The Treatment of Certain Interests in Corporations as Stock or Indebtedness, 28867-28883 [2020-08096]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 85, Number 94 (Thursday, May 14, 2020)]
[Rules and Regulations]
[Pages 28867-28883]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-08096]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9897]
RIN 1545-BN68


The Treatment of Certain Interests in Corporations as Stock or 
Indebtedness

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations regarding the 
treatment of certain interests in corporations as stock or 
indebtedness. The final regulations generally affect corporations, 
including those that are partners of certain partnerships, when those 
corporations or partnerships issue purported indebtedness to related 
corporations or partnerships.

DATES: 
    Effective date: These regulations are effective on May 14, 2020.
    Applicability dates: For dates of applicability, see Sec. Sec.  
1.385-3(j)(1) and (k) and 1.385-4(g).

FOR FURTHER INFORMATION CONTACT: Azeka J. Abramoff or D. Peter Merkel 
of the Office of Associate Chief Counsel (International) at (202) 317-
6938 or Jeremy Aron-Dine of the Office of Associate Chief Counsel 
(Corporate) at (202) 317-6848 (not toll-free numbers).

SUPPLEMENTARY INFORMATION: 

Background

I. Overview

    Section 385 authorizes the Secretary of the Treasury (Secretary) to 
prescribe rules to determine whether an interest in a corporation is 
treated as stock or indebtedness (or as in part stock and in

[[Page 28868]]

part indebtedness). On October 21, 2016, the Treasury Department and 
the IRS published T.D. 9790 in the Federal Register (81 FR 72858), 
which included final regulations under section 385 and temporary 
regulations under section 385 (2016 Final Regulations and Temporary 
Regulations, respectively, and together, the 2016 Regulations). On the 
same date, the Treasury Department and the IRS also published a notice 
of proposed rulemaking (REG-130314-16) in the Federal Register (81 FR 
72751) (2016 Proposed Regulations) by cross-reference to the Temporary 
Regulations, which included Sec. Sec.  1.385-3T and 1.385-4T. Technical 
corrections to the 2016 Regulations were published in the Federal 
Register (82 FR 8169) on January 24, 2017.
    The 2016 Regulations and the 2016 Proposed Regulations address the 
classification of certain related-party debt as stock or indebtedness 
(or as in part stock and in part indebtedness) for U.S. Federal income 
tax purposes. The 2016 Final Regulations included documentation rules 
set forth in Sec.  1.385-2 (the Documentation Regulations). The 2016 
Regulations also included Sec. Sec.  1.385-3, 1.385-3T, and 1.385-4T, 
which treat certain indebtedness as stock that is issued by a 
corporation to a controlling shareholder in a distribution or in 
another related-party transaction that achieves an economically similar 
result (the Distribution Regulations). The Distribution Regulations 
apply to taxable years ending on or after January 19, 2017.
    The Temporary Regulations set forth rules regarding the treatment 
under the Distribution Regulations of certain qualified short-term debt 
instruments, transactions involving controlled partnerships, and 
transactions involving consolidated groups. The Temporary Regulations 
apply to taxable years ending on or after January 19, 2017. The 
Temporary Regulations expired on October 13, 2019. See section 7805(e); 
Sec.  1.385-3T(l); Sec.  1.385-4T(h).
    The 2016 Proposed Regulations are proposed to apply to taxable 
years ending on or after January 19, 2017. The preamble to the 2016 
Regulations requested comments on all aspects of the Temporary 
Regulations, and the preamble to the 2016 Proposed Regulations 
requested comments on all aspects of the 2016 Proposed Regulations. 
REG-130314-16, 81 FR 72751, 72858 (October 21, 2016). The preamble to 
the 2016 Regulations also requested comments on certain aspects of the 
exception for qualified short-term debt instruments.
    On October 28, 2019, the Treasury Department and the IRS issued 
Notice 2019-58, 2019-44 I.R.B. 1022, which announced that, following 
the expiration of the Temporary Regulations, a taxpayer may rely on the 
2016 Proposed Regulations until further notice is given in the Federal 
Register, provided that the taxpayer consistently applies the rules in 
the 2016 Proposed Regulations in their entirety. On November 4, 2019, 
the Treasury Department and the IRS published an advance notice of 
proposed rulemaking in the Federal Register (84 FR 59318) (the ANPRM), 
which announced that the Treasury Department and the IRS intend to 
propose more streamlined and targeted Distribution Regulations. The 
ANPRM also obsoleted Notice 2019-58 and announced that a taxpayer may 
rely on the 2016 Proposed Regulations until further notice is given in 
the Federal Register, provided that the taxpayer consistently applies 
the rules in the 2016 Proposed Regulations in their entirety. This 
Treasury decision finalizes the 2016 Proposed Regulations without any 
substantive change (the 2020 Final Regulations).

II. Executive Order 13789

    Executive Order 13789 (E.O. 13789), issued on April 21, 2017, 
instructed the Secretary to review all significant tax regulations 
issued on or after January 1, 2016, and to take concrete action to 
alleviate the burdens of regulations that (i) impose an undue financial 
burden on U.S. taxpayers; (ii) add undue complexity to the Federal tax 
laws; or (iii) exceed the statutory authority of the IRS. E.O. 13789 
further instructed the Secretary to submit to the President within 60 
days a report (First Report) that identifies regulations that meet 
these criteria. The First Report, Notice 2017-38, 2017-30 I.R.B. 147, 
which was published on July 24, 2017, included the 2016 Regulations in 
a list of eight regulations identified by the Secretary in the First 
Report as meeting at least one of the first two criteria specified in 
E.O. 13789.
    E.O. 13789 further instructed the Secretary to submit to the 
President a report (Second Report) that recommended specific actions to 
mitigate the burden imposed by regulations identified in the First 
Report. On October 16, 2017, the Secretary published in the Federal 
Register the Second Report (82 FR 48013), which stated that (i) the 
Treasury Department and the IRS were considering a proposal to revoke 
the Documentation Regulations as issued and (ii) the Treasury 
Department will reassess the distribution regulations in light of 
impending tax reform, and the Treasury Department and the IRS may then 
propose more streamlined and targeted regulations. On September 24, 
2018, the Treasury Department and the IRS published proposed 
regulations in the Federal Register that proposed removal of the 
Documentation Regulations from the Code of Federal Regulations. See 83 
FR 48265 (September 24, 2018) (2018 Proposed Regulations). On November 
4, 2019, the Treasury Department and the IRS published T.D. 9880 in the 
Federal Register (84 FR 59297), which finalized without change the 
proposed regulations removing the Documentation Regulations.
    In response to E.O. 13789 and the 2018 Proposed Regulations, 
several comments recommended that the Treasury Department and the IRS 
revoke the Distribution Regulations in addition to the Documentation 
Regulations, while one comment recommended that the Treasury Department 
and the IRS issue more streamlined and targeted Distribution 
Regulations. The ANPRM stated that the Treasury Department and the IRS 
are cognizant that a complete withdrawal of the Distribution 
Regulations could restore incentives for multinational corporations to 
generate additional interest deductions without new investment. 
Accordingly, the Treasury Department and the IRS determined that the 
Distribution Regulations continue to be necessary at this time. The 
ANPRM also announced that the Treasury Department and the IRS intend to 
propose more streamlined and targeted Distribution Regulations.
    The 2016 Proposed Regulations cross-reference the Temporary 
Regulations, a part of the Distribution Regulations, which expired on 
October 13, 2019. Because of the general determination that the 
Distribution Regulations continue to be necessary at this time, the 
Treasury Department and the IRS are issuing the 2020 Final Regulations, 
which finalize the 2016 Proposed Regulations, while the Treasury 
Department and the IRS study the appropriate approach to revising the 
Distribution Regulations, as discussed in the ANPRM.

III. The Distribution Regulations

    Under the Distribution Regulations' general rule, the issuance of a 
debt instrument by a member of an expanded group to another member of 
the same expanded group in a distribution, or an economically similar 
acquisition transaction, may result in the treatment of the debt 
instrument as stock. See Sec.  1.385-3(b)(2). The Distribution 
Regulations also include a funding rule

[[Page 28869]]

that treats as stock a debt instrument that is issued as part of a 
series of transactions that achieves a result similar to a general rule 
transaction. See Sec.  1.385-3(b)(3)(i). Specifically, Sec.  1.385-3(b) 
treats as stock a debt instrument that was issued in exchange for 
property, including cash, to fund a distribution to an expanded group 
member or another acquisition transaction that achieves an economically 
similar result. Id. Furthermore, the Distribution Regulations include a 
per se rule, which treats a debt instrument as funding a distribution 
to an expanded group member or other acquisition transaction with a 
similar economic effect if it was issued in exchange for property 
during the period beginning 36 months before and ending 36 months after 
the issuer of the debt instrument made the distribution or undertook an 
acquisition transaction with a similar economic effect. See Sec.  
1.385-3(b)(3)(iii). The Distribution Regulations also include several 
exceptions limiting their scope. See, e.g., Sec.  1.385-3(c).
    The Distribution Regulations generally apply to transactions among 
members of an expanded group of corporations, which is generally 
defined by reference to the term ``affiliated group'' in section 
1504(a), with several modifications, such as including foreign 
corporations in the expanded group. See Sec.  1.385-1(c)(4). The 
Distribution Regulations also generally apply only to ``covered debt 
instruments'' that are issued by ``covered members'' other than certain 
regulated financial companies and regulated insurance companies. See 
Sec.  1.385-3(g)(3)(i). A covered member is a member of an expanded 
group that is a domestic corporation. See Sec.  1.385-1(c)(2). A 
covered debt instrument is generally a debt instrument that is issued 
after April 4, 2016, other than certain excluded specialized debt 
instruments. See Sec.  1.385-3(g)(3). In addition to these scope 
limitations, the funding rule also excludes qualified short-term debt 
instruments, as defined in Sec.  1.385-3(b)(3)(vii). See Sec.  1.385-
3(b)(3)(i).

Summary of Comments

    The Treasury Department and the IRS have not received any comments 
specifically in response to the Temporary Regulations or the 2016 
Proposed Regulations. Accordingly, the 2016 Proposed Regulations are 
adopted as final regulations without any substantive change. In 
addition, the Temporary Regulations are withdrawn. Comments on the 2016 
Regulations that are not specific to the particular matters addressed 
in the Temporary Regulations or the 2016 Proposed Regulations are 
beyond the scope of this rulemaking and are not addressed in this 
preamble.
    Pursuant to E.O. 13789 and the ANPRM, the Treasury Department and 
the IRS intend to issue proposed regulations modifying the Distribution 
Regulations to make them more streamlined and targeted, including by 
withdrawing the per se rule. In connection with the intended revisions, 
the Treasury Department and the IRS continue to study all appropriate 
modifications to the Distribution Regulations.

Applicability Dates

    The amendments to Sec.  1.385-3, other than Sec.  1.385-
3(f)(4)(iii), apply to taxable years ending after January 19, 2017. 
Sections 1.385-3(f)(4)(iii) and 1.385-4 provide rules applicable to 
members of consolidated groups and are issued under section 1502. 
Section 1503(a) provides in general, that in any case in which a 
consolidated return is made or is required to be made, the tax shall be 
determined, computed, assessed, collected, and adjusted in accordance 
with the regulations under section 1502 prescribed before the last day 
prescribed by law for the filing of such return. Thus, Sec. Sec.  
1.385-3(f)(4)(iii) and 1.385-4 apply to taxable years for which the 
U.S. Federal income tax return is due, without extensions, after May 
14, 2020.
    The Temporary Regulations apply to taxable years ending on or after 
January 19, 2017, and before their expiration on October 13, 2019. For 
rules applying Sec. Sec.  1.385-3T(f)(4)(iii) and 1.385-4T to taxable 
years ending on or after January 19, 2017 and for which the U.S. 
Federal income tax return was due, without extensions, on or before May 
14, 2020, see Sec. Sec.  1.385-3T and 1.385-4T (as contained in 26 CFR 
in part 1 revised as of April 1, 2019). The provisions in the Temporary 
Regulations and the corresponding provisions in the 2020 Final 
Regulations are substantially identical.
    For certain taxable years for which the U.S. Federal income tax 
return was due, without extensions, on or before May 14, 2020, there 
may be a period after October 13, 2019, to which neither Sec. Sec.  
1.385-3T(f)(4)(iii) and 1.385-4T nor Sec. Sec.  1.385-3(f)(4)(iii) and 
1.385-4 apply. The 2020 Final Regulations allow a taxpayer to choose to 
apply Sec. Sec.  1.385-3(f)(4)(iii), 1.385-4, or both to such period, 
provided that all members of the expanded group apply that section or 
sections. Accordingly, a taxpayer can choose to apply the 2020 Final 
Regulations to the period, if any, to which neither the Temporary 
Regulations nor the 2020 Final Regulations apply.

Special Analyses

I. Regulatory Planning and Review--Economic Analysis

    These regulations are not subject to review under section 6(b) of 
Executive Order 12866 pursuant to the Memorandum of Agreement (April 
11, 2018) between the Treasury Department and the Office of Management 
and Budget regarding review of tax regulations.

II. Paperwork Reduction Act

    These regulations do not establish a new collection of information 
nor modify an existing collection that requires the approval of the 
Office of Management and Budget under the Paperwork Reduction Act (44 
U.S.C. chapter 35).

