Allocation & Sourcing of Income & Deductions Among
Taxpayers Engaged in a Global Dealing Operation.

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-208299-90] RIN 1545-AP01

TITLE: Allocation and Sourcing of Income and Deductions Among
Taxpayers Engaged in a Global Dealing Operation.

AGENCY: Internal Revenue Service (IRS), Treasury.

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

SUMMARY: This document contains proposed rules for the allocation
among controlled taxpayers and sourcing of income, deductions, gains
and losses from a global dealing operation; rules applying these
allocation and sourcing rules to foreign currency transactions and
to foreign corporations engaged in a U.S. trade or business; and
rules concerning the mark-to-market treatment resulting from hedging
activities of a global dealing operation. These proposed rules
affect foreign and domestic persons that are participants in such
operations either directly or indirectly through subsidiaries or
partnerships. These proposed rules are necessary to enable
participants in a global dealing operation to determine their arm's
length contribution to a global dealing operation. This document
also provides notice of a public hearing on these proposed
regulations.

DATES: Written comments must be received by June 4, 1998.

Outlines of oral comments to be discussed at the public hearing
scheduled for July 14, 1998, must be received by June 18, 1998.

ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-208299-90), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-208299- 90),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue,
N.W., Washington, D.C. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the "Tax Regs" option
on the IRS Home Page, or by submitting comments directly to the IRS
Internet site at
http://www.irs.ustreas.gov/prod/tax_regs/comments.html. The public
hearing will be held in room 2615, Internal Revenue Building, 1111
Constitution Avenue, NW, Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations in
general, Ginny Chung of the Office of Associate Chief Counsel
(International), (202) 622-3870; concerning the mark-to-market
treatment of global dealing operations, Richard Hoge or JoLynn Ricks
of the Office of Assistant Chief Counsel (Financial Institutions &
Products), (202) 622-3920; concerning submissions and the hearing,
Michael Slaughter, (202) 622-7190 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and
Budget for review in accordance with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)). Comments on the collections of information
should be sent to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information
and Regulatory Affairs, Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Reports Clearance officer,
T:FS:FP, Washington, DC 20224. Comments on the collections of
information should be received by May 5, 1998.

Comments are specifically requested concerning:

Whether the proposed collections of information are necessary for
the proper performance of the functions of the Internal Revenue
Service, including whether the information will have practical
utility;

The accuracy of the estimated burden associated with the proposed
collections of information (see below); How the quality, utility,
and clarity of the information to be collected may be enhanced;

How the burden of complying with the proposed collections of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and Estimates of capital or start-up costs and costs of
operation, maintenance, and purchase of services to provide
information.

The collections of information in these proposed regulations are in
��1.475(g)-2(b), 1.482-8(b)(3), 1.482-8(c)(3), 1.482- 8(d)(3),
1.482-8(e)(5), 1.482-8(e)(6), and 1.863-3(h). The information is
required to determine an arm's length price. The collections of
information are mandatory. The likely recordkeepers are business or
other for-profit institutions.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by the Office
of Management and Budget.

Books or records relating to a collection of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26
U.S.C. 6103.

Estimated total annual recordkeeping burden: 20,000 hoU.S.

Estimated average annual burden per recordkeeper is 40 hoU.S.

Estimated number of recordkeepers: 500.

Background

In 1990, the IRS issued Announcement 90-106, 1990-38 IRB 29,
requesting comments on how the regulations under sections 482, 864
and other sections of the Internal Revenue Code could be improved to
address the taxation issues raised by global trading of financial
instruments. Section 482 concerns the allocation of income,
deductions, credits and allowances among related parties.

Section 864 provides rules for determining the income of a foreign
person that is "effectively connected" with the conduct of a U.S.
trade or business and therefore can be taxed on a net income basis
in the United States. Provisions under sections 864(c)(2) and (3)
provide rules for determining when U.S. source income is effectively
connected income (ECI); section 864(c)(4) provides rules for
determining when foreign source income is ECI.

The rules for determining the source of income generally are in
sections 861, 862, 863 and 865, and the regulations promulgated
under those sections. Section 1.863-7 provides a special rule for
income from notional principal contracts, under which such income
will be treated as U.S.-source ECI if it arises from the conduct of
a U.S. trade or business under principles similar to those that
apply under section 864(c)(2). An identical rule applies for
determining U.S. source ECI under �1.988-4(c) from foreign exchange
gain or loss from certain transactions denominated in a foreign
currency.

Because no regulations were issued in response to the comments that
were received after Announcement 90-106, there remain a number of
uncertainties regarding the manner in which the existing regulations
described above apply to financial institutions that deal in
financial instruments through one or more entities or trading
locations. Many financial institutions have sought to resolve these
problems by negotiating advance pricing agreements (APAs) with the
IRS. In 1994, the IRS published Notice 94-40, 1994-1 CB 351, which
provided a generic description of the IRS's experience with global
dealing operations conducted in a functionally fully integrated
manner.

Notice 94-40 specified that it was not intended to prescribe rules
for future APAs or for taxpayers that did not enter into APAs.
Moreover, Notice 94-40 provided no guidance of any kind for
financial institutions that do not conduct their global dealing
operations in a functionally fully integrated manner.

Explanation of Provisions

1. Introduction

This document contains proposed regulations relating to the
determination of an arm's length allocation of income among
participants engaged in a global dealing operation. For purposes of
these regulations, the terms "global dealing operation" and
"participant" are specifically defined. The purpose of these
regulations is to provide guidance on applying the arm's length
principle to transactions between participants in a global dealing
operation. The general rules in the final regulations under section
482 that provide the best method rule, comparability analysis, and
the arm's length range are generally adopted with some modifications
to conform these principles to the global dealing environment. In
addition, the proposed regulations contain new specified methods
with respect to global dealing operations that replace the specified
methods in ��1.482- 3 through 1.482-6.

This document also contains proposed regulations addressing the
source of income earned in a global dealing operation and the
circumstances under which such income is effectively connected to a
foreign corporation's U.S. trade or business. The regulations
proposed under section 863 generally source income earned in a
global dealing operation by reference to the residence of the
participant. For these purposes, residence is defined under section
988(a)(3)(B) such that global dealing income may be sourced between
separate qualified business units (QBUs) of a single taxpayer or
among separate taxpayers who are participants, as the case may be.
Exceptions to this general rule are discussed in further detail
below.

Proposed amendments to the regulations under section 864 provide
that the principles of the proposed section 482 regulations may be
applied to determine the amount of income, gain or loss from a
foreign corporation's global dealing operation that is effectively
connected to a U.S. trade or business of a participant. Similar
rules apply to foreign currency transactions that are part of a
global dealing operation.

The combination of these allocation, sourcing, and effectively
connected income rules is intended to enable taxpayers to establish
and recognize on an arm's length basis the contributions provided by
separate QBUs to a global dealing operation.

This document also contains proposed regulations under section 475
to coordinate the accounting rules governing the timing of income
with the allocation, sourcing, and effectively connected income
rules proposed in this document and discussed above.

2. Explanation of Specific Provisions

A. �1.482-1(a)(1)

Section 1.482-1(a)(1) has been amended to include expressly
transactions undertaken in the course of a global dealing operation
between controlled taxpayers within the scope of transactions
covered by section 482. The purpose of this amendment is to clarify
that the principles of section 482 apply to evaluate whether global
dealing transactions entered into between controlled taxpayers are
at arm's length.

B. �1.482-8(a) - General Requirements

Section 1.482-8(a)(1) lists specified methods that may be used to
determine if global dealing transactions entered into between
controlled taxpayers are at arm's length. The enumerated methods
must be applied in accordance with all of the provisions of
�1.482-1, including the best method rule of �1.482-1(c), the
comparability analysis of �1.482-1(d), and the arm's length range
rule of �1.482-1(e). The section further requires that any
modifications or supplemental considerations applicable to a global
dealing operation set forth in �1.482-8(a)(3) be taken into account
when applying any of the transfer pricing methods.

Specific modifications to the factors for determining comparability
and the arm's length range rule are provided in �1.482-8(a)(3).
These modifications and special considerations are discussed in more
detail under their respective headings below.

C. �1.482-8(a)(2) - Definitions Applicable to a Global Dealing
Operation

Section 1.482-8(a)(2) defines "global dealing operation,"
"participant," "regular dealer in securities," and other terms that
apply for purposes of these regulations. These definitions
supplement the general definitions provided in �1.482-1(i).

The rules of �1.482-8 apply only to a global dealing operation. A
"global dealing operation" consists of the execution of customer
transactions (including marketing, sales, pricing and risk
management activities) in a particular financial product or line of
financial products, in multiple tax jurisdictions and/or through
multiple participants. The taking of proprietary positions is not
included within the definition of a global dealing operation unless
the proprietary positions are entered into by a regular dealer in
securities in connection with its activities as such a dealer. Thus,
a hedge fund that does not have customers is not covered by these
regulations.

Positions held in inventory by a regular dealer in securities,
however, are covered by these regulations even if the positions are
unhedged because the dealer is taking a view as to future market
changes.

Similarly, lending activities are not included within the definition
of a global dealing operation. However, if a person makes a market
in, by buying and selling, asset-backed securities, the income from
that activity may be covered by these regulations, regardless of
whether the dealer was a party to the loans backing the securities.
Therefore, income earned from such lending activities or from
securities held for investment is not income from a global dealing
operation and is not governed by this section. A security may be
held for investment for purposes of this section even though it is
not identified as held for investment under section 475.

Activities unrelated to the conduct of a global dealing operation
are not covered by these regulations, even if they are accounted for
on a mark-to-market basis. Accordingly, income from proprietary
trading that is not undertaken in connection with a global dealing
operation, and other financial transactions that are not entered
into in a dealing capacity are not covered by these proposed
regulations. The regulations require that participants engaged in
dealing and nondealing activities and/or multiple dealing activities
segregate income and expense attributable to each separate dealing
operation so that the best method may be used to evaluate whether
controlled transactions entered into in connection with a particular
dealing activity are priced at arm's length. The regulations also
require that taxpayers segregate their dealer activities from their
lending, proprietary trading or other investment activities not
entered into in connection with a global dealing operation. Comments
are solicited on whether the proposed regulations issued under
section 475 in this notice of proposed rulemaking are sufficient to
facilitate identification of the amount of income that should be
subject to allocation under the global dealing regulations.

The term A participant @ is defined as a controlled taxpayer that is
either a regular dealer in securities within the meaning of
�1.482-8(a)(2)(iii), or a member of a group of controlled taxpayers
which includes a regular dealer in securities, so long as that
member conducts one or more activities related to the activities of
such dealer. For these purposes, such related activities are the
marketing, sales, pricing, and risk management activities necessary
to the definition of a global dealing operation. Additionally,
brokering is a related activity that may give rise to participant
status. Related activities do not include credit analysis,
accounting services, back office services, or the provision of a
guarantee of one or more transactions entered into by a regular
dealer in securities or other participant. This definition is
significant because the transfer pricing methods contained in this
section can only be used by participants, and only to evaluate
whether compensation attributable to a regular dealer in securities
or a marketing, sales, pricing, risk management or brokering
function is at arm's length. Whether the compensation paid for other
functions performed in the course of a global dealing operation
(including certain services and development of intangibles) is at
arm's length is determined under the appropriate section 482
regulations applicable to those transactions.

The definition of a global dealing operation does not require that
the global dealing operation be conducted around the world or on a
twenty-four hour basis. These regulations will apply if the
controlled taxpayers, or QBUs of a single taxpayer, operate in the
aggregate in more than one tax jurisdiction. It is not necessary,
however, for the participants to conduct the global dealing
operation in more than one tax jurisdiction. For example, a
participant that is resident in one tax jurisdiction may conduct its
participant activities in the global dealing operation through a
trade or business in another jurisdiction that is the same
jurisdiction where the dealer activity of a separate controlled
taxpayer takes place. In this situation, the rules of this section
apply to determine the allocation of income, gain or loss between
the two controlled taxpayers even if all of the income, gain or loss
is allocable within the same tax jurisdiction.

The term "regular dealer in securities" is specifically defined in
this regulation consistently with the definition of a regular dealer
under �1.954-2(a)(4)(iv). Under these proposed regulations, a dealer
in physical securities or currencies is a regular dealer in
securities if it regularly and actively offers to, and in fact does,
purchase securities or currencies from and sell securities or
currencies to customers who are not controlled taxpayers in the
ordinary course of a trade or business. In addition, a dealer in
derivatives is a regular dealer in securities if it regularly and
actively offers to, and in fact does, enter into, assume, offset,
assign or otherwise terminate positions in securities with customers
who are not controlled entities in the ordinary course of a trade or
business. The IRS solicits comments on whether these regulations
should be extended to cover dealers in commodities and/or persons
trading for their own account that are not dealers.

D. Best Method and Comparability

Consistent with the general principles of section 482, the best
method rule applies to evaluate the most appropriate method for
determining whether the controlled transactions are priced at arm's
length. New specified methods which replace the specified methods of
��1.482-2 through 1.482-6 for a global dealing operation are set
forth in ��1.482-8(b) through 1.482-8(f). The comparable profits
method of �1.482-5 has been excluded as a specified method for a
global dealing operation because of the high variability in profits
from company to company and year to year due to differences in
business strategies and fluctuations in the financial markets.

The proposed regulations do not apply specific methods to certain
trading models, such as those commonly referred to in the financial
services industry as "separate enterprise," "natural home," A
centralized product management, @ or "integrated trading." Rather,
the proposed regulations adopt the best method rule of �1.482-1(c)
to determine the most appropriate transfer pricing methodology,
taking into account all of the facts and circumstances of a
particular taxpayer's trading structure.

Consistent with the best method rule, there is no priority of
methods.

Application of the best method rule will depend on the structure and
organization of the individual taxpayer's global dealing operation
and the nature of the transaction at issue.

Where a taxpayer is engaged in more than one global dealing
operation, it will be necessary to segregate each activity and
determine on a transaction-by-transaction basis within each activity
which method provides the most reliable measure of an arm's length
price. It may be appropriate to apply the same method to multiple
transactions of the same type within a single business activity
entered into as part of a global dealing operation. For example, if
a taxpayer operates its global dealing activity in notional
principal contracts differently than its foreign exchange trading
activity, then the income from notional principal contracts may be
allocated using a different methodology than the income from foreign
exchange trading.

Moreover, the best method rule may require that different methods be
used to determine whether different controlled transactions are
priced at arm's length even within the same product line.

For example, one method may be the most appropriate to determine if
a controlled transaction between a global dealing operation and
another business activity is at arm's length, while a different
method may be the most appropriate to determine if the allocation of
income and expenses among participants in a global dealing operation
is at arm's length.

Section 1.482-8(a)(3) reiterates that the principle of comparability
in �1.482-1(d) applies to transactions entered into by a global
dealing operation. The comparability factors provided in �1.482-8(a)
(3) (functional analysis, risk, and economic conditions), however,
must be applied in place of the comparability factors discussed in
�1.482-1(d)(3). The comparability factors for contractual terms in
�1.482-8(a)(3) supplement the comparability factors for contractual
terms in �1.482-1(d)(3)(ii). The comparability factors in this
section have been included to provide guidance on the factors that
may be most relevant in assessing comparability in the context of a
global dealing operation.

