income tax t.d. 9817, page 968. employee plans

HIGHLIGHTSOF THIS ISSUEThese synopses are intended only as aids to the reader inidentifying the subject matter covered. They may not berelied upon as authoritative interpretations.

INCOME TAX

REG–135122–16, page 1005.This document contains proposed regulations relating to cer-tain financial products providing for payments that are contin-gent upon or determined by reference to U.S. source dividendpayments.

Notice 2017–19, page 1000.Resident populations of the 50 states, the District of Columbia,Puerto Rico, and the insular areas for purposes of determiningthe 2017 calendar year (1) state housing credit ceiling undersection 42(h) of the Code, (2) private activity bond volume capunder section 146, and (3) private activity bond volume limitunder section 142(k) are reproduced.

T.D. 9815, page 944.This document provides guidance to nonresident alien individ-uals and foreign corporations that hold certain financial prod-ucts providing for payments that are contingent upon or deter-mined by reference to U.S. source dividend payments. Thisdocument also provides guidance to withholding agents thatare responsible for withholding U.S. tax with respect to adividend equivalent, as well as certain other parties to section871(m) transactions and their agents.

T.D. 9817, page 968.These final regulations under section 7704(d)(1)(E) of the In-ternal Revenue Code relate to the qualifying income exceptionfor publicly traded partnerships to not be treated as corpora-tions for Federal income tax purposes. Specifically, these reg-ulations define the activities that generate qualifying incomefrom exploration, development, mining or production, process-ing, refining, transportation, and marketing of minerals or nat-ural resources.

EMPLOYEE PLANS

Rev. Rul. 2017–05, page 1000.This revenue ruling provides tables of covered compensationunder § 401(l)(5)(E) of the Internal Revenue Code and theIncome Tax Regulations thereunder, effective January 1, 2017.

Notice 2017–18, page 997.This notice sets forth updates on the corporate bond monthlyyield curve, the corresponding spot segment rates for February2017 used under § 417(e)(3)(D), the 24-month average segmentrates applicable for February 2017, and the 30-year Treasuryrates. These rates reflect the application of § 430(h)(2)(C)(iv),which was added by the Moving Ahead for Progress in the 21stCentury Act, Public Law 112–141 (MAP-21) and amended bysection 2003 of the Highway and Transportation Funding Act of2014 (HATFA).

Finding Lists begin on page ii.

Bulletin No. 2017–9February 27, 2017

The IRS MissionProvide America’s taxpayers top-quality service by helpingthem understand and meet their tax responsibilities and en-force the law with integrity and fairness to all.

IntroductionThe Internal Revenue Bulletin is the authoritative instrument ofthe Commissioner of Internal Revenue for announcing officialrulings and procedures of the Internal Revenue Service and forpublishing Treasury Decisions, Executive Orders, Tax Conven-tions, legislation, court decisions, and other items of generalinterest. It is published weekly.

It is the policy of the Service to publish in the Bulletin allsubstantive rulings necessary to promote a uniform applicationof the tax laws, including all rulings that supersede, revoke,modify, or amend any of those previously published in theBulletin. All published rulings apply retroactively unless other-wise indicated. Procedures relating solely to matters of internalmanagement are not published; however, statements of inter-nal practices and procedures that affect the rights and dutiesof taxpayers are published.

Revenue rulings represent the conclusions of the Service onthe application of the law to the pivotal facts stated in therevenue ruling. In those based on positions taken in rulings totaxpayers or technical advice to Service field offices, identify-ing details and information of a confidential nature are deletedto prevent unwarranted invasions of privacy and to comply withstatutory requirements.

Rulings and procedures reported in the Bulletin do not have theforce and effect of Treasury Department Regulations, but theymay be used as precedents. Unpublished rulings will not berelied on, used, or cited as precedents by Service personnel inthe disposition of other cases. In applying published rulings andprocedures, the effect of subsequent legislation, regulations,court decisions, rulings, and procedures must be considered,and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unlessthe facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.This part includes rulings and decisions based on provisions ofthe Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.This part is divided into two subparts as follows: Subpart A, TaxConventions and Other Related Items, and Subpart B, Legisla-tion and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.To the extent practicable, pertinent cross references to thesesubjects are contained in the other Parts and Subparts. Alsoincluded in this part are Bank Secrecy Act Administrative Rul-ings. Bank Secrecy Act Administrative Rulings are issued bythe Department of the Treasury’s Office of the Assistant Sec-retary (Enforcement).

Part IV.—Items of General Interest.This part includes notices of proposed rulemakings, disbar-ment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative index forthe matters published during the preceding months. Thesemonthly indexes are cumulated on a semiannual basis, and arepublished in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

February 27, 2017 Bulletin No. 2017–9

Part I. Rulings and Decisions Under the Internal Revenue Codeof 198626 CFR 1.871–15; 26 CFR 1.871–15T; 26 CFR1.1441–1; 26 CFR 1.1441–1T; 26 CFR 1.1441–2; 26CFR 1.1441–7; 26 CFR 1.1461–1

T.D. 9815

DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Dividend Equivalents fromSources within the UnitedStates

AGENCY: Internal Revenue Service (IRS),Treasury.

ACTION: Final regulations and tempo-rary regulations.

SUMMARY: This document providesguidance to nonresident alien individualsand foreign corporations that hold certainfinancial products providing for paymentsthat are contingent upon or determined byreference to U.S. source dividend pay-ments. This document also provides guid-ance to withholding agents that are re-sponsible for withholding U.S. tax withrespect to a dividend equivalent, as well ascertain other parties to section 871(m)transactions and their agents.

DATES: Effective Date: These regula-tions are effective on January 19, 2017.

Applicability Dates: For dates of ap-plicability, see §§ 1.871–15(r); 1.871–15T(r)(4); 1.1441–1(f)(5); 1.1441–2(f);1.1441–7(a)(4); 1.1461–1(i).

FOR FURTHER INFORMATION CON-TACT: D. Peter Merkel or Karen Walny at(202) 317-6938 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information con-tained in these final regulations has beenreviewed and approved by the Office ofManagement and Budget in accordancewith the Paperwork Reduction Act of1995 (44 U.S.C. 3507(d)) under controlnumbers 1545-0096 and 1545-1597. The

collections of information in these regula-tions are in § 1.871–15T(p) and are anincrease in the total annual burden in thecurrent regulations under §§ 1.1441–1through 1.1441–9. This information is re-quired to establish whether a payment istreated as a U.S. source dividend for pur-poses of section 871(m) of the InternalRevenue Code (Code). This informationwill be used for audit and examinationpurposes. The IRS intends that these in-formation collection requirements will besatisfied by persons complying with chap-ter 3 reporting requirements and the re-quirements of the applicable qualified in-termediary (QI) revenue procedure, oralternative certification and documenta-tion requirements set out in these regula-tions. An agency may not conduct orsponsor, and a person is not required torespond to, a collection of informationunless it displays a valid control number.

Books or records relating to a collec-tion of information must be retained aslong as their contents may become mate-rial in the administration of any internalrevenue law. Generally, tax returns andreturn information are confidential, as re-quired by 26 U.S.C. 6103.

Background

On January 23, 2012, the Federal Reg-ister published temporary regulations (TD9572) at 77 FR 3108 (2012 temporaryregulations), and a notice of proposedrulemaking by cross-reference to thetemporary regulations and notice ofpublic hearing at 77 FR 3202 (2012proposed regulations, and together withthe 2012 temporary regulations, 2012 sec-tion 871(m) regulations) under section871(m) of the Code. The 2012 section871(m) regulations relate to dividendequivalents from sources within theUnited States paid to nonresident alienindividuals and foreign corporations. Cor-rections to the 2012 temporary regulationswere published on February 6, 2012, andMarch 8, 2012, in the Federal Register at77 FR 5700 and 77 FR 13969, respec-tively. A correcting amendment to the2012 temporary regulations was also pub-lished on August 31, 2012, in the Federal

Register at 77 FR 53141. The Departmentof the Treasury (Treasury Department)and the IRS received written comments onthe 2012 proposed regulations, and a pub-lic hearing was held on April 27, 2012.

On December 5, 2013, the FederalRegister published final regulations andremoval of temporary regulations (TD9648) at 78 FR 73079 (2013 final regula-tions), which finalized a portion of the2012 section 871(m) regulations. On thesame date, the Federal Register pub-lished a withdrawal of notice of proposedrulemaking, a notice of proposed rulemak-ing, and a notice of public hearing at 78FR 73128 (2013 proposed regulations). Inlight of comments on the 2012 proposedregulations, the 2013 proposed regula-tions described a new approach for deter-mining whether a payment made pursuantto a notional principal contract (NPC) oran equity-linked instrument (ELI) is a div-idend equivalent based on the delta of thecontract. In response to written commentson the 2013 proposed regulations, theTreasury Department and the IRS re-leased Notice 2014 –14, 2014 –13 IRB881, on March 24, 2014 (see § 601.601(d)(2)(ii)(b)), stating that the Treasury De-partment and the IRS anticipated limitingthe application of the rules with respect tospecified ELIs described in the 2013 pro-posed regulations to ELIs issued on orafter 90 days after the date of publicationof final regulations.

On September 18, 2015, the FederalRegister published final regulations andtemporary regulations (TD 9734), at 80FR 56866, which finalized a portion of the2013 proposed regulations and introducednew temporary regulations based on com-ments received with respect to the 2013proposed regulations (2015 final regula-tions and 2015 temporary regulations, re-spectively, and together, the 2015 regula-tions). On the same date, the FederalRegister published a notice of proposedrulemaking by cross-reference to tempo-rary regulations and a notice of publichearing at 80 FR 56415 (2015 proposedregulations, and together with the 2015final regulations, 2015 section 871(m)regulations). A correcting amendment to


the 2015 final regulations and the 2015proposed regulations was published onDecember 7, 2015, in the Federal Regis-ter at 80 FR 75946 and 80 FR 75956,respectively.

The Treasury Department and the IRSreceived written comments on the 2015proposed regulations, which are availableat www.regulations.gov. The public hear-ing scheduled for January 15, 2016, wascancelled because no request to speak wasreceived.

On July 1, 2016, the Treasury Depart-ment and the IRS released Notice 2016–42, 2016–29 IRB 67 (see § 601.601(d)(2)(ii)(b)) (QI Notice), containing aproposed amended qualified intermediaryagreement. The QI Notice included therequirements and obligations applicable toa QI that acts as a qualified derivativesdealer (QDD). The Treasury Departmentand the IRS received written comments onNotice 2016–42, which to the extent re-lated to section 871(m) and QDDs arediscussed in the “Qualified DerivativesDealer” section of this preamble. On De-cember 30, 2016, the Treasury Depart-ment and the IRS released Revenue Pro-cedure 2017–15, 2017–3 IRB 437 (2017QI Agreement), which contains the finalQI withholding agreement and the re-quirements and obligations applicable toQDDs.

On December 2, 2016, the TreasuryDepartment and the IRS released Notice2016–76, 2016–51 IRB 834, providingguidance for complying with the final andtemporary regulations under sections871(m) and 1441, 1461, and 1473 in 2017and 2018 and explaining how the IRSintends to administer those regulations in2017 and 2018.

On March 6, 2014, temporary regula-tions (TD 9658) revising certain provi-sions of the final chapters 3 and 61 regu-lations were published in the FederalRegister (79 FR 12726), and correctionsto those temporary regulations were pub-lished in the Federal Register (79 FR37181) on July 1, 2014. Those regulationswere issued to coordinate with certainprovisions of the 2013 final chapter 4 reg-ulations, as well as temporary regulations(TD 9657) under chapter 4 published inthe Federal Register (79 FR 12812). Anotice of proposed rulemaking cross-referencing the 2014 temporary coordina-

tion regulations was published in the Fed-eral Register on March 6, 2014 (79 FR12880). On January 6, 2017, the TreasuryDepartment and IRS published in the Fed-eral Register (82 FR 2046) final chapters3 and 61 regulations, as well as temporaryregulations (TD 9808).

This Treasury decision generally adoptsthe 2015 proposed regulations with thechanges discussed in this preamble. ThisTreasury decision also includes severaltechnical amendments to the 2015 final reg-ulations in response to comments on thoseregulations, which are discussed in this pre-amble. Finally, this Treasury decision pro-vides new temporary regulations based oncomments received with respect to the 2015proposed regulations.

Summary of Comments andExplanation of Provisions

I. Technical corrections to certaindefinitions

A. Broker

Section 1.871–15(p) generally pro-vides that a broker or dealer is responsiblefor determining whether a potential sec-tion 871(m) transaction is a section871(m) transaction and for reporting tothe customer the timing and amount ofany dividend equivalent. Section 1.871–15(a)(1) defines the term broker as “a bro-ker within the meaning provided in sec-tion 6045(c).” Comments explained thatmany regulated investment companiessatisfy the definition of a broker undersection 6045(c) and the regulations there-under because the term broker includes acorporation that regularly redeems its ownshares. The comments noted that theseregulated investment companies may en-ter into transactions as a short party with aforeign financial institution who is thelong party. In these transactions, the com-ments asserted, the foreign financial insti-tution (not the regulated investment com-pany) is more capable of determiningdelta and making other calculations.

The Treasury Department and the IRSagree that an entity should not be treatedas a broker for purposes of section 871(m)solely because it redeems its own shares.The rules are intended to assign responsi-bility for making the determinations re-lated to potential section 871(m) transac-

tions to the party that regularly enters intoequity derivatives with customers or holdsequity derivatives on behalf of customers.When a regulated investment company isthe short party in a transaction with afinancial institution, the Treasury Depart-ment and the IRS agree that the financialinstitution is in the better position to de-termine delta and make other determina-tions required by section 871(m). Accord-ingly, the definition of the term broker hasbeen revised in the temporary regulationsso that it will not apply to a corporationthat would be treated as a broker pursuantto section 6045(c) solely because it regu-larly redeems its own shares.

B. Dividend equivalents

Section 1.871–15(c) provides that, sub-ject to certain exceptions, a dividendequivalent includes any payment that ref-erences the payment of a dividend from anunderlying security pursuant to a securi-ties lending or sale-repurchase transac-tion, specified NPC, or specified ELI. Adividend is defined in § 1.871–15(a)(3) as“a dividend as described in section 316.”Section 1.871–15(c)(2)(ii) reduces a divi-dend equivalent by any amount treated inaccordance with sections 305(b) and (c) as adividend (a “section 305(c) dividend”) withrespect to the underlying security referencedby the section 871(m) transaction.

A comment suggested that the regula-tions clarify how this rule applies when aderivative references an underlying secu-rity that has a section 305(c) dividend.Another comment noted that § 1.871–15(c)(2)(ii) reduces the dividend equiva-lent amount by section 305(c) dividends,and that this reduction arguably appliesboth to the person who holds the underly-ing security giving rise to the section305(c) dividend and to a holder of a sec-tion 871(m) transaction that references theunderlying security that gives rise to thesection 305(c) dividend.

To address these comments, these finalregulations revise the definition of a divi-dend to explicitly provide that it applieswithout regard to whether there is an actualdistribution of cash or property. A conform-ing change is also made to § 1.871–15(c)(2)(ii), which is revised to clarify thatonly a long party that is treated as receivinga section 305(c) dividend is entitled to re-

Bulletin No. 2017–9 February 27, 2017945

duce its dividend equivalent amount andthat a section 305(c) dividend gives rise to adividend equivalent.

Thus, for example, a long party thatowns a convertible note that is a section871(m) transaction and has a section305(c) dividend can reduce its dividendequivalent by the section 305(c) dividend.In contrast, a long party that owns a spec-ified NPC that references the same con-vertible note would receive a dividendequivalent that includes the section 305(c)dividend and would not be entitled to re-duce its dividend equivalent by the section305(c) dividend on the convertible notebecause the long party does not own thenote, and therefore, is not treated as re-ceiving a section 305(c) dividend for fed-eral income tax purposes.

C. Simple Contract

To be a simple contract as defined in§ 1.871–15(a)(14)(i), the number ofshares required to calculate the amountspaid or received on any payment determi-nation date must be ascertainable at thetime the delta for the transaction is calcu-lated. Several comments noted that trans-actions may provide for anti-dilution ad-justments to the number of shares as aresult of certain corporate actions, and thatthese adjustments could cause contractsthat otherwise would be simple contractssubject to the delta test to become com-plex contracts subject to the more compli-cated substantial equivalence test. Adjust-ments that are intended to maintain thestatus quo of shareholders generallyshould not preclude a transaction frombeing treated as a simple contract. Ac-cordingly, a sentence is added to § 1.871–15(a)(14)(i) to provide that an adjustmentto the number of shares of the underlyingsecurity for a merger, stock split, cashdividend, or similar corporate action thatimpacts all the holders of the underlyingsecurity will not prevent the transactionfrom being a simple contract.

II. Certain Insurance Contracts

The exceptions for payments madepursuant to annuity, endowment, and lifeinsurance contracts were issued as a tempo-rary rule in § 1.871–15T(c)(2)(iv) of the2015 temporary regulations. Comments

generally agreed with the result in § 1.871–15T(c)(2)(iv)(A) with respect to insurancecontracts issued by domestic insurancecompanies. Several comments requestedthat § 1.871–15T(c)(2)(iv)(A) be issued as afinal regulation without any change. Thesecomments noted that any U.S. source divi-dend that a foreign insurer receives on U.S.stock it owns with respect to an annuity,endowment, or life insurance contract is al-ready subject to withholding tax.

Another comment recommended changesto make the exception for insurance issuedby a foreign company more administrable.That comment suggested that the regula-tions be extended to any foreign insurancecompany, without regard to whether thecompany is predominantly engaged in thebusiness of insurance and would be sub-ject to tax under subchapter L. This com-ment also recommended that the regula-tions define the terms “annuity contract,”“insurance contract,” “life insurance con-tract,” “endowment contract,” and “for-eign insurance company” based on regu-lations under section 1471. Finally, thecomment noted that the requirement that acompany be “predominantly engaged inan insurance business” is unnecessary inlight of the requirement that a corporation“would be subject to tax under subchapterL if it were a domestic corporation” be-cause a corporation that would be “subjectto tax under subchapter L if it were adomestic corporation” necessarily wouldbe “predominantly engaged in an insur-ance business.”

Comments also recommended that thetemporary rule relating to reinsuranceshould be finalized. Another commentnoted that reinsurance subject to the U.S.federal excise tax under section 4371 isnot subject to withholding and expressedconcern about the interaction of the excisetax and the application of section 871(m)if the reinsurance exception in the tempo-rary regulations was allowed to expire.

These regulations finalize § 1.871–15T(c)(2)(iv) with one change. The Trea-sury Department and the IRS agree thata company that is taxable under sub-chapter L as an insurance company isnecessarily predominantly engaged inan insurance business. Accordingly, infinalizing § 1.871–15T(c)(2)(iv)(B), theredundant phrase “predominantly en-gaged in an insurance business “ is re-

moved. Although comments suggestedother modifications to certain terms andthe addition of certain defined terms,these final regulations do not make theseadditional changes. The Treasury De-partment and the IRS have determinedthat the scope of entities and contractsdescribed in the temporary regulationsas eligible for the exception is appropri-ate for section 871(m), and that it isbeyond the scope of these regulations todefine terms relating to insurance.

III. Determining delta and the initialhedge

Section 1.871–15(g)(2) provides thatthe delta of a potential section 871(m)transaction is determined only when thecontract is issued. For this purpose, anNPC or ELI is issued at the time of thecontract’s inception, original issuance, orissuance as a result of a deemed exchangepursuant to section 1001. See § 1.871–15(a)(6). The same standard is used todetermine when a contract is issued forpurposes of the substantial equivalencetest for complex contracts.

For simple contracts, comments gener-ally suggested changing the time for cal-culating delta to the earlier of the tradedate or the date on which the partiesagreed to the material terms or final pric-ing for the contract. One comment recom-mended that the date and time when thematerial terms are finalized is the appro-priate date for determining delta becausethat is the time when the economic termsof the potential section 871(m) transac-tions are established. Finally, the partiesto the contract are generally bound by theterms on the pricing date, not the settle-ment date. A comment suggested usingthe trade date if the pricing date is morethan 14 days before the issue date becauseproviding too long a period between thepricing and issue date may present an op-portunity for abuse.

For listed options, comments suggesteda different method for determining thedelta of the contract. These comments rec-ommend that the delta for listed optionsshould be based on the closing price fromthe prior trading day. The comments ac-knowledged that this approach would beless accurate than the requirement in thefinal regulations; however, these com-


ments asserted that using the delta calcu-lation from the prior day for listed optionswould substantially reduce the burden ontaxpayers and make the rules more admin-istrable. Comments also noted that theOptions Clearing Corporation currentlycalculates the end-of-day delta for optionslisted on U.S. options exchanges.

For complex contracts, comments rec-ommended that the substantial equiva-lence test should be conducted on the datewhen the short party’s hedge is estab-lished. According to the comments, theissuer of a complex contract enters into ahedge on the pricing date, not the settle-ment date. The pricing date therefore re-flects the economics of a complex contractmore accurately than the settlement date,as long as the two dates are not separatedby too much time.

The Treasury Department and the IRSagree with the comments that the date fordetermining delta and for performing thesubstantial equivalence test should be re-vised to be more administrable and toreflect more accurately the economics ofthe transactions. Accordingly, these regu-lations provide that the delta of a simplecontract is determined on the earlier of thedate that the potential section 871(m)transaction is priced and the date when thepotential section 871(m) transaction is is-sued; however, the issue date must beused to determine the delta if the potentialsection 871(m) transaction is priced morethan 14 calendar days before it is issued.A similar rule also applies to the substan-tial equivalence test.

In addition, the regulations provide anew rule for determining the delta of anoption listed on a regulated exchange. Forthese options, the delta is determinedbased on the delta of the option at theclose of business on the business day be-fore the date of issuance. For this purpose,the regulations define a regulated ex-change. A regulated exchange is any ex-change defined in § 1.871–15(l)(3)(vii) ora foreign exchange that (A) is regulatedby a government agency in the jurisdic-tion in which the exchange is located, (B)maintains certain requirements designedto protect investors and to prevent fraudand manipulation, (C) maintains rules topromote active trading of listed options,and (D) had trades for which the notional

value exceeded $10 billion per day duringthe prior calendar year.

The 2015 final regulations provided asimplified delta calculation for certainsimple contracts that reference 10 or moreunderlying securities, provided that theshort party uses an exchange-traded secu-rity that references substantially all theunderlying securities to hedge the NPC orELI at the time it is issued (the “hedgesecurity”). The simplified delta calcula-tion allows the short party to calculate thedelta of the NPC or ELI by reference tochanges in the value of the hedge security.Comments suggested that this rule be ex-tended to cases in which the short partycould fully hedge its position by acquiringthe exchange-traded security even if itdoes not in fact hedge in this manner.Because the exchange-traded securitymust provide a full hedge of the NPC orELI for this rule to apply, the TreasuryDepartment and the IRS agree that theexchange-traded security will provide anacceptable delta calculation whether ornot the short party actually uses that se-curity as its hedge. Accordingly, the reg-ulations are amended to permit the deltawith respect to those NPCs and ELIs to becalculated by determining the ratio of thechange in the fair market value of the simplecontract to a small change in the fair marketvalue of an exchanged-traded security whenthe exchange-traded security would fullyhedge the NPC or ELI.

Some comments noted that third-partydata, including delta calculations, may beavailable for certain potential section 871(m)transactions. These comments requestedthat the final regulations be amended toexplicitly permit withholding agents torely on this data. Although the final regu-lations are not amended, the Treasury De-partment and the IRS note that nothing inthe regulations prohibits a taxpayer fromobtaining information from a third party.While taxpayers and withholding agents canuse third party data to determine whether apotential section 871(m) transaction is a sec-tion 871(m) transaction, taxpayers and with-holding agents that rely on third-party dataremain responsible for the accuracy of thatinformation.

One comment noted that the issuer of astructured note (or an affiliate of the is-suer) may act as a market maker for thestructured note, and thus may purchase the

note in its dealer capacity and then sell thenote to the market. According to the com-ment, if the purchase is treated as a re-demption by the issuer of the instrumentfor tax purposes, the subsequent sale tothe market would be treated as a new issuefor section 871(m) purposes, in whichcase the delta for the instrument (or sub-stantial equivalence test) would need to berecomputed at such time. The commentsuggested that rules similar to those insection 108 with respect to the purchase ofdebt instruments by an issuer acting in adealer capacity could apply to equity de-rivative structured notes. The TreasuryDepartment and the IRS acknowledge theconcern raised by the comment. However,the Treasury Department and the IRS areconcerned that an overly broad exceptionfor dealer activity may facilitate transac-tions that are inconsistent with section871(m) by allowing dealers to offer instru-ments that would be subject to section871(m) so long as the instruments wereoriginally issued with a delta below 0.80.While a dealer that issued such an instru-ment holds the instrument in inventory, thedealer does not need to hedge the positionwith an unrelated party. For this reason,market making activity by the issuer of aninstrument (or an affiliate of the issuer) pres-ents different policy concerns from marketmaking by an unrelated dealer. The Trea-sury Department and the IRS invite furthercomments on the appropriate treatment ofstructured notes and similar instruments thatare acquired by the issuer or an affiliate in itsdealer capacity.

IV. Substantial Equivalence Test

Comments to the 2013 proposed regu-lations generally agreed that the delta testwas fair and practical for the majority ofequity-linked derivatives. However, com-ments explained that the delta test wouldbe impractical or impossible to apply tomore exotic equity derivatives, such asstructured notes in which the long party’sreturn was determined based on an ini-tially indeterminate number of shares ofthe underlying security. The 2015 section871(m) regulations address this concernby providing an alternative test—the“substantial equivalence test”—for con-tracts with indeterminate deltas. For pur-poses of applying this test, the regulations


distinguish between simple and complexcontracts. Generally, a simple contract is acontract that references a single, fixednumber of shares and has a single matu-rity or exercise date. A complex contractis any contract that is not a simple con-tract. Contracts with indeterminate deltasare classified as complex contracts and aresubject to the substantial equivalence test.

Generally, the substantial equivalencetest measures the change in value of acomplex contract when the price of theunderlying security referenced by thatcontract is hypothetically increased byone standard deviation or decreased byone standard deviation (each, a “testingprice”) and compares that change to thechange in value of the shares of the un-derlying security that would be held tohedge the complex contract when the con-tract is issued (the “initial hedge”) at eachtesting price. The smaller the proportion-ate difference between the change in valueof the complex contract and the change invalue of its initial hedge at multiple test-ing prices, the more equivalence there isbetween the contract and the referencedunderlying security. When this differenceis equal to or less than the difference for asimple contract benchmark with a delta of0.80 and its initial hedge, the complexcontract is treated as substantially equiva-lent to the underlying security. When thesteps of the substantial equivalence test can-not be applied to a particular complex con-tract, a taxpayer must use the principles ofthe substantial equivalence test to reason-ably determine whether the complex con-tract is a section 871(m) transaction withrespect to each underlying security.

The Treasury Department and the IRSrequested comments regarding the sub-stantial equivalence test. In particular,comments were requested on whether twotesting points were adequate to ensure thatthe test would capture appropriate trans-actions and on the administrability of thetest. Comments also were requested onthe application of the test to complexcontracts that reference multiple securi-ties, including path-dependent instru-ments (that is, an instrument for which thefinal value depends, in whole or in part, onthe price sequence (or path) of the under-lying security before the maturity of theinstrument). Comments generally did notrecommend material changes to the test.

As a result, these final regulations adopt thesubstantial equivalence test as proposed inthe 2015 proposed regulations with minorchanges as described in this section.

One comment noted that the substan-tial equivalence test might be unduly bur-densome in certain cases, such as when itis obvious that a particular instrumentwould satisfy the test and application ofthe test would have no effect on theamount of withholding. This commentsuggested that an issuer of a complex con-tract be allowed to use an alternative testto determine the withholding tax imposedwith respect to a dividend equivalent aslong as the alternative test resulted in thesame amount of withholding tax as wouldhave been the case if the issuer had usedthe substantial equivalence test. These fi-nal regulations do not adopt this comment.Even in those cases where the result for apotential section 871(m) transaction is in-tuitive, administration of such an alterna-tive approach would generally require ap-plying the substantial equivalence test todemonstrate that the alternative test re-sults in the same amount of withholdingtax as the substantial equivalence test. Asissuers of complex contracts become pro-ficient with the substantial equivalencetest it is expected that it will be relativelystraightforward to determine whether aparticular instrument is subject to with-holding under section 871(m).

Another comment suggested that theTreasury Department and the IRS con-sider whether the substantial equivalencetest could be manipulated to allow taxpay-ers to understate the similarity of a com-plex contract to the underlying security.This comment suggested that more guid-ance should be offered about the criteriafor determining whether a simple contractis “closely comparable” to a complex con-tract for purposes of choosing a simplecontract benchmark. The same commentrecommended that the regulations specifythat the benchmark contract could be ahypothetical instrument, and that the ma-terial terms, including the treatment ofdividends, should be consistent with theterms of the complex contract (aside fromthe terms that make the contract complexand that make the delta of the closelycomparable benchmark 0.8).

In response to this comment, the finalregulations provide that the simple con-

tract benchmark may be an actual or hy-pothetical simple contract that, at the timethe substantial equivalence test is appliedto the complex contract, has a delta of 0.8,references the applicable underlying secu-rity referenced by the complex contract,and has terms that are consistent with allthe material terms of the complex con-tract, including the maturity date. In addi-tion, to further ensure comparability be-tween the simple contract benchmark andthe complex contract, the final regulationsprovide that the simple contract bench-mark must consistently apply reasonableinputs, including a reasonable time periodfor the contract. For example, the reason-able time period for the contract must beconsistently applied in determining thestandard deviation and probability, as wellas the maturity date and any other termsdependent on that time period.

V. Amount and Timing of a Taxpayer’sLiability

Section 1.871–15(j) contains rules fordetermining the amount of the dividendequivalent. In addition, § 1.871–15(j) re-quires that the amount of a dividend equiv-alent be determined on the earlier of therecord date of the dividend and the daybefore the ex-dividend date with respect tothe dividend. In many cases, the amount ofa dividend equivalent will be determinedbefore a withholding agent will be requiredto withhold any tax pursuant to newlyredesignated § 1.1441–2(e)(7) (formerly§ 1.1441–2(e)(8)). Comments requested thata foreign holder’s tax liability be deferreduntil withholding is required, in order toavoid the need for the foreign holder to filea return and pay tax. The comments notedthat this approach would be consistent withthe general withholding regime under chap-ter 3 of the Code. With respect to a section871(m) transaction acquired by a foreigninvestor after its initial issuance, a commentrequested clarification that the foreign in-vestor is only liable for dividends deter-mined on the underlying security during theperiod that the foreign investor is the bene-ficial owner of the section 871(m) transac-tion.

These regulations include several newprovisions in response to these comments.First, § 1.871–15(j)(4) is added to providethat a long party generally is liable for tax


on a dividend equivalent in the year thedividend equivalent payment is subject towithholding pursuant to § 1.1441–2(e)(7),or in the case of a QDD, when the paymentof the applicable dividend on the underlyingsecurity is subject to withholding.

Second, the regulations are amended toclarify that the amount of a dividendequivalent subject to tax will not changebecause the tax is withheld at a later date.Section 1.871–15(j)(2) establishes thetime for determining the amount of a div-idend equivalent; the amount of the longparty’s tax liability should not change be-cause the withholding agent does notwithhold at the time the tax liability arises.Therefore, changes in facts (such as the taxrate or whether the recipient is a qualifiedresident of a country with which the U.S.has an income tax treaty) between the timethat the amount of a dividend equivalent isdetermined and the time that withholdingoccurs, do not affect tax liability. For exam-ple, if at the time for determining the divi-dend equivalent amount, the long partyqualifies for a treaty, but in the year theamount is withheld the long party does not,the dividend equivalent would qualify fortreaty benefits.

Finally, § 1.871–15(j)(1) expresslyprovides that the long party is only liablefor tax on dividend equivalents that arisewhile the long party is a party to thetransaction. For example, if long party A,a foreign person, enters into a section871(m) transaction on an underlying stockthat pays quarterly dividends, and sells thetransaction to B, a foreign person, afterfour dividends on the underlying stockhave been paid, A will be subject to tax onthose four dividend equivalents and B willbe subject to tax on subsequent dividendequivalents as long as B holds the section871(m) transaction. Alternatively, if A is aU.S. person, B would still only be subjectto tax on the dividend equivalents after itacquires the transaction.

VI. Qualified Index

Section 1.871–15(l) provides a safeharbor for derivatives based on certainqualified indices. Section 1.871–15(l)(1)provides that the purpose of the exceptionfor qualified indices is to provide a safeharbor for potential section 871(m) trans-actions that reference certain passive indi-

ces, and that an index is not a qualifiedindex if treating the index as a qualifiedindex would be contrary to this purpose.Section 1.871–15(l)(4) provides a specificsafe harbor for derivatives based on anindex in which the U.S. stock componentscomprise, in the aggregate, 10 percent orless of the weighting of all the componentsecurities in the index. A comment regard-ing the 10 percent safe harbor indicatedthat some taxpayers, notwithstandingthe purpose test for indices in § 1.871–15(l)(1), may seek to use a customizedindex to make tax-advantaged invest-ments in specific U.S. stocks. Althoughthe index described by the comment maynot be a qualified index as a result of thepurpose rule in § 1.871–15(l)(1), the finalregulations are revised to clarify that, inorder to meet this 10 percent safe harbor,an index must be widely traded and mustnot be formed or availed of with a princi-pal purpose of tax avoidance.

Comments to the qualified indicesrules in the 2015 final regulations alsorequested that the Treasury Departmentand the IRS address how the rules apply toan index in the first year it is created.Accordingly, these final regulations add§ 1.871–15(l)(2)(ii) to provide that, for thefirst year, an index is tested on the firstbusiness day it is listed, and the dividendyield calculation is determined using thedividend yield that the index would havehad in the immediately preceding year if ithad the same components throughout thatyear that it has on the day it is created.

VII. Combined transactions

For purposes of determining whethertransactions are section 871(m) transac-tions, the 2015 final regulations treat twoor more transactions as a single transac-tion when a long party (or a related per-son) enters into multiple transactions thatreference the same underlying security,the combined potential section 871(m)transactions replicate the economics ofa transaction that would be a section871(m) transaction, and the transactionswere entered into in connection with eachother. The 2015 final regulations also pro-vide brokers acting as short parties withtwo presumptions that may be applied todetermine whether to combine potentialsection 871(m) transactions. First, a bro-

ker may presume that transactions are notentered into in connection with each otherif the long party holds the transactions inseparate accounts. Second, a broker maypresume that transactions entered into twoor more business days apart are not en-tered into in connection with each other. Abroker, however, cannot rely on the firstpresumption if it has actual knowledgethat the long party created or used sepa-rate accounts to avoid section 871(m). Inaddition, neither presumption applies ifthe broker has actual knowledge thattransactions were entered into in connec-tion with each other. Section 1.1441–1(b)(4)(xxiii) also permits withholdingagents to rely on these presumptions.

Comments suggested several changes tothe combined transaction rules. Commentsnoted that it will be burdensome to identifyevery contract that a customer entered intowith respect to the same underlying securitywithin two days of each other. To replacethe presumptions, comments recommendedthat a withholding agent only be required tocombine contracts if the withholding agenthad actual knowledge that two contractswere priced, marketed, or sold in connectionwith each other.

The Treasury Department and the IRSdisagree that the priced, marketed, or soldstandard should replace the combinationpresumptions. Comments noted a “not un-common” example of an active foreigninvestor who acquires or sells within atwo-day period hundreds of listed optionsreferencing the same underlying security.The Treasury Department and the IRS,however, intended to treat those transac-tions as combined to the extent that thepotential section 871(m) transactions areentered into in connection with each otherand satisfy the other requirements of§ 1.871–15(n)(1). The priced, marketed,or sold standard provides an inadequatesubstitute for the combined transactiontest and the presumptions because inves-tors can replicate a section 871(m) trans-action by entering into multiple potentialsection 871(m) transactions. For example,an investor could replicate a delta onetransaction by entering into a put optionand a call option on the same underlyingsecurity at the same time, with the samestrike price, whether or not the options arepriced, marketed, or sold together. For thisreason, the priced, marketed, or sold stan-


dard provides an inadequate substitute forthe presumptions. The comments submit-ted with respect to the combination ruleacknowledge short parties and withhold-ing agents are aware that foreign investorsuse multiple transactions in a manner thatare combined under the final regulations.The “priced, marketed, or sold” standardwould undermine the enforcement of thecombination rules.

Notwithstanding the prior paragraph,Notice 2016–76 provides a simplifiedstandard for withholding agents to deter-mine whether transactions entered into in2017 are combined transactions. A with-holding agent will only be required tocombine transactions entered into in 2017for purposes of determining whether thetransactions are section 871(m) transactionswhen the transactions are over-the-countertransactions that are priced, marketed, orsold in connection with each other. With-holding agents will not be required to com-bine any transactions that are listed securi-ties that are entered into in 2017.

Another comment noted that the finalregulations indicated that transactionswould only be combined into simple con-tracts. This comment recommended thatthe final regulation be amended if theTreasury Department and the IRS dis-agreed with this reading of the combina-tion rule. The Treasury Department andthe IRS agree that transactions will onlybe combined into simple transactions pur-suant to § 1.871–15(n); therefore, the finalregulations are not amended.

Other comments suggested some clar-ifications to the combination rules to re-solve ambiguities. For example, com-ments requested, among other things, that(1) ordering rules provide that a contractcannot be combined more than once and(2) no combination transaction shouldhave a delta of more than one. The finalregulations are not amended to addressthese issues because the final regulationsare intended to provide a general frame-work for determining when two or moretransactions should be combined. Thecomments received to date show that in-dustry understanding of how the combi-nation rules may be administered contin-ues to develop as financial institutionswork to establish systems. As this under-standing evolves, the Treasury Depart-ment and the IRS may publish subse-

quent guidance to address the issuesraised by these comments. Until suchfurther guidance is issued, taxpayersmay adopt any reasonable methodologyto combine transactions within the gen-eral framework of the final regulations.

VIII. Party Responsible for DeterminingDelta and Other Information

The 2015 final regulations provide thatwhen one of the parties to a potentialsection 871(m) transaction is a broker ordealer, that broker or dealer is responsiblefor determining whether the transaction isa section 871(m) transaction. When bothparties to a potential section 871(m) trans-action are a broker or dealer or neither partyto a potential section 871(m) is a broker ordealer, the short party to the transactionmust determine whether the transaction is asection 871(m) transaction.

Comments noted that multiple partiescould be responsible for determiningwhether a transaction is a section 871(m)transaction because the definition of a“party to the transaction” includes a longparty, a short party, any agent acting onbehalf of a long party or short party, andany person acting as an intermediary withrespect to a potential section 871(m)transaction. Comments noted that both ashort party and one or more agents of theshort party may be a broker or dealer; in thiscase, the 2015 final regulations do not iden-tify which of the responsible parties has theprimary obligation to determine whether thetransaction is a section 871(m) transaction.

Comments requested that the regula-tions clarify which broker has the obliga-tion to determine whether a listed optionis a section 871(m) transaction when mul-tiple brokers or dealers are involved. Onecomment recommended that the long par-ty’s broker that has custody of the trans-action at the end of the day would be bestsuited to act as the responsible party.Comments also noted that the short partyor the agent of a short party may not havethe relevant information necessary to de-termine when withholding should takeplace. For example, when a long party hassold an instrument in the secondary mar-ket, the short party and its agent may nothave any knowledge of that sale. As aresult, the long party’s broker should bethe responsible party.

Other comments indicated that the is-suer should be the responsible party whenthe issuer itself is a broker or a dealer, orwhen the issuer has an affiliate that is abroker or dealer. In these cases, the issueror its affiliate is likely to have the infor-mation necessary to determine whetherthe transaction is a section 871(m) trans-action. As noted in other comments, anintermediary to a transaction issued by abroker or dealer, such as a clearinghouse,will not have the information necessaryto determine whether a potential section871(m) transaction is a section 871(m)transaction, and is unlikely to know eitherthe time or the amount to withhold.

The Treasury Department and the IRSagree that the final regulations may resultin multiple parties to a transaction quali-fying as the party responsible for deter-mining whether a potential section 871(m)transaction is a section 871(m) transac-tion. New temporary regulations resolvethis duplication of responsible parties un-der § 1.871–15(p)(1) in the following cir-cumstances: (1) both the short party andan agent or intermediary of the short partyare a broker or a dealer; (2) the short partyis not a broker or dealer and more thanone of the agents or intermediaries of theshort party is a broker or dealer; (3) theshort party and its agents or intermediariesare not brokers or dealers, and more thanone agent or intermediary acting on behalfof the long party is a broker or dealer; and(4) potential section 871(m) transactionsare traded on an exchange and cleared bya clearing organization.

