underlying qualifying arrangement was in existence on 
August 31, 1997.
    (2) Pre-FASIT interest defined. A pre-FASIT interest is an interest 
in a pre-effective date FASIT that--
    (i) Was issued before February 4, 2000;
    (ii) Was outstanding on the date the FASIT election for the 
underlying qualifying arrangement goes into effect; and
    (iii) Is considered debt of the Owner under general principles of 
Federal income tax law.
    (3) FASIT gain defined. For purposes of this section, the term 
FASIT gain means any gain that the Owner of a pre-effective date FASIT 
must recognize under the rules of this section.
    (b) Election to defer gain. The Owner of a pre-effective date FASIT 
may elect to defer the recognition of FASIT gain on assets that are 
held by the FASIT but that are allocable to pre-FASIT interests. An 
Owner that elects under this section must establish a method of 
accounting for its FASIT gain. To clearly reflect income, this method 
must periodically determine the aggregate amount of FASIT gain on all 
of the assets in the FASIT and exclude the portion of the FASIT gain 
attributable to the pre-FASIT interests.
    (c) Safe-harbor method. This paragraph (c) provides a safe-harbor 
method for determining the amount of FASIT gain that can be deferred 
under this section. The method has the following steps:
    (1) Step one: Establish pools--(i) Group assets into pools. The 
Owner must group the assets of the FASIT into one or more pools. No 
pool may contain assets of more than one of the following three types--
    (A) Assets that are valued under the special valuation rule of 
Sec. 1.860I-2(a) and that have FASIT gain on the first day held by the 
FASIT;
    (B) Assets that are valued for FASIT gain purposes under a standard 
other than the special valuation rule of Sec. 1.860I-2(a) and that have 
FASIT gain on the first day held by the FASIT; and
    (C) Assets that do not have FASIT gain on the first day held by the 
FASIT.
    (ii) Treatment of pools. If a pool contains assets described in 
paragraph (c)(1)(i)(A) or (B) of this section, the Owner must apply 
paragraphs (c)(2) through (5) of this section to the pool. If a pool 
contains assets described in paragraph (c)(1)(i)(C) of this section, 
the pool is ignored for FASIT gain purposes.
    (2) Step two: Determine the FASIT gain (or loss) at the pool 
level--(i) In general. For each taxable year, the FASIT gain (or loss) 
at the pool level is equal to the net increase (or decrease) in the 
value of the pool minus the income that is included with respect to the 
pool under general income tax principles (without regard to the FASIT 
rules). For purposes of the preceding sentence, the net increase (or 
decrease) in the value of the pool is equal to--
    (A) The sum of the value of the pool (as determined under 
Sec. 1.860I-2) at the end of the taxable year and the amount of any 
cash distributed (even if reinvested) from the pool during the taxable 
year; minus
    (B) The sum of the value of the pool (as determined under 
Sec. 1.860I-2) at the end of the previous taxable year and the Owner's 
adjusted basis in the assets contributed to the pool during the taxable 
year.
    (ii) Limitation. This paragraph applies if the calculation in 
paragraph (c)(2)(i) of this section produces a loss for the taxable 
year and the amount of the loss exceeds the net amount of the FASIT 
gain from the pool in all prior years. In this case, the amount of the 
loss for the current year is limited to the amount of net FASIT gain 
for all previous years.
    (3) Step three: Determine the percentage of total FASIT gain that 
must be recognized by the end of the current taxable year. The 
percentage of FASIT gain that must be recognized by the end of the 
current taxable year is equal to 100 percent minus the percentage of 
FASIT gain that may be deferred at the end of the current taxable year. 
The percentage of FASIT gain that may be deferred at the end of the 
taxable year is equal to the lesser of 100 percent and the ratio of--
    (i) The product of 107 percent and aggregate adjusted issue prices 
of all pre-FASIT interests outstanding on the last day of the taxable 
year; over
    (ii) The total value of all assets held by the FASIT on the last 
day of the taxable year.
    (4) Step four: Determine the total amount of FASIT gain that is not 
attributed to pre-effective date FASIT interests. The total amount of 
FASIT gain that is not attributed to pre-effective date FASIT interests 
is equal to the product of--
    (i) The sum of the amount of FASIT gain (as determined under 
paragraph (c)(2) of this section) for the current taxable year and all 
previous taxable years; and
    (ii) The percentage of FASIT gain that must be recognized in the 
current taxable year (as determined under paragraph (c)(3) of this 
section).
    (5) Step five: Determine the amount of FASIT gain (or loss) to be 
recognized in the taxable year. For the taxable year that includes the 
startup date, the amount of FASIT gain to be recognized is equal to the 
total amount of FASIT gain not attributable to pre-effective date FASIT 
interests (as determined under paragraph (c)(4) of this section). 
Thereafter, the amount of FASIT gain (or loss) to be recognized in a 
given taxable year is equal to the total amount of FASIT gain not 
attributable to pre-effective date FASIT interests for that taxable 
year (as determined under paragraph (c)(4) of this section) less the 
amount of FASIT gain not attributable to pre-effective date FASIT 
interests for the immediately preceding taxable year (as determined 
under paragraph (c)(4) of this section).
    (d) Example. The rules of this section are illustrated by the 
following example:

