Financial Asset Securitization Investment Trusts;
Real Estate Mortgage Investment Conduits

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1 and 602 [REG-100276-97;
REG-122450-98] RIN 1545-AV59; RIN 1545-AW98

TITLE: Financial Asset Securitization Investment Trusts; Real Estate
Mortgage Investment Conduits

AGENCY: Internal Revenue Service (IRS), Treasury.

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

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

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

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

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

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act of 1995
(44 U.S.C. 3507(d)). Comments on the collection of information
should be sent to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Reports Clearance Officer,
OP:FS:FP, Washington, DC 20224. Comments on the collection of
information should be received by April 7, 2000.

Comments are specifically requested concerning:

Whether the proposed collection of information is necessary for the
proper performance of the functions of the Internal Revenue Service,
including whether the collection will have a practical utility; The
accuracy of the estimated burden associated with the proposed
collection of information (see below); How the quality, utility, and
clarity of the information to be collected may be enhanced; How the
burden of complying with the proposed collection of information may
be minimized, including through the application of automated
collection techniques or other forms of information technology; and
Estimates of capital or startup costs and costs of operation,
maintenance, and purchase of services to provide information.

The collection of information is in §1.860H-1(b)(2) and
§1.860H-6(e). This information is required to permit qualified
entities to elect to become a Financial Asset Securitization
Investment Trust and to ensure the holder of the ownership interest
in a FASIT properly reports the FASIT's items of income, gain,
deduction, loss, and credit. This information will be used to
properly administer the provisions of part V of subchapter M of the
Code. The collection of information is mandatory. The likely
respondents are business or other for-profit institutions.

Estimated total annual reporting and/or record keeping burden: 750
hours.

Estimated average annual burden hours per respondent and/or record-
keeper: 5 hours.

Estimated number of respondents and/or record-keepers: 150.

Estimated annual frequency of responses: one annually.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number. Books or records
relating to a collection of information must be retained as long as
their contents may become material in the administration of any
internal revenue law. Generally, tax returns and tax information are
confidential, as required by 26 U.S.C. 6103.

Background

Section 1621(a) of the Small Business Job Protection Act of 1996,
Public Law 104-188, 110 Stat. 1755 (August 20, 1996) (the Act)
amended the Internal Revenue Code (Code) by adding part V (sections
860H through 860L) (the FASIT provisions) to subchapter M of chapter
1. Part V, which is effective September 1, 1997, authorizes a
securitization vehicle called a Financial Asset Securitization
Investment Trust (FASIT). FASITs are meant to facilitate the
securitization of debt instruments, including non-mortgage and
mortgage debt instruments.

A solicitation for comments was published in the Federal Register
for November 4, 1996 (61 FR 56647). The comments received both
raised and helped resolve significant issues. The IRS and Treasury
request comments on these proposed regulations generally, and
specifically request suggestions on how they may be revised to be
more easily understood.

Explanation of Provisions

In General

A FASIT is a qualified arrangement that elects FASIT treatment and
meets certain requirements concerning the composition of its assets
and the interests it issues to investors. A qualified arrangement
can be a corporation (other than a regulated investment company
(RIC) as defined in section 851(a)), partnership, trust, or
segregated pool of assets.

A FASIT may issue one or more classes of regular interests, which
are treated as debt for all purposes of the Code. In addition, each
FASIT must have a single ownership interest, which must be held
entirely by a non-exempt domestic C corporation (other than a RIC,
real estate investment trust (REIT), real estate mortgage investment
conduit (REMIC), or subchapter T cooperative).

A FASIT is not subject to income tax. Instead, the tax items of the
FASIT are included in the taxable income of the holder of the
ownership interest (the Owner). The Owner, (and in some
circumstances a person related to the Owner) must recognize gain (if
any) when property is either transferred to the FASIT or supports
the regular interests.

Congress enacted the FASIT provisions to facilitate the
securitization of revolving, non-mortgage debt obligations. An anti-
abuse rule incorporated in these proposed regulations is designed to
ensure that FASITs are used in a manner that is consistent with this
intent and not to create opportunities for tax planning that would
not exist but for the enactment of the FASIT provisions and these
proposed regulations.

RULES APPLICABLE TO THE FASIT

Administrative Provisions

1. Background

The administrative provisions have three objectives: (1) ensuring
accurate and timely reporting of the FASIT's tax items, (2) ensuring
compliance by the FASIT with the operating and qualification rules,
and (3) reducing administrative burdens on FASIT interest holders
and the IRS.

2. FASIT Election

The proposed regulations provide that a FASIT election is made by
attaching a statement to the Owner's Federal income tax return for
the taxable year that includes the startup day. No particular form
is presently required, but the statement must be specified as a
FASIT election, and must identify the arrangement for which the
election is made. The IRS and Treasury want to ensure that the
persons most affected by a FASIT election have agreed to make the
election.

Therefore, if the electing arrangement is an entity, the election
statement must be signed by the person who would sign the entity's
return in the absence of the FASIT election. If the electing
arrangement is a segregated pool of assets, the election statement
must be signed by each person that owns the assets in the pool for
Federal income tax purposes immediately before the startup day.

3. Treatment of FASIT Under Subtitle F

None of the FASIT provisions addresses how a FASIT is treated under
subtitle F (Procedure and Administration), which governs matters
such as returns, penalties, tax payments, and assessments. One rule
considered was to make a FASIT's subtitle F treatment depend on the
classification of the electing arrangement. Thus, for example, if a
partnership makes a FASIT election, the FASIT is a partnership for
purposes of subtitle F. Rather than adopt this approach, which leads
to several different administrative regimes for FASITs, the proposed
regulations treat each FASIT as a branch or division of its Owner
for purposes of subtitle F. Because an Owner must always be a
domestic C corporation, this solution results in uniform treatment.

The proposed regulations also make the Owner responsible for
reporting interest income with respect to the regular interests
which are treated for reporting purposes as collateralized debt
obligations (CDOs).

Relationship of a FASIT to the Owner The FASIT provisions do not
provide a general rule defining the relationship between a FASIT and
its Owner for non-FASIT Federal income tax purposes. The nature of
this relationship may be relevant in determining the Federal income
tax consequences of a number of transactions entered into with a
FASIT. For example, it is necessary to know the extent to which
transactions with a FASIT are treated as transactions with the Owner
in determining how the portfolio interest exception applies and
whether a change in the Owner of the FASIT results in a realization
event for holders of the FASIT regular interests.

The IRS and Treasury considered proposing a general rule to
characterize the FASIT's relationship to its Owner for all non-FASIT
Federal income tax purposes. Among the alternatives evaluated were
(1) treating the FASIT as an entity separate from the Owner; (2)
treating the FASIT as a branch of the Owner; and (3) treating the
FASIT as an entity for some purposes and as a branch for others.

Each alternative has some underpinning in the statutory scheme. For
example, in determining the Owner's taxable income, the FASIT
provisions treat a FASIT's assets, liabilities, and tax items as the
assets, liabilities, and tax items of the Owner. This supports
treating a FASIT as a branch of the Owner. However, the restrictions
on what kind of assets may be held and what type of investor
interests may be issued apply to the FASIT alone and favor treating
a FASIT as a separate entity.

The IRS and Treasury have decided it is better to resolve the nature
of the FASIT's relationship with the Owner on an issue-by-issue
basis rather than by adopting a single general rule. A few
situations (for example, the treatment of a FASIT under subtitle F
and the treatment of a FASIT under the portfolio interest rules) are
addressed in these proposed regulations. The IRS and Treasury
welcome additional comments on whether and how additional rules
should detail the FASIT's relationship with the Owner for non-FASIT
Federal income tax purposes.

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

1. Background

Except during a brief formation period, substantially all of a
FASIT's assets must consist of permitted assets. Permitted assets
include cash and cash equivalents, debt instruments (and rights to
acquire debt instruments), foreclosure property, interest and
currency hedges (and rights to acquire interest and currency
hedges), guarantees (and rights to acquire guarantees), regular
interests in other FASITs, and regular interests in REMICs. The
FASIT provisions generally do not allow a FASIT to hold debt
instruments issued by the Owner (or a related person).

Several commentators requested guidance on whether certain assets
qualified as permitted assets. Other comments focused on the
prohibition on Owner debt. In particular, the commentators requested
guidance on the extent to which an Owner may guarantee assets or
enter into a permitted hedge with the FASIT without violating the
prohibition on Owner debt.

2. "Substantially All"

The FASIT provisions require substantially all of a FASIT's assets
to be permitted assets.

Under the proposed regulations, a FASIT meets this test if the
aggregate adjusted basis of its assets other than permitted assets
is less than one percent of the aggregate adjusted basis of all its
assets.

The proposed rule is patterned after a safe harbor rule applicable
to REMICs. The proposed regulations do not incorporate a provision
in the REMIC safe harbor that allows a qualified entity that fails
the REMIC safe harbor to otherwise demonstrate that it does not own
more than a de minimis amount of non-qualified assets. This
provision does not appear necessary because a FASIT, unlike a REMIC,
can acquire additional permitted assets if it is in danger of
failing the substantially all test.

3. Cash and Cash Equivalents

The FASIT provisions treat cash and cash equivalents as permitted
assets. The proposed regulations generally define the phrase cash
and cash equivalents to mean functional currency.

Investment quality debt instruments that are close to maturity are
also cash and cash equivalents because of their perceived liquidity.

In response to some commentators, the proposed regulations provide
that cash and cash equivalents include shares in U.S.-dollar-
denominated money market mutual funds. Although such shares are
technically stock, money market mutual funds are practical
investments for cash balances pending either distribution to regular
interest holders or reinvestment in new debt instruments. The IRS
and Treasury, therefore, believe it is appropriate to allow FASITs
to hold these investments.

4. Debt Instruments in General

Under the FASIT provisions, a debt instrument must satisfy two
criteria to be a permitted asset. First, it has to be a debt
instrument as defined in section 1275(a)(1) of the Code, which means
it has to be a bond, debenture, note or certificate, or other
evidence of indebtedness.

Second, interest payments (if any) must be made in the manner
prescribed for REMIC regular interests. Interest payments on REMIC
regular interests must be based on a fixed or variable rate (as
allowed in regulations), or must consist of a specified portion of
the interest payments on the underlying mortgages held by the REMIC.
This means that under the FASIT provisions, interest payments on a
debt instrument held by a FASIT must also be payable at a fixed or
variable rate, or consist of a specified portion of the interest
payments on some underlying debt instrument.

The proposed regulations enumerate the types of debt instruments
that meet this standard and therefore qualify as permitted assets.
In general, a FASIT may hold fixed-rate debt instruments, specified
floating-rate debt instruments, inflation-indexed debt instruments,
and credit card receivables. In response to comments received, the
proposed regulations also clarify that a FASIT may generally hold
beneficial interests in, or coupon and principal strips created
from, these instruments.

One commentator requested that the proposed regulations specifically
allow FASITs to hold debt instruments that provide for prepayment
penalties. The commentator's concern was that prepayment penalties
might be viewed as contingent payments that are not fixed or
variable interest payments within the meaning of the FASIT
provisions. The proposed regulations accommodate this concern by
including in the list of permitted debt instruments, debt
instruments to which §1.1272-1(c) (relating to debt instruments that
provide for alternate payment schedules) applies. These rules
generally accommodate prepayment penalties.

To prevent a FASIT from indirectly holding equity-like or other non-
debt interests, the proposed regulations disqualify any debt
instrument that can be converted into, or the value of which is
based on, anything other than a permitted debt instrument.
Impermissible debt instruments include, for example, a debt
instrument convertible into stock and a debt instrument the interest
payments on which vary based on the spot price of oil. The proposed
regulations also do not permit a FASIT to hold debt instruments
that, when acquired by the FASIT, are in default due to any payment
delinquency unless the Owner reasonably expects the obligor to cure
the default (including the payment of any interest and penalties)
within 90 days of the date the instrument is acquired by the FASIT.
The concern is that a distressed debt instrument may take on the
characteristics of equity because the FASIT (and in turn the regular
interest holders): (1) may have to look to the obligor's general
assets for payment of the instrument, (2) may not receive full
payment of the instrument, and (3) may not receive any payment until
the satisfaction of claims held by the obligor's other creditors.

5. Participation Interests

One commentator requested guidance on whether a participation
interest in a pool of revolving loans would be considered a
permitted asset. The commentator pointed out that a participation
interest can be based either on a fixed percentage of assets in the
pool or on a fixed dollar amount of assets in the pool.

The proposed regulations do not specifically address participation
interests. It does not appear that guidance is needed concerning
participation interests that are based on a fixed percentage of
assets. If a FASIT owns a fixed-percentage participation interest,
as the outstanding principal balance of the pool rises and falls,
the FASIT may be required to pay additional amounts or entitled to
receive distributions to maintain its fixed percentage ownership in
the pool. As long as the distributions are paid in cash (or in the
form of an otherwise permitted asset), the FASIT's fixed-percentage
interest should be considered a fixed-percentage interest in each of
the debt instruments in the pool. Thus, the FASIT's fixed-percentage
participation interest should qualify as a permitted debt instrument
to the extent the underlying debt instruments are themselves
permitted assets. The result under the FASIT provisions is less
clear in cases where the participation interest is based on a fixed
dollar amount of assets in a pool. In this case, each change in the
outstanding balance of the pool would trigger a corresponding change
in the FASIT's percentage ownership of the pool. When the size of
the pool increases, the FASIT could be viewed as exchanging an
interest in each asset in the old pool for a lower percentage
interest in each asset in the new pool. This exchange might
constitute an impermissible asset disposition. In some cases, this
disposition could result in the imposition of the prohibited
transaction tax.

While the problem with fixed-dollar participation interests might be
resolved by treating a pool as a single asset, a rule specifically
allowing a FASIT to hold participation interests may be used as a
means of inappropriately avoiding other rules. The IRS and Treasury
welcome additional comments on whether and how the need for a FASIT
to hold fixed-dollar amount participation interests can be
accommodated.

6. Debt Instruments Issued by the Owner

To ensure that the holders of the regular interests are looking
primarily to the FASIT, and not the Owner, for payment, the FASIT
provisions generally prohibit a FASIT from holding debt instruments
issued either by the Owner or a person related to the Owner
(collectively, Owner debt). An exception is made for cash
equivalents and other instruments specified by regulation.

Under the proposed regulations, Owner debt means more than just debt
instruments issued by the Owner. It includes an obligation of the
Owner embedded in another instrument, a third party debt instrument
the performance of which is contingent on the performance of Owner
debt, and any partial interest in Owner debt such as a principal or
coupon strip. Similarly, a debt instrument guaranteed by an Owner is
treated as Owner debt, if at the time the FASIT acquires the debt
instrument, the Owner is in substance the primary obligor of the
debt instrument. See Rev. Rul. 97-3 (1997-1 C.B. 9).

Cash equivalents of the Owner, which are permitted under the FASIT
provisions, are limited by the proposed regulations to short-term
investment quality debt instruments that are acquired to temporarily
invest cash pending either distribution to the FASIT interest
holders or re-investment in other permitted assets.