Specifically, § 1.871–15T(p)(1)(ii)provides that the short party is the respon-sible party when both the short party andan agent or intermediary acting on behalfof the short party are a broker or dealer. Inthese circumstances, the Treasury Depart-ment and the IRS have determined that theshort party should be the responsible partybecause it will have access to the relevantdata regarding that transaction, whereasan agent or intermediary may not have thenecessary information. As the responsibleparty, the short party may contract with athird party to make the determinations onits behalf; however, the short party re-mains responsible for the accuracy of anycalculations by the third party.

In addition, if the short party is not abroker or dealer, but more than one agent


or intermediary acting on behalf of theshort party is a broker or dealer, § 1.871–15T(p)(1)(ii) provides that the broker ordealer closest to the short party in thepayment chain is the responsible party.The Treasury Department and the IRShave determined that the agent or interme-diary closest in the chain to the short partywill have the best access to any informa-tion the short party has that is necessary todetermine whether a potential section871(m) transaction is a section 871(m)transaction and to make other relevant de-terminations.

Section 1.871–15T(p)(1)(ii) also gen-erally provides that when one or moreagents or intermediaries acting on behalfof the long party are brokers or dealers,the agent or intermediary that is closest tothe long party in the payment chain is theresponsible party when neither the shortparty nor any agent or intermediary actingon behalf of the short party is a broker ordealer. In this situation, the temporary reg-ulations place the responsibility with theagent or intermediary closest to the longparty because this agent or intermediary willknow whether or not the long party is sub-ject to tax under section 871 or 881 andwhen the long party has terminated or oth-erwise disposed of the transaction.

Similarly, these temporary regulationsalso provide a rule for determining theresponsible party when potential section871(m) transactions are traded on an ex-change and cleared by a clearing organi-zation. When more than one broker ordealer acts as an agent or intermediarybetween the short party and a foreign in-vestor on an exchange-traded contract, thebroker or dealer that has an ongoing cus-tomer relationship with the foreign inves-tor is the responsible party. Generally, thisintermediary will be the clearing firm.

Finally, these temporary regulationsprovide that the issuer of a potential sec-tion 871(m) transaction will be the re-sponsible party for certain ELIs. Specifi-cally, the issuer is the responsible partyfor structured notes (including contingentpayment debt instruments), warrants, con-vertible stocks, and convertible debt in-struments. Because the issuer of theseELIs ordinarily will have structured theELI, determined the pricing of the ELI,and hedged the ELI, the issuer ordinarilywill be in the best position to act as the

responsible party. While the issuer of anELI may not be a broker or dealer, anissuer of an ELI typically is advised by abroker or dealer.

IX. Qualified Derivatives Dealer

Section 1.871–15T(q) permits a QDDto reduce its liability under section 871 or881 for a dividend or dividend equivalentto the extent it makes an offsetting divi-dend equivalent payment in its dealer ca-pacity. Only an eligible entity that hasentered into a QI agreement can be aQDD. An eligible entity is defined as: (1)a dealer in securities subject to regulatorysupervision as a dealer, (2) a bank subjectto regulatory supervision as a bank, or (3)a wholly-owned entity of a bank subject toregulatory supervision as a bank when thewholly-owned entity (a) issues potentialsection 871(m) transactions to customersand (b) receives dividends or dividendequivalent payments from stock or poten-tial section 871(m) transactions that hedgethe potential section 871(m) transactionsissued to customers. § 1.1441–1T(e)(6).An entity is only a QDD when acting in itsQDD capacity.

A. Income Tax Treaties

In general, section 871(m) and the reg-ulations thereunder apply to a dividendequivalent payment without regard towhether the payor of the dividend equiv-alent payment is domestic or foreign. Sec-tion 1.894–1(c)(2) provides that “[t]heprovisions of an income tax conventionrelating to dividends paid to or derived bya foreign person apply to the payment of adividend equivalent described in section871(m) and the regulations thereunder.”Consistent with the foregoing, the 2017QI Agreement provides that a QDD musttreat any dividend equivalent as a divi-dend from sources within the UnitedStates for purposes of section 881 andchapters 3 and 4 consistent section 871(m)and the regulations thereunder. The 2017QI Agreement provides that a QDD mayreduce the rate of withholding under chap-ter 3 based only on a beneficial owner’sclaim that it is entitled to a reduced rate ofwithholding for portfolio dividends underthe dividends article of an applicable in-come tax treaty.

B. Eligible Entities

Comments requested that the TreasuryDepartment and the IRS expand the scopeof entities that qualify as an eligible entityunder § 1.1441–1(e), and therefore can actas a QDD under a QI agreement. Onecomment requested that the eligibility cri-teria be expanded to permit a controlledforeign corporation (CFC) of a U.S finan-cial institution to act as a QDD even if theCFC is not a QI. Other comments recom-mended that the definition of an eligibleentity be expanded to include a bank hold-ing company if the entity regularly issuespotential section 871(m) transactions tocustomers and receives dividends or div-idend equivalent payments pursuant to po-tential section 871(m) transactions tohedge the transactions issued to custom-ers. Comments noted that a bank holdingcompany is subject to a wide range ofregulatory regimes.

Comments also recommended that thescope of eligible entities be expanded toinclude subsidiaries of securities dealers andbank holding companies that regularly issuepotential section 871(m) transactions to cus-tomers and receive dividends or dividendequivalent amounts with respect to hedgesof those customer transactions. Commentsnoted that these entities are part of a regu-lated financial group.

In response to comments, the 2017 QIAgreement announced the expansion ofthe definition of eligible entities to includea bank holding company and subsidiariesof a bank holding company. The TreasuryDepartment and the IRS agree that a bankholding company and subsidiaries of abank holding company should be includedin the definition of an eligible entity be-cause these entities are regulated financialinstitutions.

The 2017 QI Agreement clarified thatthe eligible entity test is applied at thehome office or branch level, and that eachhome office or branch is a separate QDD.The 2017 QI Agreement also expandedwhat constitutes an eligible entity to in-clude a foreign branch of a U.S. financialinstitution that would meet the require-ments of an eligible entity if the branchwere a separate entity, though such abranch will not be subject to tax on itsQDD tax liability because it is otherwisesubject to tax on a net income basis under


chapter 1. Both of these changes are in-corporated in these final regulations.These final regulations also clarify that asubsidiary of a bank or bank holding com-pany could be indirectly wholly-owned bythe qualifying bank or bank holding com-pany provided that the subsidiary, acting inits equity derivatives dealer capacity, (1)issues potential section 871(m) transactionsto customers, and (2) receives dividendswith respect to stock or dividend equivalentpayments pursuant to potential section871(m) transactions that hedge potentialsection 871(m) transactions that it issues.

These final regulations do not expandthe eligible entity definition to specificallyinclude CFCs. The comments generallydid not adequately explain why CFCs can-not avail themselves of the QI regime(with the QDD provisions). PermittingCFCs that are not QIs to be QDDs wouldeliminate the compliance benefits pro-vided in the 2017 QI Agreement andwould make it more difficult for the IRSto verify compliance with the QDD rules.However, to provide the IRS with flex-ibility to administer the QDD regime, aneligible entity is defined to include anyother person acceptable to the IRS,which is similar to the allowance pro-vided to the IRS in defining personseligible to enter into a QI agreement asprovided in § 1.1441–1(e)(5)(ii)(D).

A comment also raised a technical is-sue with who can qualify as a QI, express-ing concern that some eligible entities thatare not foreign financial institutions maynot be able to enter into QI agreementsbecause they are not eligible to become aQI. The 2017 QI Agreement and thesefinal regulations now clarify that an eligi-ble entity (notwithstanding that the entityotherwise would not be eligible to be aQI) can enter into a QI agreement in orderto implement the QDD provisions.

C. Section 871(m) Amount and QDD’sTax Liability

Section 1.871–15T(q)(1) of the 2015temporary regulations provided that aQDD generally would not be liable for taxunder section 871 or 881 on a dividend ordividend equivalent payment that theQDD receives in its capacity as a QDD,provided that the QDD complies with itsobligations under the qualified intermedi-

ary agreement. Section 1.1441–1T(e)(6)of the 2015 temporary regulations pro-vided that a QDD would not be subject towithholding on such dividends or divi-dend equivalents. Section D of this PartIX describes certain changes to the fore-going rules that the Treasury Departmentand the IRS determined are appropriate inlight of the adoption of the net delta ap-proach described in this Part IX.C.

Section 1.871–15T(q)(1) of the 2015temporary regulations further providesthat, if a QDD receives a dividend ordividend equivalent payment and the off-setting dividend equivalent payment theQDD is contractually obligated to makeon the same underlying security is lessthan the dividend and dividend equivalentamount the QDD received, the QDDwould be liable for tax under section871(a) or 881 for the difference.

The QI Notice described proposedchanges to the QI agreement that wouldimplement the QDD tax liability de-scribed in § 1.871–15T(q). Under the QINotice, a QDD’s section 871(m) amountfor a dividend was the excess of the div-idends on underlying securities associatedwith potential section 871(m) transactionsand dividend equivalent payments that itreceived that reference the same dividendover dividend equivalent payments and anyqualifying dividend equivalent offsettingpayment that the QDD made or was con-tractually obligated to make with respect tothe same dividend. The QI Notice describeda qualifying dividend equivalent offsettingpayment as (a) any payment made or con-tractually obligated to be made to a UnitedStates person that would be a dividendequivalent payment if made to a person whowas not a United States person and (b) anypayment made to a foreign person thatwould be a dividend equivalent payment ifthe payment were not treated as incomeeffectively connected with the conduct of aU.S. trade or business.

In addition, the QI Notice proposedrules regarding how a QDD would calcu-late its QDD tax liability. Specifically,under the QI Notice, the QDD tax liabilitywas the sum of a QDD’s liability undersections 871(a) and 881 for (a) its section871(m) amount; (b) its dividends that arenot on underlying securities associatedwith potential section 871(m) transactionsand its dividend equivalent payments re-

ceived as a QDD in its non-dealer capac-ity; and (c) any other payments, such asinterest, received as a QDD with respectto potential section 871(m) transactions orunderlying securities that are not dividendor dividend equivalent payments.

Comments requested that a QDD bepermitted to elect to calculate its section871(m) amount either by using (1) themethod described in the QI Notice or (2)its net delta exposure to an underlyingsecurity. According to comments, the netdelta exposure is a calculation, measuredin shares of stock, that aggregates all theshares of an underlying security and allequity derivative transactions referringto the same underlying security that theQDD has entered into in a dealer capac-ity (whether customer transactions orhedging transactions). Comments ex-plained that net delta accurately mea-sures a QDD’s residual exposure to anunderlying security. Comments notedthat financial institutions use net deltaexposure for business and non-tax reg-ulatory purposes.

Comments also requested that theTreasury Department and the IRS ex-pand the offsetting dividend equivalentpayment to include all customer trans-actions, such as potential section 871(m)transactions with a delta below 0.8,grandfathered transactions, and transac-tions that reference a qualified index.

In response to comments relating to theQI Notice, Notice 2016–76 announcedthat the regulations would be revised torequire a QDD to calculate its section871(m) amount based on the net deltaapproach. The Treasury Department andthe IRS agree that the net delta approachprovides an administrable and accuratemethod for a QDD to determine its residualexposure to underlying securities. The Trea-sury Department and the IRS, however, donot agree with comments indicating thatQDDs should be permitted to elect to usethe net delta exposure method or the ruledescribed in the QI Notice. It would beburdensome to the IRS to administer a sys-tem that permits a QDD to use multiplemethods to calculate its section 871(m)amount. The Treasury Department and theIRS, however, will consider comments thatexplain in more detail why a choice ofmethods for determining the section 871(m)


amount is in the best interests of both tax-payers and the government.

These final regulations further explainhow a QDD’s section 871(m) amount iscomputed. The amount is determined sepa-rately for each dividend on an underlyingsecurity. For example, if a QDD enters intosection 871(m) transactions that referencestock A (which pays a $5 dividend pershare), hedges the transactions by acquiringactual shares of stock, and has a net deltaexposure to one share of stock, the QDDwill have a tax liability pursuant to sections871(a) and 881 with respect to a $5 dividendbased on its net delta exposure to one shareof stock A. Amounts with respect to otherdividends on the same stock or anotherstock are not taken into account.

Because these final regulations adoptthe net delta exposure method for calcu-lating the section 871(m) amount, the con-cepts of offsetting dividend equivalentpayments and qualifying dividend equiv-alent offsetting payments have been elim-inated from these final regulations.

These final regulations revise the calcu-lation of a QDD’s tax liability on the section871(m) amount to correspond with thechanges regarding the determination of thesection 871(m) amount discussed in thissection and the changes to withholding onpayments to a QDD that are discussed in thefollowing section of this preamble. Specifi-cally, a QDD’s tax liability on its section871(m) amount is, for each dividend oneach underlying security, the amount bywhich its tax liability under section 881 forits section 871(m) amount exceeds theamount of tax paid by the QDD under sec-tion 881 (including amounts withheld onpayments to the QDD) on dividend pay-ments received by the QDD in its capacityas an equity derivatives dealer. The QDDalso is liable for tax under section 881 fordividend equivalent payments received by aQDD in its non–equity derivatives dealercapacity and for any other payments (in-cluding dividends) it receives as a QDD tothe extent the full liability was not satisfiedby withholding.

D. Withholding on Dividends Paid to aQDD

In general, under the law in effect priorto 2017, an eligible entity that would qual-ify as a QDD under these final regulations

generally was subject to tax under section881 and to withholding tax under chapters3 and 4 on actual dividends in the samemanner as any other foreign recipient. Asdescribed in the preceding section, the2015 temporary regulations provided thata QDD would no longer be subject to taxor to withholding on actual dividends re-ceived in its capacity as a QDD. The Trea-sury Department and the IRS are con-cerned that this exemption in the 2015temporary regulations, when combinedwith the net delta exposure method, couldresult in U.S. source dividends escapingU.S. tax completely in certain circum-stances. For example, if a QDD holdsphysical shares of an underlying securitythat it uses to hedge a delta 0.5 option,both the dividend and the option wouldnot be subject to tax under section 871 orsection 881. In response to this concern,Notice 2016–76 announced that the Trea-sury Department and the IRS intended torevise §§ 1.871–15T(q)(1) and 1.1441–1(b)(4)(xxii) to provide that a QDD willremain liable for tax under section881(a)(1) and subject to withholding un-der chapters 3 and 4 on dividends onphysical shares and deemed dividendsreceived. These final regulations revise§§ 1.871–15T(q)(1) and 1.1441–1(b)(4)(xxii) accordingly. However, as an-nounced in the 2017 QI Agreement, inorder to allow taxpayers time to imple-ment the net delta approach, these reg-ulations continue to provide that divi-dends on physical shares and deemeddividends received by a QDD in itsQDD capacity in 2017 will not be sub-ject to tax under section 881(a)(1) orsubject to withholding under chapters 3and 4. A QDD will be subject to with-holding on dividends (including deemeddividends) received on or after January1, 2018.

The Treasury Department and theIRS will consider comments recom-mending approaches for alleviating anyoverwithholding (and preventing anyunderwithholding) that might occur ondealer transactions with customers andon positions that hedge customer trans-actions when withholding on dividends(including deemed dividends) paid toQDDs resumes in 2018.

The QI Notice provided that a with-holding agent (other than a withholding

agent that itself was acting as a QDD)would not be required to withhold or re-port on payments made to a QDD withrespect to potential section 871(m) trans-actions and underlying securities, otherthan reporting for dividends and substitutedividends. A comment requested that awithholding agent should only be exemptfrom withholding and reporting on divi-dends and dividend equivalents paid to aQDD. In response to this comment, the2017 QI Agreement provides that all pay-ments (other than dividend equivalentpayments) made to a QDD with respect tounderlying securities will be subject towithholding and reporting if the paymentswould be subject to withholding and re-porting to a non-QDD. Consistent with the2017 QI Agreement, the final regulationsprovide that all payments (other than div-idend equivalent payments) made to aQDD with respect to underlying securitieswill be subject to withholding and report-ing if those payments would be subject towithholding and reporting when receivedby a foreign person.

E. Dealer Versus Proprietary Capacity

The 2015 temporary regulations onlypermitted a taxpayer to act as a QDD withrespect to certain payments received in itsdealer capacity. Comments requested that ataxpayer be permitted to act as a QDD forpayments received in its proprietary capac-ity for administrative reasons. The QI No-tice and the 2017 QI Agreement reflect thischange to the scope of QDD payments. Thechange in QDD scope does not impact thelimitation on amounts entitled to be offset,which remain limited to dealer activity.

Consistent with the 2015 regulations,the QI Notice and the 2017 QI Agreementprovide that, for purposes of determiningthe QDD tax liability, payments receivedby a QDD acting as a proprietary traderare treated as payments received in itsnon-dealer capacity, while transactionsproperly reflected in a QDD’s dealer bookare presumed to be held by a dealer in itsdealer capacity. For purposes of determin-ing the QDD tax liability, dealer activity islimited to its activity as an equity deriva-tives dealer. One comment requested thatthe regulations clarify and qualify the dis-tinction between receiving a payment in adealer versus in a proprietary trader ca-


pacity and the impact of the distinction onthe ability of an entity to act as a QDD.The Treasury Department and the IRShave determined that the regulations ade-quately delineate between dealer and pro-prietary transactions in § 1.871–15(q)(2).

F. Timing of Withholding

Generally, newly redesignated § 1.1441–2(e)(7) (formerly § 1.1441–2(e)(8)) pro-vides that a withholding agent must with-hold on a dividend equivalent on the later ofthe date on which the amount of the divi-dend equivalent is determined and the datethat a payment occurs. A payment generallyoccurs when money or other property ispaid to or by the long party, or the long partysells, exchanges, transfers, or otherwise dis-poses of a section 871(m) transaction. Not-withstanding this general rule applicable towithholding agents, the QI Notice an-nounced that a QDD must withhold withrespect to a dividend equivalent payment onthe dividend payment date for the applicabledividend on the underlying security as de-termined in § 1.1441–2(e)(4).

Comments noted that this changewould require a QDD to pay tax prior tothe date that other withholding agentswould have been required to withhold. Inaddition, comments expressed concernthat this rule would result in cashlesswithholding for many transactions. Com-ments also noted that withholding agentshave been building withholding systemsaccording to the general rule provided inthe final section 871(m) regulations. Com-ments recommended that the final section871(m) regulations be amended to permita QDD to elect to withhold on the pay-ment of the dividend equivalent as pro-vided in newly redesignated § 1.1441–2(e)(7) or on the dividend payment date asdetermined in § 1.1441–2(e)(4).

The Treasury Department and the IRShave determined that a QDD should con-tinue to be required to withhold on thedividend payment date as determined in§ 1.1441–2(e)(4), because the time that aQDD withholds on customer transactionsshould match the time period for which itdetermines its own tax liability with re-spect to the section 871(m) amount. Thisis because the withholding tax that mayapply to customer transactions is the jus-tification for relieving the QDD from tax

on its section 871(m) amount. In addition,this rule simplifies the reconciliation state-ment, makes it easier for reviewers andthe IRS to verify that a QDD has compliedwith the requirements of the 2017 QIAgreement, and avoids a number of otherissues that would arise under the re-quested approach, including statute oflimitation issues. With respect to the con-cerns expressed regarding the need tobuild systems, the Treasury Departmentand the IRS note that this timing rule isconsistent with the rule that was proposedin the QI Notice, released July 1, 2016.Moreover, as described in Notice 2016–76, during 2017, the IRS will take intoaccount the extent to which a QDD hasmade a good faith effort to comply withthe QDD provisions in the QI agreementwhen enforcing those provisions.

G. Qualified Securities Lenders (QSL)and Credit Forward

Notice 2010–46, 2010–24 I.R.B. 757(see § 601.601(d)(2)(ii)(b)), (QSL Notice)outlined a proposed credit forward systemthat allowed a withholding agent to limitthe aggregate U.S. gross-basis tax in aseries of securities lending transactions tothe amount of U.S. gross-basis tax appli-cable to the foreign taxpayer receiving asubstitute or actual dividend in the seriesof transactions who bears the highest rateof U.S. gross-basis tax. The preamble tothe 2015 regulations indicated that thecredit forward system remained underconsideration, but noted that, during thetransition period provided in Notice2010–46, the IRS has experienced diffi-culty verifying that prior withholding hasoccurred. Comments were requested onthe need for the regime and how it couldbe implemented.

Comments requested that the creditforward system be retained. One commentrequested that the credit forward systembe retained when QDD status was notavailable. In contrast, another commentsuggested that the stringency resultingfrom tightening the eligibility require-ments for QDDs to QIs that are subject toreporting and compliance requirementswould improve the ability to verify thatprior withholding occurred.

As discussed in Part IX.B of this pre-amble the Treasury Department and the

IRS have concluded that it is not appro-priate to permit credits or offsets forany entity that does not qualify as aneligible entity. In reaching this conclu-sion, the Treasury Department and theIRS agree with the comment that indi-cated that the QDD rules provide a moreadministrable method of determining thatwithholding properly occurred. If the en-tity is acting as an intermediary instead ofacting as a principal, it may choose to bea QI that is not a QDD. The second com-ment did not explain why the existingQDD regime is insufficient.

In addition to comments regarding thecredit forward system, a comment re-quested that QSL status be preserved as astandalone rule for securities lendingtransactions that are part of a separate lineof business from other potential section871(m) transactions. Another commentrecommended reverting to the eligibilityrequirements for a QSL in the QSL Noticeby extending QDD status to custodian QIsthat are subject to regulatory supervisionby a governmental authority in the juris-diction in which the entity was created, aslong as the entity agrees to assume pri-mary withholding and reporting responsi-bility with respect to dividend equivalentpayments and complies with all QDD cer-tification requirements.

While the Treasury Department andthe IRS understand that the QSL regimewas administratively more convenientfor taxpayers than the QI regime, it cre-ated administrability problems, particu-larly with respect to verification, for theIRS. That regime is being replaced byincorporating the QDD rules into theexisting QI framework, including thespecific rules for pooled reporting onForm 1042–S, and the QI requirementsfor compliance review and certification.With respect to banks, custodians, andclearing organizations that do not issuepotential section 871(m) transactions tocustomers, the Treasury Department andthe IRS are concerned that reverting to theeligibility requirements for a QSL in theQSL Notice would permit an entity to actas a QDD that does not act as a financialintermediary in a chain of section 871(m)transactions.

As part of the transition relief an-nounced in Notice 2016–76, the TreasuryDepartment and the IRS announced that


taxpayers may continue to rely on theQSL Notice during 2017. The QSL Noticewill be obsoleted as of January 1, 2018.

X. Rules for withholding on dividendequivalents

Newly designated § 1.1441–2(e)(7)provides that a withholding agent is notobligated to withhold on a dividend equiv-alent until the later of when a payment ismade with respect to a section 871(m)transaction and when the amount of a div-idend equivalent is determined. For pur-poses of § 1.1441–2(e)(7), a payment withrespect to a section 871(m) transactionoccurs when the long party receives ormakes a payment, when there is a finalsettlement of the section 871(m) transac-tion, or when the long party sells or oth-erwise disposes of the section 871(m)transaction. The 2015 final regulations ad-opted this approach in response to tax-payer comments.

A. Transactions transferred to adifferent account

The 2015 final regulations provide thata payment occurs when the long partysells or disposes of a section 871(m) trans-action; however, when a long party trans-fers a section 871(m) transaction from onebroker or custodian to another broker orcustodian, the 2015 final regulations donot treat that transfer as a payment. Acomment noted that it is common for in-vestors to change relationships with bro-kers and custodians who hold their secu-rities, which may result in section 871(m)transactions being transferred from onebroker or custodian to another. Thecomment asserted that it is inappropriateand burdensome for a withholding agentto be responsible for dividend equivalentamount calculations relating to dividendsthat occurred before the date that the newbroker or custodian holds the section871(m) transaction on behalf of a longparty. The comment recommended thatthe Treasury Department and the IRSamend the 2015 final regulations to pro-vide that a transfer of a section 871(m)transaction from one broker or custodianto another, without a change in beneficialownership, constitutes a payment for pur-poses of § 1.1441–2(e)(7).

The Treasury Department and the IRSagree that requiring a broker or custodianto withhold on dividend equivalent pay-ments that occurred before holding a sec-tion 871(m) transaction on behalf of acustomer would be burdensome to thewithholding agent. As a result, § 1.1441–2(e)(7) is revised to provide that a pay-ment of a dividend equivalent occurswhen a section 871(m) transaction istransferred to an account not maintainedby the withholding agent or upon a termi-nation of the account relationship.

B. Option to withhold on dividendpayment date

While § 1.1441–2(e)(7) generally de-fers withholding on a section 871(m)transaction until there is a payment madepursuant to the transaction, commentsnoted that § 1.1441–2(e)(7) will requirecashless withholding in certain circum-stances. To implement the 2015 final reg-ulations, comments noted that market par-ticipants would be required to develop oramend collateral and indemnity arrange-ments with customers. Some commentsrecommended amending the 2015 finalregulations to allow withholding agents totreat a dividend equivalent as paid andsubject to withholding on the dividendpayment date for the underlying securityreferenced by the section 871(m) transac-tion. Comments indicated that some with-holding agents believe that it will beeasier to implement withholding on thedividend payment date for the underly-ing security because their systems are al-ready designed to track the time andamount of actual dividends. Many with-holding agents, however, have contractualagreements with customers that prohibitwithholding earlier than a date permittedby regulations.

The Treasury Department and the IRSappreciate that some withholding agentswould rather not develop new systems totrack dividend equivalents over multipleyears, while other financial institutionsprefer the time for withholding providedby § 1.1441–2(e)(7). To accommodateboth approaches, the Treasury Departmentand the IRS are amending the regulationsto allow withholding agents the flexibilityto withhold either based on the “later of”rule, as determined under § 1.1441–

2(e)(7), or on the dividend payment datefor the underlying security. This changewill allow withholding agents that preferto withhold on the dividend payment dateto do so, without eliminating the “later of”rule in § 1.1441–2(e)(7) that generally tieswithholding to a cash payment. As dis-cussed in Part IX.F of this preamble, if awithholding agent acts as a QDD, it willbe required to use the dividend paymentdate.

A withholding agent that chooses towithhold on the dividend payment date forthe underlying security referenced by thesection 871(m) transaction must apply theelection consistently to all section 871(m)transactions of the same type. In otherwords, a withholding agent that chooses towithhold on the dividend payment date forsecurities lending transactions must do sofor all securities lending transactions, butmay choose to withhold on NPCs underthe rule in § 1.1441–2(e)(7). When a with-holding agent withholds on the dividendpayment date under this alternate method,the withholding agent must notify eachpayee in writing before the time for deter-mining the long party’s first dividendequivalent payment. A withholding agentthat withholds on the dividend paymentdate for the underlying security also mustattach a statement to its Form 1042 for theyear of the change notifying the IRS of thechange and when it applies.

XI. Applicability date

The current regulations provide that§ 1.871–15(d)(2) and (e) apply to anypayment made on or after January 1,2017, with respect to any transaction is-sued on or after January 1, 2017. Severalcomments requested that implementationof these provisions be delayed until atleast January 1, 2018. One comment re-quested that implementation be delayeduntil at least one year after the date guid-ance resolving all issues raised by thecomment is issued. The primary reasonscomments provided for the requests todelay implementation were the need foradditional guidance, the need for addi-tional time to make systems operational,and the recent release of additional QDDguidance in the QI Notice and in Notice2016–76. Comments also requested a de-lay in the combination rule generally. An-


other comment agreed with the request fora delayed effective date for the combina-tion rule, unless the rule was revised torequire withholding agents only to com-bine transactions that the withholdingagent has actual knowledge are priced,marketed, or sold in connection with eachother. A comment also requested a transi-tion period until December 31, 2018, forenforcement and administration of QDDobligations.

The 2013 proposed regulations pro-vided that the proposed sections wouldapply to payments made on or after thedate the regulations were finalized. How-ever, when the regulations were finalizedin 2015, the Treasury Department and theIRS provided that the regulations gener-ally would only apply to transactions is-sued on or after January 1, 2017, to ensureadequate time to develop systems neededto implement the regulations.

Both the 2015 regulations and theamendments to those regulations that areincluded in these regulations, many ofwhich were previously announced in theQI Notice, Notice 2016–76, and the 2017QI Agreement, make the withholding re-quired under section 871(m) easier to im-plement and more administrable. In lightof these revisions, the Treasury Depart-ment and the IRS have determined that itis not necessary or appropriate to uni-formly extend the applicability date for allsection 871(m) transactions. In particular,taxpayers have had ample time to developsystems to implement withholding on sec-tion 871(m) transactions that are delta onetransactions. The Treasury Departmentand the IRS have determined, however,that taxpayers and withholding agentsneed additional time to implement thesection 871(m) regulations for section871(m) transactions other than delta onetransactions. Accordingly, these regula-tions postpone the implementation of thesection 871(m) regulations with respect tonon-delta one transactions until January 1,2018.

In addition, in response to comments,Notice 2016–76 announced transition re-lief for combined transactions by provid-ing a simplified rule for withholdingagents to determine whether transactionsentered into in 2017 are combined trans-actions. Also in response to comments,Notice 2016–76 delayed the application

of section 871(m) for certain exchange-traded notes. Notice 2016–76 also an-nounced that calendar years 2017 and2018 would be phase-in years. In enforc-ing and administering section 871(m) (1)with respect to delta-one transactions in2017, and (2) with respect to non-delta-one transactions in 2018, the IRS will takeinto account the extent to which the tax-payer or withholding agent made a goodfaith effort to comply with the section871(m) regulations. Similarly, Notice2016–76 and the 2017 QI Agreement pro-vide that calendar year 2017 will be aphase-in year for QDDs. As discussed inPart XI.D, the 2017 QI Agreement andthese regulations provide that a QDD willnot be subject to withholding on actual ordeemed dividends in 2017. Finally, the2017 QI Agreement and these final regu-lations do not impose tax on a QDD’ssection 871(m) amount for tax years be-ginning before January 1, 2018.

Effect on Other Documents

Notice 2010–46 (2010–24 I.R.B. 757)is obsolete as of January 1, 2018.

Special Analyses

Certain IRS regulations, includingthese, are exempt from the requirementsof Executive Order 12866, as supple-mented and reaffirmed by Executive Or-der 13563. Therefore, a regulatory impactassessment is not required. It is herebycertified that these regulations will nothave a significant economic impact on asubstantial number of small entities. Thiscertification is based on the fact that few,if any, small entities will be affected bythese regulations. The regulations primar-ily will affect multinational financial in-stitutions, which tend to be larger busi-nesses, and foreign persons. Therefore, aRegulatory Flexibility Analysis is not re-quired. Pursuant to section 7805(f) of theCode, the notice of proposed rulemakingpreceding this regulation was submitted tothe Chief Counsel for Advocacy of theSmall Business Administration for com-ment on their impact on small business.

Drafting Information

The principal authors of these regula-tions are D. Peter Merkel and KarenWalny of the Office of Associate Chief

Counsel (International). Other personnelfrom the Treasury Department and theIRS also participated in the developmentof these regulations.* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 isamended as follows:

PART 1— INCOME TAXES

Paragraph 1. The authority citation forpart 1 is amended by removing the sec-tional authority for § 1.871–15 and addingin its place a sectional authority for§§ 1.871–15 and 1.871–15T to read inpart as follows:

Authority: 26 U.S.C. 7805 * * *§§ 1.871–15 and 1.871–15T also is-

sued under 26 U.S.C. 871(m). * * *Par. 2. Section 1.871–15 is amended

by:1. Revising paragraph (a)(1).2. Revising paragraph (a)(14)(i).3. Adding a new second sentence to

paragraph (a)(14)(ii)(B).4. Revising paragraph (c)(2)(ii).5. Revising paragraph (c)(2)(iv).6. Revising paragraphs (g)(2) through

(g)(3), redesignating paragraph (g)(4)as (g)(5), and adding new paragraph(g)(4).

7. Revising paragraph (h).8. Revising paragraphs (i)(3)(ii) and

(i)(3)(iii).9. Adding introductory text to para-

graph (j)(1).10. Adding paragraph (j)(4).11. Revising paragraph (l)(2).12. Revising paragraph (l)(4).13. Redesignating paragraphs (n)(3)(i)

and (n)(3)(ii) as (n)(3)(ii) and (n)(3)(iii), respectively.

14. Adding new paragraph (n)(3)(i).15. Revising paragraph (p)(1).16. Adding paragraphs (p)(4)(iii) and

(p)(5).17. Revising paragraph (q).18. Revising paragraphs (r)(3) and (r)(4).19. Adding paragraph (r)(5).The additions and revisions read as

follows:


§ 1.871–15 Treatment of dividendequivalents.

(a) * * * (1) Broker. [Reserved]. Forfurther guidance, see § 1.871–15T(a)(1).* * * * *

(14) * * * (i) Simple contract. A simplecontract is an NPC or ELI for which, withrespect to each underlying security, allamounts to be paid or received on matu-rity, exercise, or any other payment deter-mination date are calculated by referenceto a single, fixed number of shares (asdetermined in paragraph (j)(3) of this sec-tion) of the underlying security, providedthat the number of shares can be ascer-tained at the calculation time for the con-tract, and there is a single maturity orexercise date with respect to which allamounts (other than any upfront paymentor any periodic payments) are required tobe calculated with respect to the underly-ing security. For purposes of this section,a contract that provides an adjustment tothe number of shares of the underlyingsecurity for a merger, stock split, cashdividend, or similar corporate action thataffects all holders of the underlying secu-rities proportionately will not cease to betreated as referencing a single, fixed num-ber of shares solely as a result of thatprovision. A contract has a single exercisedate even though it may be exercised bythe holder at any time on or before thestated expiration of the contract. An NPCor ELI that includes a term that discontin-uously increases or decreases the amountpaid or received (such as a digital option),or that accelerates or extends the maturityis not a simple contract. A simple contractthat is an NPC is a simple NPC. A simplecontract that is an ELI is a simple ELI.* * * * *

(ii) * * * (B) Example. * * * Pursuantto paragraph (j)(3) of the section, the ELIreferences 200 shares when Stock X ap-preciates, but only 100 shares when StockX depreciates. * * *

(c) * * *(2) * * * (ii) Section 305 coordination.

A dividend equivalent received by a longparty, who is a shareholder as defined in§ 1.305–1(d) of an instrument that givesrise to a dividend pursuant to sections305(b) and (c) (including a debt instru-ment that is convertible into shares ofstock and stock that is convertible into

shares of another class of stock) that isalso a section 871(m) transaction, is re-duced by any amount treated as a dividendby sections 305(b) and (c) to the longparty. For other section 871(m) transac-tions that reference an underlying securitythat is an instrument treated as paying adividend pursuant to sections 305(b) and(c) and for which the long party is not ashareholder as defined in § 1.305–1(d),the dividend equivalent received by thelong party with respect to the section871(m) transaction includes (and is notreduced by) any amount treated as a div-idend pursuant to sections 305(b) and (c).* * * * *

(iv) Payments made pursuant to annu-ity, endowment, and life insurance con-tracts—(A) Insurance contracts issued bydomestic insurance companies. A pay-ment made pursuant to a contract that isan annuity, endowment, or life insurancecontract issued by a domestic corporation(including its foreign or U.S. possessionbranch) that is a life insurance companydescribed in section 816(a) does not in-clude a dividend equivalent if the paymentis subject to tax under section 871(a) orsection 881.

(B) Insurance contracts issued by for-eign insurance companies. A paymentdoes not include a dividend equivalent if itis made pursuant to a contract that is anannuity, endowment, or life insurancecontract issued by a foreign corporationthat would be subject to tax under sub-chapter L if it were a domestic corpora-tion.

(C) Insurance contracts held by for-eign insurance companies. A paymentmade pursuant to a policy of insurance(including a policy of reinsurance) doesnot include a dividend equivalent if it ismade to a foreign corporation that wouldbe subject to tax under subchapter L if itwere a domestic corporation.* * * * *

(g) * * *(2) Time for determining delta—(i) In

general. Except as provided in paragraph(g)(4) of this section, the delta of a poten-tial section 871(m) transaction is deter-mined at the calculation time for the po-tential section 871(m) transaction.

(ii) Calculation time. The calculationtime for a potential section 871(m) trans-action is the earlier of when the potential

section 871(m) transaction is priced andwhen the potential section 871(m) trans-action is issued. Notwithstanding the pre-ceding sentence, if the pricing time ismore than 14 calendar days before thepotential section 871(m) transaction is is-sued, the calculation time is when thepotential section 871(m) transaction is is-sued.

(iii) Pricing time. A potential section871(m) transaction is priced when all ma-terial economic terms for the transactionhave been agreed upon, including theprice at which the transaction is sold.

(3) Simplified delta calculation for cer-tain simple contracts that reference mul-tiple underlying securities. If an NPC orELI references 10 or more underlying se-curities and an exchange-traded security(for example, an exchange-traded fund) isavailable that would fully hedge the NPCor ELI at the calculation time, the delta ofthe NPC or ELI may be calculated bydetermining the ratio of the change in thefair market value of the simple contract toa small change in the fair market value ofthe exchange-traded security. A delta de-termined under this paragraph (g)(3) mustbe used as the delta for each underlyingsecurity for purposes of calculating theamount of a dividend equivalent as pro-vided in paragraph (j)(1)(ii) of this sec-tion.

(4) Delta calculation for listed op-tions—(i) In general. The delta of an op-tion contract that is listed on a regulatedexchange described in paragraph (g)(4)(ii)of this section is the delta of that option atthe close of business on the business daybefore the date of issuance. On the date anoption contract is listed for the first time,the delta is the delta of that option at theclose of business on the date of issuance.Notwithstanding the preceding two sen-tences, the delta of a listed option that isalso a customized option is determinedunder the rules of paragraphs (g)(2) and(g)(3) of this section.

(ii) Regulated exchange. For purposes ofparagraph (g)(4)(i) of this section, a regu-lated exchange is any exchange that is ei-ther:

(A) Described in paragraph (l)(3)(vii)of this section; or

(B) [Reserved]. For further guidance,see § 1.871–15T(g)(4)(ii)(B).* * * * *


(h) Substantial equivalence test—(1)In general. The substantial equivalencetest described in this paragraph (h) appliesto determine whether a complex contractis a section 871(m) transaction. The sub-stantial equivalence test assesses whethera complex contract substantially replicatesthe economic performance of the underly-ing security by comparing, at various test-ing prices for the underlying security, thedifferences between the expected changesin value of that complex contract and itsinitial hedge with the differences betweenthe expected changes in value of a simplecontract benchmark (as described in para-graph (h)(2) of this section) and its initialhedge. If the complex contract containsmore than one reference to a single under-lying security, all references to that under-lying security are taken into accountfor purposes of applying the substantialequivalence test with respect to that un-derlying security. With respect to an eq-uity derivative that is embedded in a debtinstrument or other derivative, the sub-stantial equivalence test is applied to thecomplex contract without taking into ac-count changes in the market value of thedebt instrument or other derivative thatare not directly related to the equity ele-ment of the instrument. The complex con-tract is a section 871(m) transaction withrespect to an underlying security if, forthat underlying security, the expectedchange in value of the complex contractand its initial hedge is equal to or less thanthe expected change in value of the simplecontract benchmark and its initial hedgewhen the substantial equivalence test de-scribed in this paragraph (h) is calculatedat the calculation time for the complexcontract. To the extent that the steps of thesubstantial equivalence test set out in thisparagraph (h) cannot be applied to a partic-ular complex contract, a taxpayer must usethe principles of the substantial equivalencetest to reasonably determine whether thecomplex contract is a section 871(m) trans-action with respect to each underlying secu-rity. For purposes of this section, the testmust be applied and the inputs must bedetermined in a commercially reasonablemanner. The term of the simple contractbenchmark must be, and the inputs mustuse, a reasonable time period, consistentlyapplied (for example, in determining thestandard deviation and probability). If a tax-

payer calculates any relevant input for non-tax business purposes, that input ordinarilyis the input used for purposes of this section.

(2) Simple contract benchmark. Thesimple contract benchmark is an actual orhypothetical simple contract that, at thecalculation time for the complex contract,has a delta of 0.8, references the applica-ble underlying security referenced by thecomplex contract, and has terms that areconsistent with all the material terms ofthe complex contract, including the matu-rity date. If an actual simple contract doesnot exist, the taxpayer must create a hy-pothetical simple contract. Depending onthe complex contract, the simple contractbenchmark might be, for example, a calloption, a put option, or a collar.

(3) Substantial equivalence. A complexcontract is a section 871(m) transaction withrespect to an underlying security if the com-plex contract calculation described in para-graph (h)(4) of this section results in anamount that is equal to or less than theamount of the benchmark calculation de-scribed in paragraph (h)(5) of this section.