III. Regulatory Flexibility Act

    Pursuant to the Regulatory Flexibility Act (5 U.S.C. Chapter 6), it 
is hereby certified that the 2020 Final Regulations will not have a 
significant economic impact on a substantial number of small entities.
    Section 1.385-3 provides that certain interests in a corporation 
that are held by a member of the corporation's expanded group and that 
otherwise would be treated as indebtedness for Federal tax purposes are 
treated as stock. The regulations under Section 1.385-3 finalized in 
the 2020 Final Regulations provide that for certain debt instruments 
issued by a controlled partnership, the holder is deemed to transfer 
all or a portion of the debt instrument to the partner or partners in 
the partnership in exchange for stock in the partner or partners. 
Section 1.385-4 provides rules regarding the application of Sec.  
1.385-3 to members of a consolidated group. Section 1.385-3 includes 
multiple exceptions that limit its application. In particular, the 
threshold exception provides that the first $50 million of expanded 
group debt instruments that otherwise would be reclassified as stock or 
deemed to be transferred to a partner in a controlled partnership under 
Sec.  1.385-3 will not be reclassified or deemed transferred under 
Sec.  1.385-3. Although it is possible that the classification rules in 
the 2020 Final Regulations could have an effect on small entities, the 
threshold exception of the first $50 million of debt instruments 
otherwise subject to recharacterization or deemed transfer under 
Sec. Sec.  1.385-3 and 1.385-4 makes it unlikely that a substantial 
number of

[[Page 28870]]

small entities will be affected by these provisions.
    Pursuant to section 7805(f) of the Code, the proposed regulations 
preceding these final regulations were submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on their 
impact on small business. No comments were received concerning the 
economic impact on small entities from the Small Business 
Administration.

IV. Unfunded Mandates Reform Act

    Section 202 of the Unfunded Mandates Reform Act of 1995 requires 
that agencies assess anticipated costs and benefits and take certain 
other actions before issuing a final rule that includes any Federal 
mandate that may result in expenditures in any one year by a state, 
local, or tribal government, in the aggregate, or by the private 
sector, of $100 million in 1995 dollars, updated annually for 
inflation. This rule does not include any Federal mandate that may 
result in expenditures by state, local, or tribal governments, or by 
the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

    Executive Order 13132 (entitled ``Federalism'') prohibits an agency 
from publishing any rule that has federalism implications if the rule 
either imposes substantial, direct compliance costs on state and local 
governments, and is not required by statute, or preempts state law, 
unless the agency meets the consultation and funding requirements of 
section 6 of the Executive order. This final rule does not have 
federalism implications and does not impose substantial direct 
compliance costs on state and local governments or preempt state law 
within the meaning of the Executive order.

Statement of Availability of IRS Documents

    IRS Notices and other guidance cited in this preamble are published 
in the Internal Revenue Bulletin and are available from the 
Superintendent of Documents, U.S. Government Publishing Office, 
Washington, DC 20402, or by visiting the IRS website at https://www/
irs.gov.

Drafting Information

    The principal authors of these final regulations are Azeka J. 
Abramoff and D. Peter Merkel of the Office of Associate Chief Counsel 
(International). However, other personnel from the IRS and the Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the entries for Sec. Sec.  1.385-3T and 1.385-4T and adding an entry 
for Sec.  1.385-4 in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
* * * * *
    Section 1.385-4 also issued under 26 U.S.C. 385 and 1502.
* * * * *


Sec.  1.385-1   [Amended]

0
Par. 2. Section 1.385-1 is amended by:
0
1. In paragraph (c)(4)(vii), designating Examples 1 through 4 as 
paragraphs (c)(4)(vii)(A) through (D), respectively.
0
2. In newly designated paragraphs (c)(4)(vii)(A) through (D), 
redesignating the paragraphs in the first column as the paragraphs in 
the second column:

------------------------------------------------------------------------
              Old  paragraphs                      New  paragraphs
------------------------------------------------------------------------
(c)(4)(vii)(A)(i) and (ii)................  (c)(4)(vii)(A)(1) and (2).
(c)(4)(vii)(B)(i) and (ii)................  (c)(4)(vii)(B)(1) and (2).
(c)(4)(vii)(C)(i) and (ii)................  (c)(4)(vii)(C)(1) and (2).
(c)(4)(vii)(D)(i) and (ii)................  (c)(4)(vii)(D)(1) and (2).
------------------------------------------------------------------------

0
3. Revise the last sentence of newly redesignated paragraph 
(c)(4)(vii)(B)(1).
0
4. In newly designated paragraphs (c)(4)(vii)(C)(2) and 
(c)(4)(vii)(D)(2), redesignating the paragraphs in the first column as 
the paragraphs in the second column:

------------------------------------------------------------------------
              Old  paragraphs                      New  paragraphs
------------------------------------------------------------------------
(c)(4)(vii)(C)(2)(A) and (B)..............  (c)(4)(vii)(C)(2)(i) and
                                             (ii).
(c)(4)(vii)(D)(2)(A) through (C)..........  (c)(4)(vii)(D)(2)(i) through
                                             (iii).
------------------------------------------------------------------------

0
5. For each paragraph listed in the table, remove the language in the 
``Remove'' column wherever it appears and add in its place the language 
in the ``Add'' column as set forth below:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(a).........................  1.385-4T............  1.385-4.
(c) introductory text.......  1.385-4T(e).........  1.385-4(e).
(c)(4)(i) introductory text.  corporations          S corporations.
                               described in
                               section 1504(b)(8).
(c)(4)(i) introductory text.  not described in      that is not an S
                               section 1504(b)(6)    corporation or a
                               or (b)(8) (an         regulated
                               expanded group        investment company
                               parent).              or a real estate
                                                     investment trust
                                                     subject to tax
                                                     under subchapter M
                                                     of chapter 1 of the
                                                     Internal Revenue
                                                     Code (a RIC or a
                                                     REIT, respectively)
                                                     (such common parent
                                                     corporation, an
                                                     expanded group
                                                     parent).
(c)(4)(vii) introductory      described in section  an S corporation, a
 text.                         1504(b)(6) or         RIC, or a REIT.
                               (b)(8).
(c)(4)(vii)(B)(2)...........  P is a real estate    P is a REIT.
                               investment trust
                               described in
                               section 1504(b)(6).
(c)(4)(vii)(B)(2)...........  Although S2 is a      Although S2 is a
                               corporation           corporation that is
                               described in          a REIT, a REIT may.
                               section 1504(b)(6),
                               a corporation
                               described in
                               section 1504(b)(6)
                               may.
(c)(4)(vii)(D)(1)...........  Example 3...........  paragraph
                                                     (c)(4)(vii)(C)(1)
                                                     of this section
                                                     (Example 3).
(d)(1)(iv)(A)...............  1.385-3T(d)(4)......  1.385-3(d)(4).
(d)(1)(iv)(B)...............  1.385-3T(f)(4)......  1.385-3(f)(4).
------------------------------------------------------------------------

    The revision reads as follows:


Sec.  1.385-1   General provisions.

* * * * *
    (c) * * *
    (4) * * *
    (vii) * * *
    (B) * * *
    (1) * * * Both P and S2 are REITs.
* * * * *

0
Par. 3. Section 1.385-3 is amended by:

[[Page 28871]]

0
1. Revising the section heading.
0
2. For each paragraph listed in the table, remove the language in the 
``Remove'' column wherever it appears and add in its place the language 
in the ``Add'' column as set forth below:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(a).........................  1.385-4T............  1.385-4.
(b)(4) introductory text....  1.385-3T............  1.385-3.
(b)(4)(i) introductory text.  1.385-3T............  1.385-3.
(b)(4)(i)(E)................  1.385-3T(k)(2)......  1.385-3(k)(2).
(b)(4)(ii) introductory text  1.385-3T............  1.385-3.
(b)(4)(ii)(D)...............  1.385-4T............  1.385-4.
(c)(1)......................  1.385-3T(f).........  1.385-3(f).
(c)(2)(i)(C)................  1.385-3T............  1.385-3.
(c)(2)(iv)..................  1.385-3T(f)(2)......  1.385-3(f)(2).
(c)(2)(v)(B)................  1.385-3T(d)(4)......  1.385-3(d)(4).
(c)(2)(v)(C)................  1.385-3T(f)(4) or     1.385-3(f)(4) or
                               (5).                  (5).
(c)(3)(i)(C)(4).............  1.385-3T(f)(4)(i)...  1.385-3(f)(4)(i).
(c)(3)(ii)(D)(6)............  1.385-3T............  1.385-3.
(d)(2)(ii)(A)...............  1.385-4T(c)(2)......  1.385-4(c)(2).
(d)(2)(ii)(B)...............  1.385-3T(f)(5)(i)...  1.385-3(f)(5)(i).
(d)(7)(ii)..................  1.385-3T(d)(4)......  1.385-3(d)(4).
(g) introductory text.......  1.385-3T and 1.385-   1.385-3 and 1.385-4.
                               4T.
(g)(3)(iii)(D)..............  1.385-3T............  1.385-3.
(j)(2)(i)...................  1.385-1, 1.385-3T,    1.385-1, 1.385-3,
                               and 1.385-4T.         and 1.385-4.
(j)(2)(ii)..................  1.385-1, 1.385-3T,    1.385-1, 1.385-3,
                               and 1.385-4T.         and 1.385-4.
(j)(2)(v)...................  1.385-1, 1.385-3,     1.385-1, 1.385-3,
                               1.385-3T, and 1.385-  and 1.385-4.
                               4T.
------------------------------------------------------------------------

0
3. Revising paragraphs (b)(3)(vii), (d)(4), (f), and (g)(5) through 
(8), (15) through (17), (22), and (23).
0
4. In paragraph (h)(3), designating Examples 1 through 19 as paragraphs 
(h)(3)(i) through (xix), respectively.
0
5. In newly designated paragraphs (h)(3)(i) through (xi), redesignating 
the paragraphs in the first column as the paragraphs in the second 
column:

------------------------------------------------------------------------
              Old  paragraphs                      New  paragraphs
------------------------------------------------------------------------
(h)(3)(i)(i) and (ii).....................  (h)(3)(i)(A) and (B).
(h)(3)(ii)(i) and (ii)....................  (h)(3)(ii)(A) and (B).
(h)(3)(iii)(i) and (ii)...................  (h)(3)(iii)(A) and (B).
(h)(3)(iv)(i) and (ii)....................  (h)(3)(iv)(A) and (B).
(h)(3)(v)(i) and (ii).....................  (h)(3)(v)(A) and (B).
(h)(3)(vi)(i) and (ii)....................  (h)(3)(vi)(A) and (B).
(h)(3)(vii)(i) and (ii)...................  (h)(3)(vii)(A) and (B).
(h)(3)(viii)(i) and (ii)..................  (h)(3)(viii)(A) and (B).
(h)(3)(ix)(i) and (ii)....................  (h)(3)(ix)(A) and (B).
(h)(3)(x)(i) and (ii).....................  (h)(3)(x)(A) and (B).
(h)(3)(xi)(i) and (ii)....................  (h)(3)(xi)(A) and (B).
------------------------------------------------------------------------

0
6. In newly designated paragraphs (h)(3)(ii)(B), (h)(3)(iii)(B), 
(h)(3)(vi)(B), (h)(3)(vii)(B), (h)(3)(viii)(B), (h)(3)(ix)(B), and 
(h)(3)(x)(B), redesignating the paragraphs in the first column as the 
paragraphs in the second column:

------------------------------------------------------------------------
              Old  paragraphs                      New  paragraphs
------------------------------------------------------------------------
(h)(3)(ii)(B)(A) and (B)..................  (h)(3)(ii)(B)(1) and (2).
(h)(3)(iii)(B)(A) and (B).................  (h)(3)(iii)(B)(1) and (2).
(h)(3)(vi)(B)(A) and (B)..................  (h)(3)(vi)(B)(1) and (2).
(h)(3)(vii)(B)(A) and (B).................  (h)(3)(vii)(B)(1) and (2).
(h)(3)(viii)(B)(A) though (F).............  (h)(3)(viii)(B)(1) though
                                             (6).
(h)(3)(ix)(B)(A) and (B)..................  (h)(3)(ix)(B)(1) and (2).
(h)(3)(x)(B)(A) though (C)................  (h)(3)(x)(B)(1) through (3).
------------------------------------------------------------------------

0
7. For each newly designated paragraph listed in the table, remove the 
language in the ``Remove'' column wherever it appears and add in its 
place the language in the ``Add'' column as set forth below:

------------------------------------------------------------------------
          Paragraph                  Remove                  Add
------------------------------------------------------------------------
(h)(3)(v)(A)................  Example 4 of this     paragraph
                               paragraph (h)(3).     (h)(3)(iv)(A) of
                                                     this section
                                                     (Example 4).
(h)(3)(v)(B)................  Example 4 of this     paragraph
                               paragraph (h)(3).     (h)(3)(iv)(B) of
                                                     this section
                                                     (Example 4).
(h)(3)(vii)(A)..............  Example 6 of this     paragraph
                               paragraph (h)(3).     (h)(3)(vi)(A) of
                                                     this section
                                                     (Example 6).
------------------------------------------------------------------------

0
8. Revising newly designated paragraphs (h)(3)(xii) through (xix) and 
paragraph (j)(1).
0
9. Adding paragraphs (j)(3) and (k).
    The revisions and additions read as follows:


Sec.  1.385-3   Certain distributions of debt instruments and similar 
transactions.

