[Federal Register Volume 69, Number 59 (Friday, March 26, 2004)]
[Rules and Regulations]
[Pages 15673-15676]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-6619]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9120]
RIN 1545-BA92


Allocation and Apportionment of Expenses; Alternative Method for 
Determining Tax Book Value of Assets

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulation.

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SUMMARY: This document contains temporary regulations providing an 
alternative method of valuing assets for purposes of apportioning 
expenses under the tax book value method of Sec.  1.861-9T. The 
alternative tax book value method, which is elective, allows taxpayers 
to determine, for purposes of apportioning expenses, the tax book value 
of all tangible property that is subject to a depreciation deduction 
under section 168 by using the straight line method, conventions, and 
recovery periods of the alternative depreciation system under section 
168(g)(2). The alternative method provided in the temporary regulations 
is intended to minimize basis disparities between foreign and domestic 
assets of taxpayers that may arise when taxpayers use adjusted tax 
basis to value assets under the tax book value method of expense 
apportionment. The text of these temporary regulations also serves as 
the text of the proposed regulations set forth in the Proposed Rules 
section of this issue of the Federal Register.

DATES: Effective Date: These regulations are effective March 26, 2004.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.861-9(h)(5)(iii) and 1.861-9T(i)(3).

FOR FURTHER INFORMATION CONTACT: Margaret A. Hogan, (202) 622-3850 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to regulations under section 
864(e) of the Internal Revenue Code (Code). Section 864(e) was enacted 
by the Tax Reform Act of 1986 (Pub. L. 99-514, 100 Stat. 2121) to 
address concerns

[[Page 15674]]

regarding the allocation and apportionment of interest expense. On 
September 14, 1988, the IRS published temporary regulations (T.D. 8228, 
1988-2 C.B. 136 [53 FR 35467]) under Sec.  1.861 implementing section 
864(e) of the Code. The temporary regulations contained in this 
document amend Sec.  1.861-9T and make conforming amendments to 
Sec. Sec.  1.861-9 and 1.861-9T(g)(1)(ii).
    Section 864(e)(2) of the Code provides that allocations and 
apportionments of interest expense shall be made on the basis of assets 
rather than gross income. For this purpose, the regulations permit a 
taxpayer to choose to compute the value of its assets under either the 
tax book value method or the fair market value method. Sections 1.861-
8T(c)(2) and 1.861-9T(g)(1)(ii). Taxpayers using the tax book value 
method may elect to change to the fair market value method at any time. 
Rev. Proc. 2003-37, 2003-1 C.B. 950 (May 27, 2003). Taxpayers that 
elect to use the fair market value method must continue to use that 
method unless expressly authorized by the Commissioner to change 
methods. Section 1.861-8T(c)(2). Section 1.861-8T(c)(2) also permits 
taxpayers to apportion certain other expenses based on the comparative 
value of assets provided that such apportionment is made in accordance 
with the rules of Sec.  1.861-9T(g).
    The use of adjusted tax basis for purposes of apportioning expenses 
under the tax book value method may result in disparities between the 
bases of domestic and foreign assets of a taxpayer because of the 
differences in depreciation methods applicable to those assets. For 
example, the tax book value of tangible property used in the United 
States generally reflects depreciation of that property pursuant to the 
modified accelerated cost recovery system (MACRS) under section 168. 
MACRS generally permits a taxpayer to depreciate tangible property 
(other than real property) under the 200-percent declining balance 
method, or the 150-percent declining balance method in the case of 
certain property. Section 168(b). MACRS also permits taxpayers to 
depreciate property over shorter recovery periods than a property's 
class life.
    In contrast, tangible property used predominantly outside the 
United States generally must be depreciated pursuant to the alternative 
depreciation system (ADS) under section 168(g). Section 168(g)(1)(A). 
ADS requires a taxpayer to depreciate tangible property using the 
straight line method of depreciation. Additionally, ADS generally 
requires taxpayers to use recovery periods equal to the property's 
class life and therefore longer periods than those used under MACRS.
    As a result of accelerated depreciation under MACRS as compared to 
slower depreciation under ADS, an asset used in the United States 
generally will have a lower adjusted tax basis (i.e., tax book value) 
than if the same asset were used predominantly outside of the United 
States. The relatively higher tax book value for assets used 
predominantly outside the United States results in an increased 
apportionment of interest expense to foreign source income and a 
corresponding reduction in the taxpayer's foreign tax credit 
limitation.
    A disparity in the apportionment of expenses between domestic and 
foreign assets also may result when a U.S. corporation owns a 10-
percent or greater interest in a foreign subsidiary that holds tangible 
property. Section 864(e)(4) provides that for purposes of allocating 
and apportioning expenses on the basis of assets, the tax basis of 
stock in a nonaffiliated 10-percent owned corporation will be adjusted 
to reflect the earnings and profits of the corporation that are 
attributable to the stock held by the taxpayer. See also Sec.  1.861-
12T(c)(2). Accordingly, the adjusted tax basis of stock in a foreign 
corporation for purposes of apportioning expenses generally will 
reflect the foreign corporation's earnings and profits, the computation 
of which reflects the depreciation of tangible property. Under section 
312(k), tangible property generally is depreciated under ADS for 
purposes of determining earnings and profits. Accordingly, a taxpayer 
that owns a 10-percent or greater interest in a foreign corporation 
that holds tangible property may be subject to a disparity similar to 
the one that arises where the taxpayer holds foreign assets directly.