(4) Complex contract calculation—(i)In general. The complex contract calcula-tion for each underlying security refer-enced by a potential section 871(m) trans-action that is a complex contract iscomputed by:

(A) Determining the change in value(as described in paragraph (h)(4)(ii) ofthis section) of the complex contract withrespect to the underlying security at eachtesting price (as described in paragraph(h)(4)(iii) of this section);

(B) Determining the change in value ofthe initial hedge for the complex contractat each testing price;

(C) Determining the absolute value ofthe difference between the change in valueof the complex contract determined in para-graph (h)(4)(i)(A) of this section and thechange in value of the initial hedge deter-mined in paragraph (h)(4)(i)(B) of this sec-tion at each testing price;

(D) Determining the probability (as de-scribed in paragraph (h)(4)(iv) of this sec-tion) associated with each testing price;

(E) Multiplying the absolute value foreach testing price determined in paragraph(h)(4)(i)(C) of this section by the corre-sponding probability for that testing pricedetermined in paragraph (h)(4)(i)(D) ofthis section;

(F) Adding the product of each calcula-tion determined in paragraph (h)(4)(i)(E) ofthis section; and

(G) Dividing the sum determined inparagraph (h)(4)(i)(F) of this section bythe initial hedge for the complex contract.

(ii) Determining the change in value.The change in value of a complex contractis the difference between the value of thecomplex contract with respect to the un-derlying security at the calculation timefor the complex contract and the value ofthe complex contract with respect to theunderlying security if the price of the un-derlying security were equal to the testingprice at the calculation time for the com-plex contract. The change in value of theinitial hedge of a complex contract withrespect to the underlying security is thedifference between the value of the initialhedge at the calculation time for the com-plex contract and the value of the initialhedge if the price of the underlying secu-rity were equal to the testing price at thecalculation time for the complex contract.

(iii) Testing price. The testing pricesmust include the prices of the underlyingsecurity if the price of the underlying se-curity at the calculation time for the com-plex contract were alternatively increasedby one standard deviation and decreasedby one standard deviation, each of whichis a separate testing price. In circum-stances where using only two testingprices is reasonably likely to provide aninaccurate measure of substantial equiva-lence, a taxpayer must use additional test-ing prices as necessary to determinewhether a complex contract satisfies thesubstantial equivalence test. If additionaltesting prices are used for the substantialequivalence test, the probabilities as de-scribed in paragraph (h)(4)(iv) of this sec-tion must be adjusted accordingly.

(iv) Probability. For purposes of para-graphs (h)(4)(i)(D) and (E) of this section,the probability of an increase by one stan-dard deviation is the measure of the like-lihood that the price of the underlyingsecurity will increase by any amount fromits price at the calculation time for thecomplex contract. For purposes of para-graphs (h)(4)(i)(D) and (E) of this section,the probability of a decrease by one stan-dard deviation is the measure of the like-lihood that the price of the underlyingsecurity will decrease by any amount from


its price at the calculation time for thecomplex contract.

(5) Benchmark calculation. The bench-mark calculation with respect to each under-lying security referenced by the potentialsection 871(m) transaction is determined byusing the computation methodology de-scribed in paragraph (h)(4) of this sectionwith respect to a simple contract benchmarkfor the underlying security.

(6) Substantial equivalence calculationfor certain complex contracts that referencemultiple underlying securities. If a complexcontract references 10 or more underlyingsecurities and an exchange-traded security(for example, an exchange-traded fund) isavailable that would fully hedge the com-plex contract at its calculation time, the sub-stantial equivalence calculations for thecomplex contract may be calculated bytreating the exchange-traded security as theunderlying security. When the exchange-traded security is used for the substantialequivalence calculation pursuant to thisparagraph (h)(6), the initial hedge is thenumber of shares of the exchange-tradedsecurity for purposes of calculating theamount of a dividend equivalent as providedin paragraph (j)(1)(iii) of this section.

(7) Example. The following exampleillustrates the rules of paragraph (h) of thissection. For purposes of this example,Stock X is common stock of domesticcorporation X. FI is the financial institu-tion that structures the transaction de-scribed in the example, and is the shortparty to the transaction. Investor is a non-resident alien individual.

Example. Complex contract that is not substan-tially equivalent. (i) FI issues an investment contract(the Contract) that has a stated maturity of one year,and Investor purchases the Contract from FI at issu-ance for $10,000. At maturity, the Contract entitlesInvestor to a return of $10,000 (i) plus 200 percent ofany appreciation in Stock X above $100 per share,capped at $110, on 100 shares or (ii) minus 100percent of any depreciation in Stock X below $90 on100 shares. At the calculation time for the Contract,the price of Stock X is $100 per share. Thus, forexample, Investor will receive $11,000 if the price ofStock X is $105 per share at maturity of the Contract,but Investor will receive $9,000 if the price of StockX is $80 per share when the Contract matures. Atissuance, FI acquires 64 shares of Stock X to fullyhedge the Contract issued to Investor. The calcula-tion time for this example is the issuance.

(ii) The Contract references an underlying secu-rity and is not an NPC, so it is classified as an ELIunder paragraph (a)(4) of this section. At the calcu-lation time for the Contract, the Contract does notprovide for an amount paid at maturity that is cal-

culated by reference to a single, fixed number ofshares of Stock X. When the Contract matures, theamount paid is effectively calculated based on either200 shares of Stock X (if the price of Stock X hasappreciated up to $110) or 100 shares of Stock X (ifthe price of Stock X has declined below $90). Con-sequently, the Contract is a complex contract de-scribed in paragraph (a)(14) of this section.

(iii) Because it is a complex ELI, FI applies thesubstantial equivalence test described in paragraph(h) of this section to determine whether the Contractis a specified ELI. FI determines that the price ofStock X would be $120 if the price of Stock X wereincreased by one standard deviation, and $79 if theprice of Stock X were decreased by one standarddeviation. Based on these results, FI next determinesthe change in value of the Contract to be $2000 at thetesting price that represents an increase by one stan-dard deviation ($12,000 testing price minus $10,000issue price) and a negative $1,100 at the testing pricethat represents a decrease by one standard deviation($10,000 issue price minus $8,900 testing price). FIperforms the same calculations for the 64 shares ofStock X that constitute the initial hedge, determiningthat the change in value of the initial hedge is $1,280at the testing price that represents an increase by onestandard deviation ($6,400 at issuance compared to$7,680 at the testing price) and negative $1,344 atthe testing price that represents a decrease by onestandard deviation ($6,400 at issuance compared to$5,056 at the testing price).

(iv) FI then determines the absolute value of thedifference between the change in value of the initialhedge and the Contract at the testing price thatrepresents an increase by one standard deviation anda decrease by one standard deviation. Increased byone standard deviation, the absolute value of thedifference is $720 ($2,000-$1,280); decreased byone standard deviation, the absolute value of thedifference is $244 (negative $1,100 minus negative$1,344). FI determines that there is a 52% chancethat the price of Stock X will have increased in valuewhen the Contract matures and a 48% chance thatthe price of Stock X will have decreased in value atthat time. FI multiplies the absolute value of thedifference between the change in value of the initialhedge and the Contract at the testing price thatrepresents an increase by one standard deviation by52%, which equals $374.40. FI multiplies the abso-lute value of the difference between the change invalue of the initial hedge and the Contract at thetesting price that represents a decrease by one stan-dard deviation by 48%, which equals $117.12. FIadds these two numbers and divides by the numberof shares that constitute the initial hedge to deter-mine that the transaction calculation is 7.68 ((374.40plus 117.12) divided by 64).

(v) FI then performs the same calculation withrespect to the simple contract benchmark, which is aone-year call option that references one share ofStock X, settles on the same date as the Contract, andhas a delta of 0.8. The one-year call option has astrike price of $79 and has a cost (the purchasepremium) of $22. The initial hedge for the one-yearcall option is 0.8 shares of Stock X.

(vi) FI first determines that the change in value ofthe simple contract benchmark is $19.05 if the test-ing price is increased by one standard deviation

($22.00 at issuance to $41.05 at the testing price) andnegative $20.95 if the testing price is decreased byone standard deviation ($22.00 at issuance to $1.05at the testing price). Second, FI determines that thechange in value of the initial hedge is $16.00 at thetesting price that represents an increase by one stan-dard deviation ($80 at issuance to $96 at the testingprice) and negative $16.80 at the testing price thatrepresents a decrease by one standard deviation($80.00 at issuance to $63.20 at the testing price).

(vii) FI determines the absolute value of thedifference between the change in value of the initialhedge and the one-year call option at the testingprice that represents an increase by one standarddeviation is $3.05 ($16.00 minus $19.05). FI nextdetermines the absolute value of the difference be-tween the change in value of the initial hedge and theoption at the testing price that represents a decreaseby one standard deviation is $4.15 (negative $16.80minus negative $20.95). FI multiplies the absolutevalue of the difference between the change in valueof the initial hedge and the option at the testing pricethat represents an increase by one standard deviationby 52%, which equals $1.586. FI multiplies theabsolute value of the difference between the changein value of the initial hedge and the option at thetesting price that represents a decrease by one stan-dard deviation by 48%, which equals $1.992. FI addsthese two numbers and divides by the number ofshares that constitute the initial hedge to determinethat the benchmark calculation is 4.473 ((1.586 plus1.992) divided by .8).

(viii) FI concludes that the Contract is not asection 871(m) transaction because the transactioncalculation of 7.68 exceeds the benchmark calcula-tion of 4.473.

(i) * * *(3) * * * (ii) Publicly available divi-

dend amount. For purposes of paragraph(i)(3)(i) of this section, if a section 871(m)transaction references the same underly-ing securities as a security (for example,stock in an exchange-traded fund) or in-dex for which there is a publicly availablequarterly dividend amount, the publiclyavailable dividend amount may be used todetermine the per-share dividend amountfor the section 871(m) transaction withany adjustment for special dividends.

(iii) Dividend amount for a section871(m) transaction using the simplifieddelta calculation. When the delta of asection 871(m) transaction is determinedunder paragraph (g)(3) of this section, theper-share dividend amount for that section871(m) transaction must be determinedusing the dividend amount for theexchange-traded security that would fullyhedge the section 871(m) transaction(whether or not the exchange-traded secu-rity is actually acquired).* * * * *


(j) * * * (1) Calculation of the amountof a dividend equivalent. The long party isliable for tax on any dividend equivalentsrequired to be determined pursuant toparagraph (j)(2) of this section only withrespect to dividend equivalents that arisewhile the long party is a party to thetransaction. The amount of any dividendequivalent is determined as follows:* * * * *

(4) Taxable year of a dividend equiva-lent. A long party is liable for tax on adividend equivalent in the year the divi-dend equivalent is subject to withholdingpursuant to § 1.1441–2(e)(7). Notwith-standing the preceding sentence, a longparty that is a qualified derivatives dealeris liable for tax on a dividend equivalentwhen the applicable dividend on the un-derlying security would be subject towithholding pursuant to § 1.1441–2(e)(4).The amount of the long party’s tax liabil-ity, however, is determined by referenceto the amount that would have been due atthe time the dividend equivalent amount isdetermined pursuant to paragraph (j)(2) ofthis section based on the beneficial ownersat that time (for example, based on the taxrate at that time, whether the long partyqualified for a treaty benefit at that time,and in the case of a partnership, based onthe partners at that time).* * * * *

(l) * * *(2) Qualified index not treated as an

underlying security—(i) In general. Forpurposes of this section, a qualified index istreated as a single security that is not anunderlying security. The determination ofwhether an index referenced in a potentialsection 871(m) transaction is a qualified in-dex is made at the calculation time for thetransaction based on whether the index is aqualified index on the first business day ofthe calendar year containing the calculationtime.

(ii) Rule for the first year of an index.In the case of an index that was not inexistence on the first business day of thecalendar year containing the calculationtime for the transaction, paragraph (l)(2)of this section is applied by testing theindex on the first business day it is cre-ated, and the dividend yield calculationrequired by paragraph (l)(3)(vi) of thissection is determined by using the divi-dend yield that the index would have had

in the immediately preceding year if it hadthe same components throughout that yearthat it has on the day it is created.* * * * *

(4) Safe harbor for certain indices thatreference assets other than underlying se-curities. Notwithstanding paragraph (l)(3)of this section, an index is a qualifiedindex if the index is widely traded, thereferenced component underlying securi-ties in the aggregate comprise 10 percentor less of the weighting of the componentsecurities in the index, and the index wasnot formed or availed of with a principalpurpose of avoiding U.S. withholding tax.* * * * *

(n) * * *(3) Short party presumptions regarding

combined transactions—(i) In general. If ashort party relies on the presumption pro-vided in paragraph (n)(3)(ii) of this sectionor in paragraph (n)(3)(iii) of this section, theshort party is not required to treat thosepotential section 871(m) transactions as partof a single transaction pursuant to paragraph(n)(1) of this section.* * * * *

(p) * * * (1) Responsible party—(i) Ingeneral. If a broker or dealer is a party to apotential section 871(m) transaction with acounterparty or customer that is not a brokeror dealer, the broker or dealer is required todetermine whether the potential section871(m) transaction is a section 871(m)transaction. If both parties to a potentialsection 871(m) transaction are brokers ordealers, or neither party to a potential sec-tion 871(m) transaction is a broker or dealer,the short party must determine whether thepotential section 871(m) transaction is a sec-tion 871(m) transaction.

(ii) [Reserved]. For further guidance,see § 1.871–15T(p)(1)(ii).

(iii) [Reserved]. For further guidance,see § 1.871–15T(p)(1)(iii).

(iv) [Reserved]. For further guidance,see § 1.871–15T(p)(1)(iv).

(v) Obligations of the responsibleparty. The party to the transaction that isrequired to determine whether a transactionis a section 871(m) transaction must alsodetermine and report to the counterparty orcustomer the timing and amount of any div-idend equivalent (as described in paragraphs(i) and (j) of this section). Except as other-wise provided in paragraph (n)(3) of thissection, the party required to make the de-

terminations described in this paragraph isrequired to exercise reasonable diligence todetermine whether a transaction is a section871(m) transaction, the amount of any div-idend equivalents, and any other informa-tion necessary to apply the rules of thissection. The information must be providedin the manner prescribed in paragraphs(p)(2) and (p)(3) of this section. The deter-minations required by paragraph (p) of thissection are binding on the parties to thepotential section 871(m) transaction and onany person who is a withholding agent withrespect to the potential section 871(m) trans-action unless the person knows or has rea-son to know that the information received isincorrect. The determinations are not bind-ing on the Commissioner.* * * * *

(4) * * *(iii) Recordkeeping required for certain

options. With respect to any option to whichparagraph (g)(4) of this section applies, con-temporaneous documentation is not re-quired to be retained provided that there is apre-existing documented methodology thatis sufficient to permit the delta for the trans-action to be verified at a later time.

(5) [Reserved]. For further guidance,see § 1.871–15T(p)(5).

(q) Dividend and dividend equivalentpayments to a qualified derivatives deal-er—(1) In general. Except as otherwiseprovided in this paragraph (q), a qualifiedderivatives dealer described in § 1.1441–1(e)(6) that receives a payment (within themeaning of paragraph (i) of this section)of a dividend equivalent in its equity de-rivatives dealer capacity will not be liablefor tax under section 881 on that dividendequivalent, provided that the qualified de-rivatives dealer complies with its obliga-tions under the qualified intermediaryagreement described in §§ 1.1441–1(e)(5)and 1.1441–1(e)(6). A qualified deriva-tives dealer is liable for tax under section881(a)(1) on its section 871(m) amountfor each dividend on each underlying se-curity. This tax liability is reduced (butnot below zero) by the amount of tax paidby the qualified derivatives dealer undersection 881(a)(1) on dividends it receiveswith respect to that underlying security onthat same dividend in its capacity as anequity derivatives dealer. In addition, aqualified derivatives dealer is liable for taxunder section 881(a)(1) for all dividend


equivalents it receives that are not receivedin its equity derivatives dealer capacity. Aqualified derivatives dealer also is liable fortax under section 881(a)(1) for all dividendsit receives, other than dividends received in2017 in its equity derivatives dealer capac-ity. This paragraph does not apply for aqualified derivatives dealer that is a foreignbranch of a United States financial institu-tion (within the meaning of § 1.1471–5(e)).

(2) Transactions on the books of anequity derivatives dealer. Transactionsproperly reflected in a qualified deriva-tives dealer’s equity derivatives dealerbook are presumed to be held by thedealer in its equity derivatives dealer ca-pacity for purposes of determining thequalified derivatives dealer’s tax liability.For purposes of determining whether adealer is acting in its equity derivativesdealer capacity, only the dealer’s activitiesas an equity derivatives dealer are takeninto account. Accordingly, for purposes ofthis paragraph (q), a dividend or dividendequivalent is treated as received by a qual-ified derivatives dealer acting in its non-equity derivatives dealer capacity if thedividend or dividend equivalent is re-ceived by a qualified derivatives dealeracting as a proprietary trader.

(3) Section 871(m) amount. For eachdividend on each underlying security, thesection 871(m) amount is the product of:

(i) The qualified derivatives dealer’s netdelta exposure to the underlying security forthe applicable dividend, multiplied by;

(ii) The applicable dividend amount pershare.

(4) Net delta exposure. The net deltaexposure to an underlying security is theamount (measured in number of shares)by which (A) the aggregate number ofshares of an underlying security that thequalified derivatives dealer has exposureto as a result of positions in the underlyingsecurity (including as a result of owningthe underlying security) with values thatmove in the same direction as the under-lying security (the long positions) exceeds(B) the aggregate number of shares of anunderlying security that the qualified de-rivatives dealer has exposure to as a resultof positions in the underlying securitywith values that move in the opposite di-rection from the underlying security (theshort positions). The net delta exposurecalculation only includes long positions

and short positions that the qualified de-rivatives dealer holds in its equity deriva-tives dealer capacity (as described in para-graph (q)(2) of this section). Any longpositions or short positions that are treatedas effectively connected with the qualifiedderivatives dealer’s conduct of a trade orbusiness in the United States for U.S. fed-eral income tax purposes are excludedfrom the net delta exposure computation.The net delta exposure to an underlyingsecurity is determined at the end of theday on the date provided in § 1.871–15(j)(2) for the applicable dividend. Forpurposes of this calculation, net delta mustbe determined in a commercially reason-able manner. If a qualified derivativesdealer calculates net delta for non-tax busi-ness purposes, the net delta ordinary will bethe delta used for that purpose, subject to themodifications required by this definition.Each qualified derivatives dealer must de-termine its net delta exposure separatelyonly taking into account transactions thatare recognized and are attributable to thatqualified derivatives dealer for U.S. federalincome tax purposes.

(5) Examples. The following examplesillustrate the rules of this paragraph (q):

Example 1. Forward contract entered into by aforeign equity derivatives dealer. (i) Facts. FB is aforeign bank that is a qualified intermediary that acts asa qualified derivatives dealer. On April 1, Year 1, FBenters into a cash settled forward contract initiated by aforeign customer (Customer) that entitles Customer toreceive from FB all of the appreciation and dividendson 100 shares of Stock X, and obligates Customer topay FB any depreciation on 100 shares of Stock X, atthe end of three years. FB hedges the forward contractby entering into a total return swap contract with adomestic broker (U.S. Broker) and maintains the swapcontract as a hedge for the duration of the forwardcontract. The swap contract entitles FB to receive anamount equal to all of the dividends on 100 shares ofStock X and obligates FB to pay an amount referencedto a floating interest rate each quarter, and also entitlesFB to receive from or pay to U.S. Broker, as the casemay be, the difference between the value of 100 sharesof Stock X at the inception of the swap and the value of100 shares of Stock X at the end of 3 years. Stock Xpays a quarterly dividend of $0.25 per share. At the endof the day on the date provided in paragraph (j)(2) ofthis section for the dividend, FB owns the forwardcontract and total return swap; FB does not own anyshares of Stock X or any other transactions that refer-ence Stock X. FB provides valid documentation to U.S.Broker that FB will receive payments under the swapcontract in its capacity as a qualified derivatives dealer,and FB contemporaneously enters both the swap con-tract with U.S. Broker and the forward contract withCustomer on its equity derivatives dealer books.

(ii) Application of rules. At the end of the day onthe date provided in paragraph (j)(2) of this section

for the dividend, FB is a long party on a delta onecontract (the total return swap) and a short party ona delta one contract (the forward contract with Cus-tomer). Pursuant to § 1.1441–1(b)(4)(xxii), U.S.Broker is not obligated to withhold on the dividendequivalent payments to FB on the swap contract thatare referenced to Stock X dividends because U.S.Broker has received valid documentation that it mayrely upon to treat the payment as made to FB actingas a qualified derivatives dealer. Pursuant to para-graph (q)(1) of this section, FB is not liable for taxunder sections 871(m) and 881 on the payments itreceives from U.S. Broker referenced to Stock Xdividends because FB’s net delta exposure with re-spect to 100 shares of Stock X is zero at the end ofthe day on the date provided in paragraph (j)(2) ofthis section for the dividend. The net delta exposureis zero because the taxpayer has 100 shares of StockX long position exposure as a result of the totalreturn swap that is reduced by 100 shares of Stock Xshort position exposure as a result of the forwardcontract. FB is required to withhold on dividendequivalent payments to Customer on the forwardcontract in accordance with § 1.1441–2(e)(7).

Example 2. At-the-money option contract enteredinto by a foreign equity derivatives dealer. (i) Facts.The facts are the same as Example 1, but Customerpurchases from FB an at-the-money call option on100 shares of Stock X with a term of one year. Thecall option has a delta of 0.5, and FB hedges the calloption by entering into a total return swap that ref-erences 50 shares of Stock X with U.S. Broker. Atthe end of the day on the date provided in paragraph(j)(2) of this section for the dividend, the call optionhas a delta of 0.6, FB hedges the call option with atotal return swap that references 60 shares of StockX with U.S. Broker, and FB has no shares of StockX or other transactions that reference Stock X.

(ii) Application of rules. At the end of the day onthe date provided in paragraph (j)(2) of this section forthe dividend, FB is a long party on 60 shares of StockX through the total return swap and a short party on anoption. Because the option has a delta of less than 0.8at the calculation time, it is not a section 871(m) trans-action. Therefore, there will be no dividend equivalentpayments made by FB to Customer that are subject towithholding. Pursuant to § 1.1441–1(b)(4)(xxii), U.S.Broker is not obligated to withhold on the dividendequivalents with respect to Stock X paid to FB becauseU.S. Broker has received valid documentation that itmay rely upon to treat the dividend equivalents as paidto FB acting as a qualified derivatives dealer. The netdelta exposure is zero at the end of the day on the dateprovided in paragraph (j)(2) of this section for thedividend because FB has a long position of 60 shares asa result of the total return swap, which is reduced byFB’s short position of 60 shares as a result of theoption.

Example 3. In-the-money option contract enteredinto by a foreign equity derivatives dealer. (i) Facts.The facts are the same as Example 2, but Customerpurchases from FB an in-the-money call option on100 shares of Stock X with a term of one year. Thecall option has a delta of 0.8 and FB hedges the calloption by purchasing 80 shares of Stock X, whichare held in an account with U.S. Broker, who alsoacts as paying agent. The price of Stock X declinessubstantially and the option lapses unexercised. At


the end of the day on the date provided in paragraph(j)(2) of this section for the dividend, the call optionhas a delta of 0.48 and FB has reduced its hedge to50 shares of Stock X with U.S. Broker. In addition,on that date, FB owns no other shares of Stock X orany other transactions that reference Stock X in itsequity derivatives dealer capacity.

(ii) Application of rules. At the end of the day onthe date provided in paragraph (j)(2) of this sectionfor the dividend, FB is a long party on 50 shares ofStock X and a short party on an option. Because theoption has a delta of 0.8 at the calculation time, it isa section 871(m) transaction. Therefore, FB is re-quired to withhold on dividend equivalent paymentsto Customer on the option contract in accordancewith § 1.1441–2(e)(7). U.S. Broker is required towithhold on the Stock X dividends paid to FB.Assuming that FB is a qualified resident of a countrythat provides withholding on dividends at a 15 per-cent rate, U.S. Broker is required withhold on thedividends with respect to the 50 shares of stock heldby FB. FB’s net delta exposure is two shares ofStock X at the end of the day on the date provided inparagraph (j)(2) of this section because FB has along position of 50 shares , reduced by FB’s shortposition of 48 shares as a result of the option. FB’ssection 881 tax on the $0.50 (two shares multiplied

by a dividend of $0.25 per share) is reduced (but notbelow zero) by the section 881 tax amount paid byqualified derivatives dealer on the 50 shares. There-fore, FB’s section 871(m) amount is zero.

(r) * * *(3) Effective/applicability date for

paragraphs (d)(2) and (e). Paragraphs(d)(2) and (e) of this section apply to anypayment made on or after January 1,2017, with respect to any transaction witha delta of one issued on or after January 1,2017. Paragraphs (d)(2) and (e) of thissection apply to any payment made on orafter January 1, 2018, with respect to anyother transaction issued on or after Janu-ary 1, 2018. Notwithstanding the priorsentence, paragraphs (d)(2) and (e) of thissection will apply to any payments madeon or after January 1, 2020, with respectto the exchange-traded notes issued on orafter January 1, 2017, that are identified ina separate notice, and not payments madebefore January 1, 2020, with respect tothose notes. Notwithstanding the first sen-

tence of this paragraph (r)(3), paragraphs(d)(2) and (e) of this section do not applyto payments made in 2017 to a qualifiedderivatives dealer in its equity derivativesdealer capacity to hedge transactions thathave a delta of less than one.

(4) Effective/applicability date for para-graphs (c)(2)(iv), (h), and (q) of this section.Paragraphs (c)(2)(iv), (h), and (q) of thissection apply to payments made on or afterJanuary 1, 2017.

(5) Effective/applicability date for para-graphs (g)(4)(ii)(B), (p)(1)(ii) through (iv),and (p)(5) of this section. [Reserved]. Forfurther guidance, see § 1.871–15T(r)(5).

§ 1.871–15 [Amended]

Par. 3. For each section listed in the table,remove the language in the “Remove” col-umn and add in its place the language in the“Add” column as set forth below:

Section Remove Add

§ 1.871–15(a)(3) section 316. section 316 (even if there is noactual distribution of cashor property).

§ 1.871–15(a)(5) the time the NPC or ELI is issued, the calculation time for the NPCor ELI,

§ 1.871–15(a)(14)(ii)(B), newlydesignated third sentence

issuance the calculation time

§ 1.871–15(a)(15), first sentence a payment with respect to

§ 1.871–15(c)(1) introductory text paragraph (2) paragraph (c)(2) of this section

§ 1.871–15(c)(1)(i) references the payment of a dividend references a dividend

§ 1.871–15(c)(1)(ii) references the payment of a dividend references a dividend

§ 1.871–15(c)(1)(iii) references the payment of a dividend references a dividend

§ 1.871–15(c)(2)(i), first sentenceand second sentence

section 871 section 871(a)

§ 1.871–15(d)(2)(i) when the NPC is issued at the calculation time for the NPC

§ 1.871–15(d)(2)(ii) when the NPC is issued at the calculation time for the NPC

§ 1.871–15(e)(1) when the ELI is issued at the calculation time for the ELI

§ 1.871–15(e)(2) when the ELI is issued at the calculation time for the ELI

§ 1.871–15(i)(1) references the payment of a dividend references a dividend

§ 1.871–15(i)(2)(i) estimated payment of dividends estimated dividend

§ 1.871–15(i)(2)(ii) estimated dividend payment estimated dividend

§ 1.871–15(i)(2)(iii), first sentenceand second sentence

the time the transaction is issued the calculation time

§ 1.871–15(i)(2)(iii), last sentence to pay a dividend to have a dividend

§ 1.871–15(j)(1)(i) each underlying security each dividend on an underlying security

§ 1.871–15(j)(1)(ii) introductory text each underlying security each dividend on an underlying security

§ 1.871–15(j)(1)(iii) introductory text each underlying security each dividend on an underlying security

§ 1.871–15(l)(1), first sentence The purpose of this section The purpose of this paragraph (l)


Section Remove Add

§ 1.871–15(l)(1), second sentence described in this paragraph. described in this paragraph (l).

§ 1.871–15(l)(7) references a security (for example,stock in an exchange-traded fund)

references an exchange-traded fund

§ 1.871–15(m)(2)(ii), first sentence at the time the potential 871(m)transaction referencing that partner-ship interest is issued

at the calculation time for the potentialsection 871(m) transaction referencingthat partnership interest

§ 1.871–15(m)(2)(ii), first sentence paragraph (m)(2)(i). paragraph (m)(2)(i) of this section.

§ 1.871–15(n)(4)(iii), heading andfirst sentence

less than fewer than

§ 1.871–15(p)(4)(ii) 10 business days of the date thepotential section 871(m) transactionis issued.

10 business days of the date containingthe calculation time for the potentialsection 871(m) transaction.

§ 1.871–15(r)(4), heading paragraphs (c)(2)(iv), (h), and (q) paragraphs (g)(4)(ii)(B), (p)(1)(ii)through (iv), and (p)(5)

Par. 4. Revise § 1.871–15T to read asfollows:

§ 1.871–15T Treatment of dividendequivalents (temporary).

(a) [Reserved]. For further guidance,see § 1.871–15(a).

(1) Broker. A broker is a broker withinthe meaning provided in section 6045(c),except that the term does not include anycorporation that is a broker solely becauseit regularly redeems its own shares.

(a)(2) through (g)(4)(ii)(A) [Reserved].For further guidance, see § 1.871–15(a)(2)through (g)(4)(ii)(A).

(B) A foreign securities exchange that:(1) Is regulated or supervised by a gov-

ernmental authority of the country inwhich the market is located;

(2) Has trading volume, listing, financialdisclosure, surveillance, and other require-ments designed to prevent fraudulent andmanipulative acts and practices, to removeimpediments to and perfect the mechanismof a free and open, fair and orderly market,and to protect investors, and the laws of thecountry in which the exchange is locatedand the rules of the exchange ensure thatthose requirements are actually enforced;

(3) Has rules that effectively promoteactive trading of listed options on the ex-change; and

(4) Has an average daily trading vol-ume on the exchange exceeding $10 bil-lion during the immediately precedingcalendar year. If an exchange in a foreigncountry has more than one tier or marketlevel on which listed options may be sep-

arately listed or traded, each tier or marketlevel is treated as a separate exchange.

(g)(5) through (p)(1)(i) [Reserved]. Forfurther guidance, see § 1.871–15(g)(5)through (p)(1)(i).

(ii) Transactions with multiple brokers.For a potential section 871(m) transactionin which both the short party and an agentor intermediary acting on behalf of theshort party are a broker or dealer, the shortparty must determine whether the poten-tial section 871(m) transaction is a section871(m) transaction. For a potential section871(m) transaction in which the shortparty is not a broker or dealer and morethan one agent or intermediary acting onbehalf of the short party is a broker ordealer, the broker or dealer that is a partyto the transaction and closest to the shortparty in the payment chain must deter-mine whether the potential section 871(m)transaction is a section 871(m) transac-tion. For a potential section 871(m) trans-action in which neither the short party norany agent or intermediary acting on behalfof the short party is a broker or dealer, andthe long party and an agent or intermedi-ary acting on behalf of the long party area broker or dealer, or more than one agentor intermediary acting on behalf of thelong party is a broker or dealer, the brokeror dealer that is a party to the transactionand closest to the long party in the pay-ment chain must determine whether thepotential section 871(m) transaction is asection 871(m) transaction.

(iii) Responsible party for transactionstraded on an exchange and cleared by aclearing organization. Except as provided

in paragraph (p)(1)(iv) of this section, for apotential section 871(m) transaction that istraded on an exchange and cleared by aclearing organization, and for which morethan one broker-dealer acts as an agent orintermediary between the short party and aforeign payee, the broker or dealer that hasan ongoing customer relationship with theforeign payee with respect to that transac-tion (generally the clearing firm) must de-termine whether the potential section871(m) transaction is a section 871(m)transaction.

(iv) Responsible party for certain struc-tured notes, warrants, and convertible in-struments. When a potential section 871(m)transaction is a structured note, warrant,convertible stock, or convertible debt, theissuer is the party responsible for determin-ing whether a potential section 871(m)transaction is a section 871(m) transaction.

(p)(1)(v) through (p)(4) [Reserved]. Forfurther guidance, see § 1.871–15(p)(1)(v)through (p)(4).

(5) Example. The following example illus-trates the rules of paragraph (p) of this section:

Example 1. CO is a domestic clearing organiza-tion and is not a broker as defined in § 1.871–15(a)(1). CO serves as a central counterparty clear-ing and settlement service provider for derivativesexchanges in the United States. EB and CB arebrokers organized in the United States and membersof CO. FC, a foreign corporation, instructs EB toexecute the purchase of a call option that is a spec-ified ELI (as described in § 1.871–15(e)). EB effectsthe trade for FC on the exchange and then, as in-structed by FC, transfers the option to CB to becleared with CO. The exchange matches FC’s orderwith an order for a written call option with the sameterms and then sends the matched trade to CO, whichclears the trade. CB and the clearing member repre-senting the person who sold the call option settle the


trade with CO. Upon receiving the matched trade,the option contracts are novated and CO becomes thecounterparty to CB and the counterparty to the clear-ing member representing the person who sold thecall option. Both EB and CB are broker-dealersacting on behalf of FC for a potential section 871(m)transaction. Under paragraph (p)(1)(iii) of this sec-tion, however, only CB is required to make thedeterminations described in § 1.871–15(p).

(q) through (r)(4) [Reserved]. For furtherguidance, see § 1.871–15(r)(1) through (4).

(5) Effective/applicability date. Thissection applies to payments made on orafter on January 19, 2017.

(s) Expiration date. This section ex-pires January 17, 2020.

Par. 5. Section 1.1441–1 is amended by:1. Revising paragraphs (b)(4)(xxii),

(e)(3)(ii)(E), (e)(5),and (e)(6).2. Adding a new sentence to the end

of paragraph (e)(2)(i).3. Adding new paragraph (f)(5).The additions and revisions read as

follows:

§ 1.1441–1 Requirement for the deductionand withholding of tax on payments toforeign persons.

* * * * *(b) * * *(4) * * *(xxii) Certain payments to qualified de-

rivatives dealers (as described in para-graph (e)(6) of this section). For purposesof this withholding exemption, the quali-fied derivatives dealer must furnish to thewithholding agent the documentation de-scribed in paragraph (e)(3)(ii) of this sec-tion. A withholding agent that makes apayment to a qualified intermediary that isacting as a qualified derivatives dealer isnot required to withhold on the followingpayments if the withholding agent can re-liably associate the payment with a validqualified intermediary withholding certif-icate as described in paragraph (e)(3)(ii)of this section, including the certificationdescribed in paragraph (e)(3)(ii)(E):

(A) A payment with respect to a poten-tial section 871(m) transaction that is notan underlying security;

(B) A payment of a dividend equiva-lent; or

(C) A payment of a dividend in 2017.* * * * *

(e) * * *(2) * * *

(i) * * * For purposes of a qualifiedintermediary acting as a qualified deriva-tives dealer, a qualified intermediary with-holding certificate, as described in para-graph (e)(3)(ii) of this section is abeneficial owner withholding certificatefor purposes of treaty claims for divi-dends.* * * * *

(3) * * *(ii) * * *(E) In the case of any payment with

respect to a potential section 871(m)transaction (including any dividend equiv-alent payment within the meaning of§ 1.871–15(i)) or underlying security (asdefined in § 1.871–15(a)(15)) received bya qualified intermediary acting as a qualifiedderivatives dealer, a certification that thehome office or branch receiving the pay-ment, as applicable, meets the requirementsto act as a qualified derivatives dealer asfurther described in paragraph (e)(6) of thissection and that the qualified derivativesdealer assumes primary withholding and re-porting responsibilities under chapters 3, 4,and 61, and section 3406 with respect to anypayments it makes with respect to potentialsection 871(m) transactions;* * * * *

(5) Qualified intermediaries—(i) Ingeneral. A qualified intermediary, as de-fined in paragraph (e)(5)(ii) of this sec-tion, may furnish a qualified intermediarywithholding certificate to a withholdingagent. The withholding certificate pro-vides certifications on behalf of other per-sons for the purpose of claiming and ver-ifying reduced rates of withholding undersection 1441 or 1442 and for the purposeof reporting and withholding under otherprovisions of the Code, such as the provi-sions under chapter 61 and section 3406(and the regulations under those provi-sions), or for the qualified derivativedealer (if applicable). Furnishing such acertificate is in lieu of transmitting to awithholding agent withholding certificatesor other appropriate documentation for thepersons for whom the qualified intermedi-ary receives the payment, including inter-est holders in a qualified intermediary thatis fiscally transparent under the regula-tions under section 894. Although thequalified intermediary is required to ob-tain withholding certificates or other ap-propriate documentation from beneficial

owners, payees, or interest holders pursu-ant to its agreement with the IRS, it isgenerally not required to attach such doc-umentation to the intermediary withhold-ing certificate. Notwithstanding the pre-ceding sentence, a qualified intermediarymust provide a withholding agent with theForms W–9, or disclose the names, ad-dresses, and taxpayer identifying num-bers, if known, of those U.S. non-exemptrecipients for whom the qualified interme-diary receives reportable amounts (withinthe meaning of paragraph (e)(3)(vi) of thissection) to the extent required in the qual-ified intermediary’s agreement with theIRS. When a qualified intermediary is act-ing as a qualified derivatives dealer, thewithholding certificate entitles a withhold-ing agent to make payments with respectto potential section 871(m) transactionsthat are not underlying securities and div-idend equivalent payments on underlyingsecurities to the qualified derivativesdealer free of withholding. A withholdingagent is required to withhold on all otherU.S. source FDAP payments made to aqualified derivatives dealer as required byapplicable law. Paragraph (e)(6) of thissection contains detailed rules prescribingthe circumstances in which a qualified in-termediary can act as a qualified deriva-tives dealer. A person may claim qualifiedintermediary status before an agreement isexecuted with the IRS if it has applied forsuch status and the IRS authorizes suchstatus on an interim basis under such pro-cedures as the IRS may prescribe.

(ii) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(ii).

(A) Through (C) [Reserved]. For addi-tional guidance, see § 1.1441–1T(e)(5)(ii)(A)–(C).

(D) A foreign person that is a homeoffice or has a branch that is an eligibleentity as described in paragraph (e)(6)(ii)of this section, without regard to the re-quirement that the person be a qualifiedintermediary; or

(E) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(ii)(E).

(iii) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(iii).

(iv) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(iv).

(v) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(v).


(A) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(v)(A).

(B) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(v)(B).

(1) – (3) [Reserved]. For additional guid-ance, see § 1.1441–1T(e)(5)(v)(B)(1)–(3).