One commentator noted that under the FASIT provisions, it is unclear
whether the Owner of two or more FASITs may use regular interests
from one FASIT to fund another of its FASITs.

If regular interests are considered debt of the Owner, then,
technically, the regular interests held by the second FASIT would be
impermissible Owner debt. The commentator noted that this form of
tiering arrangement is commonly used in REMICs and should be
available for use with FASITs. In response to this comment, the
proposed regulations allow this type of tiering arrangement. As
discussed below, however, tiered FASITs may not be used to achieve
benefits that could not be obtained without the FASIT provisions.

7. Foreclosure Property

The FASIT provisions allow a FASIT to hold an asset (foreclosure
property) acquired upon the default or imminent default of a
permitted debt instrument. The FASIT provisions generally allow a
FASIT to retain foreclosure property for a designated grace period
of approximately three to four years. After the grace period, a 100-
percent tax is imposed on any net income derived from the
foreclosure property, including income from its operation or
disposition. In some cases, the property acquired upon foreclosure
may independently qualify as another type of permitted asset. Under
the proposed regulations, the FASIT may retain this type of
foreclosure property beyond the grace period. If the FASIT retains
the property beyond the grace period, the property loses its status
as foreclosure property at the end of the grace period.

At this point, the proposed regulations require the Owner to
recognize gain, if any, on the property as if it had been
contributed to the FASIT at the close of the grace period. In
addition, after the grace period, the property can no longer qualify
for the foreclosure exception to the prohibited transaction rules.

8. Contracts or agreements in the nature of a line of credit

A FASIT may generally hold as a permitted asset a contract or
agreement in the nature of a line of credit as long as the FASIT
does not originate the contract or agreement.

9. Guarantees and hedges

Under the FASIT provisions, a contract may qualify as a permitted
asset if it is a permitted hedge or guarantee. The FASIT provisions
impose two requirements on permitted hedges and guarantees. First,
the contract must be an interest rate or foreign currency notional
principal contract, letter of credit, insurance, guarantee against
defaults, or other similar instrument.

Second, the contract must be reasonably required to guarantee or
hedge against the FASIT's risks associated with being the obligor on
the interests that the FASIT has issued. Several commentators asked
for guidance on the scope of this rule.

The proposed regulations provide guidance as to what constitutes a
permitted hedge or guarantee. Rather than focus on the type of
contract, the proposed regulations focus on its intended function.
Under the proposed regulations, a contract is a permitted hedge or
guarantee if the contract is reasonably required to offset
differences that specified risk factors may cause between the amount
or timing of the cash flows on a FASIT's assets and the amount or
timing of the cash flows on the FASIT's regular interests. The
specified risk factors are (1) fluctuations in market interest
rates, (2) fluctuations in currency exchange rates, (3) the credit
quality of the FASIT's assets and regular interests, and (4) the
receipt of payments on the FASIT's assets earlier or later than
originally anticipated.

Several commentators requested that the proposed regulations list
specific types of hedges and guarantees that qualify as permitted
assets. Because the proposed regulations define permitted assets and
guarantees in terms of their function, the proposed regulations do
not include this type of list. Out of a concern that hedges could be
used to effect the economic equivalent of a transfer of non-
permitted assets to the FASIT, the proposed regulations prohibit a
hedge or guarantee from referencing certain assets and indices. In
particular, a hedge is not a permitted hedge if it references an
asset other than a permitted asset or if it references an index,
economic indicator or financial average that is not widely
disseminated and designed to correlate closely with changes in one
or more of the four specified risk factors.

One commentator requested that the proposed regulations permit the
incidental hedging of assets allocable to ownership interests. The
commentator suggested that, as a practical matter, an Owner may
desire to hedge all of the FASIT's assets inside the FASIT even
though the FASIT securitizes less than all of the assets. The
proposed regulations accommodate this concern by allowing the FASIT
to hedge assets held (or to be held) and liabilities issued (or to
be issued).

Thus, under the proposed regulations, an Owner can hedge assets
inside a FASIT that currently relate to the ownership interest if
the assets are being held inside the FASIT because the Owner intends
for them to support FASIT regular interests in the future.

The proposed regulations provide special rules for hedges and
guarantees entered into with the Owner or a related party. These
rules generally allow a FASIT to enter into a hedge (other than a
credit hedge) with the Owner (or a related party) if two conditions
are met. First, the Owner (or related party) must be a dealer with
respect to that type of hedging contract.

Second, the Owner must maintain records establishing that the hedge
contract was entered into at arm's length. In addition, the special
rules provide that an Owner (or a related party) may issue a
guarantee to a FASIT if the Owner can demonstrate that, immediately
after the guarantee is issued, less than three percent of the value
of the FASIT's assets are attributable to Owner guarantees.

Finally, the usefulness of a hedge is diminished if the tax
character of the hedge (as an ordinary or capital asset) does not
match the tax character of the hedged item. Absent a special rule,
disposing of a FASIT hedge could generate capital loss even though
the associated assets and liabilities of the FASIT generate ordinary
income and deductions. To alleviate this character mismatch, the
proposed regulations treat a permitted hedge as an ordinary asset.

Prohibited transactions

1. Background

The FASIT provisions restrict the types of transactions in which a
FASIT may engage through the imposition of a prohibited transactions
tax. The tax is equal to 100 percent of the income a FASIT realizes
from a prohibited transaction. The four categories of prohibited
transactions set out in the FASIT provisions include the receipt of
any income from a loan originated by the FASIT and the receipt of
gains from the FASIT=s disposition of its assets.

2. Loan Origination

Commentators expressed considerable concern over the lack of
statutory guidance on determining whether a debt instrument held by
a FASIT has been originated by the FASIT.

Commentators noted that debt instruments originated through the
Owner's business activities might be deemed to be originated by the
FASIT thereby exposing the FASIT to liability for the prohibited
transactions tax on any income realized on the instrument.

The proposed regulations contain five safe harbors to limit the
scope of the prohibited transaction rules as they relate to loan
origination. Under the first safe harbor, a FASIT is not considered
to have originated a loan if the FASIT acquires the loan from an
established securities market.

Under the second safe harbor, a FASIT is not considered to have
originated a loan if the FASIT acquires the loan more than a year
after the loan was created.

Under the third safe harbor, a FASIT is not considered to have
originated a loan if the FASIT acquires the loan from a person that
regularly originates similar loans in the ordinary course of its
trade or business. Importantly, this third safe harbor extends to
transactions entered into with the Owner (or a related party). As a
result, a FASIT that acquires credit card receivables from its Owner
(or a related party), or creates new receivables from issuances made
on accounts held by the FASIT will not be considered to have
originated the receivables to the extent the Owner (or related
party) originates similar loans in the ordinary course of its
business.

The fourth safe harbor provides that the FASIT will not be treated
as originating any new loan it may receive from the same obligor in
exchange for the obligor's original loan in the context of a
workout.

Finally, a FASIT will not be treated as having originated a debt
instrument when it makes a loan pursuant to a contract or agreement
in the nature of a line of credit the FASIT is permitted to hold.

3. Substitution or Distribution of Debt Instruments.

The FASIT provisions generally impose a prohibited transaction tax
on the distribution of debt instruments to the Owner. An exception
to this rule exists for distributions to the Owner so long as the
principal purpose of the distribution is not the recognition of gain
that is due to changes in market conditions while the FASIT held the
debt instrument. This rule effectively allows an Owner to reduce
over-collateralization so long as the reduction is not designed to
obtain a character advantage. Absent this rule, in times of falling
market interest rates, an Owner could inappropriately generate
capital gain and economically offsetting ordinary loss by disposing
of distributed appreciated debt instruments while having the FASIT
dispose of related hedges. To clarify the application of the
distribution rule, the proposed regulations deem a distribution of a
debt instrument to be carried out principally to recognize gain if
the Owner (or a related person) sells the substituted or distributed
debt instrument at a gain within 180 days of the substitution or
distribution. In this case, the distribution will be a prohibited
transaction subject to the 100- percent tax.

Consequences of FASIT Cessation

Under the FASIT provisions, the Commissioner may consent to the
intended cessation of a FASIT and may grant conditional relief in
the case of an inadvertent cessation. There are, however, no
comprehensive rules describing the consequences of a cessation. The
proposed regulations, therefore, detail how a cessation affects the
FASIT, the underlying arrangement that made the FASIT election, the
Owner, and the regular interest holders. These rules apply unless a
cessation is carried out with the Commissioner's consent, in which
case the consent document controls.

Under the proposed regulations the Owner is treated as disposing of
the FASIT's assets for their fair market value in a prohibited
transaction. Gain, if any, on this deemed distribution is subject to
the prohibited transactions tax. Any loss is disallowed. The Owner
is also treated as satisfying the regular interests for an amount
equal to the lesser of the adjusted issue price or fair market value
of the regular interests. This deemed satisfaction will result in
cancellation of indebtedness income in cases where the aggregate
fair market value of the assets is less than the aggregate adjusted
issue price of the regular interests. The underlying arrangement is
no longer treated as a FASIT and generally is prohibited from making
a new FASIT election. In addition, the underlying arrangement is
treated as holding the assets of the terminated FASIT and is
classified (for example, as a corporation or partnership) under
general tax principles. Finally, the regular interest holders are
treated as exchanging their FASIT regular interests for new
interests in the underlying arrangement. These new interests are
classified under general tax principles, and the deemed exchange of
the regular interests for the new interests may require the regular
interest holders to recognize gain or loss.

RULES APPLICABLE TO OWNER

Under the FASIT provisions, an Owner generally determines its
taxable income by including the gains, losses, income and deductions
of the FASIT and by treating the assets and liabilities of the FASIT
as its own. In addition, the Owner must also follow special rules
concerning the FASIT's tax-exempt income, prohibited transactions
and method of accounting for debt instruments. Few comments were
received concerning these provisions.

Under the special rule concerning the method of accounting for debt
instruments, a FASIT must use the constant yield method in
determining all interest, acquisition discount, original issue
discount (OID), market discount, and premium deductions or
adjustments. To ensure that the Owner uses a constant yield method
for all interest and interest-like items, the proposed regulations
require the Owner to compute the amount of interest income and
premium offset accruing on debt instruments held in a FASIT under
the methodology described in §1.1272-3(c).

One commentator noted that the FASIT provisions speak in terms of
determining the Owner's taxable income, and that taxable income,
which the Code defines as gross income minus deductions, makes no
reference to credits. The proposed regulations, therefore, clarify
the extent to which an Owner, in determining its tax, may claim the
FASIT's credits. In general, the Owner may claim a credit for taxes
paid or deemed paid by the FASIT in the same manner and to the same
extent as if the FASIT were an unincorporated branch of the Owner.
As discussed below, the allowance of a foreign tax credit is subject
to the anti-abuse provisions of this regulation, and other relevant
authorities including case law and the potential application of IRS
Notice 98-5 (1998-3 I.R.B. 49).

Because the Owner includes the FASIT's tax items in determining its
credits and taxable income, the proposed regulations make the Owner
(rather than the FASIT) responsible for reporting those items on its
Federal income tax return. The Owner is required to attach a
separate statement to its income tax return detailing these items.
No specific form is required. Gain recognition on property
transferred to a FASIT 1. Background The FASIT provisions require
Owners (or, in some cases, related persons) to include in income
gain (but not loss) realized on the transfer of assets to a FASIT.
In general, the amount of gain (if any) that must be included is
equal to the value of the transferred asset over its adjusted basis
in the transferor's hands. In addition, the FASIT provisions require
gain (if any) to be recognized on assets the Owner holds outside of
the FASIT but which nonetheless support FASIT regular interests.
Significant comments were received regarding the gain recognition
rule.

In particular, comments were received on the method of valuing
property, the scope of the support rule, and the need for a gain
deferral rule.

2. Related-person Gain Recognition Rule

The IRS and Treasury have determined that the gain recognition rule
of the FASIT provisions could be circumvented when a related person
transfers property to a FASIT. Because the FASIT provisions do not
require that the related person be a taxable C corporation (or even
that the related person be subject to U.S. tax), the intended
corporate-level tax on gain could be avoided by having non-corporate
or foreign related persons make asset transfers. In this case, the
FASIT provisions could be interpreted as allocating gain to the
related person and the economically offsetting losses (usually in
the form of premium offset) to the Owner. This misallocation of
gain, if allowed, would frustrate the purpose of the gain
recognition rule.

The IRS and Treasury considered two ways to address this issue in
developing these proposed regulations. One approach would have
required any contribution from a related party to the FASIT to be
taxed as if it were a deemed sale to the Owner followed by a
contribution to the FASIT. This rule would conform the treatment of
related person contributions with the treatment of contributions
from unrelated persons under section 860I(a)(2). This rule would
also ensure that gain upon contribution would be allocated to the
taxpayer entitled to the subsequently occurring offsetting economic
loss, namely, the Owner. A second approach was to develop
regulations that would limit related person treatment to taxable,
domestic C corporations and ensure that the misallocation of gain
(in the related person) and associated loss (in the Owner) would not
produce unwarranted tax benefits.

The proposed regulations adopt the first approach. Under the
proposed regulations, transactions between a related person and the
FASIT are treated as transactions between the related person and the
Owner followed by transactions between the Owner and the FASIT. This
rule, however, does not apply in all cases. Transfers of publicly
traded property by related persons are unlikely to be abusive. The
rule in the proposed regulations, therefore, only applies if the
related person transfers property not traded on an established
securities market. Thus, for example, the rule applies to a transfer
of consumer receivables, but not to a transfer of Treasury bills.

3. Determination of Value for Gain Recognition Purposes

a. In general

To determine value for purposes of applying the gain recognition
rules, the FASIT provisions divide property into two categories: (1)
debt instruments not traded on an established securities market, and
(2) all other property. The value of debt instruments not traded on
an established securities market is determined by a special
statutory rule. The value of all other property (which includes debt
instruments that are traded on an established securities market) is
fair market value.

Under the special rule, the value of a debt instrument not traded on
an established securities market is the sum of the reasonably
expected cash flows on the instrument, discounted using semiannual
compounding at a rate equal to 120 percent of the applicable federal
rate (AFR).

The intent behind the special valuation rule is uncertain. The
legislative history of the FASIT provisions indicates the rule was
meant to be a simple and mechanical formula that, by its nature,
would not produce accurate results in every case. Specifically, the
legislative history states that the value of an asset is determined
by the special valuation rule even if a different value would be
determined by applying a willing buyer/willing seller standard. See
H.R. Rept.104-737, 104th Cong. 2d Sess., 327 (1996). At the same
time, by applying a fair market value standard to all other assets
(including market-traded debt), Congress showed a clear preference
for using actual fair market value whenever it can be determined
with reasonable accuracy.

Several commentators made suggestions on how to interpret the
legislative intent behind the special valuation rule. In general,
the commentators were concerned that implementing the rule without
modification would in many cases generate tax gains far in excess of
economic gains.

Because the commentators viewed this overvaluation as a substantial
impediment to the use of FASITs, they asked that the proposed
regulations narrow as much as possible the debt instruments subject
to the special valuation rule.