* * * * *
    (b) * * *
    (3) * * *
    (vii) Qualified short-term debt instrument. The term qualified 
short-term debt instrument means a covered debt instrument that is 
described in paragraphs (b)(3)(vii)(A) though (D) of this section.
    (A) Short-term funding arrangement. A covered debt instrument is 
described in this paragraph (b)(3)(vii)(A) if the requirements of the 
specified current assets test described in paragraph (b)(3)(vii)(A)(1) 
of this section or the 270-day test described in paragraph 
(b)(3)(vii)(A)(2) of this section (the alternative tests) are 
satisfied, provided that an issuer may only claim the benefit of one of 
the alternative tests with respect to covered debt instruments issued 
by the issuer in the same taxable year.
    (1) Specified current assets test--(i) In general. The requirements 
of this paragraph (b)(3)(vii)(A)(1) are satisfied with respect to a 
covered debt instrument if the requirement of paragraph 
(b)(3)(vii)(A)(1)(ii) of this section is satisfied, but only to the 
extent the requirement of paragraph (b)(3)(vii)(A)(1)(iii) of this 
section is satisfied.
    (ii) Maximum interest rate. The rate of interest charged with 
respect to the covered debt instrument does not exceed an arm's length 
interest rate, as determined under section 482 and Sec. Sec.  1.482-1 
through 1.482-9, that would be charged with respect to a comparable

[[Page 28872]]

debt instrument of the issuer with a term that does not exceed the 
longer of 90 days and the issuer's normal operating cycle.
    (iii) Maximum outstanding balance. The amount owed by the issuer 
under covered debt instruments issued to members of the issuer's 
expanded group that satisfy the requirements of paragraph 
(b)(3)(vii)(A)(1)(ii), (b)(3)(vii)(A)(2) (if the covered debt 
instrument was issued in a prior taxable year), or (b)(3)(vii)(B) or 
(C) of this section immediately after the covered debt instrument is 
issued does not exceed the maximum of the amounts of specified current 
assets reasonably expected to be reflected, under applicable accounting 
principles, on the issuer's balance sheet as a result of transactions 
in the ordinary course of business during the subsequent 90-day period 
or the issuer's normal operating cycle, whichever is longer. For 
purposes of the preceding sentence, in the case of an issuer that is a 
qualified cash pool header, the amount owed by the issuer shall not 
take into account deposits described in paragraph (b)(3)(vii)(D) of 
this section. Additionally, the amount owed by any issuer shall be 
reduced by the amount of the issuer's deposits with a qualified cash 
pool header, but only to the extent of amounts borrowed from the same 
qualified cash pool header that satisfy the requirements of paragraph 
(b)(3)(vii)(A)(2) (if the covered debt instrument was issued in a prior 
taxable year) or (b)(3)(vii)(A)(1)(ii) of this section.
    (iv) Specified current assets. For purposes of paragraph 
(b)(3)(vii)(A)(1)(iii) of this section, the term specified current 
assets means assets that are reasonably expected to be realized in cash 
or sold (including by being incorporated into inventory that is sold) 
during the normal operating cycle of the issuer, other than cash, cash 
equivalents, and assets that are reflected on the books and records of 
a qualified cash pool header.
    (v) Normal operating cycle. For purposes of paragraph 
(b)(3)(vii)(A)(1) of this section, the term normal operating cycle 
means the issuer's normal operating cycle as determined under 
applicable accounting principles, except that if the issuer has no 
single clearly defined normal operating cycle, then the normal 
operating cycle is determined based on a reasonable analysis of the 
length of the operating cycles of the multiple businesses and their 
sizes relative to the overall size of the issuer.
    (vi) Applicable accounting principles. For purposes of paragraph 
(b)(3)(vii)(A)(1) of this section, the term applicable accounting 
principles means the financial accounting principles generally accepted 
in the United States, or an international financial accounting 
standard, that is applicable to the issuer in preparing its financial 
statements, computed on a consistent basis.
    (2) 270-day test--(i) In general. A covered debt instrument is 
described in this paragraph (b)(3)(vii)(A)(2) if the requirements of 
paragraphs (b)(3)(vii)(A)(2)(ii) through (iv) of this section are 
satisfied.
    (ii) Maximum term and interest rate. The covered debt instrument 
must have a term of 270 days or less or be an advance under a revolving 
credit agreement or similar arrangement and must bear a rate of 
interest that does not exceed an arm's length interest rate, as 
determined under section 482 and Sec. Sec.  1.482-1 through 1.482-9, 
that would be charged with respect to a comparable debt instrument of 
the issuer with a term that does not exceed 270 days.
    (iii) Lender-specific indebtedness limit. The issuer is a net 
borrower from the lender for no more than 270 days during the taxable 
year of the issuer, and in the case of a covered debt instrument 
outstanding during consecutive tax years, the issuer is a net borrower 
from the lender for no more than 270 consecutive days, in both cases 
taking into account only covered debt instruments that satisfy the 
requirement of paragraph (b)(3)(vii)(A)(2)(ii) of this section other 
than covered debt instruments described in paragraph (b)(3)(vii)(B) or 
(C) of this section.
    (iv) Overall indebtedness limit. The issuer is a net borrower under 
all covered debt instruments issued to members of the issuer's expanded 
group that satisfy the requirements of paragraphs (b)(3)(vii)(A)(2)(ii) 
and (iii) of this section, other than covered debt instruments 
described in paragraph (b)(3)(vii)(B) or (C) of this section, for no 
more than 270 days during the taxable year of the issuer, determined 
without regard to the identity of the lender under such covered debt 
instruments.
    (v) Inadvertent error. An issuer's failure to satisfy the 270-day 
test will be disregarded if the failure is reasonable in light of all 
the facts and circumstances and the failure is promptly cured upon 
discovery. A failure to satisfy the 270-day test will be considered 
reasonable if the taxpayer maintains due diligence procedures to 
prevent such failures, as evidenced by having written policies and 
operational procedures in place to monitor compliance with the 270-day 
test and management-level employees of the expanded group having 
undertaken reasonable efforts to establish, follow, and enforce such 
policies and procedures.
    (B) Ordinary course loans. A covered debt instrument is described 
in this paragraph (b)(3)(vii)(B) if the covered debt instrument is 
issued as consideration for the acquisition of property other than 
money in the ordinary course of the issuer's trade or business, 
provided that the obligation is reasonably expected to be repaid within 
120 days of issuance.
    (C) Interest-free loans. A covered debt instrument is described in 
this paragraph (b)(3)(vii)(C) if the instrument does not provide for 
stated interest or no interest is charged on the instrument, the 
instrument does not have original issue discount (as defined in section 
1273 and Sec. Sec.  1.1273-1 and 1.1273-2), interest is not imputed 
under section 483 or section 7872 and Sec. Sec.  1.483-1 through 1.483-
4 or Sec. Sec.  1.7872-1 through 1.7872-16, respectively, and interest 
is not required to be charged under section 482 and Sec. Sec.  1.482-1 
through 1.482-9.
    (D) Deposits with a qualified cash pool header--(1) In general. A 
covered debt instrument is described in this paragraph (b)(3)(vii)(D) 
if it is a demand deposit received by a qualified cash pool header 
described in paragraph (b)(3)(vii)(D)(2) of this section pursuant to a 
cash-management arrangement described in paragraph (b)(3)(vii)(D)(3) of 
this section. This paragraph (b)(3)(vii)(D) does not apply if a purpose 
for making the demand deposit is to facilitate the avoidance of the 
purposes of this section with respect to a qualified business unit (as 
defined in section 989(a) and Sec.  1.989(a)-1) (QBU) that is not a 
qualified cash pool header.
    (2) Qualified cash pool header. The term qualified cash pool header 
means an expanded group member, controlled partnership, or QBU 
described in Sec.  1.989(a)-1(b)(2)(ii), that has as its principal 
purpose managing a cash-management arrangement for participating 
expanded group members, provided that the excess (if any) of funds on 
deposit with such expanded group member, controlled partnership, or QBU 
(header) over the outstanding balance of loans made by the header is 
maintained on the books and records of the header in the form of cash 
or cash equivalents, or invested through deposits with, or the 
acquisition of obligations or portfolio securities of, persons that do 
not have a relationship to the header (or, in the case of a header that 
is a QBU described in Sec.  1.989(a)-1(b)(2)(ii), its owner) described 
in section 267(b) or section 707(b).
    (3) Cash-management arrangement. The term cash-management 
arrangement means an arrangement the principal

[[Page 28873]]

purpose of which is to manage cash for participating expanded group 
members. For purposes of the preceding sentence, managing cash means 
borrowing excess funds from participating expanded group members and 
lending funds to participating expanded group members, and may also 
include foreign exchange management, clearing payments, investing 
excess cash with an unrelated person, depositing excess cash with 
another qualified cash pool header, and settling intercompany accounts, 
for example through netting centers and pay-on-behalf-of programs.
* * * * *
    (d) * * *
    (4) Treatment of disregarded entities. This paragraph (d)(4) 
applies to the extent that a covered debt instrument issued by a 
disregarded entity, the regarded owner of which is a covered member, 
would, absent the application of this paragraph (d)(4), be treated as 
stock under this section. In this case, rather than the covered debt 
instrument being treated as stock to such extent (applicable portion), 
the covered member that is the regarded owner of the disregarded entity 
is deemed to issue its stock in the manner described in this paragraph 
(d)(4). If the applicable portion otherwise would have been treated as 
stock under paragraph (b)(2) of this section, then the covered member 
is deemed to issue its stock to the expanded group member to which the 
covered debt instrument was, in form, issued (or transferred) in the 
transaction described in paragraph (b)(2) of this section. If the 
applicable portion otherwise would have been treated as stock under 
paragraph (b)(3)(i) of this section, then the covered member is deemed 
to issue its stock to the holder of the covered debt instrument in 
exchange for a portion of the covered debt instrument equal to the 
applicable portion. In each case, the covered member that is the 
regarded owner of the disregarded entity is treated as the holder of 
the applicable portion of the debt instrument issued by the disregarded 
entity, and the actual holder is treated as the holder of the remaining 
portion of the covered debt instrument and the stock deemed to be 
issued by the regarded owner. Under Federal tax principles, the 
applicable portion of the debt instrument issued by the disregarded 
entity generally is disregarded. This paragraph (d)(4) must be applied 
in a manner that is consistent with the principles of paragraph (f)(4) 
of this section. Thus, for example, stock deemed issued is deemed to 
have the same terms as the covered debt instrument issued by the 
disregarded entity, other than the identity of the issuer, and payments 
on the stock are determined by reference to payments made on the 
covered debt instrument issued by the disregarded entity. See Sec.  
1.385-4(b)(3) for additional rules that apply if the regarded owner of 
the disregarded entity is a member of a consolidated group. If the 
regarded owner of a disregarded entity is a controlled partnership, 
then paragraph (f) of this section applies as though the controlled 
partnership were the issuer in form of the debt instrument.
* * * * *
    (f) Treatment of controlled partnerships--(1) In general. For 
purposes of this section and Sec.  1.385-4, a controlled partnership is 
treated as an aggregate of its partners in the manner described in this 
paragraph (f). Paragraph (f)(2) of this section sets forth rules 
concerning the aggregate treatment when a controlled partnership 
acquires property from a member of the expanded group. Paragraph (f)(3) 
of this section sets forth rules concerning the aggregate treatment 
when a controlled partnership issues a debt instrument. Paragraph 
(f)(4) of this section deems a debt instrument issued by a controlled 
partnership to be held by an expanded group partner rather than the 
holder-in-form in certain cases. Paragraph (f)(5) of this section sets 
forth the rules concerning events that cause the deemed results 
described in paragraph (f)(4) of this section to cease. Paragraph 
(f)(6) of this section exempts certain issuances of a controlled 
partnership's debt to a partner and a partner's debt to a controlled 
partnership from the application of this section. For definitions 
applicable for this section, see paragraph (g) of this section. For 
examples illustrating the application of this section, see paragraph 
(h) of this section.
    (2) Acquisitions of property by a controlled partnership--(i) 
Acquisitions of property when a member of the expanded group is a 
partner on the date of the acquisition--(A) Aggregate treatment. Except 
as otherwise provided in paragraphs (f)(2)(i)(C) and (f)(6) of this 
section, if a controlled partnership, with respect to an expanded 
group, acquires property from a member of the expanded group 
(transferor member), then, for purposes of this section, a member of 
the expanded group that is an expanded group partner on the date of the 
acquisition is treated as acquiring its share (as determined under 
paragraph (f)(2)(i)(B) of this section) of the property. The expanded 
group partner is treated as acquiring its share of the property from 
the transferor member in the manner (for example, in a distribution, in 
an exchange for property, or in an issuance), and on the date on which, 
the property is actually acquired by the controlled partnership from 
the transferor member. Accordingly, this section applies to a member's 
acquisition of property described in this paragraph (f)(2)(i)(A) in the 
same manner as if the member actually acquired the property from the 
transferor member, unless explicitly provided otherwise.
    (B) Expanded group partner's share of property. For purposes of 
paragraph (f)(2)(i)(A) of this section, a partner's share of property 
acquired by a controlled partnership is determined in accordance with 
the partner's liquidation value percentage (as defined in paragraph 
(g)(17) of this section) with respect to the controlled partnership. 
The liquidation value percentage is determined on the date on which the 
controlled partnership acquires the property.
    (C) Exception if transferor member is an expanded group partner. If 
a transferor member is an expanded group partner in the controlled 
partnership, paragraph (f)(2)(i)(A) of this section does not apply to 
such partner.
    (ii) Acquisitions of expanded group stock when a member of the 
expanded group becomes a partner after the acquisition--(A) Aggregate 
treatment. Except as otherwise provided in paragraph (f)(2)(ii)(C) of 
this section, if a controlled partnership, with respect to an expanded 
group, owns expanded group stock, and a member of the expanded group 
becomes an expanded group partner in the controlled partnership, then, 
for purposes of this section, the member is treated as acquiring its 
share (as determined under paragraph (f)(2)(ii)(B) of this section) of 
the expanded group stock owned by the controlled partnership. The 
member is treated as acquiring its share of the expanded group stock on 
the date on which the member becomes an expanded group partner. 
Furthermore, the member is treated as if it acquires its share of the 
expanded group stock from a member of the expanded group in exchange 
for property other than expanded group stock, regardless of the manner 
in which the partnership acquired the stock and in which the member 
acquires its partnership interest. Accordingly, this section applies to 
a member's acquisition of expanded group stock described in this 
paragraph (f)(2)(ii)(A) in the same manner as if the member actually 
acquired the stock from a member of the expanded group in exchange for 
property other than expanded group