Explanation of Provisions

    The temporary regulations provide an alternative method of 
determining the tax book value of assets (the ``alternative tax book 
value method''). The alternative tax book value method allows a 
taxpayer to elect to determine the tax book value of its tangible 
property that is subject to depreciation under section 168 as though 
all such property had been depreciated using ADS under section 
168(g)(2) during the entire period in which it has been in service. The 
temporary regulations further provide that tax book value will be 
determined without regard to the election to expense certain 
depreciable assets under section 179. Because tax book value will be 
computed under ADS, the rules permitting a special allowance for 
property acquired after September 10, 2001, and before January 1, 2005, 
will not apply. See section 168(k)(2)(C)(ii). Application of section 
168(g)(2) as prescribed by these temporary regulations applies solely 
for determining an asset's tax book value for purposes of apportioning 
expenses (including the calculation of the alternative minimum tax 
foreign tax credit pursuant to section 59(a)) under the asset method 
described in Sec.  1.861-9T(g). Application of section 168(g)(2) 
pursuant to these regulations does not otherwise affect the result 
under other provisions of the Code, including the amount of any 
deduction claimed under sections 167, 168, 169, 263(a), 617, or any 
other capital cost recovery provision.
    The elective alternative to the existing tax book valuation method 
provides taxpayers with the option of determining the adjusted bases of 
both foreign and domestic assets under one consistent depreciation 
method for purposes of apportioning expenses under the asset method 
described in Sec.  1.861-9T(g). A uniform depreciation methodology will 
help reduce the basis disparity between foreign and domestic assets 
that can occur under the existing tax book value method.
    The temporary regulations generally provide that, for a taxpayer 
that elects the alternative tax book value method, the tax book value 
of tangible property that is depreciated under section 168 is 
determined as though such property were subject to the alternative 
depreciation system under section 168(g) for the entire period that 
such property has been in service. Thus, if a taxpayer elects the 
alternative tax book value method effective for the 2005 taxable year, 
the tax book value of tangible property placed in service in 2006 is 
determined each year using the rules of section 168(g) that apply to 
property placed in service in 2006. However, in the case of tangible 
property placed in service in a taxable year prior to the first taxable 
year to which the election to use the alternative method applies, the 
tax book value of such property is determined using the alternative 
depreciation system rules that apply to property placed in service in 
the taxable year to which the election first applies. Thus, if a 
taxpayer elects the alternative tax book value method effective for the 
2005 taxable year, the tax book value of tangible property placed in 
service in 2004 and prior years is determined each year using the rules 
of section 168(g) that apply to property placed in service in 2005. A 
special rule also applies in determining tax book value in cases where 
a taxpayer

[[Page 15675]]

