On March 30, 2007, the Federal Register published proposed amendments (REG-156779-06, 2007-17 I.R.B. 1015 [72 FR 15081]) to the Income Tax Regulations (26 CFR part I) under section 901 of the Internal Revenue Code (Code) relating to the amount of taxes paid for purposes of the foreign tax credit (the “2007 proposed regulations”). The 2007 proposed regulations would revise §1.901-2(e)(5) in two ways. First, for purposes of §1.901-2(e)(5), the 2007 proposed regulations would treat as a single taxpayer all foreign entities in which the same U.S. person has a direct or indirect interest of 80 percent or more (a “U.S.-owned foreign group”). Second, the 2007 proposed regulations would treat amounts paid to a foreign taxing authority as noncompulsory payments if those amounts are attributable to certain structured passive investment arrangements. The 2007 proposed regulations provide that the regulations will be effective for foreign taxes paid or accrued during taxable years of the taxpayer ending on or after the date on which the regulations are finalized.

The IRS and Treasury Department received written comments on the 2007 proposed regulations, which are discussed in this preamble. A public hearing was held on July 30, 2007. In response to written comments, the IRS and Treasury Department determined that the proposed change to §1.901-2(e)(5) relating to U.S.-owned foreign groups may lead to inappropriate results in certain cases. Accordingly, on November 19, 2007, the IRS and Treasury Department issued Notice 2007-95, 2007-49 I.R.B. 1091 (see §601.601(d)(2)(ii)(b)). Notice 2007-95 provided that the proposed rule for U.S.-owned foreign groups would be severed from the portion of the 2007 proposed regulations addressing the treatment of foreign payments attributable to certain structured passive investment arrangements. Notice 2007-95 further provided that the proposed rules for U.S.-owned groups would be effective for taxable years beginning after final regulations are published in the Federal Register.

In light of comments, the IRS and the Treasury Department believe that it is appropriate to issue new proposed and temporary regulations addressing the treatment of foreign payments attributable to structured passive investment arrangements. These new regulations make several changes to the 2007 proposed regulations to take into account comments received, while adopting without amendment substantial portions of the 2007 proposed regulations. The new temporary and proposed regulations will permit the IRS to enforce the rules relating to structured passive investment arrangements, while also allowing taxpayers a further opportunity for comment. The significant comments and revisions are described in this preamble.

The temporary regulations address the application of §1.901-2(e)(5) in cases in which a person claiming foreign tax credits is a party to a structured passive investment arrangement. These complex arrangements are intentionally structured to create a foreign tax liability when, removed from the elaborately engineered structure, the basic underlying business transaction generally would result in significantly less, or even no, foreign taxes. The parties use these arrangements to exploit differences between U.S. and foreign law in order to permit a person to claim a foreign tax credit for the purported foreign tax payments while also allowing the counterparty to claim a duplicative foreign tax benefit. The person claiming foreign tax credits and the counterparty share the cost of the purported foreign tax payments through the pricing of the arrangement.

The temporary regulations treat foreign payments attributable to such arrangements as noncompulsory payments under §1.901-2(e)(5) and, thus, disallow foreign tax credits for such amounts. For periods prior to the effective date of the temporary regulations, the IRS will continue to utilize all available tools under current law to challenge the U.S. tax results claimed in connection with these and other similar abusive arrangements, including the substance over form doctrine, the economic substance doctrine, debt-equity principles, tax ownership principles, other provisions of §1.901-2, section 269, and the partnership anti-abuse rules of §1.701-2.

The temporary regulations retain the general rule in the existing regulations that a taxpayer need not alter its form of doing business or the form of any transaction in order to reduce its foreign tax liability. However, §1.901-2T(e)(5)(iv)(A) provides that, notwithstanding the general rule, an amount paid to a foreign country (a “foreign payment”) is not a compulsory payment, and thus is not an amount of tax paid, if the foreign payment is attributable to a structured passive investment arrangement. For this purpose, §1.901-2T(e)(5)(iv)(B) defines a structured passive investment arrangement as an arrangement that satisfies six conditions. The six conditions consist of features that are common to arrangements that are intentionally structured to generate the foreign payment.

The first condition provided in the 2007 proposed regulations is that the arrangement utilizes an entity that meets two requirements (an “SPV”). The first requirement is that substantially all of the gross income (for United States tax purposes) of the entity, if any, is attributable to passive investment income and substantially all of the assets of the entity are assets held to produce such passive investment income. The second requirement is that there is a purported foreign tax payment attributable to income of the entity. The purported foreign tax may be paid by the entity itself, by the owner(s) of the entity (if the entity is treated as a pass-through entity under foreign law) or by a lower-tier entity (if the lower-tier entity is treated as a pass-through entity under U.S. law).

For purposes of the first requirement, §1.901-2(e)(5)(iv)(C)(4) of the 2007 proposed regulations defines passive investment income as income described in section 954(c), with two modifications. The first modification excludes income of a holding company attributable to qualifying equity interests in lower-tier entities that are predominantly engaged in the active conduct of a trade or business (or that are themselves holding companies). The second modification is that passive investment income is determined by disregarding sections 954(c)(3) and 954(c)(6) and by treating income attributable to transactions with a counterparty as ineligible for the exclusions under sections 954(h) and 954(i).

One commentator recommended, in lieu of the holding company rules in the 2007 proposed regulations, applying look-through rules to income and assets of lower-tier entities similar to the rules of section 1297(c), under which a foreign corporation, if it owns at least 25 percent of the stock of another corporation, is treated as owning its proportionate share of the assets of the other corporation and receiving its proportionate share of the income of the other corporation. Alternatively, the commentator recommended that the holding company rules in the 2007 proposed regulations be modified to eliminate the requirement that substantially all of the assets of the tested entity must consist of qualified equity interests; to permit income other than dividends (for example, interest and royalties) received from a lower-tier entity that is predominantly engaged in an active business to qualify as active income; and to treat a lower-tier entity as an operating company if more than 50 percent of either its assets or its income meet the active business test. In addition, commentators suggested eliminating the requirement that the U.S. party and the counterparty must share the opportunity of gain or loss with respect to the lower-tier entity, or replacing it with a rule disqualifying the equity interest if contractual restrictions limit the counterparty’s recourse against the lower-tier entity’s income or assets. Finally, commentators suggested that preferred stock should be treated as a qualifying equity interest.

