SERVICE PREVIEWS REGULATIONS GOVERNING SOURCE ALLOCATION OF BANK LOAN LOSSES.

Notice 89-58

SECTION 1. PURPOSE This notice provides guidance under section 865 of the Internal Revenue Code concerning the allocation and apportionment of losses incurred by banks with respect to certain loans made in the ordinary course of the bank's trade or business. Generally, this notice provides that losses recognized with respect to such loans shall be allocated to the class of interest income generated by such instruments, and shall be apportioned between U.S. source interest income and one or more separate limitation categories of foreign source interest income included within the class of interest income. The losses must be apportioned according to an asset method of apportionment that is based on the outstanding amount of loans generating interest income in such groupings. The rules contained in this notice will be incorporated in regulations to be promulgated under section 865 of the Code. This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or procedure. Any modification of the rules contained herein will be prospective only. SEC. 2. BACKGROUND Section 1211 of the Tax Reform Act of 1986, 1986-3 (Vol. 1) C.B. 1, 450, added section 865 to the Code. Section 865(j) directs the Secretary to prescribe regulations that may be necessary or appropriate to carry out the purpose of section 865 relating to the treatment of losses from sales of personal property. SEC. 3. PERSONS COVERED This notice applies only to banks as defined in section 4(a) of this notice. SEC. 4. DEFINITIONS AND GENERAL RULES (a) BANK. Solely for purposes of this notice, the term "bank" shall mean any bank as defined in section 585(a)(2) of the Code. In the case of a separate affiliated group consisting solely of banks as described in subsection (b) of this section 4, such separate affiliated group shall be treated as a "bank" that is a single corporation. With respect to banks described in section 585(a)(2)(B) (U.S. branches of foreign corporations), the rules of this notice apply only for purposes of determining the allocation and apportionment of losses incurred on loans, the interest on which is effectively connected with the conduct of a banking business within the United States. Therefore, as an initial matter, whether a loss incurred by a U.S. branch is subject to the rules of this notice depends upon whether the interest on the loan is effectively connected income. (b) AFFILIATED CORPORATIONS. Two or more banks that are members of an affiliated group (as defined in section 1.861-11T(d)(1) of the regulations) shall for purposes of this notice be treated as a separate affiliated group consisting solely of such banks. (c) ELIGIBLE LOAN. Solely for purposes of this notice, the term "eligible loan" shall mean any eligible loan as defined in section 585(b)(4) of the Code and the regulations thereunder. (d) SPECIAL RULES. The Commissioner, by a ruling issued to the taxpayer, may include in an affiliated group of banks described in section 4(b) of this notice corporations that are financial service entities within the meaning of section 1.904-4(e)(3) of the regulations and that are members of the affiliated group under section 1.861-11T(d)(1). Regardless of whether a ruling is issued pursuant to the preceding sentence, the Commissioner, by ruling issued to the taxpayer, may make appropriate adjustments to the asset apportionment method described in section 5 of this notice as applied to any member of the affiliated group to include debt instruments other than eligible loans as assets includable in the apportionment formula. In considering either type of ruling request as described above, the Commissioner will consider whether the requested adjustments result in a distortion of income. (e) PRIORITY. The source of any foreign currency loss attributable to an eligible loan shall be determined under the rules of section 988 and the regulations thereunder and not under the rules of this notice. SEC. 5. ALLOCATION AND APPORTIONMENT OF LOSSES A loss derived by a bank from the disposition, or specific charge-off under section 166 of the Code, of an eligible loan shall be allocated to the class of gross interest income derived by the bank from its portfolio of eligible loans. Where such interest income includes both U.S. and foreign source income, or foreign source income includable within more than one separate limitation category under section 904(d)(1), such loss must be apportioned between or among these residual and statutory groupings. The apportionment shall be made according to the tax book value asset method as described in section 1.861-9T(g) of the regulations (relating to the apportionment of interest expense), subject to the following rules: (a) In applying the asset apportionment method, the average value of eligible loans held by a bank shall be treated as its only assets. Accordingly, losses realized with respect to eligible loans will be apportioned among the statutory and residual groupings based on the proportion of the average value of eligible loans giving rise to income in such groupings. (b) The average value of eligible loans outstanding within each statutory or residual grouping will be determined by utilizing the beginning of the year and end of the year averaging method described in section 1.861-9T(g)(2) of the regulations. The average value of eligible loans, however, shall not be computed utilizing the fair market value method of apportionment. (c) The transition rules contained in section 1012(h)(7) of the Technical Corrections and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-647, related to allocation and apportionment of interest expense are not applicable for purposes of this notice. (d) Any loan that qualifies as an exempt asset as defined in section 1.861-8T(d)(2)(ii)(A) of the regulations shall not be treated as an eligible loan as defined in section 4, paragraph (c) of this notice. (e) Eligible loans attributable to a foreign branch of a domestic corporation shall be taken into account as assets in a manner that is consistent with section 1.861-9T(f)(2) of the regulations, and losses on such loans shall be included in the amount of losses subject to allocation and apportionment under this notice. (f) A loan to a related person within the meaning of section 267(b) shall not be treated as an eligible loan. (g) In the case of an affiliated group that is eligible to file, but does not file, a consolidated return, allocation and apportionment of losses on eligible loans will be subject to adjustments similar to those described in section 1.861-11T(g) of the regulations. SEC. 6. EFFECTIVE DATE This notice shall be effective for taxable years beginning after December 31, 1986. DRAFTING INFORMATION Questions concerning this notice may be directed to Carol P. Tello, Office of Associate Chief Counsel (International), (202) 377- 9493.