[[Page 28874]]

stock, unless explicitly provided otherwise.
    (B) Expanded group partner's share of expanded group stock. For 
purposes of paragraph (f)(2)(ii)(A) of this section, a partner's share 
of expanded group stock owned by a controlled partnership is determined 
in accordance with the partner's liquidation value percentage with 
respect to the controlled partnership. The liquidation value percentage 
is determined on the date on which a member of the expanded group 
becomes an expanded group partner in the controlled partnership.
    (C) Exception if an expanded group partner acquires its interest in 
a controlled partnership in exchange for expanded group stock. 
Paragraph (f)(2)(ii)(A) of this section does not apply to a member of 
an expanded group that acquires its interest in a controlled 
partnership either from another partner in exchange solely for expanded 
group stock or upon a partnership contribution to the controlled 
partnership comprised solely of expanded group stock.
    (3) Issuances of debt instruments by a controlled partnership to a 
member of an expanded group--(i) Aggregate treatment. If a controlled 
partnership, with respect to an expanded group, issues a debt 
instrument to a member of the expanded group, then, for purposes of 
this section, a covered member that is an expanded group partner is 
treated as the issuer with respect to its share (as determined under 
paragraph (f)(3)(ii) of this section) of the debt instrument issued by 
the controlled partnership. This section applies to the portion of the 
debt instrument treated as issued by the covered member as described in 
this paragraph (f)(3)(i) in the same manner as if the covered member 
actually issued the debt instrument to the holder-in-form, unless 
otherwise provided. See paragraph (f)(4) of this section, which deems a 
debt instrument issued by a controlled partnership to be held by an 
expanded group partner rather than the holder-in-form in certain cases.
    (ii) Expanded group partner's share of a debt instrument issued by 
a controlled partnership--(A) General rule. An expanded group partner's 
share of a debt instrument issued by a controlled partnership is 
determined on each date on which the partner makes a distribution or 
acquisition described in paragraph (b)(2) or (b)(3)(i) of this section 
(testing date). An expanded group partner's share of a debt instrument 
issued by a controlled partnership to a member of the expanded group is 
determined in accordance with the partner's issuance percentage (as 
defined in paragraph (g)(16) of this section) on the testing date. A 
partner's share determined under this paragraph (f)(3)(ii)(A) is 
adjusted as described in paragraph (f)(3)(ii)(B) of this section.
    (B) Additional rules if there is a specified portion with respect 
to a debt instrument--(1) An expanded group partner's share (as 
determined under paragraph (f)(3)(ii)(A) of this section) of a debt 
instrument issued by a controlled partnership is reduced, but not below 
zero, by the sum of all of the specified portions (as defined in 
paragraph (g)(23) of this section), if any, with respect to the debt 
instrument that correspond to one or more deemed transferred 
receivables (as defined in paragraph (g)(8) of this section) that are 
deemed to be held by the partner.
    (2) If the aggregate of all of the expanded group partners' shares 
(as determined under paragraph (f)(3)(ii)(A) of this section and 
reduced under paragraph (f)(3)(ii)(B)(1) of this section) of the debt 
instrument exceeds the adjusted issue price of the debt, reduced by the 
sum of all of the specified portions with respect to the debt 
instrument that correspond to one or more deemed transferred 
receivables that are deemed to be held by one or more expanded group 
partners (excess amount), then each expanded group partner's share (as 
determined under paragraph (f)(3)(ii)(A) of this section and reduced 
under paragraph (f)(3)(ii)(B)(1) of this section) of the debt 
instrument is reduced. The amount of an expanded group partner's 
reduction is the excess amount multiplied by a fraction, the numerator 
of which is the partner's share, and the denominator of which is the 
aggregate of all of the expanded group partners' shares.
    (iii) Qualified short-term debt instrument. The determination of 
whether a debt instrument is a qualified short-term debt instrument for 
purposes of paragraph (b)(3)(vii) of this section is made at the 
partnership-level without regard to paragraph (f)(3)(i) of this 
section.
    (4) Recharacterization when there is a specified portion with 
respect to a debt instrument issued by a controlled partnership--(i) 
General rule. A specified portion, with respect to a debt instrument 
issued by a controlled partnership and an expanded group partner, is 
not treated as stock under paragraph (b)(2) or (b)(3)(i) of this 
section. Except as otherwise provided in paragraphs (f)(4)(ii) and 
(iii) of this section, the holder-in-form (as defined in paragraph 
(g)(15) of this section) of the debt instrument is deemed to transfer a 
portion of the debt instrument (a deemed transferred receivable, as 
defined in paragraph (g)(8) of this section) with a principal amount 
equal to the adjusted issue price of the specified portion to the 
expanded group partner in exchange for stock in the expanded group 
partner (deemed partner stock, as defined in paragraph (g)(6) of this 
section) with a fair market value equal to the principal amount of the 
deemed transferred receivable. Except as otherwise provided in 
paragraph (f)(4)(vi) of this section (concerning the treatment of a 
deemed transferred receivable for purposes of section 752) and 
paragraph (f)(5) of this section (concerning specified events 
subsequent to the deemed transfer), the deemed transfer described in 
this paragraph (f)(4)(i) is deemed to occur for all Federal tax 
purposes.
    (ii) Expanded group partner is the holder-in-form of a debt 
instrument. If the specified portion described in paragraph (f)(4)(i) 
of this section is with respect to an expanded group partner that is 
the holder-in-form of the debt instrument, then paragraph (f)(4)(i) of 
this section will not apply with respect to that specified portion 
except that only the first sentence of paragraph (f)(4)(i) of this 
section is applicable.
    (iii) Expanded group partner is a consolidated group member. This 
paragraph (f)(4)(iii) applies when one or more expanded group partners 
is a member of a consolidated group that files (or is required to file) 
a consolidated U.S. Federal income tax return. In this case, 
notwithstanding Sec.  1.385-4(b)(1) (which generally treats members of 
a consolidated group as one corporation for purposes of this section), 
the holder-in-form of the debt instrument issued by the controlled 
partnership is deemed to transfer the deemed transferred receivable or 
receivables to the expanded group partner or partners that are members 
of a consolidated group that make, or are treated as making under 
paragraph (f)(2) of this section, the regarded distributions or 
acquisitions (within the meaning of Sec.  1.385-4(e)(5)) described in 
paragraph (b)(2) or (b)(3)(i) of this section in exchange for deemed 
partner stock in such partner or partners. To the extent those regarded 
distributions or acquisitions are made by a member of the consolidated 
group that is not an expanded group partner (excess amount), the 
holder-in-form is deemed to transfer a portion of the deemed 
transferred receivable or receivables to each member of the 
consolidated group that is an expanded group partner in exchange for 
deemed partner stock in the expanded group partner. The portion is the 
excess amount multiplied by a fraction, the numerator of which is

[[Page 28875]]

the portion of the consolidated group's share (as determined under 
paragraph (f)(3)(ii) of this section) of the debt instrument issued by 
the controlled partnership that would have been the expanded group 
partner's share if the partner was not a member of a consolidated 
group, and the denominator of which is the consolidated group's share 
of the debt instrument issued by the controlled partnership.
    (iv) Rules regarding deemed transferred receivables and deemed 
partner stock--(A) Terms of deemed partner stock. Deemed partner stock 
has the same terms as the deemed transferred receivable with respect to 
the deemed transfer, other than the identity of the issuer.
    (B) Treatment of payments with respect to a debt instrument for 
which there is one or more deemed transferred receivables. When a 
payment is made with respect to a debt instrument issued by a 
controlled partnership for which there is one or more deemed 
transferred receivables, then, if the amount of the retained receivable 
(as defined in paragraph (g)(22) of this section) held by the holder-
in-form is zero and a single deemed holder is deemed to hold all of the 
deemed transferred receivables, the entire payment is allocated to the 
deemed transferred receivables held by the single deemed holder. If the 
amount of the retained receivable held by the holder-in-form is greater 
than zero or there are multiple deemed holders of deemed transferred 
receivables, or both, the payment is apportioned among the retained 
receivable, if any, and each deemed transferred receivable in 
proportion to the principal amount of all the receivables. The portion 
of a payment allocated or apportioned to a retained receivable or a 
deemed transferred receivable reduces the principal amount of, or 
accrued interest with respect to, as applicable depending on the 
payment, the retained receivable or deemed transferred receivable. When 
a payment allocated or apportioned to a deemed transferred receivable 
reduces the principal amount of the receivable, the expanded group 
partner that is the deemed holder with respect to the deemed 
transferred receivable is deemed to redeem the same amount of deemed 
partner stock, and the specified portion with respect to the debt 
instrument is reduced by the same amount. When a payment allocated or 
apportioned to a deemed transferred receivable reduces accrued interest 
with respect to the receivable, the expanded group partner that is the 
deemed holder with respect to the deemed transferred receivable is 
deemed to make a matching distribution in the same amount with respect 
to the deemed partner stock. The controlled partnership is treated as 
the paying agent with respect to the deemed partner stock.
    (v) Holder-in-form transfers debt instrument in a transaction that 
is not a specified event. If the holder-in-form transfers the debt 
instrument (which is disregarded for Federal tax purposes) to a member 
of the expanded group or a controlled partnership (and therefore the 
transfer is not a specified event described in paragraph (f)(5)(iii)(F) 
of this section), then, for Federal tax purposes, the holder-in-form is 
deemed to transfer the retained receivable and the deemed partner stock 
to the transferee.
    (vi) Allocation of deemed transferred receivable under section 752. 
A partnership liability that is a debt instrument with respect to which 
there is one or more deemed transferred receivables is allocated for 
purposes of section 752 without regard to any deemed transfer.
    (5) Specified events affecting ownership following a deemed 
transfer--(i) General rule. If a specified event (within the meaning of 
paragraph (f)(5)(iii) of this section) occurs with respect to a deemed 
transfer, then, immediately before the specified event, the expanded 
group partner that is both the issuer of the deemed partner stock and 
the deemed holder of the deemed transferred receivable is deemed to 
distribute the deemed transferred receivable (or portion thereof, as 
determined under paragraph (f)(5)(iv) of this section) to the holder-
in-form in redemption of the deemed partner stock (or portion thereof, 
as determined under paragraph (f)(5)(iv) of this section) deemed to be 
held by the holder-in-form. The deemed distribution is deemed to occur 
for all Federal tax purposes, except that the distribution is 
disregarded for purposes of paragraph (b) of this section. Except when 
the deemed transferred receivable (or portion thereof, as determined 
under paragraph (f)(5)(iv) of this section) is deemed to be 
retransferred under paragraph (f)(5)(ii) of this section, the principal 
amount of the retained receivable held by the holder-in-form is 
increased by the principal amount of the deemed transferred receivable, 
the deemed transferred receivable ceases to exist for Federal tax 
purposes, and the specified portion (or portion thereof) that 
corresponds to the deemed transferred receivable (or portion thereof) 
ceases to be treated as a specified portion for purposes of this 
section.
    (ii) New deemed transfer when a specified event involves a 
transferee that is a covered member that is an expanded group partner. 
If the specified event is described in paragraph (f)(5)(iii)(E) of this 
section, the holder-in-form of the debt instrument is deemed to 
retransfer the deemed transferred receivable (or portion thereof, as 
determined under paragraph (f)(5)(iv) of this section) that the holder-
in-form is deemed to have received pursuant to paragraph (f)(5)(i) of 
this section, to the transferee expanded group partner in exchange for 
deemed partner stock issued by the transferee expanded group partner 
with a fair market value equal to the principal amount of the deemed 
transferred receivable (or portion thereof) that is retransferred. For 
purposes of this section, this deemed transfer is treated in the same 
manner as a deemed transfer described in paragraph (f)(4)(i) of this 
section.
    (iii) Specified events. A specified event, with respect to a deemed 
transfer, occurs when, immediately after the transaction and taking 
into account all related transactions:
    (A) The controlled partnership that is the issuer of the debt 
instrument either ceases to be a controlled partnership or ceases to 
have an expanded group partner that is a covered member.
    (B) The holder-in-form is a member of the expanded group 
immediately before the transaction, and the holder-in-form and the 
deemed holder cease to be members of the same expanded group for the 
reasons described in paragraph (d)(2) of this section.
    (C) The holder-in-form is a controlled partnership immediately 
before the transaction, and the holder-in-form ceases to be a 
controlled partnership.
    (D) The expanded group partner that is both the issuer of deemed 
partner stock and the deemed holder transfers (directly or indirectly 
through one or more partnerships) all or a portion of its interest in 
the controlled partnership to a person that neither is a covered member 
nor a controlled partnership with an expanded group partner that is a 
covered member. If there is a transfer of only a portion of the 
interest, see paragraph (f)(5)(iv) of this section.
    (E) The expanded group partner that is both the issuer of deemed 
partner stock and the deemed holder transfers (directly or indirectly 
through one or more partnerships) all or a portion of its interest in 
the controlled partnership to a covered member or a controlled 
partnership with an expanded group partner that is a covered member. If 
there is a transfer of only a portion of

[[Page 28876]]