These comments were not adopted. The holding company exception is intended only to clarify that a joint venture arrangement is not treated as a structured passive investment arrangement solely because it is conducted through a holding company structure, not to liberalize the definition of structured passive investment arrangements. The requirement that the parties share the opportunity for gain and risk of loss with respect to the holding company’s assets is intended to ensure that the arrangement between the parties is a bona fide joint venture. In this regard, a commentator recommended that the regulations be clarified to provide that the holding company exception is not satisfied if either the U.S. party or the counterparty is solely a creditor with respect to the entity because it either owns a hybrid instrument that is debt for U.S. tax purposes or purchases stock subject to an obligation to sell the stock back. This modification is reflected in §1.901-2T(e)(5)(iv)(C)(5)(ii) of the temporary regulations. In addition, Example 2 of §1.901-2T(e)(5)(iv)(D) is modified to clarify that the holding company exception is not met if the counterparty’s interest is acquired in a sale-repurchase transaction.

The IRS and Treasury Department recognize that under the regulations an entity conducting business through an active foreign subsidiary may fail to meet the holding company exception, even though the entity would not be treated as an SPV under the “substantially all” test if it operated the subsidiary’s business directly through a branch operation. The IRS and Treasury Department believe this result is appropriate because the segregation of active business income and assets in a lower-tier entity may facilitate the use of an upper-tier entity to conduct a structured passive investment arrangement.

The IRS and Treasury Department remain concerned that taxpayers may continue to enter into structured passive investment arrangements designed to generate foreign tax credits through entities that meet the technical requirements of the holding company exception. The IRS and Treasury Department intend to monitor the use of holding companies to facilitate abusive foreign tax credit arrangements, utilize all available tools under current law to challenge the U.S. tax results claimed in connection with such arrangements (including the substance over form doctrine, the economic substance doctrine, debt-equity principles, tax ownership principles, other provisions of §1.901-2, section 269, and the partnership anti-abuse rules of §1.701-2) in appropriate cases, and to issue additional regulations modifying or eliminating the holding company exception if necessary to prevent abuse.

The second modification in the 2007 proposed regulations is that passive investment income is determined by disregarding sections 954(c)(3) and 954(c)(6) and by treating income attributable to transactions with a counterparty as ineligible for the exclusions under sections 954(h) and 954(i). The IRS and Treasury Department received a number of comments suggesting that the definition of passive investment income should be narrowed by excluding income that would be treated as non-subpart F income under section 954(c)(3) or 954(c)(6), excluding income from unrelated persons other than the counterparty, or eliminating the requirement in section 954(h) that the tested entity’s activity be conducted in the entity’s “home country.” Other commentators suggested substituting other tests for the active financing exception in section 954(h), such as exempting financial services income as defined in section 904(d), with or without modification. For example, commentators suggested various modifications, such as excluding income derived from unrelated persons or from direct activities of employees of the tested entity; exempting any income derived from or related to transactions with customers; exempting income that would be considered attributable to an active foreign trade or business under the principles of section 864 and §1.367(a)-2T(b); or exempting income other than income from “tainted” assets such as cash or cash equivalents, stock or notes of persons related to the U.S. party or counterparty, or assets giving rise to U.S. source income. One commentator suggested that payments described in section 954(c)(3) should not be treated as passive investment income to the extent the payment was deductible under foreign law and the corresponding income inclusion by the tested entity did not result in a net increase in foreign taxes paid. This commentator suggested that the result in the U.S. borrower transaction described in Example 2 of the 2007 proposed regulations was inappropriate since the foreign tax paid by the SPV was offset by a reduction in tax paid by the CFC borrower.

The IRS and Treasury Department carefully considered these suggestions but ultimately determined that none of the suggested approaches has significant advantages over relying on section 954(h) to determine whether income from financing activities is sufficiently active that it should be excluded from passive investment income for purposes of these regulations. Section 954(h) includes detailed requirements that ensure that the entity is predominantly engaged in the active conduct of a banking, financing or similar business and conducts substantial activity with respect to such business. In addition, the IRS and Treasury Department continue to believe it is not appropriate to exclude income described in sections 954(c)(3) and 954(c)(6) from passive investment income, because financing arrangements between related parties that are engaged in the active conduct of a trade or business are commonly used in the structured transactions that are the target of these regulations. The IRS and Treasury Department also do not believe that U.S. borrower transactions should not be considered to result in a net increase in foreign tax, since in the absence of the structured passive investment arrangement the CFC borrower would still reduce its foreign tax by reason of the interest expense deduction but the U.S. party would not claim foreign tax credits for foreign payments attributable to income in the SPV that is in substance the foreign lender’s interest income. Accordingly, §1.901-2T(e)(5)(iv)(C)(5)(i) generally retains the definition of passive investment income in the 2007 proposed regulations.

However, the temporary regulations include two modifications in response to comments. First, the IRS and Treasury Department agree it is appropriate to require the entity’s activities to be conducted directly by its own employees rather than by employees of affiliates, because the purpose of the SPV condition is to distinguish between active entities and those with largely passive income, and it is reasonable to require an entity engaged in an active business to conduct that business through its own employees. Accordingly, §1.901-2T(e)(5)(iv)(C)(5)(i) provides that section 954(h)(3)(E) shall not apply, and that the entity must conduct substantial activity through its own employees.