    Example. (i) Facts. O is an eligible corporation within the 
meaning of section 860(a)(2) that uses the calendar year as its 
taxable year. On July 1, 1996, O forms TR, a trust. Shortly 
thereafter, O contributes credit card receivables to TR and TR 
issues certificates that, for Federal income tax purposes, are 
characterized as debt of O. Effective March 31, 1999, O elects FASIT 
status for TR. On March 31, 1999, TR holds credit card receivables 
that have an outstanding principal balance of $20,000,000 and TR has 
outstanding certificates (that are characterized for Federal income 
tax purposes as debt of O) that have an aggregate adjusted issue 
price of $10,000,000.
    (ii) Status as a pre-effective date FASIT. TR is a pre-effective 
date FASIT because TR was a trust that was in existence on August 
31, 1997. The certificates outstanding on March 1, 1999, are pre-
FASIT interests because they were outstanding on March 31, 1999, and 
they were considered debt of O under general principles of Federal 
income tax law.
    (iii) Facts: 1999. From April 1, 1999, through December 31, 
1999, the credit card receivables held by TR generated $800,000 of 
taxable income and $4,000,000 of total cash flow. TR distributed 
$2,500,000 of the cash flow to O in exchange for new receivables 
having an outstanding principal balance of $2,500,000. TR used the 
remaining $1,500,000 of cash flow to make payments on its 
outstanding debt instruments. On December 31, 1999, TR contributed 
additional credit card receivables with an outstanding principal 
balance of $10,700,000 and an aggregate adjusted basis of 
$10,700,000. On December 31, 1999, TR held credit card receivables 
that had an outstanding principal balance of $30,000,000, an 
aggregate adjusted basis of $30,000,000, and a value (as determined 
under Sec. 1.860I-2(a)) of $30,300,000. In addition, on December 31, 
1999, the outstanding adjusted issue price of the pre-FASIT 
interests was $9,000,000.
    (iv) FASIT gain recognition for 1999--(A) Establish pools. TR 
elects to defer gain recognition under the safe harbor method.

[[Page 5827]]