makes an election to use the alternative tax book value method after 
recently (within three years) revoking a prior election to use that 
method.
    The temporary regulations do not modify the rules for determining 
when property is placed in service for purposes of section 168. If a 
taxpayer acquires property with a carryover or substituted basis, the 
determination of the tax book value of that property using the 
alternative tax book value method will reflect that carryover or 
substituted basis, determined using the general rule for property 
placed in service during or after the year of election and using the 
special rule for property placed in service before the year of 
election. The Treasury Department and the IRS recognize that 
acquisitions, mergers, and similar transactions involving taxpayers 
that use different methods of interest expense apportionment may raise 
particular issues in applying these rules. The Treasury Department and 
the IRS request comments regarding the use of the alternative tax book 
value method with respect to tangible property acquired pursuant to an 
acquisition, merger, or similar transaction and placed in service in a 
taxable year prior to such transaction.
    The temporary regulations set forth rules for electing the 
alternative tax book value method. Generally, taxpayers may elect to 
value their assets using the alternative tax book value method with 
respect to any taxable year beginning on or after March 26, 2004. Once 
made, the election applies to all members of an affiliated group of 
corporations (as defined in Sec. Sec.  1.861-11(d) and 1.861-11T(d)). 
Taxpayers electing the alternative tax book value method may change 
from that method to the fair market value method at any time for any 
open year. However, taxpayers using the fair market value method must 
obtain the consent of the Commissioner to change methods, including a 
change to the alternative tax book value method.
    In conjunction with the issuance of these regulations, the Treasury 
Department and the IRS intend to issue a revenue procedure to provide 
temporary rules granting taxpayers automatic consent to change from the 
fair market value method to the alternative tax book value method. It 
is anticipated that the revenue procedure will apply to changes in 
method of apportionment made during a two-year period after March 26, 
2004, with the automatic consent applying to taxable years that begin 
on or after March 26, 2004, and for which the taxpayer has not filed 
its income tax return. Comments are requested concerning such an 
automatic consent procedure, including the appropriateness of a two-
year period of time for these purposes.
    The Treasury Department and the IRS are aware that application of 
the existing tax book value method may result in other similar 
disparities between the valuation of domestic and foreign assets. 
Accordingly, comments are requested regarding whether additional 
modifications to the tax book value method may be appropriate to 
address potential disparities arising from other cost recovery 
provisions, such as the treatment of intangible drilling costs, that 
distinguish between assets based on place of use.
    These temporary regulations are intended to improve the operation 
of the rules relating to the allocation and apportionment of interest 
expense. The Treasury Department and the IRS also are considering 
additional guidance with respect to interest expense allocation and 
apportionment for purposes of Sec.  1.861-9T(h). In particular, to 
prevent overvaluation of tangible assets under the fair market value 
method, the Treasury Department and the IRS intend to address 
situations in which a taxpayer that uses the fair market value method 
of apportionment takes the position that the value of its tangible 
assets pursuant to Sec.  1.861-9T(h)(1)(ii) exceeds the aggregate value 
of its assets pursuant to Sec.  1.861-9T(h)(1)(i). Comments are 
requested regarding modifications to the current regulations to address 
this situation.

Special Analyses

    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. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the Special Analyses section of the preamble to the cross-
reference notice of proposed rulemaking published in the Proposed Rules 
section in this issue of the Federal Register. Pursuant to section 
7805(f) of the Internal Revenue Code, these regulations will be 
submitted to the Chief Counsel of Advocacy of the Small Business 
Administration for comment on its impact on small businesses.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR Part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for Sec.  1.861-9 is amended by 
adding entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805. * * *
    Sections 1.861-9 and 1.861-9T also issued under 26 U.S.C. 
863(a), 26 U.S.C. 864(e), 26 U.S.C. 865(i), and 26 U.S.C 7701(f). * 
* *

    Par. 2. Section 1.861-9 is amended by:

0
1. Revising paragraphs (a) through (g)(1)(i).
0
2. Adding paragraphs (g)(1)(ii) through (h)(4), (h)(6), (i), and (j).
    The revisions and additions read as follows:


Sec.  1.861-9  Allocation and apportionment of interest expense.

    (a) through (g)(1)(i) [Reserved]. For further guidance, see Sec.  
1.861-9T(a) through (g)(1)(i).
    (g)(1)(ii) [Reserved]. For further guidance, see the second 
sentence in Sec.  1.861-9T(g)(1)(ii).
    (g)(1)(iii) through (h)(4) [Reserved]. For further guidance, see 
Sec.  1.861-9T(g)(1)(iii) through (h)(4).
    (h)(5) * * *
    (h)(6) through (j) [Reserved]. For further guidance, see Sec.  
1.861-9T(h)(6) through (j).

0
Par. 3. Section 1.861-9T is amended by:
0
1. Revising the section heading.
0
2. Adding a new sentence after the first sentence in paragraph 
(g)(1)(ii) introductory text.
0
3. Adding paragraph (i).
    The revisions and addition read as follows:
    1.861-9T Allocation and apportionment of interest expense 
(temporary).
* * * * *
    (g) * * * (1) * * * (i) * * *
    (ii) * * * For rules concerning the application of an alternative 
method of valuing assets for purposes of the tax book value method, see 
paragraph (i) of this section. * * *
* * * * *
    (i) Alternative tax book value method--(1) Alternative value for