Second, the IRS and Treasury Department agree that the requirement that activities be conducted in the entity’s “home country” reflects a subpart F policy that is more restrictive than necessary for purposes of these regulations. Accordingly, §1.901-2T(e)(5)(iv)(C)(5)(i) provides that for purposes of these regulations the term home country means any foreign country.

Concerning the requirement in §1.901-2(e)(5)(iv)(B)(1)(i) of the 2007 proposed regulations that substantially all of the gross income of the entity be passive investment income and substantially all of the entity’s assets are assets held to produce such passive investment income, one commentator recommended that the regulations provide examples illustrating situations in which such requirement is met. The IRS and Treasury Department did not adopt this comment because the “substantially all” test requires evaluation of all the facts and circumstances and cannot be satisfied by reference to a specific percentage benchmark.

Several commentators requested that the regulations clarify the time at which the six conditions must be met to result in a structured passive investment arrangement. Section 1.901-2T(e)(5)(iv)(B)(1)(ii) of the temporary regulations is revised to clarify that the foreign payment must be made with respect to a U.S. tax year in which substantially all of the gross income (for U.S. tax purposes) of the entity, if any, is attributable to passive investment income and substantially all of the assets of the entity are assets held to produce such passive investment income. This clarification is intended to ensure that foreign tax credits are disallowed for foreign payments that relate primarily to passive investment income, but not for taxes that relate to active business income earned in an earlier or later year when the entity is not treated as an SPV. The regulations do not, however, require all six conditions to be met in the same tax year. For example, the regulations disallow credits for foreign payments with respect to income of an SPV even if the U.S. party acquires its interest, or a hybrid instrument is issued to the counterparty, after the foreign payments are made.

Other commentators recommended that the regulations eliminate the SPV condition and treat as noncompulsory payments only those foreign payments that directly relate to passive investment income, or with respect to which duplicative tax benefits are claimed. The IRS and Treasury Department did not adopt such an approach in the temporary regulations because of the administrative difficulty of tracing specific foreign payments to specific income or to the duplicative tax benefits. Accordingly, the temporary regulations retain the SPV condition and the approach of treating all foreign payments attributable to a structured passive investment arrangement as noncompulsory. However, the IRS and Treasury Department recognize that an element of the arrangements intended to be covered by the regulations is that they are designed to generate duplicative tax benefits, and that some connection between the counterparty’s foreign tax benefit and the U.S. party’s share of the foreign payments should be a pre-condition to the finding of a structured passive investment arrangement. Accordingly, as described in section D of this preamble, the foreign tax benefit condition is revised to provide that the counterparty’s foreign tax benefit must correspond to 10 percent or more of the U.S. party’s share of the foreign payments or the U.S. party’s share (under U.S. tax principles) of the foreign tax base used to compute such payments.

Section 1.901-2T(e)(5)(iv)(B)(2) of the temporary regulations adopts without change the second overall condition of the 2007 proposed regulations that a person (a “U.S. party”) would be eligible to claim a credit under section 901(a) (including a credit for foreign taxes deemed paid under section 902 or 960) for all or a portion of the foreign payment if such payment were an amount of tax paid.

One commentator requested that the regulations be amended to clarify that the “U.S. party” condition must be met at the same time as the other five conditions. The temporary regulations do not include this condition because the IRS and Treasury Department believe it is inappropriate to exempt arrangements that are structured so that the U.S. party claims a credit in a taxable year or period that is not the same taxable year or period in which the counterparty is entitled to a foreign tax benefit. In addition, the IRS and Treasury Department are concerned that this modification would allow a person to acquire an interest in an SPV and claim credits with respect to purported foreign taxes paid in an earlier period by the SPV in connection with an arrangement that met the other five conditions of the regulations.

The third overall condition provided in the 2007 proposed regulations is that the foreign payment or payments are (or are expected to be) substantially greater than the amount of credits, if any, that the U.S. party would reasonably expect to be eligible to claim under section 901(a) if such U.S. party directly owned its proportionate share of the assets owned by the SPV, other than through a branch, a permanent establishment or any other arrangement (such as an agency arrangement) that would subject the income generated by its share of the assets to a net basis foreign tax. Commentators recommended several changes to the direct investment condition, several of which are adopted in the temporary regulations. First, in order to reach appropriate results in cases where more than one person owns an equity interest in the SPV for U.S. tax purposes, the temporary regulations amend the direct investment test to compare the U.S. party’s proportionate share of the foreign payment made by the SPV to the amount of foreign tax the U.S. party would be eligible to credit if the U.S. party directly owned its proportionate share of the assets. Second, the temporary regulations clarify that a dual resident corporation that is an SPV meets the direct investment condition since its ownership of the passive assets is treated the same as ownership through a branch operation. Third, a commentator suggested that the direct investment test of the 2007 proposed regulations could be avoided by entering into a sale-repurchase transaction using an SPV that acquires passive assets subject to foreign withholding tax. This commentator recommended that the direct investment condition be revised to reduce the value of the U.S. party’s interest by any amount advanced by the foreign counterparty that is treated as debt for U.S. tax purposes but as equity for foreign tax purposes. The IRS and Treasury Department agree that situations where the SPV’s income is subject to gross basis foreign taxes raise the same foreign tax credit policy concerns as situations where the SPV’s income is subject to net basis foreign taxes. The IRS and Treasury Department, however, believe the commentator’s recommended solution is incomplete, since the other conditions of the regulations can be met by structures employing techniques other than sale-repurchase agreements. Accordingly, the temporary regulations provide that the U.S. party’s proportionate share of the SPV’s assets does not include any assets that produce income subject to gross basis withholding tax.