Consistent with paragraph (c)(1) of this section, TR groups the 
assets of the FASIT into a single pool because all of the assets of 
the FASIT are credit card receivables subject to the special 
valuation rule of Sec. 1.860I-1(a) and the assets have FASIT gain on 
the date they are acquired by the FASIT.
    (B) Determination of FASIT gain for 1999. The sum of the value 
of the pool at the end of 1999 ($30,300,000) and the cash 
distributed during 1999 ($4,000,000) is $34,300,000. There are three 
contributions of assets by O during 1999: one of $20,000,000 on 
March 31, 1999; one of $2,500,000 over the course of 1999; and an 
additional contribution of $10,700,000 on December 31, 1999. Thus, 
O's basis in assets contributed to the pool during 1999 is 
$33,200,000. The net increase in the value of the pool is $1,100,000 
($34,300,000 minus $33,200,000). Under paragraph (c)(2) of this 
section, the FASIT gain for 1999 is $300,000 ($1,100,000 net 
increase in value minus $800,000 taxable income).
    (C) Determination of percentage of total FASIT gain that must be 
recognized by the end of 1999. Under paragraph (c)(3) of this 
section, the percentage of FASIT gain that may be deferred for the 
taxable year is 31.78 percent (107 percent  x  $9,000,000 adjusted 
issue price of pre-FASIT interests divided by $30,300,000 value of 
the assets). The percentage of the FASIT gain that must be 
recognized is for the taxable year, therefore, 68.22 percent (1--
31.78 percent).
    (D) Determination of total amount of FASIT gain not attributed 
to pre-effective date FASIT interests in 1999. Under paragraph 
(c)(4) of this section, the total amount of FASIT gain not 
attributed to pre-effective date FASIT interests in 1999 is $204,660 
($300,000 FASIT gain  x  68.22 percent).
    (E) Determine the amount of FASIT gain to be recognized in 1999. 
Under paragraph (c)(5) of this section, because 1999 includes the 
startup date, TR must include in income the entire $204,660 of FASIT 
gain not attributed to pre-effective date FASIT interests.
    (v) Facts: 2000. In 2000, the credit card receivables held by TR 
generated $1,500,000 of taxable income and $5,000,000 of cash flow. 
TR distributed $4,000,000 of the cash flow to O in exchange for new 
receivables having an outstanding principal balance of $4,000,000. 
TR used the remaining $1,000,000 of cash flow to make payments on 
its outstanding debt instruments. On December 31, 2000, TR 
contributed additional credit card receivables with an outstanding 
principal balance of $9,500,000 and an aggregate adjusted basis of 
$9,500,000. On December 31, 2000, TR held credit card receivables 
that had an outstanding principal balance of $40,000,000, an 
aggregate adjusted basis of $40,000,000, and a value (as determined 
under Sec. 1.860I-2(a)) of $40,800,000. In addition, on December 31, 
2000, the outstanding adjusted issue price of the pre-FASIT 
interests was $8,500,000.
    (vi) FASIT gain recognition for 2000--(A) Determination of FASIT 
gain for 2000. The sum of the value of the pool on December 31, 2000 
($40,800,000) and the cash distributed during 2000 ($5,000,000) is 
$45,800,000. The value of the pool on December 31, 1999, was 
$30,300,000. During 2000, O contributed receivables in which O had a 
basis of $13,500,000 ($4,000,000 over the course of the year and 
$9,500,000 on December 31, 2000). The net increase in the value of 
the pool during 2000 is $2,000,000 ($45,800,000 minus $43,800,000). 
Under paragraph (c)(2), the FASIT gain for 2000 is $500,000 
($2,000,000 net increase in value minus $1,500,000 taxable income).
    (B) Determination of percentage of total FASIT gain that must be 
recognized by the end of 2000. Under paragraph (c)(3), the 
percentage of FASIT gain that may be deferred for the taxable year 
is 22.29 percent (107 percent times $8,500,000 adjusted issue price 
of pre-FASIT interests divided by $40,800,000 value of the assets). 
The percentage of the FASIT gain that must be recognized is, 
therefore, 77.71 percent (1--22.29 percent).
    (C) Determination of total amount of FASIT gain not attributed 
to pre-effective date FASIT interests in 2000. Under paragraph 
(c)(4) of this section, the total amount of FASIT gain not 
attributed to pre-effective date FASIT interests in 2000 is $388,500 
($500,000 FASIT gain multiplied by 77.71 percent).
    (D) Determine the amount of FASIT gain to be recognized in 2000. 
Under paragraph (c)(5) of this section, the FASIT gain to be 
recognized for 2000 is equal to the FASIT gain that not attributable 
to pre-effective date FASIT interests in 2000 ($388,500) minus the 
FASIT gain not attributable to pre-effective date FASIT interests in 
1999 ($204,660). Thus, in 2000, TR must include $183,840.

    (e) Election to apply gain deferral retroactively. The Owner of a 
pre-effective date FASIT, including a pre-effective date FASIT having a 
startup date before February 4, 2000, may apply the rules of paragraph 
(a) of this section for the period beginning on the startup date by 
making an election in the manner prescribed by the Commissioner.
    (f) Effective date. This section is applicable on February 4, 2000.


Sec. 1.860L-4  Effective date.

    Except as otherwise provided in Sec. 1.860L-2(e) (relating to the 
rules on anti-abuse) and Sec. 1.860L-3(f) (relating to the rules 
governing transition entities) this section is applicable on the date 
final regulations are filed with the Federal Register.
    Par. 4. Section 1.861-9T is amended by redesignating the text of 
paragraph (g)(2)(iii) as paragraph (g)(2)(iii)(A) and adding a heading 
to new paragraph (g)(2)(iii)(A), and adding paragraph (g)(2)(iii)(B):


Sec. 1.861-9T  Allocation and apportionment of interest expense 
(temporary regulations).

* * * * *
    (g) * * *
    (2) * * *
    (iii) Adjustment for directly allocated interest--(A) Nonrecourse 
indebtedness and integrated financial transactions. * * *
    (B) FASIT Interest Expense. The rules of paragraph (g)(2)(iii)(A) 
of this section shall also apply to all assets to which FASIT interest 
expense is directly allocated during the current taxable year under the 
rules of Sec. 1.861-10T(f). This paragraph (g)(2)(iii)(B) applies on 
the date final regulations are filed with the Federal Register.
    Par. 5. Section 1.861-10T is amended by--
    1. Revising paragraph (a); and
    2. Adding paragraph (f).


Sec. 1.861-10T  Special allocations of interest expense (temporary 
regulations).