The proposed regulations attempt to reconcile the legislative intent
and the commentators' concerns in a consistent and principled
manner. The policy justification for the special valuation rule is
strongest where it is difficult, if not impossible, to separate the
value of a debt instrument from the value of the Owner's business
relationship with the debtor. For example, the value of credit card
receivables may be inferred if the receivables are placed in trust
and used to create new debt instruments that are sold to the public
at a disclosed price. In this case, however, the implied price
necessarily includes both the value of the receivables and the value
of the transferor's implicit or explicit promise to replace the
receivables as they mature. Because there is no objective, easily
administrable method for allocating the portion of the price
allocable to the receivable (as opposed to the portion allocable to
the transferor's ongoing business), the special valuation rule seems
appropriate in this context.

By contrast, the policy justification for the special valuation rule
is weakest in cases where the fair market value of the debt
instrument can be easily established. For example, if a FASIT
purchases a pool of non-market-traded securities for cash in a
transaction where the FASIT maintains no continuing relationship
with the seller, there appears to be no reason to distrust the value
as determined by an actual arm's length bargaining.

Consistent with this understanding of the purpose behind the special
valuation rule, the proposed regulations take a broad view of what
constitutes an established securities market. In addition, the
regulations clearly delineate whether property is subject to the
special rule and provide a number of exceptions from the special
rule.

b. Traded on an established securities market

The proposed regulations define the term traded on an established
securities market by reference to §1.1273-2(f)(2) through (4) of the
OID regulations. The proposed regulations also give the Commissioner
the power to determine that debt instruments not meeting the
standards of the OID regulations are nevertheless traded on an
established securities market. Under the cross- reference to the OID
regulations, debt is considered traded on an established securities
market if (1) it is listed on certain specified securities exchanges
or on certain interdealer quotation systems, (2) it is traded on a
board of trade or interbank market, or (3) it appears on a quotation
medium that provides a reasonable basis to determine fair market
value by disseminating either recent price quotations or actual
prices of recent sales transactions.

The proposed regulations do not cross-reference §1.1273-2(f)(5) of
the OID regulations.

Consequently, debt is not considered traded on an established
securities market if it is merely readily quotable within the
meaning of §1.1273-2(f)(5). The IRS and Treasury do not expect this
omission to have a significant impact because, under a special
exception (the spot purchase rule, discussed below) the proposed
regulations value non-publicly traded debt instruments at their cost
if a FASIT acquires them in (or soon after) an arm's length cash
purchase.

According to one commentator, bank loans and private placement
loans, which are typically made to small and medium sized
businesses, are readily quotable within the meaning of §1.1273-5(f)
(5) but would not otherwise be considered as traded on an
established securities market. The commentator stated there would be
commercial interest in securitizing these loans through FASITs but
for application of the special valuation rule. Although the proposed
regulations do not adopt the readily quotable standard, the IRS and
Treasury believe bank and private placement loans will be
securitized in transactions qualifying for the spot purchase
exception. Nevertheless, comments are requested on whether the
readily quotable standard is still necessary.

c. Exceptions for debt not traded on an established securities
market

The proposed regulations except from the special valuation rule
certain beneficial and stripped interests. Under this exception, a
certificate representing beneficial ownership of debt instruments
constitutes beneficial ownership of debt instruments traded on an
established securities market if either the certificate or all of
the underlying debt instruments are traded on an established
securities market. Similarly, a stripped bond or stripped coupon
represents debt traded on an established securities market, if
either the strip or the underlying debt instrument is traded on an
established securities market. Because fair market value is easily
determined in these circumstances, there appears to be little reason
to apply the special valuation rule.

Finally, the proposed regulations provide an exception for certain
debt instruments that are contemporaneously purchased and
transferred to the FASIT (the spot purchase rule). Under this
provision, the value of a debt instrument is its cost to the Owner
if four conditions are met: (1) the debt instrument is purchased
from an unrelated person in an arm's length transaction, (2) the
debt instrument is acquired for cash, (3) the price of the debt
instrument is fixed no more than 15 days before the date of the
purchase, and (4) the debt instrument is transferred to the FASIT no
more than 15 days after the date of the purchase.

d. Debt instruments not traded on an established securities market

As discussed above, the special valuation rule values a debt
instrument by discounting the reasonably expected cash flows on the
instrument. The proposed regulations require that the determination
of reasonably expected cash flows be commercially reasonable. The
proposed regulations also permit reasonable assumptions concerning
credit risk, early repayments, and loan servicing costs to be taken
into account. Additional rules discourage the use of assumptions
known to be inaccurate. One safeguard is a consistency test. Even
though a debt instrument may not be traded on an established
securities market, a person securitizing the debt instrument may
make certain public representations about the debt instrument, such
as in a prospectus or an offering memorandum.

The consistency test prevents the use of one set of assumptions for
tax purposes and the use of another set for different purposes.
Specifically, all assumptions used in determining reasonably
expected cash flows (for purposes of the FASIT valuation rule) must
be no less favorable than the assumptions underlying the
representations made to any of the following groups in the
prescribed order: investors, rating agencies, or governmental
agencies. For example, if one default rate is assumed to value debt
instruments in a prospectus, a higher default rate cannot be assumed
to value the debt instruments for purposes of the gain recognition
provisions. Even if no representations concerning value are made to
investors, rating agencies, or governmental agencies, the
assumptions made for purposes of the gain recognition provisions
must still be consistent with any applicable industry customs and
standards. To encourage adherence to the consistency test, the
Commissioner may determine reasonably expected cash flows without
making any adjustment if the assumption made with respect to that
adjustment (for example, assumed credit risks) fails the consistency
test or is otherwise unreasonable.

In addition to the consistency test, the proposed regulations place
a ceiling on projected loan servicing costs. Specifically, the
amount of loan servicing costs projected may not exceed the lesser
of (1) the amount the FASIT agrees to pay the Owner (or a related
person) for servicing all, or a portion, of the loans held by the
FASIT, or (2) the amount a third party would reasonably pay for the
servicing of identical loans.

e. Special valuation rule for guarantees

Because a guarantee usually is not a debt instrument, any gain
recognized on transferring a guarantee to a FASIT would be
determined using the guarantee's fair market value absent a special
rule. Nevertheless, if a guarantee relates solely to non-traded debt
instruments, the proposed regulations allow taxpayers to value the
guarantee and the debt instruments together.

Under this rule, the reasonably expected payments on the guarantee
are treated as part of the reasonably expected payments on the debt
instruments to which the guarantee relates.

4. Property Held Outside a FASIT Supporting FASIT Regular Interests

An Owner (or a person related to the Owner) must recognize gain on
any property the Owner or related person holds outside the FASIT
that supports the regular interests. In addition, property held by
the Owner or related person that supports regular interests is
treated as held by the FASIT for all purposes of the FASIT
provisions. By treating support property as transferred to and held
by a FASIT, the support rules discourage taxpayers from trying to
avoid the gain-on-transfer rules and ensure that FASIT income
includes the income from all FASIT property.

Commentators asked for a clear and narrow definition of support
property. They suggested limiting the support rule to situations in
which the arrangement with the regular interest holders indicates
that assets held outside the FASIT would have been transferred to
the FASIT but for the gain recognition rules. Under this view,
support property includes: (1) subordinated interests in debt
instruments contributed to the FASIT, (2) property securing an
Owner's guarantee, and (3) contribution agreements that allow the
FASIT to purchase a debt instrument for an amount significantly
below its fair market value. Several commentators argued that unless
a narrow view of support is adopted, the support rule threatens to
subject to the gain recognition rule all property held by an Owner
whenever the Owner guarantees a regular interest or has any kind of
continuing relationship with the FASIT.

Consistent with the comments received, the proposed regulations
narrowly define support property. Under the proposed regulations,
property generally is support property if the Owner (or a related
person): (1) identifies the property as providing security for a
regular interest, (2) sets aside the property for transfer to the
FASIT under a contribution agreement, or (3) holds an interest in
the property that is subordinate to the FASIT's interest in the
property. This last situation can arise, for example, if the Owner
holds the junior interests in a pool of debt instruments while the
FASIT holds the senior interests.

5. Deferral of Gain Recognition

Although gain must ordinarily be recognized as soon as property is
transferred, the FASIT provisions authorize regulations under which
gain on transferred property is deferred until the transferred
property supports regular interests. Several commentators
specifically requested a gain deferral system and one explained in
detail how a gain deferral system could be applied to a constantly
revolving pool of assets.

The proposed regulations do not provide a general gain deferral
system. After carefully considering the issues involved, the IRS and
Treasury have determined that gain deferral rules must build on
rules for accounting for pooled debt instruments. The IRS and
Treasury anticipate providing rules for pooled debt instrument in
future guidance, and at that time expect to revisit the FASIT gain
deferral rules.

Although the proposed regulations do not provide rules for gain
deferral generally, rules permitting gain deferral for pre-effective
date FASITs have been developed consistent with the requirements of
the Act. The IRS and the Treasury request comments on whether and
how the gain deferral system for pre-effective date FASITs may be
modified to accommodate a general gain deferral system.

Ownership Interests and Consolidated Groups

By statute, to qualify as a FASIT, an arrangement must have one (and
only one) ownership interest, and that ownership interest must be
held by one (and only one) eligible corporation. Congress, however,
anticipated that Treasury would "issue guidance on how the ownership
rule would apply to cases in which the entity that owns the FASIT
joins in the filing of a consolidated return with other members of
the group that wish to hold an ownership interest in the FASIT." See
H.R. Conf. Rep. No. 737, 104th Cong., 2d Sess. 329 (1996).

Commentators urged the IRS and Treasury to issue guidance that would
change the statutory rule and permit members of a consolidated group
to jointly hold a FASIT ownership interest. In studying the issue,
however, the IRS and Treasury became concerned about how such
guidance would continue to satisfy those general principles of the
consolidated return regulations that preclude the shifting of stock
basis, income, or loss. The IRS and Treasury considered different
models that would permit members of a consolidated group to jointly
hold (or enjoy the benefits of jointly holding) a FASIT ownership
interest, but none of these were found to adequately address the
government's concerns without adding administrative complexity for
both the IRS and taxpayers. Moreover, the IRS and Treasury are not
convinced the level of potential attribute shifting should be
disregarded or addressed through an anti-abuse rule or would be so
minor that disregarding it would be appropriate. Therefore, the
proposed regulations do not provide rules permitting members of a
consolidated group to jointly hold ownership interests in a FASIT.
The IRS and Treasury invite the submission of additional comments
that would address these concerns.

Transfers of ownership interests

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

RULES APPLICABLE TO REGULAR INTEREST HOLDERS

The FASIT provisions treat a regular interest as a debt instrument
for all purposes of the Code and require the holder to account for
gross income with respect to the regular interest under an accrual
method.

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

SPECIAL RULES

Anti-Abuse Rule

The proposed regulations contain an anti-abuse rule patterned after
the anti-abuse rule in the partnership regulations issued under
subchapter K. The FASIT anti-abuse rule evaluates transactions
against the underlying purpose of the FASIT provisions, which is to
promote the spreading of credit risk on debt instruments by
facilitating the securitization of debt instruments.

If a FASIT is formed or used to achieve a tax result inconsistent
with this purpose, the Commissioner may take remedial action,
including disregarding the FASIT election, reallocating items of
income, deductions and credits, recharacterizing regular interests,
and redesignating the holder of the ownership interest. Whether a
FASIT is formed or used to achieve a tax result that is inconsistent
with the FASIT provisions is a question of fact. In addition to
applying the specific anti-abuse rule included in these proposed
regulations, the IRS and Treasury will also continue to apply other
statutory, administrative, and judicial anti-abuse provisions, such
as the judicial doctrines of economic substance and substance over
form, to transactions and structures involving FASITs. For example,
see the principles of Notice 98-5 (1998-3 I.R.B. 49), regarding
foreign tax credits.

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

INTERNATIONAL PROVISIONS

Prohibition of Foreign FASITS and Segregated Pools Subject to
Foreign Tax.

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

The IRS and Treasury request comments regarding whether there may be
circumstances in which legitimate (non-tax) business reasons justify
allowing a FASIT election to be made by a foreign entity, or an
entity the income of which is subject to net foreign taxation, or on
behalf of a segregated pool which may be subject to net foreign
taxation.

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

Avoidance of U.S. Withholding Tax

The IRS and Treasury are also concerned that FASITs may be used by
foreign resident taxpayers to avoid U.S. withholding taxes that
would otherwise be imposed on direct cross-border financing to a
foreign person's U.S. subsidiary. In particular, the IRS and
Treasury are aware that foreign taxpayers may attempt to use FASITs
to convert interest that would be disqualified from the portfolio
interest exemption under sections 871(h)(3), 881(c)(3)(B), and
881(c)(3)(C) (concerning interest paid to a 10 percent shareholder
and interest paid to a controlled foreign corporation from a related
person) into interest that qualifies as portfolio interest. To
prevent such avoidance, the proposed regulations provide that
interest paid or accrued to a foreign holder of a FASIT regular
interest will not qualify as portfolio interest under sections
871(h)(3) and 881(c)(3) to the extent that the FASIT receives or
accrues interest from an obligor who is a U.S. resident taxpayer
(the related obligor) if (1) the foreign holder is a 10 percent
shareholder (within the meaning of Section 871(h)(3)) of the related
obligor or (2) the foreign holder is a controlled foreign
corporation and the related obligor is a related person (within the
meaning of section 864(d)(4)) with respect to the foreign holder.
For these purposes, the related obligor is defined as a conduit
debtor who is treated as paying interest directly to the 10 percent
shareholder or the controlled foreign corporation for purposes of
sections 871, 881, 1441 and 1442. This rule characterizes all
interest of the foreign regular interest holder as non-portfolio
interest if the FASIT receives or accrues an equal or greater amount
of interest from the related obligor.

Further, the IRS and Treasury request comments concerning whether
FASIT regular interests, REMIC regular interests, and pass through
certificates should be treated in a consistent manner for purposes
of applying U.S. withholding tax rules. The IRS and Treasury intend
to issue regulations that will provide that the FASIT and its Owner
are withholding agents in respect of payments made to foreign
regular interest holders.

The IRS and Treasury solicit comments with respect to circumstances
in which the FASIT and its Owner may be unaware of a possible
relationship between foreign regular interest holders and the
related obligors of the debt instruments held by the FASIT or other
circumstances under which it would be inappropriate to treat
payments to a regular interest holder as payments directly from a
conduit debtor. It is anticipated that these regulations will
provide that the FASIT and its Owner will not be responsible for
withholding amounts paid to the foreign regular interest holders in
the above circumstances unless the FASIT or its Owner knows, or has
reason to know, that the foreign regular interest holder is a 10
percent shareholder of the related obligor or is a controlled
foreign corporation considered to be receiving interest from a
related person. It is expected that these regulations will further
provide that the FASIT and its Owner shall be presumed to know that
these circumstances exist if the foreign regular interest holder
owns 10 percent or more of the total value of the FASIT's regular
interests and the debt of the related obligor accounts for 10
percent or more of the total value of the FASIT's assets.