the interest, see paragraph (f)(5)(iv) of this section.
    (F) The holder-in-form transfers the debt instrument (which is 
disregarded for Federal tax purposes) to a person that is neither a 
member of the expanded group nor a controlled partnership. See 
paragraph (f)(4)(v) of this section if the holder-in-form transfers the 
debt instrument to a member of the expanded group or a controlled 
partnership.
    (iv) Specified event involving a transfer of only a portion of an 
interest in a controlled partnership. If, with respect to a specified 
event described in paragraph (f)(5)(iii)(D) or (E) of this section, an 
expanded group partner transfers only a portion of its interest in a 
controlled partnership, then, only a portion of the deemed transferred 
receivable that is deemed to be held by the expanded group partner is 
deemed to be distributed in redemption of an equal portion of the 
deemed partner stock. The portion of the deemed transferred receivable 
referred to in the preceding sentence is equal to the product of the 
entire principal amount of the deemed transferred receivable deemed to 
be held by the expanded group partner multiplied by a fraction, the 
numerator of which is the portion of the expanded group partner's 
capital account attributable to the interest that is transferred, and 
the denominator of which is the expanded group partner's capital 
account with respect to its entire interest, determined immediately 
before the specified event.
    (6) Issuance of a partnership's debt instrument to a partner and a 
partner's debt instrument to a partnership. If a controlled 
partnership, with respect to an expanded group, issues a debt 
instrument to an expanded group partner, or if a covered member that is 
an expanded group partner issues a covered debt instrument to a 
controlled partnership, and in each case, no partner deducts or 
receives an allocation of expense with respect to the debt instrument, 
then this section does not apply to the debt instrument.
    (g) * * *
    (5) Deemed holder. The term deemed holder means, with respect to a 
deemed transfer, the expanded group partner that is deemed to hold a 
deemed transferred receivable by reason of the deemed transfer.
    (6) Deemed partner stock. The term deemed partner stock means, with 
respect to a deemed transfer, the stock deemed issued by an expanded 
group partner as described in paragraphs (f)(4)(i) and (iii) and 
(f)(5)(ii) of this section. The amount of deemed partner stock is 
reduced as described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this 
section.
    (7) Deemed transfer. The term deemed transfer means, with respect 
to a specified portion, the transfer described in paragraph (f)(4)(i) 
or (iii) or (f)(5)(ii) of this section.
    (8) Deemed transferred receivable. The term deemed transferred 
receivable means, with respect to a deemed transfer, the portion of the 
debt instrument described in paragraph (f)(4)(i) or (iii) or (f)(5)(ii) 
of this section. The deemed transferred receivable is reduced as 
described in paragraphs (f)(4)(iv)(B) and (f)(5)(i) of this section.
* * * * *
    (15) Holder-in-form. The term holder-in-form means, with respect to 
a debt instrument issued by a controlled partnership, the person that, 
absent the application of paragraph (f)(4) of this section, would be 
the holder of the debt instrument for Federal tax purposes. Therefore, 
the term holder-in-form does not include a deemed holder (as defined in 
paragraph (g)(5) of this section).
    (16) Issuance percentage. The term issuance percentage means, with 
respect to a controlled partnership and an expanded group partner, the 
ratio (expressed as a percentage) of the partner's reasonably 
anticipated distributive share of all the partnership's interest 
expense over a reasonable period, divided by all of the partnership's 
reasonably anticipated interest expense over that same period, taking 
into account any and all relevant facts and circumstances. The relevant 
facts and circumstances include, without limitation, the term of the 
debt instrument; whether the partnership anticipates issuing other debt 
instruments; and the partnership's anticipated section 704(b) income 
and expense, and the partners' respective anticipated allocation 
percentages, taking into account anticipated changes to those 
allocation percentages over time resulting, for example, from 
anticipated contributions, distributions, recapitalizations, or 
provisions in the controlled partnership agreement.
    (17) Liquidation value percentage. The term liquidation value 
percentage means, with respect to a controlled partnership and an 
expanded group partner, the ratio (expressed as a percentage) of the 
liquidation value of the expanded group partner's interest in the 
partnership divided by the aggregate liquidation value of all the 
partners' interests in the partnership. The liquidation value of an 
expanded group partner's interest in a controlled partnership is the 
amount of cash the partner would receive with respect to the interest 
if the partnership (and any partnership through which the partner 
indirectly owns an interest in the controlled partnership) sold all of 
its property for an amount of cash equal to the fair market value of 
the property (taking into account section 7701(g)), satisfied all of 
its liabilities (other than those described in Sec.  1.752-7), paid an 
unrelated third party to assume all of its Sec.  1.752-7 liabilities in 
a fully taxable transaction, and then the partnership (and any 
partnership through which the partner indirectly owns an interest in 
the controlled partnership) liquidated.
* * * * *
    (22) Retained receivable. The term retained receivable means, with 
respect to a debt instrument issued by a controlled partnership, the 
portion of the debt instrument that is not transferred by the holder-
in-form pursuant to one or more deemed transfers. The retained 
receivable is adjusted for decreases described in paragraph 
(f)(4)(iv)(B) of this section and increases described in paragraph 
(f)(5)(i) of this section.
    (23) Specified portion. The term specified portion means, with 
respect to a debt instrument issued by a controlled partnership and a 
covered member that is an expanded group partner, the portion of the 
debt instrument that is treated under paragraph (f)(3)(i) of this 
section as issued on a testing date (within the meaning of paragraph 
(f)(3)(ii) of this section) by the covered member and that, absent the 
application of paragraph (f)(4)(i) of this section, would be treated as 
stock under paragraph (b)(2) or (b)(3)(i) of this section on the 
testing date. A specified portion is reduced as described in paragraphs 
(f)(4)(iv)(B) and (f)(5)(i) of this section.
* * * * *
    (h) * * *
    (3) * * *

    (xii) Example 12: Distribution of a covered debt instrument to a 
controlled partnership--(A) Facts. CFC and FS are equal partners in 
PRS. PRS owns 100% of the stock in X Corp, a domestic corporation. 
On Date A in Year 1, X Corp issues X Note to PRS in a distribution.
    (B) Analysis. (1) Under Sec.  1.385-1(c)(4), in determining 
whether X Corp is a member of the FP expanded group that includes 
CFC and FS, CFC and FS are each treated as owning 50% of the X Corp 
stock held by PRS. Accordingly, 100% of X Corp's stock is treated as 
owned by CFC and FS, and X Corp is a member of the FP expanded 
group.
    (2) Together CFC and FS own 100% of the interests in PRS capital 
and profits, such that PRS is a controlled partnership under Sec.  
1.385-1(c)(1). CFC and FS are both expanded group partners on the 
date on which PRS acquired X Note. Therefore,

[[Page 28877]]

pursuant to paragraph (f)(2)(i)(A) of this section, each of CFC and 
FS is treated as acquiring its share of X Note in the same manner 
(in this case, by a distribution of X Note), and on the date on 
which, PRS acquired X Note. Likewise, X Corp is treated as issuing 
to each of CFC and FS its share of X Note. Under paragraph 
(f)(2)(i)(B) of this section, each of CFC's and FS's share of X 
Note, respectively, is determined in accordance with its liquidation 
value percentage determined on Date A in Year 1, the date X Corp 
distributed X Note to PRS. On Date A in Year 1, pursuant to 
paragraph (g)(17) of this section, each of CFC's and FS's 
liquidation value percentages is 50%. Accordingly, on Date A in Year 
1, under paragraph (f)(2)(i)(A) of this section, for purposes of 
this section, CFC and FS are each treated as acquiring 50% of X Note 
in a distribution.
    (3) Under paragraphs (b)(2)(i) and (d)(1)(i) of this section, X 
Note is treated as stock on the date of issuance, which is Date A in 
Year 1. Under paragraph (f)(2)(i)(A) of this section, each of CFC 
and FS are treated as acquiring 50% of X Note in a distribution for 
purposes of this section. Therefore, X Corp is treated as 
distributing its stock to PRS in a distribution described in section 
305.
    (xiii) Example 13: Loan to a controlled partnership; 
proportionate distributions by expanded group partners--(A) Facts. 
DS, USS2, and USP are partners in PRS. USP is a domestic corporation 
that is not a member of the FP expanded group. Each of DS and USS2 
own 45% of the interests in PRS profits and capital, and USP owns 
10% of the interests in PRS profits and capital. The PRS partnership 
agreement provides that all items of PRS income, gain, loss, 
deduction, and credit are allocated in accordance with the 
percentages in the preceding sentence. On Date A in Year 1, FP lends 
$200x to PRS in exchange for PRS Note with stated principal amount 
of $200x, which is payable at maturity. PRS Note also provides for 
annual payments of interest that are qualified stated interest. PRS 
uses all $200x in its business and does not distribute any money or 
other property to a partner. Subsequently, on Date B in Year 1, DS 
distributes $90x to USS1, USS2 distributes $90x to FP, and USP 
distributes $20x to its shareholder. Each of DS's and USS2's 
issuance percentage is 45% on Date B in Year 1, the date of the 
distributions and therefore a testing date under paragraph 
(f)(3)(ii)(A) of this section.
    (B) Analysis. (1) DS and USS2 together own 90% of the interests 
in PRS profits and capital and therefore PRS is a controlled 
partnership under Sec.  1.385-1(c)(1). Under Sec.  1.385-1(c)(2), 
each of DS and USS2 is a covered member.
    (2) Under paragraph (f)(3)(i) of this section, each of DS and 
USS2 is treated as issuing its share of PRS Note, and under 
paragraph (f)(3)(ii)(A) of this section, DS's and USS2's share is 
each $90x (45% of $200x). USP is not an expanded group partner and 
therefore has no issuance percentage and is not treated as issuing 
any portion of PRS Note.
    (3) The $90x distributions made by DS to USS1 and by USS2 to FP 
are described in paragraph (b)(3)(i)(A) of this section. Under 
paragraph (b)(3)(iii)(A) of this section, the portions of PRS Note 
treated as issued by each of DS and USS2 are treated as funding the 
distribution made by DS and USS2 because the distributions occurred 
within the per se period with respect to PRS Note. Under paragraph 
(b)(3)(i) of this section, the portions of PRS Note treated as 
issued by each of DS and USS2 would, absent the application of 
paragraph (f)(4)(i) of this section, be treated as stock of DS and 
USS2 on Date B in Year 1, the date of the distributions. See 
paragraph (d)(1)(ii) of this section. Under paragraph (g)(23) of 
this section, each of the $90x portions is a specified portion.
    (4) Under paragraph (f)(4)(i) of this section, the specified 
portions are not treated as stock under paragraph (b)(3)(i) of this 
section. Instead, FP is deemed to transfer a portion of PRS Note 
with a principal amount equal to $90x (the adjusted issue price of 
the specified portion with respect to DS) to DS in exchange for 
deemed partner stock in DS with a fair market value of $90x. 
Similarly, FP is deemed to transfer a portion of PRS Note with a 
principal amount equal to $90x (the adjusted issue price of the 
specified portion with respect to USS2) to USS2 in exchange for 
deemed partner stock in USS2 with a fair market value of $90x. The 
principal amount of the retained receivable held by FP is $20x 
($200x-$90x-$90x).
    (xiv) Example 14: Loan to a controlled partnership; 
disproportionate distributions by expanded group partners--(A) 
Facts. The facts are the same as in paragraph (h)(3)(xiii)(A) of 
this section (Example 13), except that on Date B in Year 1, DS 
distributes $45x to USS1 and USS2 distributes $135x to FP.
    (B) Analysis. (1) The analysis is the same as in paragraph 
(h)(3)(xiii)(B)(1) of this section (Example 13).
    (2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2) 
of this section (Example 13).
    (3) The $45x and $135x distributions made by DS to USS1 and by 
USS2 to FP, respectively, are described in paragraph (b)(3)(i)(A) of 
this section. Under paragraph (b)(3)(iii)(A) of this section, the 
portion of PRS Note treated as issued by DS is treated as funding 
the distribution made by DS because the distribution occurred within 
the per se period with respect to PRS Note, but under paragraph 
(b)(3)(i) of this section, only to the extent of DS's $45x 
distribution. USS2 is treated as issuing $90x of PRS Note, all of 
which is treated as funding $90x of USS2's $135x distribution under 
paragraph (b)(3)(iii)(A) of this section. Under paragraph (b)(3)(i) 
of this section, absent the application of paragraph (f)(4)(i) of 
this section, $45x of PRS Note would be treated as stock of DS and 
$90x of PRS Note would be treated as stock of USS2 on Date B in Year 
1, the date of the distributions. See paragraph (d)(1)(ii) of this 
section. Under paragraph (g)(23) of this section, $45x of PRS Note 
is a specified portion with respect to DS and $90x of PRS Note is a 
specified portion with respect to USS2.
    (4) Under paragraph (f)(4)(i) of this section, the specified 
portions are not treated as stock under paragraph (b)(3)(i) of this 
section. Instead, FP is deemed to transfer a portion of PRS Note 
with a principal amount equal to $45x (the adjusted issue price of 
the specified portion with respect to DS) to DS in exchange for 
stock of DS with a fair market value of $90x. Similarly, FP is 
deemed to transfer a portion of PRS Note with a principal amount 
equal to $90x (the adjusted issue price of the specified portion 
with respect to USS2) to USS2 in exchange for stock of USS2 with a 
fair market value of $90x. The principal amount of the retained 
receivable held by FP is $65x ($200x-$45x-$90x).
    (xv) Example 15: Loan to partnership; distribution in later 
year--(A) Facts. The facts are the same as in paragraph 
(h)(3)(xiii)(A) of this section (Example 13), except that USS2 does 
not distribute $90x to FP until Date C in Year 2, which is less than 
36 months after Date A in Year 1. On Date C in Year 2, DS's, USS2's, 
and USP's issuance percentages under paragraph (g)(16) of this 
section are unchanged at 45%, 45%, and 10%, respectively.
    (B) Analysis. (1) The analysis is the same as in paragraph 
(h)(3)(xiii)(B)(1) of this section (Example 13).
    (2) The analysis is the same as in paragraph (h)(3)(xiii)(B)(2) 
of this section (Example 13).
    (3) With respect to the distribution made by DS, the analysis is 
the same as in paragraph (h)(3)(xiii)(B)(3) of this section (Example 
13).
    (4) With respect to the deemed transfer to DS, the analysis is 
the same as in paragraph (h)(3)(xiii)(B)(4) of this section (Example 
13). Accordingly, the amount of the retained receivable held by FP 
as of Date B in Year 1 is $110x ($200x-$90x).
    (5) Under paragraph (f)(3)(ii)(A) of this section, USS2's share 
of PRS Note is determined on Date C in Year 2. On Date C in Year 2, 
DS's, USS2's, and USP's respective shares of PRS Note under 
paragraph (f)(3)(ii)(A) of this section are $90x, $90x, and $20x. 
However, because DS is treated as the issuer with respect to a $90x 
specified portion of PRS Note, DS's share of PRS Note is reduced by 
$90x to $0 under paragraph (f)(3)(ii)(B)(1) of this section. No 
reduction to either of USS2's or USP's share of PRS Note is required 
under paragraph (f)(3)(ii)(B)(2) of this section because the 
aggregate of DS's, USS2's, and USP's shares of PRS Note as reduced 
is $110x (DS has a $0 share, USS2 has a $90x share, and USP has a 
$20x share), which does not exceed $110x (the $200x adjusted issue 
price of PRS Note reduced by the $90x specified portion with respect 
to DS). Under paragraph (f)(3)(i) of this section, USS2 is treated 
as issuing its share of PRS Note.
    (6) The $90x distribution made by USS2 to FP is described in 
paragraph (b)(3)(i)(A) of this section. Under paragraph 
(b)(3)(iii)(A) of this section, the portion of PRS Note treated as 
issued by USS2 is treated as funding the distribution made by USS2, 
because the distribution occurred within the per se period with 
respect to PRS Note. Accordingly, the portion of PRS Note treated as 
issued by USS2 would, absent the application of paragraph (f)(4)(i) 
of this section, be treated as stock of USS2 under paragraph 
(b)(3)(i) of this section on Date C in Year 2. See paragraph 
(d)(1)(ii) of this section. Under paragraph (g)(23) of this section, 
the $90x portion is a specified portion.