(4) If a qualified intermediary is actingas a qualified derivatives dealer, designatethe accounts:

(i) For which the qualified derivativesdealer is receiving payments with respectto potential section 871(m) transactions orunderlying securities as a qualified deriv-atives dealer;

(ii) For which the qualified derivativesdealer is receiving payments with respectto potential section 871(m) transactions(and that are not underlying securities) forwhich withholding is not required;

(iii) For which qualified derivativesdealer is receiving payments with respectto underlying securities for which with-holding is required; and

(iv) If applicable, identifying the homeoffice or branch that is treated as theowner for U.S. income tax purposes; and

(6) Qualified derivatives dealers—(i)In general. To act as a qualified deriva-tives dealer under a qualified intermediarywithholding agreement, the home office orbranch that is a qualified intermediarymust be an eligible entity as described inparagraph (e)(6)(ii) of this section and, inaccordance with the qualified intermedi-ary agreement, must—

(A) Furnish to a withholding agent aqualified intermediary withholding certif-icate (described in paragraph (e)(3)(ii) ofthis section) that indicates that the homeoffice or branch receiving the payment is aqualified derivatives dealer with respect tothe payments associated with the with-holding certificate;

(B) Agree to assume the primary with-holding and reporting responsibilities, in-cluding the documentation provisions underchapters 3, 4, and 61, and section 3406, theregulations under those provisions, andother withholding provisions of the InternalRevenue Code, for payments made as aqualified derivatives dealer with respect topotential section 871(m) transactions. Forthis purpose, a qualified derivatives dealer isrequired to obtain a withholding certificateor other appropriate documentation fromeach counterparty to whom the qualifiedderivatives dealer makes a reportable pay-

ment (including a dividend equivalent pay-ment within the meaning of § 1.871–15(i)).The qualified derivatives dealer is also re-quired to determine whether any payment itmakes with respect to a potential section871(m) transaction is, in whole or in part, adividend equivalent;

(C) Agree to remain liable for tax un-der section 881, if any, on any paymentwith respect to a potential section 871(m)transaction (including a dividend equiva-lent payment within the meaning of§ 1.871–15(i)) and underlying securities(including dividends) it receives as a qual-ified derivatives dealer, or in the case ofdividend equivalents received in the eq-uity derivatives dealer capacity, the taxesrequired pursuant to § 1.871–15(q);

(D) Comply with the compliance re-view procedures applicable to a qualifiedintermediary that acts as a qualified deriv-atives dealer under the qualified interme-diary withholding agreement, which willspecify the time and manner in which aqualified derivatives dealer must:

(1) Certify to the IRS that it has com-plied with the obligations to act as a qual-ified derivatives dealer (including its per-formance of a periodic review applicableto a qualified derivatives dealer);

(2) Report to the IRS any amounts sub-ject to reporting on Forms 1042–S (in-cluding dividend equivalent payments thatit made);

(3) Report to the IRS on the appropriateU.S. tax return, its tax liabilities, includingits tax liability pursuant to § 1.871–15(q)(1)and any other taxes on payments with re-spect to potential section 871(m) transac-tions or underlying securities as defined in§ 1.871–15(a)(15) it receives; and

(4) Respond to inquiries from the IRSabout obligations it has assumed as a qual-ified derivatives dealer in a timely manner;

(E) Agree to act as a qualified derivativesdealer for all payments made as a principalwith respect to potential section 871(m)transactions and all payments received as aprincipal with respect to potential section871(m) transactions and underlying securi-ties as defined in § 1.871–15(a)(15) (includ-ing dividend equivalent payments within themeaning of § 1.871–15(i)), excluding anypayments made or received by the qualifiedderivatives dealer to the extent the paymentis treated as effectively connected with theconduct of a trade or business within the

United States within the meaning of section864, and not act as a qualified derivativesdealer for any other payments. For purposesof this paragraph (E), any securities lendingor sale-repurchase transaction that the qual-ified intermediary enters into that is a sec-tion 871(m) transaction is treated as enteredinto as a principal unless the qualified inter-mediary determines that it is acting as anintermediary with respect to that transac-tion; and

(F) Each home office or branch mustqualify and be approved for qualified de-rivatives dealer status and must representitself as a QDD on its Form W–8IMY andseparately identify the home office orbranch as the recipient on a withholdingstatement (if necessary). The home officemeans a foreign person, excluding anybranches of the foreign person, that ap-plies for qualified derivatives dealer sta-tus. Each home office or branch that ob-tains qualified derivatives dealer statusmust be treated as a separate qualifiedderivatives dealer.

(ii) Definition of eligible entity. An el-igible entity is a home office or branchthat is a qualified intermediary and that,treating the home office or branch as aseparate entity, is—

(A) An equity derivatives dealer subjectto regulatory supervision as a dealer by agovernmental authority in the jurisdiction inwhich it was organized or operates;

(B) A bank or bank holding companysubject to regulatory supervision as a bankor bank holding company (as applicable)by a governmental authority in the juris-diction in which it was organized, or op-erates or an entity that is wholly-owned(directly or indirectly) by a bank or bankholding company subject to regulatory su-pervision as a bank or bank holding com-pany (as applicable) by a governmentalauthority in the jurisdiction in which thebank or bank holding company (as appli-cable) was organized or operates and thatin its equity derivatives dealer capacity—

(1) Issues potential section 871(m)transactions to customers; and

(2) Receives dividends with respect tostock or dividend equivalent paymentspursuant to potential section 871(m) trans-actions that hedge potential section 871(m)transactions that it issued;

(C) A foreign branch of a U.S. financialinstitution, if the foreign branch would meet


the requirements of paragraph (A) or (B) ofthis section if it were a separate entity; or

(D) Any person otherwise acceptableto the IRS.* * * * *

(f) * * *(5) Effective/applicability date. Para-

graphs (e)(5)(ii)(D) and (e)(5)(v)(B)(4) ofthis section apply to payments made on orafter on January 19, 2017.

Par. 6. Section 1.1441–1T is amended by:1. Redesignating paragraph (e)(5)(ii)(D)

as paragraph (e)(5)(ii)(E), redesignatingparagraph (e)(5)(v)(B)(4) as paragraph(e)(5)(v)(B)(5) and adding new paragraphs(e)(5)(ii)(D) and (e)(5)(v)(B)(4).

2. Revising paragraphs (e)(3)(ii)(E),(e)(5)(i), (e)(5)(v)(B)(4), and (e)(6).

3. Removing the language “Except forparagraphs (e)(3)(ii)(E) and (e)(6), thissection” from the first sentence of para-graph (f)(3) and adding in its place “Thissection”, and removing the third sentencein paragraph (f)(3), and

4. Removing the language “Except forparagraphs (e)(3)(ii)(E) and (e)(6), the ap-plicability” from the first sentence of para-graph (g) and adding in its place “TheApplicability” and removing the secondsentence in paragraph (g).

§ 1.1441–1T Requirement for thededuction and withholding of tax onpayments to foreign persons (temporary).

* * * * *(e) * * *(3) * * *(ii) * * *(E) [Reserved]. For additional guid-

ance, see § 1.1441–1(e)(3)(ii)(E).* * * * *

(5) Qualified Intermediaries—(i) [Re-served]. For additional guidance, see§ 1.1441–1(e)(5)(i).

(ii) * * *(D) [Reserved]. For additional guid-

ance, see § 1.1441–1(e)(5)(ii)(D).* * * * *

(v) * * *(B) * * *(4) [Reserved]. For additional guid-

ance, see § 1.1441–1(e)(5)(v)(B)(4).* * * * *

(6) [Reserved]. For additional guid-ance, see § 1.1441–1(e)(6).* * * * *

Par. 7. Section 1.1441–2 is amended by:

1. Revising paragraphs (e)(7)(i) and(e)(7)(ii).

2. Removing “paragraph (e)(8)(ii)(A)”from paragraph (e)(7)(iii) and add-ing in “paragraph (e)(7)(ii)(A)” inits place.

3. Adding paragraphs (e)(7)(iv) through(ix).

4. Revising the last sentence of para-graph (f)(1) and adding a new lastsentence.

The revisions and additions read asfollows:

§ 1.1441–2 Amounts subject towithholding.

* * * * *(e) * * *(7) Payments of dividend equiva-

lents—(i) In general. Subject to para-graphs (e)(7)(iv), (vi), and (vii) of thissection, a payment of a dividend equiva-lent is not considered to be made until thelater of when—

(A) The amount of a dividend equiva-lent is determined as provided in § 1.871–15(j)(2), and

(B) A payment occurs with respect tothe section 871(m) transaction after theamount of a dividend equivalent is deter-mined as provided in § 1.871–15(j)(2).

(ii) Payment. For purposes of para-graph (e)(7) of this section, a paymentoccurs with respect to a section 871(m)transaction when—

(A) Money or other property is paid to orby the long party, unless the section 871(m)transaction is described in § 1.871–15(i)(3), inwhich case a payment is treated as being madeat the end of the applicable calendar quarter;

(B) The long party sells, exchanges,transfers, or otherwise disposes of the sec-tion 871(m) transaction (including by set-tlement, offset, termination, expiration,lapse, or maturity); or

(C) The section 871(m) transaction istransferred to an account that is not main-tained by the withholding agent or thelong party terminates the account relation-ship with the withholding agent.* * * * *

(iv) Option to withhold on dividend pay-ment date. A withholding agent may with-hold on the payment date described in para-graph (e)(4) of this section for the applicabledividend on the underlying security (the div-

idend payment date) if it withholds on thatdate for all section 871(m) transactions ofthe same type (securities lending or sale-repurchase transaction, NPC, or ELI) andsatisfies the requirements to paragraph(e)(7)(v) of this section.

(v) Changes to time of withholding.This paragraph describes how a withhold-ing agent changes the time that it with-holds on a dividend equivalent payment toa time described in paragraph (e)(7)(i) or(iv) of this section and these requirementsmust be satisfied for a withholding agentto change the time it withholds. A with-holding agent must apply the change con-sistently to all transactions of the sametype entered into on or after the change.For transactions of the same type enteredinto before the change, a withholdingagent must withhold under the originalapproach throughout the term of the trans-action. When a withholding agent changesthe time that it will withhold, the with-holding agent must notify each payee inwriting that it will withhold using the ap-proach described in paragraph (e)(7)(i) or(iv) of this section, as applicable, beforethe time for determining the payee’s firstdividend equivalent payment (as deter-mined under § 1.871–15(j)(2)). With re-spect to transactions held by an interme-diary or foreign flow-through entity, awithholding agent is treated as providingnotice to each payee holding that transac-tion through the entity when it notifies theintermediary or foreign flow-through en-tity of the time it will withhold, as de-scribed in the preceding sentence, pro-vided that the intermediary or foreignflow-through entity agrees to provide thesame notice to each payee. The withhold-ing agent must attach a statement to itsrelevant income tax return (filed by thedue date, including extensions) for the yearof the change notifying the IRS of thechange and when it applies, identifyingthe types of section 871(m) transaction towhich the change applies, and certifyingthat has notified its payees. For purposesof this paragraph, a withholding agent willbe considered to have entered into a trans-action on the first date the withholdingagent becomes responsible for withhold-ing on the transaction (based on the rule inparagraph (e)(7)(ix) of this section).

(vi) Withholding by qualified derivativesdealers. A withholding agent that is acting


as a qualified derivatives dealer must with-hold with respect to a dividend equivalentpayment on the payment date described inparagraph (e)(4) of this section for the ap-plicable dividend on the underlying securityand must notify each payee in writing that itwill withhold on the dividend payment datebefore the time for determining the payee’sfirst dividend equivalent payment (as deter-mined under § 1.871–15(j)(2)).

(vii) Withholding with respect to deriv-atives that reference partnerships. To theextent that a withholding agent is requiredto withhold with respect to a partnershipinterest described in § 1.871–15(m), theliability for withholding arises on March15 of the year following the year in whichthe payment of a dividend equivalent (de-termined under § 1.871–15(i)) occurs.

(viii) Notification to holders of with-holding timing. If a withholding agent isrequired to notify a payee of when it willwithhold under paragraph (e)(7)(v) of thissection, it may use the reporting methodsprescribed in § 1.871–15(p)(3)(i).

(ix) Withholding agent responsibility. Awithholding agent is only responsible fordividend equivalent amounts determined (asprovided in § 1.871–15(j)(2)) during the pe-riod the withholding agent is a withholdingagent for the section 871(m) transaction.* * * * *

(f) * * * (1) Except as otherwise pro-vided in this paragraph, paragraph (e)(7)of this section applies to payments madeon or after September 18, 2015. Para-graphs (e)(7)(ii)(D) and (e)(7)(iv) through

(viii) of this section apply to paymentsmade on or after January 19, 2017.

Par. 8. Section 1.1441–7 is amended by:1. Revising Example 7 in paragraph

(a)(3).2. Adding Example 8 and 9 to para-

graph (a)(3).3. Adding a sentence to the end of

paragraph (a)(4).The additions read as follows:

§ 1.1441–7 General provisions relatingto withholding agents.

(a) * * *(3) * * *Example 7. CO is a domestic clearing organiza-

tion. CO serves as a central counterparty clearing andsettlement service provider for derivatives exchanges inthe United States. CB is a broker organized in CountryX, a foreign country, and a clearing member of CO. CBis a nonqualified intermediary, as defined in § 1.1441–1(c)(14). FC is a foreign corporation that has an ac-count with CB. FC instructs CB to purchase a calloption that is a specified ELI (as described in § 1.871–15(e)). CB effects the trade for FC on the exchange.The exchange matches FC’s order with an order for awritten call option with the same terms. The exchangethen sends the matched trade to CO, which clears thetrade. CB and the clearing member representing theperson who sold the call option settle the trade withCO. Upon receiving the matched trade, the optioncontracts are novated and CO becomes the counter-party to CB and the counterparty to the clearing mem-ber representing the person who sold the call option. Tothe extent that there is a dividend equivalent withrespect to the call option, both CO and CB are with-holding agents as described in paragraph (a)(1) of thissection. As a withholding agent, CO and CB must eachdetermine whether it is obligated to withhold underchapter 3 of the Internal Revenue Code and the regu-lations thereunder.

Example 8. FCO is a foreign clearing organization.FCO serves as a central counterparty clearing and set-tlement service provider for derivatives exchanges inCountry A, a foreign country. CB is a broker organizedin Country A, and a clearing member of FCO. CB is anonqualified intermediary, as defined in § 1.1441–1(c)(14). FC is a foreign corporation that has an ac-count with CB. FC instructs CB to purchase a calloption that is a section 871(m) transaction. CB effectsthe trade for FC on the exchange. The exchangematches FC’s order with an order for a written calloption with the same terms. The exchange then sendsthe matched trade to FCO, which clears the trade. CBand the clearing member representing the call optionseller settle the trade with FCO. Upon receiving thematched trade, the option contracts are novated andFCO becomes the counterparty to CB and the counter-party to the clearing member representing the call op-tion seller. To the extent that there is a dividend equiv-alent with respect to the call option, both FCO and CBare withholding agents as described in paragraph (a)(1)of this section.

Example 9. The facts are the same as Example 8,except that CB is a qualified intermediary, as definedin § 1.1441–1(c)(15), that has assumed the primaryobligation to withhold, deposit, and report amountsunder chapters 3 and 4 of Internal Revenue Code.CB provides a written statement to FCO representingthat it has assumed primary withholding responsibil-ity for any dividend equivalent payment with respectto the call option. FCO, therefore, is not requiredwithhold on a dividend equivalent payment to CB.

(4) * * * Example 8 and Example 9 ofparagraph (a)(3) of this section apply to pay-ments made on or after January 19, 2017.* * * * *

§ 1.1461–1 [Amended]

Par. 9. For each section listed in the table,remove the language in the “Remove” col-umn and add in its place the language in the“Add” column as set forth below:

Section Remove Add

§ 1.1461–1(c)(2)(i) introductorytext, fourth sentence

a withholding agent withheldan amount

a withholding agent withheld (includingunder § 1.1441–2(e)(7)) an amount

§ 1.1461–1(c)(2)(i)(M) references the payment of adividend

references a dividend

§ 1.1461–1(c)(2)(ii)(J) or (xxiii); or (xxiii). This exception does not apply towithholding agents that are qualifiedderivatives dealers;

John Dalrymple

Deputy Commissioner for Servicesand Enforcement.

Approved: January 11, 2017

Mark J. MazurAssistant Secretary of the Treasury

(Tax Policy).

(Filed by the Office of the Federal Register on January 19,2017, 4:15 p.m., and published in the issue of the FederalRegister for January 24, 2017, 82 F.R. 8144)

26 CFR 1.7704–4: Qualifying income – mineral andnatural resources


T.D. 9817DEPARTMENT OF THETREASURYInternal Revenue Service26 CFR Part 1

Qualifying Income fromActivities of Publicly TradedPartnerships With Respect toMinerals or NaturalResources


ACTION: Final regulations.

SUMMARY: This document contains fi-nal regulations under section 7704(d)(1)(E) of the Internal Revenue Code(Code) relating to the qualifying incomeexception for publicly traded partnershipsto not be treated as corporations for Fed-eral income tax purposes. Specifically,these regulations define the activities thatgenerate qualifying income from explora-tion, development, mining or production,processing, refining, transportation, andmarketing of minerals or natural re-sources. These regulations affect publiclytraded partnerships and their partners.

DATES: Effective Date: These regula-tions are effective January 19, 2017.

Applicability Date: For dates of appli-cability, see § 1.7704–4(g).

FOR FURTHER INFORMATION CON-TACT: Caroline E. Hay, (202) 317-5279(not a toll-free number).


Background

This document contains amendmentsto 26 CFR part 1 under section 7704(d)(1)(E) of the Code relating to qualifyingincome from certain activities with re-spect to minerals or natural resources.

Congress enacted section 7704 as partof the Omnibus Budget ReconciliationAct of 1987 (Section 10211(a), PublicLaw 100–203, 101 Stat. 1330 (1987)).The following year, Congress clarifiedsection 7704 in the Technical and Miscel-laneous Revenue Act of 1988 (Section2004(f), Public Law 100–647, 102 Stat.

3342 (1988)). Section 7704(a) providesthat, as a general rule, publicly tradedpartnerships (PTPs) will be treated as cor-porations for Federal income tax pur-poses. In section 7704(c), Congress pro-vided an exception to this rule if 90percent or more of a PTP’s gross incomeis “qualifying income.” Qualifying in-come is generally passive-type income,such as interest, dividends, and rent. Sec-tion 7704(d)(1)(E) provides, however,that qualifying income also includes in-come and gains derived from the explora-tion, development, mining or production,processing, refining, transportation, ormarketing of minerals or natural re-sources.

There has been no prior guidance thatPTPs can rely on that defines the specificactivities that generate qualifying incomein the mineral and natural resource indus-tries. In order to obtain certainty that in-come from their activities constitutesqualifying income under section 7704(d)(1)(E), PTPs have sought opinion lettersfrom legal counsel or private letter rulings(PLRs) from the IRS. For the first 20 yearsin which the legislation has been in force,demand for PLRs under section 7704(d)(1)(E) was minimal. The IRS issued onlya few letters each year and often none.More recently, however, demand forPLRs has increased sharply, and in 2013,the IRS received more than 30 PLR re-quests under section 7704(d)(1)(E).

The increase in PLR requests has beendriven by a combination of factors. First,legal counsel have told the Department ofthe Treasury (Treasury Department) andthe IRS that they are reluctant to issueopinion letters unless a certain activitywas clearly contemplated by Congress,which has required PTPs to seek PLRs astheir activities expand beyond more tradi-tional qualifying activities, for example be-cause of technological advances, deconsoli-dation, and specialization. Second, investordemand for higher yields has increased theincentive to push for an expanded definitionof qualifying income through PLR requestsconcerning novel or non-traditional activi-ties. See Todd Keator, “Hydraulically Frac-turing” Section 7704(d)(1)(E) – StimulatingNovel Sources of “Qualifying Income” forMLPs, 29 Tax Mgmt. Real Est. J. 223, 227(2013). Third, a PLR may not be used asprecedent, requiring each PTP to obtain its

own PLR for activities similar to those of acompetitor. See section 6110(k)(3).

Absent regulatory guidance prescrib-ing a uniform framework for determiningwhich activities generate qualifying in-come, the IRS has historically reviewedPLR requests one-by-one as they havearisen and without the benefit of codifiedor regulatory principles demarcating theouter boundary of activities that Congressintended to generate qualifying income.PLR requests often seek approval not onlyfor activities that have been approved in acompetitor’s PLR, but also for additionalactivities similar to, but marginally differ-ent from, activities approved in earlierPLRs. The absence of regulatory guidancecan make it difficult for the IRS to distin-guish between such activities, creating thepotential for treating similarly situatedtaxpayers differently or expanding thescope of qualifying income beyond whatCongress intended. This risk of expansionpersists and increases in the absence ofregulatory guidance.

Given the increased demand for PLRs,the responsibility to treat all taxpayersequally, and the desire to apply section7704(d)(1)(E) consistent with congressio-nal intent, the Treasury Department andthe IRS determined there was a clear pub-lic need for guidance in this area. InMarch 2014, the IRS announced a pausein issuing PLRs under section 7704(d)(1)(E), which it lifted on March 6, 2015.On May 6, 2015, the Treasury Departmentand the IRS published a notice of pro-posed rulemaking (REG–132634–14) inthe Federal Register (80 FR 25970) pro-viding guidance on whether income fromactivities with respect to minerals or nat-ural resources is qualifying income undersection 7704(d)(1)(E). On June 18, 2015,the Treasury Department and the IRS pub-lished in the Federal Register (80 FR34856) several non-substantive correc-tions to the proposed regulations.

The Treasury Department and the IRSreceived numerous written and electroniccomments in response to the proposedregulations. All comments are available atwww.regulations.gov. The Treasury De-partment and the IRS held a public hear-ing on the proposed regulations on Octo-ber 27, 2015. In addition, the TreasuryDepartment and the IRS met with industryrepresentatives and worked extensively


with IRS engineers specializing in petro-leum, mining, and forestry to understandthe relevant industries. The many com-ments, hearing, and meetings were invalu-able in understanding the technicalaspects of exploration, development, min-ing and production, processing, refining,transportation, and marketing of mineralsand natural resources, and how these finalregulations can best provide needed guid-ance. After consideration of all of thecomments received, including the com-ments made at the hearing, the proposedregulations are adopted as final regula-tions as revised by this Treasury decision.In general, these final regulations followthe approach of the proposed regulationswith some modifications based on the rec-ommendations made in public comments.This preamble describes the comments re-ceived by the Treasury Department andthe IRS and the revisions made.

These final regulations are divided intoseven parts. The first part establishes thebasic rule that qualifying income includesincome and gains from qualifying activi-ties with respect to minerals or naturalresources. Qualifying activities are either“section 7704(d)(1)(E) activities” or “in-trinsic activities.” The second part defines“mineral or natural resource” consistentwith the definition set forth in section7704(d)(1) of the Code. The third partdefines and identifies the specific compo-nent activities that are included in each ofthe section 7704(d)(1)(E) activities, thatis, exploration, development, mining orproduction, processing, refining, transpor-tation, and marketing. Where necessary,component activities are listed by typeof mineral or natural resource. Thefourth part provides rules for determin-ing whether activities that are not section7704(d)(1)(E) activities are nonethelessintrinsic activities, which are those thatare specialized, essential, and require sig-nificant services by the PTP with respectto a section 7704(d)(1)(E) activity. Thefifth and sixth parts provide, respectively,a rule regarding interpretations of sections611 and 613 of the Code (dealing withdepletion of minerals and natural re-sources) in relation to § 1.7704–4 andexamples illustrating the provisions in§ 1.7704–4. Finally, the last part providesthat the final regulations apply to incomereceived by a partnership in a taxable year

beginning on or after January 19, 2017,but also contains a 10-year transition pe-riod for certain PTPs.

Summary of Comments andExplanation of Revisions

I. General Interpretation ofCongressional Intent

These final regulations prescribe a uni-form framework for determining whichmineral and natural resource activitiesgenerate qualifying income based on thestatutory language and congressional in-tent as interpreted by the Treasury Depart-ment and the IRS. In relevant part, section7704(d)(1)(E) provides merely that “in-come and gains derived from the explora-tion, development, mining or production,processing, refining, transportation (in-cluding pipelines transporting gas, oil, orproducts thereof), or the marketing of anymineral or natural resource (including fer-tilizer, geothermal energy, and timber)” isqualifying income. The limited statutorytext supplies only one relevant defini-tion—for “mineral or natural resource.”See section 7704(d)(1). The legislativehistory regarding the specific text at issueis likewise brief and susceptible to differ-ent interpretations, as demonstrated by thecomment letters received.

Although the statute and the legislativehistory do not provide definitions or aclear demarcation of the eight active termsand industry experts disagree on the scopeof these terms, certain guiding principlescan be gleaned. First, the Treasury De-partment and the IRS regard as particu-larly significant the fact that Congresspassed section 7704 in whole to restrictthe growth of PTPs, which it viewed aseroding the corporate tax base. See H.R.Rep. No. 100–391, at 1065 (1987) (“Therecent proliferation of publicly tradedpartnerships has come to the committee’sattention. The growth in such partnershipshas caused concern about long-term ero-sion of the corporate tax base.”) Congressexpressed alarm that the changes enactedin the Tax Reform of Act of 1986 thatreflected their intent to preserve the cor-porate level of tax were “being circum-vented by the growth of publicly tradedpartnerships that are taking advantage ofan unintended opportunity for disincorpo-ration and elective integration of the cor-

porate and shareholder levels of tax.” Id.at 1066. Congress made an exception forpassive-type income and “certain types ofnatural resources” because “special con-siderations appl[ied].” Id. at 1066, 1069.Well-established statutory constructionprinciples direct that, because section7704(d)(1)(E) was an exception to thegeneral rule, it should be read narrowly.See, for example, Comm’r v. Jacobson,336 U.S. 28, 49 (1949) (“The incometaxed is described in sweeping terms andshould be broadly construed in accor-dance with an obvious purpose to tax in-come comprehensively. The exemptions,on the other hand, are specifically statedand should be construed with restraint inthe light of the same policy.”).

Second, the eight listed active terms insection 7704(d)(1)(E) represent stages inthe extraction of minerals or natural re-sources and the eventual offering of cer-tain products for sale. A mineral or naturalresource may be explored for and, iffound, is developed, mined or produced,processed, refined, transported, and ulti-mately marketed. Manufacturing is not anactivity referenced in the statute, althoughas some might argue, processing and re-fining are forms of manufacturing. Theomission of manufacturing is significantespecially in light of other directives fromthe legislative history. Most importantly,the Conference Committee Report pro-vides, by example, an endpoint to activi-ties the income from which would bequalifying, by indicating that “[o]il, gas,or products thereof are not intended toencompass oil or gas products that areproduced by additional processing beyondthat of petroleum refineries or field facil-ities, such as plastics or similar petroleumderivatives.” H.R. Rep. No. 100–495, at947 (1987). The Treasury Department andthe IRS have interpreted this language tomean that Congress did not intend to in-clude extended processing or manufactur-ing activities beyond getting an extractedmineral or natural resource to market in aform in which those products are gener-ally sold.

This interpretation is reinforced byCongress’s explanation in the legislativehistory that natural resources were grantedan exception to the general rule of corpo-rate taxation in section 7704 because theactivities in those industries “have com-


monly or typically been conducted in part-nership form, and the committee considersthat disruption of present practices in suchactivities is currently inadvisable due togeneral economic conditions in these in-dustries.” H.R. Rep. No. 100–391, at1066 (1987). The committees responsiblefor drafting the legislation had previouslyheld three days of hearings dedicated toreviewing the use and taxation of masterlimited partnerships (MLPs), another termfor PTPs, and heard multiple witnessesdiscuss the use of partnerships and jointventures to raise capital for oil and gasexploration, the difference between in-vesting in wasting natural resource assetsand investing in active businesses, theprice of commodities, and the importanceof natural resource development to thenation’s security. See, for example, Mas-ter Limited Partnerships: Hearings Beforethe H. Subcomm. on Select Revenue Mea-sures of the Comm. on Ways and Means,100th Cong. 10 and 189 (1987) (statementof J. Roger Mentz, Asst. Sec. for TaxPolicy, U.S. Dep’t of the Treasury, ex-pressing concern that the rise in MLPswas “not limited to passive ownership orwasting assets such as oil and gas or nat-ural resource properties,” but instead were“increasingly being used for active busi-ness enterprises,” and statement of Chris-topher L. Davis, President, InvestmentPartnership Association, explaining that“[o]il and gas exploration and develop-ment are among the riskiest of businessventures,” but that partnerships had been“an economical way to share the risks”).See also Master Limited Partnerships:Hearing before the S. Subcomm. onTaxation and Debt Management of theComm. on Finance, 100th Cong. 90(1987) (statement of James R. Moffett,CEO, Freeport-McMoran, Inc., statingthat the “commodities in this country havebeen decimated” and that the mining andnatural resources businesses must be com-pletely rebuilt). There was no testimonyabout the need to protect manufacturingindustries.

These principles have informed thescope and approach of these final regula-tions and the responses to commenters inthis Summary of Comments and Explana-tion of Revisions. The Treasury Depart-ment and the IRS have concluded that inusing general terms without technical def-

initions, Congress did not intend a uni-form definition of such terms across allminerals and natural resources. Rather,Congress meant to capture those activitiescustomary to each industry that move adepletable asset to a point at which it iscommonly sold, and did not mean to in-clude those activities that create a new ordifferent product through further, ex-tended processing or manufacturing. Ac-cordingly, these final regulations describeas qualifying income the income and gainsfrom the activities performed to produceproducts typically found at field facilitiesand petroleum refineries or the equivalentfor other natural resources, certain transpor-tation and marketing activities with respectto those products, and intrinsic service ac-tivities that are specialized, essential, andrequire significant services with respect toexploration, development, mining and pro-duction, processing, refining, transportation,and marketing.

II. Definition of Mineral or NaturalResource

In section 7704(d)(1), Congress de-fined the term “mineral or natural re-source” as “any product of a characterwith respect to which a deduction for de-pletion is allowable under section 611;except that such term shall not include anyproduct described in subparagraph (A) or(B) of section 613(b)(7).” Products de-scribed in section 613(b)(7)(A) and (B)are soil, sod, dirt, turf, water, mosses, andminerals from sea water, the air, or othersimilar inexhaustible sources. The pro-posed regulations adopted, almost verba-tim, this same definition, but also specif-ically included fertilizer, geothermalenergy, and timber in the definition ofmineral or natural resource, and explainedthat the regulations did not address indus-trial source carbon dioxide, fuels de-scribed in section 6426(b) through (e), anyalcohol fuel defined in section 6426(b)(4)(A), or any biodiesel fuel as defined insection 40A(d)(1).

Many commenters recommended thatthe definition of mineral or natural re-source be expanded to include not onlyproducts of a character with respect towhich a deduction for depletion is allow-able under section 611, but also “productsthereof.” These commenters believed

Congress intended the definition of min-eral or natural resource to be read expan-sively, citing to the 1987 legislative his-tory, which provides that: “[N]aturalresources include fertilizer[,] geothermalenergy, and timber, as well as oil, gas orproducts thereof. . . . For this purpose, oil,gas, or products thereof means gasoline,kerosene, number 2 fuel oil, refined lubri-cating oils, diesel fuel, methane, butane,propane, and similar products which arerecovered from petroleum refineries orfield facilities.” H.R. Rep. No. 100–495,at 946-947 (1987). The significance ofthese commenters’ expansive definition isthat, under this view, so long as a productwas depletable at the time of its produc-tion or extraction, it remains a “productthereof” throughout its processing, refin-ing, transportation, and marketing. Underthis theory, a depletable product does notlose its status as a mineral or natural re-source by being processed or refined, andcan therefore be further processed or re-fined without limitation.

These final regulations do not adopt thisrecommendation. As originally passed in1987, section 7704(d)(1)(E) did not definethe term mineral or natural resource. Con-gress added the definition in 1988 (one yearafter the 1987 legislative history cited by thecommenters) as part of the Technical andMiscellaneous Revenue Act of 1988. It isthat same statutory definition added by Con-gress that these final regulations adopt al-most word for word. Moreover, in the stat-utory text, the phrase “products thereof” isused only in a parenthetical describingtransportation. See section 7704(d)(1)(E)(“income and gains derived from the . . .transportation (including pipelines trans-porting gas, oil, or products thereof)”). The1988 legislative history likewise used thephrase “products thereof” in a limited man-ner, that is only when describing transpor-tation and marketing. See, for example,H.R. Rep. No. 100–1104(II), at 17 (1988)(“In the case of transportation activities withrespect to oil and gas and products thereof”)and S. Rep. 100–445, at 424 (1988) (“Withrespect to the marketing of minerals andnatural resources (e.g., oil and gas and prod-ucts therefof [sic])”). Finally, defining min-eral and natural resource without includingproducts thereof is the most logical interpre-tation of the statute, taking into account theenumerated activities the statute contem-


plates to be undertaken with respect to thoseminerals or natural resources. One does notexplore for gasoline, kerosene, or number 2fuel oil, for example; rather, one exploresfor the depletable product, such as crude oilor natural gas. Once that crude oil or naturalgas has been refined or processed, however,Congress intended to make clear that the“products thereof” (the gasoline, kerosene,number 2 fuel oil, etc.) could be transportedand marketed and still give rise to qualifyingincome.

Commenters cautioned, however, thatthe Treasury Department and the IRSshould take into account the words “of acharacter” in the definition of mineral ornatural resource and the additional legis-lative history from 1988. That legislativehistory explained: “The reference in thebill to products for which a depletiondeduction is allowed is intended only toidentify the minerals or natural re-sources and not to identify what incomefrom them is treated as qualifying in-come. Consequently, whether income istaken into account in determining per-centage depletion under section 613does not necessarily determine whethersuch income is qualifying income undersection 7704(d).” S. Rep. No. 100 – 445,at 424 (1988). Commenters expressedthe concern that the Treasury Depart-ment and the IRS would interpret thestatutory definition to require those per-forming qualifying activities to havestarted with a depletable product them-selves or otherwise be eligible to claimdepletion deductions under section 611.

The Treasury Department and the IRSagree with the commenters that the defi-nition of mineral or natural resource undersection 7704(d)(1) does not require con-tinual ownership or control of the deplet-able asset from extraction through each ofthe eight listed active terms, but that qual-ifying activities can take place beginningat different points along that progressionof activities described by the active termsby those who purchase, take control of, ormerely perform section 7704(d)(1)(E) ac-tivities with respect to partially processedor refined minerals or natural resources.Compare with §§ 1.611–1(b) and (c) and1.613–1(a) (providing that annual deple-tion deductions are allowed only to theowner of an economic interest in mineraldeposits or standing timber). In adding the

definition of minerals or natural resourcesto section 7704(d)(1), Congress meant todelineate the type of asset involved, andnot to require any particular type of con-trol or ownership of the property. SeeH.R. Rep. No. 100–1104(II), at 16 (1988)(“the Senate amendment includes as qual-ifying income of publicly traded partner-ships the income from any depletableproperty (rather than from property eligi-ble for percentage depletion. . .)”). Thedefinitions of the eight listed active termsin these final regulations contemplate thatqualifying income may arise from certainactivities that may be performed on prod-ucts altered by earlier qualifying activi-ties.

In addition to the income and gainsderived from certain activities related tominerals or natural resources, Congressexpanded section 7704(d)(1)(E) in 2008to include income and gains from certainactivities related to industrial source car-bon dioxide, fuels described in section6426(b) through (e), alcohol fuel definedin section 6426(b)(4)(A), or biodiesel fuelas defined in section 40A(d)(1) as quali-fying income. Because the IRS has notreceived many PLR requests related tothese products, the preamble to the pro-posed regulations asked whether guidanceis needed with respect to those activitiesand, if so, the specific items the guidanceshould address. In response, commenterssuggested that although liquefied naturalgas (LNG) and liquefied petroleum gas(LPG) are included within those fuels de-scribed in section 6426(b), they shouldalso be specifically identified as naturalresources under section 7704(d)(1)(E). Inthe alternative, commenters requested thatthe final regulations treat the liquefactionand regasification of natural gas as part oftransportation.

These final regulations do not list LNGand LPG as natural resources since theyare not a mineral or natural resource underthe definition provided by Congress. Nei-ther LNG nor LPG is found in mines,wells, or other natural deposits listed insection 611, but each is instead a result ofprocessing or refining petroleum or natu-ral gas, as well as of activities to preparethe processed or refined product for stor-age and transportation. The Treasury De-partment and the IRS thus agree withcommenters that liquefaction and regasifi-

cation of natural gas may be part of trans-portation as further discussed in sectionIII.E of this Summary of Comments andExplanation of Revisions. Therefore,these final regulations include liquefyingor regasifying natural gas on the list ofqualifying transportation activities. Be-cause the Treasury Department and theIRS received no other comments seekingguidance with respect to industrial sourcecarbon dioxide, fuels described in section6426(b) through (e), alcohol fuel definedin section 6426(b)(4)(A), or biodiesel fuelas defined in section 40A(d)(1), these finalregulations do not provide any furtherguidance with respect to those items.

III. Section 7704(d)(1)(E) Activities

A. Replacement of exclusive list

The proposed regulations provided thatqualifying income included only incomeand gains from qualifying activities,which were defined to include section7704(d)(1)(E) activities and intrinsic ac-tivities. The proposed regulations furtherprovided an exclusive list of operationsthat comprised the section 7704(d)(1)(E)activities. Although the list could be ex-panded by the Commissioner through noticeor other forms of published guidance, theproposed regulations specifically stated that“[n]o other activities qualify as section7704(d)(1)(E) activities.”

Numerous commenters objected tothe use of an exclusive list of section7704(d)(1)(E) activities. They argued thata static list would ignore technologicaladvances in the dynamic mineral and nat-ural resource industries and doubted theability of the Treasury Department and theIRS to expeditiously issue guidance up-dating the list when needed. One com-menter noted that an exclusive list is ap-propriate only when the universe ofmatters to be included or excluded isknown, defined, considered, and catego-rized. The commenter questioned whetherthe Treasury Department and the IRS areaware of all of the current activities takingplace in the mineral and natural resourceindustries. Illustrating these concerns,many commenters cited examples of ac-tivities they believed were omitted fromthe list (either through inadvertence orlack of knowledge). Rather than an exclu-


sive list, some commenters recommendedthat the final regulations provide a generaldescription of the eight listed active termsin section 7704(d)(1)(E) (that is, explora-tion, development, mining or production,processing, refining, transportation, andmarketing), followed by a non-exclusivelist of examples of qualifying activitiesand, where appropriate, non-qualifyingactivities. They suggested that such a listwould provide helpful guidance to PTPs,while allowing other activities to betreated as qualifying, including throughthe issuance of PLRs.

Recognizing the practical difficultiesof ensuring comprehensive coverage ofthe activities generating qualifying in-come, the Treasury Department and theIRS agree with commenters that the list ofsection 7704(d)(1)(E) activities should notbe exclusive. Therefore, these final regu-lations provide a general definition ofeach of the eight listed active terms insection 7704(d)(1)(E) followed by a non-exclusive list of examples of each. TheTreasury Department and the IRS antici-pate that by setting forth the known activ-ities that generate qualifying income, theguidance will be clearer and, as a result,the number of PLR requests the IRS re-ceives will decrease. At the same time, theTreasury Department and the IRS do notintend that these final regulations be inter-preted or applied in an expansive manner.Instead, they should be interpreted andapplied in a manner that is consistent withtheir plain meaning and the overall intentof Congress to restrict this exception totreatment as a corporation under section7704(a) as described in section I of thisSummary of Comments and Explanationof Revisions.

B. Exploration and development

The proposed regulations defined ex-ploration as an activity performed to as-certain the existence, location, extent, orquality of any deposit of mineral or natu-ral resource before the beginning of thedevelopment stage of the natural depositby: (1) drilling an exploratory or strati-graphic type test well; (2) conducting drillstem and production flow tests to verifycommerciality of the deposit; (3) conduct-ing geological or geophysical surveys; or(4) interpreting data obtained from geo-

logical or geophysical surveys. For min-erals, exploration also included testpitting,trenching, drilling, driving of explorationtunnels and adits, and similar types ofactivities described in Rev. Rul. 70–287(1970–1 CB 146), if conducted prior todevelopment activities with respect to theminerals.

Separately, the proposed regulationsdefined development as an activity per-formed to make minerals or natural re-sources accessible by: (1) drilling wells toaccess deposits of minerals or natural re-sources; (2) constructing and installingdrilling, production, or dual purpose plat-forms in marine locations, or any similarsupporting structures necessary for ex-traordinary non-marine terrain (such asswamps or tundra); (3) completing wells,including by installing lease and wellequipment, such as pumps, flow lines,separators, and storage tanks, so that wellsare capable of producing oil and gas andthe production can be removed from thepremises; (4) performing a developmenttechnique such as, for minerals, stripping,benching and terracing, dredging by dra-gline, stoping, and caving or room-and-pillar excavation, and for oil and naturalgas, fracturing; or (5) constructing andinstalling gathering systems and custodytransfer stations.

One commenter noted that the pro-posed regulations provided a workabledefinition of exploration and developmentactivities consistent with past standards ofindustry practice, but did not allow forchanges in technologies developed in thefuture. Another commenter recommendedexpanding the list to include any activitythe payment for which is: (1) a geologicalor geophysical cost under section 167(h);(2) an intangible drilling cost under sec-tion 263(c); or (3) a mine exploration ordevelopment cost under section 616(a) or617(a). According to the commenter, thebenefit of such a rule is that the relevantindustries understand the costs covered bythose Code provisions and the law in thearea is well developed.

The only change made to the defini-tions of exploration and development inthese final regulations is the addition ofthe word “including” to show that the listof activities is not exclusive, as discussedin section III.A of this Summary of Com-ments and Explanation of Revisions.

These final regulations do not adopt thesuggestion to include as a qualifying ac-tivity all services giving rise to costs un-der section 167(h), 263(c), 616(a), or617(a). Some of the activities are alreadyspecifically included in the definitions ofsection 7704(d)(1)(E) activities, but oth-ers would expand the list of qualifyingactivities beyond that intended by Con-gress and allow service-provider PTPs tocircumvent the intrinsic test in § 1.7704–4(d). As discussed in section I of thisSummary of Comments and Explanationof Revisions, Congress enacted section7704 to restrict the growth of PTPs due to“concern about long-term erosion of thecorporate tax base.” H.R. Rep. No. 100–391, at 1065 (1987). Congress made anexception for natural resource activities inpart because it recognized the fragile eco-nomic conditions in those industries at thetime. Id. at 1066. Although Congress in-tended to benefit oil and gas developers, itdid not intend to exempt, for example,construction and debris removal compa-nies, suppliers, or other non-specializedservice providers to those industries. In-tangible drilling costs, for example, in-clude amounts paid for fuel, repairs, haul-ing, and supplies. See §§ 1.263(c)–1 and1.612–4(a). Although these costs may benecessarily incurred by oil and gas devel-opers, that does not mean that a third-party service provider that receives pay-ment for those services is performingactivities giving rise to qualifying income.