Earnings stripping and original issue discount

The IRS and Treasury are also aware that regular interests in FASITs
may be used by foreign residents to avoid other consequences that
might apply to cross-border related-party payments. The IRS and
Treasury are concerned that taxpayers may attempt to use FASITs to
avoid the deferrals on deductibility imposed by sections 163(e)(3)
on OID owing to related foreign persons and 163(j) on net interest
expense that is otherwise treated as disqualified under the earnings
stripping rules.

Similar to the rules adopted for portfolio indebtedness purposes,
the proposed regulations treat a U.S. resident taxpayer who is an
obligor to a FASIT as a conduit debtor to the extent a related
person (within the meaning of section 267(b) or 707(b)(1)) who would
not be subject to tax on a direct payment by the U.S. obligor
receives interest with respect to a regular interest in the FASIT.
In such circumstances, the earnings stripping provisions will apply
to treat interest paid by a U.S. corporation or a U.S. trade or
business of a foreign corporation on an obligation held by a FASIT
as disqualified interest for purposes of section 163(j). Similarly,
the conduit debtor rule also operates to treat OID accrued to a
FASIT by a domestic party as deferred to the extent a related
foreign person (as defined in section 163(e)(3)(B)) receives
interest with respect to a regular interest of the FASIT. These
rules apply to payments and accruals made during the same period the
regular interest in the FASIT is held by the 10 percent shareholder
or foreign related party.

No correlative adjustments to FASIT

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

Interest expense allocation

For purposes of applying the interest expense allocation rules to
the Owner under section 864(e) and the regulations thereunder, new
proposed regulations provide that all interest expense from all
FASITs that is treated as incurred by any Owner or by any other
Owner that is a member of the same affiliated group of which the
Owner is a member is directly allocated solely to all income from
all FASITs of such Owners. The directly allocated interest expense
is treated as directly related to all activities and assets of all
the Owner's FASITs and is apportioned between domestic and foreign
source FASIT gross income by applying the general asset method to
the FASIT's assets. The proposed interest allocation rules also
extend the existing asset adjustment rules under the asset method in
§1.861-9T(g), which reduce assets to reflect the principal amount of
indebtedness outstanding relating to the interest which is directly
allocated. The rules of §1.861-10T(d)(2) are also made applicable.
In addition, the new proposed interest allocation rules are the
exclusive method for the direct allocation of FASIT interest
expense. The IRS and Treasury are not aware of any situations in
which the direct allocation rules of the existing temporary
regulations would apply to any items of FASIT income and interest
expense.

Comments are solicited in this regard.

The rules apply to interest expense with respect to any FASIT as of
that FASIT's startup day and throughout the entire period that the
arrangement continues to qualify as a FASIT. The rules provide the
Commissioner with discretion to continue to directly allocate
interest expense with respect to a ceased FASIT to FASIT income if
the Commissioner determines that a principle purpose for terminating
the FASIT was to affect the interest allocation.

The IRS and Treasury believe that directly allocating FASIT interest
expense solely to FASIT gross income is an administrable and
appropriate way to limit distortions (favorable or unfavorable as
the case may be) to a taxpayer's overall allocation of interest
expense for foreign tax credit purposes. It is recognized, however,
that the new proposed direct allocation rules may enable certain
interest expense allocation planning that may create distortions
that would not occur under existing interest allocation rules. To
address these concerns, the IRS and Treasury are considering whether
to adopt rules in final regulations that limit the extent to which
the direct allocation rules may apply, including rules regarding the
amount of variance between the direct allocation and combined asset
allocation rules that is appropriate. Comments are solicited on this
issue.

PRE-EFFECTIVE DATE FASITs

Section 1691(e) of the Small Business Job Protection Act of 1996
(the Act) provides special transition rules for securitization
entities in existence on August 31, 1997. Under these rules, the
Owner of a pre-effective date FASIT may defer the recognition of
FASIT gain on assets attributable to pre-FASIT interests. For
purposes of this rule, a pre-effective date FASIT is a FASIT the
underlying arrangement of which was in existence on August 31, 1997.
A pre-FASIT interest is an interest in the underlying arrangement
that was outstanding on the FASIT startup date and that is
considered debt under general tax principles.

The proposed regulations provide a safe-harbor method of accounting
that allows the separation of FASIT gain attributable to pre-FASIT
interests, and other FASIT gain. Basically, the safe-harbor method
has three steps. Under the first step, the Owner groups the assets
of the FASIT into pools. To ensure that each pool can be marked to
market using a valuation methodology appropriate for its constituent
assets, the proposed regulations provide that no pool may contain
assets of more than one of the following three types: (1) assets
that are valued under the special valuation rule and that have FASIT
gain on the first day they are held by the FASIT, (2) assets that
are valued under general fair market value principles and that have
FASIT gain on the first day they are held by the FASIT, and (3)
assets that do not have FASIT gain on the first day they are held by
the FASIT.

Under the second step, the Owner periodically computes for each pool
the difference between the income determined under a mark-to-market
system (using the appropriate FASIT valuation methodology) and the
income determined under an accrual system. This difference is
referred to as FASIT gain (or loss) and is essentially a measure of
the gain (or loss) from the pool that is attributable to the
operation of the FASIT gain recognition rules. These rules require
gain to be determined at the pool level when assets are contributed
to a FASIT, and implicitly allow this gain to be reversed out (as
deductions in the nature of premium offset) as the assets in the
pool mature. In periods in which net contributions are made to the
pool, the calculation generally will produce FASIT gain. In periods
in which the pool decreases in size or duration, the calculation
generally will produce FASIT loss. This FASIT loss is, in effect, a
recapture of previously determined FASIT gain. Over the entire life
of a pool, the aggregate FASIT gain (or loss) will be zero; the
FASIT valuation rules do not create lifetime net income.

Under the third step, the Owner determines the proper amount of
FASIT gain (or loss) to recognize during the current period. To
determine this amount, the Owner first calculates the total amount
of FASIT gain as of the last day of the current period. The Owner
then reduces this amount to exclude the percentage of the FASIT gain
that is attributable to pre-FASIT interests outstanding on the last
day of the period. This reduced amount represents the cumulative
amount of FASIT gain the Owner should recognize by the end of the
current period. Finally, to adjust for amounts recognized in
previous periods, the Owner subtracts from this amount the
cumulative amount of FASIT gain that the Owner had recognized at the
end of the previous period. The difference is the amount of FASIT
gain (or loss) to be recognized in the current period.

Owners of pre-effective date FASITs that presently use a gain
deferral methodology that differs from the safe harbor method
described above may adopt the safe-harbor method. The IRS and
Treasury request comments on whether guidance is needed on how this
change of method may be accomplished.

PROPOSED AMENDMENT TO REMIC REGULATIONS

Final regulations governing REMICs, issued in 1992, contain rules
governing the transfer of noneconomic REMIC residual interests. In
general, a transfer of a noneconomic residual interest is
disregarded for all tax purposes if a significant purpose of the
transfer is to enable the transferor to impede the assessment or
collection of tax. A purpose to impede the assessment or collection
of tax (a wrongful purpose) exists if the transferor, at the time of
the transfer, either knew or should have known that the transferee
would be unwilling or unable to pay taxes due on its share of the
REMIC's taxable income.

Under a safe harbor, the transferor of a REMIC residual interest is
presumed not to have a wrongful purpose if two requirements are
satisfied. First, the transferor must conduct a reasonable
investigation of the transferee's financial condition. Second, the
transferor must secure a representation from the transferee to the
effect that the transferee understands the tax obligations
associated with holding a residual interest and intends to pay those
taxes.

The IRS and Treasury are concerned that some transferors of residual
interests claim they satisfy the safe harbor even in situations
where the economics of the transfer clearly indicate the transferee
is unwilling or unable to pay the tax associated with holding the
interest. The proposed regulations, therefore, would clarify the
safe harbor. The proposal explains that the safe harbor is
unavailable unless the present value of the anticipated tax
liabilities associated with holding the residual interest does not
exceed the sum of: (1) the present value of any consideration given
to the transferee to acquire the interest; (2) the present value of
the expected future distributions on the interest; and (3) the
present value of the anticipated tax savings associated with holding
the interest as the REMIC generates losses. No inference is intended
regarding whether any existing transactions satisfy the substantive
requirements of this safe harbor before the clarification made by
this amendment.

Proposed Effective Date

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

Special Analyses

It is hereby certified that these proposed regulations will not have
a significant economic impact on a substantial number of small
entities. This certification is based on the fact that it is
unlikely that a substantial number of small entities will hold FASIT
ownership interests.

Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C.

chapter 6) is not required. It has been determined that this
Treasury decision is not a significant regulatory action as defined
in Executive Order 12866. Therefore, a regulatory assessment is not
required. Pursuant to section 7805(f) of the Internal Revenue Code,
these proposed regulations will be submitted to the Chief Counsel
for Advocacy of the Small Business Administration for comment on
their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed
original and eight (8) copies) that are submitted timely to the IRS.
All comments will be available for public inspection and copying.

A public hearing has been scheduled for May 15, 2000, beginning at
10 a.m. in Room 2615 of the Internal Revenue Building, 1111
Constitution Avenue, NW., Washington, DC. Due to building security
procedures, visitors must enter at the 10 Street entrance, located
between th Constitution and Pennsylvania Avenues, NW. In addition,
all visitors must present photo identification to enter the
building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts. For information about having your name
placed on the building access list to attend the hearing, see the
"FOR FURTHER INFORMATION CONTACT" section of this preamble. The
rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish
to present oral comments at the hearing must submit written comments
and an outline of the topics to be discussed and the time to be
devoted to each topic (signed original and eight (8) copies) by
April 24, 2000. A period of 10 minutes will be allotted to each
person for making comments. An agenda showing the scheduling of the
speakers will be prepared after the deadline for receiving outlines
has passed. Copies of the agenda will be available free of charge at
the hearing. Drafting Information The principal author of these
proposed regulations is David L. Meyer, Office of Assistant Chief
Counsel (Financial Institutions and Products), IRS. However, other
personnel from the IRS and Treasury Department participated in their
development.

List of Subjects

26 CFR Part 1 Income taxes, Reporting and record keeping
requirements.

26 CFR Part 602 Reporting and record keeping requirements.

Proposed Amendments to the Regulations

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

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by
removing the entry for 1.861-10(e) and adding entries in numerical
order to read as follows: Authority: 26 U.S.C. 7805. * * *

Section 1.860H-1 also issued under 26 U.S.C. 860L(h).

Section 1.860H-2 also issued under 26 U.S.C. 860L(h).

Section 1.860H-3 also issued under 26 U.S.C. 860L(h) and 860L(f).

Section 1.860H-4 also issued under 26 U.S.C. 860L(h).

Section 1.860H-5 also issued under 26 U.S.C. 860L(h) and 7701(l).

Section 1.860I-1 also issued under 26 U.S.C. 860L(h) and 860I(c).

Section 1.860I-2 also issued under 26 U.S.C. 860L(h).

Section 1.860J-1 also issued under 26 U.S.C. 860L(h).

Section 1.860K-1 also issued under 26 U.S.C. 860L(h).

Section 1.860L-1 also issued under 26 U.S.C. 860L(h).

Section 1.860L-2 also issued under 26 U.S.C. 860L(h).

Section 1.860L-3 also issued under 26 U.S.C. 860L(h).

Section 1.860L-4 also issued under 26 U.S.C. 860L(h). * * *

Section 1.861-9 also issued under 26 U.S.C. 864(e)(7).

Section 1.861-10 also issued under 26 U.S.C 863(a), 26 U.S.C. 864(e)
(7), 26 U.S.C. 865(i), and 26 U.S.C. 7701(f). * * *

Par. 2. Section 1.860E-1 is amended by:

1. Revising paragraph (c)(4).

2. Adding paragraphs (c)(5) and (c)(6).

The addition and revision read as follows: §1.860E-1 Treatment of
taxable income of a residual interest holder in excess of daily
accruals.

* * * * *

(c) * * *

(4) Safe harbor for establishing lack of improper knowledge. A
transferor is presumed not to have improper knowledge if--

(i) The transferor conducted, at the time of the transfer, a
reasonable investigation of the financial condition of the
transferee and, as a result of the investigation, the transferor
found that the transferee had historically paid its debts as they
came due and found no significant evidence to indicate that the
transferee will not continue to pay its debts as they come due in
the future;

(ii) The transferee represents to the transferor that it understands
that, as the holder of the noneconomic residual interest, the
transferee may incur tax liabilities in excess of any cash flows
generated by the interest and that the transferee intends to pay
taxes associated with holding residual interest as they become due;
and

(iii) The present value of the anticipated tax liabilities
associated with holding the residual interest does not exceed the
sum of--

(A) The present value of any consideration given to the transferee
to acquire the interest;

(B) The present value of the expected future distributions on the
interest; and

(C) The present value of the anticipated tax savings associated with
holding the interest as the REMIC generates losses.

(5) Computational assumptions. The following rules apply for
purposes of paragraph

(c)(4)(iii) of this section:

(i) The transferee is assumed to pay tax at a rate equal to the
highest rate of tax specified in section 11(b)(1); and

(ii) Present values are computed using a discount rate equal to the
applicable Federal rate prescribed by section 1274(d) compounded
semiannually (a lower discount rate may be used if the transferee
can demonstrate that it regularly borrows, in the course of its
trade or business, substantial funds at such lower rate from
unrelated third parties). (6) Effective date. Paragraphs (c)(4) and
(5) of this section are applicable on February 4, 2000.

Par. 3. Sections 1.860H-0 through 1.860L-4 are added to read as
follows: §1.860H-0 Table of contents.

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

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

(a) FASIT defined.

(b) FASIT election.

(1) Person that makes the election.

(2) Form of election.

(3) Time for filing election.

(4) Contents of election.

(5) Required signatures.

(6) Special rules regarding startup day.

(c) General definitions.

(1) Owner.

(2) Transfer. §1.860H-2 Assets permitted to be held by a FASIT.

(a) Substantially all.

(b) Permitted debt instrument.

(1) In general.

(2) Special rules for short-term debt instruments issued by the
Owner or related person.

(3) Exceptions.

(c) Cash and cash equivalents.

(d) Hedges and guarantees.

(1) In general.

(2) Referencing other than permitted assets.

(3) Association with particular assets or regular interests.

(4) Creating an investment prohibited.

(e) Hedges and guarantees issued by Owner (or related person).

(1) Hedges.

(2) Guarantees.

(f) Foreclosure property.

(g) Special rule for contracts or agreements in the nature of a line
of credit.

(h) Contracts to acquire hedges or debt instruments. §1.860H-3
Cessation of a FASIT.

(a) In general.

(b) Time of cessation.

(c) Consequences of cessation.

(d) Disregarding inadvertent failures to remain qualified.

§1.860H-4 Regular interests in general.

(a) Issue price of regular interests.

(1) Regular interests not issued for property.

(2) Regular interests issued for property.

(b) Special rules for high-yield regular interests.

(1) High-yield interests held by a securities dealer.

(2) High-yield interests held by a pass-thru. §1.860H-5 Foreign
resident holders of regular interests.