Several commentators recommended that the regulations include an exception for certain transactions in which the amount of the foreign payments attributable to income of an SPV does not substantially exceed the amount of foreign taxes that would have been paid by a controlled foreign corporation that owns the SPV in the absence of the arrangement. The commentators suggested that such foreign payments should not be treated as noncompulsory payments because they effectively substitute for taxes that would have been imposed on the controlled foreign corporation in the absence of the arrangement.

These comments raise the fundamental question as to the appropriate baseline to which such transactions should be compared to determine if there has been a significant increase in the total amount of foreign taxes paid. Although the IRS and Treasury Department carefully considered an exception from the definition of structured passive investment arrangements for such transactions, the IRS and Treasury Department have been unable to develop an exception that can be administered by the IRS and that does not exclude abusive cases. Accordingly, the temporary regulations do not include this exception.

The fourth condition provided in the 2007 proposed regulations is that the arrangement is structured in such a manner that it results in a foreign tax benefit (such as a credit, deduction, loss, exemption or a similar tax benefit) for a counterparty or for a person that is related to the counterparty, but not related to the U.S. party. In response to comments, to relieve administrative burdens these regulations clarify that while the benefit must be reasonably expected, there is no requirement to show that the benefit be intended or actually realized. The temporary regulations also provide that the ability to surrender the use of a tax loss to another person is a foreign tax benefit because a foreign tax benefit need only be made available to a counterparty. See Example 9 of §1.901-2T(e)(5)(iv)(D).

Several commentators recommended that the regulations be revised to require a causal relationship between one or more of the six conditions. For example, one commentator recommended adding a requirement that the foreign tax benefit either relate to the foreign tax paid by the SPV or result from the counterparty being treated for foreign but not U.S. tax purposes as owning an equity interest in the SPV or a portion of the SPV’s assets. Another commentator suggested requiring that the inconsistent aspect of the arrangement be created or used to achieve the foreign tax benefit. Another commentator recommended requiring that the foreign tax benefit would not have been allowed or allowable “but for” the existence of one or more of the other conditions.

In response to the comments, the temporary regulations revise the “foreign tax benefit” condition to provide that the credit, deduction, loss, exemption, exclusion or other tax benefit must correspond to 10 percent or more of the U.S. party’s share (for U.S. tax purposes) of the foreign payment or 10 percent or more of the foreign tax base with respect to which the U.S. party’s share of the foreign payment is imposed. The revisions are intended to clarify that a joint venture that does not involve any duplication of tax benefits is not covered by the temporary regulations. At the same time, the temporary regulations provide that the duplication need not be direct. For example, while the U.S. party generally seeks to claim foreign tax credits in the United States for foreign payments attributable to income of the SPV, the counterparty’s foreign tax benefit may consist of tax-exempt income corresponding to the SPV’s income with respect to which foreign payments claimed as credits by the U.S. party were made and deductions or losses attributable to payments of corresponding amounts to the SPV or U.S. party. See Example 3 of §1.901-2T(e)(5)(iv)(D).

The 2007 proposed regulations define a counterparty as a person (other than the SPV) that is unrelated to the U.S. party and that (i) directly or indirectly owns 10 percent or more of the equity of the SPV under the tax laws of a foreign country in which such person is subject to tax on the basis of place of management, place of incorporation or similar criterion or otherwise subject to a net basis foreign tax or (ii) acquires 20 percent or more of the assets of the SPV under the tax laws of a foreign country in which such person is subject to tax on the basis of place of management, place of incorporation or similar criterion or otherwise subject to a net basis foreign tax.

Commentators proposed that the counterparty factor be amended to include certain related parties. Commentators noted that structured transactions engaged in by related persons under common foreign ownership present the same tax policy concerns as transactions between unrelated persons. However, these same commentators noted that structured transactions engaged in by related parties that are under common U.S. ownership do not pose the same tax policy concerns because the reduction in foreign tax liability obtained by the U.S.-controlled foreign counterparty will result in a corresponding increase in U.S. taxes when the foreign counterparty repatriates its earnings to the United States. The IRS and Treasury Department agree with these comments. Consequently, the temporary regulations amend the definition of a counterparty to include related persons, but excluding cases where the U.S. party is a U.S. corporation or individual that owns (directly or indirectly) at least 80 percent of the value of the potential counterparty and cases where at least 80 percent of the value of the U.S. party and the potential counterparty are owned (directly or indirectly) by the same U.S. corporation or individual.

Several commentators also suggested that the requirement that the counterparty own at least 10 percent (directly or indirectly) of the equity of the SPV or acquire at least 20 percent of the assets of the SPV should be revised. Some commentators proposed these thresholds be increased to 50 percent. Other commentators proposed that the ownership of all foreign parties deriving a foreign tax benefit should be aggregated to determine whether the thresholds are met. The IRS and Treasury Department agree that the regulatory conditions should be revised to better reflect that the counterparty is entitled to more than a nominal foreign tax benefit. Accordingly, the temporary regulations eliminate the percentage ownership thresholds from the counterparty definition, and modify the definition of a foreign tax benefit in §1.901-2T(e)(5)(iv)(B)(4), as described in section D of this preamble.

The sixth condition in the 2007 proposed regulations is that the U.S. and an applicable foreign country treat the arrangement differently under their respective tax systems. For this purpose, an applicable foreign country is any foreign country in which either the counterparty, a person related to the counterparty or the SPV is subject to net basis tax. To provide clarity and limit the scope of this factor, the 2007 proposed regulations provide that the arrangement must be subject to one of four specified types of inconsistent treatment. Specifically, the U.S. and the foreign country (or countries) must treat one or more of the following aspects of the arrangement differently, and the U.S. treatment of the inconsistent aspect must materially affect the amount of foreign tax credits claimed, or the amount of income recognized, by the U.S. party to the arrangement: (i) the classification of an entity as a corporation or other entity subject to an entity-level tax, a partnership or other flow-through entity or an entity that is disregarded for tax purposes; (ii) the characterization as debt, equity or an instrument that is disregarded for tax purposes of an instrument issued in the transaction; (iii) the proportion of the equity of the SPV (or an entity that directly or indirectly owns the SPV) that is considered to be owned directly or indirectly by the U.S. party and the counterparty; or (iv) the amount of taxable income of the SPV for one or more tax years during which the arrangement is in effect.

