[Code of Federal Regulations]
[Title 26, Volume 6]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.483-4]

[Page 665-666]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.483-4  Contingent payments.

    (a) In general. This section applies to a contract for the sale or 
exchange of property (the overall contract) if the contract provides for 
one or more contingent payments and the contract is subject to section 
483. This section applies even if the contract provides for adequate 
stated interest under Sec. 1.483-2. If this section applies to a 
contract, interest under the contract is generally computed and 
accounted for using rules similar to those that would apply if the 
contract were a debt instrument subject to Sec. 1.1275-4(c). 
Consequently, all noncontingent payments under the overall contract are 
treated as if made under a separate contract, and interest accruals on 
this separate contract are computed under rules similar to those 
contained in Sec. 1.1275-4(c)(3). Each contingent payment under the 
overall contract is characterized as principal and interest under rules 
similar to those contained in Sec. 1.1275-4(c)(4). However,

[[Page 666]]

any interest, or amount treated as interest, on a contract subject to 
this section is taken into account by a taxpayer under the taxpayer's 
regular method of accounting (e.g., an accrual method or the cash 
receipts and disbursements method).
    (b) Examples. The following examples illustrate the provisions of 
paragraph (a) of this section:

    Example 1. Deferred payment sale with contingent interest--(i) 
Facts. On December 31, 1996, A sells depreciable personal property to B. 
As consideration for the sale, B issues to A a debt instrument with a 
maturity date of December 31, 2001. The debt instrument provides for a 
principal payment of $200,000 on the maturity date, and a payment of 
interest on December 31 of each year, beginning in 1997, equal to a 
percentage of the total gross income derived from the property in that 
year. However, the total interest payable on the debt instrument over 
its entire term is limited to a maximum of $50,000. Assume that on 
December 31, 1996, the short-term applicable Federal rate is 4 percent, 
compounded annually, and the mid-term applicable Federal rate is 5 
percent, compounded annually.
    (ii) Treatment of noncontingent payment as separate contract. Each 
payment of interest is a contingent payment. Accordingly, under 
paragraph (a) of this section, for purposes of applying section 483 to 
the debt instrument, the right to the noncontingent payment of $200,000 
is treated as a separate contract. The amount of unstated interest on 
this separate contract is equal to $43,295, which is the amount by which 
the payment ($200,000) exceeds the present value of the payment 
($156,705), calculated using the test rate of 5 percent, compounded 
annually. The $200,000 payment is thus treated as consisting of a 
payment of interest of $43,295 and a payment of principal of $156,705. 
The interest is includible in A's gross income, and deductible by B, 
under their respective methods of accounting.
    (iii) Treatment of contingent payments. Assume that the amount of 
the contingent payment that is paid on December 31, 1997, is $20,000. 
Under paragraph (a) of this section, the $20,000 payment is treated as a 
payment of principal of $19,231 (the present value, as of the date of 
sale, of the $20,000 payment, calculated using a test rate equal to 4 
percent, compounded annually) and a payment of interest of $769. The 
$769 interest payment is includible in A's gross income, and deductible 
by B, in their respective taxable years in which the payment occurs. The 
amount treated as principal gives B additional basis in the property on 
December 31, 1997. The remaining contingent payments on the debt 
instrument are accounted for similarly, using a test rate of 4 percent, 
compounded annually, for the payments made on December 31, 1998, and 
December 31, 1999, and a test rate of 5 percent, compounded annually, 
for the payments made on December 31, 2000, and December 31, 2001.
    Example 2. Contingent stock payout--(i) Facts. M Corporation and N 
Corporation each owns one-half of the stock of O Corporation. On 
December 31, 1996, pursuant to a reorganization qualifying under section 
368(a)(1)(B), M acquires the one-half interest of O held by N in 
exchange for 30,000 shares of M voting stock and a non-assignable right 
to receive up to 10,000 additional shares of M's voting stock during the 
next 3 years, provided the net profits of O exceed certain amounts 
specified in the contract. No interest is provided for in the contract. 
No additional shares are received in 1997 or in 1998. In 1999, the 
annual earnings of O exceed the specified amount, and, on December 31, 
1999, an additional 3,000 M voting shares are transferred to N. The fair 
market value of the 3,000 shares on December 31, 1999, is $300,000. 
Assume that on December 31, 1996, the short-term applicable Federal rate 
is 4 percent, compounded annually. M and N are calendar year taxpayers.
    (ii) Allocation of interest. Section 1274 does not apply to the 
right to receive the additional shares because the right is not a debt 
instrument for federal income tax purposes. As a result, the transfer of 
the 3,000 M voting shares to N is a deferred payment subject to section 
483 and a portion of the shares is treated as unstated interest under 
that section. The amount of interest allocable to the shares is equal to 
the excess of $300,000 (the fair market value of the shares on December 
31, 1999) over $266,699 (the present value of $300,000, determined by 
discounting the payment at the test rate of 4 percent, compounded 
annually, from December 31, 1999, to December 31, 1996). As a result, 
the amount of interest allocable to the payment of the shares is $33,301 
($300,000-$266,699). Both M and N take the interest into account in 
1999.

    (c) Effective date. This section applies to sales and exchanges that 
occur on or after August 13, 1996.

[T.D. 8674, 61 FR 30138, June 14, 1996]

 regulations applicable for taxable years beginning on or before april 
                                21, 1993