E. Arm's Length Range

In determining the arm's length range, �1.482-1(e) will apply except
as modified by these proposed regulations. In determining the
reliability of an arm's length range, the IRS believes that it is
necessary to consider the fact that the market for financial
products is highly volatile and participants in a global dealing
operation frequently earn only thin profit margins. The reliability
of using a statistical range in establishing a comparable price of a
financial product in a global dealing operation is based on facts
and circumstances. In a global dealing operation, close proximity in
time between a controlled transaction and an uncontrolled
transaction may be a relevant factor in determining the reliability
of the uncontrolled transaction as a measure of the arm's length
price.

The relevant time period will depend on the price volatility of the
particular product.

The district director may, notwithstanding �1.482-1(e)(1), adjust a
taxpayer's results under a method applied on a transaction-by-
transaction basis if a valid statistical analysis demonstrates that
the taxpayer's controlled prices, when analyzed on an aggregate
basis, provide results that are not arm's length.

See �1.482-1(f)(2)(iv). This may occur, for example, when there is a
pattern of prices in controlled transactions that are higher or
lower than the prices of comparable uncontrolled transactions.

Comments are solicited on the types of analyses and factors that may
be relevant for pricing controlled financial transactions in a
global dealing operation. Section 1.482-1(e) continues to apply in
its entirety to transactions among participants that are common to
businesses other than a global dealing operation. In this regard,
the existing rules continue to apply to pricing of certain services
from a participant to a regular dealer in securities other than
services that give rise to participant status.

F. Comparable Uncontrolled Financial Transaction Method The
comparable uncontrolled financial transaction (CUFT) method is set
forth in �1.482-8(b). The CUFT method evaluates whether controlled
transactions satisfy the arm's length standard by comparing the
price of a controlled financial transaction with the price of a
comparable uncontrolled financial transaction.

Similarity in the contractual terms and risks assumed in entering
into the financial transaction are the most important comparability
factors under this method.

Ordinarily, in global dealing operations, proprietary pricing models
are used to calculate a financial product's price based upon market
data, such as interest rates, currency rates, and market risks. The
regulations contemplate that indirect evidence of the price of a
CUFT may be derived from a proprietary pricing model if the data
used in the model is widely and routinely used in the ordinary
course of the taxpayer's business to price uncontrolled
transactions, and adjustments are made to the amount charged to
reflect differences in the factors that affect the price to which
uncontrolled taxpayers would agree. In addition, the proprietary
pricing model must be used in the same manner to price transactions
with controlled and uncontrolled parties. If a taxpayer uses its
internal pricing model as evidence of a CUFT, it must, upon request,
furnish the pricing model to the district director in order to
substantiate its use.

G. Gross Margin Method

The gross margin method is set forth in �1.482-8(c) and should be
considered in situations where a taxpayer performs only a routine
marketing or sales function as part of a global dealing operation.
Frequently, taxpayers that perform the sales function in these
circumstances participate in the dealing of a variety of, rather
than solely identical, financial products. In such a case, the
variety of financial products sold within a relevant time period may
limit the availability of comparable uncontrolled financial
transactions. Where the taxpayer has performed a similar function
for a variety of products, however, the gross margin method can be
used to determine if controlled transactions are priced at arm's
length by reference to the amount earned by the taxpayer for
performing similar functions with respect to uncontrolled
transactions.

The gross margin method determines if the gross profit realized on
sales of financial products acquired from controlled parties is at
arm's length by comparing that profit to the gross profit earned on
uncontrolled transactions. Since comparability under this method
depends on the similarity of functions performed and risks assumed,
adjustments must be made for differences between the functions
performed in the disposition of financial products acquired in
controlled transactions and the functions performed in the
disposition of financial products acquired in uncontrolled
transactions. Although close product similarity will tend to improve
the reliability of the gross margin method, the reliability of this
method is not as dependent on product similarity as the CUFT method.

Participants in a global dealing operation may act simply as
brokers, or they may participate in structuring complex products.

As the role of the participant exceeds the brokerage function, it
becomes more difficult to find comparable functions because the
contributions made in structuring one complex financial product are
not likely to be comparable to the contributions made in structuring
a different complex financial product. Accordingly, the regulations
provide that the reliability of this method is decreased where a
participant is substantially involved in developing a financial
product or in tailoring the product to the unique requirements of a
customer prior to resale.

H. Gross Markup Method

Like the gross margin method, the gross markup method set forth in
�1.482-8(d) should generally be considered in situations where a
taxpayer performs only a routine marketing or sales function as part
of a global dealing operation, and, as is often the case, handles a
variety of financial products within a relevant time period. The
gross markup method is generally appropriate in cases where the
taxpayer performs a routine sales function in buying a financial
product from an uncontrolled party and reselling or transferring the
product to a controlled party.

The gross markup method determines if the gross profit earned on the
purchase of financial products from uncontrolled parties and sold to
controlled taxpayers is at arm's length by comparing that profit to
the gross profit earned on uncontrolled transactions. Like the gross
margin method, comparability under this method depends on the
similarity of the functions performed and risks assumed in the
controlled and uncontrolled transactions. Accordingly, adjustments
should be made for differences between the functions performed in
the sale or transfer of financial products to controlled parties,
and the functions performed with respect to the sale or transfer of
financial products to uncontrolled parties. Although close product
similarity will tend to improve the reliability of the gross markup
method, the reliability of this method is not as dependent on
product similarity as the CUFT method.

As in the gross margin method, the regulations provide that the
reliability of this method generally is decreased where a
participant is substantially involved in developing a financial
product or in tailoring the product to the unique requirements of a
customer prior to resale.

I. Profit Split Methods

New profit split methods are proposed for global dealing
participants under �1.482-8(e). Global dealing by its nature
involves a certain degree of integration among the participants in
the global dealing operation. The structure of some global dealing
operations may make it difficult to apply a traditional
transactional method to determine if income is allocated among
participants on an arm's length basis. Two profit split methods, the
total profit split method and the residual profit split method, have
been included as specified methods for determining if global dealing
income is allocated at arm's length.

Profit split methods may be used to evaluate if the allocation of
operating profit from a global dealing operation compensates the
participants at arm's length for their contribution by evaluating if
the allocation is one which uncontrolled parties would agree to.
Accordingly, the reliability of this method is dependent upon clear
identification of the respective contributions of each participant
to the global dealing operation.

In general, the profit split methods must be based on objective
market benchmarks that provide a high degree of reliability, i.e.,
comparable arrangements between unrelated parties that allocate
profits in the same manner and on the same basis. Even if such
comparable uncontrolled transactions are not available, however, the
taxpayer may be able to demonstrate that a total profit split
provides arm's length results that reflect the economic value of the
contribution of each participant, by reference to other objective
factors that provide reliability due to their arm's length nature.
For example, an allocation of income based on trader bonuses may be
reliable, under the particular facts and circumstances of a given
case, if the taxpayer can demonstrate that such bonuses are based on
the value added by the individual traders. By contrast, an
allocation based on headcount or gross expenses may be unreliable,
because the respective participants might, for example, have large
differences in efficiency or cost control practices, which would
tend to make such factors poor reflections of the economic value of
the functions contributed by each participant.

The proposed regulations define gross profit as gross income earned
by the global dealing operation. Operating expenses are those not
applicable to the determination of gross income earned by the global
dealing operation. The operating expenses are global expenses of the
global dealing operation and are subtracted from gross profit to
determine the operating profit.

Taxpayers may need to allocate operating expenses that relate to
more than one global dealing activity.

The regulations state that in appropriate circumstances a multi-
factor formula may be used to determine whether an allocation is at
arm's length. Use of a multi-factor formula is permitted so long as
the formula allocates the operating profit or loss based upon the
factors that uncontrolled taxpayers would consider. The regulations
do not prescribe specific factors to be used in the formula since
the appropriateness of any one factor will depend on all the facts
and circumstances associated with the global dealing operation.
However, the regulations require that the multi-factor formula take
into account all of the functions performed and risks assumed by a
participant, and attribute the appropriate amount of income or loss
to each function. The IRS also solicits comments concerning which
factors may be appropriate (for example, initial net present value
of derivatives contracts) and the circumstances under which specific
factors may be appropriately applied.

The purpose of the factors is to measure the relative value
contributed by each participant. Thus, adjustments must be made for
any circumstances other than the relative value contributed by a
participant that influence the amount of a factor so that the factor
does not allocate income to a participant based on circumstances
that are not relevant to the value of the function or activity being
measured. For example, if trader compensation is used to allocate
income among participants, and the traders in two different
jurisdictions would be paid different amounts (for example, due to
cost of living differences) to contribute the same value,
adjustments should be made for the difference so that the factors
accurately measure the value contributed by the trading function.
The IRS solicits comments regarding the types of adjustments that
should be made, how to make such adjustments, and the need for
further guidance on this point.

The total profit split method entails a one step process whereby the
operating profit is allocated among the participants based on their
relative contributions to the profitability of the global dealing
operation. No distinction is made between routine and nonroutine
contributions. The total profit split method may be useful to
allocate income earned by a highly integrated global dealing
operation where all routine and nonroutine dealer functions are
performed by each participant in each location.

Accordingly, total profit or loss of the global dealing operation
may be allocated among various jurisdictions based on the relative
performance of equivalent functions in each jurisdiction.

The residual profit split method entails a two step process.

In the first step, the routine functions are compensated with a
market return based upon the best transfer pricing method applicable
to that transaction. Routine functions may include, but are not
limited to, functions that would not give rise to participant status
and which should be evaluated under ��1.482-3 through 1.482-6. After
compensating the routine functions, the remaining operating profit
(the A residual profit @ ) is allocated among the participants based
upon their respective nonroutine contributions.

It should be noted that, while in appropriate cases a profit split
method may be used to determine if a participant is compensated at
arm's length, use of the profit split method does not change the
contractual relationship between participants, nor does it affect
the character of intercompany payments. For example, if a controlled
taxpayer provides solely trading services to a global dealing
operation in a particular jurisdiction, any payment it receives as
compensation for services retains its character as payment for
services and, under the regulations, is not converted into a pro
rata share of each item of gross income earned by the global dealing
operation.

J. Unspecified Methods

Consistent with the principles underlying the best method rule, the
regulations provide the option to use an unspecified method if it is
determined to be the best method. The IRS solicits comments on the
extent to which the variety of methods on which specific guidance
has been provided is adequate.

Guidance on the use of a comparable profits method has specifically
not been included as a specified method in the proposed regulations
because use of that method depends on the existence of arrangements
between uncontrolled taxpayers that perform comparable functions and
assume comparable risks. Global dealing frequently involves the use
of unique intangibles such as trader know-how. Additionally,
anticipated profit is often influenced by the amount of risk a
participant is willing to bear. Accordingly, the IRS believes it is
unlikely that the comparability of these important functions can be
measured and adjusted for accurately in a global dealing operation.

K. Source of Global Dealing Income

Under current final regulations in �1.863-7(a), all of the income
attributable to a notional principal contract is sourced by
reference to the taxpayer's residence. Exceptions are provided for
effectively connected notional principal contract income, and for
income earned by a foreign QBU of a U.S. resident taxpayer if the
notional principal contract is properly reflected on the books of
the foreign QBU. Attribution of all of the income from a notional
principal contract to a single location has generally been referred
to as the A all or nothing @ rule. The current final regulations do
not provide for multi-location sourcing of notional principal
contract income among the QBUs that have participated in the
acquisition or risk management of a notional principal contract and
therefore do not recognize that significant activities, including
structuring or risk managing derivatives, often occur through QBUs
in more than one jurisdiction.

Recognizing the need for multi-location sourcing of income earned in
a global dealing operation, the proposed regulations provide a new
rule under �1.863-3(h) which sources income from a global dealing
operation in the same manner as the income would be allocated under
�1.482-8 if each QBU were a separate entity.

However, the rules must be applied differently to take into account
the economic differences between acting through a single legal
entity and through separate legal entities.

Accordingly, income from a single transaction may be split-sourced
to more than one location, so long as the allocation methodology
satisfies the arm's length standard. The all or nothing rule of
�1.863-7(a) continues to apply to notional principal contract income
attributable to activities not related to a global dealing
operation. Corresponding changes have been made in proposed
�1.988-4(h) to exclude exchange gain or loss derived in the conduct
of a global dealing operation from the general source rules in
�1.988-4(b) and (c).

These special source rules apply only with respect to participants
that perform a dealing, marketing, sales, pricing, risk management
or brokering function. Moreover, these rules do not apply to income,
such as fees for services, for which a specific source rule is
provided in section 861, 862 or 865 of the Code. Accordingly, if a
controlled taxpayer provides back office services, the amount and
source of an intercompany payment for such services is determined
under existing transfer pricing and sourcing rules applicable to
those services without regard to whether the controlled taxpayer is
also a participant in a global dealing operation.

If an entity directly bears the risk assumed by the global dealing
operation, it should be compensated for that function.

In providing, however, that the source (and effectively connected
status) of global dealing income is determined by reference to where
the dealing, marketing, sales, pricing, risk management or brokering
function that gave rise to the income occurred, the regulations
effectively provide that compensation for risk bearing should be
sourced by reference to where the capital is employed by traders,
marketers and salespeople, rather than the residence of the capital
provider. This principle applies where a taxpayer directly bears
risk arising from the conduct of a global dealing operation, such as
when it acts as a counterparty without performing other global
dealing functions. A special rule provides that the activities of a
dependent agent may give rise to participant status through a deemed
QBU that performs its participant functions in the same location
where the dependent agent performs its participant functions. The
deemed QBU may be created without regard to the books and records
requirement of �1.989-1(b).

As indicated, accounting, back office, credit analysis, and general
supervision and policy control functions do not give rise to
participant status in a global dealing operation but are services
that should be remunerated and sourced separately under existing
rules. This principle also applies where a taxpayer bears risk
indirectly, such as through the extension of a guarantee.
Accordingly, the sourcing rule of �1.863-3(h) does not apply to
interest, dividend, or guarantee fee income received by an owner or
guarantor of a global dealing operation that is conducted by another
controlled taxpayer. The source of interest, dividend and guarantee
fee income, substitute interest and substitute dividend payments
sourced under ��1.861-2(a)(7) and 1.861-3(a)(6), and other income
sourced by section 861, 862 or 865 continues to be governed by the
source rules applicable to those transactions.

The proposed regulations provide, consistent with U.S. tax
principles, that an agreement between two QBUs of a single taxpayer
does not give rise to a transaction because a taxpayer cannot enter
into nor profit from a A transaction @ with itself.

See, e.g., �1.446-3(c)(1). The IRS believes, however, that these
agreements between QBUs of a single taxpayer may provide evidence of
how income from the taxpayer's transactions with third parties
should be allocated among QBUs. It is a common practice for
taxpayers to allocate income or loss from transactions with third
parties among QBUs for internal control and risk management
purposes. Accordingly, the proposed regulations specifically provide
that such allocations may be used to source income to the same
extent and in the same manner as they may be used to allocate income
between related persons. Conversely, such transactions may not be
used to the extent they do not provide an arm's length result.

L. Determination of Global Dealing Income Effectively Connected with
a U.S. Business

After determining the source of income, it is necessary to determine
the extent to which such income is ECI. Under current law, the
general rule is that all of the income, gain or loss from a global
dealing operation is effectively connected with a U.S. trade or
business if the U.S. trade or business materially participates in
the acquisition of the asset that gives rise to the income, gain or
loss, or property is held for use in the active conduct of a U.S.
trade or business, or the business activities conducted by the U.S.
trade or business are a material factor in the realization of
income, gain or loss. As noted above, the current final regulations
do not permit the attribution of income, gain or loss from a single
transaction to more than one QBU.

