[Federal Register Volume 64, Number 172 (Tuesday, September 7, 1999)]
[Rules and Regulations]
[Pages 48545-48547]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-23082]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 8838]
RIN 1545-AU45
Inflation-Indexed Debt Instruments
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the
federal income tax treatment of inflation-indexed debt instruments,
including Treasury Inflation-Indexed Securities. The regulations in
this document provide needed guidance to holders and issuers of
inflation-indexed debt instruments.
EFFECTIVE DATE: The regulations are effective September 7, 1999.
FOR FURTHER INFORMATION CONTACT: Helen Vanek-Bigelow or William E.
Blanchard, (202) 622-3950 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On January 6, 1997, temporary regulations (TD 8709 [1997-1 C.B.
167]) relating to the federal income tax treatment of inflation-indexed
debt instruments under sections 1275 and 1286 of the Internal Revenue
Code (Code) were published in the Federal Register (62 FR 615). A
notice of proposed rulemaking (REG-242996-96 [1997-1 C.B. 784]) cross-
referencing the temporary regulations was published in the Federal
Register for the same day (62 FR 694). A public hearing was held on
April 30, 1997. However, no one requested to speak at the hearing.
No written comments responding to the notice were received.
Therefore, the proposed regulations under sections 1275 and 1286 are
adopted by this Treasury decision with no changes, and the
corresponding temporary regulations are redesignated as final
regulations.
Explanation of Provisions
The following is a general explanation of the provisions in the
final regulations, which are the same as the provisions in the
temporary regulations.
A. In General
The final regulations provide rules for the treatment of certain
debt instruments that are indexed for inflation and deflation,
including Treasury Inflation-Indexed Securities. The final regulations
generally require holders and issuers of inflation-indexed debt
instruments to account for interest and original issue discount (OID)
using constant yield principles. In addition, the final regulations
generally require holders and issuers of inflation-indexed debt
instruments to account for inflation and deflation by making current
adjustments to their OID accruals.
B. Applicability
The final regulations apply to inflation-indexed debt instruments.
In general, an inflation-indexed debt instrument is a debt instrument
that (1) is issued for cash, (2) is indexed for inflation and deflation
(as described below), and (3) is not otherwise a contingent payment
debt instrument. The final regulations do not apply, however, to
certain debt instruments, such as debt instruments issued by qualified
state tuition programs.
C. Indexing Methodology
A debt instrument is considered indexed for inflation and deflation
if the payments on the instrument are indexed by reference to the
changes in the values of a general price or wage index over the term of
the instrument. Specifically, the amount of each payment on an
inflation-indexed debt instrument must equal the product of (1) the
amount of the payment that would be payable on the instrument
(determined as if there were no inflation or deflation over the term of
the instrument) and (2) the ratio of the value of the reference index
for the payment date to the value of the reference index for the issue
date.
The reference index for a debt instrument is the mechanism for
measuring inflation and deflation over the term of the instrument. This
mechanism associates the value of a single qualified inflation index
for a particular month with a specified day of a succeeding month. For
example, under the terms of the Treasury Inflation-Indexed Securities,
the reference index for the first day of a month is the value of a
qualified inflation index for the third preceding month. The reference
index must be reset once a month to the current value of a qualified
inflation index. Between reset dates, the value of the reference index
is determined through straight-line interpolation.
A qualified inflation index is a general price or wage index that
is updated and published at least monthly by an agency of the United
States Government. A general price or wage index is an index that
measures price or wage changes in the economy as a whole. An index is
not general if it only
[[Page 48546]]
measures price or wage changes in a particular segment of the economy.
For example, the non-seasonally adjusted U.S. City Average All Items
Consumer Price Index for All Urban Consumers (CPI-U), which is
published by the Bureau of Labor Statistics of the Department of Labor,
is a qualified inflation index because it measures general price
changes in the economy. By contrast, the gasoline price component of
the CPI-U is not a qualified inflation index because it only measures
price changes in a particular segment of the economy.
D. Coupon Bond Method
The final regulations provide a simplified method of accounting for
qualified stated interest and inflation adjustments on certain
inflation-indexed debt instruments (the coupon bond method). To qualify
for the coupon bond method, an inflation-indexed debt instrument must
satisfy two conditions. First, there must be no more than a de minimis
difference between the debt instrument's issue price and its principal
amount for the issue date. Second, all stated interest on the debt
instrument must be qualified stated interest. Because Treasury
Inflation-Indexed Securities that are not stripped into principal and
interest components satisfy both of these conditions, the coupon bond
method applies to these securities.
If an inflation-indexed debt instrument qualifies for the coupon
bond method, the stated interest payable on the debt instrument is
taken into account under the taxpayer's regular method of accounting.
Any increase in the inflation-adjusted principal amount is treated as
OID for the period in which the increase occurs. Any decrease in the
inflation-adjusted principal amount is taken into account under the
rules for deflation adjustments described below.
For example, if a taxpayer holds a Treasury Inflation-Indexed
Security for an entire calendar year and the taxpayer uses the cash
receipts and disbursements method of accounting (cash method), the
taxpayer generally includes in income the interest payments received on
the security during the year. In addition, the taxpayer includes in
income an amount of OID measured by subtracting the inflation-adjusted
principal amount of the security at the beginning of the year from the
inflation-adjusted principal amount of the security at the end of the
year. If the taxpayer uses an accrual method of accounting rather than
the cash method, the taxpayer includes in income the qualified stated
interest that accrued on the debt instrument during the year and an
amount of OID measured by subtracting the inflation-adjusted principal
amount of the security at the beginning of the year from the inflation-
adjusted principal amount of the security at the end of the year.