C. Mining or production

The proposed regulations defined min-ing or production as an activity performedto extract minerals or other natural re-sources from the ground by: (1) operatingequipment to extract natural resourcesfrom mines and wells; or (2) operatingequipment to convert raw mined productsor raw well effluent to substances that canbe readily transported or stored (for exam-ple, passing crude oil through mechanicalseparators to remove gas, placing crudeoil in settling tanks to recover basic sedi-ment and water, dehydrating crude oil,and operating heater-treaters that separateraw oil well effluent into crude oil, naturalgas, and salt water).

Generally, commenters sought to ex-pand the definition of mining or produc-


tion. They suggested that the regulationsadopt the definition of mining from sec-tion 613, which includes not only the ex-traction of ores or minerals from theground but also certain mining processes.See section 613(c)(2). Similarly, com-menters suggested that the regulations de-fine production to include not only theextraction of oil or natural gas from thewell but also certain processing activitiesthat occur post-production up to the “de-pletion cut-off point” established undersections 611 and 613. These commentersexplained that the explicit reference insection 7704(d)(1) to the depletion rulesin section 611 should be interpreted asmeaning that all the terms in 7704(d)(1)(E) should be defined the same as theterms in section 611. A consequence ofexpanding the definition of mining or pro-duction to include certain processing ac-tivities, commenters reasoned, is that thedefinition of processing for purposes ofsection 7704(d)(1)(E) would necessarilyencompass something more, further ex-panding qualifying activities as discussedin section III.D.3 of this Summary ofComments and Explanation of Revisions(concerning processing and refining ofores and minerals other than crude oil andnatural gas). Finally, one commenternoted that, in addition to mining from theground, minerals and natural resourcescan be extracted from waste deposits orresidue from prior mining, and that suchextraction should also be treated as min-ing or production. See section 613(c)(3)and § 1.613–4(i).

These final regulations do not adopt thesuggestion to expand the definition ofmining or production to include miningprocesses or other processing activitiesbefore the depletion cut-off point. Instead,these final regulations clarify the proposedregulations’ definition of mining or pro-duction activities to include only extrac-tion activities. In addition, the final regu-lations move activities that convert rawmined products or raw well effluent intoproducts that can be readily transported orstored to the definition of processing. As aresult, qualifying processing activities areincluded under the definition of process-ing in these final regulations. In its en-tirety, section 7704(d)(1)(E) covers abroader category of income than and con-templates a different end point of activi-

ties from those of sections 611 and 613,and therefore the definitions of miningand production are not interchangeablebetween the two regimes. Sections 611and 613 describe what is gross incomefrom the exhaustion of capital assets forpurposes of applying the depletion rules.See section 611(a) and United States v.Cannelton Sewer Pipe Co., 364 U.S. 76,81–85 (1960). For purposes of section613, mining, an upstream activity, gener-ally includes those treatments normallyapplied to prepare an extracted mineral ornatural resource to the point at which it isfirst marketable (which may involve alimited amount of processing and trans-portation), but no further. See section613(c)(2). In contrast, section 7704(d)(1)(E) separately lists certain upstream,midstream, and downstream activities, en-compassing a progression of stages of ac-tivities performed upon a mineral or nat-ural resource up to the point at whichproducts are typically produced at fieldfacilities and petroleum refineries or theequivalent for other natural resources, aswell as transportation and marketingthereafter. It would therefore be duplica-tive to define mining to include both min-ing and mining processes as defined insection 613 for purposes of section7704(d)(1)(E). The reference in section7704(d)(1) to section 611 merely definesthe scope of included minerals and naturalresources as discussed in section II of thisSummary of Comments and Explanationof Revisions. Nothing in the statute indi-cates that other concepts in section 611and 613 are intended to be incorporated aswell.

These final regulations adopt the re-quest that mining or production be definedto include the extraction of minerals ornatural resources from the waste depositsor residue of prior mining or production.The recycling of scrap or salvaged metalsor minerals from previously manufacturedproducts or manufacturing processes,however, is not considered to be the ex-traction of ores or minerals from waste orresidue, and therefore does not give rise toqualifying income.

D. Processing and refining

The proposed regulations combinedthe activities of processing and refining

together in one definition that includedboth a general definition followed by spe-cific rules for different categories of nat-ural resources (natural gas, petroleum,ores and minerals, and timber). The vastmajority of the comments received on theproposed regulations concerned the defi-nition of processing or refining, address-ing issues related to both the general def-inition and specific rules. Section III.D.1of this Summary of Comments and Expla-nation of Revisions addresses the com-ments related to the general definition.Sections III.D.2 through III.D.4 of thisSummary of Comments and Explanationof Revisions address comments related tothe specific rules.

1. General Definition

The general definition of processingand refining in the proposed regulationsstated that, except as otherwise provided,an activity was processing or refining ifdone to purify, separate, or eliminate im-purities, but would not qualify if: (1) thePTP did not use a consistent Modified Ac-celerated Cost Recovery System (MACRS)class life for assets used in the activity(the MACRS consistency requirement);(2) the activity caused a substantial phys-ical or chemical change in a mineral ornatural resource (the physical and chemi-cal change limitation); or (3) the activitytransformed the extracted mineral or nat-ural resource into a new or different min-eral product or into a manufactured prod-uct (the manufacturing limitation).

a. Separate definitions for processingand refining

Multiple commenters argued that theproposed regulations’ use of a joint defi-nition for processing and refining wronglyread the term “processing” out of the stat-ute. These commenters reasoned that Con-gress used a comma between the terms toindicate that each term must be accordedsignificance and effect, in contrast to the“or” between mining (for ores and miner-als) or production (for natural gas andcrude oil), which described the same ac-tivity but with respect to different indus-tries. Commenters noted that the versionof the legislation that passed in the Housedid not include the term processing.


Rather, it was added in conference andtherefore must mean that the two termsare not synonymous. While some com-menters admitted that it is not uncommonin the industry to use the words processingand refining interchangeably to refer tothe same activities, they maintained thatCongress intended to include a broaderrange of activities than either word alonewould allow.

Although the Treasury Department andthe IRS have determined that the termscan overlap, these final regulations adoptthe suggestion of defining processing andrefining separately in order to better clar-ify what activities generate qualifying in-come under section 7704(d)(1)(E). Thesefinal regulations generally define process-ing for purposes of section 7704(d)(1)(E)as an activity performed to convert rawmined or harvested products or raw welleffluent to substances that can be readilytransported or stored as further describedin the specific rules for the different cate-gories of natural resources. This definitioncaptures the processing that is generallyperformed at the wellhead, mine, field fa-cilities, or other location where miningprocesses are generally applied, as de-scribed in § 1.613–4(f)(1)(iii), becausethe legislative history contemplates thatqualifying activities do not include activ-ities that create products through addi-tional processing beyond that of petro-leum refineries or field facilities.

These final regulations do not providea general definition of refining, but insteadset forth the activities that qualify as re-fining activities under the specific rulesfor the different categories of natural re-sources. Consistent with the discussion insection III.D.1.e of this Summary of Com-ments and Explanation of Revisions, theTreasury Department and the IRS haveconcluded that refining does not have gen-eral application to all minerals and naturalresources.

b. MACRS consistency requirement

Commenters argued that the require-ment in the proposed regulations that aPTP use a consistent MACRS class lifefor assets generating qualifying income asa result of being used for processing orrefining has no statutory support andwould create uncertainty for PTPs and

their investors. They stressed that it wouldbe inappropriate to deny qualifying in-come treatment to a PTP whose activitiesmet the definition of processing or refin-ing merely because it, or a processor orrefiner further upstream, failed to use theappropriate MACRS class life. Comment-ers also challenged the idea that the assetclass lives in Rev. Proc. 87–56 (1987–2CB 674) are helpful in distinguishing be-tween qualifying and non-qualifying ac-tivities. Commenters raised similar con-cerns regarding the discussion of theNorth American Industry ClassificationSystem (NAICS) codes in the preamble ofthe proposed regulations to give examplesof qualifying activities.

The proposed regulations included aMACRS requirement because the Trea-sury Department and the IRS believedMACRS provided a useful demarcation ofthose processing and refining activitiestypically performed by a field facility or arefinery, as compared to non-qualifyingprocessing activities performed furtherdownstream from those activities, such aspetrochemical manufacturing or the man-ufacturing of pulp and paper. Compare,for example, Rev. Proc. 87–56, asset class13.3 (Petroleum Refining) and asset class28.0 (Manufacture of Chemicals); also,asset class 24.1 (Cutting of Timber) andasset class 26.1 (Manufacture of Pulp andPaper). In addition, the IRS released Rev.Proc. 87–56 six months before the passageof section 7704, making that demarcationcontemporaneous with section 7704. Af-ter consideration of the comments receivedon this issue, however, the Treasury Depart-ment and the IRS are persuaded that theMACRS class lives are not comprehensivenor sufficiently detailed for every industry.Accordingly, these final regulations do notinclude a MACRS consistency requirement.Nor do these final regulations reference theNAICS codes. Notwithstanding the lack of aMACRS consistency requirement, MACRSor NAICS codes nevertheless may provideuseful insight when determining whether anactivity generates qualifying income as pro-vided in these final regulations.

c. Physical and chemical changelimitation

Many commenters contended that thephysical and chemical change limitation

in the proposed regulations ignoreddecades-old authorities that such transfor-mative changes are an understood andrealistic part of processing and refining.See § 1.613A–7(s) (refining crude oil is“any operation by which the physical orchemical characteristics of crude oil arechanged”); IRM § 4.41.1.6.1 (modernrefining operations may involve the“separation of components plus thebreaking down, restructuring, and re-combining of hydrocarbon molecules”);Processing, New Oxford American Dic-tionary, 1307 (2001 ed.) (to perform aseries of mechanical or chemical opera-tions on, in order to change or preserve it).Commenters also criticized the referenceto § 1.613–4(g)(5) in the preamble of theproposed regulations, cited to show thatthe physical and chemical change limita-tion was consistent with definitions foundelsewhere in the Code and regulations.They argued that the physical and chem-ical change prohibition in § 1.613–4(g)(5)is helpful only in determining what is notincluded in calculating gross income fromthe exhaustion of capital assets for pur-poses of applying the depletion rules, butnot in distinguishing when an activityqualifies as processing or refining undersection 7704(d)(1)(E).

The Treasury Department and the IRSagree with the commenters that process-ing and refining may cause a substantialphysical or chemical change, dependingon the mineral or natural resource at issue.Indeed, the specific rule in the proposedregulations for the processing or refiningof petroleum recognized that refineriesperform physical and chemical changes,for example when converting the physi-cally separated components of crude oilinto gasoline or other fuels. Accordingly,because the general definition is at oddswith some of the specific rules for certainnatural resources, these final regulationsno longer include a general physical orchemical change limitation.

d. Manufacturing limitation

Commenters criticized the manufactur-ing limitation in the proposed regulations,arguing that the activities that qualify asprocessing and refining under section7704(d)(1)(E) are types of manufacturing.Many commenters elaborated that the pro-


posed regulations wrongly focus on theoutput of an activity. These commentersmaintained that the entire analysis shouldinstead rest on whether or not the input isa mineral or natural resource, or a productthereof. That is, so long as an item wasonce a mineral or natural resource, theincome derived from any further process-ing or refining of the item up to and, someargued, including a plastic is qualifying.Similar to the comments regarding thedefinition of mineral or natural resourcediscussed in section II of this Summary ofComments and Explanation of Revisions,these comments reflect a belief that theTreasury Department and the IRS havemisinterpreted the statement in the legis-lative history that “[o]il, gas, or productsthereof are not intended to encompass oilor gas products that are produced by ad-ditional processing beyond that of petro-leum refineries or field facilities,” H.R.Rep. No. 100–495, at 947 (1987), as alimitation on processing and refining in-stead of a clarification of what is includedas a natural resource that can be furtherprocessed and refined. As a corollary tothe comments regarding output, somecommenters argued that Congress knewhow to, but did not, limit processing andrefining to the creation of certain products,for example by specifying “or any pri-mary products thereof” as it did whenlisting oil and gas as excluded propertyunder the Foreign Sales Corporation pro-visions enacted in 1984. See section927(a)(2)(C), now repealed.

As discussed in section I of this Sum-mary of Comments and Explanation ofRevisions, the Treasury Department andthe IRS interpret the terms processing andrefining in section 7704(d)(1)(E) and thelegislative history as capturing those ac-tivities that produce the products typicallyfound at field facilities and petroleum re-fineries, or the equivalent for other naturalresources. The Treasury Department andthe IRS do not construe the lack of theword “primary” in the legislative historyas an indication that products producedthrough additional processing beyond therefinery or field facility should be in-cluded. Instead, the similarity between thelist of products in the regulations underformer section 927 and in the legislativehistory for section 7704(d)(1)(E) indicatethat Congress understood processing and

refining oil and natural gas to result in theproducts identified as primary products inthe regulations under former section 927.Compare § 1.927(a)–1T(g)(2)(i) (defining“primary product from oil” as crude oiland all products derived from the destruc-tive distillation of crude oil, including vol-atile products, light oils such as motor fueland kerosene, distillates such as naphtha,lubricating oils, greases and waxes, andresidues such as fuel oil) and § 1.927(a)–1T(g)(2)(ii) (defining “primary productfrom gas” as all gas and associated hydro-carbon components from gas or oil wells,whether recovered at the lease or uponfurther processing, including natural gas,condensates, liquefied petroleum gasessuch as ethane, propane, and butane, andliquid products such as natural gasoline)with the Conference Committee Reportfor section 7704(d)(1)(E), H.R. Rep. No.100–495, at 947 (1987) (“gasoline, kero-sene, number 2 fuel oil, refined lubricatingoils, diesel fuel, methane, butane, pro-pane”).

The Treasury Department and the IRSrecognize, however, that the wording ofthe manufacturing limitation in the pro-posed regulations was vague and couldcause confusion. Therefore, the generaldefinitions of processing and refining inthe final regulations no longer contain thespecific language that made up the manu-facturing limitation. Instead, the specificdefinitions for the processing and refiningof natural gas and crude oil capture con-gressional intent by including only thoseactivities that are generally performed atfield facilities and petroleum refineries, orthose that produce products typicallyfound at field facilities and refineries. Thedefinitions for processing and refining donot include additional processing or man-ufacturing activities, such as petrochemi-cal manufacturing. The final regulationsapply a similar end point for the process-ing and refining of ores, other minerals,and timber in a manner tailored to the typeof resource at issue.

e. Specific rules for each category ofnatural resource

Some commenters dismissed the needfor industry specific rules. These com-menters maintained that Congress did notlimit qualifying income based on the

different processes used for the varioustypes of minerals and natural resources,and therefore one overarching definitionshould apply consistently across all re-sources.

The final regulations retain separatedefinitions for processing and refining ofnatural gas, crude oil, ores and other min-erals, and timber. As a practical matter,the minerals and natural resources subjectto depletion under section 611 are differ-ent, and there is no uniform way to ad-dress them. For example, geothermal en-ergy is not processed or refined. Theprocessing of timber necessarily differsfrom the processing of natural gas. Theabsence of specific rules for each type ofnatural resource would result in vagueguidelines lacking clear distinctions be-tween qualifying and non-qualifying ac-tivities. Furthermore, a more general ap-proach would lead to an unwarrantedexpansion of the scope of qualifying in-come beyond that intended by Congress,since a general definition would need toencompass the activities of the resourcewith the broadest definition of processingand refining.

2. Natural Gas and Crude Oil

The proposed regulations defined pro-cessing or refining of natural gas as anactivity performed to: (1) purify naturalgas, including by removal of oil or con-densate, water, or non-hydrocarbon gases(including carbon dioxide, hydrogen sulfide,nitrogen, and helium); (2) separate naturalgas into its constituents which are normallyrecovered in a gaseous phase (methaneand ethane) and those which are normallyrecovered in a liquid phase (propane, bu-tane, pentane, and gas condensate); or (3)convert methane in one integrated conver-sion into liquid fuels that are otherwiseproduced from petroleum. The proposedregulations defined processing or refiningof petroleum as an activity, the end prod-uct of which is not a plastic or similarpetroleum derivative, performed to: (1)physically separate crude oil into its com-ponent parts, including, but not limited to,naphtha, gasoline, kerosene, fuel oil, lu-bricating base oils, waxes and similarproducts; (2) chemically convert the phys-ically separated components if one ormore of the products of the conversion are


recombined with other physically sepa-rated components of crude oil in a mannerthat is necessary to the cost-effective pro-duction of gasoline or other fuels (for ex-ample, gas oil converted to naphthathrough a cracking process that is hydro-treated and combined into gasoline); or(3) physically separate products created in(1) and (2). The proposed regulations alsoprovided a partial list of products thatwould not be treated as obtained throughthe qualified processing or refining of pe-troleum, including: (1) heat, steam, orelectricity produced by the refining pro-cesses; (2) products that are obtained fromthird parties or produced onsite for use inthe refinery, such as hydrogen, if excessamounts are sold; and (3) any product thatresults from further chemical change ofthe product produced from the separationof crude oil if it is not combined withother products separated from the crudeoil. For example, the proposed regulationsindicated that production of petroleumcoke from heavy (refinery) residuum qual-ifies as processing or refining, but anyupgrading of petroleum coke (such as toanode-grade coke) does not qualify be-cause it is further chemically changed.

Numerous commenters argued that theproposed regulations inappropriately fa-vored (1) crude oil over natural gas, and(2) fuel products over other products. Forexample, under the proposed regulations,qualifying processing or refining includedchemically converting the componentparts of crude oil into products that wouldbe combined into a fuel and products thatcould be separated further, sometimes re-sulting in olefins such as ethylene andpropylene. In contrast, the proposed reg-ulations recognized as qualifying only theconversion of one component of naturalgas (methane) into a fuel, and did not treatas qualifying the creation of olefins fromnatural gas. Commenters asserted thatthere is no basis for differentiating be-tween hydrocarbon sources for fuels orolefins, and that such differentiationcauses difficulties for pipeline operatorsand marketers, who cannot tell if the fun-gible fuels or olefins come from qualify-ing crude oil processing or non-qualifyingnatural gas conversions. Also regardingthis same language in the proposed regu-lations, one commenter asked that thephrase “in one integrated conversion” be

clarified so as to not exclude multistepconversion techniques which result in gas-oline. Similarly, commenters contendedthat the refining of lubricants, waxes, sol-vents, and asphalts should also be in-cluded as qualifying activities since they,like fuel, are products of petroleum refin-eries.

Two commenters stated that the pro-posed regulations were not consistent infavoring fuels since the sale of methanolwas not treated as a qualifying activity.See proposed § 1.7704–4(e), Example 3(concluding that “the production and saleof methanol, an intermediate product inthe conversion [from methane to diesel],is not a section 7704(d)(1)(E) activity be-cause methanol is not a liquid fuel other-wise produced from the processing ofcrude oil”). These commenters argued thatthe processing and sale of methanolshould be a qualifying activity because it:(1) is similar to methane or to natural gasliquids (NGLs), (2) is an intermediateproduct produced in the act of convertinggas into gasoline, (3) is itself a fuel (albeitan alcohol fuel), and (4) can be producedfrom oil using typical refinery processes,catalysts, and equipment.

Rather than the definitions in the pro-posed regulations, commenters offeredtwo different possible regulatory stan-dards for determining whether an activityqualifies as the processing or refining ofcrude oil or natural gas: (1) whether theactivity is performed in a crude oil refin-ery; or (2) whether the activity produces aproduct of a type that is produced in acrude oil refinery. For the second recom-mended standard, some commenters sug-gested that the final regulations adopt thelist of products produced by a refinery ascompiled by the U.S. Energy InformationAdministration (EIA). In support of thissecond standard, one commenter said thatusing the EIA list would give effect to thecongressional intent that oil and gas prod-ucts necessitating processing beyond thetype of processing that takes place in pe-troleum refineries should not give rise toqualifying income. Another commenteradded that using the second standardwould make the regulations administrableby avoiding inquiry into the nature andextent of the production process. Othercommenters recommended that the finalregulations provide a list of “bad prod-

ucts,” that is products of processing orrefining that do not give rise to qualifyingincome, such as a list of plastic resinsmaintained by trade industry associationsfor the plastic industry.

In response to these comments, thesefinal regulations make several changes.First, as discussed in section III.D.1.a ofthis Summary of Comments and Explana-tion of Revisions, these final regulationsseparately define processing and refining.Processing of natural gas and crude oil forpurposes of section 7704(d)(1)(E) encom-passes those activities that convert rawwell effluent to substances that can bereadily transported or stored, that is, whatis generally performed at the wellhead orfield facilities. For natural gas, processingis the purification of natural gas, includingby removing oil or condensate, water, ornon-hydrocarbon gases (such as carbondioxide, hydrogen sulfide, nitrogen, andhelium), and the separation of natural gasinto its constituents which are normallyrecovered in a gaseous phase (methaneand ethane) and those which are normallyrecovered in a liquid phase (propane, bu-tane, pentane, and gas condensate). Forcrude oil, processing is the separation ofcrude oil by passing it through mechanicalseparators to remove gas, placing crudeoil in settling tanks to recover basic sedi-ment and water, dehydrating crude oil,and operating heater-treaters that separateraw oil well effluent into crude oil, naturalgas, and salt water.

Second, consistent with the legislativehistory’s limitation to products of petro-leum refineries or field facilities, the Trea-sury Department and the IRS adopt thesuggestion to list the qualifying productsof a refinery for the definition of refining ofnatural gas and crude oil for purposes of7704(d)(1)(E) and, for this purpose, lookto information compiled by the EIA. TheTreasury Department and the IRS havedetermined that the EIA currently pro-vides an authoritative list of products of arefinery. Following the oil market disrup-tion in 1973, Congress established theEIA in 1977 to collect, analyze, and dis-seminate comprehensive, independent andimpartial energy information in order toassess the adequacy of energy resources tomeet economic and social demands. See42 U.S.C. 7135(a). As part of that man-date, the EIA is required to gather infor-


mation from persons engaged in owner-ship, control, exploration, development,extraction, refining or otherwise process-ing, storage, transportation, or distributionof mineral fuel resources. See 42 U.S.C.7135(h)(4) and (6). These final regulationsare informed by Form EIA–810,“Monthly Refinery Report,” and FormEIA–816, “Monthly Natural Gas LiquidsReport,” which are the surveys that eachrefinery or natural gas processing plantmust complete to report both finished andunfinished products of their operations.

Specifically, these final regulations de-fine the refining of natural gas and crudeoil as the further physical or chemicalconversion or separation processes ofproducts resulting from processing and re-fining activities, and the blending of pe-troleum hydrocarbons, to the extent theygive rise to products listed in the defini-tion of processing or the following prod-ucts: ethane, ethylene, propane, propyl-ene, normal butane, butylene, isobutane,isobutene, isobutylene, pentanes plus, un-finished naphtha, unfinished kerosene andlight gas oils, unfinished heavy gas oils,unfinished residuum, reformulated gasolinewith fuel ethanol, reformulated other motorgasoline, conventional gasoline with fuelethanol – Ed55 and lower gasoline, conven-tional gasoline with fuel ethanol – greaterthan Ed55 gasoline, conventional gasolinewith fuel ethanol – other conventional fin-ished gasoline, reformulated blendstock foroxygenate (RBOB), conventional blend-stock for oxygenate (CBOB), gasolinetreated as blendstock (GTAB), other mo-tor gasoline blending components definedas gasoline blendstocks as provided in§ 48.4081–1(c)(3), finished aviation gas-oline and blending components, specialnaphthas (solvents), kerosene-type jetfuel, kerosene, distillate fuel oil (heatingoils, diesel fuel, ultra-low sulfur dieselfuel), residual fuel oil, lubricants (lubri-cating base oils), asphalt and road oil (at-mospheric or vacuum tower bottom),waxes, petroleum coke, still gas, andnaphtha less than 401°F end-point, as wellas any other products of a refinery that theCommissioner may identify through pub-lished guidance.

The final regulations have modified orclarified several of the terms from the EIAlists to ensure that the listed products areonly those of the type produced in a pe-

troleum refinery or traditional gas fieldprocessing plant. Thus, for example, thelisted product “lubricants” includes theparenthetical “lubricating base oils” toclarify that refining does not include cre-ating a lubricant not of the type producedin a petroleum refinery that has beenmixed with non-petroleum hydrocarbons.The EIA reports are required to be filedonly by refiners and natural gas proces-sors; consequently, the EIA need not cir-cumscribe the products to include solelythose generally produced by a petroleumrefinery or processing plant. The TreasuryDepartment and the IRS modified the EIAlist to more specifically identify thoseproducts solely produced by refineries andfield facilities. In addition, the list in thefinal regulations must be read consistentlywith that view to include only those typesof listed products that are generally pro-duced in a petroleum refinery or naturalgas processing plant. For example, a lu-bricant that is not of a type that is gener-ally produced by a refiner is not within theproduct list. Therefore, the definitionshave been slightly adjusted to reflect lu-bricants of a petroleum refinery as op-posed to those from a manufacturer orentity that is adding more than the mini-mal amount permitted under additization(discussed in section III.H.5 of this Sum-mary of Comments and Explanation ofRevisions) of different minerals, naturalresources, or other products to the lubri-cant.

Also, in adopting the approach of list-ing the products of a petroleum refinery ora natural gas processing plant, these finalregulations no longer provide languageregarding converting methane in one inte-grated conversion into liquid fuels or re-garding the various acceptable chemicalconversions with respect to crude oil. Ac-tivities are treated as refining to the extentthey give rise to products listed in theregulation.

Adopting the EIA’s list of products ofa refinery resolved several other issuesraised by commenters. These final regula-tions no longer differentiate between therefining of natural gas and the refining ofcrude oil, particularly in regard to the cre-ation of olefins and certain liquid fuels.Although traditional gas field processingplants do not produce olefins or certainfuels from natural gas, these products are

created in petroleum refineries (albeit insmall quantities in the case of olefins).The Treasury Department and the IRSrecognize that changes in technology haveexpanded the ways to create liquid fuels,and thus continue to be guided by thestated goal in the legislative history ofincluding as qualifying those activitiesthat create products “which are recoveredfrom petroleum refineries or field facili-ties.” H.R. Rep. No. 100–495, at 947(1987). Similarly, the final regulations nolonger omit the refining of non-fuel prod-ucts of a refinery, such as lubricants,waxes, solvents, and asphalts of the typeproduced in petroleum refineries.

Conversely, the EIA list does not in-clude methanol as a product of a refineryor natural gas processing plant, and there-fore these final regulations do not adoptcommenters’ suggestion to treat as quali-fying the creation of methanol. Indeed,one commenter who recommended adopt-ing the list of products produced by arefinery as compiled by the EIA acknowl-edged that the Treasury Department andthe IRS would need to expand the EIA listto encompass methanol and synthesis gassince they are typically not produced atrefineries. Given the EIA’s expertise, theTreasury Department and the IRS declineto supplement the products of a refinery asidentified by the EIA, and also note thatalcohols (such as methanol) were specifi-cally not included as a primary product ofoil and gas in the regulations under theForeign Sales Corporation provisions,whose list of oil and gas products is sim-ilar to that in the legislative history forsection 7704(d)(1)(E). See § 1.927(a)–1T(g)(2)(iv) and discussion under sectionIII.D.1.d of this Summary of Commentsand Explanation of Revisions. Whethermethanol is similar to NGLs, is a liquidfuel, or can be created using typical oilrefining processes is immaterial to the de-termination of whether the manufacture ofmethanol is a qualifying activity. Thesefinal regulations, therefore, amend the rea-soning in Example 3, now in § 1.7704–4(f), to reflect that methanol is not in-cluded among the listed products.

These final regulations also do notadopt the recommendation to treat asqualifying all activities performed in arefinery. Such a standard would allowPTPs to thwart Congress’s limitation on


qualifying activities by simply movingprocesses that are normally not conductedin a refinery within the refinery fence. Forexample, some refineries have added hy-drogen production plants to their facilities,though Congress did not intend the gen-eration of hydrogen for sale to be a qual-ifying activity. Indeed, these final regula-tions continue to provide that products ofrefining do not include products producedonsite for the use in the refinery, such ashydrogen, if excess amounts are sold. TheTreasury Department and the IRS under-stand that some commenters suggestedthis broader definition of refining in orderto include as qualifying the refining ofnon-fuel products (lubricants, waxes, sol-vents, and asphalts). Their concern, how-ever, is addressed to the extent those prod-ucts are included in the list of products ofa refinery, thus avoiding the need for abroad and potentially vague rule thatwould encompass all activities undertakenin a refinery.

Finally, these final regulations retainlanguage similar to that in the proposedregulations clarifying that certain otherproducts are not products of refining, in-cluding heat, steam or electricity producedby refining processes, products obtainedfrom third parties or produced onsite foruse in the refinery if excess amounts aresold, any product that results from furtherchemical change of a product on the list ofproducts of a refinery that does not resultin the same or another product listed as aproduct of a refinery, and plastics or sim-ilar petroleum derivatives. For this lastitem, these final regulations do not adoptthe suggestion of some commenters toprovide a non-exclusive list of non-qualifying plastic resins, as the TreasuryDepartment and the IRS do not agree thatproviding such a list aids taxpayers. A listof some of the non-qualifying products isnot relevant because the final regulationslist all of the qualifying products andmight create confusion if a product werenot included on either list.

3. Ores and Minerals

The proposed regulations provided thatan activity constituted processing or refiningof ores and minerals if it met the definitionof mining processes under § 1.613–4(f)(1)(ii)or refining under § 1.613–4(g)(6)(iii). In ad-

dition, the proposed regulations repeatedpart of the definition of refining found in§ 1.613–4(g)(6)(iii) by stating that, gen-erally, refining of ores and minerals is anyactivity that eliminates impurities or for-eign matter from smelted or partially pro-cessed metallic and nonmetallic ores andminerals, as for example the refining ofblister copper.

Commenters generally sought to ex-pand the definition of processing and re-fining of ores and minerals. As discussedin greater detail in section III.C of thisSummary of Comments and Explanationof Revisions, commenters maintained thatsection 7704(d)(1)(E) should use the def-inition of mining from section 613(c)(2).Because that definition already includescertain mining processes, commenters fur-ther argued that the definition of process-ing for section 7704(d)(1)(E) should in-clude something more, specifically someor all of the “nonmining processes” listedin section 613(c)(5) and § 1.613–4(g).Moreover, they reasoned that unless thenonmining processes are included in thedefinition of processing, there is a holebetween processing and refining, as de-fined in the proposed regulations, whichcould not have been intended. For exam-ple, the proposed regulations identified therefining of blister copper as a qualifyingactivity, but did not allow as qualifyingthe activity that precedes that step (that is,the smelting of the copper ore concentrateto produce the blister copper), which oc-curs after the mining processes identifiedin § 1.613–4(f)(2)(i)(d). Additionally, com-menters elaborated that some of the non-mining processes under section 613(c)(5)are themselves activities that “purify, sep-arate, or eliminate impurities,” thus fallingwithin the general definition of processingprovided in the proposed regulations.Some commenters argued that the cok-ing of coal, the making of activatedcarbon, and the fine pulverization ofmagnetite should all be considered qual-ifying activities.

Based on the comments received, theTreasury Department and the IRS havedetermined that the definition of process-ing and refining of ores and minerals inthe proposed regulations needed clarifica-tion. Like the final regulations on process-ing and refining of natural gas or crude oil,and as discussed in section III.D.1.a of

this Summary of Comments and Explana-tion of Revisions, these final regulationsseparately define processing and refiningof ores and minerals other than natural gasor crude oil.

Processing of ores and minerals otherthan natural gas or crude oil is defined inthese final regulations as those activitiesthat meet the definition of mining pro-cesses under § 1.613–4(f)(1)(ii), withoutregard to § 1.613–4(f)(2)(iv) (related towho is performing the processing). Ac-cordingly, processing includes the activi-ties generally performed at or near thepoint of extraction of the ores or mineralsfrom the ground (generally within a 50-mile radius or greater if the Commis-sioner determines that physical or otherrequirements cause the plants or mills tobe at a greater distance) that are nor-mally applied to obtain commerciallymarketable mineral products. Therefore,this definition captures the concept of“field facilities” in the legislative his-tory to section 7704(d)(1)(E).

Because the legislative history does notprovide any examples of products pro-duced from ores and minerals that maygenerate qualifying income, other thanthose relating to oil, gas, and fertilizer, theTreasury Department and the IRS haveapplied limitations to ores and mineralsthat are comparable to those specificallyexpressed by Congress regarding oil andgas. See H.R. Rep. No. 100–495, at 947(1987) (“[o]il, gas, or products thereof arenot intended to encompass oil or gas prod-ucts that are produced by additional pro-cessing beyond that of petroleum refiner-ies or field facilities, such as plastics orsimilar petroleum derivatives”). In con-trast, commenters’ suggestion to includenonmining processes in the definition ofprocessing is not consistent with the Trea-sury Department’s and the IRS’s view ofcongressional intent because the term“nonmining processes” in § 1.613–4(g) isa catch-all category that includes any pro-cess applied beyond mining processes, in-cluding refining, blending, manufacturing,transportation, and storage. See § 1.613–4(g) (which lists various nonmining pro-cesses, and also provides that “a processapplied subsequent to a nonmining pro-cess (other than nonmining transportation)shall also be considered to be a nonminingprocess”). In addition to causing the def-


inition of processing to be partly duplica-tive of other listed section 7704(d)(1)(E)activities, adopting this suggestion wouldmean that so long as a product started as adepletable product, any income derivedfrom any manipulation of that productwould be qualifying income. Such a resultwould be in direct conflict with the desireof Congress to restrict the scope of activ-ities engaged in by PTPs. Therefore, thesefinal regulations do not adopt that sugges-tion.

Nevertheless, in response to com-ments, these final regulations includesome nonmining processes in the defini-tion of refining of ores and minerals otherthan natural gas or crude oil. Refining ofores and minerals other than natural gas orcrude oil is defined in these final regula-tions as those various processes subse-quent to mining processes performed toeliminate impurities or foreign matter andwhich are necessary steps in the goal ofachieving a high degree of purity fromspecified metallic ores and minerals whichare not customarily sold in the form of thecrude mineral product. The specified me-tallic ores and minerals identified in thesefinal regulations are: lead, zinc, copper,gold, silver, and any other ores or miner-als that the Commissioner may identifythrough published guidance. These are thesame metallic ores and minerals treated as“not customarily sold in the form of thecrude mineral product” under section613(c)(4)(D), except that fluorspar oresand potash are not included in these reg-ulations because they will be addressed inregulations specifically addressing fertil-izer and uranium is not included becauseit is not purified to a high concentrate.Uranium is not mined to isolate pure ura-nium at the high-purity levels as is donewith other metals such as lead, zinc, cop-per, gold, or silver, but, overwhelmingly,is instead mined to attain a uranium oxide(UO2) material for the manufacture ofnuclear fuel pellets. This process rejectsapproximately 95–99 percent of theoriginally-extracted uranium ore (a U238� U235 mixture), in order to raise theconcentration of the desired uranium iso-tope (U235), in what the Treasury Depart-ment and the IRS have concluded is amanufacturing process.

Refining processes for these specifiedmetallic ores and minerals include some

non-mining processes (such as fine pul-verization, electrowinning, electrolyticdeposition, roasting, thermal or electricsmelting, or substantially equivalent pro-cesses or combinations of processes) tothe extent those processes are used to sep-arate or extract the metal from the speci-fied metallic ore for the primary purposeof producing a purer form of the metal, asfor example the smelting of concentratesto produce Doré bars or refining of blistercopper. Income from the smelting of iron,for example, is not qualifying income un-der the final regulations because iron is anore or mineral customarily sold in theform of the crude mineral product, and thusnot a product listed in section 613(c)(4)(D).Compare § 1.613–4(f)(2)(i)(c) and (d). Inaddition, these final regulations specifi-cally provide that refining does not in-clude the introduction of additives thatremain in the metal, for example, in themanufacture of alloys of gold. Also, theapplication of nonmining processes as de-fined in § 1.613–4(g) to produce a speci-fied metal that is considered a waste orby-product during the production of anon-specified metallic ore or mineral isnot considered refining.

These final regulations provide a moredetailed definition of refining than the pro-posed regulations and better articulate acommon understanding of what refiningincludes, that is in a metallurgical sense.To eliminate uncertainty, these final reg-ulations define refining to include onlyactivities with respect to those ores andminerals that are generally refined to ahigh degree of purity, which are also thoseores and minerals that normally requiremore processing before they are sold, asidentified in § 613(c)(4) and § 1.613–4(f)(2)(i)(d). In addition, these final regu-lations also allow the necessary, precedingprocesses performed to eliminate impuri-ties from the specified ores and minerals,thereby addressing commenters’ concernsregarding a hole in processing activities inthe proposed regulations. In providing thisdefinition, the final regulations also effectcongressional intent to limit qualifying in-come to certain activities that have “com-monly or typically been conducted in part-nership form.” H.R. Rep. No. 100–391, at1066 (1987). Both in 1987 and since,large manufacturing operations such assmelting aluminum and manufacturing

steel have generally been conducted bycorporations. Despite the existence ofhundreds of different ores and minerals,only a handful of businesses that workwith ores and minerals other than naturalgas or crude oil have operated as PTPs,perhaps reflecting a general understandingthat expanded processing activities werenot considered by Congress to be activi-ties that could generate qualifying income.The Treasury Department and the IRShave determined that it would be inappro-priate to expand the definition of refiningof ores and minerals beyond that intendedby Congress.

The final regulations do not recognizeas qualifying activities the coking of coalor the making of activated carbon. Theprocessing of coal, as contemplated by§ 1.613–4(f)(2)(i)(a), includes the clean-ing, breaking, sizing, dust allaying, treat-ing to prevent freezing, and loading forshipment. At that point, the coal is readyfor sale. Because Congress intended prod-ucts resulting from processing to includeonly those products produced in field fa-cilities or refineries, coking of coal is nota processing activity. Furthermore, coal isnot refined into coke or activated carbonin the metallurgical sense in which oresare refined. Coal is itself the mineral ornatural resource for purposes of sections611 and 613 that is extracted from theground. Unlike ores where extraction oc-curs in order to obtain the mineral at is-sue—for which refining may be requiredto separate the mineral from the orerock—coal is extracted to be used sub-stantially as is. Refining ores to obtain apurer form of the minerals found in rock isnot analogous to coking coal to obtaincarbon. Cokemaking and creating acti-vated carbon are manufacturing processesused to create a new product. Refining isnot changing a mineral into a new ordifferent mineral product or creating aproduct that is, altogether, not a mineral.

Similarly, these final regulations do notinclude the fine pulverization of magne-tite, as requested by a commenter. As dis-cussed, Congress intended processing toinclude only those activities typically per-formed at the equivalent of field facilitiesfor minerals and ores. Fine pulverizationis generally not included as a mining pro-cess as it is not helpful in bringing the oresor minerals to shipping grade generally,


although pulverization may qualify as amining process if, with respect to the min-eral or ore at issue, it is necessary toanother process that is a mining process.See § 1.613–4(f)(2)(iii). These final reg-ulations do not alter this treatment.

4. Timber

The proposed regulations provided thatan activity constituted processing of tim-ber if performed to modify the physicalform of timber, including by the applica-tion of heat or pressure to timber, withoutadding any foreign substances. The pro-posed regulations specified that process-ing of timber did not include activities thatadded chemicals or other foreign sub-stances to timber to manipulate its physi-cal or chemical properties, such as using adigester to produce pulp. Products thatresulted from timber processing includedwood chips, sawdust, rough lumber, kiln-dried lumber, veneers, wood pellets, woodbark, and rough poles. Products that werenot the result of timber processing in-cluded pulp, paper, paper products, treatedlumber, oriented strand board/plywood,and treated poles.

Commenters argued that the proposedregulations wrongly limited the productsof timber processing and restricted addi-tives. These commenters noted that theproposed regulations departed from PLRsissued in the past that permitted pulpingand other engineered wood products madewith resins and treated with chemicals.Specific to pulping, commenters appliedthe general definition in the proposed reg-ulations that provided for separation andpurification to reason that the pulping ofcut timber is merely separation into thecomponent parts of wood—water, cellu-lose fibers, lignin, and hemicelluloses—through the addition of water and chemi-cals. Therefore, they argued, the specificrule for timber was more restrictive thanthe general rule for all natural resources.In contrast, one commenter acknowledgedthat the production of plywood and otherengineered wood products should not gen-erate qualifying income because a non-natural resource (that is, a synthetic adhe-sive) is a material input in the process thatproduces engineered wood products.