To implement these rules, the regulations under ��1.864-4 and
1.864-6 have been amended to provide that income, gain or loss from
a global dealing operation that is allocated and sourced to a U.S.
trade or business under �1.863-3(h) shall be effectively connected.
In this regard, an asset used in a global dealing operation is
treated as an asset used in a U.S. trade or business to the extent
that an allocation is made to a U.S. QBU.

Similarly, the U.S. trade or business is also treated as a material
factor in the realization of income, gain or loss for which an
allocation is made to a U.S. QBU. A special rule for U.S. source
interest and dividend income, including substitute interest and
substitute dividends, earned by a foreign banking or similar
financial institution in a global dealing operation treats such
income as attributable to a U.S. trade or business to the extent
such income would be sourced to the United States under �1.863-3(h).
Any foreign source income allocated to the United States under the
principles of �1.863-3(h) is also treated as attributable to the
U.S. trade or business.

The proposed regulations also limit an entity's effectively
connected income from a global dealing operation to that portion of
an item of income, gain or loss that would be sourced to the U.S.
trade or business if the rules of �1.863-3(h) were to apply.

These rules are intended to ensure that income for which a specific
source rule is provided in section 861, 862 or 865 does not produce
effectively connected income unless it was earned through functions
performed by a U.S. QBU of the taxpayer.

With respect to notional principal contract income and foreign
exchange gain or loss, proposed ��1.863-3(h) and 1.988- 4(h) also
provide that such income, gain or loss is effectively connected with
the conduct of a U.S. trade or business to the extent that it is
sourced to the United States under �1.863-3(h).

In certain circumstances, the global dealing activities of an entity
acting as the agent of a foreign taxpayer in the United States may
cause the foreign taxpayer to be engaged in a U.S. trade or
business. Any income effectively connected with the U.S. trade or
business must be reported by the foreign corporation on a timely
filed U.S. tax return in order for the foreign corporation to be
eligible for deductions and credits attributable to such income. See
�1.882-4. In addition, the agent must also report any income earned
in its capacity as agent on its own tax return. The provisions
governing the time and manner for foreign corporations to make
elections under ��1.882-5 and 1.884-1 remain in force as
promulgated. Under current rules, these formalities must be observed
even if all of the global dealing income would be allocated between
a U.S. corporation and a foreign corporation's U.S. trade or
business. The IRS believes that these requirements are justified
because of potential differences that might occur with respect to
the realization of losses and between actual dividend remittances of
a U.S. corporation and deemed dividend remittances under the branch
profits tax. The IRS, however, solicits comments regarding whether
these filing requirements can be simplified, taking into
consideration the policies underlying the filing requirements of
�1.882-4.

The Business Profits article contained in U.S. income tax treaties
requires the United States to attribute to a permanent establishment
that portion of the income earned by the entity from transactions
with third parties that the permanent establishment might be
expected to earn if it were an independent enterprise. Because the
proposed regulations contained in this document allocate global
trading income among permanent establishments under the arm's length
principle of the Associated Enterprises article of U.S. income tax
treaties, such rules are consistent with our obligations under the
Business Profits article. Accordingly, a proposed rule under section
894 provides that, if a taxpayer is engaged in a global dealing
operation through a U.S. permanent establishment, the proposed
regulations will apply to determine the income attributable to that
U.S. permanent establishment under the applicable U.S. income tax
treaty.

M. Relationship to Other Regulations

The allocation rules contained herein do not apply to the allocation
of interest expense. As discussed in the preamble to �1.882-5 (TD
8658, 1996-1 CB 161, 162, 61 FR 9326, March 5, 1996), the rules
contained in �1.882-5 are the exclusive rules for allocating
interest expense, including under U.S. income tax treaties.

Proposed regulations have been issued under sections 882 and 884
(INTL-0054-95, 1996-1 CB 844, 61 FR 9377, March 5, 1996) for
purposes of allocating interest expense and determining the
U.S..assets and/or liabilities reflected on the books of a foreign
corporation's U.S. trade or business that are attributable to its
activities as a dealer under section 475. The proposed regulations
(and similar final regulations) under section 884 address the
treatment of assets which give rise to both effectively connected
and non-effectively connected income.

Those rules thus address a situation analogous to the split-sourcing
situation addressed in these proposed regulations. The IRS
anticipates issuing proposed regulations under section 861 that
provide a similar rule for purposes of allocating interest expense
of a U.S. corporation that has assets that give rise to split-
sourced income. Comments are solicited on the compatibility of the
proposed regulations contained in this document with the principles
of the proposed regulations that address a foreign corporation's
allocation of interest expense, including its computation of U.S.
assets included in step 1 of the �1.882-5 formula and component
liabilities included in steps 2 and 3 of the �1.882-5 formula.

The IRS believes that the transfer pricing compliance issues
associated with a global dealing operation are substantially similar
to those raised by related party transactions generally.

The IRS also believes that the existing regulations under section
6662 adequately address these issues. Accordingly, amendments have
not been proposed to the regulations under section 6662.

Section 6662 may not in certain circumstances, however, apply to the
computation of effectively connected income in accordance with
proposed regulations under section 475, 863, 864 or 988 contained in
this document. The IRS will propose regulations under section 6038C
regarding the information reporting and recordkeeping requirements
applicable to foreign corporations engaged in a global dealing
operation. It is anticipated that these regulations will coordinate
the application of sections 6662 and 6038C where necessary.

No inference should be drawn from the examples in these proposed
regulations concerning the treatment or significance of liquidity
and creditworthiness or the effect of such items on the valuation of
a security. The purpose of the proposed regulations under section
482 is not to provide guidance on the valuation of a security, but
rather to determine whether the prices of controlled transactions
satisfy the arm's length standard.

Section 475 and the regulations thereunder continue to govern
exclusively the valuation of securities.

N. Section 475

A dealer in securities as defined in section 475 is generally
required to mark its securities to market. Securities are exempt
from mark-to-market accounting if the securities are held for
investment or not held for sale to customers and are properly
identified on the taxpayer's books and records.

Additionally, securities that hedge positions that are not subject
to mark-to-market accounting are exempt from mark-to-market
accounting if they are properly identified.

Under the current regulations, a taxpayer may not take into account
an agreement between separate business units within the same entity
that transfers risk management responsibility from a non-dealing
business unit to a dealing business unit. Moreover, such an
agreement may not be used to allocate income, expense, gain or loss
between activities that are accounted for on a mark-to- market basis
and activities that are accounted for on a non-mark- to-market
basis. In contrast, the regulations proposed in this document under
sections 482, 863, 864, 894, and 988 allow a taxpayer to take into
account records of internal transfers when allocating global dealing
income earned from third parties for purposes of determining source
and effectively connected income.

This may cause a mismatch in the timing of income, expense, gain, or
loss.

For example, if a taxpayer's lending desk enters into a third-party
transaction that exposes the lending desk to currency or interest
rate risk, the lending desk may transfer responsibility for managing
the risk for that particular transaction to another business
activity that can manage the risk more efficiently (e.g., the desk
that deals in currency or interest rate derivatives). The dealing
desk then, in the ordinary course of its business, may enter into a
transaction such as a swap with a third party to hedge the aggregate
risk of the dealing desk and, indirectly, the risk incurred by the
lending desk with respect to the original transaction. Where, as is
generally the case, the dealing desk has a large volume of
transactions, it is not possible as a practical matter to associate
the aggregate hedge with the risk of the lending desk.

Since the transactions entered into by the dealing desk must
generally be marked to market, the third-party transaction that
hedges the aggregate risk of the dealing desk (which includes the
risk transferred from the lending desk) must generally also be
marked. To the extent that a portion of the income, expense, gain,
or loss from the aggregate hedging transaction is allocated to the
lending desk under the proposed global dealing regulations, the
potential timing mismatch described above will occur if the lending
desk accounts for its positions on a non-mark- to-market basis. This
mismatch could occur because the portion of the income, expense,
gain, or loss from the hedging transaction, although allocated to
the lending desk for sourcing and effectively connected income
purposes, will be accounted for on a mark-to-market basis under the
dealing desk's method of accounting. Entirely exempting the
aggregate hedging transaction from mark-to-market accounting does
not adequately solve this problem, because it results in the portion
of the income, expense, gain or loss from the aggregate hedging
transaction that is allocated to the dealing desk being accounted
for on other than a mark-to-market method.

As the example shows, respecting records of internal transfers for
purposes of sourcing without respecting these same records for
purposes of timing could produce unpredictable and arbitrary
results. Accordingly, the proposed regulations permit participants
in a global dealing operation to respect records of internal
transfers in applying the timing rules of section 475.

Because the need to reconcile sourcing and timing exists only in the
context of a cross-border operation, the proposed regulations have a
limited scope. In particular, for the proposed regulations to apply,
income of the global dealing desk must be subject to allocation
among two or more jurisdictions or be sourced to two or more
jurisdictions.

The purpose of the proposed regulations under section 475 is to
coordinate section 475 with the proposed global dealing regulations
and to facilitate identification of the amount of income, expense,
gain or loss from third party transactions that is subject to mark-
to-market accounting. This rule is not intended to allow a shifting
of income inconsistent with the arm's length standard.

Under the proposed section 475 regulations, an interdesk agreement
or "risk transfer agreement" (RTA) includes a transfer of
responsibility for risk management between a business unit that is
hedging some of its risk (the hedging .QBU) and another business
unit of the same taxpayer that uses mark-to-market accounting (the
marking QBU). If the marking QBU, the hedging QBU, and the RTA
satisfy certain requirements, the RTA is taken into account for
purposes of determining the timing of income allocated by the
proposed global dealing regulations to the separate business units
of a taxpayer.

The proposed amendments to the section 475 regulations require that
the marking QBU must be a dealer within the meaning of proposed
�1.482-8(a)(2)(iii) and that its income must be allocated to at
least two jurisdictions under proposed �1.482-8 or sourced to at
least two jurisdictions under proposed �1.863- 3(h). Additionally,
the RTA qualifies only if the marking QBU would mark its side of the
RTA to market under section 475 if the transaction were with an
unrelated third party. Thus, if the marking QBU were to identify the
RTA as a hedge of a position that is not subject to mark-to-market
accounting (such as debt issued by the marking QBU), the RTA would
not qualify. The IRS requests comments on whether the marking QBU
should ever be able to exempt its position in the RTA from mark-to-
market treatment and account for its position in the RTA.

The proposed amendments to the section 475 regulations are intended
to address situations where the hedging QBU transfers responsibility
for the management of risk arising from a transaction with a third
party. Accordingly, the proposed regulations require that the
hedging QBU's position in the RTA would be a hedge within the
meaning of �1.1221-2(b) if the transaction were entered into with an
unrelated entity. The IRS solicits comments on whether this
requirement is broad enough to address the business needs of
entities engaged in global dealing and nondealing activities.
Comments that suggest broadening the requirement (e.g., to include
risk reduction with respect to capital assets) should address how
such a regime could be coordinated with other relevant rules (e.g.,
the straddle rules).

Additionally, if a taxpayer suggests changes to the section 475
rules proposed in this notice, the IRS requests additional comments
addressing whether or not corresponding changes should be made to
�1.1221-2(d).

The proposed regulations also require that the RTA be recorded on
the books and records of the QBU no later than the time the RTA is
effective. RTAs that are not timely recorded do not qualify under
the proposed regulations. Additionally, the RTA must be accounted
for in a manner that is consistent with the QBU's usual accounting
practices.

If all of the requirements of the proposed regulations are
satisfied, then for purposes of determining the timing of income,
expense, gain, or loss allocated to a QBU under the global dealing
regulations, the marking QBU and the hedging QBU account for their
respective positions in the RTA as if the position were entered into
with an unrelated third party.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory impact analysis is not required. It
is hereby certified that these regulations do not have a significant
economic impact on a substantial number of small entities. This
certification is based upon the fact that these regulations affect
entities who participate in cross-border global dealing of stocks
and securities. These regulations affect the source of income and
allocation of income, deductions, credits, and allowances among such
entities. The primary participants who engage in cross-border global
dealing activities are large regulated commercial banks and
brokerage firms, and investment banks. Accordingly, the IRS does not
believe that a substantial number of small entities engage in cross-
border global dealing activities covered by these regulation.
Therefore, a Regulatory Flexibility Analysis under the Regulatory
Flexibility Act (5 U.S.C. Chapter 6) is not required. Pursuant to
section 7805(f) of the Code, this notice of proposed rulemaking will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments that are
submitted timely to the IRS (a signed original and eight (8)
copies). All comments will be available for public inspection and
copying..A public hearing has been scheduled for July 14, 1998, at
10 a.m. in room 2615, Internal Revenue Building, 1111 Constitution
Avenue NW, Washington, DC. Because of access restrictions, visitors
will not be admitted beyond the Internal Revenue Building lobby more
than 15 minutes before the hearing starts.

The rules of 26 CFR 601.601(a)(3) apply to the hearing.

Persons that wish to present oral comments at the hearing must
submit written comments by June 4, 1998, and submit an outline of
the topics to be discussed and the time to be devoted to each topic
by June 18, 1998.

A period of 10 minutes will be allotted to each person for making
comments.

An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed.

Copies of the agenda will be available free of charge at the
hearing.

Proposed Effective Date

These regulations are proposed to be effective for taxable years
beginning after the date final regulations are published in the
Federal Register.

Drafting Information

The principal authors of these regulations are Ginny Chung of the
Office of Associate Chief Counsel (International) and Richard Hoge
of the Office of Assistant Chief Counsel (Financial Institutions &
Products). However, other personnel from the IRS and Treasury
Department participated in their development.

List of Subjects in 26 CFR Part 1 Income taxes, Reporting and
recordkeeping requirements.

Proposed Amendments to the Regulations

Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read as follows:

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

�1.475(g)-2 also issued under 26 U.S.C. 475. * * *

�1.482-8 also issued under 26 U.S.C. 482. * * *

Section 1.863-3(h) also issued under 26 U.S.C. 863 and 26 U.S.C.
865(j). * * *

Section 1.988-4(h) also issued under 26 U.S.C. 863 and 26 U.S.C.
988. * * *

Par. 2. Section 1.475(g)-2 is added as follows:

�1.475(g)-2 Risk transfer agreements in a global dealing operation.

(a) In general. This section provides computational rules to
coordinate the application of section 475 and �1.446-4 with rules
for allocation and sourcing under the global dealing regulations. If
the requirements in paragraph (c) of this section are met, a risk
transfer agreement (RTA) (as defined in paragraph (b) of this
section) is accounted for under the rules of paragraph (d) of this
section.

(b) Definition of risk transfer agreement. For purposes of this
section, a risk transfer agreement (RTA) is a transfer of risk
between two qualified business units (QBUs) (as defined in
�1.989(a)-1(b)) of the same taxpayer such that--

(1) The transfer is consistent with the business practices and risk
management policies of each QBU;

(2) The transfer is evidenced in each QBU's books and records;

(3) Each QBU records the RTA on its books and records at a time no
later than the time the RTA is effective; and

(4) Except to the extent required by paragraph (b)(3) of this
section, the entry in the books and records of each QBU is
consistent with that QBU's normal accounting practices.

