[Federal Register Volume 69, Number 98 (Thursday, May 20, 2004)]
[Rules and Regulations]
[Pages 29066-29067]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-11360]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9129]
RIN 1545-BB63


Uniform Capitalization of Interest Expense in Safe Harbor Sale 
and Leaseback Transactions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains regulations relating to the 
capitalization of interest expense incurred in sale and leaseback 
transactions under the Economic Recovery Tax Act of 1981 (ERTA) safe 
harbor leasing provisions. The regulations affect taxpayers that 
provide purchase money obligations in connection with these 
transactions. The text of the temporary regulations also serves as the 
text of the proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules section in this issue 
of the Federal Register. The final regulations consist of technical 
revisions to reflect the issuance of the temporary regulations.

DATES: Effective Date: These regulations are effective May 20, 2004.
    Applicability Dates: For dates of applicability, see Sec.  1.263A-
15T(a)(3).

FOR FURTHER INFORMATION CONTACT: Grant Anderson, 202-622-4930 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1 under section 
263A(f) of the Internal Revenue Code (Code) relating to the treatment 
of certain interest expense incurred by the lessor in a sale and 
leaseback transaction under the ERTA safe harbor leasing provisions 
(former section 168(f)(8), as enacted by section 201(a) of ERTA, Public 
Law 97-34, 95 Stat. 214).
    Section 263A (the uniform capitalization rules) generally requires 
the capitalization of direct costs and indirect costs properly 
allocable to real property and tangible personal property produced by a 
taxpayer.
    Section 263A(f) and the regulations thereunder provide special 
rules for capitalizing interest to property produced by a taxpayer. In 
general, section 263A(f) only requires the capitalization of interest 
that is paid or incurred during the production period of certain 
property (referred to as designated property). Designated property 
includes all real property and certain tangible personal property. See 
Sec.  1.263A-8(b) of the Income Tax Regulations.
    In general, interest incurred on debt that is directly attributable 
to production expenditures with respect to designated property (traced 
debt) is capitalized first. See section 263A(f)(2)(A)(i). If production 
expenditures with respect to designated property exceed the amount of 
traced debt, interest on any other debt of the taxpayer is capitalized 
to the extent that the interest could have been reduced if production 
expenditures had not been incurred. See section 263A(f)(2)(A)(ii). The 
amount of interest required to be capitalized under section 263A(f) is 
calculated by reference to eligible debt. See Sec.  1.263A-9(a)(4). 
Eligible debt generally includes all outstanding debt of the taxpayer. 
Certain types of debt (listed in paragraphs (i) to (viii) of Sec.  
1.263A-9(a)(4)), however, are excluded from the definition of eligible 
debt.
    The ERTA safe harbor leasing provisions were intended to permit 
owners of property to transfer the tax benefits of ownership 
(depreciation and the investment credit) to other persons. The ERTA 
safe harbor leasing provisions operate by guaranteeing that, for 
federal tax purposes, (i) a transaction meeting certain stated 
qualifications (a qualifying transaction) will be treated as a lease 
even though the qualifying transaction otherwise would not be 
considered a lease, and (ii) the nominal lessor will be treated as the 
owner of the property even though the nominal lessee is in substance 
the owner of the property.
    Regulations issued under the ERTA safe harbor leasing provisions 
clarify that a qualifying transaction may be part of a sale and 
leaseback transaction, in which the nominal lessee sells the underlying 
property for Federal tax purposes to the nominal lessor for a cash 
payment and an interest bearing note (purchase money note), and the 
nominal lessor simultaneously leases the property back to the nominal 
lessee. See Sec.  5c.168(f)(8)-1(e) Example 2. Generally, the nominal 
lessor deducts, and the nominal lessee includes in income, the interest 
accruing on the purchase money note, subject to certain limitations. 
See Sec.  5c.168(f)(8)-7.

Explanation of Provisions

    The temporary regulations provide that eligible debt under section 
263A(f) does not include a purchase money obligation given by the 
lessor to the lessee (or a party related to the lessee) in a sale and 
leaseback transaction under former section 168(f)(8) as enacted by 
ERTA. Accordingly, these obligations are excluded from the definition 
of eligible debt, and the interest accruing on the obligations is not 
subject to capitalization with respect to designated property under 
section 263A(f).
    The temporary regulations apply to interest incurred in taxable 
years beginning on or after May 20, 2004, except that, in the case of 
property that is inventory in the hands of the taxpayer, the temporary 
regulations apply to taxable years beginning on or after May 20, 2004. 
However, taxpayers may elect to apply the temporary regulations to 
interest incurred in taxable years beginning on or after January 1, 
1995, or, in the case of property that is inventory in the hands of the 
taxpayer, to taxable years beginning on or after January 1, 1995 (the 
general effective date of the interest capitalization regulations).