[[Page 28878]]

    (7) Under paragraph (f)(4)(i) of this section, the specified 
portion of PRS Note treated as issued by USS2 is not treated as 
stock under paragraph (b)(3)(i) of this section. Instead, on Date C 
in Year 2, FP is deemed to transfer a portion of PRS Note with a 
principal amount equal to $90x (the adjusted issue price of the 
specified portion with respect to USS2) to USS2 in exchange for 
stock in USS2 with a fair market value of $90x. The principal amount 
of the retained receivable held by FP is reduced from $110x to $20x.
    (xvi) Example 16: Loan to a controlled partnership; partnership 
ceases to be a controlled partnership--(A) Facts. The facts are the 
same as in paragraph (h)(3)(xiii)(A) of this section (Example 13), 
except that on Date C in Year 4, USS2 sells its entire interest in 
PRS to an unrelated person.
    (B) Analysis. (1) On date C in Year 4, PRS ceases to be a 
controlled partnership with respect to the FP expanded group under 
Sec.  1.385-1(c)(1). This is the case because DS, the only remaining 
partner that is a member of the FP expanded group, only owns 45% of 
the total interest in PRS profits and capital. Because PRS ceases to 
be a controlled partnership, a specified event (within the meaning 
of paragraph (f)(5)(iii)(A) of this section) occurs with respect to 
the deemed transfers with respect to each of DS and USS2.
    (2) Under paragraph (f)(5)(i) of this section, on Date C in Year 
4, immediately before PRS ceases to be a controlled partnership, 
each of DS and USS2 is deemed to distribute its deemed transferred 
receivable to FP in redemption of FP's deemed partner stock in DS 
and USS2. The specified portion that corresponds to each of the 
deemed transferred receivables ceases to be treated as a specified 
portion. Furthermore, the deemed transferred receivables cease to 
exist, and the retained receivable held by FP increases from $20x to 
$200x.
    (xvii) Example 17: Transfer of an interest in a partnership to a 
covered member--(A) Facts. The facts are the same as in paragraph 
(h)(3)(xiii)(A) of this section (Example 13), except that on Date C 
in Year 4, USS2 sells its entire interest in PRS to USS1.
    (B) Analysis. (1) After USS2 sells its interest in PRS to USS1, 
DS and USS1 together own 90% of the interests in PRS profits and 
capital and therefore PRS continues to be a controlled partnership 
under Sec.  1.385-1(c)(1). A specified event (within the meaning of 
paragraph (f)(5)(iii)(E) of this section) occurs as result of the 
sale only with respect to the deemed transfer with respect to USS2.
    (2) Under paragraph (f)(5)(i) of this section, on Date C in Year 
4, immediately before USS2 sells its entire interest in PRS to USS1, 
USS2 is deemed to distribute its deemed transferred receivable to FP 
in redemption of FP's deemed partner stock in USS2. Because the 
specified event is described in paragraph (f)(5)(iii)(E) of this 
section, under paragraph (f)(5)(ii) of this section, FP is deemed to 
retransfer the deemed transferred receivable deemed received from 
USS2 to USS1 in exchange for deemed partner stock in USS1 with a 
fair market value equal to the principal amount of the deemed 
transferred receivable that is retransferred to USS1.
    (xviii) Example 18: Loan to partnership and all partners are 
members of a consolidated group--(A) Facts. USS1 and DS are equal 
partners in PRS. USS1 and DS are members of a consolidated group, as 
defined in Sec.  1.1502-1(h). The PRS partnership agreement provides 
that all items of PRS income, gain, loss, deduction, and credit are 
allocated equally between USS1 and DS. On Date A in Year 1, FP lends 
$200x to PRS in exchange for PRS Note. PRS uses all $200x in its 
business and does not distribute any money or other property to any 
partner. On Date B in Year 1, DS distributes $200x to USS1, and USS1 
distributes $200x to FP. If neither of USS1 or DS were a member of 
the consolidated group, each would have an issuance percentage under 
paragraph (g)(16) of this section, determined as of Date A in Year 
1, of 50%.
    (B) Analysis. (1) Pursuant to Sec.  1.385-4(b)(6), PRS is 
treated as a partnership for purposes of this section. Under Sec.  
1.385-4(b)(1), DS and USS1 are treated as one corporation for 
purposes of this section, and thus a single covered member under 
Sec.  1.385-1(c)(2). For purposes of this section, the single 
covered member owns 100% of the PRS profits and capital and 
therefore PRS is a controlled partnership under Sec.  1.385-1(c)(1). 
Under paragraph (f)(3)(i) of this section, the single covered member 
is treated as issuing all $200x of PRS Note to FP, a member of the 
same expanded group as the single covered member. DS's distribution 
to USS1 is a disregarded distribution because it is a distribution 
between members of a consolidated group that is disregarded under 
the one-corporation rule described in Sec.  1.385-4(b)(1). However, 
under paragraph (b)(3)(iii)(A) of this section, PRS Note, treated as 
issued by the single covered member, is treated as funding the 
distribution by USS1 to FP, which is described in paragraph 
(b)(3)(i)(A) of this section and which is a regarded distribution. 
Accordingly, PRS Note, absent the application of paragraph (f)(4)(i) 
of this section, would be treated as stock under paragraph (b) of 
this section on Date B in Year 1. Thus, pursuant to paragraph 
(g)(23) of this section, the entire PRS Note is a specified portion.
    (2) Under paragraphs (f)(4)(i) and (iii) of this section, the 
specified portion is not treated as stock and, instead, FP is deemed 
to transfer PRS Note with a principal amount equal to $200x to USS1 
in exchange for stock of USS1 with a fair market value of $200x. 
Under paragraph (f)(4)(iii) of this section, FP is deemed to 
transfer PRS Note to USS1 because only USS1 made a regarded 
distribution described in paragraph (b)(3)(i) of this section.
    (xix) Example 19: Loan to a disregarded entity--(A) Facts. DS 
owns DRE, a disregarded entity within the meaning of Sec.  1.385-
1(c)(3). On Date A in Year 1, FP lends $200x to DRE in exchange for 
DRE Note. Subsequently, on Date B in Year 1, DS distributes $100x of 
cash to USS1.
    (B) Analysis. Under paragraph (b)(3)(iii)(A) of this section, 
$100x of DRE Note would be treated as funding the distribution by DS 
to USS1 because DRE Note is issued to a member of the FP expanded 
group during the per se period with respect to DS's distribution to 
USS1. Accordingly, under paragraphs (b)(3)(i)(A) and (d)(1)(ii) of 
this section, $100x of DRE Note would be treated as stock on Date B 
in Year 1. However, under paragraph (d)(4) of this section, DS, as 
the regarded owner, within the meaning of Sec.  1.385-1(c)(5), of 
DRE is deemed to issue its stock to FP in exchange for a portion of 
DRE Note equal to the $100x applicable portion (as defined in 
paragraph (d)(4) of this section). Thus, DS is treated as the holder 
of $100x of DRE Note, which is disregarded, and FP is treated as the 
holder of the remaining $100x of DRE Note. The $100x of stock deemed 
issued by DS to FP has the same terms as DRE Note, other than the 
issuer, and payments on the stock are determined by reference to 
payments on DRE Note.
* * * * *
    (j) * * * (1) In general. Except as provided in paragraph (j)(2) or 
(3) or (k) of this section, this section applies to taxable years 
ending on or after January 19, 2017.
* * * * *
    (3) Paragraph (f)(4)(iii) of this section. Paragraph (f)(4)(iii) of 
this section applies to taxable years for which the U.S. Federal income 
tax return is due, without extensions, after May 14, 2020. For taxable 
years ending on or after January 19, 2017, and for which the U.S. 
Federal income tax return is due, without extensions, on or before May 
14, 2020, see Sec.  1.385-3T(f)(4)(iii), as contained in 26 CFR in part 
1 in effect on April 1, 2019. In the case of a taxable year that ends 
after October 13, 2019, and on or before May 14, 2020, a taxpayer may 
choose to apply paragraph (f)(4)(iii) of this section to the portion of 
the taxable year that occurs after the expiration of Sec.  1.385-3T on 
October 13, 2019, provided that all members of the taxpayer's expanded 
group apply such paragraph.
    (k) Additional transition rules. See transition rules in Sec.  
1.385-3T(k)(2) as contained in 26 CFR in part 1 in effect on April 1, 
2019.


Sec.  Sec.  1.385-3T and 1.385-4T   [Removed]

0
Par. 4. Sections 1.385-3T and 1.385-4T are removed.

0
Par. 5. Section 1.385-4 is added to read as follows:


Sec.  1.385-4   Treatment of consolidated groups.

    (a) Scope. This section provides rules for applying Sec.  1.385-3 
to members of consolidated groups. Paragraph (b) of this section sets 
forth rules concerning the extent to which, solely for purposes of 
applying Sec.  1.385-3, members of a consolidated group that file (or 
that are required to file) a consolidated U.S. Federal income tax 
return are treated as one corporation. Paragraph (c) of this

[[Page 28879]]

section sets forth rules concerning the treatment of a debt instrument 
that ceases to be, or becomes, a consolidated group debt instrument. 
Paragraph (d) of this section provides rules for applying the funding 
rule of Sec.  1.385-3(b)(3) to members that depart a consolidated 
group. For definitions applicable to this section, see paragraph (e) of 
this section and Sec. Sec.  1.385-1(c) and 1.385-3(g). For examples 
illustrating the application of this section, see paragraph (f) of this 
section.
    (b) Treatment of consolidated groups--(1) Members treated as one 
corporation. For purposes of this section and Sec.  1.385-3, and except 
as otherwise provided in this section and Sec.  1.385-3, all members of 
a consolidated group (as defined in Sec.  1.1502-1(h)) that file (or 
that are required to file) a consolidated U.S. Federal income tax 
return are treated as one corporation. Thus, for example, when a member 
of a consolidated group issues a covered debt instrument that is not a 
consolidated group debt instrument, the consolidated group generally is 
treated as the issuer of the covered debt instrument for purposes of 
this section and Sec.  1.385-3. Also, for example, when one member of a 
consolidated group issues a covered debt instrument that is not a 
consolidated group debt instrument and therefore is treated as issued 
by the consolidated group, and another member of the consolidated group 
makes a distribution or acquisition described in Sec.  1.385-
3(b)(3)(i)(A) through (C) with an expanded group member that is not a 
member of the consolidated group, Sec.  1.385-3(b)(3)(i) may treat the 
covered debt instrument as funding the distribution or acquisition made 
by the consolidated group. In addition, except as otherwise provided in 
this section, acquisitions and distributions described in Sec.  1.385-
3(b)(2) and (b)(3)(i) in which all parties to the transaction are 
members of the same consolidated group both before and after the 
transaction are disregarded for purposes of this section and Sec.  
1.385-3.
    (2) One-corporation rule inapplicable to expanded group member 
determination. The one-corporation rule described in paragraph (b)(1) 
of this section does not apply in determining the members of an 
expanded group. Notwithstanding the previous sentence, an expanded 
group does not exist for purposes of this section and Sec.  1.385-3 if 
it consists only of members of a single consolidated group.
    (3) Application of Sec.  1.385-3 to debt instruments issued by 
members of a consolidated group--(i) Debt instrument treated as stock 
of the issuing member of a consolidated group. If a covered debt 
instrument treated as issued by a consolidated group under the one-
corporation rule described in paragraph (b)(1) of this section is 
treated as stock under Sec.  1.385-3, the covered debt instrument is 
treated as stock in the member of the consolidated group that would be 
the issuer of such debt instrument without regard to this section. But 
see Sec.  1.385-3(d)(7) (providing that a covered debt instrument that 
is treated as stock under Sec.  1.385-3(b)(2), (3), or (4) and that is 
not described in section 1504(a)(4) is not treated as stock for 
purposes of determining whether the issuer is a member of an affiliated 
group (within the meaning of section 1504(a)).
    (ii) Application of the covered debt instrument exclusions. For 
purposes of determining whether a debt instrument issued by a member of 
a consolidated group is a covered debt instrument, each test described 
in Sec.  1.385-3(g)(3) is applied on a separate member basis without 
regard to the one-corporation rule described in paragraph (b)(1) of 
this section.
    (iii) Qualified short-term debt instrument. The determination of 
whether a member of a consolidated group has issued a qualified short-
term debt instrument for purposes of Sec.  1.385-3(b)(3)(vii) is made 
on a separate member basis without regard to the one-corporation rule 
described in paragraph (b)(1) of this section.
    (4) Application of the reductions of Sec.  1.385-3(c)(3) to members 
of a consolidated group--(i) Application of the reduction for expanded 
group earnings--(A) In general. A consolidated group maintains one 
expanded group earnings account with respect to an expanded group 
period, and only the earnings and profits, determined in accordance 
with Sec.  1.1502-33 (without regard to the application of Sec.  
1.1502-33(b)(2), (e), and (f)), of the common parent (within the 
meaning of section 1504) of the consolidated group are considered in 
calculating the expanded group earnings for the expanded group period 
of the consolidated group. Accordingly, a regarded distribution or 
acquisition made by a member of a consolidated group is reduced to the 
extent of the expanded group earnings account of the consolidated 
group.
    (B) Effect of certain corporate transactions on the calculation of 
expanded group earnings--(1) Consolidation. A consolidated group 
succeeds to the expanded group earnings account of a joining member 
under the principles of Sec.  1.385-3(c)(3)(i)(F)(2)(ii).
    (2) Deconsolidation--(i) In general. Except as otherwise provided 
in paragraph (b)(4)(i)(B)(2)(ii) of this section, no amount of the 
expanded group earnings account of a consolidated group for an expanded 
group period, if any, is allocated to a departing member. Accordingly, 
immediately after leaving the consolidated group, the departing member 
has no expanded group earnings account with respect to its expanded 
group period.
    (ii) Allocation of expanded group earnings to a departing member in 
a distribution described in section 355. If a departing member leaves 
the consolidated group by reason of an exchange or distribution to 
which section 355 (or so much of section 356 that relates to section 
355) applies, the expanded group earnings account of the consolidated 
group is allocated between the consolidated group and the departing 
member in proportion to the earnings and profits of the consolidated 
group and the earnings and profits of the departing member immediately 
after the transaction.
    (ii) Application of the reduction for qualified contributions--(A) 
In general. For purposes of applying Sec.  1.385-3(c)(3)(ii)(A) to a 
consolidated group--
    (1) A qualified contribution to any member of a consolidated group 
that remains a member of the consolidated group immediately after the 
qualified contribution from a person other than a member of the same 
consolidated group is treated as made to the one corporation described 
in paragraph (b)(1) of this section;
    (2) A qualified contribution that causes a member of a consolidated 
group to become a departing member of that consolidated group is 
treated as made to the departing member and not to the consolidated 
group of which the departing member was a member immediately prior to 
the qualified contribution; and
    (3) No contribution of property by a member of a consolidated group 
to any other member of the consolidated group is a qualified 
contribution.
    (B) Effect of certain corporate transactions on the calculation of 
qualified contributions--(1) Consolidation. A consolidated group 
succeeds to the qualified contributions of a joining member under the 
principles of Sec.  1.385-3(c)(3)(ii)(F)(2)(ii).
    (2) Deconsolidation--(i) In general. Except as otherwise provided 
in paragraph (b)(4)(ii)(B)(2)(ii) of this section, no amount of the 
qualified contributions of a consolidated group for an expanded group 
period, if any, is allocated to a departing member.