The final regulations do not adopt com-menters’ requests to expand the definition

of the processing of timber, but adopt therule in the proposed regulations withoutchange. As discussed in section I of thisSummary of Comments and Explanationof Revisions, the Treasury Departmentand the IRS interpret the legislative his-tory of section 7704(d)(1)(E) to mean thatCongress did not intend to extend process-ing activities beyond those involved ingetting a natural resource such as timberto market in a form generally sold. Poten-tial products made from wood are numer-ous, and include: pulp, paper and otherpaper products, certain chemicals (such astar, tall oil, or turpentine), engineeredwood products, lumber, sawdust, woodchips, and furniture. The point where pro-cessing turns into manufacturing is defin-able: the modification of the physical stateof wood is a process, whereas the additionof chemicals in an attempt to manipulatethe physical or chemical properties ofwood is extended processing more akin tomanufacturing, and thus beyond the scopeof activities intended by Congress to gen-erate qualifying income. The corollary ofa field processing plant for timber is asawmill or pellet mill. Sawmills producelumber and lumber products (such as bark,sawdust, and wood chips) from felledlogs. Pellet mills produce pellets fromlogs, chipped wood, lumber scraps, saw-dust or pulpwood. These processes do notchange the wood into a different product.The distinction between processing andmanufacturing of timber is demonstratedin the MACRS class lives in Rev. Proc.87–56, which separate the sawing of stockfrom logs (24.2 and 24.3) from the man-ufacture of furniture, pulp, and paper(24.4 and 26.1). Despite commenters’statements that pulping is like crude oilrefining, timber is not commonly under-stood to be “refined” to a higher level ofpurity. Timber is simply “processed”;therefore, these regulations do not includetimber in the definition of refining.

E. Transportation

The proposed regulations provided thattransportation was the movement of min-erals or natural resources and products ofmining, production, processing, or refin-ing, including by pipeline, barge, rail, ortruck, except for transportation (not in-cluding pipeline transportation) to a place

that sells or dispenses to retail customers.Retail customers did not include a personwho acquired oil or gas for refining orprocessing, or a utility. The following ac-tivities qualified as transportation underthe proposed regulations: (i) providingstorage services; (ii) terminalling; (iii) op-erating gathering systems and custodytransfer stations; (iv) operating pipelines,barges, rail, or trucks; and (v) constructionof a pipeline only to the extent that a pipewas run to connect a producer or refiner toa preexisting interstate or intrastate lineowned by the PTP (interconnect agree-ments).

Commenters requested both clarifica-tion and expansion of the definition oftransportation in three main areas. First,commenters asked that the regulations ex-plain who can generate qualifying incomefrom transportation via pipeline and ma-rine shipping. Specifically, different com-menters sought assurances that those “op-erating pipelines” include operators whomove the product, owners and lessors whoreceive income for use of their pipelines,and logistic service providers who sched-ule the movement of product on pipelines.Similarly, another commenter asked thatthe regulations specify that transportationunder a time charter is a qualifying activ-ity. Under such contractual arrangements,a PTP provides a crew and operates a ma-rine vessel, though the customer (such as anoil and gas company) directs where theproduct is to be delivered. Essential to thisrequest is the additional proposal that theterm “barges” in the proposed regulations beread expansively to include marine transpor-tation via other types of vessels, especiallythose that move under their own powerrather than being pushed or towed.

To transport is “to carry or convey (athing) from one place to another,” andtransportation is “the movement of goodsor persons from one place or another by acarrier.” Black’s Law Dictionary (8th ed.2004). As a general matter, these finalregulations do not require ownership orcontrol of the assets used to perform alisted activity so long as the action beingperformed is within the definition of aqualifying activity. Following this ap-proach, those performing the physicalwork to move the product along a pipeline(such as taking delivery of the product,metering quantities, monitoring specifica-


tions, and actually controlling the move-ment of the product) or to transport theproduct via marine vessel (including op-erating the vessel under a time charter) areperforming a qualifying activity. Also,given the dedicated use of pipelines in theoil and gas industry, these final regula-tions specifically allow as qualifying in-come the income owners and lessors re-ceive for the use of their pipelines totransport minerals or natural resources. Incontrast, a logistics service provider in-volved in scheduling services alone nei-ther carries nor conveys, and is thereforenot a transporter. A logistics service pro-vider may, however, have qualifying in-come if it meets the intrinsic test de-scribed in further detail in section IV ofthis Summary of Comments and Explana-tion of Revisions. Additionally, these finalregulations replace the word “barge” with“marine vessel” so as not to limit marinetransportation to one type of watercraft.

The second area of concern raised bycommenters dealt with the exception fortransportation to retail customers. Com-menters asked that the regulations clarifythat certain transportation to retail cus-tomers is a qualifying activity. For exam-ple, citing to one sentence in the legisla-tive history that “[i]ncome from anytransportation of oil or gas or productsthereof by pipeline is treated as qualifyingincome,” one commenter asserted thatCongress intended to include as a quali-fying activity the transportation of oil andgas by pipeline directly to homeowners.H.R. Conf. Rep. 100–1104(II), at 18(1988) (emphasis added). Likewise, manyother commenters asserted that Congressintended that the transportation and corre-sponding marketing of liquefied petro-leum gas (primarily propane) to retail cus-tomers generate qualifying income. Thesecommenters pointed to floor statementsmade by Senator Lloyd Bentsen and Rep-resentative Dan Rostenkowski after enact-ment of section 7704, which were specif-ically referenced in a footnote in theConference Report to the Technical andMiscellaneous Revenue Act of 1988. See133 Cong. Rec. S18651 (December 22,1987), 133 Cong. Rec. H11968 (Decem-ber 21, 1987), and H.R. Conf. Rep. 100–1104(II), at 18 (1988).

To provide more clarity, these finalregulations explain when transportation to

a place that sells to retail customers ortransportation directly to retail customersis a qualifying activity. Specifically, thesefinal regulations provide that transporta-tion includes the movement of minerals ornatural resources, and products producedunder processing and refining, via pipelineto a place that sells to retail customers, butdo not expand the list of qualifying activ-ities to include the movement of suchitems via pipeline directly to retail cus-tomers. In addition, these final regulationsprovide that transportation includes themovement of liquefied petroleum gas viatrucks, rail cars, or pipeline to a place thatsells to retail customers as well as directlyto retail customers.

These provisions implement Congres-sional intent as expressed in the legislativehistory accompanying the Technical andMiscellaneous Revenue Act of 1988which provided: “in general, income fromtransportation of oil and gas and productsthereof to a bulk distribution center suchas a terminal or a refinery (whether bypipeline, truck, barge or rail) be treated asqualifying income. Income from anytransportation of oil or gas or productsthereof by pipeline is treated as qualifyingincome. Except in the case of pipelinetransport, however, transportation of oil orgas or products thereof to a place fromwhich it is dispensed or sold to retailcustomers is generally not intended to betreated as qualifying income. Solely forthis purpose, a retail customer does notinclude a person who acquires the oil orgas for refining or processing, or partiallyrefined or processed products thereof forfurther refining or processing, nor does aretail customer include a utility providingpower to customers. For example, incomefrom transporting refined petroleum prod-ucts by truck to retail customers is notqualifying income.” H.R. Conf. Rep.100–1104(II), at 17–18 (1988). A foot-note added that “[i]ncome from transpor-tation and marketing of liquefied petro-leum gas in trucks and rail cars or bypipeline, however, may be treated as qual-ifying income,” citing the floor statementsidentified by commenters. Id.

Although the legislative history sup-ports much of what commenters haveasked to be clarified, it does not supportthe proposal that the transportation bypipeline of oil, gas, and products thereof

(other than liquefied petroleum gas) di-rectly to homeowners is qualifying in-come. Although Congress stated that“any” transportation by pipeline qualifies,when read in context with the remainderof the paragraph, it is clear that Congresswas discussing bulk transportation. Seealso S. Rep. 100–445, at 424 (1988)(“[i]n the case of transportation activitieswith respect to oil and gas and productsthereof, the Committee intends that, ingeneral, income from bulk transportationof oil and gas and products thereof betreated as qualifying income”). This treat-ment also parallels Congressional intentregarding marketing, which is a qualifyingactivity “at the level of exploration, devel-opment, processing or refining,” but not“to end users at the retail level.” Id.

The third area of comments on trans-portation were requests to include spe-cific, additional activities in the list ofexamples, in this case, compression ser-vices, liquefaction and regasification, andthe sale of renewable identification num-bers (RINs). Each of these activities re-lates directly to the conveyance of certainoil and natural gas products and thereforethese final regulations adopt commenters’suggestions to add them as examples tothe list of qualifying transportation activ-ities. Natural gas compression is a me-chanical process whereby a volume ofnatural gas is compressed to a requiredhigh pressure in order to transport the gasthough pipelines. A compression serviceprovider selects appropriate compressionequipment (for example, the number ofcompressors and the compressor configu-ration), then installs, operates, services,repairs, and maintains that equipment,typically working on a continuous basis.More than the mere sale of equipment, acompression service company is engagedin transportation activities by making nat-ural gas move from one point to another.

Similarly, liquefaction and regasifica-tion are the process of transforming meth-ane from a gas to a liquid (LNG) to facil-itate its transportation and storage, and theprocess of reconverting the liquid to a gas,respectively. The regasified natural gas isfungible with natural gas that has not beenliquefied and regasified. Moreover, in2008, Congress amended section 7704(d)(1)(E) to add that income and gains fromthe transportation or storage of any fuel


described in section 6426(d), which in-cludes compressed or liquefied naturalgas, generates qualifying income. SeePublic Law 110–343, 122 Stat. 3765, Sec-tion 208(a), and section 6426(d)(2)(C).Since the transportation and storage ofLNG clearly is a qualifying activity, theliquefaction and regasification must alsogenerate qualifying income.

Finally, RINs are part of aCongressionally-mandated program to en-sure that transportation fuel sold in the U.S.contains a minimum percentage of renew-able fuel. Generally, RINs are assigned toeach gallon of renewable fuel, and areseparated when the renewable fuel is com-bined with conventional fuel. Companieswho blend such additives into conven-tional fuels are assigned annual quotas ofRINs that they must acquire. Companieswho acquire more RINs than needed inany year may sell the surplus to otherswho have not met their quota. Although itis not a direct, physical conveyance of amineral or natural resource or product ofprocessing and refining, the Treasury De-partment and the IRS agree that the sale ofRINs gives rise to qualifying income as apart of transportation and marketing activ-ities—that is, additization, as that activityis described in more detail in sectionIII.H.5 of this Summary of Comments andExplanation of Revisions.

In addition to the three areas of com-ments discussed regarding transportationin this section III.E of this Summary ofComments and Explanation of Revisions,commenters also suggested that the finalregulations expand the types of intercon-nect agreements that are treated as givingrise to qualifying transportation activities.Because these final regulations address allconstruction activities related to perform-ing section 7704(d)(1)(E) activities in anew section regarding cost reimburse-ments, construction of pipelines is movedfrom the section on transportation andthose comments are discussed in moredetail in section III.H.1 of this Summaryof Comments and Explanation of Revi-sions.

F. Marketing

The proposed regulations provided thatan activity constituted marketing if it wasperformed to facilitate sale of minerals or

natural resources and products of miningor production, processing, and refining,including by blending additives into fuels.The proposed regulations explained thatmarketing did not include activities andassets involved primarily in retail sales(sales made in small quantities directly toend users), which included, but were notlimited to, operation of gasoline servicestations, home heating oil delivery ser-vices, and local natural gas delivery ser-vices.

In addition to the comments receivedconcerning retail sales of liquid petroleumgas addressed in section III.E of this Sum-mary of Comments and Explanation ofRevisions, one commenter recommendedrevising the definition of marketing to bet-ter reflect the common meaning of theword by including the act of selling andother activities designed to encouragesales, including the packaging of prod-ucts. This same commenter also suggestedrewording the exclusion for retail sales sothat the regulation is more direct and in-volves an intent test. The commenter pro-posed eliminating the concepts relating to“assets” and “involved” in retail sales be-cause they create uncertainty and chang-ing the definition from “sales made insmall quantities directly to end users” to“sales to ultimate consumers to meet per-sonal needs, rather than for commercial orindustrial uses of the articles sold.”

Adopting some of these suggestions,these final regulations directly state thatmarketing is the bulk sale of minerals ornatural resources, and products producedthrough processing or refining, and in-cludes activities that facilitate sales (suchas packaging). These final regulationscontinue to provide that marketing gener-ally does not include retail sales. Thesefinal regulations do not, however, changethe definition of retail sales to create anintent-based test that looks to determinethe purpose of the purchase. The finalregulations are consistent with the legis-lative history, which clarified that, “[w]ithrespect to marketing of minerals and nat-ural resources (e.g., oil and gas and prod-ucts therefof [sic]), the Committee intendsthat qualifying income be income frommarketing at the level of exploration, de-velopment, processing or refining themineral or natural resource. By contrast,income from marketing minerals and nat-

ural resources to end users at the retaillevel is not intended to be qualifying in-come. For example, income from retailmarketing with respect to refined petro-leum products (e.g., gas station opera-tions) is not intended to be treated asqualifying income.” S. Rep. No. 100–445, at 424 (1988). This legislative historyindicates that a small business owner whofills his delivery truck at the gas stationbefore delivering his wares is still an enduser at the retail level, even though thegasoline is used for commercial purposes.

G. Fertilizer

The final regulations reserve a para-graph for fertilizer under section 7704(d)(1)(E) activities in anticipation of a newnotice of proposed rulemaking that willdefine fertilizer as well as explain whatactivities involving fertilizer will generatequalifying income. The Treasury Depart-ment and the IRS will address the com-ment received on fertilizer in those pro-posed regulations.

H. Additional activities

The Treasury Department and theIRS received comments regarding cer-tain other activities that are not exclu-sive to just one section 7704(d)(1)(E)activity, including seeking reimburse-ment for the costs of performing section7704(d)(1)(E) activities, receiving in-come from passive interests, blending,and additization. These final regulationsinclude these activities as qualifying ac-tivities, and clarify the extent to whichthese activities generate qualifying in-come. This preamble also discussescomments received concerning hedging,and requests further comments.

1. Cost Reimbursements

The list of section 7704(d)(1)(E) activ-ities identified only the overarching pur-suits undertaken by businesses engaged inthe exploration, development, mining orproduction, processing, refining, transpor-tation, or marketing of minerals or naturalresources. The proposed regulations didnot list as section 7704(d)(1)(E) activitiesthe many other activities required to run abusiness, such as hiring employees, nego-


tiating contracts, or acquiring assets usedin the business. Normally those typical,administrative activities are considered togive rise to business costs, and are notunderstood to be the trade or business thatgenerates income for those in the mineraland natural resource industries. Under theproposed regulations, however, a partner-ship could demonstrate that it performedintrinsic activities, meaning its activitieswere so closely tied to section 7704(d)(1)(E) activities that income therefromshould be considered derived from thosesection 7704(d)(1)(E) activities, and thusbe treated as qualifying income. Intrinsicactivities included limited, active servicesthat closely supported section 7704(d)(1)(E) activities by being specialized, es-sential, and significant. The proposed reg-ulations also identified a number of ser-vice activities that would not meet therequirements to be considered an intrinsicactivity, including legal, financial, con-sulting, accounting, insurance, and othersimilar services, or activities that princi-pally involved the design, construction,manufacturing, repair, maintenance, lease,rent, or temporary provision of property.This did not mean that a business per-forming intrinsic activities was prohibitedfrom engaging in the typical activities re-quired to operate its own business, onlythat supplying those services to otherswould not generate qualifying income un-der section 7704(d)(1)(E) for those busi-nesses.

Commenters asked that the final regu-lations clarify two issues regarding thesegeneral services that are not specific to themineral and natural resource industries.First, commenters recommended that thesection 7704(d)(1)(E) activities be de-fined to include the functions (such asengineering, construction, operations,maintenance, security, billing, hiring,accounting, and tax financial reporting)that, taken in the aggregate, are necessaryfor the overall operation of the qualifyingactivity. Commenters thus recommendedthat the final regulations reflect more gen-erally that income from performing thefunctions required for the operation ofqualifying assets or qualifying businesses(including cost reimbursements) consti-tutes qualifying income, even if the oper-ator does not own the underlying assets.As an illustration of this request, one com-

menter provided the example of a pipelineor processing facility operator that pro-vides all of the services to run assetsowned by a third party (such as contract-ing with customers for the use of the pipe-line or processing facility, loading/un-loading the product, performing tasksnecessary to transport or process the prod-uct, metering quantities, and monitoringspecifications), but also manages the con-struction of any assets necessary for thecompletion of the activities and handlesall of the back-office functions such aspayroll and other administrative services.Although the costs of providing that workmay be imbedded in the charge to itsclient for operating the pipeline or pro-cessing facility, sometimes an operatingpartnership may instead send its client abill with a separate line item for construc-tion or back office expenses.

The Treasury Department and the IRSagree with commenters that operating in-come (including from construction andback-office functions) should constitutequalifying income so long as the activitiesto which the income is attributable arepart of the partnership’s business of per-forming the section 7704(d)(1)(E) activ-ity. Whether the partnership adds the costto a general overhead account or providesthe client with a separate line item detail-ing that cost in its bill should not matter—that income is still derived from perform-ing the section 7704(d)(1)(E) activity. Apartnership performing a section 7704(d)(1)(E) activity that recoups its costs ismarkedly different from a business solelyperforming one of the services identifiedin the intrinsic activities section that areidentified as not essential or not signifi-cant. Therefore, to clarify this issue, thesefinal regulations provide that if the part-nership is, itself, in the trade or businessof performing a section 7704(d)(1)(E) ac-tivity, income received to reimburse thepartnership for its costs incurred in per-forming that section 7704(d)(1)(E) activ-ity, whether imbedded in the rate the part-nership charges or separately itemized, isqualifying income. Reimbursable costsmay include, but are not limited to, thecost of designing, constructing, installing,inspecting, maintaining, metering, moni-toring, or relocating an asset used in thatsection 7704(d)(1)(E) activity, or of pro-viding office functions necessary to the

operation of that section 7704(d)(1)(E) ac-tivity (such as staffing, purchasing sup-plies, billing, accounting, and financial re-porting). For example, a pipeline operatorthat charges a customer for its cost tobuild, repair, or schedule flow on the pipe-lines that it operates will have qualifyingincome from such activity whether or notthe operator itemizes those costs when itbills the customer.

Because these final regulations addressreimbursement to a PTP for the construc-tion of assets used by it to perform asection 7704(d)(1)(E) activity more gen-erally, these final regulations remove thenarrow provision under the definition oftransportation that listed construction of apipeline as a qualified activity but only tothe extent that the pipe was run to connecta producer or refiner to a preexisting in-terstate or intrastate line owned by thepartnership. Many commenters protestedthat the provisions were too limited, ex-plaining that the Federal Energy Regula-tory Commission, which regulates pipe-lines, may require pipelines to connectwith other pipelines to facilitate the effi-cient movement of product, and that manyother new and existing operations (such asgathering systems, utilities, power gener-ation facilities, refineries, local distribu-tion companies, or other commercial orgovernmental clients) may also wish toconnect to pipelines. Based on the hear-ings held before the passage of section7704 and the legislative history, it is clearthat Congress was concerned about cer-tain mineral and natural resource partner-ships being able to acquire necessary cap-ital to build the assets to be used in theirsection 7704(d)(1)(E) activities. Buildinga new facility or pipeline is capital inten-sive and, to the extent that a partnershippasses some of those costs on to the client,the income from the reimbursement ofthose costs, when received, is a part of thepartnership’s income from performing thesection 7704(d)(1)(E) activity.

The second issue raised by comment-ers is an extension of the first. Comment-ers suggested that management feesearned by a direct or indirect co-owner ofa business performing a section 7704(d)(1)(E) activity should be treated as quali-fying income. One commenter noted thatthe partner of the business may providesuch legal, financial or accounting ser-


vices for efficiency purposes or underagreement where one partner performs thesection 7704(d)(1)(E) activities while an-other performs the administrative activi-ties. These final regulations do not adoptthis suggestion. To the extent a partner ofa PTP is receiving a management fee (asdistinguished from a distributive share ofpartnership income) for such administra-tive tasks as legal, financial or accountingservices, it is no different than any otherbusiness providing a service to the PTP.Whether income from the services is qual-ifying will depend on whether the partnercan demonstrate that it is performing anintrinsic activity as discussed in sectionIV of this Summary of Comments andExplanation of Revisions.

2. Hedging

The proposed regulations did not ad-dress whether income from hedging trans-actions was qualifying income. Severalcommenters noted this and specifically re-quested guidance on this question. Com-menters noted that commodity prices arevolatile and PTPs must hedge their risksto ensure consistent cash flows, both froman operational and working capital per-spective, and from an investor demandperspective. Commenters recommendedthat the final regulations provide that in-come derived from any hedging transac-tions that are entered into by a PTP in thenormal course of its trade or business andthat manage the PTP’s risk with respect toprice fluctuations of the minerals or natu-ral resources should be included as qual-ifying income. Other commenters wouldinclude income from any hedging transac-tions entered into by a PTP in order tomanage its prudent business concerns, in-cluding transactions hedging interest raterisks and foreign currency transactions re-lated to its qualifying activities. One com-menter further recommended that a hedgeof an aggregate risk with respect to both aqualifying activity and a non-qualifyingactivity should be considered incomefrom the qualifying activity if substan-tially all of the risk hedged relates to thequalifying activity.

The Treasury Department and the IRSagree with commenters that hedging in-come, when it is derived from a section7704(d)(1)(E) activity, should give rise to

qualifying income under section 7704(d)(1)(E). Engaging in hedging activities is acommon part of the industry and repre-sents prudent business practice. However,because hedging transactions are gener-ally used to fix the price of property withrespect to a section 7704(d)(1)(E) activity,the Treasury Department and the IRS be-lieve that both the income and gains, aswell as the deductions and losses, withrespect to hedges should be taken intoaccount in determining the income from asection 7704(d)(1)(E) activity. These finalregulations reserve on the issue of hedg-ing while the Treasury Department andthe IRS consider what types of hedgingtransactions would result in qualifying in-come and whether to adjust gross incomefor such hedging transactions. To that end,the Treasury Department and the IRS re-quest comments on methods to accountfor the income and gains, as well as thedeductions and losses, with respect tohedges. For example, future regulationsmay generally provide that income, de-duction, gain, or loss from a hedgingtransaction entered into by the partnershipprimarily to manage risk of price changesor currency fluctuations with respect toordinary property (as defined in § 1.1221–2(c)(2)) with respect to which qualify-ing income is derived from a section7704(d)(1)(E) activity is treated as an ad-justment to qualifying income, providedthat the transaction is entered into in theordinary course of the PTP’s business andis clearly identified by the end of the dayon which it is entered into. The principlesof section 1221(b)(2)(B) and the regula-tions thereunder, regarding identification,recordkeeping, and the effect of identifi-cation and non-identification, would applyto hedging transactions entered into by thePTP.

For example, a partnership might havegain or loss on a forward contract that itenters into to hedge the price risk relatedto its sale of a commodity with respect towhich qualifying income is derived from aqualifying activity. If the partnership hasgain that is recognized on the hedge underits method of accounting, then such gainwould be treated, for purposes of section7704(c)(2), as an additional amount real-ized with respect to the commodity andwould be treated under these rules as in-creasing the amount of qualifying income

derived from the qualifying activity.Conversely, if the taxpayer recognizesloss under its accounting method with re-spect to the hedge, then the loss wouldbe treated, for purposes of section7704(c)(2), as a decrease in the amountrealized on the commodity thus decreas-ing the qualifying income derived fromthe qualifying activity.

The Treasury Department and the IRSdo not agree, however, that income fromhedging with respect to an activity that isnot a section 7704(d)(1)(E) activityshould give rise to qualifying income un-der section 7704(d)(1)(E). Other types ofhedges, however, may be included underother provisions of section 7704. Forexample, as noted by some of the com-menters, the existing regulations under§ 1.7704–3 provide that qualifying in-come includes (1) income from notionalprincipal contracts (NPC) if the property,income, or cash flow that measures theamount to which the partnership is enti-tled under the NPC would give rise toqualifying income if held or received di-rectly by the partnership and (2) othersubstantially similar income from ordi-nary and routine investments to the extentdetermined by the Commissioner. See§ 1.7704–3(a)(1).

3. Passive Interests

Income from passive interests was notaddressed in the proposed regulations.Commenters suggested that income frompassive, non-operating economic interestsin minerals and natural resources (for ex-ample, royalty interests, net profits inter-ests, rights to production payments, delayrental payments, and lease bonus pay-ments) should be qualifying income. Onecommenter explained that passive eco-nomic interest owners have an economicinterest in the minerals in place (for ex-ample, they are treated as the owner of themineral or natural resource when it is infact produced) and a right to share andparticipate in the proceeds derived fromthe production of the minerals and naturalresources. Another commenter noted thatsurface damage payments may arise as apart of mining or production. For exam-ple, if surface ownership and mineralownership are separate, a miner may payroyalties to both the surface owner and


mineral owner. One commenter explainedthat several parties may derive incomefrom exploration, development, mining,production, or marketing: (1) owners ofpassive economic interests that them-selves do not engage in the productionoperations associated with mineral or nat-ural resource properties, but benefit fromtheir respective shares of productionrevenue; (2) working interest owners(whether or not the “operator”) that areresponsible for the activities of exploringfor, drilling for, and producing natural re-sources from the mineral properties, and(3) third-party service providers, who gen-erally do not own an economic interest inthe mineral properties, but charge theworking interest owners fees or servicecharges. The commenter noted that theproposed regulations addressed income ofworking interest owners and third-partyservice providers, but not those with pas-sive economic interests.

Because income from passive eco-nomic interests can be generated at manydifferent stages throughout the process ofgetting minerals and natural resources to amarketable form, these final regulationsinclude income from passive economicinterests in minerals and natural resourcesas qualifying income.

4. Blending

Commenters raised several questionsabout the extent to which the blendingof the same mineral or natural resource,or products thereof, was a qualifyingactivity. The proposed regulations refer-enced some blending activities by treatingas a section 7704(d)(1)(E) activity thechemical conversion of the physicallyseparated components of crude oil if oneor more of the products of the conversionwere recombined with other physicallyseparated components of crude oil in amanner that was necessary to the cost-effective production of gasoline or otherfuels. The proposed regulations also in-cluded “blending additives into fuel” as amarketing activity.

Commenters noted that terminal oper-ators also perform blending services as apart of their transportation activities, andrequested that the regulations be clarifiedto list blending as a transportation activity.Commenters explained that terminals may

blend different grades of crude oil to-gether to achieve the desired grade orquality of crude oil, or they may blend adiluent (such as diesel fuel, or a lightergrade of crude oil) into heavier crude oilto achieve a level of viscosity appropriatefor the subsequent mode of transportation.Another commenter stated that refineriesalso perform some blending activities, andasked that income from such blending betreated as qualifying income. Commentersalso raised concerns that the restriction inthe proposed regulations to the blendingof just fuels does not account for the otherproducts of a refinery that may be pro-duced through blending activities. In ad-dition, one commenter noted that termi-nals for other natural resources performblending activities. For example, the com-menter explained that coal terminals maymix or homogenize grades of coal fromdifferent mines or mining regions withdissimilar characteristics (for example,higher sulfur coal and lower sulfur coal)to achieve coal that meets product speci-fications.

Expanding on this idea, some com-menters asked for clarification that thecombination of different minerals and nat-ural resources, or products thereof, shouldalso be a qualifying activity where allproducts combined are natural resourcesor products thereof. For example, onecommenter suggested that the physicalmixing of asphalt with aggregates to pro-duce road paving material should betreated as processing provided that theprimary purpose of the mixing is to en-hance the inherent use of each of the prod-ucts mixed. That commenter thought thata product would no longer be considered anatural resource if the product does notretain a majority of the physical andchemical characteristics of the mineral ornatural resource from which it was pro-duced.

These final regulations adopt the rec-ommendation that qualifying incomeshould include income from the blendingof the same mineral or natural resource, orproducts thereof. Income from blending isthus added as a type of additional quali-fying income because blending may bepart of processing, refining, transporta-tion, or marketing. In response to com-ments, these final regulations also providethat, for purposes of the blending rules in

these regulations, products of crude oiland natural gas will be considered as fromthe same natural resource. These final reg-ulations do not, however, expand the def-inition of processing or refining to includethe combination of different minerals ornatural resources, except as permitted un-der the rules related to additization, whichare discussed in section III.H.5 of thisSummary of Comments and Explanationof Revisions. Allowing the combinationof different natural resources wouldgreatly expand the scope of qualifyingactivities beyond that intended by Con-gress, and is akin to additional processingto the point of manufacturing a new prod-uct. For example, once asphalt is mixedwith rock aggregate, it is no longer a prod-uct of a refinery or a product of mineralprocessing, but has become a new roadpaving product.

5. Additization

As they did for blending, commentersraised several questions about the extentto which the addition of a minimal amountof different minerals or natural resourcesor other materials to minerals or naturalresources is a qualifying activity. The pro-posed regulations recognized that someadditization was a qualifying activity, butonly to the extent it was a marketing ac-tivity and only with respect to fuels.

The proposed regulations left unde-fined what additization included. Onecommenter recommended that the addi-tion of additives to enhance, preserve, orcomplement the mineral or natural re-source product, such as the chemical treat-ment of sand, should qualify. Anothercommenter recommended that additiza-tion activities that do not change a naturalresource into a new product should giverise to qualifying income whether done aspart of processing, refining, transporta-tion, or marketing and no matter the typeof product (allowing, for example, additi-zation with respect to lubricants or as-phalt).

The Treasury Department and the IRSagree that it is appropriate to treat someadditization services as qualifying activi-ties. For example, certain additizationmay occur in order to safely transport aproduct (sand terminals, for example, maytreat sand with a detergent to prevent dust


as the sand travels by rail or truck to itsfinal destination) or to comply with Fed-eral, state, or local regulations concerningproduct specifications (as, for example, inthe case of the addition of dyes to gaso-line). However, the Treasury Departmentand the IRS remain concerned about dis-tinguishing between products of refineriesand field facilities, and products of addi-tional processing. Accordingly, and con-sistent with some of the comments re-ceived, these final regulations distinguishbetween additives that are merely a smalladdition to a product of a refinery, fieldfacility, or mill, and additives that maychange the product into a new or differentproduct. These final regulations thus pro-vide rules regarding additization tailoredto crude oil, natural gas, other ores andminerals, and timber.

With respect to crude oil, natural gas,and products thereof, commenters ex-plained that the additives, which are typ-ically not natural resources for the pur-poses of section 7704, are often requiredby applicable regulations or otherwise en-hance motor fuel blend stock. These ad-ditives are added at the terminal because itallows products owned by different cus-tomers to be commingled for storage, butthen customized for each customer asloaded into carriers for shipment. Typicaladditives include detergents, dyes, cetaneimprovers, cold flow improvers, fuel oilstabilizers, isotopic markers, lubricity/conductivity improvers, anti-icing agents,and proprietary gasoline additives. Etha-nol is also typically blended into gasolineto satisfy EPA guidelines, and biodiesel isoften blended into diesel fuel. Comment-ers noted that ethanol typically constitutes10 percent of the blend but can be higher,while biodiesel typically constitutes 20percent of the blend but can be lower orhigher. Other additives typically make upa very small portion of the blended stock(typically less than 1 percent).

Commenters also argued that, just asadditives were permitted in the proposedregulations with respect to fuels, additiza-tion should also be allowed for other prod-ucts of oil and natural gas processing andrefining. These commenters noted thatthere is no practical difference betweenadding ethanol, biodiesel, or other addi-tives into fuels, and adding additives intolubricating oils and waxes. For example,

commenters explained that lubricatingoils, waxes, and other refined productsmay be blended together and with addi-tives to provide increased anti-wear pro-tection, reduce friction, extend oil life,improve corrosion protection, give theability to separate from water, and reduceenergy usage. Lubricants may also bemixed with a detergent and a thickener toproduce greases in multiple grades and formany uses. These commenters also rec-ommended that additization should not belimited to just a marketing activity as, forexample, terminals and refineries bothmay perform additization activities.

The Treasury Department and the IRSagree that, since additization activities arecommonly performed by refineries and byterminals with respect to all products of arefinery, additization should be treated asa qualifying activity that generates quali-fying income. These final regulationsadopt this change and provide that, to theextent the additives generally constituteless than 5 percent of the total volume forproducts of natural gas and crude oil andare added into the product by the terminaloperator or upstream of the terminal op-erator, the additization activity generatesqualifying income. As previously ex-plained, added ethanol and biodiesel mayconstitute up to 20 percent of the totalvolume for products of natural gas andcrude oil; therefore, the final regulationsprovide for a 20 percent threshold for eth-anol and biodiesel. Although the TreasuryDepartment and the IRS remain con-cerned that qualifying income not includethe manufacture of new products beyondthose generally produced in field facilitiesor refineries, the Treasury Department andthe IRS have concluded that the smallamount of additives discussed in some ofthe comments do not pose a risk if theyare consistent with the limitations set forthin the final regulations.

In the case of minerals other than oiland gas, the final regulations provide thatthe addition of incidental amounts of ma-terial such as paper dots to identify ship-ments, anti-freeze to aid in shipping, orcompounds to allay dust as required bylaw or reduce losses during shipping ispermissible.

Regarding timber, one commenternoted that the treatment of lumber andpoles with an immaterial amount of addi-

tives that protect or enhance the naturalresource or that are necessary to meetenvironmental or regulatory standardsshould also constitute timber processing.This commenter noted that the proposedregulations included an intent-based testthat looks to whether chemicals are addedto “manipulate” physical or chemicalproperties of the timber. The commenterargued that there is no manipulation ofphysical or chemical properties of the tim-ber in the case of relatively small amountsof additives, such as those that constitutefive percent or less of the product. Thiscommenter provided no examples of whattypes of treatment processes would be re-quired under environmental or regulatorystandards for lumber and poles, but didargue that, although wood pellets are com-monly made without the addition of anynon-timber additives, it is possible thatcustomers or regulators may require theaddition of an additive to reduce the emis-sions profile of wood pellets.

As previously discussed, these final reg-ulations generally allow for small amountsof additives where required in order tocomply with Federal, state, or local lawwhen such additives do not rise to thelevel of a manufacturing activity. As such,the final regulations provide that, for tim-ber, additization of incidental amounts ofmaterial as required by law is permissible,to the extent such additions do not createa new product. These final regulationsclarify, however, that the application ofchemicals and pressure to produce pres-sure treated wood does not give rise toqualifying income. This is a process gen-erally completed at a separate site fromthe mill, and creates a new and differentmanufactured product.

IV. Intrinsic Activities

The proposed regulations provided thatfor purposes of section 7704(d)(1)(E),qualifying income includes only incomeand gains from qualifying activities withrespect to minerals or natural resources.Qualifying activities were defined to in-clude section 7704(d)(1)(E) activities andintrinsic activities. The preamble to theproposed regulations explained that theTreasury Department and the IRS be-lieved that certain limited support activi-ties intrinsic to section 7704(d)(1)(E) ac-


tivities also gave rise to qualifying incomebecause the income is “derived from” thesection 7704(d)(1)(E) activities. The pro-posed regulations set forth three require-ments for a support activity to be intrinsicto a section 7704(d)(1)(E) activity: theactivity must be specialized to support thesection 7704(d)(1)(E) activity, essential tothe completion of the section 7704(d)(1)(E) activity, and require the provisionof significant services to support the sec-tion 7704(d)(1)(E) activity. The preamblefurther explained that the Treasury De-partment and the IRS intended that intrin-sic activities constitute active support ofsection 7704(d)(1)(E) activities, and notmerely the supply of goods.

A. General issues

The intrinsic activities provision pro-vided a way for businesses whose activi-ties were not listed as section 7704(d)(1)(E) activities to demonstrate that theywere so closely tied to section 7704(d)(1)(E) activities that they should be con-sidered a part of the mineral or naturalresource industries, and that their activi-ties therefore generated qualifying in-come. Because these intrinsic activitieswere discussed as support or service ac-tivities, some commenters mistakenly be-lieved that all service providers that didnot own or possess control of the under-lying mineral or natural resource (such asa subcontractor) must test whether theiractivities generated qualifying incomesolely under the intrinsic activities test,even if the activity being performed waslisted as a section 7704(d)(1)(E) activity.For example, one commenter recom-mended an alternative intrinsic activitystandard whereby activities of a serviceprovider would qualify as intrinsic to asection 7704(d)(1)(E) activity if theywould have qualified as a section 7704(d)(1)(E) activity, or an indispensable partthereof, if performed directly by the ser-vice recipient.

Conversely, one commenter arguedthat the simplest and most direct way todefine what activities are qualifying forpurposes of section 7704(d)(1)(E) is torequire possession of the mineral or natu-ral resource. This commenter argued thatthe Treasury Department and the IRS ex-panded the scope of qualifying income

beyond that intended by Congress by ac-commodating additional support activitiessuch as water delivery and disposal.

Like the proposed regulations, thesefinal regulations do not contain any re-quirement that a PTP engaged in a section7704(d)(1)(E) activity must own or pos-sess control of the underlying mineral ornatural resource. Such a requirement con-flicts with some of the listed 7704(d)(1)(E) activities. For example, a PTP pipe-line company may not own the productsbeing transported. Many of the examplesof activities defining each of the listed7704(d)(1)(E) activities can be performedwithout having ownership or possessionof the mineral or natural resource. Fur-thermore, the legislative history clarifiedthat “[t]he reference provided in the bill todepletable products is intended only toidentify the minerals or natural resourcesand not to identify what income fromthem is treated as qualifying income. Con-sequently, whether income is taken intoaccount in determining percentage deple-tion under section 613 is not necessarilyrelevant in determining whether such in-come is qualifying income under section7704(d).” H.R. Rep. No. 100–795, at 400(1988). Because the activities listed insection 7704(d)(1)(E) may commonly beperformed by persons without ownershipof the underlying resource, the ownershiprequirements in sections 611 and 613 arenot relevant in determining whether in-come is qualifying for purposes of section7704(d)(1)(E). Finally, section 7704(d)(1)(E) provides that qualifying income isincome “derived from” exploration, de-velopment, mining or production, pro-cessing, refining, transportation, and mar-keting. The intrinsic activities test appliesto those PTPs who engage in activitiesother than those listed as a section7704(d)(1)(E) activity but that may re-ceive income “derived from” a section7704(d)(1)(E) activity. Although the exis-tence of the intrinsic activities test wasespecially important in the proposedregulations since the list of section7704(d)(1)(E) activities was exclusive, thetest retains purpose in the final regulationsbecause it potentially allows as qualifyingsome activities that closely support, but donot specifically constitute, an enumeratedsection 7704(d)(1)(E) activity.

To the extent the commenter who sug-gested the alternative intrinsic activitiesstandard was also asking that an activitybe considered a qualifying activity when asubcontractor performs only a subset ofthe tasks of a larger qualifying activity,that suggestion ignores the main thrust ofsection 7704(d)(1)(E), which looks to theactivity that is being performed that gen-erates the income received. For example,this commenter argued that, because a re-finer may use an air separation unit toseparate air into its primary componentsfor use in refining, a taxpayer that is solelyengaged in providing air separation unitservices to that refiner should have quali-fying income. However, the use of air toproduce nitrogen and oxygen is clearlynot a section 7704(d)(1)(E) activity. Air isnot a mineral or natural resource. See sec-tions 7704(d)(1) and 613(b)(7)(B). A re-finery may use such gases in its activities,but that does not mean the provision of theair separation unit to create the gasessomehow should give rise to qualifyingincome solely because the nitrogen andoxygen are provided to a refinery. Theprovision and operation of an air separa-tion unit would only qualify to the extentsuch activity meets the intrinsic test.

Aside from general criticism that theintrinsic activities provision was too sub-jective overall and challenging to apply insituations that require a high level of cer-tainty, the remainder of the comments onthe intrinsic activities provision requestedchanges to the requirements of two spe-cific prongs of the test dealing with spe-cialization and significant services, asdiscussed in sections IV.B and IV.C, re-spectively, of this Summary of Commentsand Explanation of Revisions. The Trea-sury Department and the IRS received nocomments recommending changes to theessential prong of the intrinsic activitiestest in the proposed regulations, whichrequired that the activity be necessary to(a) physically complete the section7704(d)(1)(E) activity (including in acost-effective manner, such as by makingthe activity economically viable), or (b)comply with Federal, state, or local lawregulating the section 7704(d)(1)(E) activ-ity. These final regulations thus adopt theessential prong of the intrinsic activitiestest with no changes.


