[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.163-12]

[Page 876-878]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.163-12  Deduction of original issue discount on instrument held 
by related foreign person.

    (a) General rules--(1) Deferral of deduction. Except as provided in 
paragraph (b) of this section, section 163(e)(3) requires a taxpayer to 
use the cash method of accounting with respect to the deduction of 
original issue discount owed to a related foreign person. A deduction 
for an otherwise deductible portion of original issue discount with 
respect to a debt instrument will not be allowable as a deduction to the 
issuer until paid if, at the close of the issuer's taxable year in which 
such amount would otherwise be deductible, the person holding the debt 
instrument is a related foreign person. For purposes of this section, a 
related foreign person is any person that is not a United States person 
within the meaning of section 7701(a)(30), and that is related (within 
the meaning of section 267(b)) to the issuer at the close of the taxable 
year in which the amount incurred by the taxpayer would otherwise be 
deductible. Section 267(f) defines ``controlled group'' for purposes of 
section 267(b) without regard to the limitations of section 1563(b). An 
amount is treated as paid for purposes of this section if the amount is 
considered paid for purposes of section 1441 or section 1442 (including 
an amount taken into account pursuant to section 871(a)(1)(C), section 
881(a)(3), or section 884(f)). The rules of this paragraph (a) apply 
even if the original issue discount is not subject to United States tax, 
or is subject to a reduced rate of tax, pursuant to a provision of the 
Internal Revenue Code or a treaty obligation of the United States. For 
purposes

[[Page 877]]

of this section, original issue discount is an amount described in 
section 1273, whether from sources inside or outside the United States.
    (2) Change in method of accounting. A taxpayer that uses a method of 
accounting other than that required by the rules of this section must 
change its method of accounting to conform its method to the rules of 
this section. The taxpayer's change in method must be made pursuant to 
the rules of section 446(e), the regulations thereunder, and any 
applicable administrative procedures prescribed by the Commissioner. 
Because the rules of this section prescribe a method of accounting, 
these rules apply in the determination of a taxpayer's earnings and 
profits pursuant to Sec. 1.312-6(a).
    (b) Exceptions and special rules--(1) Effectively connected income. 
The provisions of section 267(a)(2) and the regulations thereunder, and 
not the provisions of paragraph (a) of this section, apply to an amount 
of original issue discount that is income of the related foreign person 
that is effectively connected with the conduct of a United States trade 
or business of such related foreign person. An amount described in this 
paragraph (b)(1) thus is allowable as a deduction as of the day on which 
the amount is includible in the gross income of the related foreign 
person as effectively connected income under sections 872(a)(2) or 
882(b) (or, if later, as of the day on which the deduction would be so 
allowable but for section 267(a)(2)). However, this paragraph (b)(1) 
does not apply if the related foreign person is exempt from United 
States income tax on the amount owed, or is subject to a reduced rate of 
tax, pursuant to a treaty obligation of the United States (such as under 
an article relating to the taxation of business profits).
    (2) Certain obligations issued by natural persons. This section does 
not apply to any debt instrument described in section 163(e)(4) 
(relating to obligations issued by natural persons before March 2, 1984, 
and to loans between natural persons).
    (3) Amounts owed to a foreign personal holding company, controlled 
foreign corporation, or passive foreign investment company--(i) Foreign 
personal holding companies. If an amount to which paragraph (a) of this 
section otherwise applies is owed to a related foreign person that is a 
foreign personal holding company within the meaning of section 552, then 
the amount is allowable as a deduction as of the day on which the amount 
is includible in the income of the foreign personal holding company. The 
day on which the amount is includible in income is determined with 
reference to the method of accounting under which the foreign personal 
holding company computes its taxable income and earnings and profits for 
purposes of sections 551 through 558. See section 551(c) and the 
regulations thereunder for the reporting requirements of the foreign 
personal holding company provisions (sections 551 through 558).
    (ii) Controlled foreign corporations. If an amount to which 
paragraph (a) of this section otherwise applies is owed to a related 
foreign person that is a controlled foreign corporation within the 
meaning of section 957, then the amount is allowable as a deduction as 
of the day on which the amount is includible in the income of the 
controlled foreign corporation. The day on which the amount is 
includible in income is determined with reference to the method of 
accounting under which the controlled foreign corporation computes its 
taxable income and earnings and profits for purposes of sections 951 
through 964. See section 6038 and the regulations thereunder for the 
reporting requirements of the controlled foreign corporation provisions 
(sections 951 through 964).
    (iii) Passive foreign investment companies. If an amount to which 
paragraph (a) of this section otherwise applies is owed to a related 
foreign person that is a passive foreign investment company within the 
meaning of section 1296, then the amount is allowable as a deduction as 
of the day on which amount is includible in the income of the passive 
foreign investment company. The day on which the amount is includible in 
income is determined with reference to the method of accounting under 
which the earnings and profits of the passive foreign investment company 
are computed for purposes of sections 1291 through 1297. See sections 
1291

[[Page 878]]

through 1297 and the regulations thereunder for the reporting 
requirements of the passive foreign investment company provisions. This 
exception shall apply, however, only if the person that owes the amount 
at issue has made and has in effect an election pursuant to section 1295 
with respect to the passive foreign investment company to which the 
amount at issue is owed.
    (c) Application of section 267. Except as limited in paragraph 
(b)(1) of this section, the provisions of section 267 and the 
regulations thereunder shall apply to any amount of original issue 
discount to which the provisions of this section do not apply.
    (d) Effective date. The rules of this section are effective with 
respect to all original issue discount on debt instruments issued after 
June 9, 1984.

[T.D. 8465, 58 FR 236, Jan. 5, 1993; 58 FR 8098, Feb. 11, 1993]