(a) Look-through to underlying FASIT debt.

(b) Conduit debtor.

(c) Limitation.

(d) Cross-references. §1.860H-6 Taxation of Owner, Owner's reporting
requirements, transfers of ownership interest.

(a) In general.

(b) Constant yield method to apply.

(c) Method of accounting for, and character of, hedges.

(d) Coordination with mark to market provisions.

(1) No mark to market accounting.

(2) Transfer of a mark to market asset to a FASIT.

(e) Owner's annual reporting requirements.

(f) Treatment of FASIT under subtitle F of Title 26 U.S.C.

(g) Transfer of ownership interest.

(1) In general.

(2) Safe harbor for establishing lack of improper knowledge.

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

(a) In general.

(b) Support property defined.

(c) Time of gain determination and recognition.

(d) Gain deferral election. [Reserved]

(e) Amount of gain.

(f) Record keeping requirements.

(g) Special rule applicable to property of related persons.

'1.860I-2 Value of property.

(a) Special valuation rule.

(b) Traded on an established securities market.

(c) Reasonably expected payments.

(1) In general.

(2) Consistency requirements.

(3) Servicing costs.

(4) Nonconforming or unreasonable assumptions.

(d) Special rules.

(1) Beneficial ownership interests.

(2) Stripped interests.

(3) Contemporaneous purchase and transfer of debt instruments.

(4) Guarantees.

(e) Definitions. '1.860J-1 Non-FASIT losses not to offset certain
FASIT inclusions.

(a) In general.

(b) Special rule for holders of multiple ownership interests.

(c) Related persons.

(1) Taxable income.

(2) Effect on net operating loss.

(3) Coordination with minimum tax. '1.860L-1 Prohibited
transactions.

(a) Loan origination.

(1) In general.

(2) Acquisitions presumed not to be loan origination.

(3) Activities presumed to be loan origination.

(4) Loan workouts.

(b) Origination of a contract or agreement in the nature of a line
of credit.

(1) In general.

(2) Activities presumed to be origination.

(3) Debt instruments issued under contracts or agreements in the
nature of a line of credit.

(c) Disposition of debt instruments.

(d) Exclusion of prohibited transactions tax to dispositions of
hedges. '1.860L-2 Anti-abuse rule.

(a) Intent of FASIT provisions.

(b) Application of FASIT provisions.

(c) Facts and circumstances analysis. '1.860L-3 Transition rule for
pre-effective date FASITs.

(a) Scope.

(1) Pre-effective date FASIT defined.

(2) Pre-FASIT interest defined.

(3) FASIT gain defined.

(b) Election to defer gain.

(c) Safe harbor method.

(d) Example

(e) Election to apply gain deferral retroactively

(f) Effective date. §1.860L-4 Effective date. '1.860H-1 FASIT
defined, FASIT election, other definitions.

(a) FASIT defined. (1) A FASIT is a qualified arrangement (as
defined in paragraph

(a)(2) of this section) that meets the requirements of section
860L(a)(1) and the FASIT regulations (as defined in paragraph (c) of
this section). A qualified arrangement fails to meet the
requirements of section 860L(a)(1) unless it has one and only one
ownership interest and that ownership interest is held by one and
only one eligible corporation (as defined in section 860L(a)(2)).

(2) Except as provided in paragraph (a)(3) of this section, a
qualified arrangement is an arrangement that is either--

(i) An entity (other than a regulated investment company as defined
in section 851(a)); or

(ii) A segregated pool of assets if--

(A) The initial assets of the pool are clearly identified, such as
through an indenture; and

(B) Changes in the assets of the pool are clearly identified, such
as through instruments of conveyance or release.

(3) Notwithstanding paragraph (a)(2) of this section, a qualified
arrangement does not include--

(i) An entity created or organized under the law of a foreign
country or a possession of the United States;

(ii) An entity any of the income of which is or ever has been
subject to net tax by a foreign country or a possession of the
United States; or

(iii) A segregated pool of assets any of the income of which at any
time is subject to net tax by a foreign country or a possession of
the United States.

(b) FASIT election--(1) Person that makes the election. For a
qualified arrangement to be a FASIT an eligible corporation (as
defined in section 860L(a)(2)) must make the election required under
section 860L(a)(1)(A).

(i) If the qualified arrangement is an entity described in paragraph
(a)(2)(i) of this section, the eligible corporation making the
election must hold one or more interests in the entity, and one of
those interests must be the interest designated as the FASIT's
ownership interest.

(ii) If the qualified arrangement is a segregated pool of assets
described in paragraph (a)(2)(ii) of this section, the eligible
corporation making the election must be the first taxpayer to be
treated as the Owner of the resulting FASIT.

(2) Form of election. Unless the Commissioner prescribes otherwise,
a FASIT election is made by means of a statement attached to the
Federal income tax return of the eligible corporation making the
election.

(3) Time for filing election. The statement referred to in paragraph
(b)(2) of this section must be attached to a timely filed (including
extensions) original Federal income tax return for the eligible
corporation's taxable year in which the FASIT's startup day occurs.
An election may not be made on an amended return.

(4) Contents of election. The statement referred to in paragraph (b)
(2) of this section must include--

(i) For other than a segregated pool of assets, the name, address,
and taxpayer identification number of the arrangement (if one was
issued prior to the making of the election);

(ii) For a segregated pool of assets, the following information--

(A) The name, address, and taxpayer identification number of the
person or persons holding legal title to the pool of assets;

(B) The name, address, and taxpayer identification number of the
person or persons that, immediately before the startup day, are
considered to own the pool for Federal income tax purposes; and

(C) Information describing the origin of the pool (including the
caption and date of execution of any instruments of indenture or
similar documents that govern the pool);

(iii) The startup day; and

(iv) The name and title of all persons signing the statement.

(5) Required signatures. The statement referred to in paragraph (b)
(2) of this section must be signed by the authorized person,
described in this paragraph (b)(5).

(i) For other than a segregated pool of assets, the authorized
person is any person authorized to sign the qualified arrangement's
Federal income tax return in the absence of a FASIT election. For
example, if a qualified arrangement is a corporation or trust under
applicable state law, an authorized person is a corporate officer or
trustee, respectively.

(ii) For a segregated pool of assets, the authorized person is each
person who, for Federal income tax purposes, owns the assets of the
pool immediately before the earlier of the date on which--

(A) An outstanding interest in the pool is designated as a regular
or ownership interest in a FASIT; or

(B) The pool issues an interest designated at the time of issuance
as a regular or ownership interest in a FASIT.

(6) Special rule regarding startup day. The startup day must be a
day on which the eligible corporation making the election is
described in paragraph (b)(1)(i) or (ii) of this section.

(c) General definitions. For purposes of the regulations issued
under part V of subchapter M of chapter 1 of subtitle A of the
Internal Revenue Code (the FASIT regulations)--

(1) Owner means the eligible corporation that holds the interest
described in section 860L(b)(2);

(2) Transfer includes a sale, contribution, endorsement, or other
conveyance of a legal or beneficial interest in property.

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

(a) Substantially all. For purposes of section 860L(a)(1)(D),
substantially all of the assets held by a FASIT consist of permitted
assets if the total adjusted bases of the permitted assets is more
than 99 percent of the total adjusted bases of all the assets held
by the FASIT, including those assets deemed to be held under section
860I(b)(2).

(b) Permitted debt instrument--(1) In general. Except as otherwise
provided, a debt instrument is described in section 860L(c)(1)(B)
only if it is a permitted debt instrument. For purposes of the FASIT
regulations, a permitted debt instrument is--

(i) A fixed rate debt instrument, including a debt instrument having
more than one payment schedule for which a single yield can be
determined under '1.1272-1(c) or (d);

(ii) A variable rate debt instrument within the meaning of '1.1275-5
if the debt instrument provides for interest at a qualified floating
rate within the meaning of '1.1275-5(b);

(iii) A REMIC regular interest;

(iv) A FASIT regular interest (including a FASIT regular interest
issued by another FASIT in which the Owner (or a related person)
holds an ownership interest);

(v) An inflation-indexed debt instrument as defined in '1.1275-7;

(vi) Any receivable generated through an extension of credit under a
revolving credit agreement (such as a credit card account);

(vii) A stripped bond or stripped coupon (as defined in section
1286(e)(2) and (3)), if the debt instrument from which the stripped
bond or stripped coupon is created is described in paragraphs (b)(1)
(i) through (vi) of this section; and (viii) A certificate of trust
representing a beneficial ownership interest in a debt instrument
described in paragraphs (b)(1)(i) through (vii) of this section.

(2) Special rules for short-term debt instruments issued by the
Owner or related person.

Notwithstanding section 860L(c)(2) and paragraph (b)(3)(iii) of this
section, a debt instrument issued by the Owner (or a related person)
is a permitted debt instrument if it--

(i) Is described in paragraph (b)(1)(i) or (ii) of this section;

(ii) Has an original stated maturity of 270 days or less;

(iii) Is rated at least investment quality by a nationally
recognized statistical rating organization that is not a related
person of the issuer; and

(iv) Is acquired to temporarily invest cash awaiting either
reinvestment in permitted assets not described in this paragraph (b)
(2), or distribution to the Owner or holders of one or more FASIT
regular interests.

(3) Exceptions. Notwithstanding paragraph (b)(1) of this section,
the following debt instruments are not permitted assets.

(i) Equity-linked debt instrument. A debt instrument is not a
permitted asset if the debt instrument contains a provision that
permits the instrument to be converted into, or exchanged for, any
legal or beneficial ownership interest in any asset other than a
permitted debt instrument (such as a debt instrument that is
exchangeable for an interest in a partnership). Similarly, a debt
instrument is not a permitted asset if the debt instrument contains
a provision under which one or more payments on the instrument are
determined by reference to, or are contingent upon, the value of any
asset other than a permitted debt instrument (such as a debt
instrument containing a provision under which one or more payments
on the instrument are determined by reference to, or are contingent
upon, the value of stock).

(ii) Defaulted debt instrument. A debt instrument is not a permitted
asset if, on the date the debt instrument is acquired by the FASIT,
the debt instrument is in default due to the debtor's failure to
have timely made one or more of the payments owed on the debt
instrument and the Owner has no reasonable expectation that all
delinquent payments on the debt instrument, including any interest
and penalties thereon, will be fully paid on or before the date that
is 90 days after the date the instrument is first held by the FASIT.

(iii) Owner debt. A debt instrument is not a permitted asset if the
debt instrument is issued by the Owner (or a related person) and the
debt instrument does not qualify as a permitted debt instrument
under paragraphs (b)(1)(iv) or (2) of this section.

(iv) Certain Owner-guaranteed debt. A debt instrument is not a
permitted asset if the debt instrument is guaranteed by the Owner
(or a related person) and, based on all of the facts and
circumstances existing at the time the guarantee is given, or at the
time the FASIT acquires the guaranteed debt instrument the Owner (or
a related person) is, in substance, the primary obligor on the debt
instrument. For this purpose, a guarantee includes any promise to
pay in the case of the default or imminent default of any debt
instrument.

(v) Debt instrument linked to the Owner's credit. A debt instrument
that is issued by a person other than the Owner (or a related
person) is not a permitted asset if the timing or amount of payments
on the instrument are determined by reference to, or are contingent
on, the timing or amount of payments made on a debt instrument
issued by the Owner (or a related person).

(vi) Partial interests in non-permitted debt instruments. A debt
instrument is not a permitted asset if the debt instrument is a
partial interest such a stripped bond or stripped coupon (as defined
in section 1286(e)) in a debt instrument described in paragraphs (b)
(3)(i) through (v) of this section.

(vii) Certain Foreign Debt Subject to Withholding Tax. A debt
instrument is not a permitted asset if the debt instrument is traded
on an established securities market (within the meaning of
§1.860I-2) and interest on the debt instrument is subject to any tax
determined on a gross basis (such as a withholding tax) other than a
tax which is in the nature of a prepayment of a tax imposed on a net
basis.

(c) Cash and cash equivalents. For purposes of section 860L(c)(1)(A)
and the FASIT regulations, the term cash and cash equivalents
means--

(1) The United States dollar;

(2) A currency other than the United States dollar if the currency
is received as payment on a permitted asset described in '1.860H-2,
or the currency is required by the FASIT to make a payment on a
regular interest issued by the FASIT according to the terms of the
regular interest;

(3) A debt instrument if it--

(i) Is described--

(A) In paragraphs (b)(1)(i), (ii), or (v) of this section, or

(B) In paragraph (b)(vii) of this section if it is created from an
instrument described in paragraphs (b)(1)(i), (ii), or (v) of this
section;

(ii) Has a remaining maturity of 270 days or less; and

(iii) Is rated at least investment quality by a nationally
recognized statistical rating organization that is not a related
person to the issuer; and

(4) Shares in a U.S.-dollar-denominated money market fund (as
defined in 17 CFR 270.2a-7).

(d) Hedges and guarantees--(1) In general. Subject to the rules in
paragraphs (d)(2) through (4) of this section, a hedge or guarantee
contract is described in section 860L(c)(1)(D) (a permitted hedge)
only if the hedge or guarantee contract is reasonably required to
offset any differences that any risk factor may cause between the
amount or timing of the receipts on assets the FASIT holds (or
expects to hold) and the amount or timing of the payments on the
regular interests the FASIT has issued (or expects to issue). For
purposes of this paragraph (d), the risk factors are--

(i) Fluctuations in market interest rates;

(ii) Fluctuations in currency exchange rates;

(iii) The credit quality of, or default on, the FASIT's assets or
debt instruments underlying the FASIT's assets; and

(iv) The receipt of payments on the FASIT's assets earlier or later
than originally anticipated.

(2) Referencing other than permitted assets. A hedge or guarantee
contract is not a permitted hedge if it references an asset other
than a permitted asset or if it references an index, economic
indicator, or financial average, that is not both widely
disseminated and designed to correlate closely with changes in one
or more of the risk factors described in paragraphs (d)(1)(i)
through (iv) of this section.

(3) Association with particular assets or regular interests. A hedge
or guarantee contract need not be associated with any of the FASIT's
assets or regular interests, or any group of its assets or regular
interests, if the hedge or guarantee contract offsets the
differences described in paragraph (d)(1) of this section.

(4) Creating an investment prohibited. A hedge or guarantee contract
is not a permitted hedge if at the time the hedge or guarantee is
entered into, it in substance creates an investment in the FASIT.

(e) Hedges and guarantees issued by Owner (or related person)--(1)
Hedges. A hedge contract issued by the Owner (or a related person)
is a permitted asset only if--

(i) The contract is a permitted hedge other than a guarantee
contract;

(ii) The Owner (or the related person) regularly provides, offers,
or sells substantially similar contracts in the ordinary course of
its trade or business;

(iii) On the date the contract is acquired by the FASIT (and on any
later date that it is substantially modified) its terms are
consistent with the terms that would apply in the case of an arm's
length transaction between unrelated parties; and

(iv) The Owner maintains records that--

(A) Show the terms of the contract are consistent with the terms
that would apply in the case of an arm's length transaction between
unrelated parties; and

(B) Explain how the Owner (or related person) determined the
consideration for the contract.