E. Discount Bond Method
If an inflation-indexed debt instrument does not qualify for the
coupon bond method (for example, because it is issued at a discount),
the instrument is subject to the discount bond method. In general, the
discount bond method requires holders and issuers to make current
adjustments to their OID accruals to account for inflation and
deflation.
Under the discount bond method, a taxpayer determines the amount of
OID allocable to an accrual period by using steps similar to those
provided in Sec. 1.1272-1(b)(1). First, the taxpayer determines the
yield to maturity of the debt instrument as if there were no inflation
or deflation over the term of the instrument. Second, the taxpayer
determines the length of the accrual periods to be used to allocate OID
over the term of the debt instrument, provided no accrual period is
longer than one month. Third, the taxpayer determines the percentage
change in the value of the reference index during the accrual period by
comparing the value at the beginning of the period to the value at the
end of the period. Fourth, the taxpayer determines the OID allocable to
the accrual period by using a formula that takes into account both the
yield of the debt instrument and the percentage change in the value of
the reference index during the period. Fifth, the taxpayer allocates to
each day in the accrual period a ratable portion of the OID for the
accrual period (the daily portions). If the daily portions for an
accrual period are positive amounts, these amounts are taken into
account under section 163(e) by an issuer and under section 1272 by a
holder. If the daily portions for an accrual period are negative
amounts, these amounts are taken into account under the rules for
deflation adjustments described below.
F. Deflation Adjustments
The final regulations treat deflation adjustments in a manner
consistent with the treatment of net negative adjustments on contingent
payment debt instruments under Sec. 1.1275-4(b)(6)(iii). If a holder
has a deflation adjustment for a taxable year, the deflation adjustment
first reduces the amount of interest otherwise includible in income
with respect to the debt instrument for the taxable year. If the amount
of the deflation adjustment exceeds the interest otherwise includible
in income for the taxable year, the holder treats the excess as an
ordinary loss in the taxable year. However, the amount treated as an
ordinary loss is limited to the amount by which the holder's total
interest inclusions on the debt instrument in prior taxable years
exceed the total amount treated by the holder as an ordinary loss on
the debt instrument in prior taxable years. If the deflation adjustment
exceeds the interest otherwise includible in income by the holder with
respect to the debt instrument for the taxable year and the amount
treated as an ordinary loss for the taxable year, the excess is carried
forward to offset interest income on the debt instrument in subsequent
taxable years. Similar rules apply to determine an issuer's interest
deductions and income for the debt instrument.
G. Miscellaneous Rules
The final regulations provide special rules for reopenings, strips,
subsequent holders, and minimum guarantees.
H. Effective Date
The final regulations apply to an inflation-indexed debt instrument
issued on or after January 6, 1997.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has been
determined that section 553(b) of the Administrative Procedure Act (5
U.S.C. chapter 5) does not apply to these regulations and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, the notice of proposed
rulemaking preceding these regulations was submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting information. The principal author of the regulations is
Helen Vanek-Bigelow, Office of Assistant Chief Counsel (Financial
Institutions and 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.
[[Page 48547]]
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by
removing the entries for Secs. 1.1275-7T and 1.1286-2T and adding two
entries in numerical order to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.1275-7 also issued under 26 U.S.C. 1275(d). * * *
Section 1.1286-2 also issued under 26 U.S.C. 1286(f). * * *
Sec. 1.148-4 [Amended]
Par. 2. Section 1.148-4 is amended by:
1. Removing the ``T'' from the reference ``Sec. 1.1275-7T'' in
paragraph (h)(2)(v)(A).
2. Removing the ``T'' from the reference ``Sec. 1.1275-7T'' in
paragraph (h)(2)(v)(B).
Sec. 1.163-13 [Amended]
Par. 3. Section 1.163-13 is amended by:
1. Removing the ``T'' from the reference ``Sec. 1.1275-
7T(f)(1)(ii)'' in the next to the last sentence in paragraph (e)(2).
2. Removing the ``T'' from the reference ``Sec. 1.1275-7T'' in the
last sentence in paragraph (e)(2).
Sec. 1.171-3 [Amended]
Par. 4. Section 1.171-3 is amended by:
1. Removing the ``T'' from the reference ``Sec. 1.1275-
7T(f)(1)(i)'' in the next to last sentence in paragraph (b).
2. Removing the ``T'' from the reference ``Sec. 1.1275-7T'' in the
last sentence in paragraph (b).
Par. 5. In Sec. 1.1271-0, paragraph (b) is amended by revising the
entry for Sec. 1.1275-7T to read as follows:
Sec. 1.1271-0 Original issue discount; effective date; table of
contents.
* * * * *
(b) * * *
* * * * *
Sec. 1.1275-7 Inflation-indexed debt instruments.
* * * * *
Sec. 1.1275-4 [Amended]
Par. 6. Section 1.1275-4 is amended by removing the ``T'' from the
reference ``Sec. 1.1275-7T'' in paragraph (a)(2)(vii).
Sec. 1.1275-7T [Redesignated as Sec. 1.1275-7]
Par. 7. Section 1.1275-7T is redesignated as Sec. 1.1275-7 and the
language ``(temporary)'' is removed from the section heading.
Sec. 1.1286-2T [Redesignated as Sec. 1.1286-2]
Par. 8. Section 1.1286-2T is redesignated as Sec. 1.1286-2 and the
language ``(temporary)'' is removed from the section heading.
Par. 9. Newly designated Sec. 1.1286-2 is amended by removing the
``T'' from the reference ``Sec. 1.1275-7T(e)''.
Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
Approved: August 25, 1999.
Jonathan Talisman,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 99-23082 Filed 9-3-99; 8:45 am]
BILLING CODE 4830-01-P