Commentators recommended that this condition be clarified so that the U.S. treatment of the inconsistent aspect must materially increase the amount of the U.S. party’s foreign tax credits or materially decrease the U.S. party’s income for U.S. tax purposes. The temporary regulations reflect this clarification. In addition, commentators requested that this factor be limited to instances when the inconsistent treatment is reasonably expected to result in a permanent difference in the U.S. party’s income or foreign tax credits. The IRS and Treasury Department believe that the revisions to the foreign tax benefit condition described in Section D of this preamble are sufficient to establish the appropriate linkage between the inconsistent U.S. and foreign law treatment and the duplicative tax benefits. Accordingly, the temporary regulations retain the inconsistent treatment factor without further changes.

One commentator also recommended that the inconsistent treatment condition be narrowed to instances where the inconsistent treatment under U.S. and foreign law related to definitions of ownership and the amount of the SPV’s taxable income. The IRS and Treasury Department have not adopted this recommendation because it would cause certain types of abusive arrangements to fall outside the scope of the regulations and because differences in entity classification are features common to structured passive investment arrangements.

Commentators also made suggestions that did not relate to any single factor. For example, commentators also requested clarification that the foreign payments treated as noncompulsory amounts under the regulation may be deductible payments under sections 162 and 212 and reduce a foreign corporation’s earnings and profits for purposes of subpart F. The IRS and Treasury Department believe that providing guidance regarding sections 162, 212, and 964 is beyond the scope of this regulation project. The usual rules for determining the deductibility of a payment and determining the earnings and profits of a foreign corporation for subpart F purposes apply.

In addition, commentators requested that foreign payments attributable to a structured passive investment arrangement be excluded from the scope of the regulations if the arrangement has a valid business purpose. Other commentators suggested that the regulations adopt a broad anti-abuse rule that would deny a foreign tax credit in any case where allowance of the credit would be inconsistent with the purpose of the foreign tax credit regime. The IRS and Treasury Department are concerned that these approaches would create uncertainty for both taxpayers and the IRS. The IRS and Treasury Department have concluded that, at this time, a targeted rule denying foreign tax credits in arrangements described in the temporary regulations is more appropriate.

In response to comments, the temporary regulations include more examples illustrating additional variations of the structured passive investment arrangements that are covered by the regulations. For example, new Example 3 illustrates a U.S. borrower transaction in which a foreign lender acquires assets instead of an equity interest in the SPV and new Example 10 illustrates a joint venture in which the counterparty’s foreign tax benefits do not correspond to the U.S. party’s share of the base with respect to which the foreign payment is imposed. Modifications to examples in the 2007 proposed regulations were also necessary to reflect comments received and other changes to the regulations.

The 2007 proposed regulations were proposed to be effective for foreign taxes paid or accrued during taxable years of the taxpayer ending on or after the date on which the final regulations are published in the Federal Register. A commentator observed that the final regulations would potentially be retroactively effective because the regulations would apply, for example, to calendar year taxpayers as of January 1 of the year in which the final regulations are published in the Federal Register and to taxpayers that participated in structured passive investment arrangements involving entities with taxable years that differ from the U.S. taxpayers’ taxable years. Commentators also requested clarification of whether the relevant taxable year for purposes of the effective date is the taxable year of the SPV in which it pays or accrues the purported foreign taxes, or the taxable year of the U.S. taxpayer in which it claims a credit. For example, commentators observed that if the taxable year of the U.S. taxpayer in which it claims a credit is the relevant taxable year, the final regulations would apply to U.S. shareholders of controlled foreign corporations where the shareholder claims a deemed paid credit under section 902 with respect to foreign taxes paid by the foreign corporation in years prior to the effective date of the regulations. These commentators recommended that the regulations provide that the relevant taxable year is the SPV’s taxable year. Commentators also recommended that the final regulations apply only to foreign taxes paid or accrued in taxable years beginning after the date the final regulations are published, or only to foreign taxes paid or accrued with respect to income accrued after the date the final regulations are published.

The IRS and Treasury Department have not adopted the recommendation to delay the effective date of these regulations to apply only in tax years beginning after the regulations are published. The IRS and Treasury Department generally believe the regulations should apply to disallow credits for foreign payments that would otherwise be eligible to be claimed as credits in taxable years ending after the regulations are published. The IRS and Treasury Department agree, however, that the regulations should not apply to foreign taxes paid or accrued by a foreign corporation in a U.S. taxable year of the foreign corporation ending prior to the effective date of the regulations, provided that such year ends prior to the first taxable year of the domestic corporate shareholder for which these regulations are first applicable.

Accordingly, the effective date for these regulations is July 16, 2008. The regulations generally apply to foreign payments that, if they were an amount of tax paid, would be considered paid or accrued by a U.S. or foreign entity in taxable years ending on or after July 16, 2008. In the case of foreign payments by a foreign corporation that has a domestic corporate shareholder, the regulations also apply to such payments that would be considered paid or accrued in the foreign corporation’s U.S. taxable years ending with or within taxable years of its domestic corporate shareholder ending on or after July 16, 2008. Finally, in the case of foreign payments by a partnership, trust or estate for which any partner or beneficiary would otherwise be eligible to claim a foreign tax credit, the regulations also apply to payments that would be considered paid or accrued in taxable years ending with or within taxable years of such partners or beneficiaries ending on or after July 16, 2008.

No inference is intended regarding the U.S. tax consequences of structured passive investment arrangements prior to the effective date of the regulations.