(2) Guarantees. A guarantee contract issued by the Owner (or a
related person) is a permitted asset only if--

(i) The contract is a permitted hedge and satisfies paragraphs (e)
(1)(iii) and (iv) of this section;

(ii) The contract is a credit enhancement contract under
'1.860G-2(c); and

(iii) Immediately after the contract is acquired by the FASIT (and
on any later date that it is substantially modified), the value
(determined under section 860I and '1.860I-2) of all the FASIT=s
guarantee contracts issued by the Owner (and related persons) is
less than 3 percent of the value (determined under section 860I and
'1.860I-2) of all the FASIT=s assets.

(f) Foreclosure property. Property acquired in connection with the
default or imminent default of a debt instrument held by a FASIT may
qualify both as foreclosure property under section 860L(c)(1)(C) and
as another type of permitted asset under section 860L(c)(1). If
foreclosure property qualifies as another type of permitted asset,
the FASIT may hold the property beyond the grace period prescribed
for foreclosure property under section 860L(c)(3).

In this case, immediately after the grace period ends, the taxpayer
must recognize gain, if any, as if the property had been contributed
by the Owner to the FASIT on that date. See §1.860I-1( a)(1)(iii).
In addition, after the close of the grace period, disposition of the
property is subject to the prohibited transactions tax imposed under
section 860L(e) without the benefit of the exception for foreclosure
property.

(g) Special rule for contracts or agreements in the nature of a line
of credit. For purposes of section 860L(c)(1), the term permitted
asset includes a lender's position in a contract or agreement in the
nature of a line of credit (other than a contract or agreement that
is originated by the FASIT). Such a contract or agreement is not
subject to the rules of section 860I(a) at the time the contract or
agreement is transferred to the FASIT. Extensions of credit under
the contract or agreement are subject to the rules of section
860I(a) at the time the extension is made.

See section 860I(d)(2). To determine whether a contract or agreement
is originated by a FASIT, see §1.860L-1.

(h) Contracts to acquire hedges or debt instruments. A contract is
not described in section 860L(c)(1)(E) if it is an agreement under
which the Owner (or a related person) agrees to transfer permitted
hedges or permitted debt instruments to a FASIT for less than --

(1) Fair market value, in the case of hedges or debt instruments
traded on an established securities market (as defined in
'1.860I-2); or

(2) Ninety percent of their value, as determined under section
860I(d)(1)(A) and the FASIT regulations, in the case of debt
instruments not traded on an established securities market.
'1.860H-3 Cessation of a FASIT.

(a) In general. An arrangement ceases to be a FASIT if it revokes
its election with the consent of the Commissioner or if it fails to
qualify as a FASIT and the Commissioner does not determine the
failure to be inadvertent.

(b) Time of cessation. An arrangement ceases to be a FASIT at the
close of the day designated by the Commissioner in the consent to
revoke, or if there is no consent to revoke or determination of
inadvertence, at the close of the day on which the arrangement
initially fails to qualify as a FASIT.

(c) Consequences of cessation. Except as otherwise determined by the
Commissioner, the consequences of cessation are as follows:

(1) The FASIT and the underlying arrangement. The arrangement that
made the FASIT election (the underlying arrangement) is no longer a
FASIT and cannot re-elect FASIT treatment without the Commissioner's
approval. Immediately after the cessation, the arrangement's
classification (for example, as a partnership or corporation) is
determined under general principles of Federal income tax law.
Immediately after the cessation, the arrangement holds the FASIT=s
assets with a fair market value basis. Any election the Owner made
(other than the FASIT election), and any method of accounting the
Owner adopted with respect to those assets, binds the underlying
arrangement as if the underlying arrangement itself had made the
election or adopted the method of accounting. If the underlying
arrangement is a segregated pool of assets, the person holding legal
title to the pool is responsible for complying with any tax filing
or reporting requirements arising from the pool's operation.

(2) The Owner. (i) The Owner is treated as exchanging the assets of
the FASIT for an amount equal to their value (as determined under
§1.860I-2). Gain realized on the exchange is treated as gain from a
prohibited transaction and the Owner is subject to the tax imposed
by 860L without exception. Loss, if any, is disallowed. The
determination of gain or loss on assets for purposes of this
paragraph is made on an asset-by-asset basis.

(ii) The Owner must recognize cancellation of indebtedness income in
an amount equal to the adjusted issue price of the regular interests
outstanding immediately before the cessation over the fair market
value of those interests immediately before the cessation. This
determination is made on a regular interest by regular interest
basis. The Owner cannot take any deduction for acquisition premium.

(iii) If, after the cessation, the Owner has a continuing economic
interest in the assets, the characterization of this economic
interest (for example, as stock or a partnership interest) is
determined under general principles of Federal income tax law. If
the Owner has a continuing economic interest in the assets
immediately after cessation, the Owner holds the interest with a
fair market value basis.

(3) The regular interest holders. Holders of the regular interests
are treated as exchanging their regular interests for interests in
the underlying arrangement. Interests in the underlying arrangement
are classified (for example, as debt or equity) under general
principles of Federal income tax law. Gain must be recognized if a
regular interest is exchanged either for an interest not classified
as debt or for an interest classified as debt that differs
materially either in kind or extent. No loss may be recognized on
the exchange. The basis of an interest in the underlying arrangement
equals the basis in the regular interest exchanged for it, increased
by any gain recognized on the exchange under this paragraph (c)(3).

(d) Disregarding inadvertent failures to remain qualified--(1) If a
qualified arrangement that ceases to be a FASIT meets the
requirements of paragraph (d)(2) of this section, then the
Commissioner may either--

(i) Deem the qualified arrangement as continuing to be a FASIT
notwithstanding the cessation; or

(ii) Allow the qualified arrangement to re-elect FASIT status after
cessation notwithstanding the prohibition in section 860L(a)(4) .

(2) The requirements of this paragraph are satisfied if --

(i) The Commissioner determines that the cessation was inadvertent;

(ii) No later than a reasonable time after the discovery of the
event resulting in the cessation, steps are taken so that all of the
requirements for a FASIT are satisfied; and

(iii) The qualified arrangement and each person holding an interest
in the qualified arrangement at any time during the period the
qualified arrangement failed to qualify as a FASIT agree to make
such adjustments (consistent with the treatment of the qualified
arrangement as a FASIT or the treatment of the Owner as a C
corporation) as the Commissioner may require with respect to such
period.

'1.860H-4 Regular interests in general. (a) Issue price of regular
interests--(1) Regular interests not issued for property. The issue
price of a FASIT regular interest not issued for property is
determined under section 1273(b).

(2) Regular interests issued for property. Notwithstanding sections
1273 and 1274 and the regulations thereunder, the issue price of a
FASIT regular interest issued for property is the fair market value
of the regular interest determined as of the issue date.

(b) Special rules for high-yield regular interests--(1) High-yield
interests held by a securities dealer--(i) Due date of tax imposed
on securities dealer under section 860K(d). The excise tax imposed
under section 860K(d) (treatment of high-yield interest held by a
securities dealer that is not an eligible corporation) must be paid
on or before the due date of the securities dealer's Federal income
tax return for the earlier of the taxable year in which the
securities dealer--

(A) Ceases to be a dealer in securities; or

(B) Commences holding the high-yield interest for investment.

(ii) [Reserved]

(2) High-yield interests held by a pass-thru--(i) Nature and due
date of tax imposed under section 860K(e). The tax imposed under
section 860K(e) (treatment of high-yield interest held by a pass-
thru entity) is an excise tax which must be paid on or before the
due date of the pass-thru entity's Federal income tax return for the
taxable year in which the pass-thru entity issues the debt or equity
interest described in section 860K(e).

(ii) Pass-thru entity includes REMIC. For purposes of section
860K(e), a pass-thru entity includes a real estate mortgage
investment conduit (REMIC) as defined in section 860D.

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

(a) Look-through to underlying FASIT debt. If, during the same
period, a foreign resident holds (either directly or through a
vehicle which itself is not subject to the Federal income tax such
as a partnership or trust) a regular interest in a FASIT and a
conduit debtor (as defined in paragraph (b) of this section) pays or
accrues interest on a debt instrument held by the FASIT, then any
interest received or accrued by the foreign resident with respect to
the regular interest during that period is treated as received or
accrued from the conduit debtor. This rule applies to both the
foreign resident holder of the FASIT regular interest and the
conduit debtor for all purposes of subtitle A and the regulations
thereunder.

(b) Conduit debtor. A debtor is a conduit debtor if the debtor is a
U.S. resident taxpayer or a foreign resident taxpayer to which
interest expense paid or accrued with respect to the debt held by
the FASIT is treated as paid or accrued by a U.S. trade or business
of the foreign taxpayer under section 884(f)(1)(A), and the foreign
resident holder described in paragraph (a) of this section--

(1) Is a 10-percent shareholder of the debtor (within the meaning of
section 871(h)(3)(B));

(2) Is a controlled foreign corporation, but only if the debtor is a
related person (within the meaning of section 864(d)(4)) with
respect to the controlled foreign corporation; or

(3) Is related to the debtor (within the meaning of section 267(b)
or 707(b)(1)).

(c) Limitation. The amount of income treated under paragraph (a) of
this section as received from a conduit debtor is the lesser of--

(1) The income received or accrued by the foreign resident holder
with respect to the FASIT regular interest; or

(2) The amount paid or accrued by the conduit debtor with respect to
the debt instrument held by the FASIT.

(d) Cross references. For the treatment of related-party interest
accrued to foreign related persons, see sections 163(e)(3), 163(j),
871(h)(3), 881(c)(3)(B), and 881(c)(3)(C).

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

(a) In general. For purposes of determining an Owner's credits and
taxable income, all assets, liabilities, and items of income, gain,
deduction, loss, and credit of the FASIT are treated as assets,
liabilities, and such items of the Owner.

(b) Constant yield method to apply. The income from each debt
instrument a FASIT holds is determined by applying the constant
yield method (including the rules of section 1272(a)(6)) described
in §1.1272-3(c).

(c) Method of accounting for, and character of, hedges. The method
of accounting used for a permitted hedge (as described in
§1.860H-2(e)) must clearly reflect income and otherwise comply with
the rules of §1.446-4 (whether or not the permitted hedge instrument
is part of a hedging transaction as defined in §1.1221-2(b)). The
character of any gain or loss realized on a permitted hedge (as
described in §1.860H-2(e)) is ordinary.

(d) Coordination with mark-to market provisions--(1) No mark to
market accounting.

Mark to market accounting does not apply to any asset (other than a
non-permitted asset) while it is held, or deemed held, by a FASIT.

(2) Transfer of a mark to market asset to a FASIT. If an Owner
transfers a permitted asset to a FASIT and the asset would have been
marked to market if the taxable year had ended immediately before
the transfer (for example, an asset accounted for under section
475(a)), then immediately before the transfer, the Owner must mark
the asset to market and take gain or loss into account as if the
taxable year had ended at that point. See '1.475(b)-1(b)(4). If the
asset is a debt instrument that is valued under the special
valuation rule of '1.860I-2(a), then immediately after the asset is
marked to market under this paragraph (d)(2), the asset is also
valued under '1.860I-2(a), and any additional gain is taken into
account under section 860I. The latter gain, but not any mark to
market gain, is subject to section 860J.

(e) Owner's annual reporting requirements. Unless the Commissioner
otherwise prescribes, specified information regarding the FASIT must
be reported by means of a separate statement, attached by the Owner
to its income tax return for the taxable year that includes the
reporting period. The reporting period is the period in the Owner's
taxable year during which the Owner holds the ownership interest in
the FASIT. Unless the Commissioner otherwise requires, the statement
must set forth--

(1) The name, address, and taxpayer identification number (if any)
of the FASIT and any other information necessary to establish the
identity of the FASIT for which the statement is being filed;

(2) If the ownership interest was acquired from another person
during the Owner's taxable year, the date on which it was acquired,
and the name and address of the person from which it was acquired;

(3) If the ownership interest was transferred by the Owner during
the Owner's taxable year, the date on which it was transferred, the
name and address of the person to which it was transferred, and
whether such person is described in section 860L(a)(2);

(4) If any regular interests are issued during the reporting period,
a description of the prepayment and reinvestment assumptions that
are made pursuant to section 1272(a)(6) and any regulations
thereunder, including a statement supporting the selection of the
prepayment assumption;

(5) The FASIT's items (taken into account during the reporting
period) of income, gain, loss, deduction and credit from permitted
transactions, and separately stated, the FASIT=s items (taken into
account during the reporting period) of income, gain, loss,
deduction and credit from prohibited transactions;

(6) Information detailing the extent to which the items described in
paragraph (f)(5) of this section consist of interest accrued that,
but for section 860H(b)(4), is exempt from the taxes imposed under
subtitle A of 26 U.S.C.; and

(7) If a qualified arrangement ceases to be a FASIT during a
reporting period (including at the close of a reporting period),
information disclosing--

(i) The effective date of the cessation;

(ii) A description of how the cessation occurred; and

(iii) A statement regarding whether the arrangement will continue
after cessation and, if so, the continuing arrangement's name,
address, and taxpayer identification number.

(f) Treatment of FASIT under subtitle F of Title 26 U.S.C. For
purposes of subtitle F (Procedure and Administration)--

(1) A FASIT is treated as a branch or division of the Owner;

(2) The Owner is treated as the issuer of the regular interests; and
(3) The regular interests are treated as collateralized debt
obligations as defined in '1.6049-7(d)(2).

(g) Transfer of ownership interest--(1) In general. If, at the time
of any transfer of the ownership interest, the Owner knew or should
have known that the transferee would be unwilling or unable to pay
some or all of the tax arising from the application of section
860H(b), then the transfer is disregarded for all Federal tax
purposes.

(2) Safe harbor for establishing lack of improper knowledge. A
transfer will not be disregarded under paragraph (g)(1) of this
section if the rules of '1.860E-1(c)(4) (safe harbor for
establishing lack of improper knowledge on the transfer of a non-
economic REMIC residual interest) are satisfied with respect to the
FASIT ownership interest.

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

(a) In general--(1) Except as provided in paragraphs (a)(2) and (d)
of this section, the Owner of a FASIT (or a related person ) must
recognize gain (if any) on--

(i) Property the Owner (or the related person) transfers either to
the FASIT or its regular interest holders;

(ii) Support property; and

(iii) Property acquired by the FASIT as foreclosure property and
held beyond the grace period allowed for foreclosure property.

(2) An Owner (or a related person) does not have to recognize gain
under section 860I or paragraph (a)(1) of this section on a transfer
or pledge of property to a regular interest holder, if the Owner (or
the related person) makes the transfer or pledge in a capacity other
than as Owner (or related person), and the regular interest holder
receives the transfer or pledge in a capacity other than regular
interest holder.