[[Page 28880]]

Accordingly, immediately after leaving the consolidated group, the 
departing member has no qualified contributions with respect to its 
expanded group period.
    (ii) Allocation of qualified contributions to a departing member in 
a distribution described in section 355. If a departing member leaves 
the consolidated group by reason of an exchange or distribution to 
which section 355 (or so much of section 356 that relates to section 
355) applies, each qualified contribution of the consolidated group is 
allocated between the consolidated group and the departing member in 
proportion to the earnings and profits of the consolidated group and 
the earnings and profits of the departing member immediately after the 
transaction.
    (5) Order of operations. For purposes of this section and Sec.  
1.385-3, the consequences of a transaction involving one or more 
members of a consolidated group are determined as provided in 
paragraphs (b)(5)(i) and (ii) of this section.
    (i) First, determine the characterization of the transaction under 
Federal tax law without regard to the one-corporation rule described in 
paragraph (b)(1) of this section.
    (ii) Second, apply this section and Sec.  1.385-3 to the 
transaction as characterized to determine whether to treat a debt 
instrument as stock, treating the consolidated group as one corporation 
under paragraph (b)(1) of this section, unless otherwise provided.
    (6) Partnership owned by a consolidated group. For purposes of this 
section and Sec.  1.385-3, and notwithstanding the one-corporation rule 
described in paragraph (b)(1) of this section, a partnership that is 
wholly owned by members of a consolidated group is treated as a 
partnership. Thus, for example, if members of a consolidated group own 
all of the interests in a controlled partnership that issues a debt 
instrument to a member of the consolidated group, such debt instrument 
would be treated as a consolidated group debt instrument because, under 
Sec.  1.385-3(f)(3)(i), for purposes of this section and Sec.  1.385-3, 
a consolidated group member that is an expanded group partner is 
treated as the issuer with respect to its share of the debt instrument 
issued by the partnership.
    (7) Predecessor and successor--(i) In general. Pursuant to 
paragraph (b)(5) of this section, the determination as to whether a 
member of an expanded group is a predecessor or successor of another 
member of the consolidated group is made without regard to paragraph 
(b)(1) of this section. For purposes of Sec.  1.385-3(b)(3), if a 
consolidated group member is a predecessor or successor of a member of 
the same expanded group that is not a member of the same consolidated 
group, the consolidated group is treated as a predecessor or successor 
of the expanded group member (or the consolidated group of which that 
expanded group member is a member). Thus, for example, a departing 
member that departs a consolidated group in a distribution or exchange 
to which section 355 applies is a successor to the consolidated group 
and the consolidated group is a predecessor of the departing member.
    (ii) Joining members. For purposes of Sec.  1.385-3(b)(3), the term 
predecessor also means, with respect to a consolidated group, a joining 
member and the term successor also means, with respect to a joining 
member, a consolidated group.
    (c) Consolidated group debt instruments--(1) Debt instrument ceases 
to be a consolidated group debt instrument but continues to be issued 
and held by expanded group members--(i) Consolidated group member 
leaves the consolidated group. For purposes of this section and Sec.  
1.385-3, when a debt instrument ceases to be a consolidated group debt 
instrument as a result of a transaction in which the member of the 
consolidated group that issued the instrument (the issuer) or the 
member of the consolidated group holding the instrument (the holder) 
ceases to be a member of the same consolidated group but both the 
issuer and the holder continue to be members of the same expanded 
group, the issuer is treated as issuing a new debt instrument to the 
holder in exchange for property immediately after the debt instrument 
ceases to be a consolidated group debt instrument. To the extent the 
newly-issued debt instrument is a covered debt instrument that is 
treated as stock under Sec.  1.385-3(b)(3), the covered debt instrument 
is then immediately deemed to be exchanged for stock of the issuer. For 
rules regarding the treatment of the deemed exchange, see Sec.  1.385-
1(d). For examples illustrating the rule in this paragraph (c)(1)(i), 
see paragraphs (f)(3)(iv) and (v) of this section (Examples 4 and 5).
    (ii) Consolidated group debt instrument that is transferred outside 
of the consolidated group. For purposes of this section and Sec.  
1.385-3, when a member of a consolidated group that holds a 
consolidated group debt instrument transfers the debt instrument to an 
expanded group member that is not a member of the same consolidated 
group (transferee expanded group member), the debt instrument is 
treated as issued by the consolidated group to the transferee expanded 
group member immediately after the debt instrument ceases to be a 
consolidated group debt instrument. Thus, for example, for purposes of 
this section and Sec.  1.385-3, the sale of a consolidated group debt 
instrument to a transferee expanded group member is treated as an 
issuance of the debt instrument by the consolidated group to the 
transferee expanded group member in exchange for property. To the 
extent the newly-issued debt instrument is a covered debt instrument 
that is treated as stock upon being transferred, the covered debt 
instrument is deemed to be exchanged for stock of the member of the 
consolidated group treated as the issuer of the debt instrument 
(determined under paragraph (b)(3)(i) of this section) immediately 
after the covered debt instrument is transferred outside of the 
consolidated group. For rules regarding the treatment of the deemed 
exchange, see Sec.  1.385-1(d). For examples illustrating the rule in 
this paragraph (c)(1)(ii), see paragraphs (f)(3)(ii) and (iii) of this 
section (Examples 2 and 3).
    (iii) Overlap transactions. If a debt instrument ceases to be a 
consolidated group debt instrument in a transaction to which both 
paragraphs (c)(1)(i) and (ii) of this section apply, then only the 
rules of paragraph (c)(1)(ii) of this section apply with respect to 
such debt instrument.
    (iv) Subgroup exception. A debt instrument is not treated as 
ceasing to be a consolidated group debt instrument for purposes of 
paragraphs (c)(1)(i) and (ii) of this section if both the issuer and 
the holder of the debt instrument are members of the same consolidated 
group immediately after the transaction described in paragraph 
(c)(1)(i) or (ii) of this section.
    (2) Covered debt instrument treated as stock becomes a consolidated 
group debt instrument. When a covered debt instrument that is treated 
as stock under Sec.  1.385-3 becomes a consolidated group debt 
instrument, then immediately after the covered debt instrument becomes 
a consolidated group debt instrument, the issuer is deemed to issue a 
new covered debt instrument to the holder in exchange for the covered 
debt instrument that was treated as stock. In addition, in a manner 
consistent with Sec.  1.385-3(d)(2)(ii)(A), when the covered debt 
instrument that previously was treated as stock becomes a consolidated 
group debt instrument, other covered debt instruments issued by the 
issuer of that instrument (including a consolidated group that includes 
the

[[Page 28881]]

issuer) that are not treated as stock when the instrument becomes a 
consolidated group debt instrument are re-tested to determine whether 
those other covered debt instruments are treated as funding the 
regarded distribution or acquisition that previously was treated as 
funded by the instrument (unless such distribution or acquisition is 
disregarded under paragraph (b)(1) of this section). Further, also in a 
manner consistent with Sec.  1.385-3(d)(2)(ii)(A), a covered debt 
instrument that is issued by the issuer (including a consolidated group 
that includes the issuer) after the application of this paragraph 
(c)(2) and within the per se period may also be treated as funding that 
regarded distribution or acquisition.
    (3) No interaction with the intercompany obligation rules of Sec.  
1.1502-13(g). The rules of this section do not affect the application 
of the rules of Sec.  1.1502-13(g). Thus, any deemed satisfaction and 
reissuance of a debt instrument under Sec.  1.1502-13(g) and any deemed 
issuance and deemed exchange of a debt instrument under this paragraph 
(c) that arise as part of the same transaction or series of 
transactions are not integrated. Rather, each deemed satisfaction and 
reissuance under the rules of Sec.  1.1502-13(g), and each deemed 
issuance and exchange under the rules of this section, are respected as 
separate steps and treated as separate transactions.
    (d) Application of the funding rule of Sec.  1.385-3(b)(3) to 
members departing a consolidated group. This paragraph (d) provides 
rules for applying the funding rule of Sec.  1.385-3(b)(3) when a 
departing member ceases to be a member of a consolidated group, but 
only if the departing member and the consolidated group are members of 
the same expanded group immediately after the deconsolidation.
    (1) Continued application of the one-corporation rule. A 
disregarded distribution or acquisition by any member of the 
consolidated group continues to be disregarded when the departing 
member ceases to be a member of the consolidated group.
    (2) Continued recharacterization of a departing member's covered 
debt instrument as stock. A covered debt instrument of a departing 
member that is treated as stock of the departing member under Sec.  
1.385-3(b) continues to be treated as stock when the departing member 
ceases to be a member of the consolidated group.
    (3) Effect of issuances of covered debt instruments that are not 
consolidated group debt instruments on the departing member and the 
consolidated group. If a departing member has issued a covered debt 
instrument (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section) that is not a 
consolidated group debt instrument and that is not treated as stock 
immediately before the departing member ceases to be a consolidated 
group member, then the departing member (and not the consolidated 
group) is treated as issuing the covered debt instrument on the date 
and in the manner the covered debt instrument was issued. If the 
departing member is not treated as the issuer of a covered debt 
instrument pursuant to the preceding sentence, then the consolidated 
group continues to be treated as issuing the covered debt instrument on 
the date and in the manner the covered debt instrument was issued.
    (4) Treatment of prior regarded distributions or acquisitions. This 
paragraph (d)(4) applies when a departing member ceases to be a 
consolidated group member in a transaction other than a distribution to 
which section 355 (or so much of section 356 as relates to section 355) 
applies, and the consolidated group has made a regarded distribution or 
acquisition. In this case, to the extent the distribution or 
acquisition has not caused a covered debt instrument of the 
consolidated group to be treated as stock under Sec.  1.385-3(b) on or 
before the date the departing member leaves the consolidated group, 
then--
    (i) If the departing member made the regarded distribution or 
acquisition (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section), the departing member 
(and not the consolidated group) is treated as having made the regarded 
distribution or acquisition.
    (ii) If the departing member did not make the regarded distribution 
or acquisition (determined without regard to the one-corporation rule 
described in paragraph (b)(1) of this section), then the consolidated 
group (and not the departing member) continues to be treated as having 
made the regarded distribution or acquisition.
    (e) Definitions. The definitions in this paragraph (e) apply for 
purposes of this section.
    (1) Consolidated group debt instrument. The term consolidated group 
debt instrument means a covered debt instrument issued by a member of a 
consolidated group and held by a member of the same consolidated group.
    (2) Departing member. The term departing member means a member of 
an expanded group that ceases to be a member of a consolidated group 
but continues to be a member of the same expanded group. In the case of 
multiple members leaving a consolidated group as a result of a single 
transaction that continue to be members of the same expanded group, if 
such members are treated as one corporation under paragraph (b)(1) of 
this section immediately after the transaction, that one corporation is 
a departing member with respect to the consolidated group.
    (3) Disregarded distribution or acquisition. The term disregarded 
distribution or acquisition means a distribution or acquisition 
described in Sec.  1.385-3(b)(2) or (b)(3)(i) between members of a 
consolidated group that is disregarded under the one-corporation rule 
described in paragraph (b)(1) of this section.
    (4) Joining member. The term joining member means a member of an 
expanded group that becomes a member of a consolidated group and 
continues to be a member of the same expanded group. In the case of 
multiple members joining a consolidated group as a result of a single 
transaction that continue to be members of the same expanded group, if 
such members were treated as one corporation under paragraph (b)(1) of 
this section immediately before the transaction, that one corporation 
is a joining member with respect to the consolidated group.
    (5) Regarded distribution or acquisition. The term regarded 
distribution or acquisition means a distribution or acquisition 
described in Sec.  1.385-3(b)(2) or (b)(3)(i) that is not disregarded 
under the one-corporation rule described in paragraph (b)(1) of this 
section.
    (f) Examples--(1) Assumed facts. Except as otherwise stated, the 
following facts are assumed for purposes of the examples in paragraph 
(f)(3) of this section:
    (i) FP is a foreign corporation that owns 100% of the stock of 
USS1, a covered member, and 100% of the stock of FS, a foreign 
corporation;
    (ii) USS1 owns 100% of the stock of DS1 and DS3, both covered 
members;
    (iii) DS1 owns 100% of the stock of DS2, a covered member;
    (iv) FS owns 100% of the stock of UST, a covered member;
    (v) At the beginning of Year 1, FP is the common parent of an 
expanded group comprised solely of FP, USS1, FS, DS1, DS2, DS3, and UST 
(the FP expanded group);
    (vi) USS1, DS1, DS2, and DS3 are members of a consolidated group of 
which USS1 is the common parent (the USS1 consolidated group);
    (vii) The FP expanded group has outstanding more than $50 million 
of

[[Page 28882]]

debt instruments described in Sec.  1.385-3(c)(4) at all times;
    (viii) No issuer of a covered debt instrument has a positive 
expanded group earnings account, within the meaning of Sec.  1.385-
3(c)(3)(i)(B), or has received a qualified contribution, within the 
meaning of Sec.  1.385-3(c)(3)(ii)(B);
    (ix) All notes are covered debt instruments, within the meaning of 
Sec.  1.385-3(g)(3), and are not qualified short-term debt instruments, 
within the meaning of Sec.  1.385-3(b)(3)(vii);
    (x) All notes between members of a consolidated group are 
intercompany obligations within the meaning of Sec.  1.1502-
13(g)(2)(ii);
    (xi) Each entity has as its taxable year the calendar year;
    (xii) No domestic corporation is a United States real property 
holding corporation within the meaning of section 897(c)(2);
    (xiii) Each note is issued with adequate stated interest (as 
defined in section 1274(c)(2)); and
    (xiv) Each transaction occurs after January 19, 2017.
    (2) No inference. Except as otherwise provided in this section, it 
is assumed for purposes of the examples in paragraph (f)(3) of this 
section that the form of each transaction is respected for Federal tax 
purposes. No inference is intended, however, as to whether any 
particular note would be respected as indebtedness or as to whether the 
form of any particular transaction described in an example in paragraph 
(f)(3) of this section would be respected for Federal tax purposes.
    (3) Examples. The following examples illustrate the rules of this 
section.