(c) Requirements for application of operational rule--(1) The
position in the RTA of one QBU (the hedging QBU) would qualify as a
hedging transaction (within the meaning of �1.1221- 2(b)) with
respect to that QBU if--

(i) The RTA were a transaction entered into with an unrelated party;
and

(ii) For purposes of determining whether the hedging QBU's position
satisfies the risk reduction requirement in �1.1221-2(b), the only
risks taken into account are the risks of the hedging QBU (that is,
the risks that would be taken into account if the hedging QBU were a
separate corporation that had made a separate-entity election under
�1.1221-2(d)(2));

(2) The other QBU (the marking QBU) is a regular dealer in
securities (within the meaning of �1.482-8(a)(2)(iii));

(3) The marking QBU would mark to market its position in the RTA
under section 475 if the RTA were a transaction entered into with an
unrelated party; and

(4) Income of the marking QBU is subject to allocation under
�1.482-8 to two or more jurisdictions or is sourced under �1.863-
3(h) to two or more jurisdictions.

(d) Operational rule. If the requirements in paragraph (c) of this
section are met, each QBU that is a party to a RTA (as defined in
paragraph (b) of this section) takes its position in the RTA into
account as if that QBU had entered into the RTA with an unrelated
party. Thus, the marking QBU marks its position to market, and the
hedging QBU accounts for its position under �1.446-4. Because this
section only effects coordination with the allocation and sourcing
rules, it does not affect factors such as the determination of the
amount of interest expense that is incurred by either QBU and that
is subject to allocation and apportionment under section 864(e) or
882(c).

Par. 3. Section 1.482-0 is amended as follows:

1. The introductory text is revised.

2. The section heading and entries for �1.482-8 are redesignated as
the section heading and entries for �1.482-9.

3. A new section heading and entries for �1.482-8 are added.

The addition and revision read as follows:

�1.482-0 Outline of regulations under section 482.

This section contains major captions for ��1.482-1 through 1.482-9.

* * * * *

�1.482-8 Allocation of income earned in a global dealing operation.

(a) General requirements and definitions.

(1) In general.

(2) Definitions.

(i) Global dealing operation.

(ii) Participant.

(iii) Regular dealer in securities.

(iv) Security.

(3) Factors for determining comparability for a global dealing
operation.

(i) Functional analysis.

(ii) Contractual terms.

(iii) Risk.

(iv) Economic conditions.

(4) Arm's length range.

(i) General rule.

(ii) Reliability.

(iii) Authority to make adjustments.

(5) Examples.

(b) Comparable uncontrolled financial transaction method.

(1) General rule.

(2) Comparability and reliability.

(i) In general.

(ii) Adjustments for differences between controlled and uncontrolled
transactions.

(iii) Data and assumptions.

(3) Indirect evidence of the price of a comparable uncontrolled
financial transaction.

(i) In general.

(ii) Public exchanges or quotation media.

(iii) Limitation on use of public exchanges or quotation media.

(4) Arm's length range..(5) Examples.

(c) Gross margin method.

(1) General rule.

(2) Determination of an arm's length price.

(i) In general.

(ii) Applicable resale price.

(iii) Appropriate gross profit.

(3) Comparability.

(i) In general.

(ii) Adjustments for differences between controlled and uncontrolled
transactions.

(iii) Reliability.

(iv) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Arm's length range.

(5) Example.

(d) Gross markup method.

(1) General rule.

(2) Determination of an arm's length price.

(i) In general.

(ii) Appropriate gross profit.

(3) Comparability and reliability.

(i) In general.

(ii) Adjustments for differences between controlled and uncontrolled
transactions.

(iii) Reliability.

(iv) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(4) Arm's length range.

(e) Profit split method.

(1) General rule.

(2) Appropriate share of profit and loss.

(i) In general.

(ii) Adjustment of factors to measure contribution clearly.

(3) Definitions.

(4) Application.

(5) Total profit split.

(i) In general.

(ii) Comparability.

(iii) Reliability.

(iv) Data and assumptions.

(A) In general.

(B) Consistency in accounting.

(6) Residual profit split.

(i) In general.

(ii) Allocate income to routine contributions.

(iii) Allocate residual profit.

(iv) Comparability.

(v) Reliability.

(vi) Data and assumptions.

(A) General rule.

(B) Consistency in accounting.

(7) Arm's length range.

(8) Examples.

(f) Unspecified methods.

(g) Source rule for qualified business units.

Par. 4. Section 1.482-1 is amended as follows:

1. In paragraph (a)(1), remove the last sentence and add two new
sentences in its place.

2. Revise paragraph (b)(2)(i).

3. In paragraph (c)(1), revise the last sentence.

4. In paragraph (d)(3)(v), revise the last sentence.

5. In paragraph (i), revise the introductory text.

The additions and revisions read as follows:

�1.482-1 Allocation of income and deductions among taxpayers.

(a) In general--(1) Purpose and scope. * * * Section 1.482- 8
elaborates on the rules that apply to controlled entities engaged in
a global securities dealing operation. Finally, �1.482-9 provides
examples illustrating the application of the best method rule.

* * * * *

(b) * * *

(2) * * *

(i) Methods. Sections 1.482-2 through 1.482-6 and �1.482-8 provide
specific methods to be used to evaluate whether transactions between
or among members of the controlled group satisfy the arm's length
standard, and if they do not, to determine the arm's length result.

(c) Best method rule--(1) In general. * * * See �1.482-9 for
examples of the application of the best method rule.

* * * * *

(d) * * *

(3) * * *

(v) Property or services. * * * For guidance concerning the specific
comparability considerations applicable to transfers of tangible and
intangible property, see ��1.482-3 through 1.482-6 and �1.482-8; see
also �1.482-3(f), dealing with the coordination of the intangible
and tangible property rules.

* * * * *

(i) Definitions. The definitions set forth in paragraphs (i)(1)
through (10) of this section apply to ��1.482-1 through 1.482-9.

* * * * *

Par. 5. Section 1.482-2 is amended as follows:

1. In paragraph (a)(3)(iv), revise the first sentence.

2. Revise paragraph (d).

The revisions read as follows:

�1.482-2 Determination of taxable income in specific situations.

(a) * * *

(3) * * *

(iv) Fourth, section 482 and paragraphs (b) through (d) of this
section and ��1.482-3 through 1.482-8, if applicable, may be applied
by the district director to make any appropriate.allocations, other
than an interest rate adjustment, to reflect an arm's length
transaction based upon the principal amount of the loan or advance
and the interest rate as adjusted under paragraph (a)(3)(i), (ii),
or (iii) of this section. * * *

* * * * *

(d) Transfer of property. For rules governing allocations under
section 482 to reflect an arm's length consideration for controlled
transactions involving the transfer of property, see ��1.482-3
through 1.482-6 and �1.482-8.

�1.482-8 [Redesignated as �1.482-9] Par. 6. Section 1.482-8 is
redesignated as �1.482-9 and a new �1.482-8 is added to read as
follows:

�1.482-8 Allocation of income earned in a global securities dealing
operation.

(a) General requirements and definitions--(1) In general.

Where two or more controlled taxpayers are participants in a global
dealing operation, the allocation of income, gains, losses,
deductions, credits and allowances (referred to herein as income and
deductions) from the global dealing operation is determined under
this section. The arm's length allocation of income and deductions
related to a global dealing operation must be determined under one
of the methods listed in paragraphs (b) through (f) of this section.
Each of the methods must be applied in accordance with all of the
provisions of �1.482-1, including the best method rule of
�1.482-1(c), the comparability analysis of �1.482-1(d), and the
arm's length range of �1.482-1(e), as those sections are
supplemented or modified in paragraphs (a)(3) and (a)(4) of this
section. The available methods are--

(i) The comparable uncontrolled financial transaction method,
described in paragraph (b) of this section;

(ii) The gross margin method, described in paragraph (c) of this
section;

(iii) The gross markup method, described in paragraph (d) of this
section;

(iv) The profit split method, described in paragraph (e) of this
section; and

(v) Unspecified methods, described in paragraph (f) of this section.

(2) Definitions--(i) Global dealing operation. A global dealing
operation consists of the execution of customer transactions,
including marketing, sales, pricing and risk management activities,
in a particular financial product or line of financial products, in
multiple tax jurisdictions and/or through multiple participants, as
defined in paragraph (a)(2)(ii) of this section. The taking of
proprietary positions is not included within the definition of a
global dealing operation unless the proprietary positions are
entered into by a regular dealer in securities in its capacity as
such a dealer under paragraph (a)(2)(iii) of this section. Lending
activities are not included within the definition of a global
dealing operation.

Therefore, income earned from such lending activities or from
securities held for investment is not income from a global dealing
operation and is not governed by this section. A global dealing
operation may consist of several different business activities
engaged in by participants. Whether a separate business activity is
a global dealing operation shall be determined with respect to each
type of financial product entered on the taxpayer's books and
records.

(ii) Participant--(A) A participant is a controlled taxpayer, as
defined in �1.482-1(i)(5), that is--

(1) A regular dealer in securities as defined in paragraph (a)(2)
(iii) of this section; or

(2) A member of a group of controlled taxpayers which includes a
regular dealer in securities, but only if that member conducts one
or more activities related to the activities of such dealer.

(B) For purposes of paragraph (a)(2)(ii)(A)(2) of this section, such
related activities are marketing, sales, pricing, risk management or
brokering activities. Such related activities do not include credit
analysis, accounting services, back office services, general
supervision and control over the policies of the controlled
taxpayer, or the provision of a guarantee of one or more
transactions entered into by a regular dealer in securities or other
participant.

(iii) Regular dealer in securities. For purposes of this section, a
regular dealer in securities is a taxpayer that--

(A) Regularly and actively offers to, and in fact does, purchase
securities from and sell securities to customers who are not
controlled taxpayers in the ordinary course of a trade or business;
or

(B) Regularly and actively offers to, and in fact does, enter into,
assume, offset, assign or otherwise terminate positions in
securities with customers who are not controlled entities in the
ordinary course of a trade or business.

(iv) Security. For purposes of this section, a security is a
security as defined in section 475(c)(2) or foreign currency.

(3) Factors for determining comparability for a global dealing
operation. The comparability factors set out in this paragraph (a)
(3) must be applied in place of the comparability factors described
in �1.482-1(d)(3) for purposes of evaluating a global dealing
operation.

(i) Functional analysis. In lieu of the list set forth in
�1.482-1(d)(3)(i)(A) through (H), functions that may need to be
accounted for in determining the comparability of two transactions
are--

(A) Product research and development;

(B) Marketing;

(C) Pricing;

(D) Brokering; and

(E) Risk management.

(ii) Contractual terms. In addition to the terms set forth in
�1.482-1(d)(3)(ii)(A), and subject to �1.482-1(d)(3)(ii)(B),
significant contractual terms for financial products transactions
include--

(A) Sales or purchase volume;

(B) Rights to modify or transfer the contract;

(C) Contingencies to which the contract is subject or that are
embedded in the contract;

(D) Length of the contract;

(E) Settlement date;

(F) Place of settlement (or delivery);

(G) Notional principal amount;

(H) Specified indices;

(I) The currency or currencies in which the contract is denominated;

(J) Choice of law and jurisdiction governing the contract to the
extent chosen by the parties; and

(K) Dispute resolution, including binding arbitration.

(iii) Risk. In lieu of the list set forth in �1.482- 1(d)(3),
significant risks that could affect the prices or profitability
include--

(A) Market risks, including the volatility of the price of the
underlying property;

(B) Liquidity risks, including the fact that the property (or the
hedges of the property) trades in a thinly traded market; (C)
Hedging risks;

(D) Creditworthiness of the counterparty; and

(E) Country and transfer risk.

(iv) Economic conditions. In lieu of the list set forth in
�1.482-1(d)(3)(iv)(A) through (H), significant economic conditions
that could affect the prices or profitability include--

(A) The similarity of geographic markets;

(B) The relative size and sophistication of the markets;

(C) The alternatives reasonably available to the buyer and seller;

(D) The volatility of the market; and

(E) The time the particular transaction is entered into.

(4) Arm's length range-- (i) General rule. Except as modified in
this paragraph (a)(4), �1.482-1(e) will apply to determine the arm's
length range of transactions entered into by a global dealing
operation as defined in paragraph (a)(2)(i) of this section. In
determining the arm's length range, whether the participant is a
buyer or seller is a relevant factor.

(ii) Reliability. In determining the reliability of an arm's length
range, it is necessary to consider the fact that the market for
financial products is highly volatile and participants in a global
dealing operation frequently earn only thin profit margins. The
reliability of using a statistical range in establishing a
comparable price of a financial product in a global dealing
operation is based on facts and circumstances. In a global dealing
operation, close proximity in time between a controlled transaction
and an uncontrolled transaction may be a relevant factor in
determining the reliability of the uncontrolled transaction as a
measure of the arm's length price.

The relevant time period will depend on the price volatility of the
particular product.

(iii) Authority to make adjustments. The district director may,
notwithstanding �1.482-1(e)(1), adjust a taxpayer's results under a
method applied on a transaction by transaction basis if a valid
statistical analysis demonstrates that the taxpayer's controlled
prices, when analyzed on an aggregate basis, provide results that
are not arm's length. See �1.482-1(f)(2)(iv). This may occur, for
example, when there is a pattern of prices in controlled
transactions that are higher or lower than the prices of comparable
uncontrolled transactions.

(5) Examples. The following examples illustrate the principles of
this paragraph (a).

Example 1.Identification of participants. (i) B is a foreign bank
that acts as a market maker in foreign currency in country X, the
country of which it is a resident. C, a country Y resident
corporation, D, a country Z resident corporation, and USFX, a U.S.
resident corporation are all members of a controlled group of
taxpayers with B, and each acts as a market maker in foreign
currency. In addition to market-making activities conducted in their
respective countries, C, D, and USFX each employ marketers and
traders, who also perform risk management with respect to their
foreign currency operations. In a typical business day, B, C, D, and
USFX each enter into several hundred spot and forward contracts to
purchase and sell Deutsche marks (DM) with unrelated third parties
on the interbank market. In the ordinary course of business, B, C,
D, and USFX also enter into contracts to purchase and sell DM with
each other.

(ii) Under �1.482-8(a)(2)(iii), B, C, D, and USFX are each regular
dealers in securities because they each regularly and actively offer
to, and in fact do, purchase and sell currencies to customers who
are not controlled taxpayers, in the ordinary course of their trade
or business. Consequently, each controlled taxpayer is also a
participant. Together, B, C, D, and USFX conduct a global dealing
operation within the meaning of �1.482- 8(a)(2)(i) because they
execute customer transactions in multiple tax jurisdictions.
Accordingly, the controlled transactions between B, C, D, and USFX
are evaluated under the rules of �1.482-8.

Example 2.Identification of participants. (i) The facts are the same
as in Example 1, except that USFX is the only member of the group of
controlled taxpayers that buys from and sells foreign currency to
customers. C performs marketing and pricing activities with respect
to the controlled group's foreign currency operation. D performs
accounting and back office services for B, C, and USFX, but does not
perform any marketing, sales, pricing, risk management or brokering
activities with respect to the controlled group's foreign currency
operation. B provides guarantees for all transactions entered into
by USFX.

(ii) Under �1.482-8(a)(2)(iii), USFX is a regular dealer in
securities and therefore is a participant. C also is a participant
because it performs activities related to USFX's foreign currency
dealing activities. USFX's and C's controlled transactions relating
to their DM activities are evaluated under �1.482-8. D is not a
participant in a global dealing operation because its accounting and
back office services are not related activities within the meaning
of �1.482-8(a)(2)(ii)(B). B also is not a participant in a global
dealing operation because its guarantee function is not a related
activity within the meaning of �1.482-8(a)(2)(ii)(B). Accordingly,
the determination of whether transactions between B and D and other
members of the controlled group are at arm's length is not
determined under �1.482-8.