B. Specialization

The proposed regulations provided thatan activity was specialized if the partner-ship provided personnel to perform orsupport a section 7704(d)(1)(E) activityand those personnel received trainingunique to the mineral or natural resourceindustry that was of limited utility otherthan to perform or support a section7704(d)(1)(E) activity (hereinafter “spe-cialized personnel requirement”). In addi-tion, to the extent that the activity in-cluded the sale, provision, or use ofproperty, the proposed regulations re-quired that either: (1) the property wasprimarily tangible property that was ded-icated to, and had limited utility outsideof, section 7704(d)(1)(E) activities andwas not easily converted to another use(hereinafter “specialized property require-ment”); or (2) the property was used as aninjectant to perform a section 7704(d)(1)(E) activity that was also commonlyused outside of section 7704(d)(1)(E) ac-tivities (such as water, lubricants, andsand) and, as part of the activity, the part-nership also collected and cleaned, recy-cled, or otherwise disposed of the inject-ant after use in accordance with Federal,state, or local regulations concerningwaste products from mining or productionactivities (hereinafter “injectants excep-tion”).

Commenters identified concerns withall three parts of the specialization prong.Regarding the specialized personnel re-quirement, one commenter said it was un-clear how much training was necessaryfor a skill to be considered specialized.Regarding the specialized property re-quirement, the same commenter criticizedas vague the language about propertyhaving limited utility outside section7704(d)(1)(E). Other commenters arguedthat the specialized property requirementshould be removed entirely or that the useof specialized property should be treatedas an indication that a certain activity wasspecialized rather than being required.They explained that service companiesuse a lot of equipment, some of whichwould not be specialized (for example,telephones, hammers, or bulldozers) inperforming their duties. Finally, one com-menter recommended that the specializa-tion prong be amended to recognize that

activities may be specialized if they sup-port a section 7704(d)(1)(E) activity in aremote or difficult environment (for ex-ample, marine locations). This commenterdescribed as an example of such activitiesallowing access to and use of its marinedocks and terminals, as a support base forunrelated third-party oilfield service com-panies selling products and providing ser-vices in the Gulf of Mexico in support ofproduction of oil and gas.

Overall, the Treasury Department andthe IRS remain concerned that the finalregulations provide a means to differenti-ate between the mere provision of generalservices, goods, or equipment to othersand the active support of a section7704(d)(1)(E) activity. The final regula-tions thus do not adopt the recommenda-tion that the test be amended to includeany support provided for section 7704(d)(1)(E) activities performed in remote ordifficult environments. Support is a vagueterm that could include the provision offood or everyday supplies to workers on amarine platform. In addition, merely mak-ing docks available for use by third partiesdoes not give rise to qualifying incomeunder section 7704(d)(1)(E). The Trea-sury Department and the IRS continue toconsider the specialized personnel andspecialized property requirements impor-tant in insuring that the services or goodsprovided have a clear nexus to section7704(d)(1)(E) activities.

The final regulations also do not adoptthe suggestion to provide requirements forhow much training is necessary to meetthe specialized personnel requirement. In-stead, these regulations retain the provi-sion that personnel must have receivedtraining unique to the mineral or naturalresource industry. The particular industryat issue would determine the type andamount of training necessary to performthe support activity. However, the Trea-sury Department and the IRS agree withcommenters that the specialized propertyrequirement in the proposed regulationswas overly broad. These final regulationsspecifically provide that the use of non-specialized property typically used inci-dentally in operating a business will notcause a PTP to fail the specialized prop-erty requirement. However, these finalregulations retain the restrictions in thespecialized personnel requirement and the

specialized property requirement thattraining provided for and property (otherthan property typically used incidentallyin operating a business) involved in theactivity must not have applications out-side of section 7704(d)(1)(E) activities.

Commenters provided many sugges-tions for changes regarding the injectantsexception. Multiple commenters recom-mended that sand should be removed fromthe examples of injectants because it is anatural resource, and therefore the bulksale or wholesale of sand would, in itself,qualify as a section 7704(d)(1)(E) activi-ty—marketing. These final regulationsadopt this recommendation and removesand as an example of an injectant in theinjectants exception.

Another commenter recommended ex-panding the injectants exception to en-compass the supply, cleaning, or recyclingof all products required for any section7704(d)(1)(E) activity, not just injectants.This commenter provided as an examplethe supply and recycling of sulfuric acid,used as a catalyst for purposes of alkyla-tion (a process used to produce alkylates).These final regulations do not adopt thissuggestion. A general rule that allows forsupply, cleaning, and recycling of anygood provided to others engaged in sec-tion 7704(d)(1)(E) activities is too broadand contrary to the stated goal of the in-trinsic test in differentiating section7704(d)(1)(E) support activities from themere provision of a good. The TreasuryDepartment and the IRS continue to con-sider it appropriate to limit the exceptionto just injectants because Federal, state,and local law require that producers recy-cle or otherwise properly dispose of in-jectants, such as water, after use in miningand production activities. Oilfield servicecompanies providing that service are thusa required part of the mining and produc-tion process—their income is thus “de-rived from” the production activity. Ex-panding the injectants exception asrequested would lead to many industrialwaste recycling activities potentially be-ing included in what is intended to be alimited exception for a legally requiredstep in section 7704(d)(1)(E) activities.Thus, these regulations do not adopt thissuggestion.

Commenters also had a number ofcomments specifically concerning water


under the injectants exception. Multiplecommenters noted that, although theygenerally supported the proposed regula-tions in their effort to provide a frame-work for the types of oilfield service ac-tivities that would generate qualifyingincome, as a practical matter, they be-lieved that a requirement that a PTP per-form both the water delivery and disposalactivities at each well or development sitein order for that water delivery service toqualify would be satisfied infrequently.These commenters also argued that, solong as they also are engaged in per-forming disposal services, their businessmodel is not merely supplying a good,that is, water. Multiple commenters rec-ommended that the injectants exceptionshould not require that the product (inparticular, water) that is delivered must bethe product that is picked up and recy-cled—what these commenters describedas a “well by well” approach. These com-menters explained that it is common in theindustry for a well operator to source itswater supply and disposal service require-ments with multiple providers and that itmay be difficult or impossible for a PTP tosatisfy the necessary “well by well” fac-tual determination. Accordingly, com-menters suggested several alternatives tothe “well by well” approach.

One commenter recommended thatwater delivery services should qualify asintrinsic activities only if exclusively pro-vided by a PTP to those engaged in one ormore section 7704(d)(1)(E) activities incases where the PTP’s operations also in-clude conducting necessary water disposalservices on an ongoing or frequent basis,though not necessarily in the same loca-tion. Another commenter recommendedthat the injectants exception be met if thepartnership providing the injectant alsoprovides other specialized services withrespect to such injectant at the wellsite,such as transporting the water to smallertemporary storage facilities at the wellsite,treating the water prior to it going down-hole, and monitoring and testing the utili-zation of water throughout the transferand pressure pumping process. This com-menter alternatively recommended thatthe regulations only require that there bedelivery and clean up in the same geo-graphic area (a “basin by basin” ap-proach). Others suggested that mere water

delivery should qualify so long as the wa-ter is delivered to those engaged in one ormore section 7704(d)(1)(E) activities, orthe water enhances the producers’ abilityto produce oil or gas (as opposed to beingprovided for other purposes). Finally, onecommenter argued that the regulationsshould not require disposal in compliancewith Federal, state, or local regulationssince making a tax determination contin-gent on such compliance introduces astandard that would be difficult to admin-ister.

The Treasury Department and the IRSdo not find support for the argument thatthe mere delivery of water qualifies. Sec-tion 7704(d)(1) is clear that a mineral ornatural resource does not include water;thus, income from the simple marketingand transportation of water is not qualify-ing income. As explained previously, theTreasury Department and the IRS haveconcluded that companies that providewater with legally required disposal ser-vices have a strong nexus to a section7704(d)(1)(E) activity (in particular, min-ing and production). Some commentersshare that belief and support the efforts ofthe Treasury Department and the IRS,agreeing that there is a difference betweencompanies that simply provide water (themere provision of a good) and those thatprovide both water and specialized ser-vices. Nor do the final regulations adoptthe suggestion to remove the languagethat the injectants are disposed after use inaccordance with Federal, state, or localregulations concerning waste productsfrom mining or production activities. Al-though, for tax compliance purposes, theIRS will generally not confirm that thePTP actually disposed of the injectants asrequired under Federal, state, or local law,the injectants exception is based on thePTP providing disposal services where re-quired by Federal, state, or local law.

The Treasury Department and the IRSagree with commenters that the injectionsexception should be revised to account forindustry practice in which a miner or pro-ducer may not hire the same company toprovide both water delivery and disposalservices. Accordingly, these final regula-tions instead adopt the “basin by basin”approach recommended in comments—solong as the PTP provides the water exclu-sively to those engaged in section

7704(d)(1)(E) activities and both deliversand recycles within the same geographicarea, the PTP’s income from such activi-ties is qualifying. The Treasury Depart-ment and the IRS have concluded that thisrequirement would provide a clear, ad-ministrable rule concerning when waterdelivery is not merely the delivery of agood, but part of the provision of special-ized disposal services.

C. Significant services

The proposed regulations provided thatan activity requires significant services tosupport the section 7704(d)(1)(E) activityif it must be conducted on an ongoing orfrequent basis by the partnership’s person-nel at the site or sites of the section7704(d)(1)(E) activities. Alternatively,those services could be conducted offsiteif the services are performed on an ongo-ing or frequent basis and are offered ex-clusively to those engaged in one or moresection 7704(d)(1)(E) activities. Whetherservices are conducted on an ongoing orfrequent basis is determined based on allthe facts and circumstances, including rec-ognized best practices in the relevant in-dustry. Partnership personnel performedsignificant services only if those serviceswere necessary for the partnership to per-form an activity that is essential to thesection 7704(d)(1)(E) activity, or to sup-port the section 7704(d)(1)(E) activity. Fi-nally, an activity did not constitute signif-icant services with respect to a section7704(d)(1)(E) activity if the activity prin-cipally involved the design, construction,manufacturing, repair, maintenance, lease,rent, or temporary provision of property.

One commenter argued that a facts andcircumstances test to determine whetherservices are conducted on an ongoing ba-sis is vague and would be subject to var-ious interpretations. Another commenterrecommended the removal of the signifi-cant services prong completely, arguingthat the frequency with which an activityis performed is not relevant to determin-ing whether an activity should qualify.Instead, the test should focus on the needsand activities of the operator, rather thanthe activities of the service provider. Onecommenter suggested that the proposedregulations wrongly listed repair andmaintenance as activities that do not con-


stitute significant services with respect toa section 7704(d)(1)(E) activity, arguingthat the repair and maintenance of equip-ment and facilities are often required bythe operator on a near-continuous basisunder typical services agreements.

The Treasury Department and the IRSdo not find support for the contention thatthe test should solely focus on the needsof the operator. Section 7704(d)(1) appliesto determine whether a PTP’s income isqualifying income; therefore, the focus ofthese regulations is on the activities per-formed by the PTP giving rise to the in-come at issue. The significant servicesprong is an important part of determiningwhether the activity performed by a sup-port services PTP has the required nexuswith a section 7704(d)(1)(E) activity. Assuch, these final regulations do not adoptthese changes and retain the “significantservices” prong of the intrinsic servicestest as well as the statement that signifi-cant services do not include an activityprincipally involving repair or mainte-nance of property.

One commenter recommended that therestriction that services conducted offsitemust be offered exclusively to those en-gaged in performing section 7704(d)(1)(E) activities should be removed, sinceactivities such as clean-up and disposalhappen offsite and may be performed forservice recipients other than those en-gaged in section 7704(d)(1)(E) activities.These final regulations modify this provi-sion to provide that services may be con-ducted offsite if the services are offered tothose engaged in one or more section7704(d)(1)(E) activities. If the services aremonitoring services, those services mustbe offered exclusively to those engaged inone or more section 7704(d)(1)(E) activi-ties.

Finally, commenters also expressedconcerns that it was not clear whetherservices are counted for purposes of thepersonnel requirement if they are pro-vided by an affiliate, subcontractor, or in-dependent contractor. These commentersnoted that it is common for PTPs to workthrough related companies and subcontrac-tors. One commenter recommended that thedefinition of “qualifying activities” in theregulations make clear that an activity isno less a qualifying activity because it isperformed by a subcontractor or consists

of a subset of the tasks of a larger quali-fying activity.

The Treasury Department and the IRSagree that a PTP should be able to meetthe personnel requirement through affili-ates or subcontractors in addition to thePTP’s own employees. This is true forpurposes of satisfying the specializationprong (including determining whether thepersonnel have received specialized train-ing) or the significant services prong. Ac-cordingly, the final regulations adopt thischange and clarify that these prongs canbe met through employees of affiliates orsubcontractors, so long as they are beingcompensated by the PTP.

V. Effective Date

The proposed regulations providedthat, except as otherwise provided, theregulations would apply to income earnedby a partnership in a taxable year begin-ning on or after the date the final regula-tions are published in the Federal Regis-ter. An exception was made for certainincome earned during a transition period,which would end on the last day of thepartnership’s taxable year that includedthe date that is ten years after the date thefinal regulations are published in the Fed-eral Register (the Transition Period).That exception provided that a partnershipcould treat income from an activity asqualifying income during the TransitionPeriod if: (a) the partnership received aprivate letter ruling from the IRS holdingthat the income from that activity is qual-ifying income; (b) prior to the publicationof the final regulations, the partnershipwas publicly traded, engaged in the activ-ity, and treated the activity as giving riseto qualifying income under section7704(d)(1)(E), and that income was qual-ifying income under the statute as reason-ably interpreted prior to the issuance ofthe proposed regulations; or (c) the part-nership is publicly traded and engages inthe activity after the issuance of the pro-posed regulations but before the date thefinal regulations are published in the Fed-eral Register and the income from thatactivity is qualifying income under theproposed regulations.

Commenters objected that the Transi-tion Period is not sufficient and that theIRS should allow PTPs that have received

favorable PLRs that are contrary to thesefinal regulations to continue to rely onthem permanently. They argued that re-voking a PLR sets a bad precedent thatwill cause taxpayers and investors not torely on PLRs. They also argued that therevocation of a PLR would hurt them ec-onomically and would harm investors. Fi-nally, some commenters requested that thefinal regulations clarify that a technicaltermination of a partnership under section708(b)(1)(B) does not end the TransitionPeriod.

The Transition Period is a reasonableamount of time for PTPs to rearrange theiraffairs as necessary and is consistent withcomments made in Congress concerningthe ten-year transition relief granted whensection 7704(d)(1)(E) was added in 1987.The IRS may revoke a PLR when theletter is found to be in error or not inaccord with the current views of the Ser-vice, or there is a material change in fact.If the revocation is as a result of an erroror a change in view, this revocation mayoccur through the issuance of final regu-lations. See Section 11.04 of Rev. Proc.2016–1, 2016–1 I.R.B. 1. Therefore, thefinal regulations do not adopt the sugges-tion that the IRS permanently allow PTPswith favorable PLRs that are contrary tothese final regulations to continue to relyon them. The final regulations do, how-ever, adopt the request for clarificationthat a technical termination does not endthe Transition Period. This addition isconsistent with statements made concern-ing the original 10-year transition periodprovided by Congress when section7704(d)(1)(E) was added. See JointComm. on Taxation, 100th Cong., De-scription of the Technical Corrections Actof 1988 (H.R. 4333 and S. 2238), JCS–10–88, at 412 (1988) (“[i]t is intendedthat a publicly traded partnership not betreated as ceasing to be an existing part-nership solely by reason of a terminationof the partnership (within the meaning ofsection 708) caused by the sale or ex-change through trading of 50 percent ormore of the partnership interests.”)

Special Analyses

Certain IRS regulations, including these,are exempt from the requirements of Ex-ecutive Order 12866, as supplemented andreaffirmed by Executive Order 13563.


Therefore, a regulatory impact assessmentis not required. Because these regulationsdo not impose a collection of informationon small entities, the Regulatory Flexibil-ity Act (5 U.S.C. chapter 6) does not ap-ply. Pursuant to section 7805(f) of theCode, the notice of proposed rulemakingthat preceded these final regulations wassubmitted to the Chief Counsel for Advo-cacy of the Small Business Administra-tion for comment on its impact on smallbusiness, and no comments were received.


The principal author of these regula-tions is Caroline E. Hay, Office of theAssociate Chief Counsel (Passthroughsand Special Industries). However, otherpersonnel from the Treasury Departmentand the IRS participated in their develop-ment.* * * * *

Adoption of Amendments to theRegulations

Accordingly, 26 CFR part 1 is amendedas follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *Par. 2. Section 1.7704–4 is added to

read as follows:

§ 1.7704–4 Qualifying income –mineral and natural resources.

(a) In general. For purposes of section7704(d)(1)(E), qualifying income is in-come and gains from qualifying activitieswith respect to minerals or natural re-sources as defined in paragraph (b) of thissection. Qualifying activities are section7704(d)(1)(E) activities (as described inparagraph (c) of this section) and intrinsicactivities (as described in paragraph (d) ofthis section).

(b) Mineral or natural resource. Theterm mineral or natural resource (includ-ing fertilizer, geothermal energy, and tim-ber) means any product of a characterwith respect to which a deduction for de-pletion is allowable under section 611,except that such term does not include anyproduct described in section 613(b)(7)(A)

or (B) (soil, sod, dirt, turf, water, mosses,or minerals from sea water, the air, orother similar inexhaustible sources). Forpurposes of this section, the term mineralor natural resource does not include indus-trial source carbon dioxide, fuels de-scribed in section 6426(b) through (e), anyalcohol fuel defined in section 6426(b)(4)(A), or any biodiesel fuel as defined insection 40A(d)(1).

(c) Section 7704(d)(1)(E) activities—(1) Definition. Section 7704(d)(1)(E) ac-tivities include the exploration, develop-ment, mining or production, processing,refining, transportation, or marketing ofany mineral or natural resource. Solely forpurposes of section 7704(d), such termsare defined as provided in this paragraph(c).

(2) Exploration. An activity constitutesexploration if it is performed to ascertainthe existence, location, extent, or qualityof any deposit of mineral or natural re-source before the beginning of the devel-opment stage of the natural deposit in-cluding by—

(i) Drilling an exploratory or strati-graphic type test well;

(ii) Conducting drill stem and produc-tion flow tests to verify commerciality ofthe deposit;

(iii) Conducting geological or geo-physical surveys;

(iv) Interpreting data obtained fromgeological or geophysical surveys; or

(v) For minerals, testpitting, trenching,drilling, driving of exploration tunnelsand adits, and similar types of activitiesdescribed in Rev. Rul. 70–287 (1970–1CB 146), (see § 601.601(d)(2)(ii)(b) ofthis chapter) if conducted prior to devel-opment activities with respect to the min-erals.

(3) Development. An activity consti-tutes development if it is performed tomake accessible minerals or natural re-sources, including by—

(i) Drilling wells to access deposits ofminerals or natural resources;

(ii) Constructing and installing drilling,production, or dual purpose platforms inmarine locations, or any similar support-ing structures necessary for extraordinarynon-marine terrain (such as swamps ortundra);

(iii) Completing wells, including by in-stalling lease and well equipment, such as

pumps, flow lines, separators, and storagetanks, so that wells are capable of produc-ing oil and gas, and the production can beremoved from the premises;

(iv) Performing a development tech-nique such as, for minerals other than oiland natural gas, stripping, benching andterracing, dredging by dragline, stoping,and caving or room-and-pillar excavation,and for oil and natural gas, fracturing; or

(v) Constructing and installing gather-ing systems and custody transfer stations.

(4) Mining or production. An activityconstitutes mining or production if it isperformed to extract minerals or naturalresources from the ground including byoperating equipment to extract minerals ornatural resources from mines and wells, orto extract minerals or natural resourcesfrom the waste or residue of prior miningor production allowable under this sec-tion. The recycling of scrap or salvagedmetals or minerals from previously man-ufactured products or manufacturing pro-cesses is not considered to be the extrac-tion of ores or minerals from waste orresidue.

(5) Processing. An activity constitutesprocessing if it is performed to convertraw mined or harvested products or rawwell effluent to substances that can bereadily transported or stored, as describedin this paragraph (c)(5).

(i) Natural gas. An activity constitutesprocessing of natural gas if it is performedto—

(A) Purify natural gas, including byremoval of oil or condensate, water, ornon-hydrocarbon gases (such as carbondioxide, hydrogen sulfide, nitrogen, andhelium); and

(B) Separate natural gas into its con-stituents which are normally recovered ina gaseous phase (methane and ethane) andthose which are normally recovered in aliquid phase (propane, butane, pentane,and heavier streams).

(ii) Crude oil. An activity constitutesprocessing of crude oil if it is performedto separate produced fluids by passingcrude oil through mechanical separators toremove gas, placing crude oil in settlingtanks to recover basic sediment and water,dehydrating crude oil, and operatingheater-treaters that separate raw oil welleffluent into crude oil, natural gas, and saltwater.


(iii) Ores and minerals other than nat-ural gas or crude oil. An activity consti-tutes processing of ores and mineralsother than natural gas or crude oil if itmeets the definition of mining processesunder § 1.613–4(f)(1)(ii), without regardto § 1.613–4(f)(2)(iv).

(iv) Timber. An activity constitutesprocessing of timber if it is performed tomodify the physical form of timber, in-cluding by the application of heat or pres-sure to timber, without adding any foreignsubstances. Processing of timber does notinclude activities that add chemicals orother foreign substances to timber to ma-nipulate its physical or chemical proper-ties, such as using a digester to producepulp. Products that result from timber pro-cessing include wood chips, sawdust,rough lumber, kiln-dried lumber, veneers,wood pellets, wood bark, and rough poles.Products that are not the result of timberprocessing include pulp, paper, paperproducts, treated lumber, oriented strandboard/plywood, and treated poles.

(6) Refining. An activity constitutes re-fining if the activity is set forth in thisparagraph (c)(6).

(i) Natural gas and crude oil. (A) Therefining of natural gas and crude oil in-cludes the further physical or chemicalconversion or separation processes ofproducts resulting from activities listed inparagraph (c)(5)(i) and (ii) of this section,and the blending of petroleum hydrocar-bons, to the extent they give rise to aproduct listed in paragraph (c)(5)(i) or (ii)of this section or to the products of a typeproduced in a petroleum refinery or natu-ral gas processing plant listed in this para-graph (c)(6)(i)(A). Refining of natural gasand crude oil also includes the furtherphysical or chemical conversion or sepa-ration processes and blending of the prod-ucts listed in this paragraph (c)(6)(i)(A),to the extent that the resulting product isalso listed in this paragraph (c)(6)(i)(A).The following products are of a type pro-duced in a petroleum refinery or naturalgas processing plant:

(1) Ethane.(2) Ethylene.(3) Propane.(4) Propylene.(5) Normal butane.(6) Butylene.(7) Isobutane.

(8) Isobutene.(9) Isobutylene.(10) Pentanes plus.(11) Unfinished naphtha.(12) Unfinished kerosene and light gas

oils.(13) Unfinished heavy gas oils.(14) Unfinished residuum.(15) Reformulated gasoline with fuel

ethanol.(16) Reformulated other motor gaso-

line.(17) Conventional gasoline with fuel

ethanol – Ed55 and lower gasoline.(18) Conventional gasoline with fuel

ethanol – greater than Ed55 gasoline.(19) Conventional gasoline with fuel

ethanol – other conventional finished gas-oline.

(20) Reformulated blendstock for oxy-genate (RBOB).

(21) Conventional blendstock for oxy-genate (CBOB).

(22) Gasoline treated as blendstock(GTAB).

(23) Other motor gasoline blendingcomponents defined as gasoline blend-stocks as provided in § 48.4081–1(c)(3) ofthis chapter.

(24) Finished aviation gasoline andblending components.

(25) Special naphthas (solvents).(26) Kerosene-type jet fuel.(27) Kerosene.(28) Distillate fuel oil (heating oils,

diesel fuel, and ultra-low sulfur dieselfuel).

(29) Residual fuel oil.(30) Lubricants (lubricating base oils).(31) Asphalt and road oil (atmospheric

or vacuum tower bottom).(32) Waxes.(33) Petroleum coke.(34) Still gas.(35) Naphtha less than 401°F end-

point.(36) Other products of a refinery that

the Commissioner may identify throughpublished guidance.

(B) For purposes of this section, theproducts listed in this paragraph (c)(6)(i)(B) are not products of refining:

(1) Heat, steam, or electricity producedby processing or refining.

(2) Products that are obtained fromthird parties or produced onsite for use in

the refinery, such as hydrogen, if excessamounts are sold.

(3) Any product that results from fur-ther chemical change of a product listed inparagraph (c)(6)(i)(A) of this section thatdoes not result in the same or anotherproduct listed in paragraph (c)(6)(i)(A) ofthis section (for example, production ofpetroleum coke from heavy (refinery) re-siduum qualifies, but any upgrading ofpetroleum coke (such as to calcined coke)does not qualify because it is furtherchemically changed and does not result inthe same or another product listed in para-graph (c)(6)(i)(A) of this section).

(4) Plastics or similar petroleum deriv-atives.

(ii) Ores and minerals other than nat-ural gas or crude oil. (A) An activityconstitutes refining of ores and mineralsother than natural gas or crude oil if it isone of the various processes performedsubsequent to mining processes (as de-fined in paragraph (c)(5)(iii) of this sec-tion) to eliminate impurities or foreignmatter and which are necessary steps inachieving a high degree of purity frommetallic ores and minerals which are notcustomarily sold in the form of the crudemineral product, as specified in paragraph(c)(6)(ii)(B) of this section. Refining pro-cesses include: fine pulverization, electrow-inning, electrolytic deposition, roasting,thermal or electric smelting, or substan-tially equivalent processes or combina-tions of processes used to separate orextract the specified metals listed in para-graph (c)(6)(ii)(B) of this section from theore for the primary purpose of producing apurer form of the metal, as for examplethe smelting of concentrates to produceDoré bars or refining of blister copper.

(B) For purposes of this section, thespecified metallic ores or minerals whichare not customarily sold in the form of thecrude mineral product are—

(1) Lead;(2) Zinc;(3) Copper;(4) Gold;(5) Silver; and(6) Any other ores or minerals that the

Commissioner may identify through pub-lished guidance.

(C) Refining does not include the in-troduction of additives that remain in themetal, for example, in the manufacture of


alloys of gold. Also, the application of non-mining processes as defined in § 1.613–4(g)in order to produce a specified metal that isconsidered a waste or by-product of produc-tion from a non-specified mineral deposit isnot considered refining for purposes of thissection.

(7) Transportation—(i) General rule.An activity constitutes transportation if itis performed to move minerals or naturalresources, and products under paragraph(c)(4), (5), or (6) of this section, includingby pipeline, marine vessel, rail, or truck.Except as provided in paragraph (c)(7)(ii)of this section, transportation does not in-clude the movement of minerals or naturalresources, and products produced underparagraph (c)(4), (5), or (6) of this section,directly to retail customers or to a placethat sells or dispenses to retail customers.Retail customers do not include a personwho acquires oil or gas for refining orprocessing, or a utility. Transportation in-cludes the following activities:

(A) Providing storage services.(B) Providing terminalling services, in-

cluding the following: receiving productsfrom pipelines, marine vessels, railcars, ortrucks; storing products; loading productsto pipelines, marine vessels, railcars, ortrucks for distribution; testing and treat-ing, as well as blending and additization,if income from such activities would bequalifying income pursuant to paragraph(c)(10)(iv) and (v) of this section; andseparating and selling excess renewableidentification numbers acquired as part ofadditization services to comply with envi-ronmental regulations.

(C) Moving or carrying (whether byowner or operator) products via pipelines,gathering systems, and custody transferstations.

(D) Operating marine vessels (includ-ing time charters), railcars, or trucks.

(E) Providing compression services toa pipeline.

(F) Liquefying or regasifying naturalgas.

(ii) Transportation to retail customersor to a place that sells to retail customers.Transportation includes the movement ofminerals or natural resources, and prod-ucts under paragraph (c)(4), (5), or (6) ofthis section, via pipeline to a place thatsells to retail customers. Transportationalso includes the movement of liquefied

petroleum gas via trucks, rail cars, orpipeline to a place that sells to retail cus-tomers or directly to retail customers.

(8) Marketing—(i) General rule. Anactivity constitutes marketing if it is thebulk sale of minerals or natural resources,and products under paragraph (c)(4), (5),or (6) of this section. Except as providedin paragraph (c)(8)(ii) of this section, mar-keting does not include retail sales (salesmade in small quantities directly to endusers), which includes the operation ofgasoline service stations, home heating oildelivery services, and local natural gasdelivery services.

(ii) Retail sales of liquefied petroleumgas. Retail sales of liquefied petroleumgas are included in marketing.

(iii) Certain activities that facilitatesale. Marketing also includes certain ac-tivities that facilitate sales that constitutemarketing under paragraphs (c)(8)(i) and(ii) of this section, including packaging, aswell as and blending and additization, ifincome from blending and additizationwould be qualifying income pursuant toparagraph (c)(10)(iv) and (v) of this sec-tion.

(9) Fertilizer. [Reserved](10) Additional activities. The follow-

ing types of income as described in para-graph (c)(10)(i) through (v) of this sectionwill be considered derived from a section7704(d)(1)(E) activity.

(i) Cost reimbursements. If the partner-ship is in the trade or business of perform-ing a section 7704(d)(1)(E) activity, qual-ifying income includes income received toreimburse the partnership for its costs inperforming that section 7704(d)(1)(E) ac-tivity, whether imbedded in the rate thepartnership charges or separately item-ized. Reimbursable costs may include thecost of designing, constructing, installing,inspecting, maintaining, metering, moni-toring, or relocating an asset used in thatsection 7704(d)(1)(E) activity, or provid-ing office functions necessary to the oper-ation of that section 7704(d)(1)(E) activity(such as staffing, purchasing supplies,billing, accounting, and financial report-ing). For example, a pipeline operator thatcharges a customer for its cost to build,repair, or schedule flow on the pipelinesthat it operates will have qualifying in-come from such activity whether or not it

itemizes those costs when it bills the cus-tomer.

(ii) Hedging. [Reserved](iii) Passive Interests. Qualifying in-

come includes income and gains from apassive interest or non-operating interest,including production royalties, minimumannual royalties, net profits interests, de-lay rentals, and lease-bonus payments, ifthe interest is in a mineral or natural re-source as defined in paragraph (b) of thissection. Payments received on a produc-tion payment will not be qualifying in-come if they are properly treated as loanpayments under section 636.

(iv) Blending. Qualifying income in-cludes income and gains from performingblending activities or services with respectto products under paragraph (c)(4), (5), or(6) of this section, so long as the productsbeing blended are component parts of thesame mineral or natural resource. For pur-poses of this paragraph (c)(10)(iv), prod-ucts of oil and natural gas will be consid-ered as from the same natural resource.Blending does not include combining dif-ferent minerals or natural resources orproducts thereof together. However, seeparagraph (c)(10)(v) of this section forrules concerning additization.

(v) Additization. Qualifying income in-cludes income and gains from providingadditization services with respect to prod-ucts under paragraph (c)(4), (5), or (6) ofthis section to the extent specifically per-mitted in this paragraph (c)(10)(v). Theaddition of additives described in para-graph (c)(10)(v)(A) through (C) of thissection is permissible if the additives aidin the transportation of a product, enhanceor protect the intrinsic properties of aproduct, or are necessary as required byfederal, state, or local law (for example, tomeet environmental standards), but only ifsuch additives do not create a new prod-uct.

(A) The addition of additives to prod-ucts of natural gas and crude oil is per-missible, provided that such additivesconstitute less than 5 percent (except thatethanol or biodiesel may be up to 20 per-cent) of the total volume for products ofnatural gas and crude oil and are addedinto the product by the terminal operatoror upstream of the terminal operator.

(B) In the case of ores and mineralsother than natural gas or crude oil, the


addition of incidental amounts of materialsuch as paper dots to identify shipments,anti-freeze to aid in shipping, or com-pounds to allay dust as required by law orreduce losses during shipping is permissi-ble.

(C) In the case of timber, additizationof incidental amounts to comply with gov-ernment regulations is permissible, to theextent such additization does not create anew product. For example, the pressuretreatment of wood is impermissible be-cause it creates a new product.

(d) Intrinsic activities—(1) General re-quirements. An activity is an intrinsic ac-tivity only if the activity is specialized tosupport a section 7704(d)(1)(E) activity, isessential to the completion of the section7704(d)(1)(E) activity, and requires theprovision of significant services to supportthe section 7704(d)(1)(E) activity. Whetheran activity is an intrinsic activity is deter-mined on an activity-by-activity basis.

(2) Specialization. An activity is a spe-cialized activity if—

(i) The partnership provides personnel(including employees of the partnership,an affiliate, subcontractor, or independentcontractor performing work on behalf ofthe partnership) to support a section7704(d)(1)(E) activity and those person-nel have received training in order to sup-port the section 7704(d)(1)(E) activity thatis unique to the mineral or natural re-source industry and of limited utility otherthan to perform or support a section7704(d)(1)(E) activity; and

(ii) To the extent that the activity in-volves the sale, provision, or use of spe-cific property, either—

(A) The property is primarily tangibleproperty that is dedicated to, and has lim-ited utility outside of, section 7704(d)(1)(E) activities and is not easily con-verted (as determined based on all thefacts and circumstances, including thecost to convert the property) to anotheruse other than supporting or performingthe section 7704(d)(1)(E) activities (ex-cept that the use of non-specialized prop-erty typically used incidentally in operat-ing a business will not cause a partnershipto fail this paragraph (d)(2)(ii)(A)); or

(B) If the property is used as an inject-ant to perform a section 7704(d)(1)(E)activity that is also commonly used out-side of section 7704(d)(1)(E) activities

(such as water and lubricants), the part-nership provides the injectants exclusivelyto those engaged in section 7704(d)(1)(E)activities; the partnership is also in thetrade or business of collecting, cleaning,recycling, or otherwise disposing of in-jectants after use in accordance with Fed-eral, state, or local regulations concerningwaste products from mining or productionactivities; and the partnership operates itsinjectant delivery and disposal serviceswithin the same geographic area.

(3) Essential. (i) An activity is essentialto the section 7704(d)(1)(E) activity if it isrequired to—

(A) Physically complete a section7704(d)(1)(E) activity (including in acost-effective manner, such as by makingthe activity economically viable), or

(B) Comply with Federal, state, or lo-cal law regulating the section 7704(d)(1)(E) activity.

(ii) Legal, financial, consulting, ac-counting, insurance, and other similar ser-vices do not qualify as essential to a sec-tion 7704(d)(1)(E) activity.

(4) Significant services. (i) An activityrequires significant services to support thesection 7704(d)(1)(E) activity if those ser-vices must be conducted on an ongoing orfrequent basis by the partnership’s person-nel at the site or sites of the section7704(d)(1)(E) activities. Alternatively,those services may be conducted offsite ifthe services are performed on an ongoingor frequent basis and are offered to thoseengaged in one or more section 7704(d)(1)(E) activities. If the services are moni-toring, those services must be offered ex-clusively to those engaged in one or moresection 7704(d)(1)(E) activities. Whetherservices are conducted on an ongoing orfrequent basis is determined based on allthe facts and circumstances, including rec-ognized best practices in the relevant in-dustry.

(ii) Personnel perform significant ser-vices only if those services are necessaryfor the partnership to perform an activitythat is essential to the section 7704(d)(1)(E) activity, or to support the section7704(d)(1)(E) activity. Personnel includeemployees of the partnership, an affiliate,subcontractor, or independent contractorperforming work on behalf of the partner-ship.

(iii) Services are not significant ser-vices with respect to a section 7704(d)(1)(E) activity if the services principallyinvolve the design, construction, manu-facturing, repair, maintenance, lease, rent,or temporary provision of property.

(e) Interpretations of section 611 andsection 613. This section and interpreta-tions of this section have no effect oninterpretations of sections 611 and 613, orother sections of the Code, or the regula-tions thereunder; however, this section in-corporates some of the interpretationsunder section 611 and 613 and the regu-lations thereunder as provided in this sec-tion.

(f) Examples. The following examplesillustrate the provisions of this section:

Example 1. Petrochemical products sourcedfrom an oil and gas well. (i) Z, a publicly tradedpartnership, chemically converts a mixture of ethaneand propane (obtained from physical separation ofnatural gas) into ethylene and propylene through useof a steam cracker. Z sells the ethylene and propyl-ene in bulk to a third party.

(ii) Ethylene and propylene are products of re-fining as provided in paragraph (c)(6)(i) of thissection; therefore, Z is engaged in a section7704(d)(1)(E) activity. The income Z receives fromthe sale of ethylene and propylene is qualifyingincome for purposes of section 7704(d)(1)(E).

Example 2. Petroleum streams chemically con-verted into refinery grade olefins byproducts. (i) Y, apublicly traded partnership, owns a petroleum refin-ery. The refinery physically separates crude oil, ob-taining heavy gas oil. The refinery then uses a cata-lytic cracking unit to chemically convert the heavygas oil into a liquid stream suitable for gasolineblending and a gas stream containing ethane, ethyl-ene, and other gases. The refinery also further phys-ically separates the gas stream, resulting in refinery-grade ethylene. Y sells the ethylene in bulk to a thirdparty.

(ii) Y’s activities give rise to products of refiningas provided in paragraph (c)(6)(i) of this section;therefore, Y is engaged in a section 7704(d)(1)(E)activity. The income Y receives from the sales ofethylene is qualifying income for purposes of section7704(d)(1)(E).

Example 3. Converting methane gas into syn-thetic fuels through chemical change. (i) Y, a pub-licly traded partnership, chemically converts meth-ane into methanol and synthesis gas, and furtherchemically converts those products into gasoline anddiesel fuel. Y receives income from bulk sales ofgasoline and diesel created during the conversionprocesses, as well as from sales of methanol.

(ii) With respect to the production of gasoline ordiesel from methane, gasoline and diesel are prod-ucts of refining as provided in paragraph (c)(6)(i) ofthis section; therefore, Y is engaged in a section7704(d)(1)(E) activity. Y’s income from the sale ofgasoline and diesel is qualifying income for purposesof section 7704(d)(1)(E).


(iii) The income from the sale of methanol, anintermediate product in the conversion process, isnot qualifying income for purposes of section7704(d)(1)(E) because methanol is not a product ofprocessing or refining as defined in paragraph (c)(5)and (6) of this section.

Example 4. Converting methanol into gasolineand diesel. (i) Assume the same facts as in Example3 of this paragraph (f), except Y purchases methanoland synthesis gas and chemically converts the meth-anol and synthesis gas into gasoline and diesel.

(ii) The chemical conversion of methanol andsynthesis gas into gasoline and diesel is not refiningas provided in paragraph (c)(6)(i) of this sectionbecause it is not the physical or chemical conversionor the separation or blending of products listed inparagraph (c)(6)(i)(A) of this section. Accordingly,the income from the sales of the gasoline and dieselis not qualifying income for purposes of section7704(d)(1)(E).

Example 5. Delivery of refined products. (i) X, apublicly traded partnership, sells diesel to a govern-ment entity at wholesale prices and delivers thosegoods in bulk.

(ii) X’s sale of a refined product to the govern-ment entity is a section 7704(d)(1)(E) activity be-cause it is a bulk transportation and sale as describedin paragraph (c)(7) and (8) of this section and is nota retail sale.

Example 6. Constructing a pipeline. (i) X, apublicly traded partnership, operates interstate andintrastate natural gas pipelines. Y, a corporation, is aconstruction firm. X pays Y to build a pipeline. Xlater seeks reimbursement for its cost to build thepipeline from A, a refiner who contracts with X totransport gasoline.

(ii) X, as an operator of pipelines, is engaged intransportation pursuant to paragraph (c)(7)(i)(C) ofthis section. The reimbursement X receives from Afor X’s cost to build the pipeline is qualifying in-come pursuant to paragraph (c)(10)(i) of this sectionbecause X receives the income to reimburse X for itscosts in performing X’s transportation activity andreimbursable costs may include construction costs.In contrast, Y is not in the trade or business ofperforming a 7704(d)(1)(E) activity, thus income Yreceived from X for building the pipeline is notqualifying income to Y.

Example 7. Delivery of water. (i) X, a publiclytraded partnership, owns interstate and intrastate nat-ural gas pipelines. X built a water delivery pipelinealong the existing right of way for its natural gaspipeline to deliver water to A for use in A’s fractur-ing activity. A uses the delivered water in fracturingto develop A’s natural gas reserve in a cost-efficientmanner. X earns income for transporting natural gasin the pipelines and for delivery of water.

(ii) X’s income from transporting natural gas inits interstate and intrastate pipelines is qualifyingincome for purposes of section 7704(c) because trans-portation of natural gas is a section 7704(d)(1)(E)activity as provided in paragraph (c)(7)(i)(C) ofthis section.