For periods after the effective date of the temporary regulations, the IRS and Treasury Department will continue to scrutinize other arrangements that are not covered by the regulations but are inconsistent with the purpose of the foreign tax credit. Such arrangements may include arrangements that are similar to arrangements described in the temporary regulations, but that do not meet all of the conditions included in the temporary regulations. The IRS will continue to challenge the claimed U.S. tax results in appropriate cases. In addition, the IRS and Treasury Department may issue additional regulations in the future in order to address such other arrangements.

The temporary regulations also amend §1.901-1(a) and (b) to reflect statutory changes made by the Foreign Investors Tax Act of 1966 (Public Law 89-809 (80 Stat. 1539), section 106(b)), the Tax Reform Act of 1976 (Public Law 94-455 (90 Stat. 1520), section 1901(a)(114)), and the American Jobs Creation Act of 2004 (Public Law 108-357 (118 Stat. 1418-20), section 405(b)).

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. For applicability of the Regulatory Flexibility Act, please refer to the cross-referenced notice of proposed rulemaking published elsewhere in this issue of the Bulletin. Pursuant to section 7805(f) of the Internal Revenue Code, this regulation has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses.

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

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

Par. 2. Section 1.901-1 is amended by revising paragraphs (a) and (b) to read as follows:

On October 17, 2005, the IRS published in the Federal Register proposed regulations (REG-114444-05, 2005-2 C.B. 934) at 70 FR 60256 and final and temporary regulations (T.D. 9227, 2005-2 C.B. 924) at 70 FR 60214 amending 26 CFR part 801. One written comment was received. No public hearing was requested. This document adopts, without modification, the proposed regulations as final regulations.

The commentator suggested that modification of the regulation was not needed. The commentator further suggested that the Quantity measure “number of cases closed” should never be used to evaluate IRS employees or suggest goals. The amendment of Part 801 retains the absolute prohibition on the use of quantity data to evaluate non-supervisory employees who exercise judgment with respect to tax enforcement results. The amendment allows communicating the quantity goals of an organizational unit with employees, including quantity expectations, such as the average number of case closures needed to meet the unit’s goal. These communications must recognize that the facts and circumstances of each case will affect an employee’s actual closures, and that the employee is not being given a quota which must be met. Accordingly, the commentator’s suggestion was not adopted.

In addition, the inclusion of some outcome-neutral production data as examples of quantity measures (for example, cycle time and number or percentage of overage cases) (§801.6(c)) does not preclude an organizational unit’s use of this or other outcome-neutral production data as quality measures.

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 the section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulation does not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Par. 2. The center heading and §§801.1, 801.2, 801.3, 801.4, 801.5, 801.6, and 801.7 are removed.

Par. 3. The center heading preceding §801.1T is removed.

Par. 4. Sections 801.1T, 801.2T, 801.3T, 801.4T, 801.5T, 801.6T, 801.7T, and 801.8T are redesignated as §§801.1, 801.2, 801.3, 801.4, 801.5, 801.6, 801.7, and 801.8 and the language “T” following the section number and “(temporary)” is removed from each section heading, respectively.

Par. 5. Newly designated §801.1(a) is amended by removing the language “(Pub. L. 105-106, 112 Stat. 685, 715-716, 722)” and adding the language “(Public Law 105-106, 112 Stat. 685, 715-716, 722)” in its place.

Par. 6. Newly designated §801.2 is amended by removing the language “Pub. L. 104-106, 110 Stat. 186, 679); the Government Performance and Results Act of 1993 (Pub. L. 103-62, 107 Stat. 285); and the Chief Financial Officers Act of 1990 (Pub. L. 101-576, 108 Stat. 2838)” and adding the language “(Public Law 104-106, 110 Stat. 186, 679); the Government Performance and Results Act of 1993 (Public Law 103-62, 107 Stat. 285); and the Chief Financial Officers Act of 1990 (Public Law 101-576, 108 Stat. 2838)” in its place.

Par. 7. Newly designated §801.3(e)(1) and (e)(3) is amended by removing the language “§801.6T” in each location and adding the language “801.6” in its place.

Par. 8. Newly designated §801.7(a) introductory text is amended by removing the language “§801.3T” and adding the language “§801.3” in its place.

Par. 9. New designated §801.8 is revised to read as follows:

The “old-law” contribution and benefit base for 2009 is $79,200. This is the base that would have been effective under the Act without the enactment of the 1977 amendments.

The “old-law” contribution and benefit base is used by:

(a) The Railroad Retirement program to determine certain tax liabilities and tier II benefits payable under that program to supplement the tier I payments which correspond to basic Social Security benefits,

(b) the Pension Benefit Guaranty Corporation to determine the maximum amount of pension guaranteed under the Employee Retirement Income Security Act (section 230(d) of the Act),

(c) Social Security to determine a year of coverage in computing the special minimum benefit, as described earlier, and

(d) Social Security to determine a year of coverage (acquired whenever earnings equal or exceed 25 percent of the “old-law” base for this purpose only) in computing benefits for persons who are also eligible to receive pensions based on employment not covered under section 210 of the Act.

The minimum amount a domestic worker must earn so that such earnings are covered under Social Security or Medicare is the domestic employee coverage threshold. For 2009, this threshold is $1,700. Section 3121(x) of the Internal Revenue Code provides the formula for increasing the threshold.

Under the formula, the domestic employee coverage threshold amount for 2009 shall be equal to the 1995 amount of $1,000 multiplied by the ratio of the national average wage index for 2007 to that for 1993. If the resulting amount is not a multiple of $100, it shall be rounded to the next lower multiple of $100.

Multiplying the 1995 domestic employee coverage threshold amount ($1,000) by the ratio of the national average wage index for 2007 ($40,405.48) to that for 1993 ($23,132.67) produces the amount of $1,746.68. We then round this amount to $1,700. Accordingly, the domestic employee coverage threshold amount is $1,700 for 2009.