(b) Support property defined. Property is support property if the
Owner (or a related person)--

(1) Pledges the property, directly or indirectly, to pay a FASIT
regular interest, or otherwise identifies the property as providing
security for the payment of a FASIT regular interest;

(2) Sets aside the property for transfer to a FASIT under any
agreement or understanding; or

(3) Holds an interest in the property that is subordinate to the
FASIT=s interest in the property (for example, the Owner holds
subordinate interests in a pool of mortgages and the FASIT holds
senior interests in the same pool).

(c) Timing of gain determination and recognition. Gain is determined
and recognized under paragraph (a)(1) of this section immediately
before the property is transferred to the FASIT or becomes support
property, or in the case of foreclosure property, on the day
immediately following the termination of the grace period allowed
for foreclosure property.

(d) Gain deferral election. [Reserved]

(e) Amount of gain. Except as provided in paragraph (f) of this
section, the amount of gain recognized under paragraph (a)(1) of
this section is the same as if the Owner (or the related person) had
sold the property for its value as determined under '1.860I-2.

(f) Record keeping requirements. The Owner is required to maintain
such books and records as may be necessary or appropriate to
demonstrate that the requirements of this section are satisfied.

(g) Special rule applicable to property of related persons. Except
in the case of property traded on an established securities market
(as defined in '1.860I-2(b)), if a related person holds property
that becomes support property, or if a related person transfers
property to a FASIT or its regular interest holders, then for
purposes of applying the gain recognition provisions of this
section--

(1) The related person is treated as transferring the property to
the Owner for the property's fair market value as determined under
general tax principles; and

(2) The Owner is treated as transferring the property to the FASIT
for the property's value as determined under '1.860I-2.

§1.860I-2 Value of property.

(a) Special valuation rule. For purposes of section 860I(d)(1)(A),
except as provided in paragraph (c) of this section, the value of a
debt instrument not traded on an established securities market is
the present value of the reasonably expected payments on the
instrument determined--

(1) As of the date the instrument is to be valued (as described in
'1.860I-1(c)); and

(2) By using a discount rate equal to 120 percent of the applicable
federal rate, compounded semi-annually, for instruments having the
same term as the weighted average maturity of the reasonably
expected payments on the instrument. For this purpose, the
applicable federal rate is the rate prescribed under section 1274(d)
for the period that includes the date the instrument is valued (as
described in '1.860I-1(c))..

(b) Traded on an established securities market. For purposes of
section 860I(d)(1)(A), a debt instrument is traded on an established
securities market if it is traded on a market described in
'1.1273-2(f)(2), (3), or (4).

(c) Reasonably expected payments-- (1) In general. Reasonably
expected payments on an instrument must be determined in a
commercially reasonable manner and, except as otherwise provided in
this section (c), may take into account reasonable assumptions
concerning early repayments, late payments, non-payments, and loan
servicing costs. No other assumptions may be considered.

(2) Consistency requirements. Except as provided in paragraph (c)(3)
of this section, any assumption used in determining the reasonably
expected payments on an instrument must be consistent with (and no
less favorable than) the first of the following categories that
applies--

(i) Representations made in connection with the offering of a
regular interest in the FASIT;

(ii) Representations made to any nationally recognized statistical
rating organizations;

(iii) Representations made in any filings or registrations with any
governmental agency with respect to the FASIT; and

(iv) Industry customs or standards (as defined in paragraph (e) of
this section).

(3) Servicing costs. Notwithstanding paragraph (c)(2) of this
section, the amount of loan servicing costs assumed may not exceed
the lesser of--

(i) The amount the FASIT agrees to pay the Owner for servicing the
loans held by the FASIT if the Owner is providing the servicing; or

(ii) The amount a third party would reasonably pay for servicing
identical loans.

(4) Nonconforming or unreasonable assumptions. If a taxpayer, in
determining the expected payments on an instrument, takes into
account an assumption that either fails to meet the requirements of
paragraph (c)(2) or (3) of this section or is unreasonable, the
Commissioner may determine the reasonably expected payments on the
instrument without the assumption. Thus, for example, if a taxpayer
makes an unreasonable assumption concerning non-payments, the
Commissioner may compute expected payments without any adjustment
for non-payments.

(d) Special rules--(1) Beneficial ownership interests. A certificate
representing beneficial ownership of a debt instrument, is deemed to
represent beneficial ownership of a debt instrument traded on an
established securities market, if either --

(i) The certificate is traded on an established securities market;
or

(ii) The certificate represents ownership in a pool of assets
composed solely of debt instruments all of which are traded on
established securities markets.

(2) Stripped interests. A stripped bond or stripped coupon (as
defined in section 1286(e)) not otherwise traded on an established
securities market is considered as being traded on an established
securities market, if--

(i) The underlying bond (the bond from which the stripped bond or
stripped coupon is created) is traded on an established securities
market; and

(ii) The stripped bond or stripped coupon is valued using a
commercially reasonable method based on the market value of the
underlying bond.

(3) Contemporaneous purchase and transfer of debt instruments--(i)
Notwithstanding paragraph (a) of this section, the value of a debt
instrument not traded on an established securities market is its
cost to the Owner (or a related person) if--

(A) The debt instrument is purchased from an unrelated person in an
arm's length transaction in which no other property is transferred
or services provided;

(B) The debt instrument is acquired solely for cash;

(C) The price of the debt instrument is fixed no more than 15 days
before the date of purchase; and

(D) The debt instrument is transferred to the FASIT no more than 15
days after the date of purchase.

(ii) For purposes of paragraph (d)(3)(i) of this section, the date
of purchase is the earliest date on which the burdens and benefits
of ownership of the debt instrument irrevocably pass to the Owner
(or a related person).

(4) Guarantees. Notwithstanding paragraph (c)(1) of this section, if
a guarantee qualifying as a permitted hedge under this paragraph (d)
relates solely to a debt instrument not traded on an established
securities market and the taxpayer determines the reasonably
expected payments on the debt instrument by including the reasonably
expected payments on the guarantee, then the guarantee and the
property need not be valued separately.

(e) Definitions. For purposes of '1.860I-2--

(1) An industry custom is any long-standing practice in use by
entities that engage in asset securitization as part of their
ordinary business activities; and

(2) An industry standard is any standard that is both--

(i) Commonly used in evaluating the expected payments on securitized
debt instruments (or debt instruments pending securitization) in
similar transactions; and

(ii) Disseminated through written or electronic means by any
independent, nationally recognized trade association or other
authority that is recognized as competent to issue the standard.

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

(a) In general. For purposes of applying section 860J(a)(1), an
Owner's taxable income from a FASIT includes any gains recognized by
the Owner under '1.860I-1(a).

(b) Special rule for holders of multiple ownership interests. For
purposes of applying section 860J and the rules of '1.860J-1, a
person may aggregate the net income (or loss) from all FASITs in
which the person holds the ownership interest.

(c) Related persons--(1) Taxable income. The taxable income of a
related person for any taxable year is no less than the sum of--

(i) The amounts specified in section 860J(a); plus

(ii) Any gains recognized under '1.860I-1(a).

(2) Effect on net operating loss. Any increase in a related person's
taxable income attributable to paragraph (c)(1) of this section is
disregarded--

(i) In determining under section 172 the amount of the related
person's net operating loss for the taxable year; and

(ii) In determining the related person's taxable income for such
taxable year for purposes of the second sentence of section 172(b)
(2).

(3) Coordination with minimum tax. For purposes of part VI of
subchapter A of chapter 1 of subtitle A of Title 26 U.S.C., the
alternative minimum taxable income of any related person is in no
event less than the related person's taxable income as computed
under paragraph (c)(1) of this section.

'1.860L-1 Prohibited transactions.

(a) Loan origination--(1) In general. Section 860L(e) imposes a
prohibited transactions tax on the receipt of any income derived
from any loan originated by a FASIT. Except as provided in
paragraphs (a)(2) and (3) of this section, whether a FASIT
originates a loan for purposes of section 860L(e) depends on all the
facts and circumstances.

(2) Acquisitions presumed not to be loan origination. Except as
provided in paragraph (a)(3) of this section, a FASIT is considered
not to have originated a loan if the FASIT acquires the loan--

(i) From an established securities market described in '1.1273-2(f)
(2), (3), or (4);

(ii) On a date more than 12 months after the loan was issued; or

(iii) From a person (including the Owner or a related person) that
regularly originates similar loans (such as through a standardized
contract) in the ordinary course of its business.

(3) Activities presumed to be loan origination. (i) Notwithstanding
paragraph (a)(2) of this section, a FASIT is considered to originate
a loan if the FASIT either engages in or facilitates (other than
through a person from whom the FASIT acquires the loan and who is
described in paragraph (a)(2)(iii) of this section)--

(A) Soliciting the loan, including advertising to solicit borrowers,
accepting the loan application, or generally making any offer to
lend funds to any person;

(B) Evaluating an applicant's financial condition;

(C) Negotiating or establishing any terms of the loan;

(D) Preparing or processing any document related to negotiating or
entering into the loan; or

(E) Closing the loan transaction.

(ii) For purposes of paragraph (a)(3)(i) of this section, if a FASIT
enters into a contract to engage in purchases described in paragraph
(a)(2)(iii) of this section, the FASIT is not treated as originating
the loans it acquires solely because it was a party to the contract.

(4) Loan workouts. If a FASIT holds a loan, the FASIT is not treated
as originating a new loan that it receives from the same obligor in
exchange for the old loan in the context of a workout.

(b) Origination of a contract or agreement in the nature of a line
of credit-(1) In general.

A FASIT is presumed not to have originated a contract or agreement
in the nature of a line of credit if the FASIT acquires the contract
or agreement from a person (including the Owner or a related person)
that regularly originates similar contracts or agreements in the
ordinary course of its business.

(2) Activities presumed to be origination. If a FASIT assumes the
role of a lender under a contract or agreement in the nature of a
line of credit from a person that does not regularly originate
similar contracts or agreements in the ordinary course of its
business, the FASIT is considered to originate the contract or
agreement if, with respect to the contract or agreement, the FASIT
engages in any of the activities described in paragraphs (A) through
(E) of §1.860L-1( a)(3)(i) of this section.

(3) Debt instruments issued under contracts or agreements in the
nature of a line of credit.

If a FASIT acquires a debt instrument as a result of the FASIT's
position as a lender under a contract or agreement in the nature of
a line of credit, the FASIT is presumed to have originated the debt
instrument if and only if the FASIT originated the related contract
or agreement.

(c) Disposition of debt instruments. Notwithstanding sections
860L(e)(3)(B)(i) and (ii) (certain exceptions from the prohibited
transactions tax), the distribution to the Owner of a debt
instrument contributed by the Owner, and the transfer to the Owner
of one debt instrument in exchange for another, are prohibited
transactions, if within 180 days of receiving the debt instrument
the Owner realizes a gain on the disposition of the instrument to
any person, regardless of whether the realized gain is recognized.

(d) Exclusion of prohibited transactions tax to dispositions of
hedges. The rules of section 860L(e) and paragraph (b) of this
section do not apply to the disposition of any asset described in
section 860L(c)(1)(D).

'1.860L-2 Anti-abuse rule.

(a) Intent of FASIT provisions. Part V of subchapter M of the
Internal Revenue Code (the FASIT provisions) is intended to promote
the spreading of credit risk on debt instruments by facilitating the
securitization of those debt instruments. Implicit in the intent of
the FASIT provisions are the following requirements--

(1) Assets to be securitized through a FASIT consist primarily of
permitted debt instruments;

(2) The source of principal and interest payments on a FASIT=s
regular interests is primarily the principal and interest payments
on permitted debt instruments held by the FASIT (as opposed to
receipts on other assets or deposits of cash); and

(3) No FASIT provision may be used to achieve a Federal tax result
that cannot be achieved without the provision unless the provision
clearly contemplates that result.

(b) Application of FASIT provisions. The FASIT provisions and the
FASIT regulations must be applied in a manner consistent with the
intent of the FASIT provisions as set forth in paragraph (a) of this
section. Therefore, if a principal purpose of forming or using a
FASIT is to achieve results inconsistent with the intent of the
FASIT provisions and the FASIT regulations, the Commissioner may
make any appropriate adjustments with regard to the FASIT and any
arrangement or transaction (or series of transactions) involving the
FASIT. The Commissioner's authority includes--

(1) Disregarding a FASIT election;

(2) Treating one or more assets of a FASIT as held by a person or
persons other than the Owner;

(3) Allocating FASIT income, loss, deductions and credits to a
person or persons other than the Owner;

(4) Disallowing any item of FASIT income, loss, deduction, or
credit;

(5) Treating the ownership interest in a FASIT as held by a person
other than the nominal holder;

(6) Treating a FASIT regular interest as other than a debt
instrument; and

(7) Treating a regular interest held by any person as having the
same tax characteristics as one or more of the assets held by the
FASIT.

(c) Facts and circumstances analysis. Whether a FASIT is created or
used for a principal purpose of achieving a result inconsistent with
the intent of the FASIT provisions is determined based on all of the
facts and circumstances, including a comparison of the purported
business purpose for a transaction and the claimed tax benefits
resulting from the transaction.

(d) Effective date. This section is applicable on February 4, 2000.

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

(a) Scope. This section applies if a pre-effective date FASIT has
one or more pre-FASIT interests outstanding on the startup day of
the FASIT.

(1) Pre-effective date FASIT defined. A pre-effective date FASIT is
a FASIT whose underlying qualifying arrangement was in existence on
August 31, 1997.

(2) Pre-FASIT interest defined. A pre-FASIT interest is an interest
in a pre-effective date FASIT that--

(i) Was issued before February 4, 2000;

(ii) Was outstanding on the date the FASIT election for the
underlying qualifying arrangement goes into effect; and

(iii) Is considered debt of the Owner under general principles of
Federal income tax law.

(3) FASIT gain defined. For purposes of this section, the term FASIT
gain means any gain that the Owner of a pre-effective date FASIT
must recognize under the rules of this section.

(b) Election to defer gain. The Owner of a pre-effective date FASIT
may elect to defer the recognition of FASIT gain on assets that are
held by the FASIT but that are allocable to pre-FASIT interests. An
Owner that elects under this section must establish a method of
accounting for its FASIT gain. To clearly reflect income, this
method must periodically determine the aggregate amount of FASIT
gain on all of the assets in the FASIT and exclude the portion of
the FASIT gain attributable to the pre-FASIT interests.

(c) Safe-harbor method. This paragraph (c) provides a safe-harbor
method for determining the amount of FASIT gain that can be deferred
under this section. The method has the following steps:

(1) Step one: Establish pools--(i) Group assets into pools. The
Owner must group the assets of the FASIT into one or more pools. No
pool may contain assets of more than one of the following three
types--

(A) Assets that are valued under the special valuation rule of
'1.860I-2(a) and that have FASIT gain on the first day held by the
FASIT;

(B) Assets that are valued for FASIT gain purposes under a standard
other than the special valuation rule of '1.860I-2(a) and that have
FASIT gain on the first day held by the FASIT; and

(C) Assets that do not have FASIT gain on the first day held by the
FASIT.

(ii) Treatment of pools. If a pool contains assets described in
paragraph (c)(1)(i)(A) or

(B) of this section, the Owner must apply paragraphs (c)(2) through
(5) of this section to the pool. If a pool contains assets described
in paragraph (c)(1)(i)(C) of this section, the pool is ignored for
FASIT gain purposes.