Example 3.Scope of a global dealing operation. (i) C, a U.S.
resident commercial bank, conducts a banking business in the United
States and in countries X and Y through foreign branches.

C regularly and actively offers to, and in fact does, purchase from
and sell foreign currency to customers who are not controlled
taxpayers in the ordinary course of its trade or business in the
United States and countries X and Y. In all the same jurisdictions,
C also regularly and actively offers to, and in fact does, enter
into, assume, offset, assign, or otherwise terminate positions in
interest rate and cross-currency swaps with customers who are not
controlled taxpayers. In addition, C regularly makes loans to
customers through its U.S. and foreign branches. C regularly sells
these loans to a financial institution that repackages the loans
into securities.

(ii) C is a regular dealer in securities within the meaning of
�1.482-8(a)(2)(ii) because it purchases and sells foreign currency
and enters into interest rate and cross-currency swaps with
customers. Because C conducts these activities through U.S. and
foreign branches, these activities constitute a global dealing
operation within the meaning of �1.482-8(a)(2)(i). The income,
expense, gain or loss from C's global dealing operation is sourced
under ��1.863-3(h) and 1.988-4(h). Under �1.482- 8(a)(2)(i), C's
lending activities are not, however, part of a global dealing
operation.

Example 4.Dissimilar products. The facts are the same as in Example
1, but B, C, D, and USFX also act as a market maker in Malaysian
ringgit-U.S. dollar cross-currency options in the United States and
countries X, Y, and Z. The ringgit is not widely traded throughout
the world and is considered a thinly traded currency. The functional
analysis required by �1.482- 8(a)(3)(i) shows that the development,
marketing, pricing, and risk management of ringgit-U.S. dollar
cross-currency option contracts are different than that of other
foreign currency contracts, including option contracts. Moreover,
the contractual terms, risks, and economic conditions of ringgit-
U.S. dollar cross-currency option contracts differ considerably from
that of other foreign currency contracts, including option
contracts.

See �1.482-8(a)(3)(ii) through (iv). Accordingly, the ringgit-U.

S. dollar cross-currency option contracts are not comparable to
contracts in other foreign currencies.

Example 5.Relevant time period. (i) USFX is a U.S. resident
corporation that is a regular dealer in securities acting as a
market maker in foreign currency by buying from and selling
currencies to customers. C performs marketing and pricing activities
with respect to USFX's foreign currency operation.

Trading in Deutsche marks (DM) is conducted between 10:00 a.m.

and 10:30 a.m. and between 10:45 a.m. and 11:00 a.m. under the
following circumstances.

10:00 a.m. 1.827DM: $1 Uncontrolled Transaction

10:04 a.m. 1.827DM: $1 Controlled Transaction

10:06 a.m. 1.826DM: $1 Uncontrolled Transaction

10:08 a.m. 1.825DM: $1 Uncontrolled Transaction

10:10 a.m. 1.827DM: $1 Controlled Transaction

10:12 a.m. 1.824DM: $1 Uncontrolled Transaction

10:15 a.m. 1.825DM: $1 Uncontrolled Transaction

10:18 a.m. 1.826DM: $1 Controlled Transaction

10:20 a.m. 1.824DM: $1 Uncontrolled Transaction

10:23 a.m. 1.825DM: $1 Uncontrolled Transaction

10:25 a.m. 1.825DM: $1 Uncontrolled Transaction

10:27 a.m. 1.827DM: $1 Controlled Transaction

10:30 a.m. 1.824DM: $1 Uncontrolled Transaction

10:45 a.m. 1.822DM: $1 Uncontrolled Transaction

10:50 a.m. 1.821DM: $1 Uncontrolled Transaction

10:55 a.m. 1.822DM: $1 Uncontrolled Transaction

11:00 a.m. 1.819DM: $1 Uncontrolled Transaction

(ii) USFX and C are participants in a global dealing operation under
�1.482-8(a)(2)(i). Therefore, USFX determines its arm's length price
for its controlled DM contracts under �1.482-8(a)(4). Under
�1.482-8(a)(4), the relevant arm's length range for setting the
prices of USFX's controlled DM transactions occurs between 10:00
a.m. and 10:30 a.m. Because USFX has no controlled transactions
between 10:45 a.m. and 11:00 a.m., and the price movement during
this later time period continued to decrease, the 10:45 a.m. to
11:00 a.m. time period is not part of the relevant arm's length
range for pricing USFX's controlled transactions.

(b) Comparable uncontrolled financial transaction method--

(1) General rule. The comparable uncontrolled financial transaction
(CUFT) method evaluates whether the amount charged in a controlled
financial transaction is arm's length by reference to the amount
charged in a comparable uncontrolled financial transaction.

(2) Comparability and reliability--(i) In general. The provisions of
�1.482-1(d), as modified by paragraph (a)(3) of this section, apply
in determining whether a controlled financial transaction is
comparable to a particular uncontrolled financial transaction. All
of the relevant factors in paragraph (a)(3) of this section must be
considered in determining the comparability of the two financial
transactions. Comparability under this method depends on close
similarity with respect to these factors, or adjustments to account
for any differences. Accordingly, unless the controlled taxpayer can
demonstrate that the relevant aspects of the controlled and
uncontrolled financial transactions are comparable, the reliability
of the results as a measure of an arm's length price is
substantially reduced.

(ii) Adjustments for differences between controlled and uncontrolled
transactions. If there are differences between controlled and
uncontrolled transactions that would affect price, adjustments
should be made to the price of the uncontrolled transaction
according to the comparability provisions of �1.482- 1(d)(2) and
paragraph (a)(3) of this section.

(iii) Data and assumptions. The reliability of the results derived
from the CUFT method is affected by the completeness and accuracy of
the data used and the reliability of the assumptions made to apply
the method. See �1.482-1(c)(2)(ii). In the case of a global dealing
operation in which the CUFT is set through the use of indirect
evidence, participants generally must establish data from a public
exchange or quotation media contemporaneously to the time of the
transaction, retain records of such data, and upon request furnish
to the district director any pricing model used to establish
indirect evidence of a CUFT, in order for this method to be a
reliable means of evaluating the arm's length nature of the
controlled transactions.

(3) Indirect evidence of the price of a comparable uncontrolled
financial transaction--(i) In general. The price of a CUFT may be
derived from data from public exchanges or quotation media if the
following requirements are met--

(A) The data is widely and routinely used in the ordinary course of
business in the industry to negotiate prices for uncontrolled sales;

(B) The data derived from public exchanges or quotation media is
used to set prices in the controlled transaction in the same way it
is used for uncontrolled transactions of the taxpayer, or the same
way it is used by uncontrolled taxpayers; and

(C) The amount charged in the controlled transaction is adjusted to
reflect differences in quantity, contractual terms, counterparties,
and other factors that affect the price to which uncontrolled
taxpayers would agree.

(ii) Public exchanges or quotation media. For purposes of paragraph
(b)(3)(i) of this section, an established financial market, as
defined in �1.1092(d)-1(b), qualifies as a public exchange or a
quotation media.

(iii) Limitation on use of data from public exchanges or quotation
media. Use of data from public exchanges or quotation media is not
appropriate under extraordinary market conditions.

For example, under circumstances where the trading or transfer of a
particular country's currency has been suspended or blocked by
another country, causing significant instability in the prices of
foreign currency contracts in the suspended or blocked currency, the
prices listed on a quotation medium may not reflect a reliable
measure of an arm's length result.

(4) Arm's length range. See �1.482-1(e)(2) and paragraph (a)(4) of
this section for the determination of an arm's length range.

(5) Examples. The following examples illustrate the principles of
this paragraph (b).

Example 1.Comparable uncontrolled financial transactions.

(i) B is a foreign bank resident in country X that acts as a market
maker in foreign currency in country X. C, a country Y resident
corporation, D, a country Z resident corporation, and USFX, a U.S.
resident corporation are all members of a controlled group of
taxpayers with B, and each acts as a market maker in foreign
currency. In addition to market marking activities conducted in
their respective countries, C, D, and USFX each employ marketers and
traders, who also perform risk management with respect to their
foreign currency operations. In a typical business day, B, C, D, and
USFX each enter into several hundred spot and forward contracts to
purchase and sell Deutsche marks (DM) with unrelated third parties
on the interbank market. In the ordinary course of business, B, C,
D, and USFX also each enter into contracts to purchase and sell DM
with each other. On a typical day, no more than 10% of USFX's DM
trades are with controlled taxpayers. USFX's DM-denominated spot and
forward contracts do not vary in their terms, except as to the
volume of DM purchased or sold. The differences in volume of DM
purchased and sold by USFX do not affect the pricing of the DM. USFX
maintains contemporaneous records of its trades, accounted for by
type of trade and counterparty. The daily volume of USFX's DM-
denominated spot and forward contracts consistently provides USFX
with third party transactions that are contemporaneous with the
transactions between controlled taxpayers.

(ii) Under �1.482-8(a)(2)(iii), B, C, D, and USFX each are regular
dealers in securities because they each regularly and actively offer
to, and in fact do, purchase and sell currencies to customers who
are not controlled taxpayers, in the ordinary course of their trade
or business. Consequently, each controlled taxpayer is also a
participant. Together, B, C, D, and USFX conduct a global dealing
operation within the meaning of �1.482- 8(a)(2)(i) because they
execute customer transactions in multiple tax jurisdictions. To
determine the comparability of USFX's controlled and uncontrolled
DM-denominated spot and forward transactions, the factors in
�1.482-8(a)(3) must be considered.

USFX performs the same functions with respect to controlled and
uncontrolled DM-denominated spot and forward transactions. See
�1.482-8(a)(3)(i). In evaluating the contractual terms under
�1.482-8(a)(3)(ii), it is determined that the volume of DM
transactions varies, but these variances do not affect the pricing
of USFX's uncontrolled DM transactions. Taking into account the risk
factors of �1.482-8(a)(3)(iii), USFX's risk associated with both the
controlled and uncontrolled DM transactions does not vary in any
material respect. In applying the significant factors for evaluating
the economic conditions under �1.482-8(a)(3)(iv), USFX has
sufficient third party DM transactions to establish comparable
economic conditions for evaluating an arm's length price.
Accordingly, USFX's uncontrolled transactions are comparable to its
controlled transactions in DM spot and forward contracts.

Example 2.Lack of comparable uncontrolled financial transactions.
The facts are the same as in Example 1, except that USFX trades
Italian lira (lira) instead of DM. USFX enters into few uncontrolled
and controlled lira-denominated forward contracts each day. The
daily volume of USFX's lira forward purchases and sales does not
provide USFX with sufficient third party transactions to establish
that uncontrolled transactions are sufficiently contemporaneous with
controlled transactions to be comparable within the meaning of
�1.482-8(a)(3). In applying the comparability factors of �1.482-8(a)
(3), and of paragraph (a)(3)(iv) of this section in particular,
USFX's controlled and uncontrolled lira forward purchases and sales
are not entered into under comparable economic conditions.
Accordingly, USFX's uncontrolled transactions in lira forward
contracts are not comparable to its controlled lira forward
transactions.

Example 3.Indirect evidence of the price of a comparable
uncontrolled financial transaction. (i) The facts are the same as in
Example 2, except that USFX uses a computer quotation system (CQS)
that is an interdealer market, as described in �1.1092(d)-1(b)(2),
to set its price on lira forward contracts with controlled and
uncontrolled taxpayers. Other financial institutions also use CQS to
set their prices on lira forward contracts. CQS is an established
financial market within the meaning of �1.1092(d)-1(b).

(ii) Because CQS is an established financial market, it is a public
exchange or quotation media within the meaning of �1.482- 8(b)(3)
(i). Because other financial institutions use prices from CQS in the
same manner as USFX, prices derived from CQS are deemed to be widely
and routinely used in the ordinary course of business in the
industry to negotiate prices for uncontrolled sales. See �1.482-8(b)
(3)(i)(A) and (B). If USFX adjusts the price quoted by CQS under the
criteria specified in �1.482- 8(b)(2)(ii)(A)(3), the controlled
price derived by USFX from CQS qualifies as indirect evidence of the
price of a comparable uncontrolled financial transaction.

Example 4.Indirect evidence of the price of a comparable
uncontrolled financial transaction - internal pricing models.

(i) T is a U.S. resident corporation that acts as a market maker in
U.S. dollar-denominated notional principal contracts. T's marketers
and traders work together to sell notional principal contracts
(NPCs), primarily to T's North and South American customers. T
typically earns 4 basis points at the inception of each standard 3
year U.S. dollar-denominated interest rate swap that is entered into
with an unrelated, financially sophisticated, creditworthy
counterparty. TS, T's wholly owned U.K. subsidiary, also acts as a
market maker in U.S. dollar-denominated NPCs, employing several
traders and marketers who initiate contracts primarily with European
customers. On occasion, for various business reasons, TS enters into
a U.S. dollar-denominated NPC with T. The U.S. dollar-denominated
NPCs that T enters into with unrelated parties are comparable in all
material respects to the transactions that T enters into with TS.

TS prices all transactions with T using the same pricing models that
TS uses to price transactions with third parties. The pricing models
analyze relevant data, such as interest rates and volatilities,
derived from public exchanges. TS records the data that were used to
determine the price of each transaction at the time the transaction
was entered into. Because the price produced by the pricing models
is a mid-market price, TS adjusts the price so that it receives the
same 4 basis point spread on its transactions with T that it would
earn on comparable transactions with comparable counterparties
during the same relevant time period.

(ii) Under �1.482-8(a)(2), T and TS are participants in a global
dealing operation that deals in U.S. dollar-denominated NPCs.
Because the prices produced by TS's pricing model are derived from
information on public exchanges and TS uses the same pricing model
to set prices for controlled and uncontrolled transactions, the
requirements of �1.482-8(b)(3)(i)(A) and (B) are met. +Because the
U.S. dollar-denominated NPCs that T enters into with customers
(uncontrolled transactions) are comparable to the transactions
between T and TS within the meaning of �1.482- 8(a)(3) and TS earns
4 basis points at inception of its uncontrolled transactions that
are comparable to its controlled transactions, TS has also satisfied
the requirements of �1.482- 8(b)(3)(i)(C). Accordingly, the price
produced by TS's pricing model constitutes indirect evidence of the
price of a comparable uncontrolled financial transaction.

(c) Gross margin method--(1) General rule. The gross margin method
evaluates whether the amount allocated to a participant in a global
dealing operation is arm's length by reference to the gross profit
margin realized on the sale of financial products in comparable
uncontrolled transactions. The gross margin method may be used to
establish an arm's length price for a transaction where a
participant resells a financial product to an unrelated party that
the participant purchased from a related party. The gross margin
method may apply to transactions involving the purchase and resale
of debt and equity instruments. The method may also be used to
evaluate whether a participant has received an arm's length
commission for its activities in a global dealing operation when the
participant has not taken title to a security or has not become a
party to a derivative financial product. To meet the arm's length
standard, the gross profit margin on controlled transactions should
be similar to that of comparable uncontrolled transactions.

(2) Determination of an arm's length price--(i) In general.

The gross margin method measures an arm's length price by
subtracting the appropriate gross profit from the applicable resale
price for the financial product involved in the controlled
transaction under review.