This document contains proposed amendments to 26 CFR Part 1 under sections 108 and 721 of the Code relating to the application of section 108(e)(8) to partnerships.

Section 108(e)(8) was amended by section 896 of the American Jobs Creation Act of 2004, Public Law 108-357 (118 Stat. 1648), to include discharges of partnership indebtedness occurring on or after October 22, 2004. Prior to the amendment, section 108(e)(8) only applied to discharges of corporate indebtedness. Section 108(e)(8), as amended, provides that for purposes of determining income of a debtor from discharge of indebtedness (COD income), if a debtor corporation transfers stock or a debtor partnership transfers a capital or profits interest in such partnership to a creditor in satisfaction of its recourse or nonrecourse indebtedness, such corporation or partnership shall be treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock or interest. In the case of a partnership, any COD income recognized under section 108(e)(8) shall be included in the distributive shares of the partners in the partnership immediately before such discharge.

These regulations are proposed to apply to debt-for-equity exchanges occurring on or after the date these regulations are published as final regulations in the Federal Register.

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

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. The IRS and the Treasury Department request comments on the clarity of the proposed rules and how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for February 19, 2009, beginning at 10:00 a.m. in the IRS Auditorium, Internal Revenue Building, 1111 Constitution Avenue, NW, Washington, DC. Due to building security procedures, all visitors must enter at the Constitution Avenue entrance. 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 30 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 or electronic comments by January 27, 2009. Outline of the topics to be discussed and the time to be devoted to each topic (signed original and eight (8) copies) by January 27, 2009. A period of 10 minutes will be allotted to each person for making comments. An agenda showing the schedule of 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.

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

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

Par. 2. Section 1.108-8 is added to read as follows:

Temporary regulations in this issue of the Bulletin contain amendments to the Income Tax Regulations (26 CFR Part 1) which provide rules relating to the determination of the amount of taxes paid for purposes of the foreign tax credit. The text of those regulations also serves as the text of these proposed regulations. The preamble to the temporary regulations explains the temporary regulations and these proposed regulations. The regulations affect individuals and corporations claiming foreign tax credits.

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

Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. In particular, the IRS and Treasury Department continue to study arrangements in which the foreign payments attributable to income of a special purpose vehicle (SPV) do not substantially exceed the foreign taxes that would have been paid by a controlled foreign corporation that owns the SPV in the absence of the arrangement. The IRS and Treasury Department seek additional comments on how to overcome the administrative challenges of determining the amount of foreign taxes that would have been paid but for such arrangement. The IRS and Treasury Department also request comments on whether the regulations should contain additional guidance on the extent to which activities are conducted by an entity’s employees or on the treatment of employees of affiliates that are seconded to, or supervised by employees of, the tested entity. Finally, the IRS and Treasury Department request comments on the clarity of the proposed regulations and how they can be made easier to understand. All comments will be available for public inspection and copying.

A public hearing has been scheduled for December 11, 2008, at 10 a.m. in the Auditorium, Internal Revenue Building, 1111 Constitution Avenue, N.W., Washington, D.C. Due to building security procedures, visitors must enter at the Constitution Avenue entrance. 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 more than 30 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 must submit electronic or written comments by October 14, 2008, and an outline of the topics to be discussed and time to be devoted to each topic (a signed original and eight (8) copies) by November 20, 2008. 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.

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

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

Par. 2. Section 1.901-1 is amended by revising paragraphs (a) and (b) to read as follows:

The Genetic Information Nondiscrimination Act of 2008 (GINA) was enacted on May 21, 2008 (Public Law 110-233). Title I of GINA amends the Employee Retirement Income Security Act of 1974 (ERISA), the Public Health Service Act (PHS Act), the Internal Revenue Code of 1986 (Code), and the Social Security Act (SSA) to prohibit discrimination in health coverage based on genetic information. Sections 101 through 104 of GINA apply to employment-based health coverage, individual market health insurance, and Medicare supplemental (MedSupp or Medigap) coverage. The new requirements were added to Part 7 of Subtitle B of Title I of ERISA, Title XXVII of the PHS Act, Subtitle K of the Code, and section 1882 of the SSA.

GINA prohibits group health plans and health insurance issuers (that is, insurance companies or health maintenance organizations (HMOs)) in the group market from using genetic information to adjust premium or contribution amounts for the group covered under the plan. Plans and issuers in the group market are still allowed to increase the premium rate for an employer based on the manifestation of a disease or disorder of an individual enrolled in the plan, but they are prohibited from using the manifested disease or disorder of one individual as genetic information about other group members to further increase the premium.

In the individual market, health insurance issuers are prohibited from using genetic information to determine individual eligibility or premium rates, although they are allowed (to the extent consistent with other provisions of law) to use information about a manifestation of a disease or disorder to determine eligibility or premium rates for an individual who is covered or would be covered by a policy. Individual market health insurance issuers are also prohibited from using genetic information in imposing a preexisting condition exclusion, although a manifestation of a disease or disorder in an individual can be the basis for an exclusion. In the MedSupp market, GINA prohibits issuers from denying or conditioning the issuance or effectiveness of a policy (including the imposition of any exclusion of benefits based on a preexisting condition) or discriminating in the pricing of the policy based on an individual’s genetic condition. However, if otherwise permitted under section 1882 of the Social Security Act, the issuer can still impose such limitations based on a manifested disease of an individual who is covered or would be covered under the policy.

GINA also prohibits group health plans and health insurance issuers in the group, individual, and MedSupp markets from requesting or requiring an individual or family member of an individual to undergo a genetic test. Plans and issuers are not precluded from obtaining and using the results of a genetic test to make a determination regarding payment, but they may only use the minimum amount of information necessary.