[[Page 29067]]

    For purposes of Sec.  1.263A-15(a)(2), the exclusion of purchase 
money obligations given by the lessor to the lessee (or a party related 
to the lessee) in a sale and leaseback transaction under former section 
168(f)(8) as enacted by ERTA will be considered to be a reasonable 
position for the application of section 263A(f) in taxable years 
beginning before January 1, 1995. Consequently, a taxpayer changing a 
method of accounting for property that is not inventory in the hands of 
the taxpayer to conform to the temporary regulations may elect to 
include interest incurred after December 31, 1986, in taxable years 
beginning on or after December 31, 1986 (the general effective date of 
section 263A), and before January 1, 1995, in the determination of its 
adjustment under section 481(a). A taxpayer changing a method of 
accounting for property that is inventory in the hands of the taxpayer 
to conform to the temporary regulations must revalue its beginning 
inventory in the year of change as if the new method of accounting had 
been in effect during all prior years.

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 also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. Please refer to 
the cross-referenced notice of proposed rulemaking published elsewhere 
in this issue of the Federal Register for applicability of the 
Regulatory Flexibility Act (5 U.S.C. chapter 6). Pursuant to section 
7805(f) of the Code, these temporary regulations will be submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on their impact on small business.

Drafting Information

    The principal author of these regulations is Grant Anderson of the 
Office of Associate Chief Counsel (Income Tax and Accounting). However, 
other personnel from the IRS and the 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 part 1 continues to read in 
part as follows:

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

0
Par. 2. Section 1.263A-9 is amended by revising paragraphs (a)(4)(vii), 
and (viii) and adding paragraph (a)(4)(ix) to read as follows:


Sec.  1.263A-9  The avoided cost method.

    (a) * * *
    (4) * * *
    (vii) Reserves, deferred tax liabilities, and similar items that 
are not treated as debt for Federal income tax purposes, regardless of 
the extent to which the taxpayer's applicable financial accounting or 
other regulatory reporting principles require or support treating these 
items as debt;
    (viii) Federal, State, and local income tax liabilities, deferred 
tax liabilities under section 453A, and hypothetical tax liabilities 
under the look-back method of section 460(b) or similar provisions; and
    (ix) [Reserved]. For further guidance, see Sec.  1.263A-
9T(a)(4)(ix).
* * * * *

0
Par. 3. Section 1.263A-9T is added to read as follows:


Sec.  1.263A-9T  The avoided cost method (temporary).

    (a) (1) through (3) [Reserved]. For further guidance, see Sec.  
1.263A-9(a)(1) through (3).
    (4) Definition of eligible debt. Except as provided in this 
paragraph (a)(4), eligible debt includes all outstanding debt (as 
evidenced by a contract, bond, debenture, note, certificate, or other 
evidence of indebtedness). Eligible debt does not include--
    (i) through (viii) [Reserved]. For further guidance, see Sec.  
1.263A-9(a)(4)(i) through (viii).
    (ix) A purchase money obligation given by the lessor to the lessee 
(or a party that is related to the lessee) in a sale and leaseback 
transaction involving an agreement qualifying as a lease under Sec.  
5c.168(f)(8)-1 through Sec.  5c.168(f)(8)-11 of this chapter. See Sec.  
5c.168(f)(8)-1(e) Example (2) of this chapter.
    (b) through (g) [Reserved]. For further guidance, see Sec.  1.263A-
9(b) through (g).

0
Par. 4. Section 1.263A-15T is added to read as follows:


Sec.  1.263A-15T  Effective dates, transitional rules, and anti-abuse 
rule (temporary).

    (a)(1) and (2) [Reserved]. For further guidance, see Sec.  1.263A-
15(a)(1) and (2).
    (3) Section 1.263A-9T applies to interest incurred in taxable years 
beginning on or after May 20, 2004, except that, in the case of 
property that is inventory in the hands of the taxpayer, Sec.  1.263A-
9T applies to taxable years beginning on or after May 20, 2004. 
However, taxpayers may elect to apply Sec.  1.263A-9T to interest 
incurred in taxable years beginning on or after January 1, 1995, or, in 
the case of property that is inventory in the hands of the taxpayer, to 
taxable years beginning on or after January 1, 1995. A change in a 
taxpayer's treatment of interest to a method consistent with Sec.  
1.263A-9T is a change in method of accounting to which sections 446 and 
481 apply.
    (b) and (c) [Reserved]. For further guidance, see Sec.  1.263A-
15(b) and (c).

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: May 10, 2004.
Gregory F. Jenner,
Acting Assistant Secretary of the Treasury.
[FR Doc. 04-11360 Filed 5-19-04; 8:45 am]
BILLING CODE 4830-01-P