[[Page 15676]]

certain tangible property. A taxpayer may elect to determine the tax 
book value of its tangible property that is depreciated under section 
168 (section 168 property) using the rules provided in this paragraph 
(the alternative tax book value method). The alternative tax book value 
method applies solely for purposes of apportioning expenses (including 
the calculation of the alternative minimum tax foreign tax credit 
pursuant to section 59(a)) under the asset method described in 
paragraph (g) of this section.
    (i) The tax book value of section 168 property placed in service 
during or after the first taxable year to which the election to use the 
alternative tax book value method applies shall be determined as though 
such property were subject to the alternative depreciation system under 
section 168(g) for the entire period that such property has been in 
service.
    (ii) In the case of section 168 property placed in service prior to 
the first taxable year to which the election to use the alternative tax 
book value method applies, the tax book value of such property shall be 
determined under the depreciation method, convention, and recovery 
period provided for under section 168(g) for the first taxable year to 
which the election applies.
    (iii) If a taxpayer revokes an election to use the alternative tax 
book value method (``the prior election'') and later makes another 
election to use the alternative tax book value method (the ``subsequent 
election'') that is effective for a taxable year that begins within 3 
years of the end of the last taxable year to which the prior election 
applied, the taxpayer shall determine the tax book value of its section 
168 property as though the prior election has remained in effect.
    (iv) The tax book value of section 168 property shall be determined 
without regard to the election to expense certain depreciable assets 
under section 179.
    (v) Examples. The provisions of this paragraph (i)(1) are 
illustrated in the following examples:

    Example 1. In 2000, a taxpayer purchases and places in service 
section 168 property used solely in the United States. In 2005, the 
taxpayer elects to use the alternative tax book value method, 
effective for the current taxable year. For purposes of determining 
the tax book value of its section 168 property, the taxpayer's 
depreciation deduction is determined by applying the method, 
convention, and recovery period rules of the alternative 
depreciation system under section 168(g)(2) as in effect in 2005 to 
the taxpayer's original cost basis in such property. In 2006, the 
taxpayer acquires and places in service in the United States new 
section 168 property. The tax book value of this section 168 
property is determined under the rules of section 168(g)(2) 
applicable to property placed in service in 2006.
    Example 2. Assume the same facts as in Example 1, except that 
the taxpayer revokes the alternative tax book value method election 
effective for taxable year 2010. Additionally, in 2011, the taxpayer 
acquires new section 168 property and places it in service in the 
United States. If the taxpayer elects to use the alternative tax 
book value method effective for taxable year 2012, the taxpayer must 
determine the tax book value of its section 168 property as though 
the prior election still applied. Thus, the tax book value of 
property placed in service prior to 2005 would be determined by 
applying the method, convention, and recovery period rules of the 
alternative depreciation system under section 168(g)(2) applicable 
to property placed in service in 2005. The tax book value of section 
168 property placed in service during any taxable year after 2004 
would be determined by applying the method, convention, and recovery 
period rules of the alternative depreciation system under section 
168(g)(2) applicable to property placed in service in such taxable 
year.

    (2) Timing and scope of election. (i) Except as provided in this 
paragraph (i)(2), a taxpayer may elect to use the alternative tax book 
value method with respect to any taxable year beginning on or after 
March 26, 2004. However, pursuant to Sec.  1.861-8T(c)(2), a taxpayer 
that has elected the fair market value method must obtain the consent 
of the Commissioner prior to electing the alternative tax book value 
method. Any election made pursuant to this paragraph (i)(2) shall apply 
to all members of an affiliated group of corporations as defined in 
Sec. Sec.  1.861-11(d) and 1.861-11T(d). Any election made pursuant to 
this paragraph (i)(2) shall apply to all subsequent taxable years of 
the taxpayer unless revoked by the taxpayer. Revocation of such an 
election, other than in conjunction with an election to use the fair 
market value method, for a taxable year prior to the sixth taxable year 
for which the election applies requires the consent of the 
Commissioner.
    (ii) Example. The provisions of this paragraph (i)(2) are 
illustrated in the following example:

    Example.  Corporation X, a calendar year taxpayer, elects on its 
original, timely filed tax return for the taxable year ending 
December 31, 2007, to use the alternative tax book value method for 
its 2007 year. The alternative tax book value method applies to X's 
2007 year and all subsequent taxable years. X may not, without the 
consent of the Commissioner, revoke its election and determine tax 
book value using a method other than the alternative tax book value 
method with respect to any taxable year beginning before January 1, 
2012. However, X may automatically elect to change from the 
alternative tax book value method to the fair market value method 
for any open year.

    (3) Effective date. (i) Paragraph (i) of this section applies to 
taxable years beginning on or after March 26, 2004.
    (ii) The applicability of this paragraph (i) expires on or before 
March 26, 2007.
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: March 16, 2004.
Gregory Jenner,
Assistant Secretary of the Treasury.
[FR Doc. 04-6619 Filed 3-25-04; 8:45 am]
BILLING CODE 4830-01-P