(ii) Applicable resale price. The applicable resale price is equal
to either the price at which the financial product involved is sold
in an uncontrolled sale or the price at which contemporaneous
resales of the same product are made. If the product purchased in
the controlled sale is resold to one or more related parties in a
series of controlled sales before being resold in an uncontrolled
sale, the applicable resale price is the price at which the product
is resold to an uncontrolled party, or the price at which
contemporaneous resales of the same product are made. In such case,
the determination of the appropriate gross profit will take into
account the functions of all members of the controlled group
participating in the series of controlled sales and final
uncontrolled resales, as well as any other relevant factors
described in paragraph (a)(3) of this section.

(iii) Appropriate gross profit. The appropriate gross profit is
computed by multiplying the applicable resale price by the gross
profit margin, expressed as a percentage of total revenue derived
from sales, earned in comparable uncontrolled transactions.

(3) Comparability and reliability-- (i) In general. The provisions
of �1.482-1(d), as modified by paragraph (a)(3) of this section,
apply in determining whether a controlled transaction is comparable
to a particular uncontrolled transaction. All of the factors
described in paragraph (a)(3) of this section must be considered in
determining the comparability of two financial products
transactions, including the functions performed. The gross margin
method considers whether a participant has earned a sufficient gross
profit margin on the resale of a financial product (or line of
products) given the functions performed by the participant. A
reseller's gross profit margin provides compensation for performing
resale functions related to the product or products under review,
including an operating profit in return for the reseller's
investment of capital and the assumption of risks. Accordingly,
where a participant does not take title, or does not become a party
to a financial product, the reseller's return to capital and
assumption of risk are additional factors that must be considered in
determining an appropriate gross profit margin. An appropriate gross
profit margin primarily should be derived from comparable
uncontrolled purchases and resales of the reseller involved in the
controlled sale. This is because similar characteristics are more
likely to be found among different resales of a financial product or
products made by the same reseller than among sales made by other
resellers. In the absence of comparable uncontrolled transactions
involving the same reseller, an appropriate gross profit margin may
be derived from comparable uncontrolled transactions of other
resellers.

(ii) Adjustments for differences between controlled and uncontrolled
transactions. If there are material differences between controlled
and uncontrolled transactions that would affect the gross profit
margin, adjustments should be made to the gross profit margin earned
in the uncontrolled transaction according to the comparability
provisions of �1.482-1(d)(2) and paragraph (a)(3) of this section.
For this purpose, consideration of operating expenses associated
with functions performed and risks assumed may be necessary because
differences in functions performed are often reflected in operating
expenses.

The effect of a difference in functions performed on gross profit,
however, is not necessarily equal to the difference in the amount of
related operating expenses.

(iii) Reliability. In order for the gross margin method to be
considered a reliable measure of an arm's length price, the gross
profit should ordinarily represent an amount that would allow the
participant who resells the product to recover its expenses (whether
directly related to selling the product or more generally related to
maintaining its operations) and to earn a profit commensurate with
the functions it performed. The gross margin method may be a
reliable means of establishing an arm's length price where there is
a purchase and resale of a financial product and the participant who
resells the property does not substantially participate in
developing a product or in tailoring the product to the unique
requirements of a customer prior to the resale.

(iv) Data and assumptions--(A) In general. The reliability of the
results derived from the gross margin method is affected by the
completeness and accuracy of the data used and the reliability of
the assumptions made to apply the method. See �1.482-1(c)(2)(ii). A
participant may establish the gross margin by comparing the bid and
offer prices on a public exchange or quotation media. In such case,
the prices must be contemporaneous to the controlled transaction,
and the participant must retain records of such data.

(B) Consistency in accounting. The degree of consistency in
accounting practices between the controlled transaction and the
uncontrolled transactions may affect the reliability of the gross
margin method. For example, differences as between controlled and
uncontrolled transactions in the method used to value similar
financial products (including methods of accounting, methods of
estimation, and the timing for changes of such methods) could affect
the gross profit. The ability to make reliable adjustments for such
differences could affect the reliability of the results.

(4) Arm's length range. See �1.482-1(e)(2) and paragraph (a)(4) of
this section for the determination of an arm's length range.

(5) Example. The following example illustrates the principles of
this paragraph (c).

Example 1.Gross margin method. (i) T is a U.S. resident financial
institution that acts as a market maker in debt and equity
instruments issued by U.S. corporations. Most of T's sales are to
U.S.-based customers. TS, T's U.K. subsidiary, acts as a market
maker in debt and equity instruments issued by European corporations
and conducts most of its business with European-based customers. On
occasion, however, a customer of TS wishes to purchase a security
that is either held by or more readily accessible to T. To
facilitate this transaction, T sells the security it owns or
acquires to TS, who then promptly sells it to the customer. T and TS
generally derive the majority of their profit on the difference
between the price at which they purchase and the price at which they
sell securities (the bid/offer spread). On average, TS's gross
profit margin on its purchases and sales of securities from
unrelated persons is 2%.

Applying the comparability factors specified in �1.482-8(a)(3), T's
purchases and sales with unrelated persons are comparable to the
purchases and sales between T and TS.

(ii) Under �1.482-8(a)(2), T and TS are participants in a global
dealing operation that deals in debt and equity securities. Since
T's related purchases and sales are comparable to its unrelated
purchases and sales, if TS's gross profit margin on purchases and
sales of comparable securities from unrelated persons is 2%, TS
should also typically earn a 2% gross profit on the securities it
purchases from T. Thus, when TS resells for $100 a security that it
purchased from T, the arm's length price at which TS would have
purchased the security from T would normally be $98 ($100 sales
price minus (2% gross profit margin x $100)).

(d) Gross markup method--(1) General rule. The gross markup method
evaluates whether the amount allocated to a participant in a global
dealing operation is arm's length by reference to the gross profit
markup realized in comparable uncontrolled transactions. The gross
markup method may be used to establish an arm's length price for a
transaction where a participant purchases a financial product from
an unrelated party that the participant sells to a related party.
This method may apply to transactions involving the purchase and
resale of debt and equity instruments. The method may also be used
to evaluate whether a participant has received an arm's length
commission for its role in a global dealing operation when the
participant has not taken title to a security or has not become a
party to a derivative financial product. To meet the arm's length
standard, the gross profit markup on controlled transactions should
be similar to that of comparable uncontrolled transactions.

(2) Determination of an arm's length price--(i) In general.

The gross markup method measures an arm's length price by adding the
appropriate gross profit to the participant's cost or anticipated
cost, of purchasing, holding, or structuring the financial product
involved in the controlled transaction under review (or in the case
of a derivative financial product, the initial net present value,
measured by the anticipated cost of purchasing, holding, or
structuring the product).

(ii) Appropriate gross profit. The appropriate gross profit is
computed by multiplying the participant's cost or anticipated cost
of purchasing, holding, or structuring a transaction by the gross
profit markup, expressed as a percentage of cost, earned in
comparable uncontrolled transactions.

(3) Comparability and reliability--(i) In general. The provisions of
�1.482-1(d), as modified by paragraph (a)(3) of this section, apply
in determining whether a controlled transaction is comparable to a
particular uncontrolled transaction. All of the factors described in
paragraph (a)(3) of this section must be considered in determining
the comparability of two financial products transactions, including
the functions performed. The gross markup method considers whether a
participant has earned a sufficient gross markup on the sale of a
financial product, or line of products, given the functions it has
performed. A participant's gross profit markup provides compensation
for purchasing, hedging, and transactional structuring functions
related to the transaction under review, including an operating
profit in return for the investment of capital and the assumption of
risks. Accordingly, where a participant does not take title, or does
not become a party to a financial product, the reseller's return to
capital and assumption of risk are additional factors that must be
considered in determining the gross profit markup. An appropriate
gross profit markup primarily should be derived from comparable
uncontrolled purchases and sales of the participant involved in the
controlled sale. This is because similar characteristics are more
likely to be found among different sales of property made by the
same participant than among sales made by other resellers.

In the absence of comparable uncontrolled transactions involving the
same participant, an appropriate gross profit markup may be derived
from comparable uncontrolled transactions of other parties whether
or not such parties are members of the same controlled group.

(ii) Adjustments for differences between controlled and uncontrolled
transactions. If there are material differences between controlled
and uncontrolled transactions that would affect the gross profit
markup, adjustments should be made to the gross profit markup earned
in the uncontrolled transaction according to the comparability
provisions of �1.482-1(d)(2) and paragraph (a)(3) of this section.
For this purpose, consideration of operating expenses associated
with the functions performed and risks assumed may be necessary,
because differences in functions performed are often reflected in
operating expenses.

The effect of a difference in functions on gross profit, however, is
not necessarily equal to the difference in the amount of related
operating expenses.

(iii) Reliability. In order for the gross markup method to be
considered a reliable measure of an arm's length price, the gross
profit should ordinarily represent an amount that would allow the
participant who purchases the product to recover its expenses
(whether directly related to selling the product or more generally
related to maintaining its operations) and to earn a profit
commensurate with the functions it performed. As with the gross
margin method, the gross markup method may be a reliable means of
establishing an arm's length price where there is a purchase and
resale of a financial product and the participant who resells the
property does not substantially participate in developing a product
or in tailoring the product to the unique requirements of a customer
prior to the resale.

(iv) Data and assumptions--(A) In general. The reliability of the
results derived from the gross markup method is affected by the
completeness and accuracy of the data used and the reliability of
the assumptions made to apply the method. See �1.482-1(c)(2)(ii). A
participant may establish the gross markup by comparing the bid and
offer prices on a public exchange or quotation media. In such case,
the prices must be contemporaneous with the controlled transaction,
and the participant must retain records of such data.

(B) Consistency in accounting. The degree of consistency in
accounting practices between the controlled transaction and the
uncontrolled transactions may affect the reliability of the gross
markup method. For example, differences as between controlled and
uncontrolled transactions in the method used to value similar
financial products (including methods in accounting, methods of
estimation, and the timing for changes of such methods) could affect
the gross profit. The ability to make reliable adjustments for such
differences could affect the reliability of the results.

(4) Arm's length range. See �1.482-1(e)(2) and paragraph (a)(4) of
this section for the determination of an arm's length range.

(e) Profit split method--(1) General rule. The profit split method
evaluates whether the allocation of the combined operating profit or
loss of a global dealing operation to one or more participants is at
arm's length by reference to the relative value of each
participant's contribution to that combined operating profit or
loss. The combined operating profit or loss must be derived from the
most narrowly identifiable business activity of the participants for
which data is available that includes the controlled transactions
(relevant business activity).

(2) Appropriate share of profit and loss--(i) In general.

The relative value of each participant's contribution to the global
dealing activity must be determined in a manner that reflects the
functions performed, risks assumed, and resources employed by each
participant in the activity, consistent with the comparability
provisions of �1.482-1(d), as modified by paragraph (a)(3) of this
section. Such an allocation is intended to correspond to the
division of profit or loss that would result from an arrangement
between uncontrolled taxpayers, each performing functions similar to
those of the various controlled taxpayers engaged in the relevant
business activity. The relative value of the contributions of each
participant in the global dealing operation should be measured in a
manner that most reliably reflects each contribution made to the
global dealing operation and each participant's role in that
contribution. In appropriate cases, the participants may find that a
multi-factor formula most reliably measures the relative value of
the contributions to the profitability of the global dealing
operation. The profit allocated to any particular participant using
a profit split method is not necessarily limited to the total
operating profit from the global dealing operation. For example, in
a given year, one participant may earn a profit while another
participant incurs a loss, so long as the arrangement is comparable
to an arrangement to which two uncontrolled parties would agree. In
addition, it may not be assumed that the combined operating profit
or loss from the relevant business activity should be shared equally
or in any other arbitrary proportion. The specific method must be
determined under paragraph (e)(4) of this section.

(ii) Adjustment of factors to measure contribution clearly.

In order to reliably measure the value of a participant's
contribution, the factors, for example, those used in a multi-factor
formula, must be expressed in units of measure that reliably
quantify the relative contribution of the participant.

If the data or information is influenced by factors other than the
value of the contribution, adjustments must be made for such
differences so that the factors used in the formula only measure the
relative value of each participant's contribution. For example, if
trader compensation is used as a factor to measure the value added
by the participants' trading expertise, adjustments must be made for
variances in compensation paid to traders due solely to differences
in the cost of living.

(3) Definitions. The definitions in this paragraph (e)(3) apply for
purposes of applying the profit split methods in this paragraph (e).

Gross profit is gross income earned by the global dealing operation.

Operating expenses includes all expenses not included in the
computation of gross profit, except for interest, foreign income
taxes as defined in �1.901-2(a), domestic income taxes, and any
expenses not related to the global dealing activity that is
evaluated under the profit split method. With respect to interest
expense, see section 864(e) and the regulations thereunder and
�1.882-5.

Operating profit or loss is gross profit less operating expenses,
and includes all income, expense, gain, loss, credits or allowances
attributable to each global dealing activity that is evaluated under
the profit split method. It does not include income, expense, gain,
loss, credits or allowances from activities that are not evaluated
under the profit split method, nor does it include extraordinary
gains or losses that do not relate to the continuing global dealing
activities of the participant.

(4) Application. Profit or loss shall be allocated under the profit
split method using either the total profit split, described in
paragraph (e)(5) of this section, or the residual profit split,
described in paragraph (e)(6) of this section.

(5) Total profit split--(i) In general. The total profit split
derives the percentage of the combined operating profit of the
participants in a global dealing operation allocable to a
participant in the global dealing operation by evaluating whether
uncontrolled taxpayers who perform similar functions, assume similar
risks, and employ similar resources would allocate their combined
operating profits in the same manner.

(ii) Comparability. The total profit split evaluates the manner by
which comparable uncontrolled taxpayers divide the combined
operating profit of a particular global dealing activity. The degree
of comparability between the controlled and uncontrolled taxpayers
is determined by applying the comparability standards of
�1.482-1(d), as modified by paragraph (a)(3) of this section. In
particular, the functional analysis required by �1.482-1(d)(3)(i)
and paragraph (a)(3)(i) of this section is essential to determine
whether two situations are comparable. Nevertheless, in certain
cases, no comparable ventures between uncontrolled taxpayers may
exist. In this situation, it is necessary to analyze the remaining
factors set forth in paragraph (a)(3) of this section that could
affect the division of operating profits between parties. If there
are differences between the controlled and uncontrolled taxpayers
that would materially affect the division of operating profit,
adjustments must be made according to the provisions of �1.482- 1(d)
(2) and paragraph (a)(3) of this section.

(iii) Reliability. As indicated in �1.482-1(c)(2)(i), as the degree
of comparability between the controlled and uncontrolled
transactions increases, the reliability of a total profit split also
increases. In a global dealing operation, however, the absence of
external market benchmarks (for example, joint ventures between
uncontrolled taxpayers) on which to base the allocation of operating
profits does not preclude use of this method if the allocation of
the operating profit takes into account the relative contribution of
each participant. The reliability of this method is increased to the
extent that the allocation has economic significance for purposes
other than tax (for example, satisfying regulatory standards and
reporting, or determining bonuses paid to management or traders).
The reliability of the analysis under this method may also be
enhanced by the fact that all parties to the controlled transaction
are evaluated under this method. The reliability of the results,
however, of an analysis based on information from all parties to a
transaction is affected by the reliability of the data and
assumptions pertaining to each party to the controlled transaction.
Thus, if the data and assumptions are significantly more reliable
with respect to one of the parties than with respect to the others,
a different method, focusing solely on the results of that party,
may yield more reliable results.