(iii) The income X obtains from its water deliv-ery services is not a section 7704(d)(1)(E) activity asprovided in paragraph (c) of this section. However,because X’s water delivery supports A’s develop-ment of natural gas, a section 7704(d)(1)(E) activity,

X’s income from water delivery services may bequalifying income for purposes of section 7704(c) ifthe water delivery service is an intrinsic activity asprovided in paragraph (d) of this section. An activityis an intrinsic activity if the activity is specialized tosupport the section 7704(d)(1)(E) activity, is essen-tial to the completion of the section 7704(d)(1)(E)activity, and requires the provision of significantservices to support the section 7704(d)(1)(E) activ-ity. Under paragraph (d)(2)(ii)(B) of this section, theprovision of water for use as an injectant in a section7704(d)(1)(E) activity is specialized to that activityonly if the partnership (1) provides the water exclu-sively to those engaged in section 7704(d)(1)(E)activities, (2) is also in the trade or business ofcleaning, recycling, or otherwise disposing of waterafter use in accordance with Federal, state, or localregulations concerning waste products from miningor production activities, and (3) operates these dis-posal services within the same geographic area asthat in which it delivers water. Because X does notperform such disposal services, X’s water deliveryactivities are not specialized to support the section7704(d)(1)(E) activity. Thus, X’s water delivery isnot an intrinsic activity. Accordingly, X’s incomefrom the delivery of water is not qualifying incomefor purposes of section 7704(c).

Example 8. Delivery of water and recovery andrecycling of flowback. (i) Assume the same facts asin Example 7 of this paragraph (f), except that X alsocollects and treats flowback at the drilling site inaccordance with state regulations as part of its waterdelivery services and transports the treated flowbackaway from the site. In connection with these ser-vices, X provides personnel to perform these ser-vices on an ongoing or frequent basis that is consis-tent with best industry practices. X has providedthese personnel with specialized training regardingthe recovery and recycling of flowback producedduring the development of natural gas, and this train-ing is of limited utility other than to perform orsupport the development of natural gas.

(ii) The income X obtains from its water deliveryservices is not a section 7704(d)(1)(E) activity asprovided in paragraph (c) of this section. However,because X’s water delivery supports A’s develop-ment of natural gas, a section 7704(d)(1)(E) activity,X’s income from water delivery services may bequalifying income for purposes of section 7704(c) ifthe water delivery service is an intrinsic activity asprovided in paragraph (d) of this section.

(iii) An activity is an intrinsic activity if theactivity is specialized to support the section7704(d)(1)(E) activity, is essential to the completionof the section 7704(d)(1)(E) activity, and requiresthe provision of significant services to support thesection 7704(d)(1)(E) activity. Under paragraph(d)(2)(ii)(B) of this section, the provision of waterfor use as an injectant in a section 7704(d)(1)(E)activity is specialized to that activity only if thepartnership (1) provides the water exclusively tothose engaged in section 7704(d)(1)(E) activities, (2)is also in the trade or business of cleaning, recycling,or otherwise disposing of water after use in accor-dance with Federal, state, or local regulations con-cerning waste products from mining or productionactivities, and (3) operates these disposal serviceswithin the same geographical area as where it deliv-

ers water. X’s provision of personnel is specializedbecause those personnel received training regardingthe recovery and recycling of flowback producedduring the development of natural gas, and this train-ing is of limited utility other than to perform orsupport the development of natural gas. The provi-sion of water is also specialized because water is aninjectant used to perform a section 7704(d)(1)(E)activity, and X also collects and treats flowback inaccordance with state regulations as part of its waterdelivery services. Therefore, X meets the specializa-tion requirement. The delivery of water is essentialto support A’s development activity because thewater is needed for use in fracturing to develop A’snatural gas reserve in a cost-efficient manner. Fi-nally, the water delivery and recovery and recyclingactivities require significant services to support thedevelopment activity because X’s personnel provideservices necessary for the partnership to perform thesupport activity at the development site on an ongo-ing or frequent basis that is consistent with bestindustry practices. Because X’s delivery of waterand X’s collection, transport, and treatment of flow-back is a specialized activity, is essential to thecompletion of a section 7704(d)(1)(E) activity, andrequires significant services, the delivery of waterand the transport and treatment of flowback is anintrinsic activity. X’s income from the delivery ofwater and the collection, treatment, and transport offlowback is qualifying income for purposes of sec-tion 7704(c).

(g) Effective/applicability date andtransition rule. (1) In general. Except asprovided in paragraph (g)(2) of this sec-tion, this section applies to income earnedby a partnership in a taxable year begin-ning on or after January 19, 2017. Para-graph (g)(2) of this section applies duringthe period that ends on the last day of thepartnership’s taxable year that includesJanuary 19, 2027 (Transition Period).

(2) Income during Transition Period.A partnership may treat income from anactivity as qualifying income during theTransition Period if—

(i) The partnership received a privateletter ruling from the IRS holding that theincome from that activity is qualifyingincome;

(ii) Prior to May 6, 2015, the partner-ship was publicly traded, engaged in theactivity, and treated the activity as givingrise to qualifying income under section7704(d)(1)(E), and that income was qual-ifying income under the statute as reason-ably interpreted prior to May 6, 2015;

(iii) Prior to May 6, 2015, the partner-ship was publicly traded and had enteredinto a binding agreement for constructionof assets to be used in such activity thatwould give rise to income that was qual-


ifying income under the statute as reason-ably interpreted prior to May 6, 2015; or

(iv) The partnership is publicly tradedand engages in the activity after May 6,2015 but before January 19, 2017, and theincome from that activity is qualifying in-come under the proposed regulations(REG–132634–14) contained in the Inter-nal Revenue Bulletin (IRB) 2015–21 (seehttps://www.irs.gov/pub/irs-irbs/irb15-21.pdf).

(3) Relief from technical termination.In the event of a technical termination

under section 708(b)(1)(B) of a partner-ship that satisfies the requirements ofparagraph (g)(2) of this section withoutregard to the technical termination, theresulting partnership will be treated as thepartnership that satisfies the requirementsof paragraph (g)(2) of this section for pur-poses of applying the Transition Period.

John DalrympleDeputy Commissioner for Services and

Enforcement.Approved: January 12, 2017

Mark J. MazurAssistant Secretary of the Treasury (Tax

Policy).



Part III. Administrative, Procedural, and MiscellaneousUpdate for WeightedAverage Interest Rates,Yield Curves, and SegmentRates

Notice 2017–18

This notice provides guidance on thecorporate bond monthly yield curve, thecorresponding spot segment rates used un-der § 417(e)(3), and the 24-month averagesegment rates under § 430(h)(2) of theInternal Revenue Code. In addition, thisnotice provides guidance as to the interestrate on 30-year Treasury securities under§ 417(e)(3)(A)(ii)(II) as in effect for planyears beginning before 2008 and the 30-year Treasury weighted average rate un-der § 431(c)(6)(E)(ii)(I).

YIELD CURVE AND SEGMENTRATES

Generally, except for certain plans un-der sections 104 and 105 of the PensionProtection Act of 2006 and CSEC plansunder § 414(y), § 430 of the Code speci-fies the minimum funding requirements

that apply to single-employer plans pursu-ant to § 412. Section 430(h)(2) specifiesthe interest rates that must be used todetermine a plan’s target normal cost andfunding target. Under this provision, pres-ent value is generally determined usingthree 24-month average interest rates(“segment rates”), each of which appliesto cash flows during specified periods. Tothe extent provided under § 430(h)(2)(C)(iv), these segment rates are adjustedby the applicable percentage of the 25-year average segment rates for the periodending September 30 of the year preced-ing the calendar year in which the planyear begins.1 However, an election maybe made under § 430(h)(2)(D)(ii) to usethe monthly yield curve in place of thesegment rates.

Notice 2007–81, 2007–44 I.R.B. 899,provides guidelines for determining themonthly corporate bond yield curve, andthe 24-month average corporate bond seg-ment rates used to compute the target nor-mal cost and the funding target. Consis-tent with the methodology specified inNotice 2007–81, the monthly corporatebond yield curve derived from January2017 data is in Table I at the end of this

notice. The spot first, second, and thirdsegment rates for the month of January2017 are, respectively, 2.00, 3.91, and4.66.

The 24-month average segment ratesdetermined under § 430(h)(2)(C)(i) through(iii) must be adjusted pursuant to§ 430(h)(2)(C)(iv) to be within the appli-cable minimum and maximum percent-ages of the corresponding 25-year averagesegment rates. For plan years beginningbefore 2021, the applicable minimum per-centage is 90% and the applicable maxi-mum percentage is 110%. The 25-yearaverage segment rates for plan years be-ginning in 2015, 2016, and 2017 werepublished in Notice 2014–50, 2014–40I.R.B. 590, Notice 2015–61, 2015–39I.R.B. 408, and Notice 2016–54, 2016–40I.R.B. 429, respectively.

24-MONTH AVERAGE CORPORATEBOND SEGMENT RATES

The three 24-month average corporatebond segment rates applicable for Febru-ary 2017 without adjustment for the 25-year average segment rate limits are asfollows:

ApplicableMonth

FirstSegment

SecondSegment

ThirdSegment

February 2017 1.60 3.79 4.74

Based on § 430(h)(2)(C)(iv), the 24-month averages applicable for February

2017 adjusted to be within the applicableminimum and maximum percentages of

the corresponding 25-year average seg-ment rates, are as follows:

For PlanYears

BeginningIn

Adjusted 24-Month AverageSegment Rates

ApplicableMonth

FirstSegment

SecondSegment

ThirdSegment

2016 February 2017 4.43 5.91 6.65

2017 February 2017 4.16 5.72 6.48

30-YEAR TREASURY SECURITIESINTEREST RATES

Generally for plan years beginning af-ter 2007, § 431 specifies the minimum

funding requirements that apply to mul-tiemployer plans pursuant to § 412. Sec-tion 431(c)(6)(B) specifies a minimumamount for the full-funding limitation de-scribed in § 431(c)(6)(A), based on the

plan’s current liability. Section 431(c)(6)(E)(ii)(I) provides that the interest rateused to calculate current liability for thispurpose must be no more than 5 percentabove and no more than 10 percent below

1Pursuant to § 433(h)(3)(A), the 3rd segment rate determined under § 430(h)(2)(C) is used to determine the current liability of a CSEC plan (which is used to calculate the minimum amountof the full funding limitation under § 433(c)(7)(C)).


the weighted average of the rates of inter-est on 30-year Treasury securities duringthe four-year period ending on the last daybefore the beginning of the plan year.Notice 88–73, 1988–2 C.B. 383, providesguidelines for determining the weighted

average interest rate. The rate of intereston 30-year Treasury securities for January2017 is 3.02 percent. The Service deter-mined this rate as the average of the dailydeterminations of yield on the 30-yearTreasury bond maturing in November

2046. For plan years beginning in themonth shown below, the weighted aver-age of the rates of interest on 30-yearTreasury securities and the permissiblerange of rates used to calculate currentliability are as follows:

For Plan YearsBeginning in

30-YearTreasuryWeightedAverage

Permissible Range

Month Year 90% to 105%

February 2017 2.90 2.61 3.05

MINIMUM PRESENT VALUESEGMENT RATES

In general, the applicable interest ratesunder § 417(e)(3)(D) are segment rates

computed without regard to a 24-monthaverage. Notice 2007–81 provides guide-lines for determining the minimum pres-ent value segment rates. Pursuant to thatnotice, the minimum present value seg-

ment rates determined for January 2017are as follows:

FirstSegment

SecondSegment

ThirdSegment

2.00 3.91 4.66

DRAFTING INFORMATION

The principal author of this notice isTom Morgan of the Office of the Associ-ate Chief Counsel (Tax Exempt and Gov-ernment Entities). However, other person-nel from the IRS participated in thedevelopment of this guidance. For furtherinformation regarding this notice, contactMr. Morgan at 202-317-6700 or TonyMontanaro at 202-317-8698 (not toll-freenumbers).


Table IMonthly Yield Curve for January 2017

Derived from January 2017 Data

Maturity Yield Maturity Yield Maturity Yield Maturity Yield Maturity Yield

0.5 1.16 20.5 4.45 40.5 4.68 60.5 4.76 80.5 4.81

1.0 1.41 21.0 4.46 41.0 4.68 61.0 4.77 81.0 4.81

1.5 1.63 21.5 4.47 41.5 4.69 61.5 4.77 81.5 4.81

2.0 1.83 22.0 4.48 42.0 4.69 62.0 4.77 82.0 4.81

2.5 2.00 22.5 4.49 42.5 4.69 62.5 4.77 82.5 4.81

3.0 2.14 23.0 4.50 43.0 4.70 63.0 4.77 83.0 4.81

3.5 2.28 23.5 4.51 43.5 4.70 63.5 4.77 83.5 4.81

4.0 2.40 24.0 4.51 44.0 4.70 64.0 4.77 84.0 4.81

4.5 2.53 24.5 4.52 44.5 4.70 64.5 4.77 84.5 4.81

5.0 2.65 25.0 4.53 45.0 4.71 65.0 4.78 85.0 4.81

5.5 2.77 25.5 4.54 45.5 4.71 65.5 4.78 85.5 4.81

6.0 2.89 26.0 4.54 46.0 4.71 66.0 4.78 86.0 4.81

6.5 3.02 26.5 4.55 46.5 4.71 66.5 4.78 86.5 4.81

7.0 3.13 27.0 4.56 47.0 4.72 67.0 4.78 87.0 4.81

7.5 3.25 27.5 4.56 47.5 4.72 67.5 4.78 87.5 4.82

8.0 3.36 28.0 4.57 48.0 4.72 68.0 4.78 88.0 4.82

8.5 3.46 28.5 4.58 48.5 4.72 68.5 4.78 88.5 4.82

9.0 3.56 29.0 4.58 49.0 4.72 69.0 4.78 89.0 4.82

9.5 3.65 29.5 4.59 49.5 4.73 69.5 4.79 89.5 4.82

10.0 3.73 30.0 4.59 50.0 4.73 70.0 4.79 90.0 4.82

10.5 3.81 30.5 4.60 50.5 4.73 70.5 4.79 90.5 4.82

11.0 3.88 31.0 4.60 51.0 4.73 71.0 4.79 91.0 4.82

11.5 3.95 31.5 4.61 51.5 4.73 71.5 4.79 91.5 4.82

12.0 4.01 32.0 4.61 52.0 4.74 72.0 4.79 92.0 4.82

12.5 4.06 32.5 4.62 52.5 4.74 72.5 4.79 92.5 4.82

13.0 4.11 33.0 4.62 53.0 4.74 73.0 4.79 93.0 4.82

13.5 4.15 33.5 4.63 53.5 4.74 73.5 4.79 93.5 4.82

14.0 4.19 34.0 4.63 54.0 4.74 74.0 4.79 94.0 4.82

14.5 4.23 34.5 4.64 54.5 4.75 74.5 4.80 94.5 4.82

15.0 4.26 35.0 4.64 55.0 4.75 75.0 4.80 95.0 4.82

15.5 4.28 35.5 4.65 55.5 4.75 75.5 4.80 95.5 4.83

16.0 4.31 36.0 4.65 56.0 4.75 76.0 4.80 96.0 4.83

16.5 4.33 36.5 4.65 56.5 4.75 76.5 4.80 96.5 4.83

17.0 4.35 37.0 4.66 57.0 4.75 77.0 4.80 97.0 4.83

17.5 4.37 37.5 4.66 57.5 4.76 77.5 4.80 97.5 4.83

18.0 4.39 38.0 4.66 58.0 4.76 78.0 4.80 98.0 4.83

18.5 4.40 38.5 4.67 58.5 4.76 78.5 4.80 98.5 4.83

19.0 4.42 39.0 4.67 59.0 4.76 79.0 4.80 99.0 4.83

19.5 4.43 39.5 4.67 59.5 4.76 79.5 4.80 99.5 4.83

20.0 4.44 40.0 4.68 60.0 4.76 80.0 4.80 100.0 4.83


2017 Calendar YearResident PopulationFigures

Notice 2017–19

This notice advises State and localhousing credit agencies that allocate low-income housing tax credits under § 42 ofthe Internal Revenue Code, and States andother issuers of tax-exempt private activ-ity bonds under § 141, of the populationfigures to use in calculating: (1) the 2017calendar year population-based compo-nent of the State housing credit ceiling(Credit Ceiling) under § 42(h)(3)(C)(ii);(2) the 2017 calendar year volume cap(Volume Cap) under § 146; and (3) the2017 volume limit (Volume Limit) under§ 142(k)(5).

Generally, § 146(j) requires determiningthe population figures for the population-based component of both the Credit Ceilingand the Volume Cap for any calendar yearon the basis of the most recent census esti-mate of the resident population of a State (orissuing authority) released by the U.S. Cen-sus Bureau before the beginning of the cal-endar year. Similarly, § 142(k)(5) bases theVolume Limit on the State population.

Sections 42(h)(3)(H) and 146(d)(2) re-quire adjusting for inflation the population-based component of the Credit Ceiling andthe Volume Cap. The adjustments for the2017 calendar year are in Rev. Proc. 2016–55, 2016–45 I.R.B. 707. Section 3.08 ofRev. Proc. 2016–55 provides that, for cal-endar year 2017, the amount for calculatingthe Credit Ceiling under § 42(h)(3)(C)(ii) isthe greater of $2.35 multiplied by the Statepopulation, or $2,710,000. Further, section3.20 of Rev. Proc. 2016–55 provides thatthe amount for calculating the Volume Capunder § 146(d)(1) for calendar year 2017 isthe greater of $100 multiplied by the Statepopulation, or $305,315,000.

For the 50 states, the District of Co-lumbia, and Puerto Rico, the populationfigures for calculating the Credit Ceiling,the Volume Cap, and the Volume Limitfor the 2017 calendar year are the residentpopulation estimates released electroni-cally by the U.S. Census Bureau on De-cember 20, 2016, and described in PressRelease CB16–214. For American Sa-

moa, Guam, the Northern Mariana Is-lands, and the U.S. Virgin Islands, thepopulation figures for the 2017 calendaryear are the 2016 midyear population fig-ures in the U.S. Census Bureau’s Interna-tional Data Base (IDB). The U.S. CensusBureau electronically announced an up-date of the IDB on August 17, 2016, inPress Release CB16–TPS128.

For convenience, these figures are re-printed below.

Resident Population Figures

Alabama 4,863,300

Alaska 741,894

AmericanSamoa

54,194

Arizona 6,931,071

Arkansas 2,988,248

California 39,250,017

Colorado 5,540,545

Connecticut 3,576,452

Delaware 952,065

District ofColumbia

681,170

Florida 20,612,439

Georgia 10,310,371

Guam 162,742

Hawaii 1,428,557

Idaho 1,683,140

Illinois 12,801,539

Indiana 6,633,053

Iowa 3,134,693

Kansas 2,907,289

Kentucky 4,436,974

Louisiana 4,681,666

Maine 1,331,479

Maryland 6,016,447

Massachusetts 6,811,779

Michigan 9,928,300

Minnesota 5,519,952

Mississippi 2,988,726

Missouri 6,093,000

Montana 1,042,520

Nebraska 1,907,116

Nevada 2,940,058

New Hampshire 1,334,795

New Jersey 8,944,469

New Mexico 2,081,015

New York 19,745,289

Resident Population Figures

North Carolina 10,146,788

North Dakota 757,952

Northern MarianaIslands

53,467

Ohio 11,614,373

Oklahoma 3,923,561

Oregon 4,093,465

Pennsylvania 12,784,227

Puerto Rico 3,411,307

Rhode Island 1,056,426

South Carolina 4,961,119

South Dakota 865,454

Tennessee 6,651,194

Texas 27,862,596

Utah 3,051,217

Vermont 624,594

Virginia 8,411,808

Virgin Islands,U.S.

102,951

Washington 7,288,000

West Virginia 1,831,102

Wisconsin 5,778,708

Wyoming 585,501

The principal authors of this notice areJames A. Holmes, Office of the AssociateChief Counsel (Passthroughs and SpecialIndustries), and Timothy L. Jones, Officeof the Associate Chief Counsel (FinancialInstitutions and Products). For further in-formation regarding this notice, pleasecontact Mr. Holmes at (202) 317-4137(not a toll-free number).

Section 401.— QualifiedPension, Profit-Sharing,and Stock Bonus Plans26 CFR 1.401(l)–1: Permitted disparity in employer-provided contributions or benefits

Rev. Rul. 2017–05

This revenue ruling provides tables ofcovered compensation under § 401(l)(5)(E) of the Internal Revenue Code andthe Income Tax Regulations thereunder,for the 2017 plan year.

Section 401(l)(5)(E)(i) defines coveredcompensation with respect to an employeeas the average of the contribution and


benefit bases in effect under section 230of the Social Security Act (the “Act”) foreach year in the 35-year period endingwith the year in which the employee at-tains social security retirement age.

Section 401(l)(5)(E)(ii) states that thedetermination for any year preceding theyear in which the employee attains socialsecurity retirement age shall be made byassuming that there is no increase in cov-ered compensation after the determinationyear and before the employee attains so-cial security retirement age.

Section 1.401(l)–1(c)(34) of the In-come Tax Regulations defines the taxablewage base as the contribution and benefitbase under section 230 of the Act.

Section 1.401(l)–1(c)(7)(i) defines cov-ered compensation for an employee as the

average (without indexing) of the taxablewage bases in effect for each calendaryear during the 35-year period endingwith the last day of the calendar year inwhich the employee attains (or will attain)social security retirement age. A 35-yearperiod is used for all individuals regard-less of the year of birth of the individual.In determining an employee’s coveredcompensation for a plan year, the taxablewage base for all calendar years beginningafter the first day of the plan year is as-sumed to be the same as the taxable wagebase in effect as of the beginning of the planyear. An employee’s covered compensationfor a plan year beginning after the 35-yearperiod applicable under § 1.401(l)–1(c)(7)(i) isthe employee’s covered compensation for aplan year during which the 35-year period

ends. An employee’s covered compensa-tion for a plan year beginning before the35-year period applicable under § 1.401(l)–1(c)(7)(i) is the taxable wage base in effectas of the beginning of the plan year.

Section 1.401(l)–1(c)(7)(ii) providesthat, for purposes of determining theamount of an employee’s covered com-pensation under § 1.401(l)–1(c)(7)(i), aplan may use tables, provided by theCommissioner, that are developed byrounding the actual amounts of coveredcompensation for different years of birth.

For purposes of determining coveredcompensation for the 2017 year, the tax-able wage base is $127,200.

The following tables provide coveredcompensation for 2017.

ATTACHMENT I

2017 COVERED COMPENSATION TABLE

CALENDARYEAR OF

BIRTH

CALENDAR YEAR OFSOCIAL SECURITYRETIREMENT AGE

2017 COVEREDCOMPENSATION

TABLE II

1907 1972 $ 4,488

1908 1973 4,704

1909 1974 5,004

1910 1975 5,316

1911 1976 5,664

1912 1977 6,060

1913 1978 6,480

1914 1979 7,044

1915 1980 7,692

1916 1981 8,460

1917 1982 9,300

1918 1983 10,236

1919 1984 11,232

1920 1985 12,276

1921 1986 13,368

1922 1987 14,520

1923 1988 15,708

1924 1989 16,968

1925 1990 18,312

1926 1991 19,728

1927 1992 21,192

1928 1993 22,716

1929 1994 24,312

1930 1995 25,920

1931 1996 27,576


ATTACHMENT I


CALENDARYEAR OF

BIRTH



TABLE II

1932 1997 29,304

1933 1998 31,128

1934 1999 33,060

1935 2000 35,100

1936 2001 37,212

1937 2002 39,444

1938 2004 43,992

1939 2005 46,344

1940 2006 48,816

1941 2007 51,348

1942 2008 53,952

1943 2009 56,628

1944 2010 59,268

1945 2011 61,884

1946 2012 64,560

1947 2013 67,308

1948 2014 69,996

1949 2015 72,636

1950 2016 75,180

1951 2017 77,880

1952 2018 80,496

1953 2019 83,052

1954 2020 85,560

1955 2022 90,372

1956 2023 92,724

1957 2024 94,980

1958 2025 97,152

1959 2026 99,264

1960 2027 101,304

1961 2028 103,296

1962 2029 105,204

1963 2030 107,088

1964 2031 108,924

1965 2032 110,700

1966 2033 112,380

1967 2034 113,940

1968 2035 115,392

1969 2036 116,724

1970 2037 117,936

1971 2038 119,088

1972 2039 120,204

1973 2040 121,272


ATTACHMENT I


CALENDARYEAR OF

BIRTH



TABLE II

1974 2041 122,220

1975 2042 123,060

1976 2043 123,780

1977 2044 124,368

1978 2045 124,944

1979 2046 125,532

1980 2047 126,024

1981 2048 126,408

1982 2049 126,696

1983 2050 126,948

1984 andLater

2051 and Later 127,200

ATTACHMENT II

2017 ROUNDED COVERED COMPENSATION TABLE

CALENDARYEAR OF

BIRTH

COVEREDCOMPENSATION

ROUNDED

1937 $ 39,000

1938–1939 45,000

1940 48,000

1941 51,000

1942 54,000

1943 57,000

1944 60,000

1945 63,000

1946–1947 66,000

1948 69,000

1949 72,000

1950 75,000

1951 78,000

1952 81,000

1953 84,000

1954 87,000

1955 90,000

1956 93,000

1957–1958 96,000

1959 99,000

1960–1961 102,000

1962 105,000

1963–1964 108,000

1965–1966 111,000

1967–1968 114,000


ATTACHMENT II

2017 ROUNDED COVERED COMPENSATION TABLE

CALENDARYEAR OF

BIRTH

COVEREDCOMPENSATION

ROUNDED

1969–1970 117,000

1971–1973 120,000

1974–1977 123,000

1978–1981 126,000

1982 and Later 127,200

DRAFTING INFORMATION

The principal author of this notice isTom Morgan of the Office of the Associ-

ate Chief Counsel (Tax Exempt and Gov-ernment Entities). However, other person-nel from the IRS participated in thedevelopment of this guidance. For further

information regarding this notice, contactMr. Morgan at 202-317-6700 or MichaelSpaid at 206-946-3480 (not toll-freenumbers).


Part IV. Items of General InterestNotice of ProposedRulemaking.Dividend Equivalents fromSources within the UnitedStatesREG–135122–16


ACTION: Notice of proposed rulemakingby cross-reference to temporary regulations.

SUMMARY: This document contains pro-posed regulations relating to certain finan-cial products providing for payments thatare contingent upon or determined by ref-erence to U.S. source dividend payments.

DATES: Written or electronic commentsmust be received by April 24, 2017.

ADDRESSES: Send submissions to CC:PA:LPD:PR (REG–135122–16), room5203, Internal Revenue Service, PO Box7604, Ben Franklin Station, Washington,DC 20044. Submissions may be hand deliv-ered Monday through Friday between thehours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG–135122–16), Courier’sdesk, Internal Revenue Service, 1111 Con-stitution Avenue, NW., Washington, DC20044, or sent electronically, via the FederaleRulemaking Portal at www.regulations-.gov (IRS REG–135122–16). The publichearing will be held in the IRS Auditorium,Internal Revenue Building, 1111 Constitu-tion Avenue, N.W., Washington, DC.

FOR FURTHER INFORMATION CON-TACT: Concerning the regulations, D. Pe-ter Merkel or Karen Walny at (202) 317-6938; concerning submissions of com-ments, the hearing, and/or to be placed onthe building access list to attend the hear-ing Regina Johnson at (202) 317-6901(not toll-free numbers).


Background and Explanation ofProvisions

Final and temporary regulations in theRules and Regulations section of this is-sue of the Internal Revenue Bulletin

contain amendments to the Income TaxRegulations (26 CFR Part 1), which pro-vide rules relating to dividend equivalentsfor purposes of section 871(m). The tem-porary regulations provide guidance relat-ing to when the delta of an option that islisted on a foreign regulated exchangemay be calculated based on the delta ofthat option at the close of business on thebusiness day prior to the date of issuance.The temporary regulations also provideguidance identifying which party to a po-tential section 871(m) transaction is re-sponsible for determining whether a trans-action is a section 871(m) transactionwhen multiple brokers or dealers are in-volved in the transaction. The text of thosetemporary regulations also serves as thetext of these proposed regulations. Thepreamble to the final and temporary reg-ulations explains the temporary regula-tions and these proposed regulations. Theregulations affect nonresident alien indi-viduals, foreign corporations, and with-holding agents, as well as certain otherparties to section 871(m) transactions andtheir agents.

Special Analyses

Certain IRS regulations, including thisone, are exempt from the requirements ofExecutive Order 12866, as supplementedand reaffirmed by Executive Order 13563.Therefore, a regulatory impact assessmentis not required. Because the regulations donot impose a collection of information onsmall entities, the Regulatory FlexibilityAct (5 U.S.C. chapter 6) does not apply.Pursuant to section 7805(f), these regula-tions have been submitted to the ChiefCounsel for Advocacy of the Small Busi-ness Administration for comment on itsimpact on small business.

Comments and Request for PublicHearing

Before these proposed regulations areadopted as final regulations, considerationwill be given to any comments that aresubmitted timely to the IRS as prescribedin this preamble under the “Addresses”heading. The Treasury Department andthe IRS request comments on all aspectsof the proposed rules. All comments will

be available at www.regulations.gov orupon request. A public hearing will bescheduled if requested in writing by anyperson that timely submits written com-ments. If a public hearing is scheduled,notice of the date, time, and place for thepublic hearing will be published in theFederal Register.


The principal authors of these regula-tions are D. Peter Merkel and KarenWalny of the Office of Chief Counsel(International). However, other personnelfrom the Treasury Department and theIRS participated in their development.

* * * * *

Proposed Amendments to theRegulations

Accordingly, 26 CFR part 1 is pro-posed to be amended as follows:

PART 1—INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *§ 1.871–15 also issued under 26 U.S.C.

871(m). * * *Par. 2. Section 1.871–15 is amended

by revising paragraph (a)(1), paragraph(g)(4)(ii)(B), paragraphs (p)(1)(ii) through(p)(1)(iv), and paragraph (p)(5) to read asfollows:

§ 1.871–15 Treatment of dividendequivalents.

(a) * * *(1) [The text of the proposed amend-

ments to § 1.871–15(a)(1) is the same asthe text of § 1.871–15T(a)(1) publishedelsewhere in this issue of the Bulletin.]* * * * *

(g) * * *(4) * * *(ii) * * *(B) [The text of the proposed amend-

ments to § 1.871–15(g)(4)(ii)(B) is the sameas the text of § 1.871–15T(g)(4)(ii)(B)published elsewhere in this issue of theBulletin.]* * * * *

(p) * * *


(1) * * *(ii) [The text of the proposed amend-

ments to § 1.871–15(p)(1)(ii) is the same asthe text of § 1.871–15T(p)(1)(ii) pub-lished elsewhere in this issue of the Bul-letin.

(iii) [The text of the proposed amend-ments to § 1.871–15(p)(1)(iii) is the same asthe text of § 1.871–15T(p)(1)(iii) publishedelsewhere in this issue of the Bulletin.]

(iv) [The text of the proposed amend-ments to § 1.871–15(p)(1)(iv) is the sameas the text of § 1.871–15T(p)(1)(iv) pub-lished elsewhere in this issue of the Bul-letin.]* * * * *

(5) [The text of the proposed amend-ments to § 1.871–15(p)(5) is the same asthe text of § 1.871–15T(p)(5) publishedelsewhere in this issue of the Bulletin.]* * * * *

John DalrympleDeputy Commissioner for Services and

Enforcement.



Definition of TermsRevenue rulings and revenue procedures(hereinafter referred to as “rulings”) thathave an effect on previous rulings use thefollowing defined terms to describe theeffect:

Amplified describes a situation whereno change is being made in a prior pub-lished position, but the prior position isbeing extended to apply to a variation ofthe fact situation set forth therein. Thus, ifan earlier ruling held that a principle ap-plied to A, and the new ruling holds thatthe same principle also applies to B, theearlier ruling is amplified. (Compare withmodified, below).

Clarified is used in those instanceswhere the language in a prior ruling isbeing made clear because the languagehas caused, or may cause, some confu-sion. It is not used where a position in aprior ruling is being changed.

Distinguished describes a situationwhere a ruling mentions a previously pub-lished ruling and points out an essentialdifference between them.

Modified is used where the substanceof a previously published position is beingchanged. Thus, if a prior ruling held that aprinciple applied to A but not to B, and thenew ruling holds that it applies to both A

and B, the prior ruling is modified becauseit corrects a published position. (Comparewith amplified and clarified, above).

Obsoleted describes a previously pub-lished ruling that is not considered deter-minative with respect to future transac-tions. This term is most commonly used ina ruling that lists previously published rul-ings that are obsoleted because of changesin laws or regulations. A ruling may alsobe obsoleted because the substance hasbeen included in regulations subsequentlyadopted.

Revoked describes situations where theposition in the previously published rulingis not correct and the correct position isbeing stated in a new ruling.

Superseded describes a situation wherethe new ruling does nothing more thanrestate the substance and situation of apreviously published ruling (or rulings).Thus, the term is used to republish underthe 1986 Code and regulations the sameposition published under the 1939 Codeand regulations. The term is also usedwhen it is desired to republish in a singleruling a series of situations, names, etc.,that were previously published over a pe-riod of time in separate rulings. If the newruling does more than restate the sub-

stance of a prior ruling, a combination ofterms is used. For example, modified andsuperseded describes a situation where thesubstance of a previously published rulingis being changed in part and is continuedwithout change in part and it is desired torestate the valid portion of the previouslypublished ruling in a new ruling that isself contained. In this case, the previouslypublished ruling is first modified and then,as modified, is superseded.

Supplemented is used in situations inwhich a list, such as a list of the names ofcountries, is published in a ruling and thatlist is expanded by adding further namesin subsequent rulings. After the originalruling has been supplemented severaltimes, a new ruling may be published thatincludes the list in the original ruling andthe additions, and supersedes all prior rul-ings in the series.

Suspended is used in rare situations toshow that the previous published rulingswill not be applied pending some futureaction such as the issuance of new oramended regulations, the outcome ofcases in litigation, or the outcome of aService study.

AbbreviationsThe following abbreviations in currentuse and formerly used will appear in ma-terial published in the Bulletin.

A—Individual.Acq.—Acquiescence.B—Individual.BE—Beneficiary.BK—Bank.B.T.A.—Board of Tax Appeals.C—Individual.C.B.—Cumulative Bulletin.CFR—Code of Federal Regulations.CI—City.COOP—Cooperative.Ct.D.—Court Decision.CY—County.D—Decedent.DC—Dummy Corporation.DE—Donee.Del. Order—Delegation Order.DISC—Domestic International Sales Corporation.DR—Donor.E—Estate.EE—Employee.E.O.—Executive Order.ER—Employer.

ERISA—Employee Retirement Income Security Act.EX—Executor.F—Fiduciary.FC—Foreign Country.FICA—Federal Insurance Contributions Act.FISC—Foreign International Sales Company.FPH—Foreign Personal Holding Company.F.R.—Federal Register.FUTA—Federal Unemployment Tax Act.FX—Foreign corporation.G.C.M.—Chief Counsel’s Memorandum.GE—Grantee.GP—General Partner.GR—Grantor.IC—Insurance Company.I.R.B.—Internal Revenue Bulletin.LE—Lessee.LP—Limited Partner.LR—Lessor.M—Minor.Nonacq.—Nonacquiescence.O—Organization.P—Parent Corporation.PHC—Personal Holding Company.PO—Possession of the U.S.PR—Partner.PRS—Partnership.

PTE—Prohibited Transaction Exemption.Pub. L.—Public Law.REIT—Real Estate Investment Trust.Rev. Proc.—Revenue Procedure.Rev. Rul.—Revenue Ruling.S—Subsidiary.S.P.R.—Statement of Procedural Rules.Stat.—Statutes at Large.T—Target Corporation.T.C.—Tax Court.T.D.—Treasury Decision.TFE—Transferee.TFR—Transferor.T.I.R.—Technical Information Release.TP—Taxpayer.TR—Trust.TT—Trustee.U.S.C.—United States Code.X—Corporation.Y—Corporation.Z—Corporation.

Bulletin No. 2017–9 February 27, 2017i

Numerical Finding List1

Bulletin 2017–1 through 2017–9

Action on Decision:

2017-1, 2016-7 I.R.B. 868

Announcements:

2017-01, 2017-08 I.R.B. 941

Notices:

2017-1, 2017-2 I.R.B. 3672017-2, 2017-4 I.R.B. 5392017-3, 2017-2 I.R.B. 3682017-4, 2017-4 I.R.B. 5412017-5, 2017-6 I.R.B. 7792017-6, 2017-3 I.R.B. 4222017-7, 2017-3 I.R.B. 4232017-8, 2017-3 I.R.B. 4232017-9, 2017-4 I.R.B. 5422017-10, 2017-4 I.R.B. 5442017-12, 2017-5 I.R.B. 7422017-13, 2017-6 I.R.B. 7802017-14, 2017-6 I.R.B. 7832017-15, 2017-6 I.R.B. 7832017-16, 2017-7 I.R.B. 9132017-18, 2017-9 I.R.B. 9972017-19, 2017-9 I.R.B. 1000

Proposed Regulations:

REG-137604-07, 2017-7 I.R.B. 923REG-128276-12, 2017-2 I.R.B. 369REG-103477-14, 2017-5 I.R.B. 746REG-112324-15, 2017-4 I.R.B. 547REG-127203-15, 2017-7 I.R.B. 921REG-131643-15, 2017-6 I.R.B. 865REG-134438-15, 2017-2 I.R.B. 373REG-112800-16, 2017-4 I.R.B. 569REG-123829-16, 2017-5 I.R.B. 764REG-123841-16, 2017-5 I.R.B. 766REG-133353-16, 2017-2 I.R.B. 372REG-134247-16, 2017-5 I.R.B. 744REG-135122-16, 2017-9 I.R.B. 1005

Revenue Procedures:

2017-1, 2017-1 I.R.B. 12017-2, 2017-1 I.R.B. 1062017-3, 2017-1 I.R.B. 1302017-4, 2017-1 I.R.B. 1462017-5, 2017-1 I.R.B. 2302017-7, 2017-1 I.R.B. 2692017-12, 2017-3 I.R.B. 4242017-13, 2017-6 I.R.B. 7872017-14, 2017-3 I.R.B. 4262017-15, 2017-3 I.R.B. 4372017-16, 2017-3 I.R.B. 5012017-18, 2017-5 I.R.B. 743

Revenue Procedures:—Continued

2017-19, 2017-7 I.R.B. 9132017-21, 2017-6 I.R.B. 7912017-22, 2017-6 I.R.B. 8632017-23, 2017-7 I.R.B. 9152017-24, 2017-7 I.R.B. 916

Revenue Rulings:

2017-1, 2017-3 I.R.B. 3772017-2, 2017-2 I.R.B. 3642017-3, 2017-4 I.R.B. 5222017-4, 2017-6 I.R.B. 7762017-5, 2017-9 I.R.B. 1000

Treasury Decisions:

9794, 2017-2 I.R.B. 2739795, 2017-2 I.R.B. 3269796, 2017-3 I.R.B. 3809801, 2017-2 I.R.B. 3559802, 2017-2 I.R.B. 3619803, 2017-3 I.R.B. 3849804, 2017-3 I.R.B. 4069806, 2017-4 I.R.B. 5249807, 2017-5 I.R.B. 5739808, 2017-5 I.R.B. 5809809, 2017-5 I.R.B. 6649810, 2017-6 I.R.B. 7759811, 2017-7 I.R.B. 8699814, 2017-7 I.R.B. 8789815, 2017-9 I.R.B. 9449817, 2017-9 I.R.B. 968

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–27 through 2016–52 is in Internal Revenue Bulletin2016–52, dated December 26, 2016.

February 27, 2017 Bulletin No. 2017–9ii

Finding List of Current Actions onPreviously Published Items1

Bulletin 2017–1 through 2017–8

Notices:

2002-1Amplified byNotice 2017-1, 2017-2 I.R.B. 367

2010-46Obsoleted byNotice 2017-1, 2017-2 I.R.B. 367

2016-29Modified byNotice 2017-6, 2017-3 I.R.B. 422

Revenue Procedures:

2013-22Clarified byRev. Proc. 2017-18, 2017-05 I.R.B. 743

2015-57Modified byRev. Proc. 2017-24, 2017-07 I.R.B. 916

Treasury Decisions:

2010-46Obsoleted byT.D. 9815 2017-09 I.R.B. 944

1A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–27 through 2016–52 is in Internal Revenue Bulletin2016–52, dated December 26, 2016.

Bulletin No. 2017–9 February 27, 2017iii

INTERNAL REVENUE BULLETINThe Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue

Bulletins are available at www.irs.gov/irb/.

We Welcome Comments About the Internal Revenue BulletinIf you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we

would be pleased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page(www.irs.gov) or write to the Internal Revenue Service, Publishing Division, IRB Publishing Program Desk, 1111 Constitution Ave.NW, IR-6230 Washington, DC 20224.

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