(2) Step two: Determine the FASIT gain (or loss) at the pool
level-(i) In general. For each taxable year, the FASIT gain (or
loss) at the pool level is equal to the net increase (or decrease)
in the value of the pool minus the income that is included with
respect to the pool under general income tax principles (without
regard to the FASIT rules). For purposes of the preceding sentence,
the net increase (or decrease) in the value of the pool is equal
to--

(A) The sum of the value of the pool (as determined under '1.860I-2)
at the end of the taxable year and the amount of any cash
distributed (even if reinvested) from the pool during the taxable
year; minus

(B) The sum of the value of the pool (as determined under '1.860I-2)
at the end of the previous taxable year and the Owner's adjusted
basis in the assets contributed to the pool during the taxable year.

(ii) Limitation. This paragraph applies if the calculation in
paragraph (c)(2)(i) of this section produces a loss for the taxable
year and the amount of the loss exceeds the net amount of the FASIT
gain from the pool in all prior years. In this case, the amount of
the loss for the current year is limited to the amount of net FASIT
gain for all previous years.

(3) Step three: Determine the percentage of total FASIT gain that
must be recognized by the end of the current taxable year. The
percentage of FASIT gain that must be recognized by the end of the
current taxable year is equal to 100 percent minus the percentage of
FASIT gain that may be deferred at the end of the current taxable
year. The percentage of FASIT gain that may be deferred at the end
of the taxable year is equal to the lesser of 100 percent and the
ratio of--

(i) The product of 107 percent and aggregate adjusted issue prices
of all pre-FASIT interests outstanding on the last day of the
taxable year; over

(ii) The total value of all assets held by the FASIT on the last day
of the taxable year.

(4) Step four: Determine the total amount of FASIT gain that is not
attributed to pre-effective date FASIT interests. The total amount
of FASIT gain that is not attributed to pre-effective date FASIT
interests is equal to the product of--

(i) The sum of the amount of FASIT gain (as determined under
paragraph (c)(2) of this section) for the current taxable year and
all previous taxable years; and

(ii) The percentage of FASIT gain that must be recognized in the
current taxable year (as determined under paragraph (c)(3) of this
section).

(5) Step five: Determine the amount of FASIT gain (or loss) to be
recognized in the taxable year. For the taxable year that includes
the startup date, the amount of FASIT gain to be recognized is equal
to the total amount of FASIT gain not attributable to pre-effective
date FASIT interests (as determined under paragraph (c)(4) of this
section). Thereafter, the amount of FASIT gain (or loss) to be
recognized in a given taxable year is equal to the total amount of
FASIT gain not attributable to pre-effective date FASIT interests
for that taxable year (as determined under paragraph (c)(4) of this
section) less the amount of FASIT gain not attributable to pre-
effective date FASIT interests for the immediately preceding taxable
year (as determined under paragraph (c)(4) of this section).

(d) Example. The rules of this section are illustrated by the
following example: Example. (i) Facts. O is an eligible corporation
within the meaning of section 860(a)(2) that uses the calendar year
as its taxable year. On July 1, 1996, O forms TR, a trust. Shortly
thereafter, O contributes credit card receivables to TR and TR
issues certificates that, for Federal income tax purposes, are
characterized as debt of O. Effective March 31, 1999, O elects FASIT
status for TR. On March 31, 1999, TR holds credit card receivables
that have an outstanding principal balance of $20,000,000 and TR has
outstanding certificates (that are characterized for Federal income
tax purposes as debt of O) that have an aggregate adjusted issue
price of $10,000,000.

(ii) Status as a pre-effective date FASIT. TR is a pre-effective
date FASIT because TR was a trust that was in existence on August
31, 1997. The certificates outstanding on March 1, 1999, are pre-
FASIT interests because they were outstanding on March 31, 1999, and
they were considered debt of O under general principles of Federal
income tax law.

(iii) Facts: 1999. From April 1, 1999, through December 31, 1999,
the credit card receivables held by TR generated $800,000 of taxable
income and $4,000,000 of total cash flow.

TR distributed $2,500,000 of the cash flow to O in exchange for new
receivables having an outstanding principal balance of $2,500,000.
TR used the remaining $1,500,000 of cash flow to make payments on
its outstanding debt instruments. On December 31, 1999, TR
contributed additional credit card receivables with an outstanding
principal balance of $10,700,000 and an aggregate adjusted basis of
$10,700,000. On December 31, 1999, TR held credit card receivables
that had an outstanding principal balance of $30,000,000, an
aggregate adjusted basis of $30,000,000, and a value (as determined
under '1.860I-2(a)) of $30,300,000. In addition, on December 31,
1999, the outstanding adjusted issue price of the pre-FASIT
interests was $9,000,000.

(iv) FASIT gain recognition for 1999--(A) Establish pools. TR elects
to defer gain recognition under the safe harbor method. Consistent
with paragraph (c)(1) of this section, TR groups the assets of the
FASIT into a single pool because all of the assets of the FASIT are
credit card receivables subject to the special valuation rule of
'1.860I-1(a) and the assets have FASIT gain on the date they are
acquired by the FASIT.

(B) Determination of FASIT gain for 1999. The sum of the value of
the pool at the end of 1999 ($30,300,000) and the cash distributed
during 1999 ($4,000,000) is $34,300,000. There are three
contributions of assets by O during 1999: one of $20,000,000 on
March 31, 1999; one of $2,500,000 over the course of 1999; and an
additional contribution of $10,700,000 on December 31, 1999. Thus,
O's basis in assets contributed to the pool during 1999 is
$33,200,000. The net increase in the value of the pool is $1,100,000
($34,300,000 minus $33,200,000). Under paragraph (c)(2) of this
section, the FASIT gain for 1999 is $300,000 ($1,100,000 net
increase in value minus $800,000 taxable income).

(C) Determination of percentage of total FASIT gain that must be
recognized by the end of 1999. Under paragraph (c)(3) of this
section, the percentage of FASIT gain that may be deferred for the
taxable year is 31.78 percent (107 percent x $9,000,000 adjusted
issue price of pre-FASIT interests divided by $30,300,000 value of
the assets). The percentage of the FASIT gain that must be
recognized is for the taxable year, therefore, 68.22 percent (1 -
31.78 percent).

(D) Determination of total amount of FASIT gain not attributed to
pre-effective date FASIT interests in 1999. Under paragraph (c)(4)
of this section, the total amount of FASIT gain not attributed to
pre-effective date FASIT interests in 1999 is $204,660 ($300,000
FASIT gain x 68.22 percent).

(E) Determine the amount of FASIT gain to be recognized in 1999.
Under paragraph (c)(5) of this section, because 1999 includes the
startup date, TR must include in income the entire $204,660 of FASIT
gain not attributed to pre-effective date FASIT interests.

(v) Facts: 2000. In 2000, the credit card receivables held by TR
generated $1,500,000 of taxable income and $5,000,000 of cash flow.
TR distributed $4,000,000 of the cash flow to O in exchange for new
receivables having an outstanding principal balance of $4,000,000.
TR used the remaining $1,000,000 of cash flow to make payments on
its outstanding debt instruments. On December 31, 2000, TR
contributed additional credit card receivables with an outstanding
principal balance of $9,500,000 and an aggregate adjusted basis of
$9,500,000. On December 31, 2000, TR held credit card receivables
that had an outstanding principal balance of $40,000,000, an
aggregate adjusted basis of $40,000,000, and a value (as determined
under '1.860I-2(a)) of $40,800,000. In addition, on December 31,
2000, the outstanding adjusted issue price of the pre-FASIT
interests was $8,500,000.

(vi) FASIT gain recognition for 2000--(A) Determination of FASIT
gain for 2000. The sum of the value of the pool on December 31, 2000
($40,800,000) and the cash distributed during 2000 ($5,000,000) is
$45,800,000. The value of the pool on December 31, 1999, was
$30,300,000. During 2000, O contributed receivables in which O had a
basis of $13,500,000 ($4,000,000 over the course of the year and
$9,500,000 on December 31, 2000). The net increase in the value of
the pool during 2000 is $2,000,000 ($45,800,000 minus $43,800,000).

Under paragraph (c)(2), the FASIT gain for 2000 is $500,000
($2,000,000 net increase in value minus $1,500,000 taxable income).

(B) Determination of percentage of total FASIT gain that must be
recognized by the end of 2000. Under paragraph (c)(3), the
percentage of FASIT gain that may be deferred for the taxable year
is 22.29 percent (107 percent times $8,500,000 adjusted issue price
of pre-FASIT interests divided by $40,800,000 value of the assets).
The percentage of the FASIT gain that must be recognized is,
therefore, 77.71 percent (1 - 22.29 percent).

(C) Determination of total amount of FASIT gain not attributed to
pre-effective date FASIT interests in 2000. Under paragraph (c)(4)
of this section, the total amount of FASIT gain not attributed to
pre-effective date FASIT interests in 2000 is $388,500 ($500,000
FASIT gain multiplied by 77.71 percent).

(D) Determine the amount of FASIT gain to be recognized in 2000.
Under paragraph (c)(5) of this section, the FASIT gain to be
recognized for 2000 is equal to the FASIT gain that not attributable
to pre-effective date FASIT interests in 2000 ($388,500) minus the
FASIT gain not attributable to pre-effective date FASIT interests in
1999 ($204,660). Thus, in 2000, TR must include $183,840.

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

(f) Effective date. This section is applicable on February 4, 2000.

§1.860L-4 Effective date. Except as otherwise provided in
§1.860L-2(e) (relating to the rules on anti-abuse) and §1.860L-3(f)
(relating to the rules governing transition entities) this section
is applicable on the date final regulations are filed with the
FEDERAL REGISTER.

Par. 4. Section 1.861-9T is amended by redesignating the text of
paragraph (g)(2)(iii) as paragraph (g)(2)(iii)(A) and adding a
heading to new paragraph (g)(2)(iii)(A), and adding paragraph (g)(2)
(iii)(B): §1.861-9T Allocation and apportionment of interest expense
(temporary regulation).

* * * * *

(g) * * *

(2) * * *

(iii) Adjustment for directly allocated interest-- (A) Nonrecourse
indebtedness and integrated financial transactions.* * *

(B) FASIT Interest Expense. The rules of paragraph (g)(2)(iii)(A) of
this section shall also apply to all assets to which FASIT interest
expense is directly allocated during the current taxable year under
the rules of §1.861-10T(f). This paragraph (g)(2)(iii)(B) applies on
the date final regulations are filed with the FEDERAL REGISTER.

Par. 5. Section 1.861-10T is amended by--

1. Revising paragraph (a); and

2. Adding paragraph (f).

§1.861-10T Special allocations of interest expense (temporary
regulation).

(a) In general. This section applies to all taxpayers and provides
four exceptions to the rules of §1.861-9T that require the
allocation and apportionment of interest expense on the basis of all
assets of all members of the affiliated group. Paragraph (b) of this
section describes the direct allocation of interest expense to the
income generated by certain assets that are subject to qualified
nonrecourse indebtedness. Paragraph (c) of this section describes
the direct allocation of interest expense to income generated by
certain assets that are acquired in integrated financial
transactions. Paragraph (d) of this section provides special rules
that are applicable to all transactions described in paragraphs (b)
and (c) of this section. Paragraph (e) of this section requires the
direct allocation of third party interest of an affiliated group to
such group's investment in related controlled foreign corporations
in cases involving excess related person indebtedness (as defined
therein). Paragraph (f) of this section provides rules for the
direct allocation and apportionment of all FASIT interest expense to
all FASIT gross income, on the basis of all FASIT assets. See also
§1.861-9T(b)(5), which requires direct allocation of amortizable
bond premium.

* * * * *

(f) FASIT Interest Expense --(1) In general. All FASIT interest
expense of the taxpayer's affiliated group (or the taxpayer, if the
taxpayer is not a member of an affiliated group) shall be directly
allocated solely to the FASIT gross income of the affiliated group
(or the taxpayer, if the taxpayer is not a member of an affiliated
group).

(2) Asset method. Interest expense that is directly allocated under
this paragraph (f) shall be treated as directly related to all the
activities and assets of all FASITs in which the taxpayer or any
member of the taxpayer's affiliated group holds the ownership
interest. The directly allocated interest expense shall be
apportioned among all of the FASIT gross income of the affiliated
group (or the taxpayer, if the taxpayer is not a member of an
affiliated group) under the asset method described in §1.861-9T(g).

(3) FASIT period. After a FASIT's startup day (as defined in section
860L(d)(1)), the taxpayer must allocate the interest expense of the
FASIT according to the rules of this paragraph (f) during the entire
period that the arrangement continues to be a FASIT. If an
arrangement ceases to be a FASIT, interest expense with respect to
the ceased FASIT arrangement shall no longer be allocated and
apportioned under the rules of this paragraph (f) as of the time the
arrangement is treated as having ceased in accordance with
§1.860H-3(b). The Commissioner may continue to allocate interest
expense with respect to a ceased FASIT arrangement under this
paragraph (f) if the Commissioner determines that the principal
purpose of ending the arrangement's qualification as a FASIT was to
affect the taxpayer's interest expense allocation.

(4) Application of special rules. In applying this paragraph (f),
the rules of paragraph (d)(2)of this section shall apply.

(5) Definitions. For purposes of this paragraph (f):

(i) FASIT defined. FASIT has the meaning given such term in
§1.860H-1(a).

(ii) FASIT interest expense defined. (A) In general. FASIT interest
expense means any amount paid or accrued by or on behalf of a FASIT
to a holder of a regular interest in such FASIT, if such amount is--

(1) Treated as incurred by the taxpayer or any member of the
taxpayer's affiliated group by reason of §1.860H-6(a), because the
taxpayer or such member holds the ownership interest in a FASIT; and

(2) Treated as interest by reason of section 860H(c).

(B) Interest equivalents. FASIT interest expense includes any
expense or loss from a hedge that is a permitted asset (as described
in §1.860H-2(d) and (e)), but only to the extent such expense or
loss is an interest equivalent as described in §1.861-9T(b).

(iii) FASIT gross income defined. FASIT gross income means gross
income of the taxpayer's affiliated group (or the taxpayer, if the
taxpayer is not a member of an affiliated group) treated as received
or accrued by the taxpayer, or any member of the taxpayer's
affiliated group, by reason of §1.860H-6(a).

(iv) Affiliated group defined. Affiliated group has the meaning
given such term by §1.861- 11T(d).

(6) Coordination with other provisions. If any FASIT interest
expense is directly allocable under both this paragraph (f) and
paragraph (b) or (c) (determined without regard to this paragraph
(f)(6)), only the rules of this paragraph (f) shall apply.

(7) Effective date. The rules of this section apply for taxable
years beginning after December 31, 1986. However, paragraphs (a) and
(f) apply as of the date final regulations are filed with the
FEDERAL REGISTER, and paragraph (e) applies to all taxable years
beginning after December 31, 1991.

Deputy Commissioner of Internal Revenue
Robert E. Wenzel

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