(iv) Data and assumptions--(A) In general. The reliability of the
results derived from the total profit split method is affected by
the quality of the data used and the assumptions used to apply the
method. See �1.482-1(c)(2)(ii). The reliability of the allocation of
income, expense, or other attributes between the participants'
relevant business activities and the participants' other activities
will affect the reliability of the determination of the combined
operating profit and its allocation among the participants. If it is
not possible to allocate income, expense, or other attributes
directly based on factual relationships, a reasonable allocation
formula may be used. To the extent direct allocations are not made,
the reliability of the results derived from application of this
method is reduced relative to the results of a method that requires
fewer allocations of income, expense, and other attributes.
Similarly, the reliability of the results derived from application
of this method is affected by the extent to which it is possible to
apply the method to the participants' financial data that is related
solely to the controlled transactions. For example, if the relevant
business activity is entering into interest rate swaps with both
controlled and uncontrolled taxpayers, it may not be possible to
apply the method solely to financial data related to the controlled
transactions. In such case, the reliability of the results derived
from application of this method will be reduced.

(B) Consistency in accounting. The degree of consistency between the
controlled and uncontrolled taxpayers in accounting practices that
materially affect the items that determine the amount and allocation
of operating profit affects the reliability of the result. Thus, for
example, if differences in financial product valuation or in cost
allocation practices would materially affect operating profit, the
ability to make reliable adjustments for such differences would
affect the reliability of the results.

(6) Residual profit split--(i) In general. The residual profit split
allocates the combined operating profit or loss between participants
following the two-step process set forth in paragraphs (e)(6)(ii)
and (iii) of this section.

(ii) Allocate income to routine contributions. The first step
allocates operating income to each participant to provide an arm's
length return for its routine contributions to the global dealing
operation. Routine contributions are contributions of the same or
similar kind as those made by uncontrolled taxpayers involved in
similar business activities for which it is possible to identify
market returns. Routine contributions ordinarily include
contributions of tangible property, services, and intangibles that
are generally owned or performed by uncontrolled taxpayers engaged
in similar activities. For example, transactions processing and
credit analysis are typically routine contributions. In addition, a
participant that guarantees obligations of or otherwise provides
credit support to another controlled taxpayer in a global dealing
operation is regarded as making a routine contribution. A functional
analysis is required to identify the routine contributions according
to the functions performed, risks assumed, and resources employed by
each of the participants. Market returns for the routine
contributions should be determined by reference to the returns
achieved by uncontrolled taxpayers engaged in similar activities,
consistent with the methods described in ��1.482-2 through 1.482-4
and this �1.482-8.

(iii) Allocate residual profit. The allocation of income to the
participant's routine contributions will not reflect profits
attributable to each participant's valuable nonroutine contributions
to the global dealing operation. Thus, in cases where valuable
nonroutine contributions are present, there normally will be an
unallocated residual profit after the allocation of income described
in paragraph (e)(6)(ii) of this section. Under this second step, the
residual profit generally should be divided among the participants
based upon the relative value of each of their nonroutine
contributions. Nonroutine contributions are contributions so
integral to the global dealing operation that it is impossible to
segregate them from the operation and find a separate market return
for the contribution.

Pricing and risk managing financial products almost invariably
involve nonroutine contributions. Similarly, product development and
information technology are generally nonroutine contributions.
Marketing may be a nonroutine contribution if the marketer
substantially participates in developing a product or in tailoring
the product to the unique requirements of a customer.

The relative value of the nonroutine contributions of each
participant in the global dealing operation should be measured in a
manner that most reliably reflects each nonroutine contribution made
to the global dealing operation and each participant's role in the
nonroutine contributions.

(iv) Comparability. The first step of the residual profit split
relies on external market benchmarks of profitability.

Thus, the comparability considerations that are relevant for the
first step of the residual profit split are those that are relevant
for the methods that are used to determine market returns for
routine contributions. In the second step of the residual profit
split, however, it may not be possible to rely as heavily on
external market benchmarks. Nevertheless, in order to divide the
residual profits of a global dealing operation in accordance with
each participant's nonroutine contributions, it is necessary to
apply the comparability standards of �1.482-1(d), as modified by
paragraph (a)(3) of this section. In particular, the functional
analysis required by �1.482-1(d)(3)(i) and paragraph (a)(3)(i) of
this section is essential to determine whether two situations are
comparable. Nevertheless, in certain cases, no comparable ventures
between uncontrolled taxpayers may exist. In this situation, it is
necessary to analyze the remaining factors set forth in paragraph
(a)(3) of this section that could affect the division of operating
profits between parties. If there are differences between the
controlled and uncontrolled taxpayers that would materially affect
the division of operating profit, adjustments must be made according
to the provisions of �1.482-1(d)(2) and paragraph (a)(3) of this
section.

(v) Reliability. As indicated in �1.482-1(c)(2)(i), as the degree of
comparability between the controlled and uncontrolled transactions
increases, the reliability of a residual profit split also
increases. In a global dealing operation, however, the absence of
external market benchmarks (for example, joint ventures between
uncontrolled taxpayers) on which to base the allocation of operating
profits does not preclude use of this method if the allocation of
the residual profit takes into account the relative contribution of
each participant. The reliability of this method is increased to the
extent that the allocation has economic significance for purposes
other than tax (for example, satisfying regulatory standards and
reporting, or determining bonuses paid to management or traders).
The reliability of the analysis under this method may also be
enhanced by the fact that all parties to the controlled transaction
are evaluated under this method. The reliability of the results,
however, of an analysis based on information from all parties to a
transaction is affected by the reliability of the data and
assumptions pertaining to each party to the controlled transaction.
Thus, if the data and assumptions are significantly more reliable
with respect to one of the parties than with respect to the others,
a different method, focusing solely on the results of that party,
may yield more reliable results.

(vi) Data and assumptions--(A) General rule. The reliability of the
results derived from the residual profit split is measured under the
standards set forth in paragraph (e)(5)(iv)(A) of this section.

(B) Consistency in accounting. The degree of accounting consistency
between controlled and uncontrolled taxpayers is measured under the
standards set forth in paragraph (e)(5)(iv)(B) of this section.

(7) Arm's length range. See �1.482-1(e)(2) and paragraph (a)(4) of
this section for the determination of an arm's length range.

(8) Examples. The following examples illustrate the principles of
this paragraph (e).

Example 1.Total profit split. (i) P, a U.S. corporation, establishes
a separate U.S. subsidiary (USsub) to conduct a global dealing
operation in over-the-counter derivatives. USsub in turn establishes
subsidiaries incorporated and doing business in the U.K. (UKsub) and
Japan (Jsub). USsub, UKsub, and Jsub each employ marketers and
traders who work closely together to design and sell derivative
products to meet the particular needs of customers. Each also
employs personnel who process and confirm trades, reconcile trade
tickets and provide ongoing administrative support (back office
services) for the global dealing operation. The global dealing
operation maintains a single common book for each type of risk, and
the book is maintained where the head trader for that type of risk
is located. Thus, notional principal contracts denominated in North
and South American currencies are booked in USsub, notional
principal contracts denominated in European currencies are booked in
UKsub, and notional principal contracts denominated in Japanese yen
are booked in Jsub. However, each of the affiliates has authorized a
trader located in each of the other affiliates to risk manage its
books during periods when the booking location is closed. This grant
of authority is necessary because marketers, regardless of their
location, are expected to sell all of the group's products, and need
to receive pricing information with respect to products during their
clients' business hours, even if the booking location is closed.
Moreover, P is known for making a substantial amount of its profits
from trading activities, and frequently does not hedge the positions
arising from its customer transactions in an attempt to profit from
market changes. As a result, the traders in "off-hours" locations
must have a substantial amount of trading authority in order to
react to market changes.

(ii) Under �1.482-8(a)(2), USsub, UKsub and Jsub are participants in
a global dealing operation in over-the-counter derivatives. P
determines that the total profit split method is the best method to
allocate an arm's length amount of income to each participant. P
allocates the operating profit from the global dealing operation
between USsub, UKsub and Jsub on the basis of the relative
compensation paid to marketers and traders in each location. In
making the allocation, P adjusts the compensation amounts to account
for factors unrelated to job performance, such as the higher cost of
living in certain jurisdictions. Because the traders receive
significantly greater compensation than marketers in order to
account for their greater contribution to the profits of the global
dealing operation, P need not make additional adjustments or weight
the compensation of the traders more heavily in allocating the
operating profit between the affiliates. For rules concerning the
source of income allocated to Ussub, Uksub and Jsub (and any U.S.
trade or business of the participants), see �1.863-3(h).

Example 2.Total profit split. The facts are the same as in Example
1, except that the labor market in Japan is such that traders paid
by Jsub are paid the same as marketers paid by Jsub at the same
seniority level, even though the traders contribute substantially
more to the profitability of the global dealing operation. As a
result, the allocation method used by P is unlikely to compensate
the functions provided by each affiliate so as to be a reliable
measure of an arm's length result under ��1.482-8(e)(2) and
1.482-1(c)(1), unless P weights the compensation of traders more
heavily than the compensation of marketers or develops another
method of measuring the contribution of traders to the profitability
of the global dealing operation.

Example 3.Total profit split. The facts are the same as in Example
2, except that, in P's annual report to shareholders, P divides its
operating profit from customer business into "dealing profit" and
"trading profit." Because both marketers and traders are involved in
the dealing function, P divides the "dealing profit" between the
affiliates on the basis of the relative compensation of marketers
and traders. However, because only the traders contribute to the
trading profit, P divides the trading profit between the affiliates
on the basis of the relative compensation only of the traders. In
making that allocation, P must adjust the compensation of traders in
Jsub in order to account for factors not related to job performance.

Example 4.Total profit split. The facts are the same as in Example
1, except that P is required by its regulators to hedge its customer
positions as much as possible and therefore does not earn any
"trading profit." As a result, the marketing intangibles, such as
customer relationships, are relatively more important than the
intangibles used by traders. Accordingly, P must weight the
compensation of marketers more heavily than the compensation of
traders in order to take into account accurately the contribution
each function makes to the profitability of the business.

Example 5.Residual profit split. (i) P is a U.S. corporation that
engages in a global dealing operation in foreign currency options
directly and through controlled taxpayers that are incorporated and
operate in the United Kingdom (UKsub) and Japan (Jsub). Each
controlled taxpayer is a participant in a global dealing operation.
Each participant employs marketers and traders who work closely
together to design and sell foreign currency options that meet the
particular needs of customers.

Each participant also employs salespeople who sell foreign currency
options with standardized terms and conditions, as well as other
financial products offered by the controlled group. The traders in
each location risk manage a common book of transactions during the
relevant business hours of each location.

P has a AAA credit rating and is the legal counterparty to all third
party transactions. The traders in each location have discretion to
execute contracts in the name of P. UKsub employs personnel who
process and confirm trades, reconcile trade tickets, and provide
ongoing administrative support (back office services) for all the
participants in the global dealing operation. The global dealing
operation has generated $192 of operating profit for the period.

(ii) After analyzing the foreign currency options business, P has
determined that the residual profit split method is the best method
to allocate the operating profit of the global dealing operation and
to determine an arm's length amount of compensation allocable to
each participant in the global dealing operation.

(iii) The first step of the residual profit split method
(�1.482-8(e)(6)(ii)) requires P to identify the routine
contributions performed by each participant. P determines that the
functions performed by the salespeople are routine. P determines
that the arm's length compensation for salespeople is $3, $4, and $5
in the United States, the United Kingdom, and Japan, respectively.
Thus, P allocates $3, $4, and $5 to P, UKsub, and Jsub,
respectively.

(iv) Although the back office function would not give rise to
participant status, in the context of a residual profit split
allocation, the back office function is relevant for purposes of
receiving remuneration for routine contributions to a global dealing
operation. P determines that an arm's length compensation for the
back office is $20. Since the back office services constitute
routine contributions, $20 of income is allocated to UKsub under
step 1 of the residual profit split method. In addition, P
determines that the comparable arm's length compensation for the
risk to which P is subject as counterparty is $40. Accordingly, $40
is allocated to P as compensation for acting as counterparty to the
transactions entered into in P's name by Jsub and UKsub.

(v) The second step of the residual profit split method (�1.482-8(e)
(6)(iii)) requires that the residual profit be allocated to
participants according to the relative value of their nonroutine
contributions. Under P's transfer pricing method, P allocates the
residual profit of $120 ($192 gross income minus $12 salesperson
commissions minus $20 payment for back office services minus $40
compensation for the routine contribution of acting as counterparty)
using a multi-factor formula that reflects the relative value of the
nonroutine contributions. Applying the comparability factors set out
in �1.482-8(a)(3), P allocates 40% of the residual profit to UKsub,
35% of the residual profit to P, and the remaining 25% of residual
profit to Jsub. Accordingly, under step 2, $48 is allocated to
UKsub, $42 is allocated to P, and $30 is allocated to Jsub. See �
1.863-3(h) for the source of income allocated to P with respect to
its counterparty function.

(f) Unspecified methods. Methods not specified in paragraphs
(b),(c),(d), or (e) of this section may be used to evaluate whether
the amount charged in a controlled transaction is at arm's length.
Any method used under this paragraph (f) must be applied in
accordance with the provisions of �1.482-1 as modified by paragraph
(a)(3) of this section.

(g) Source rule for qualified business units. See �1.863- 3(h) for
application of the rules of this section for purposes of determining
the source of income, gain or loss from a global dealing operation
among qualified business units (as defined in section 989(c) and
��1.863-3(h)(3)(iv) and 1.989(a)-1).

Par. 7. Section 1.863-3 is amended as follows:

1. Paragraph (h) is redesignated as paragraph (i).

2. A new paragraph (h) is added.

The addition reads as follows:

�1.863-3 Allocation and apportionment of income from certain sales
of inventory.

* * * * *

(h) Income from a global dealing operation--(1) Purpose and scope.
This paragraph (h) provides rules for sourcing income, gain and loss
from a global dealing operation that, under the rules of �1.482-8,
is earned by or allocated to a controlled taxpayer qualifying as a
participant in a global dealing operation under �1.482-8(a)(2)(ii).
This paragraph (h) does not apply to income earned by or allocated
to a controlled taxpayer qualifying as a participant in a global
dealing operation that is specifically sourced under sections 861,
862 or 865, or to substitute payments earned by a participant in a
global dealing operation that are sourced under �1.861-2(a)(7) or
�1.861- 3(a)(6).

(2) In general. The source of any income, gain or loss to which this
section applies shall be determined by reference to the residence of
the participant. For purposes of this paragraph (h), the residence
of a participant shall be determined under section 988(a)(3)(B).

(3) Qualified business units as participants in global dealing
operations--(i) In general. Except as otherwise provided in this
paragraph (h), where a single controlled taxpayer conducts a global
dealing operation through one or more qualified business units
(QBUs), as defined in section 989(a) and �1.989(a)-1, the source of
income, gain or loss generated by the global dealing operation and
earned by or allocated to the controlled taxpayer shall be
determined by applying the rules of �1.482-8 as if each QBU that
performs activities of a regular dealer in securities as defined in
�1.482-8(a)(2)(ii)(A) or the related activities described in
�1.482-8(a)(2)(ii)(B) were a separate controlled taxpayer qualifying
as a participant in the global dealing operation within the meaning
of �1.482- 8(a)(2)(ii). Accordingly, the amount of income sourced in
the United States and outside of the United States shall be
determined by treating the QBU as a participant in the global
dealing operation, allocating income to each participant under
�1.482-8, as modified by paragraph (h)(3)(ii) of this section, and
sourcing the income to the United States or outside of the United
States under �1.863-3(h)(2).