GINA includes a research exception under which a group health plan or a health insurance issuer in the group, individual, or MedSupp market may request (but not require) a participant or beneficiary to undergo a genetic test if the following five conditions are met:

Group health plans and health insurance issuers in the group, individual, and MedSupp markets are prohibited from requesting, requiring, or purchasing genetic information for underwriting purposes or prior to an individual’s enrollment under a plan or policy. Plans and issuers are still allowed to collect (that is, to request, require, or purchase) health information that relates to the manifestation of a disease or disorder of an individual enrolled in a plan or who is covered by or would be covered by a policy issued in the individual or MedSupp market, and use it for permitted underwriting purposes with respect to that individual. Furthermore, an exception to the prohibition on requesting, requiring, or purchasing genetic information is included for collection of genetic information which is incidental to the request, requirement, or purchase of other information concerning an individual, provided it is not used for underwriting purposes.

GINA defines genetic information with respect to any individual as information about that individual’s genetic tests, the genetic tests of family members of the individual, and the manifestation of a disease or disorder in family members of the individual. The term genetic information also includes an individual’s request for, or receipt of, genetic services, but does not include information about the sex or age of any individual. Genetic services are further defined as a genetic test, genetic counseling (which includes obtaining, interpreting, or assessing genetic information), or genetic education. A genetic test is defined for purposes of Title I of GINA as an analysis of human DNA, RNA, chromosomes, proteins, or metabolites that detects genotypes, mutations, or chromosomal changes. The term is not meant to include an analysis of proteins or metabolites that does not detect genotypes, mutations, or chromosomal changes, or an analysis of proteins or metabolites that is directly related to a manifested disease, disorder, or pathological condition that a health care professional with appropriate training and expertise could reasonably detect. Definitions of family member and underwriting purposes are also included, as well as provisions clarifying that references to genetic information concerning an individual include the genetic information of a fetus carried by a pregnant woman and of an embryo legally held by an individual utilizing an assisted reproductive technology.

The provisions of GINA are effective with respect to group health plans and health insurance issuers in the group market for plan years beginning after May 21, 2009. For health insurance issuers in the individual market, the provisions are effective with respect to health insurance coverage sold, issued, renewed, in effect, or operated in the individual market after May 21, 2009. For MedSupp coverage, States must incorporate the GINA provisions into their regulatory programs no later than July 1, 2009.

Executive Order 12866 requires an assessment of the costs and benefits of a significant rulemaking action and the alternatives considered, using the guidance provided by the Office of Management and Budget. These costs and benefits are not limited to the Federal government, but pertain to the affected public as a whole. Under Executive Order 12866, a determination must be made whether implementation of GINA sections 101 through 104 will be economically significant. A rule that has an annual effect on the economy of $100 million or more is considered economically significant.

In addition, the Regulatory Flexibility Act may require the preparation of an analysis of the economic impact on small entities of proposed rules and regulatory alternatives. An analysis under the Regulatory Flexibility Act must generally include, among other things, an estimate of the number of small entities subject to the regulations (for this purpose, plans, employers, and issuers and, in some contexts small governmental entities), the expense of the reporting and other compliance requirements (including the expense of using professional expertise), and a description of any significant regulatory alternatives considered that would accomplish the stated objectives of the statute and minimize the impact on small entities. The Departments seek additional information from small entities regarding any special problems they might encounter in implementing the requirements of sections 101 through 104 of GINA and any regulatory guidance that might minimize those problems.

The Paperwork Reduction Act requires an estimate of how many “respondents” will be required to comply with any “collection of information” aspects of the regulations and how much time and cost will be incurred as a result. A collection of information includes record-keeping, reporting to governmental agencies, and third-party disclosures.

The Departments are requesting comments that may contribute to the analyses that will be performed under these requirements, both generally and with respect to the following specific areas:

(i) What policies, procedures, or practices of group health plans and health insurance issuers may be impacted by regulations under GINA? What direct or indirect costs would result? What direct or indirect benefits would result? Which stakeholders will be impacted by such benefits and costs?

(ii) Are there unique costs and benefits for small employers or small plans? What special consideration, if any, is needed for small employers or small plans?

The Departments are seeking comments to aid in the development of regulations regarding sections 101 through 104 of GINA. To assist interested parties in responding, this request for information describes specific areas in which the Departments are particularly interested; however, the Departments also request comments and suggestions concerning any area or issue pertinent to the development of regulations.

1. To what extent do group health plans and health insurance issuers currently use genetic information, such as family medical history, and for what purposes? For example, is genetic information currently used for group rating purposes, or for purposes of a wellness program that otherwise complies with HIPAA’s nondiscrimination requirements?

2. How do plans and issuers currently obtain genetic information (for example, through health risk assessments, the Medical Information Bureau, or other entities under common control)?

3. Under what circumstances do plans or issuers currently request or require an individual to take a genetic test?

4. Under what circumstances do plans or issuers currently ask for the results of a genetic test in order to make a determination regarding payment of benefits? What is the minimum amount of information necessary for a plan or issuer to make a determination under such circumstances?

5. What types of research do plans or issuers currently conduct or support using genetic tests?

6. Would a model notice be helpful to facilitate disclosure to plan participants and beneficiaries regarding a plan’s or issuer’s use of the research exception? In this regard, what information would be most helpful to participants and beneficiaries?

7. Similarly, would a model form be helpful for reporting to the Departments by a plan or issuer claiming the research exception? In this regard, what information should plans and issuers report?

8. When might genetic information be collected incidentally?

9. What terms or provisions (such as genetic information, genetic test, genetic services, or underwriting) would require additional clarification to facilitate compliance? What specific clarifications would be helpful?

Signed at Washington, DC this 4th day of June, 2008.

Signed at Washington, DC this 5th day of June, 2008.

Signed at Washington, DC this 2nd day of October, 2008.

Dated June 30, 2008.