    (a) In general. This section applies to all taxpayers and provides 
four exceptions to the rules of Sec. 1.861-9T that require the 
allocation and apportionment of interest expense on the basis of all 
assets of all members of the affiliated group. Paragraph (b) of this 
section describes the direct allocation of interest expense to the 
income generated by certain assets that are subject to qualified 
nonrecourse indebtedness. Paragraph (c) of this section describes the 
direct allocation of interest expense to income generated by certain 
assets that are acquired in integrated financial transactions. 
Paragraph (d) of this section provides special rules that are 
applicable to all transactions described in paragraphs (b) and (c) of 
this section. Paragraph (e) of this section requires the direct 
allocation of third party interest of an affiliated group to such 
group's investment in related controlled foreign corporations in cases 
involving excess related person indebtedness (as defined therein). 
Paragraph (f) of this section provides rules for the direct allocation 
and apportionment of all FASIT interest expense to all FASIT gross 
income, on the basis of all FASIT assets. See also Sec. 1.861-9T(b)(5), 
which requires direct allocation of amortizable bond premium.
* * * * *
    (f) FASIT Interest Expense--(1) In general. All FASIT interest 
expense of the taxpayer's affiliated group (or the taxpayer, if the 
taxpayer is not a member of an affiliated group) shall be directly 
allocated solely to the FASIT gross income of the affiliated group (or 
the taxpayer, if the taxpayer is not a member of an affiliated group).
    (2) Asset method. Interest expense that is directly allocated under 
this paragraph (f) shall be treated as directly related to all the 
activities and assets of all FASITs in which the taxpayer or any

[[Page 5828]]

member of the taxpayer's affiliated group holds the ownership interest. 
The directly allocated interest expense shall be apportioned among all 
of the FASIT gross income of the affiliated group (or the taxpayer, if 
the taxpayer is not a member of an affiliated group) under the asset 
method described in Sec. 1.861-9T(g).
    (3) FASIT period. After a FASIT's startup day (as defined in 
section 860L(d)(1)), the taxpayer must allocate the interest expense of 
the FASIT according to the rules of this paragraph (f) during the 
entire period that the arrangement continues to be a FASIT. If an 
arrangement ceases to be a FASIT, interest expense with respect to the 
ceased FASIT arrangement shall no longer be allocated and apportioned 
under the rules of this paragraph (f) as of the time the arrangement is 
treated as having ceased in accordance with Sec. 1.860H-3(b). The 
Commissioner may continue to allocate interest expense with respect to 
a ceased FASIT arrangement under this paragraph (f) if the Commissioner 
determines that the principal purpose of ending the arrangement's 
qualification as a FASIT was to affect the taxpayer's interest expense 
allocation.
    (4) Application of special rules. In applying this paragraph (f), 
the rules of paragraph (d)(2)of this section shall apply.
    (5) Definitions. For purposes of this paragraph (f):
    (i) FASIT defined. FASIT has the meaning given such term in 
Sec. 1.860H-1(a).
    (ii) FASIT interest expense defined. (A) In general. FASIT interest 
expense means any amount paid or accrued by or on behalf of a FASIT to 
a holder of a regular interest in such FASIT, if such amount is--
    (1) treated as incurred by the taxpayer or any member of the 
taxpayer's affiliated group by reason of Sec. 1.860H-6(a), because the 
taxpayer or such member holds the ownership interest in a FASIT; and
    (2) treated as interest by reason of section 860H(c).
    (B) Interest equivalents. FASIT interest expense includes any 
expense or loss from a hedge that is a permitted asset (as described in 
Sec. 1.860H-2 (d) and (e)), but only to the extent such expense or loss 
is an interest equivalent as described in Sec. 1.861-9T(b).
    (iii) FASIT gross income defined. FASIT gross income means gross 
income of the taxpayer's affiliated group (or the taxpayer, if the 
taxpayer is not a member of an affiliated group) treated as received or 
accrued by the taxpayer, or any member of the taxpayer's affiliated 
group, by reason of Sec. 1.860H-6(a).
    (iv) Affiliated group defined. Affiliated group has the meaning 
given such term by Sec. 1.861-11T(d).
    (6) Coordination with other provisions. If any FASIT interest 
expense is directly allocable under both this paragraph (f) and 
paragraph (b) or (c) (determined without regard to this paragraph 
(f)(6)), only the rules of this paragraph (f) shall apply.
    (7) Effective date. The rules of this section apply for taxable 
years beginning after December 31, 1986. However, paragraphs (a) and 
(f) apply as of the date final regulations are filed with the Federal 
Register, and paragraph (e) applies to all taxable years beginning 
after December 31, 1991.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 00-1896 Filed 2-4-00; 8:45 am]
BILLING CODE 4830-01-U