(ii) Economic effects of a single legal entity. In applying the
principles of �1.482-8, the taxpayer shall take into account the
economic effects of conducting a global dealing operation through a
single entity instead of multiple legal entities. For example, since
the entire capital of a corporation supports all of the entity's
transactions, regardless of where those transactions may be booked,
the payment of a guarantee fee within the entity is inappropriate
and will be disregarded.

(iii) Treatment of interbranch and interdesk amounts. An agreement
among QBUs of the same taxpayer to allocate income, gain or loss
from transactions with third parties is not a transaction because a
taxpayer cannot enter into a contract with itself. For purposes of
this paragraph (h)(3), however, such an agreement, including a risk
transfer agreement (as defined in �1.475(g)-2(b)) may be used to
determine the source of global dealing income from transactions with
third parties in the same manner and to the same extent that
transactions between controlled taxpayers in a global dealing
operation may be used to allocate income, gain or loss from the
global dealing operation under the rules of �1.482-8.

(iv) Deemed QBU. For purposes of this paragraph (h)(3), a QBU shall
include a U.S. trade or business that is deemed to exist because of
the activities of a dependent agent in the United States, without
regard to the books and records requirement of �1.989(a)-1(b).

(v) Examples. The following examples illustrate this paragraph (h)
(3).

Example 1.Use of comparable uncontrolled financial transactions
method to source global dealing income between branches. (i) F is a
foreign bank that acts as a market maker in foreign currency through
branch offices in London, New York, and Tokyo. In a typical business
day, the foreign exchange desk in F's U.S. branch (USFX) enters into
several hundred spot and forward contracts on the interbank market
to purchase and sell Deutsche marks (DM) with unrelated third
parties. Each of F's branches, including USFX, employs both
marketers and traders for their foreign currency dealing. In
addition, USFX occasionally transfers risk with respect to its third
party DM contracts to F's London and Tokyo branches. These
interbranch transfers are entered into in the same manner as trades
with unrelated third parties. On a typical day, risk management
responsibility for no more than 10% of USFX's DM trades are
transferred interbranch. F records these transfers by making
notations on the books of each branch that is a party to the
transfers. The accounting procedures are nearly identical to those
followed when a branch enters into an offsetting hedge with a third
party. USFX maintains contemporaneous records of its interbranch
transfers and third party transactions, separated according to type
of trade and counterparty. Moreover, the volume of USFX's DM spot
purchases and sales each day consistently provides USFX with third
party transactions that are contemporaneous with the transfers
between the branches.

(ii) As provided in paragraph (h)(3)(i) of this section, USFX and
F's other branches that trade DM are participants in a global
dealing operation. Accordingly, the principles of �1.482- 8 apply in
determining the source of income earned by F's qualified business
units that are participants in a global dealing operation. Applying
the comparability factors in �1.482- 8(a)(3) shows that USFX's
interbranch transfers and uncontrolled DM-denominated spot and
forward contracts have no material differences. Because USFX sells
DM in uncontrolled transactions and transfers risk management
responsibility for DM-denominated contracts, and the uncontrolled
transactions and interbranch transfers are consistently entered into
contemporaneously, the interbranch transfers provide a reliable
measure of an arm's length allocation of third party income from F's
global dealing operation in DM-denominated contracts. This
allocation of third party income is treated as U.S. source in
accordance with ��1.863-3(h) and 1.988-4(h) and accordingly will be
treated as income effectively connected with F's U.S. trade or
business under �1.864-4.

Example 2.Residual profit split between branches. (i) F is a bank
organized in country X that has a AAA credit rating and engages in a
global dealing operation in foreign currency options through branch
offices in London, New York, and Tokyo. F has dedicated marketers
and traders in each branch who work closely together to design and
sell foreign currency options that meet the particular needs of
customers. Each branch also employs general salespeople who sell
standardized foreign currency options, as well as other financial
products and foreign currency offered by F. F's traders work from a
common book of transactions that is risk managed at each branch
during local business hours. Accordingly, all three branches share
the responsibility for risk managing the book of products. Personnel
in the home office of F process and confirm trades, reconcile trade
tickets, and provide ongoing administrative support (back office
services) for the other branches. The global dealing operation has
generated $223 of operating profit for the period.

(ii) Under �1.863-3(h), F applies �1.482-8 to allocate global
dealing income among its branches, because F's London, New York, and
Tokyo branches are treated as participants in a global dealing
operation that deals in foreign currency options under �1.482-8(a)
(2). After analyzing the foreign currency options business, F has
determined that the residual profit split method is the best method
to determine an arm's length amount of compensation allocable to
each participant in the global dealing operation.

(iii) Under the first step of the residual profit split method
(�1.482-8(e)(6)(ii)), F identifies and compensates the routine
contributions performed by each participant. F determines that an
arm's length compensation for general salespeople is $3, $4, and $5
in New York, London, and Tokyo, respectively, and that the home
office incurred $11 of expenses in providing the back office
services. Since F's capital legally supports all of the obligations
of the branches, no amount is allocated to the home office of F for
the provision of capital.

(iv) The second step of the residual profit split method
(�1.482-8(e)(6)(iii)) requires that the residual profit be allocated
to participants according to their nonroutine contributions. F
determines that a multi-factor formula best reflects these
contributions. After a detailed functional analysis, and applying
the comparability factors in �1.482- 8(a)(3), 40% of the residual
profit is allocated to the London branch, 35% to the New York
branch, and the remaining 25% to the Tokyo branch. Thus, the
residual profit of $200 ($223 operating profit minus $12 general
salesperson commissions minus $11 back office allocation) is
allocated $80 to London (40% allocation x $200), $70 to New York
(35% x $200) and $50 to Tokyo (25% x $200).

Example 3.Residual profit split--deemed branches. (i) P, a U.K.
corporation, conducts a global dealing operation in notional
principal contracts, directly and through a U.S. subsidiary (USsub)
and a Japanese subsidiary (Jsub). P is the counterparty to all
transactions entered into with third parties. P, USsub, and Jsub
each employ marketers and traders who work closely together to
design and sell derivative products to meet the particular needs of
customers. USsub also employs personnel who process and confirm
trades, reconcile trade tickets and provide ongoing administrative
support (back office services) for the global dealing operation. The
global dealing operation maintains a single common book for each
type of risk, and the book is maintained where the head trader for
that type of risk is located. However, P, USsub, and Jsub have
authorized a trader located in each of the other affiliates to risk
manage its books during periods when the primary trading location is
closed. This grant of authority is necessary because marketers,
regardless of their location, are expected to sell all of the
group's products, and need to receive pricing information with
respect to products during their clients' business hours, even if
the booking location is closed. The global dealing operation has
generated $180 of operating profit for the period.

(ii) Because employees of USsub have authority to enter into
contracts in the name of P, P is treated as being engaged in a trade
or business in the United States through a deemed QBU.

�1.863-3(h)(3)(iv). Similarly, under U.S. principles, P would be
treated as being engaged in business in Japan through a QBU.

Under �1.482-8(a)(2), P, USsub, and Jsub are participants in the
global dealing operation relating to notional principal contracts.
Additionally, under �1.863-3(h)(3), the U.S. and Japanese QBUs are
treated as participants in a global dealing operation for purposes
of sourcing the income from that operation. Under �1.863-3(h), P
applies the methods in �1.482-8 to determine the source of income
allocated to the U.S. and non-U.

S. QBUs of P.

(iii) After analyzing the notional principal contract business, P
has concluded that the residual profit split method is the best
method to allocate income under �1.482-8 and to source income under
�1.863-3(h).

(iv) Under the first step of the residual profit split method
(�1.482-8(e)(6)(ii)), P identifies and compensates the routine
contributions performed by each participant. Although the back
office function does not give rise to participant status, in the
context of a residual profit split allocation, the back office
function is relevant for purposes of receiving remuneration for a
routine contribution to a global dealing operation. P determines
that an arm's length compensation for the back office is $20. Since
the back office services constitute a routine contribution, $20 of
income is allocated to USsub under step 1 of the residual profit
split method.

Similarly, as the arm's length compensation for the risk to which P
is subject as counterparty is $40, $40 is allocated to P as
compensation for acting as counterparty.

(v) The second step of the residual profit split method (�1.482-8(e)
(6)(iii)) requires that the residual profit be allocated to
participants according to the relative value of their nonroutine
contributions. Under P's transfer pricing method, P allocates the
residual profit of $120 ($180 gross income minus $20 for back office
services minus $40 compensation for the routine contribution of
acting as counterparty) using a multi-factor formula that reflects
the relative value of the nonroutine contributions. Applying the
comparability factors set out in �1.482-8(a)(3), P allocates 40% of
the residual profit to P, 35% of the residual profit to USsub, and
the remaining 25% of residual profit to Jsub. Accordingly, under
step 2, $48 is allocated to P, $42 is allocated to USsub, and $30 is
allocated to Jsub. Under �1.863-3(h), the amounts allocated under
the residual profit split is sourced according to the residence of
each participant to which it is allocated.

(vi) Because the $40 allocated to P consists of compensation for the
use of capital, the allocation is sourced according to where the
capital is employed. Accordingly, the $40 is sourced 35% to P's
deemed QBU in the United States under �1.863- 3(h)(3)(iv) and 65% to
non-U.S. sources.

* * * * *

Par. 8. Section 1.863-7(a)(1) is amended by revising the second
sentence to read as follows:

�1.863-7 Allocation of income attributable to certain notional
principal contracts under section 863(a).

(a) Scope--(1) Introduction. * * * This section does not apply to
income from a section 988 transaction (as defined in section 988(c)
and �1.988-1(a)), or to income from a global dealing operation (as
defined in �1.482-8(a)(2)(i)) that is sourced under the rules of
�1.863-3(h). * * *

* * * * *

Par. 9. Section 1.864-4 is amended as follows:

1. Paragraphs (c)(2)(iv), (c)(2)(v), (c)(3)(ii), and (c)(5)(vi)(a)
and (b) are redesignated as (c)(2)(v), (c)(2)(vi), (c)(3)(iii), and
(c)(5)(vi)(b) and (c), respectively.

2. New paragraphs (c)(2)(iv), (c)(3)(ii), and (c)(5)(vi)(a) are
added.

The additions read as follows:

�1.864-4 U.S. source income effectively connected with U.S.
business.

* * * * *

(c) * * *

(2) * * *

(iv) Special rule relating to a global dealing operation.

An asset used in a global dealing operation, as defined in
�1.482-8(a)(2)(i), will be treated as an asset used in a U.S. trade
or business only if and to the extent that the U.S. trade or
business is a participant in the global dealing operation under
�1.863-3(h)(3), and income, gain or loss produced by the asset is
U.S. source under �1.863-3(h) or would be treated as U.S. source if
�1.863-3(h) were to apply to such amounts.

* * * * *

(3) * * *

(ii) Special rule relating to a global dealing operation. A U.S.
trade or business shall be treated as a material factor in the
realization of income, gain or loss derived in a global dealing
operation, as defined in �1.482-8(a)(2)(i), only if and to the
extent that the U.S. trade or business is a participant in the
global dealing operation under �1.863-3(h)(3), and income, gain or
loss realized by the U.S. trade or business is U.S. source under
�1.863-3(h) or would be treated as U.S. source if �1.863-3(h) were
to apply to such amounts.

* * * * *

(5) * * *

(vi) * * *

(a) Certain income earned by a global dealing operation.

Notwithstanding paragraph (c)(5)(ii) of this section, U.S. source
interest, including substitute interest as defined in �1.861- 2(a)
(7), and dividend income, including substitute dividends as defined
in �1.861-3(a)(6), derived by a participant in a global dealing
operation, as defined in �1.482-8(a)(2)(i), shall be treated as
attributable to the foreign corporation's U.S. trade or business,
only if and to the extent that the income would be treated as U.S.
source if �1.863-3(h) were to apply to such amounts.

Par. 10. Section 1.864-6 is amended as follows:

1. Paragraph (b)(2)(ii)(d)(3) and (b)(3)(ii)(c) are added.

2. Paragraph (b)(3)(i) is revised by adding a new sentence after the
last sentence.

The additions and revision read as follows:

�1.864-6 Income, gain or loss attributable to an office or other
fixed place of business in the United States.

* * * * *

(b) * * *

(2) * * *

(ii) * * *

(d) * * *

(3) Certain income earned by a global dealing operation.

Notwithstanding paragraphs (b)(2)(ii)(a) or (b) of this section,
foreign source interest, including substitute interest as defined in
�1.861-2(a)(7), or dividend income, including substitute dividends
as defined in �1.861-3(a)(6), derived by a participant in a global
dealing operation, as defined in �1.482-8(a)(2)(i) shall be treated
as attributable to the foreign corporation's U.S. trade or business
only if and to the extent that the income would be treated as U.S.
source if �1.863-3(h) were to apply to such amounts. * * *

(3) * * *

(i) * * * Notwithstanding paragraphs (b)(3)(i)(1) and (2) of this
section, an office or other fixed place of business of a nonresident
alien individual or a foreign corporation which is located in the
United States and which is a participant in a global dealing
operation, as defined in �1.482-8(a)(2)(i), shall be considered to
be a material factor in the realization of foreign source income,
gain or loss, only if and to the extent that such income, gain or
loss would be treated as U.S. source if �1.863-3(h) were to apply to
such amounts.

(ii) * * *

(c) Property sales in a global dealing operation.

Notwithstanding paragraphs (b)(3)(ii)(a) or (b) of this section,
personal property described in section 1221(1) and sold in the
active conduct of a taxpayer's global dealing operation, as defined
in �1.482-8(a)(2)(i), shall be presumed to have been sold for use,
consumption, or disposition outside of the United States only if and
to the extent that the income, gain or loss to which the sale gives
rise would be sourced outside of the United States if �1.863-3(h)
were to apply to such amounts.

Par. 11. Section 1.894-1 is amended as follows:

1. Paragraph (d) is redesignated as paragraph (e).

2. New paragraph (d) is added.

The addition reads as follows:

�1.894-1 Income affected by treaty.

* * * * *

(d) Income from a global dealing operation. If a taxpayer that is
engaged in a global dealing operation, as defined in �1.482-8(a)(2)
(i), has a permanent establishment in the United States under the
principles of an applicable U.S. income tax treaty, the principles
of �1.863-3(h), �1.864-4(c)(2)(iv), �1.864-4(c)(3)(ii), �1.864-4(c)
(5)(vi)(a) or �1.864- 6(b)(2)(ii)(d)(3) shall apply for purposes of
determining the income attributable to that U.S. permanent
establishment.

* * * * *

Par. 12. Section 1.988-4 is amended as follows:

1. Paragraph (h) is redesignated as paragraph (i).

2. A new paragraph (h) is added.

The addition and revision read as follows:

�1.988-4 Source of gain or loss realized on a section 988 transfer.

* * * * *

(h) Exchange gain or loss from a global dealing operation.

Notwithstanding the provisions of this section, exchange gain or
loss derived by a participant in a global dealing operation, as
defined in �1.482-8(a)(2)(i), shall be sourced under the rules set
forth in �1.863-3(h).

* * * * *

Deputy Commissioner of Internal Revenue

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