    (i) Example 1: Order of operations--(A) Facts. On Date A in Year 
1, UST issues UST Note to USS1 in exchange for DS3 stock 
representing less than 20% of the value and voting power of DS3.
    (B) Analysis. UST is acquiring the stock of DS3, the non-common 
parent member of a consolidated group. Pursuant to paragraph 
(b)(5)(i) of this section, the transaction is first analyzed without 
regard to the one-corporation rule described in paragraph (b)(1) of 
this section, and therefore UST is treated as issuing a covered debt 
instrument in exchange for expanded group stock. The exchange of UST 
Note for DS3 stock is not an exempt exchange within the meaning of 
Sec.  1.385-3(g)(11) because UST and USS1 are not parties to an 
asset reorganization. Pursuant to paragraph (b)(5)(ii) of this 
section, Sec.  1.385-3 (including Sec.  1.385-3(b)(2)(ii)) is then 
applied to the transaction, thereby treating UST Note as stock for 
Federal tax purposes when it is issued by UST to USS1. The UST Note 
is not treated as property for purposes of section 304(a) because it 
is not property within the meaning specified in section 317(a). 
Therefore, UST's acquisition of DS3 stock from USS1 in exchange for 
UST Note is not an acquisition described in section 304(a)(1).
    (ii) Example 2: Distribution of consolidated group debt 
instrument--(A) Facts. On Date A in Year 1, DS1 issues DS1 Note to 
USS1 in a distribution. On Date B in Year 2, USS1 distributes DS1 
Note to FP.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of 
Sec.  1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a 
distribution on Date A in Year 1, DS1 is not treated as issuing a 
debt instrument to another member of DS1's expanded group in a 
distribution for purposes of Sec.  1.385-3(b)(2), and DS1 Note is 
not treated as stock under Sec.  1.385-3. When USS1 distributes DS1 
Note to FP, DS1 Note is deemed satisfied and reissued under Sec.  
1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to be an 
intercompany obligation. Under paragraph (c)(1)(ii) of this section, 
when USS1 distributes DS1 Note to FP, the USS1 consolidated group is 
treated as issuing DS1 Note to FP in a distribution on Date B in 
Year 2. Accordingly, DS1 Note is treated as stock under Sec.  1.385-
3(b)(2)(i). Under paragraph (c)(1)(ii) of this section, DS1 Note is 
deemed to be exchanged for stock of the issuing member, DS1, 
immediately after DS1 Note is transferred outside of the USS1 
consolidated group. Under paragraph (c)(3) of this section, the 
deemed satisfaction and reissuance under Sec.  1.1502-13(g)(3)(ii) 
and the deemed issuance and exchange under paragraph (c)(1)(ii) of 
this section, are respected as separate steps and treated as 
separate transactions.
    (iii) Example 3: Sale of consolidated group debt instrument--(A) 
Facts. On Date A in Year 1, DS1 lends $200x of cash to USS1 in 
exchange for USS1 Note. On Date B in Year 2, USS1 distributes $200x 
of cash to FP. Subsequently, on Date C in Year 2, DS1 sells USS1 
Note to FS for $200x.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of 
Sec.  1.385-3. Accordingly, when USS1 issues USS1 Note to DS1 for 
property on Date A in Year 1, the USS1 consolidated group is not 
treated as a funded member, and when USS1 distributes $200x to FP on 
Date B in Year 2, that distribution is a transaction described in 
Sec.  1.385-3(b)(3)(i)(A), but does not cause USS1 Note to be 
recharacterized under Sec.  1.385-3(b)(3). When DS1 sells USS1 Note 
to FS, USS1 Note is deemed satisfied and reissued under Sec.  
1.1502-13(g)(3)(ii), immediately before USS1 Note ceases to be an 
intercompany obligation. Under paragraph (c)(1)(ii) of this section, 
when the USS1 Note is transferred to FS for $200x on Date C in Year 
2, the USS1 consolidated group is treated as issuing USS1 Note to FS 
in exchange for $200x on that date. Because USS1 Note is issued by 
the USS1 consolidated group to FS within the per se period as 
defined in Sec.  1.385-3(g)(19) with respect to the distribution by 
the USS1 consolidated group to FP, USS1 Note is treated as funding 
the distribution under Sec.  1.385-3(b)(3)(iii)(A) and, accordingly, 
is treated as stock under Sec.  1.385-3(b)(3). Under Sec.  1.385-
3(d)(1)(i) and paragraph (c)(1)(ii) of this section, USS1 Note is 
deemed to be exchanged for stock of the issuing member, USS1, 
immediately after USS1 Note is transferred outside of the USS1 
consolidated group. Under paragraph (c)(3) of this section, the 
deemed satisfaction and reissuance under Sec.  1.1502-13(g)(3)(ii) 
and the deemed issuance and exchange under paragraph (c)(1)(ii) of 
this section are respected as separate steps and treated as separate 
transactions.
    (iv) Example 4: Treatment of consolidated group debt instrument 
and departing member's regarded distribution or acquisition when the 
issuer of the instrument leaves the consolidated group--(A) Facts. 
The facts are the same as provided in paragraph (f)(1) of this 
section, except that USS1 and FS own 90% and 10% of the stock of 
DS1, respectively. On Date A in Year 1, DS1 distributes $80x of cash 
and newly-issued DS1 Note, which has a value of $10x, to USS1. Also 
on Date A in Year 1, DS1 distributes $10x of cash to FS. On Date B 
in Year 2, FS purchases all of USS1's stock in DS1 (90% of the stock 
of DS1), resulting in DS1 ceasing to be a member of the USS1 
consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of 
Sec.  1.385-3. Accordingly, DS1's distribution of $80x of cash to 
USS1 on Date A in Year 1 is a disregarded distribution or 
acquisition, and under paragraph (d)(1) of this section, continues 
to be a disregarded distribution or acquisition when DS1 ceases to 
be a member of the USS1 consolidated group. In addition, when DS1 
issues DS1 Note to USS1 in a distribution on Date A in Year 1, DS1 
is not treated as issuing a debt instrument to a member of DS1's 
expanded group in a distribution for purposes of Sec.  1.385-
3(b)(2)(i), and DS1 Note is not treated as stock under Sec.  1.385-
3(b)(2)(i). DS1's issuance of DS1 Note to USS1 is also a disregarded 
distribution or acquisition, and under paragraph (d)(1) of this 
section, continues to be a disregarded distribution or acquisition 
when DS1 ceases to be a member of the USS1 consolidated group. The 
distribution of $10x cash by DS1 to FS on Date A in Year 1 is a 
regarded distribution or acquisition. When FS purchases 90% of the 
stock of DS1's from USS1 on Date B in Year 2 and DS1 ceases to be a 
member of the USS1 consolidated group, DS1 Note is deemed satisfied 
and reissued under Sec.  1.1502-13(g)(3)(ii), immediately before DS1 
Note ceases to be an intercompany obligation. Under paragraph 
(c)(1)(i) of this section, for purposes of Sec.  1.385-3, DS1 is 
treated as issuing a new debt instrument to USS1 in exchange for 
property immediately after DS1 Note ceases to be a consolidated 
group debt instrument. Under paragraph (d)(4)(i) of this section, 
the departing member, DS1 (and not the USS1 consolidated group) is 
treated as having distributed $10x to FS on Date A in Year 1 (a 
regarded distribution or acquisition) for purposes of applying Sec.  
1.385-3(b)(3) after DS1 ceases to be a member of the USS1 
consolidated group. Because DS1 Note is reissued by DS1 to USS1 
within the per se period (as defined in Sec.  1.385-3(g)(19)) with 
respect to DS1's regarded distribution to FS, DS1 Note is treated as 
funding the distribution under Sec.  1.385-3(b)(3)(iii)(A) and,

[[Page 28883]]

accordingly, is treated as stock under Sec.  1.385-3(b)(3). Under 
Sec.  1.385-3(d)(1)(i) and paragraph (c)(1)(i) of this section, DS1 
Note is immediately deemed to be exchanged for stock of DS1 on Date 
B in Year 2. Under paragraph (c)(3) of this section, the deemed 
satisfaction and reissuance under Sec.  1.1502-13(g)(3)(ii) and the 
deemed issuance and exchange under paragraph (c)(1)(i) of this 
section are respected as separate steps and treated as separate 
transactions. Under Sec.  1.385-3(d)(7)(i), after DS1 Note is 
treated as stock held by USS1, DS1 Note is not treated as stock for 
purposes of determining whether DS1 is a member of the USS1 
consolidated group.
    (v) Example 5: Treatment of consolidated group debt instrument 
and consolidated group's regarded distribution or acquisition--(A) 
Facts. On Date A in Year 1, DS1 issues DS1 Note to USS1. On Date B 
in Year 2, USS1 distributes $100x of cash to FP. On Date C in Year 
3, USS1 sells all of its interest in DS1 to FS, resulting in DS1 
ceasing to be a member of the USS1 consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of 
Sec.  1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a 
distribution on Date A in Year 1, DS1 is not treated as issuing a 
debt instrument to a member of DS1's expanded group in a 
distribution for purposes of Sec.  1.385-3(b)(2)(i), and DS1 Note is 
not treated as stock under Sec.  1.385-3(b)(2)(i). DS1's issuance of 
DS1 Note to USS1 is also a disregarded distribution or acquisition, 
and under paragraph (d)(1) of this section, continues to be a 
disregarded distribution or acquisition when DS1 ceases to be a 
member of the USS1 consolidated group. The distribution of $100x 
cash by DS1 to USS1 on Date B in Year 2 is a regarded distribution 
or acquisition. When FS purchases all of the stock of DS1 from USS1 
on Date C in Year 3 and DS1 ceases to be a member of the USS1 
consolidated group, DS1 Note is deemed satisfied and reissued under 
Sec.  1.1502-13(g)(3)(ii), immediately before DS1 Note ceases to be 
an intercompany obligation. Under paragraph (c)(1)(i) of this 
section, for purposes of Sec.  1.385-3, DS1 is treated as issuing a 
new debt instrument to USS1 in exchange for property immediately 
after DS1 Note ceases to be a consolidated group debt instrument. 
Under paragraph (d)(4)(ii) of this section, the USS1 consolidated 
group (and not DS1) is treated as having distributed $100x to FP on 
Date B in Year 2 (a regarded distribution or acquisition) for 
purposes of applying Sec.  1.385-3(b)(3) after DS1 ceases to be a 
member of the USS1 consolidated group. Because DS1 has not engaged 
in a regarded distribution or acquisition that would have been 
treated as funded by the reissued DS1 Note, the reissued DS1 Note is 
not treated as stock.
    (vi) Example 6: Treatment of departing member's issuance of a 
covered debt instrument--(A) Facts. On Date A in Year 1, FS lends 
$100x of cash to DS1 in exchange for DS1 Note. On Date B in Year 2, 
USS1 distributes $30x of cash to FP. On Date C in Year 2, USS1 sells 
all of its DS1 stock to FP, resulting in DS1 ceasing to be a member 
of the USS1 consolidated group.
    (B) Analysis. Under paragraph (b)(1) of this section, the USS1 
consolidated group is treated as one corporation for purposes of 
Sec.  1.385-3. Accordingly, on Date A in Year 1, the USS1 
consolidated group is treated as issuing DS1 Note to FS, and on Date 
B in Year 2, the USS1 consolidated group is treated as distributing 
$30x of cash to FP. Because DS1 Note is issued by the USS1 
consolidated group to FS within the per se period as defined in 
Sec.  1.385-3(g)(19) with respect to the distribution by the 
USS1consoldiated group of $30x cash to FP, $30x of DS1 Note is 
treated as funding the distribution under Sec.  1.385-
3(b)(3)(iii)(A), and, accordingly, is treated as stock on Date B in 
Year 2 under Sec.  1.385-3(b)(3) and Sec.  1.385-3(d)(1)(ii). Under 
paragraph (d)(3) of this section, DS1 (and not the USS1 consolidated 
group) is treated as the issuer of the remaining portion of DS1 Note 
for purposes of applying Sec.  1.385-3(b)(3) after DS1 ceases to be 
a member of the USS1 consolidated group.

    (g) Applicability date. This section applies to taxable years for 
which the U.S. Federal income tax return is due, without extensions, 
after May 14, 2020. For taxable years ending on or after January 19, 
2017, and for which the U.S. Federal income tax return is due, without 
extensions, on or before May 14, 2020, see Sec.  1.385-4T, as contained 
in 26 CFR in part 1 in effect on April 1, 2019. In the case of a 
taxable year that ends after October 13, 2019, and on or before May 14, 
2020, a taxpayer may choose to apply this section to the portion of the 
taxable year that occurs after the expiration of Sec.  1.385-4T on 
October 13, 2019, provided that all members of the taxpayer's expanded 
group apply this section in its entirety.

Sunita Lough,
Deputy Commissioner for Services and Enforcement.
    Approved: April 2, 2020.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-08096 Filed 5-13-20; 8:45 am]
BILLING CODE 4830-01-P